U.S. regulators define "safe" home loan

By Dave Clarke

WASHINGTON (Reuters) – U.S. banks would have to demand at least a 20 percent down payment on a mortgage if they wanted to later sell the entire loan to investors, under a proposal that regulators endorsed on Tuesday.

The Federal Deposit Insurance Corp board and the Federal Reserve agreed to seek public comment on the plan that is intended to restore lending discipline and define the safest form of mortgages that can be completely resold to other investors.

However, the rule is expected to have little near-term impact on the housing and securitization markets because investors are not yet eager to buy repackaged mortgages.

Also, the rule would not include loans sold to mortgage finance giants Fannie Mae and Freddie Mac, which stand behind about 90 percent of home mortgages.

“Eventually — and I say that in all caps — the market will come back… This paves the road for when the market recovers,” said Marty Mosby, a bank analyst with Guggenheim Securities.

Last year’s Dodd-Frank financial law requires firms that package loans into securities — a practice known as securitization — to keep at least 5 percent of the credit risk on their books.

The Group of 20 leading countries have agreed to force banks to retain some of the securitized products they sell. Both the EU and the United States have put forth rules mandating 5 percent retention.

The provision is meant to force securitizes to have “skin in the game,” so they don’t churn out poorly underwritten loans and then pass along the risk to investors, as happened during the 2007-2009 financial crisis.

Mortgages that meet strict underwriting standards, known as qualified residential mortgages (QRMs), are exempt from the risk requirement.

Mortgages sold to Fannie and Freddie also would not be subject to the risk retention requirement, at least while the mortgage finance giants remain controlled by the government, because they guarantee the loans they sell to investors.

There is broad agreement in Washington that the government’s role in the housing market should be reduced, but little agreement on how to do that and by how much.

“The zero risk retention requirement for loans sold to Fannie and Freddie really knock the teeth out of this proposal,” said Jaret Seiberg, an analyst at MF Global Inc. “It means that 97% of the mortgage market will be outside the risk retention regime.”

Other tests for QRMs include that a borrower’s monthly housing costs should not exceed 28 percent of their gross income and monthly debts should not exceed 36 percent of gross income.

Auto, commercial and commercial real estate loans could also be exempted from the risk retention requirement if they meet strict underwriting standards.

DOWN PAYMENT TOO HIGH?

The proposal includes more than 170 issues that regulators are seeking feedback on from stakeholders, indicating the rule could change significantly before it is finalized.

The Securities and Exchange Commission will consider the proposal on Wednesday and all the of the agencies involved have said they will vote on it this week. The proposal will be out for public comment for 60 days.

Consumer groups, some mortgage lenders and financial services groups have complained that a 20 percent down payment is too high and will make it difficult for many people to purchase a home, causing a further drag on the struggling U.S. housing market.

FDIC Chairman Sheila Bair said on Tuesday that the agency is particularly interested in what impact the rule may have on low-income borrowers. An alternative posed by regulators is for 10 percent down with mortgage insurance.

Bair played down the likely impact. “This does not mean that under the rule, all home buyers would have to meet these high standards to qualify for a mortgage,” she said.

Another complaint regulators are facing is that the proposal is so strict that it will do little to revive the private securitization market.

Restarting securitizations is seen as key to economic growth since the $11 trillion market relies on investors to take on risk and free lenders to lend again.

Only two significant so-called private-label mortgage bonds have surfaced over the last two years, both from Redwood Trust, a California-based REIT.

The strict QRM requirements and exemptions for mortgages guaranteed by Freddie and Fannie “will further prolong the U.S. government’s 95% market share of the credit risk of newly originated mortgages,” said Tom Deutsch, executive director of the American Securitization Forum.

LIVING WILLS

The FDIC board also proposed a rule written with the Federal Reserve that lays out the requirement for living wills large banks and financial firms will to write — another Dodd-Frank measure.

The wills are meant to tell regulators how to shut down an institution on the brink of collapse in an orderly way, averting the need for bailouts or bankruptcies.

Large financial institutions would have to submit a resolution plan to regulators six months after the rule goes into effect and would have to update it at least once a year.

Big financial firms would also have to give regulators a “Credit Exposure Report” every quarter.

This rule will also be out for 60 days of comment.

(Reporting by Dave Clarke, with additional reporting by Corbett Daly in Washington, Adam Tempkin and Al Yoon in New York and Joe Rauch in Charlotte; Editing by Tim Dobbyn)

U.S. regulators define "safe" home loan