Risk in Credits Has New Face in Proposed Financial Regulations

Jack Humphrey, Regulatory journalist
April 01, 2011 /

A new proposal in financial regulations presented by six federal agencies will revise existing rules on credit risk retention program.

The Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the U.S. Securities and Exchange Commission, the Federal Housing Finance Agency, and the Department of Housing and Urban Development moved to propose for at least 5pc retention of credit risks by sponsors of asset-backed securities (ABS).

The proposal will forbid ABS sponsors to transfer or hedge the credit risk.

Careful deliberation was taken when formulating the proposal so as to keep the value of the amount of credit risks retained and avoid any negative effect to consumers in terms of credit availability and costs.

Under the proposal, ABS sponsors may choose to retain credit risk by holding at least 5pc of each class of ABS, also known as vertical retention. They may also retain first-loss residual interest with amount equal to vertical retention.

In either way, sponsors are required to meet the proposed financial regulations as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The proposal describes loans exempted from the new financial regulations such as the ABS of which only collateral is residential mortgage that qualifies as “qualified residential mortgages”.

Part of the requirements is a retained-interest disclosure from investors regarding their securitization transaction material information, which will be used by investors and the six federal agencies to monitor risk retention compliance among sponsors.

For securities collateralized by commercial loans, commercial mortgages, or automobile loans, the proposal allows for zero percent risk-retention since this kind of collateral meets specific underwriting standards that ensure low credit risk in loans backing the ABS.

The 100 percent guarantee of principal and interest provided by Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Mortgage Loan Corporation) are recognized by the new financial regulations to meet risk retention requirements as long as ABS sponsors are in conservatorship or receivership with capital support from the U.S. government.

Public comments are welcome until June 10, 2011.


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