Thursday, April 14, 2011

House Hearings on Risk Retention Proposal Reveal Concern over GSE Exemption and Scope of Qualified Residential Mortgage Carve Out

House hearings on the SEC-federal banking interagency proposal to implement the risk retention provisions of Dodd-Frank revealed significant concerns centering on an exemption for government-sponsored entities and 20 percent down payment to qualify for the qualified residential mortgage carve out from risk retention.

The hearings were held by the Capital Markets Subcommittee Chaired by Rep. Scott Garrett (R-NJ). Chairman Garrett noted that the proposals go directly against the legislative intent of Dodd-Frank by exempting government-sponsored entities. He admonished that the final rules should not exempt Fannie Mae and Freddie Mac. Echoing this concern, full Financial Services Committee Chair Spencer Bachus (R-AL) said that the proposed exemption of the GSEs is problematic and contrary to the intent of Dodd-Frank, and could create an unlevel playing field. Chairman Bachus specifically associated himself with testimony by Fed General Counsel Scott Alvarez that, unlike the various other types of risk retention, which all involve the acquisition of an asset by the sponsor, the GSEs' risk exposure is in the form of an unfunded guarantee, which would not satisfy the risk retention requirements of the proposed rules.

SEC Director of Corporation Finance Meredith Cross said that the SEC shares Chairman Garrett’s concern over the GSE exemption, but, looking at it from an investor protection perspective, the Commission is fine with the proposal’s approach, but remains concerned.

Patrick Lawler, Chief Economist at the Federal Housing Finance Agency, defended the proposal in that it does not exempt the enterprises from the risk retention requirements but allows the full guarantee of the credit risk by Fannie Mae and Freddie Mac on their single-family mortgage-backed securities to qualify as a permissible form of risk retention while they are in conservatorship with financial support from the U.S. Treasury. The 100 percent risk retention by the Enterprises on their guaranteed MBS is obviously the maximum possible, he noted, and far exceeds the five percent retention required by Section 941 of Dodd-Frank. But Chairman Garrett said that the problem Congress has with that explanation is that it is essentially saying that the GSEs are exempt from risk retention because of a taxpayer guarantee.

There is also great congressional concern over the proposal to condition a qualified residential mortgage on a 20 percent down payment. The residential mortgage carve out codified in Section 941directs the SEC and the federal banking agencies to define qualified residential mortgage by taking into consideration underwriting and product features that historical loan performance data indicate result in a lower risk of default.

Rep. Ruben Hinojosa (D-TX) submitted a letter into the record from a number of civil rights groups opposing the 20 percent down requirement. He said that the requirement would harm well-qualified buyers, and could subject minority and first-time home buyers to predatory lending.

Full Committee Ranking Member Barney Frank (D-MA) said that 20 percent is too high. Rep. Frank described this issue as the most important one before the Committee. Rep. Frank asked if the regulators would consider a lower percentage coupled with qualitative factors. He queried whether we have the regulatory capacity to enforce qualitative residential mortgage standards and thus do not have to have bright line standards. He asked regulators to respond in writing to that question. Fed GC Scott Alvarez said there may be a sense among regulators that they are not qualified to evaluate qualitative standards.

FHA Acting Commissioner Bob Ryan allowed that 20 percent may be too high. Julie Williams, OCC Chief Counsel, said that the issue involves market factors, trade-offs, and the balancing of complex issues. Mr. Lawler said that the regulators read Dodd-Frank to mean that, since qualified residential mortgages do not need risk retention, the standards must be high.

Corp Fin Director Cross described how the SEC’s pre-Dodd-Frank proposal on asset-backed securities will be harmonized post-Dodd-Frank. The April 2010 asset-backed securities proposals dealt with issues subsequently referenced in Dodd-Frank and others not addressed in Dodd-Frank. Proposals referenced in Dodd-Frank are those repealing the current credit rating references in shelf eligibility criteria for asset-backed issuers and establishing four new shelf eligibility criteria, including a requirement that the sponsor of a shelf-eligible offering retain five percent of the risk and an undertaking to continue reporting under the Exchange Act so long as non-affiliates of the depositor hold any securities that were sold in registered transactions backed by the same pool of assets.

The Commission also proposed requiring that prospectuses for public offerings of asset-backed securities and ongoing Exchange Act reports contain specified asset-level information about each of the assets in the pool. Proposals addressing issues not referenced in Dodd-Frank are one to revise filing deadlines for asset-backed securities offerings to provide investors with more time to consider transaction-specific information, including information about the pool assets. In addition, the Commission proposed requiring, along with the prospectus filing, the filing of a computer program of the cash flow waterfall provisions. Finally, the Commission proposed new information requirements for the safe harbors for exempt offerings and resales of asset-backed securities

The Director said that the staff is currently reviewing the comment letters received on these proposals and working to develop recommendations for the Commission that will harmonize these proposals with the regulatory revisions required under the Dodd-Frank Act.