By: Daniel A. Cozzi

On October 22, 2014 The Office of the Comptroller of the Currency, Treasury; Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation; U.S. Securities and Exchange Commission; Federal Housing Finance Agency (FHFA); and Department of Housing and Urban Development adopted rules to implement the credit risk retention requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank Act, enacted in 2010, requires the implementation of stricter rules governing mortgage-backed securities. The adopted rules seek to balance the importance of the securities market in providing credit to homeowners with appropriate underwriting standards, in light of the 2008 financial crisis. (“During the financial crisis, securitization transactions displayed significant vulnerabilities arising from inadequate information and incentive misalignment among various parties involved in the process.”) See Joint Final Rule to implement the requirements of section 941 of the Dodd–Frank Act.

Under Dodd-Frank, firms which issue mortgage-backed securities must retain a portion of the risk or demonstrate that the mortgages are held by borrowers with an ability to repay the debt. These risk retention requirements are meant to ensure that lenders retain some “skin in the game.” The rules require that lenders retain 5% of the risk associated with mortgages packaged as securities or comply with Consumer Financial Protection Bureau rules governing borrower debt-to-income ratios. The latter exception would require that lenders verify that a borrower can repay the debt and comply with other requirements, such as verification that the borrower’s debt payments do not exceed 43% of his or her income.

The new rules go into effect in the Fall of 2015 and will only impact the market for private securities. Securities sold to Fannie Mae and Freddie Mac are exempt from the new rules.