Comptroller Dugan Says Minimum Underwriting Standards Could Play Major Role in Reforming Securitization Markets

NATIONAL HARBOR, Md. — Comptroller of the Currency John C. Dugan said today that a robust securitization market is vital to funding the needs of consumers and businesses, and 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,” he said in a speech to the American Securitization Forum.  “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 OCC 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 FAS 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?  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 said.

“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,” he said.  “This could significantly increase the regulatory capital charge for such securitizations.”

Mr. Dugan said 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.”

The Comptroller said 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.”

Mr. Dugan said Congress could ensure these steps were taken by directing the agencies to coordinate in setting minimum underwriting standards.  “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 added.  “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.”

The Comptroller said it is critical that comparable standards be established for all loan originators and that there be truly comparable levels of effective regulatory implementation.  He said regulators should stick to the basic, core standards on which there is the clearest consensus, including:

• Effective verification of income and financial information;
• Meaningful down payments;
• Reasonable debt-to-income ratios; and
• For monthly payments that increase over time, qualifying borrowers based on the higher, later rate, rather than the lower, initial rate.

“I do not mean to suggest that minimum underwriting standards are a panacea, or even that they would work as well for other asset classes as I think they would for mortgages,” Mr. Dugan added.  “Other measures, including more robust disclosures, credit rating reform, and changes in compensation practices all merit consideration by policymakers, and that process is underway.  I do think, however, for the reasons I’ve discussed, that minimum underwriting standards should be strongly considered as an alternative to rigid skin-in-the-game requirements.”

Related Links

• Remarks before the American Securitization Forum (PDF 53KB)
• Remarks before the Special Seminar on International Banking and Finance (PDF 45KB)
• Comptroller of the Currency John C. Dugan