QRM: Risk Retention and the Mortgage Market
October 30, 2014
QRM: Risk Retention and the Mortgage Market
In October 2014, federal regulators issued a final rule
which mortgages were originated with the intention of
implementing the credit risk retention (CRR) requirement
securitizing them and selling the MBS to investors. Because
of Section 941 of the Dodd-Frank Act (DFA). The CRR
those involved in the securitization process sold the credit
rule applies to many different types of asset-backed
risk to other investors, the argument goes, the securitizer
securities (ABS), including ABS backed by student loans,
did not have sufficient incentive to ensure that the
auto loans, credit card receivables, and other asset classes.
underlying mortgages in the MBS were made to borrowers
This In Focus, however, focuses on the elements of the rule
who would repay. Some argue that this led to a loosening of
related to the residential mortgage market.
underwriting standards for mortgages. By requiring a
securitizer to retain some of the credit risk (have some “skin
Risk Retention
in the game”), the securitizer may have more incentive to
What Is Securitization? Securitization is the process in
monitor the quality of the underlying assets. Others,
which an institution acquires and pools assets that have a
however, question the extent to which the OTD model
stream of payments and issues securities to investors. The
contributed to the financial crisis, arguing that securitizers
streams of payments of the assets are forwarded to the
often retained risk in their deals for their own business
investors who purchase the securities. The assets that are
purposes.
the source of the underlying payments are said to
collateralize the security, thus making it an asset-backed
security. In the case of a mortgage-backed security (MBS),
“Congress intended the risk retention requirements...
the assets that are pooled together are mortgages. The
to help address problems in the securitization markets
institution that organizes and initiates the securitization
by requiring that securitizers, as a general matter,
transaction is the sponsor of the securitization. The sponsor
retain an economic interest in the credit risk of the
could be a bank or a nonbank, and the CRR rule applies to
assets they securitize.” — Preamble to the CRR Rule
both.
Qualified Residential Mortgage
What Is Credit Risk? Credit risk is the risk that a
What Is a QRM? Section 941 of the DFA provided the
borrower will not repay its debt as required. In the case of a
regulators with some discretion in coming up with a
MBS, if homeowners do not make their monthly mortgage
definition for QRM. It directed the regulators to take “into
payments, less money would be paid to investors who
consideration underwriting and product features that
purchased the MBS that is collateralized by those
historical loan performance data indicate result in a lower
mortgages.
risk of default.” Section 941 also directed the regulators to
make the QRM definition “no broader” than the definition
What Is the Credit Risk Retention Rule? Under the CRR
for a qualified mortgage (QM). In the CRR Rule, the
rule, the sponsor of a securitization is required to retain at
regulators decided to align the definition for QRM with the
least 5% of the credit risk of the assets that comprise the
definition of QM, meaning that a mortgage is a QRM if it
ABS. The sponsor, with a few exceptions, is not allowed to
meets the definition for QM. The definition of QRM is
hedge or transfer the credit risk that it is required to retain.
significant because, as mentioned before, if all the assets in
The requirement to retain risk expires after several years,
a MBS are QRM, the sponsor of the securitization is
depending on the type of assets collateralizing the ABS. In
exempt from retaining the credit risk.
some cases, if the assets that collateralize the ABS meet
certain requirements indicating a low credit risk, the
What Is a QM? Title XIV of the DFA established the
sponsor may be allowed to retain less than 5% of the credit
ability-to-repay (ATR) requirement and instructed the
risk. In the case of mortgages, if all the mortgages
Consumer Financial Protection Bureau (CFPB) to establish
collateralizing a MBS are qualified residential mortgages
the definition for QM as part of its implementation. The
(QRMs), then the sponsor does not have to retain any of the
ATR rule requires a lender to determine based on
credit risk. Securitizing QRMs is a way for a sponsor to be
documented and verified information that at the time a
exempt from the risk retention requirements.
mortgage loan is made, the borrower has the ability to repay
the loan. Lenders that fail to comply with the ATR rule
Why Was This Rule Adopted? In its deliberations on the
could be subject to legal liability.
DFA, Congress noted that the financial crisis shed light on
several weaknesses in securitization transactions and
A lender is presumed to have complied with the ATR rule
attempted to address those weaknesses in various portions
when it offers a QM. A QM is a mortgage that satisfies
of the act. One of the weaknesses addressed by the CRR
certain underwriting and product feature requirements, such
rule concerned the originate-to-distribute (OTD) model of
as being below specified debt-to-income ratios, having a
funding mortgages. The OTD model describes a process in
term of 30 years or fewer, and having fees associated with
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QRM: Risk Retention and the Mortgage Market
the mortgage below certain thresholds. There are several
The Rulemaking Process
different categories of a QM, including mortgages made by
Who Issued the Rule? The portions of the final rule
small lenders and lenders in rural or underserved areas and
dealing with residential mortgages were jointly issued by
mortgages that meet the standards of Fannie Mae and
the Office of the Comptroller of the Currency (OCC), the
Freddie Mac.
Board of Governors of the Federal Reserve System, the
Federal Deposit Insurance Corporation (FDIC), the
In sum, offering a QM is one way for a lender to comply
Securities and Exchange Commission (SEC), the FHFA,
with the ATR rule while securitizing a QRM is a way for a
and the Department of Housing and Urban Development
sponsor to be exempt from the risk retention requirements.
(HUD). FHFA and HUD were not part of the portions of
The ATR rule addresses underwriting requirements in the
the rule that addressed non-mortgage assets.
primary mortgage market (i.e., the market where a
mortgage is made), and the CRR rule concerns
When Does the Credit Risk Requirement Go Into
securitization requirements in the secondary mortgage
Effect? The rule (not yet published) is effective one year
market (i.e., the market where mortgages are bought and
after it is published in the Federal Register for MBS and
sold).
two years after it is published for other types of ABS.
Does QRM Have a Downpayment Requirement?
Will the QRM Definition Be Reviewed? The regulators
Although the proposed CRR rule generally would have
will review the definition of QRM at least every five years
required a mortgage to have a 20% downpayment to qualify
to ensure it is consistent with the DFA’s requirements.
as a QRM, the final CRR rule does not require a minimum
downpayment.
Selected Policy Issues
Does the Definition of QRM Balance the Goals of Credit
Why Align QRM and QM? In the preamble to the final
Availability and Incentive Alignment? Some argue that
rule, the regulators state that aligning QM and QRM “meets
regulators should define QRM as broadly as possible under
the statutory goals and directive of [the risk retention
the statutory framework to free up mortgage credit. Others
requirement] to protect investors and enhance financial
argue that requiring risk retention is important to aligning
stability, in part by limiting credit risk, while also
the incentives of securitizers and investors. Exempting a
preserving access to affordable credit and facilitating
large part of the market through a broad definition of QRM,
compliance.” Aligning the two definitions could also reduce
they argue, undermines the efficacy of the CRR rule.
the regulatory compliance burden associated with having
two different mortgage standards.
How is the CRR Rule Addressed in the Housing Finance
Reform Proposals? H.R. 2767, the PATH Act, would
Although many consumer and industry groups support the
repeal the CRR requirement. S. 1217, the Housing Finance
alignment of QM and QRM, others, such as former
Reform and Taxpayer Protection Act, would provide a
Representative Barney Frank, argue that QRM should have
government guarantee for some MBS, which would make
a stricter definition and only the highest quality mortgages
those MBS exempt from the CRR requirement.
should be exempted from the CRR rule.
Will Finalizing the CRR Rule Jumpstart the Private-
Besides QRM, Are There Other Mortgage-Related
Label Securities (PLS) Market? In the aftermath of the
Exemptions or Options to Risk Retention? The CRR rule
financial crisis, the PLS market—the market for MBS that
includes several other mortgage-related exemptions and
do not have a government guarantee—has shrunk
options. For example, Fannie Mae and Freddie Mac do not
dramatically. Some analysts argue that the absence of the
need to retain additional credit risk beyond the guarantee
CRR rule created uncertainty for the PLS market and
that they provide on their MBS so long as they continue to
contributed to its reduction. While finalizing the CRR rule
operate under conservatorship or receivership of the Federal
will reduce some of that uncertainty, other issues remain
Housing Finance Agency (FHFA) and are receiving support
that may contribute to the PLS market’s current state,
from the U.S. Treasury.
including uncertainty about the future of housing finance
reform, unresolved legal cases stemming from the financial
All ABS fully guaranteed by the government are exempt
crisis, and other structural issues related to PLS.
from the CRR rule. MBS guaranteed by Ginnie Mae,
therefore, are exempt because Ginnie Mae is a government
In addition, some argue that Fannie Mae’s and Freddie
agency that guarantees MBS composed of government-
Mac’s exemption from having to retain additional risk
insured mortgages.
under the CRR rule further entrenches their large role in the
market at the expense of PLS. Others counter that their
Certain community focused residential mortgages, such as
guarantee already exposes them to a significant amount of
those originated by eligible non-profit organizations, are not
credit risk independent of the CRR rule.
QMs (and because they are not QMs, they are not QRMs)
but are exempt from the ATR rule. The CRR rule also
Sean M. Hoskins, Analyst in Financial Economics
provides an exemption from risk retention for certain
community-focused residential mortgages.
IF10204
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QRM: Risk Retention and the Mortgage Market
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