Although bankers are likely to have significant concerns about the risk retention proposal due next week, they appear to have won at least one victory already: a choice over how to structure risk that must be retained.
Under the plan, lenders must retain 5% of the risk of any loan — or pool of loans — they sell into the secondary market. But it has been unclear until now how that risk must be structured; namely, whether lenders must retain 5% of the overall risk or 5% of each tranche.
According to sources familiar with the risk retention proposal, regulators are expected to give lenders a choice on that critical question, a move that will please bankers but is likely to raise concerns about whether they are giving institutions too much leeway.
The idea of offering the issuers themselves an option on which risk model they can use has been kicking around since early January at least, mortgage bankers told National Mortgage News.
Banks are issuers of GNMA MBS but those bonds are exempt from the rule. Residential funders and commercial banks do not issue Fannie/Freddie MBS. The GSEs themselves are the issuers of record, so it's unclear what immediate effect the rule will have because the private label MBS market is almost nonexistent.
"The issuers will very much appreciate the ability to choose the form of risk retention for their transaction," said Tom Deutsch, executive director of the American Securitization Forum. "There are some investors who will be very concerned about those choices. Some investors would like to see a one size fits best approach but different issuers in different asset classes would be very concerned with that."
At issue is whether lenders must retain a so-called "horizontal" or "vertical" slice of the risk. A horizontal slice would require lenders to take a 5% first loss interest in the overall securitization structure, while a vertical, or pro-rata piece, would require lenders to keep 5% of every piece of it, such as subordinated and senior tranches.
