Speaking before the American Securitization Forum, Comptroller of the Currency John C. Dugan said that a robust securitization market is vital to funding the needs of consumers and businesses, and he urged policy-makers to focus reform efforts on improving underwriting standards rather than ‘skin in the game’ risk-retention proposals.
‘Asset securitization played a significant role in the crisis, and nobody should think that we can just wait for the market to stabilize and then go back to business as before,’ Dugan said. ‘But I hope we also recognize just how important securitization is to our economy. Done correctly, securitization helps consumers and businesses by increasing the availability of credit on terms that might otherwise be unavailable.’
The Office of the Comptroller of the Currency supports accounting and regulatory changes that more appropriately align securitizations with risk, he said, although they make it more difficult for these transactions to qualify as true sales and move off the balance sheet.
However, these standards, including Financial Accounting Standards 166 and 167, raise fundamental and difficult questions about how securitizations can be structured in the future to result in true sales, true risk-shifting, true off-balance sheet treatment and appropriately lower regulatory capital charges, he said.
"Will it be possible to move securitized assets off the balance sheet in a way that works economically for both securitizers and investors?" Dugan asked. "And if not – if securitizations are much more often treated as "financings' rather than true sales – will it be possible to have a truly robust securitization market?"
Proposals for risk-retention requirements, which are intended to assure sound underwriting by requiring securitizers to hold some part of the securitized loans on its own balance sheet, create a potential problem, he added.
"Where a securitizer retains a material risk of loss on loans transferred in a securitization, the new accounting and regulatory capital rules may require that all loans in the securitization vehicle be kept on the bank's balance sheet – not just the amount of risk required to be retained," Dugan said. "This could significantly increase the regulatory capital charge for such securitizations."
Dugan added that there is a great deal of uncertainty about how the new accounting standards will work in practice.
"We don't yet know whether the mere fact of retention by itself will constitute such control, but it appears to be a distinct possibility," he said. "At a minimum, it appears that it will be a significant factor weighing against off-balance sheet treatment in a given transaction."
Dugan suggested that a better and more direct way to assure sound underwriting for all mortgages, regardless of whether they are sold or held, would be to set minimum standards by regulation and stipulate that if the standards were met, there would be no need for skin-in-the-game risk retention requirements.
"We could do this," he said. "Bank and thrift regulators could establish minimum underwriting standards for all mortgages originated, purchased or sold by banks, thrifts, and – very importantly – by all of their affiliates. The Federal Housing Finance Agency could ensure similar treatment for all mortgages purchased or accepted as collateral by Fannie Mae, Freddie Mac and the Federal Home Loan Banks. And the Federal Housing Administration, which already establishes minimum underwriting standards for U.S. government-guaranteed mortgages, could coordinate those actions with the other regulators."
Additionally, Congress could ensure these steps were taken by directing the agencies to coordinate in setting minimum underwriting standards, Dugan said.
"And it could more directly reach the part of the mortgage market not currently subject to direct federal regulation – unregulated mortgage originators and brokers – by subjecting them to the standards set by federal regulators, bolstered by an effective enforcement mechanism," he stated. "And it could also consider going even further by making it unlawful for any person to sell or transfer a mortgage without representing that such standards are satisfied."
Cautioning that minimum underwriting standards are not a panacea, Dugan added that other measures – including more robust disclosures, credit rating reform and changes in compensation practices – all merit consideration.