The Dodd- Frank Bill has laid out a pathway for future operations in the financial services arena.  However, the road has not yet been paved.  The job of laying the pavement has been left to individual industry regulators who have 270 days from the date of passage to develop, write, publish, submit for comment and issue as final the regulation which will govern our business for the foreseeable future.

This guidance giving, as opposed to concrete rulemaking, has created confusion in interpreting new risk retention rules. For instance it is believed that new risk retention regulations will not affect GSE loans. One should read carefully Section 941:  “Regulation of Credit Risk Retention” in the Dodd-Frank bill (PAGE 516). It is the cornerstone of the financial foundation for mortgage bankers and will be the threshold for determining the quality of originations in the future.

From the MBA' summary:

Section 941 "Requires federal banking agencies and SEC to jointly prescribe rules requiring securitizers to retain economic interest of at least five percent of credit risk of assets they securitize. Regulations must include separate requirements for different asset classes, and may allocate the retention amount between originator and securitizer. HUD and the Federal Housing Finance Agency must participate in joint rulemaking process for residential mortgage backed securities (MBS) risk retention requirements"

Confusion arises when exemptions to this rule are discussed. The text of the legislation states that the GSEs do not fall under the government insured/issued exemption umbrella:

‘‘(3) CERTAIN INSTITUTIONS AND PROGRAMS EXEMPT.—

‘‘(A) FARM CREDIT SYSTEM INSTITUTIONS.—Notwithstanding any other provision of this section, the requirements of this section shall not apply to any loan or other financial asset made, insured, guaranteed, or purchased by any institution that is subject to the supervision of the Farm Credit Administration, including the Federal Agricultural Mortgage Corporation.

‘‘(B) OTHER FEDERAL PROGRAMS.—This section shall not apply to any residential, multifamily, or health care facility mortgage loan asset, or securitization based directly or indirectly on such an asset, which is insured or guaranteed
by the United States or an agency of the United States. For purposes of this subsection, the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Federal home loan banks shall not be considered an agency of the United States.

That doesn't mean high-quality GSE loan paper won't fall under the exemption umbrella though, that is up to regulators to decide.

‘‘(4) EXEMPTION FOR QUALIFIED RESIDENTIAL MORTGAGES.—

‘‘(A) IN GENERAL.—The Federal banking agencies, the Commission, the Secretary of Housing and Urban Development, and the Director of the Federal Housing Finance Agency shall jointly issue regulations to exempt qualified residential mortgages from the risk retention requirements of this subsection.

‘‘(B) QUALIFIED RESIDENTIAL MORTGAGE.—The Federal banking agencies, the Commission, the Secretary of Housing and Urban Development, and the Director of the Federal Housing Finance Agency shall jointly define the term ‘qualified residential mortgage’ for purposes of this subsection, taking into consideration underwriting and product features that historical loan performance data indicate result in a lower risk of default, such as—

‘‘(i) documentation and verification of the financial resources relied upon to qualify the mortgagor;

‘‘(ii) standards with respect to—

‘‘(I) the residual income of the mortgagor after all monthly obligations;
‘‘(II) the ratio of the housing payments of the mortgagor to the monthly income of the mortgagor;
‘‘(III) the ratio of total monthly installment payments of the mortgagor to the income of the mortgagor;

‘‘(iii) mitigating the potential for payment shock on adjustable rate mortgages through product features and underwriting standards;

‘‘(iv) mortgage guarantee insurance or other types of insurance or credit enhancement obtained at the time of origination, to the extent such insurance or credit enhancement reduces the risk of default; and

‘‘(v) prohibiting or restricting the use of balloon payments, negative amortization, prepayment penalties, interest-only payments, and other features that have been demonstrated to exhibit a higher risk of borrower default.

The current product offering of the GSEs fits that description but we still don't know how regulators will implement these new “Risk Retention” requirements and the GSEs have already been ruled out of exemption status. The first shoe has already dropped though....

Regardless of their "Qualified Exemption", Ginnie Mae has preemptively established new net-worth requirements for all Ginnie Mae issuers to mirror the requirements of depository capital requirements. Now for the first time non-depository issuers will have the same capital requirements as depository institutions.  The problem is this comes at a time when the economy is in turmoil and the future is at best murky, making it hard for non-depository institutions to raise need funds to stay in compliance on new risk retention regs.

Released by Ginnie Mae on August 10, 2010:

There’s no question that the financial landscape over the past few years has produced uncertainty and new risks,” said Theodore Tozer, Ginnie Mae president. “To ensure that we continue to run a conservative and sound program, Ginnie Mae will soon raise its net worth requirements, implement institution-wide capital ratio requirements, and establish a liquid asset requirement for all Single-Family Issuers.” Mr. Tozer also announced that the changes are expected to take place in September.

Net worth requirements are core tools used by regulators, lenders, insurers, and others to manage counterparty risk. The policy changes announced today will include the following:

Increased net worth requirements of $2.5 million plus one percent for mortgage-backed securities (MBS) outstanding principal balance between $5 and $20 million and 0.2 percent above $20 million will be phased in for all current Single-Family Issuers. All new Issuers will be required to hold this amount before they are allowed entry into the Ginnie Mae program. This new requirement is designed to ensure Issuers have a greater capital cushion to absorb losses. Ginnie Mae last announced increased net worth requirements for Single-Family Issuers from $250,000 to $1 million in September 2008.

Institution-wide capital requirements, designed to match those of institutions considered to be “well-capitalized” by bank and thrift regulatory agencies and other government-sponsored agencies, will also be established. These capital requirements capture the risk of an Issuer’s total book of business and will further enhance Ginnie Mae’s risk position. These requirements are as follows:

  • Total risk-based capital of at least ten percent
  • Tier 1 risk-based capital of at least six percent
  • Tier 1 leverage capital ratio of at least five percent
  • Non-depository institutions will be required to hold equity capital of six percent of total assets

Similar verbiage was outlined in Section 915 of the Dodd-Frank bill indicating new regulations apply to originators regardless of whether the shop is an depository institution or a non-depository institution, so independent mortgage bankers will be expected to meet whatever risk retention regs are released by regulators.

Whenever you are faced with doing business in a muddled environment you have two choices; retreat and hold until everything is clear or move forward by improving your process, preparing for the most draconian measures and seizing the opportunity to capitalize on the confusion.