securitizations of legacy loans from risk retention would satisfy the
statutory criteria for an exemption under 15G(e) of the Exchange
Act.\117\
---------------------------------------------------------------------------

    \117\ See 15 U.S.C. 78o-11(e).
---------------------------------------------------------------------------

4. Corporate Debt Repackagings
    Several commenters urged the agencies to adopt an exemption from
risk retention for ``corporate debt repackaging'' \118\ securitization
transactions. One commenter asserted that currently in corporate debt
repackaging transactions, depositors and sponsors do not hold any
interest in the repackaging vehicle. These commenters asserted that
sponsors would not pursue corporate debt repackagings if they were
required to retain risk, because it would fundamentally change the
dynamics of these transactions and could raise accounting and other
issues. Another commenter observed that corporate debt obligations are,
generally, full recourse obligations of the issuing company and the
issuer of the corporate bonds bears 100 percent of the credit risk. The
commenters stated that adding an additional layer of risk retention to
a repackaging of obligations that are themselves the subject of 100
percent risk retention by requiring the sponsor of the repackaging
transaction to retain an additional 5 percent of the credit risk would
serve no regulatory purpose. Another commenter asserted that not
granting an exemption for corporate debt repackagings would reduce the
ability of investors to invest in tailored repackaged securities and
likewise reduce funding and liquidity to the detriment of access of
businesses to credit on reasonable terms.
---------------------------------------------------------------------------

    \118\ According to commenters, corporate debt repackagings are
created by the deposit of corporate debt securities purchased by the
sponsoring institution in the secondary market into a trust which
issues certificates backed by cash flows on the underlying corporate
bonds.
---------------------------------------------------------------------------

    The agencies are not proposing an exemption from risk retention for
corporate debt repackagings. The agencies do not believe an exemption
is warranted because the underlying assets (the corporate bonds) are
not ABS. Regardless of the level of credit risk a corporate debt issuer
believes it holds on its underlying corporate bonds, the risk retention
requirement would apply at the securitization level, and the sponsor of
the securitization should be required to hold 5 percent of the credit
risk of the securitization transaction. Risk retention at the
securitization level for corporate debt repackagings aligns the
sponsor's interests in selecting the bonds in the pool with investors
in the securitization, who are often retail investors.
5. ``Non-Conduit'' CMBS Transactions
    Some commenters on the original proposal requested that the
agencies include an exemption or special treatment for ``non-conduit''
CMBS transactions. Examples of ``non-conduit'' CMBS transactions
include single-asset transactions; single-borrower transactions; large
loan transactions (fixed and floating) with pools of one to 10 loans;
and large loan transactions having only an investment-grade component.
Commenters asserted that, because such transactions involve very small
pools of loans (or a single loan), a prospective investor is able to

scrutinize each loan and risk retention would be unnecessary for
investor protection. In particular, commenters noted that the CMBS menu
option would work only for ``conduit'' CMBS securitizations in which
originators of commercial mortgage loans aggregate loan pools of 10 to
100 loans. Suggestions for the treatment of ``non-conduit'' CMBS
transactions included:
     Providing a complete exemption for single-asset
transactions; single-borrower transactions; large loan transactions
(fixed and floating) with pools of one to 10 loans; and large loan
transactions having only an investment-grade component;
     Allowing mezzanine loans in single borrower and floating
rate CMBS transactions to satisfy the risk retention requirement and
any PCCRA requirements; and
     Exempting single borrower and large loan transactions with
less than a certain number of loans.
    The agencies are not proposing an exemption from risk retention for
``non-conduit'' CMBS securitizations. While the agencies do not dispute
that the smaller pools of loans in these transaction allow for fuller
asset-level disclosure in offering documents and could allow
prospective investors the opportunity to review each loan in the pool,
the agencies do not believe that this fact alone is sufficient grounds
to satisfy the exemption standards of section 15G of the Exchange Act.
Furthermore, the agencies do not believe that there are significant
differences between ``conduit'' and ``non-conduit'' CMBS to warrant a
special exemption for ``non-conduit'' CMBS.
6. Tax Lien-Backed Securities Sponsored by a Municipal Entity
    One commenter on the original proposal asserted that tax lien-
backed securitizations are not ABS under the Exchange Act and should
not be subject to risk retention requirement. According to this
commenter, under state and municipal law, all property taxes,
assessment and sewer and water charges become liens on the day they
become due and payable if unpaid. These taxes, assessments and charges,
and any related tax liens, arise by operation of law and do not involve
an extension of credit by any party or any underwriting decision on the
party of the city. If the agencies disagreed with the position that tax
lien securitizations are not ABS, this commenter requested that the
agencies provide a narrowly tailored exemption for any tax lien-backed
securitization transactions sponsored by a municipality. In this
regard, the commenter argued that such securitizations do not involve
any of the public policy concerns underlying the risk retention
requirement because the tax liens arise by operation of law and do not
involve an extension of credit or underwriting decisions on the part of
the city. As a result, this commenter stated that applying the credit
risk retention rules would not further the agencies' stated goals of
encouraging prudent underwriting standards and ensuring the quality of
the assets underlying a securitization transaction.
    The agencies are not proposing an exemption from risk retention for
securitizations of tax lien-backed securities sponsored by municipal
entities. The agencies believe that there is insufficient data to
justify granting a specific exemption. Furthermore, the agencies are
concerned that this type of exemption could end up being overly broad
in its application and be used to exempt sponsors of securitizations of
securities from programs, such as Property Assessed Clean Energy
programs, that use a securitized ``tax lien'' structure to fund and
collect consensual financing for property improvements desired by
private property owners.
7. Rental Car Securitizations
    One commenter on the original proposal requested that the agencies
exempt rental car securitizations because of the extensive
overcollateralization required to support a rental car securitization,
the on-going structural protections with respect to collateral
valuation, and the importance of the vehicles to the business
operations of the car rental operating company.
    The agencies are not proposing an exemption from risk retention for
rental car securitizations. Risk retention is required of other
sponsors that similarly rely on securitization for funding and that
sponsor securitizations with similar overcollateralization protections
and structural features. The agencies do not believe that there are
particular features of this type of securitization that would warrant
an exemption under the factors that the agencies must consider in
section 15G(e) of the Exchange Act.

E. Safe Harbor for Foreign Securitization Transactions

    The original proposal included a ``safe harbor'' provision for
certain securitization transactions based on the limited nature of the
transactions' connections with the United States and U.S. investors
(foreign securitization transactions). The safe harbor was intended to
exclude from the proposed risk retention requirements transactions in
which the effects on U.S. interests are sufficiently remote so as not
to significantly impact underwriting standards and risk management
practices in the United States or the interests of U.S. investors.
Accordingly, the conditions for use of the safe harbor limited
involvement by persons in the United States with respect to both assets
being securitized and the ABS sold in connection with the transaction.
Finally, as originally proposed, the safe harbor would not have been
available for any transaction or series of transactions that, although
in technical compliance with the conditions of the safe harbor, was
part of a plan or scheme to evade the requirements of section 15G
Exchange Act and the proposed rules.
    As set forth in the original proposal, the risk retention
requirement would not apply to a securitization transaction if: (1) The
securitization transaction is not required to be and is not registered
under the Securities Act; (2) no more than 10 percent of the dollar
value by proceeds (or equivalent if sold in a foreign currency) of all
classes of ABS interests sold in the securitization transaction are
sold to U.S. persons or for the account or benefit of U.S. persons; (3)
neither the sponsor of the securitization transaction nor the issuing
entity is (i) chartered, incorporated, or organized under the laws of
the United States, or a U.S. state or territory or (ii) the
unincorporated branch or office located in the United States of an
entity not chartered, incorporated, or organized under the laws of the
United States, or a U.S. state or territory (collectively, a U.S.-
located entity); (4) no more than 25 percent of the assets
collateralizing the ABS sold in the securitization transaction were
acquired by the sponsor, directly or indirectly, from a consolidated
affiliate of the sponsor or issuing entity that is a U.S.-located
entity.\119\
---------------------------------------------------------------------------

    \119\ See infra note 112 for the definition of ``state.''
---------------------------------------------------------------------------

    Commenters on the original proposal generally favored the creation
of a safe harbor for certain foreign securitizations. Several
commenters, however, requested that the exemption be broadened.
Specifically, several commenters noted that the U.S. risk retention
rules may be incompatible with foreign risk retention requirements,
such as the European Union risk retention requirements, and requested
that the safe harbor be modified to more readily facilitate cross-
border compliance with varied foreign risk retention requirements.

    Several commenters supported a mutual recognition system for some
cross-border offerings. For example, commenters recommended various
methodologies for establishing a mutual recognition framework that
would permit non-U.S. securitizers to either satisfy or be exempt from
U.S. risk retention requirements if a sufficient minimum amount of a
foreign securitization complies with foreign risk retention
requirements that would be recognized under such a framework. A few
commenters recommended that in the absence of a mutual recognition
framework, a higher proceeds limit threshold of 30 percent, or as much
as 33 percent, would be more appropriate to preserve cross-border
market liquidity, in at least some circumstances. A few commenters also
requested clarification of how the percentage value of ABS sold to U.S.
investors under the 10 percent proceeds limit should be calculated.
    The agencies are proposing a foreign safe harbor that is similar to
the original proposal but modified to address some commenter concerns.
The proposal makes a revision to the safe harbor eligibility
calculation to clarify that interests retained by the sponsor may be
included in calculating the percentage of ABS interests sold in the
securitization transaction that are sold to U.S. persons or for the
account or benefit of U.S. persons. The proposed safe harbor
eligibility calculation also would clarify that any ABS transferred to
U.S. persons or for the account or benefit of U.S. persons, including
U.S. affiliates of non-U.S. sponsors, must be included in calculating
eligibility for the safe harbor.
    The agencies are again proposing a 10 percent limit on the value of
classes of ABS sold to U.S. persons for safe harbor eligibility,
similar to the original proposal. The agencies continue to believe that
the proposed 10 percent limit appropriately aligns the safe harbor with
the objective of the rule, which is to exclude only those transactions
with limited effect on U.S. interests, underwriting standards, risk
management practices, or U.S. investors.
    In addition, the agencies are concerned that expansion of the 10
percent limit would not effectively address the concerns of foreign
securitization sponsors, some of whom rely extensively on U.S.
investors for liquidity. However, the agencies also believe that the
proposed rule incorporates sufficient flexibility for sponsors with
respect to forms of eligible risk retention to permit foreign sponsors
seeking a significant U.S. investor base to retain risk in a format
that satisfies home country and U.S. regulatory requirements. For
example, in response to comments from mortgage securitizers in the
United Kingdom who use revolving trust structures, the agencies are
proposing to permit seller's interest to qualify as risk retention for
revolving master trusts securitized by non-revolving assets. The
agencies' revisions to the original proposal that are designed to
provide flexibility to foreign securitization sponsors that use the
revolving master trust structure are discussed in detail in Part
III.B.2 of this SUPPLEMENTARY INFORMATION.
    The agencies considered the comments requesting a mutual
recognition framework and observe that such a framework has not been
generally adopted in non-U.S. jurisdictions with risk retention
requirements. The agencies believe that given the many differences
between jurisdictions, finding comparability among securitization
frameworks that place the obligation to comply with risk retention
requirements upon different parties in the securitization transaction,
have different requirements for hedging, risk transfer, or unfunded
risk retention, or otherwise vary materially, it likely would not be
practicable to construct such a ``mutual recognition'' system that
would meet all the requirements of section 15G of the Exchange Act.
Moreover, in several such jurisdictions, the risk retention framework
recognizes unfunded forms of risk retention, such as standby letters of
credit, which the agencies do not believe provide sufficient alignment
of incentives and have rejected as eligible forms of risk retention
under the U.S. framework.
Request for Comment
    74. Are there any extra or special considerations relating to these
circumstances that the agencies should take into account?
    75(a). Should the more than 10 percent proceeds trigger be higher
or lower (e.g., 0 percent, 5 percent, 15 percent, or 20 percent)?
75(b). If so, what should the trigger be and why? 75(c). Are the
eligibility calculations appropriate? 75(d). If not, how should they be
modified?

F. Sunset on Hedging and Transfer Restrictions

    As discussed in Part III.D of this SUPPLEMENTARY INFORMATION,
Section 15G(c)(1)(A) of the Exchange Act provides that sponsors may not
hedge or transfer the risk retention interest they are required to
hold.\120\
---------------------------------------------------------------------------

    \120\ 15 U.S.C. 78o-11(c)(1)(A). As with other provisions of
risk retention, the agencies could provide an exemption under
section 15G(e) of the Exchange Act if certain findings were met. See
id. at section 78o-11(e).
---------------------------------------------------------------------------

    The agencies originally proposed that sponsors generally would have
to hold risk retention for the duration of a securitization
transaction. The proposal did not provide any sunset provisions after
which the prohibitions on sale and hedging of retained interests would
expire, though the proposal did specifically include a question related
to including a sunset provision in the final rule and requested
commenter feedback.
    While a few commenters representing the investor community
expressed support for risk retention for the life of the security, the
majority of commenters who discussed this topic in their letters
opposed risk retention lasting for the duration of the transaction.
Generally, these commenters argued that credit losses on underlying
assets due to poor underwriting tend to occur in the first few years of
the securitization and that defaults occur less frequently as the
assets are seasoned. Additionally, they asserted that the risk
retention requirement as proposed would reduce liquidity in the
financial system and increase the amount of capital banks would be
required to hold, thereby reducing credit availability and raising
borrowing costs for consumers and businesses. Thus, they argued, a
sunset provision should be included in the final rule to help offset
the costs and burden created by the retention requirement. After the
mandated risk retention period, sponsors or their consolidated
affiliates would be allowed to hedge or transfer to an unaffiliated
third party the retained interest or assets.
    Commenters proposed a variety of suggestions for incorporating a
sunset provision in the final rule. Some favored a blanket risk
retention provision, whereby retention of the interest would no longer
be required after a certain period of time, regardless of the asset
class. They stated that a blanket sunset requirement would be the
easiest to implement and dovetails with the agencies' stated goal of
reducing regulatory complexity. Among those commenters advocating for a
blanket sunset, most stated that a three year sunset provision would be
ideal. A subset of these commenters acknowledged that three years could
be too long for some asset classes (such as automobile ABS), however
they maintained that historical loss rates show that this duration
would be appropriate for some of the largest asset classes, in
particular CMBS and RMBS. They stated that, after three years, losses

related to underwriting defects have already occurred and any future
credit losses are typically attributed to financial events or, in the
case of RMBS, life events such as illness or unemployment, unrelated to
the underwriting quality. One commenter estimated that a three-year
sunset would reduce the costs associated with risk retention by 50
percent.
    Other commenters suggested that the sunset provision should vary by
asset class. While this might be more operationally complex to
implement than a blanket sunset provision, they stated it would be more
risk sensitive as it would take into account the fact that different
asset classes have varying default rates and underlying exposure
durations (for example, 30 years for a standard residential mortgage
versus five years for a typical automobile loan). For example,
commenters suggested a range of risk retention durations for RMBS,
stating that anywhere from two to five years would be appropriate.
Another commenter advocated that the risk retention requirement for
RMBS should end at the later of five years or when the pool is reduced
to 25 percent of its original balance. Similarly for CMBS, some
commenters suggested requiring risk retention for only two or three
years in the final rule. A few commenters stated that a sunset
provision should be based upon the duration of the asset in question.
For instance, one commenter stated that automobile ABS should have a
sunset provision of less than five years since automobile loans are of
such a short duration, while another commenter advocated using the
average pool duration to determine the length of required risk
retention.
    The agencies have carefully considered the comments, as well as
other information on credit defaults for various asset classes in
contemplating whether a limit on the duration of the risk retention
requirement would be appropriate. The agencies have concluded that the
primary purpose of risk retention--sound underwriting--is less likely
to be effectively promoted by risk retention requirements after a
certain period of time has passed and a peak number of delinquencies
for an asset class has occurred.
    Accordingly, the agencies are proposing two categories of duration
for the transfer and hedging restrictions under the proposed rule--one
for RMBS and one for other types of ABS. For all ABS other than RMBS,
the transfer and hedging restrictions under the rule would expire on or
after the date that is the latest of (1) the date on which the total
unpaid principal balance of the securitized assets that collateralize
the securitization is reduced to 33 percent of the original unpaid
principal balance as of the date of the closing of the securitization,
(2) the date on which the total unpaid principal obligations under the
ABS interests issued in the securitization is reduced to 33 percent of
the original unpaid principal obligations at the closing of the
securitization transaction, or (3) two years after the date of the
closing of the securitization transaction.
    Similarly, the agencies are proposing, as an exception to the
transfer and hedging restrictions of the proposed rule and section 15G
of the Exchange Act, to permit the transfer of the retained B-piece
interest from a CMBS transaction by the sponsor or initial third-party
purchaser to another third-party purchaser five years after the date of
the closing of the securitization transaction, provided that the
transferee satisfies each of the conditions applicable to the initial
third-party purchaser under the CMBS option (as described above in Part
III.B.5 of this SUPPLEMENTARY INFORMATION).
    The agencies believe the exemptions to the prohibitions on transfer
and hedging for both non-residential mortgage ABS and CMBS would help
ensure high quality underwriting standards for the securitizers and
originators of non-residential mortgage ABS and CMBS, would improve the
access of consumers and businesses to credit on reasonable terms, and
are in the public interest and for the protection of investors--and
thus satisfy the conditions for exceptions to the rule.\121\ After
losses due to underwriting quality occur in the initial years following
a securitization transaction, risk retention does little to improve the
underwriting quality of ABS as most subsequent losses are related to
financial events or, in the case of RMBS, life events not captured in
the underwriting process. In addition, these exemptions would improve
access to credit for consumer and business borrowers by increasing
potential liquidity in the non-residential mortgage ABS and CMBS
markets.
---------------------------------------------------------------------------

    \121\ 15 U.S.C. 78o-11(e)(2).
---------------------------------------------------------------------------

    Because residential mortgages typically have a longer duration than
other assets, weaknesses in underwriting may show up later than in
other asset classes and can be masked by strong housing markets.
Moreover, residential mortgage pools are uniquely sensitive to adverse
selection through prepayments: If market interest rates fall, borrowers
refinance their mortgages and prepay their existing mortgages, but
refinancing is not available to borrowers whose credit has
deteriorated, so the weaker credits become concentrated in the RMBS
pool in later years. Accordingly, the agencies are proposing a
different sunset provision for RMBS backed by residential mortgages
that are subject to risk retention. Under the rule, risk retention
requirements with respect to RMBS would end on or after the date that
is the later of (1) five years after the date of the closing of the
securitization transaction or (2) the date on which the total unpaid
principal balance of the residential mortgages that collateralize the
securitization is reduced to 25 percent of the original unpaid
principal balance as of the date of the closing of the securitization.
In any event, risk retention requirements for RMBS would expire no
later than seven years after the date of the closing of the
securitizations transaction.
    The proposal also makes clear that the proposed rule's restrictions
on transfer and hedging end if a conservator or receiver of a sponsor
or other holder of risk retention is appointed pursuant to federal or
state law.
Request for Comment
    76(a). Are the sunset provisions appropriately calibrated for RMBS
(i.e., later of five years or 25 percent, but no later than seven
years) and all other asset classes (i.e., later of two years or 33
percent)? 76(b). If not, please provide alternative sunset provision
calibrations and any relevant analysis to support your assertions.
    77(a). Is it appropriate to provide a sunset provision for all
RMBS, as opposed to only amortizing RMBS? 77(b). Why or why not? 77(c).
What effects might this have on securitization market practices?

G. Federal Deposit Insurance Corporation Securitizations

    The agencies are proposing an additional exemption from risk
retention for securitization transactions that are sponsored by the
FDIC acting as conservator or receiver under any provision of the
Federal Deposit Insurance Act or Title II of the Dodd-Frank Act. This
new exemption is being proposed because such exemption would help
ensure high quality underwriting and is in the public interest and for
the protection of investors.\122\ These receivers and conservators
perform a function that benefits creditors in liquidating and
maximizing the value of assets of failed financial institutions for the
benefit of creditors and, accordingly, their actions are guided by
sound underwriting

practices. Such receivers and conservators do not originate loans or
other assets and thus are not engaged in ``originate to distribute''
activities that led to poorly underwritten loans and that were a
significant reason for the passage of section 941 of the Dodd-Frank
Act. The quality of the assets securitized by these receivers and
conservators and the ABS collateralized by those assets will be
carefully monitored and structured so as to be consistent with the
relevant statutory authority. Moreover, this exemption is in the public
interest because it would, for example, allow the FDIC to maximize the
value of assets of a conservatorship or receivership and thereby reduce
the potential costs of financial institution failures to creditors.
---------------------------------------------------------------------------

    \122\ See 15 U.S.C. 78o-11(e).
---------------------------------------------------------------------------

V. Reduced Risk Retention Requirements and Underwriting Standards for
ABS Backed by Qualifying Commercial, Commercial Real Estate, or
Automobile Loans

    As contemplated by section 15G of the Exchange Act, the original
proposal included a zero risk retention requirement, or exemption, for
securitizations of commercial loans, commercial real estate loans, and
automobile loans that met specific proposed underwriting
standards.\123\ All three categories of proposed underwriting standards
contained two identical requirements. First, a securitization exempt
from risk retention under these proposed provisions could be backed
only by a pool consisting entirely of assets that met the underwriting
standards. Second, sponsors would be required to repurchase any assets
that were found not to have met the underwriting criteria at
origination.
---------------------------------------------------------------------------

    \123\ Pursuant to section 15G, only the Federal banking agencies
are proposing the underwriting definitions in Sec.  ----.14 (except
the asset class definitions of automobile loan, commercial loan, and
commercial real estate loan, which are being proposed by the Federal
banking agencies and the Commission), and the exemption and
underwriting standards in Sec. Sec.  ----.15 through ----.18 of the
proposed rules.
---------------------------------------------------------------------------

    The agencies note the concern expressed by some commenters with
respect to all three of these asset classes that, for the residential
mortgage asset class and QRM, a significant portion of the existing
market would qualify for an exemption from risk retention, whereas in
proposing the underwriting standards for qualifying commercial loans,
commercial real estate loans, and automobile loans, the agencies have
proposed conservative underwriting criteria that will not capture an
equivalent portion of the respective markets. The agencies believe this
is appropriate because the homogeneity in the securitized residential
mortgage loan market is dissimilar to the securitization market for
commercial loan or commercial real estate loan asset classes.
Commercial loans and commercial real estate loans typically focus on a
common set of borrower and collateral metrics, but they are
individually underwritten and tailored to a specific borrower or
property, and often certain terms developed in view not only of the
borrower's financial position but also the general business cycle,
industry business cycle, and standards for appropriate leverage in that
industry sub-sector. The agencies believe the additional complexity
needed to create underwriting standards for every major type of
business in every economic cycle would be so great that originators
would almost certainly be dissuaded from attempting to implement them
or attempting to stay abreast of the numerous regulatory revisions the
agencies would be required to issue from time to time.
    Moreover, the proposed underwriting standards establish clear
requirements, which are necessary to enable originators, sponsors, and
investors to be certain as to whether any particular loan meets the
rule's requirements for an exemption. For the agencies to expand the
underwriting criteria in the fashion suggested by some commenters, the
rules would need to accommodate numerous relative standards. The
resulting uncertainty on behalf of market participants whether any
particular loan was actually correctly designated on a particular point
of those relative standards to qualify for an exemption would be
expected to eliminate the market's willingness to rely on the
exemption.
    While there may be more homogeneity in the securitized automobile
loan class, the agencies are concerned that attempting to accommodate a
significantly large share of the current automobile loan securitization
market would require weakening the underwriting standards to the point
where the agencies are skeptical that they would consistently reflect
loans of a low credit risk. For example, the agencies note that current
automobile lending often involves no or small down payments, financing
in excess of the value of the automobile (which is itself a quickly
depreciating asset) to accommodate taxes and fees, and a credit score
in lieu of an analysis of the borrower's ability to repay. These
concerns as to credit quality are evidenced by the high levels of
credit support automobile securitization sponsors build into their ABS,
even for so-called ``prime'' automobile loans. Moreover, securitizers
from the automobile sector explicitly disavowed any interest in using
any underwriting-based exemptive approach unless the agencies
incorporated the industry's current model, which relies almost
exclusively on matrices of credit scores (like FICO) and LTV. As is
discussed in the agencies' original proposal, the agencies are not
persuaded that it would be appropriate for the underwriting-based
exemptions under the rule to incorporate a credit score metric.
Request for Comment
    78(a). In light of the significant expansion of the proposed
definition of QRM, should the agencies similarly significantly expand
the type of loans that would meet the qualifying commercial, commercial
real estate and automobile loan exemptions? 78(b). If so, please
provide sufficient detailed data regarding loan underwriting criteria
for each type of loan.

A. Qualifying Commercial Loans

    The original proposal included definitions and underwriting
standards for qualifying commercial loans (QCL), that, when securitized
in a pool of solely QCLs, would have been exempt from the risk
retention requirements. The proposed definition of commercial loan
generally would have included any business loan that did not fit the
definition of a commercial real estate loan or 1-4 family residential
real estate loan.
    The proposed criteria for a QCL included reviewing two years of
past data; forecasting two years of future data; a total liabilities
ratio less than or equal to 50 percent; a leverage ratio of less than
or equal to 3.0 percent; a debt service coverage ratio of greater than
or equal to 1.5 percent; a straight-line amortizing payment; fixed
interest rates; a maximum five-year, fully amortizing loan term; and
representations and warranties against the borrower taking on
additional debt. Additional standards were proposed for QCLs that are
backed by collateral, including lien perfection and collateral
inspection.
    Commenters generally asserted the proposed criteria were too strict
in one or more areas. These commenters proposed a general loosening of
the QCL standards to incorporate more loans, and suggested the agencies
develop underwriting standards that would encompass 20 to 30 percent of
loans currently issued. One commenter asserted that if the criteria
were not loosened, the small chance a loan might qualify as a QCL would
not incentivize

lenders to go through all the initial tests and perform burdensome
monitoring after origination.
    Comments on the specific underwriting criteria included an
observation that some commercial loans are offered with 15- or 20-year
terms, with adjustable interest rates that reset every five years, and
that such loans should qualify for the exemption. Another commenter
suggested allowing second lien loans to qualify if they met all other
underwriting criteria. A third commenter suggested requiring qualifying
appraisals for all tangible or intangible assets collateralizing a
qualified commercial loan.
    In developing the underwriting standards for the original proposal,
the agencies intended for the standards to be reflective of very high-
quality loans because the loans would be completely exempt from risk
retention. The agencies have carefully considered the comments on the
original proposal, and generally believe that the high standards
proposed are appropriate for an exemption from risk retention for
commercial loans. In addition, while commercial loans do exist with
longer terms, the agencies do not believe such long-term commercial
loans are necessarily as safe as shorter-term commercial loans, as
longer loans involve more uncertainty about continued repayment
ability. Accordingly, the agencies are proposing underwriting standards
for QCLs similar to those in the original proposal. However, as
discussed below, the agencies are proposing to allow blended pools to
facilitate the origination and securitization of QCLs.
    The agencies are proposing some modifications to the standards in
the original proposal for QCLs. Under the proposal, junior liens may
collateralize a QCL. However, if the purpose of the commercial loan is
to finance the acquisition of tangible or intangible property, or to
refinance such a loan, the lender would be required to obtain a first
lien on the property for the loan to qualify as a QCL. While a
commercial lender should consider the appropriate value of the
collateral to the extent it is a factor in the repayment of the
obligation, the agencies are declining to propose a requirement of a
qualifying appraisal, so as not to increase the burden associated with
underwriting a QCL.
Request for Comment
    79(a). Are the revisions to the qualifying commercial loan
exemption appropriate? 79(b). Should other revisions be made?
    80(a). In evaluating the amortization term for qualifying
commercial loans, is full amortization appropriate? 80(b). If not, what
would be an appropriate amortization period or amount for high-quality
commercial loans?

B. Qualifying Commercial Real Estate Loans

    The original proposal included underwriting standards for CRE loans
that would have been exempt from risk retention (qualifying CRE loans,
or QCRE loans). The proposed standards focused predominately on the
following criteria: The borrower's capacity to repay the loan; the
value of, and the originator's security interest in, the collateral;
the loan-to-value (LTV) ratio; and, whether the loan documentation
includes the appropriate covenants to protect the value of the
collateral.
    Commenters generally supported the exemption from risk retention in
the original proposal for QCRE loans. However, many questioned whether
the QCRE loan exemption would be practicable, due to the stringency of
the qualifying criteria proposed by the agencies. Some commenters
asserted that less than 0.4 percent of conduit loans that have been
securitized since the beginning of the CMBS market would meet the
criteria. Most commenters requested that the agencies loosen the QCRE
loan criteria to allow more loans to qualify for the exemption.
    In the original proposal, a commercial real estate (CRE) loan would
have been defined as any loan secured by a property of five or more
residential units or by non-residential real property, where the
primary source of repayment would come from the proceeds of sale or
refinancing of the property or rental income from entities not
affiliated with the borrower. In addition, the definition would have
specifically excluded land loans and loans to real estate investment
trusts (REITs).
    Three main concerns were expressed by commenters with respect to
the definition of CRE loans in the original proposal. First, some
commenters questioned why CRE loans must be repaid from funds that do
not include rental income from an affiliate of the borrower. These
commenters said that in numerous commercial settings, particularly
hotels and hospitals, entities often rent commercial properties from
affiliated borrowers, and those rental proceeds are used to repay the
underlying loans. These commenters strongly encouraged the agencies to
remove the affiliate rent prohibition.
    Second, some commenters questioned the exclusion of certain land
loans from the definition of CRE in the original proposal.
Specifically, these commenters stated that numerous CMBS
securitizations include loans to owners of a fee interest in land that
is ground leased to a third party who owns the improvements and whose
ground lease payments are a source of income for debt service payments
on the loan. These commenters suggested that the agencies clarify that
the exclusion did not apply to such loans.
    Third, many commenters criticized the agencies for excluding loans
to REITs from the definition of CRE loans in the original proposal.
These commenters asserted that mortgage loans on commercial properties
where the borrower was a REIT are no riskier than similar loans where
the borrower was a non-REIT partnership or corporation and that a
significant portion of the CMBS market involves underlying loans to
finance buildings owned by REITs. These commenters requested that the
agencies delete the restriction against REITs, or in the alternative
clarify that the prohibition only applies to loans to REITs that are
not secured by mortgages on specific commercial real estate.
    The agencies are proposing the CRE definition from the original
proposal again, with some modifications to address the commenter
concerns discussed above. Regarding affiliate rental income, the
agencies were concerned when developing the original proposal that a
parent company might lease a building to an affiliate and manipulate
the rental income so that the loan on the building would meet the
requirements for a qualifying CRE loan. However, the agencies did not
intend to exclude the types of hotel loans mentioned by commenters from
the CRE loan definition, because the agencies do not consider income
from hotel guests to be derived from an affiliate. The agencies are
therefore proposing to specify that ``rental income'' in the CRE loan
definition would be any income derived from a party who is not an
affiliate of the borrower, or who is an affiliate but the ultimate
income stream for repayment comes from unaffiliated parties (for
example, in a hotel, dormitory, nursing home, or similar property).
    Regarding land loans, the agencies are concerned that weakening any
restriction on land loans would allow for riskier QCRE loans, as
separate parties could own the land and the building on the land and
could make servicing and foreclosure on the loan more difficult.
Therefore, the agencies are continuing to propose to exclude all land
loans from the CRE loan definition.

    Finally, in developing the original proposal, the agencies intended
to not allow unsecured loans to REITs, or loans secured by general
pools of REIT assets rather than by specific properties, to be
qualifying CRE loans. However, the agencies did not intend to exclude
otherwise valid CRE loans from the definition solely because the
borrower was organized as a REIT structure. After reviewing the
comments and the definition of CRE loan, the agencies have decided to
remove the language excluding REITs in the proposed definition.
    The agencies divided the underwriting criteria in the original
proposal into four categories: Ability to repay, loan-to-value
requirement, valuation of the collateral, and risk management and
monitoring.
1. Ability To Repay
    The agencies proposed in the original proposal a number of criteria
relating to the borrower's ability to repay in order for a loan to
qualify as QCRE. The borrower would have been required to have a debt
service coverage (DSC) ratio of at least 1.7, or at least 1.5 for
certain residential properties or certain commercial properties with at
least 80 percent triple-net leases.\124\ The proposed standards also
would have required reviewing two years of historical financial data
and two years of prospective financial data of the borrower. The loan
would have been required to have either a fixed interest rate or a
floating rate that was effectively fixed under a related swap
agreement. The loan document also would have had to prohibit any
deferral of principal or interest payments and any interest reserve
fund. The loan payment amount had to be based on straight-line
amortization over the term of the loan not to exceed 20 years, with
payments made at least monthly for at least 10 years of the loan's
term.
---------------------------------------------------------------------------

    \124\ The original proposal defined a triple-net lease as one in
which the lessee, not the lessor, is obligated to pay for taxes,
insurance, and maintenance on the leased property.
---------------------------------------------------------------------------

    Numerous commenters objected to the agencies' proposed DSC ratios
as too conservative, and proposed eliminating the DSC ratio, lowering
qualifying DSC ratios to a range between 1.15 and 1.40, or establishing
criteria similar to those used by Fannie Mae or Freddie Mac to fund
multifamily real estate loans.
    Many commenters stated that, if the agencies retained the DSC
ratios, they should remove the triple-net-lease requirement. Many of
these commenters stated that full service gross leases, rather than
triple-net leases, are used more often in the industry.\125\
---------------------------------------------------------------------------

    \125\ In a full-service gross lease, the lessor pays for taxes,
maintenance, and insurance (presumably covering the additional costs
by charging a higher rental amount to the lessee than under a
triple-net lease).
---------------------------------------------------------------------------

    Some commenters supported replacing the proposed requirement to
examine two years of past and future borrower data with one to gather
two or three years of historical financial data on the property, not
attempt to forecast two years of future data and to allow new
properties with no operating history to qualify. Many commenters
supported the requirement for fixed interest rate loans for QCRE.
However, some commenters suggested expanding the types of derivatives
allowed to convert a floating rate into a fixed rate. Many commenters
also supported the restrictions on deferrals of principal and interest
and on interest reserve funds. However, a few commenters supported
allowing some interest-only loans or interest-only periods, in
connection with a lower LTV ratio (such at 50 percent).
    Many commenters objected to the minimum length and amortization of
QCRE loans. These commenters said that 3, 5, and 7-year CRE loans have
become common in the industry, and so a minimum 10-year term would
disqualify numerous loans. In addition, most commenters supported a
longer amortization period for QCRE loans, such as 25 or 30 years. Some
commenters also proposed replacing the amortization requirement with a
maximum LTV at maturity (based on value at origination) that is lower
than LTV at origination, which would require some amortization of the
loan principal.
    After considering the comments on the underwriting criteria for
QCREs, the agencies are proposing criteria similar to that of the
original proposal, with some modifications. Based on a review of
underwriting standards and performance data for multifamily loans
purchased by the Enterprises, the agencies are proposing to require a
1.25 DSCR for multifamily properties to be QCRE.\126\ After review of
the comments and the Federal banking agencies' historical standards for
conservative CRE lending,\127\ for loans other than qualifying
multifamily property loans, the agencies are proposing to retain the
1.5 DSCR for leased QCRE loans and 1.7 for all other QCREs. As
discussed below, removing the criterion on triple-net leases should
allow more loans to qualify for an exemption with the 1.5 DSCR
requirement, rather than the 1.7 DSCR requirement that would have
applied under the original proposal.
---------------------------------------------------------------------------

    \126\ The agencies reviewed origination volume and performance
history, as tracked by the TREPP CMBS database, for multifamily
loans securitized from 2000 through 2011.
    \127\ These standards include the ``Interagency Guidelines for
Real Estate Lending.'' 12 CFR part 34, subpart D, Appendix A (OCC);
12 CFR part 208, subpart C, Appendix A (FRB); 12 CFR part 365,
Appendix A (FDIC).
---------------------------------------------------------------------------

    The agencies considered the comments requesting a debt yield
requirement, but have decided not to include that in the proposed rule.
Historically, DSCR has been, and continues to be, widely used in CRE
lending. Debt yield is a relatively recent concept that was not tracked
in many historic CMBS deals, which makes it difficult for the agencies
to calculate historical performance and determine what the appropriate
level should be for a CRE loan exempt from risk retention. The agencies
recognize that the DSCR is not a perfect measure, particularly in low
interest rate environments. However, the agencies also do not want to
introduce a relatively new methodology into the CRE market without
long-term data to support the appropriateness of that measure.
    Based on the agencies' further review of applicable data, it
appears that a significant number of leases are written as full-service
gross leases, not triple-net leases, and that difference should not
preclude treatment as a QCRE loan. Since the proposed underwriting
requirements are based on net operating income (NOI), whether a tenant
has a triple-net lease or full-service gross lease should not
significantly affect the borrower's NOI.
    The agencies propose to continue to require that the analysis of
whether a loan is a QCRE be made with respect to the borrower and not
be limited to the property only. While the agencies observe that some
CRE loans are non-recourse, others include guarantees by the borrowers.
The agencies are concerned that focusing solely on the property could
be problematic in cases where the borrower may have other outstanding
commitments that may lead the borrower to siphon cash flow from the
underwritten property to service the other commitments. By analyzing
the borrower's position, and not solely the property's income, the
underwriting should better address this risk. The agencies believe that
two years of historical data collection and two years of forecasted
data are appropriate, and that properties with less than two years of
operating history should not qualify as QCRE loans. The longer a
property has been operating, particularly after the first few years of
operation, the better the originator can assess the stability of cash
flows from the property going

forward. New properties present significant additional risks and loans
on those properties generally should not be exempt from risk retention.
    The proposal would continue to require that the interest rate on a
QCRE loan be fixed or fully convertible into a fixed rate using a
derivative product. The agencies are not proposing to allow other types
of derivatives because of concerns about transparency with other types
of derivative products, including mixed derivative products. For
example, if the agencies allowed a derivative that established an
interest rate cap, it may not be clear to investors whether a loan was
underwritten using the current market rate or the maximum rate allowed
under the interest rate cap. The agencies are also proposing to retain
from the original proposal the requirement not to include interest-only
loans or interest-only periods in QCRE loans. The agencies believe that
interest-only loans or interest-only periods are associated with higher
credit risk. If a borrower is not required to make any form of
principal payment, even with a 25-year amortization period, it raises
questions as to the riskiness of the loan, and would be inappropriate
for qualifying CRE loan treatment.
    The agencies are proposing some modifications from the original
proposal to the standards for QCRE loan terms. The agencies recognize
that there are CRE loans with amortization periods in excess of 20
years. Allowing a longer amortization period reduces the amount of
principal paid on the CRE loan before maturity, which can increase
risks related to having to refinance a larger principal amount than
would be the case for a CRE loan with a shorter amortization period.
Because the agencies believe exemptions from risk retention should be
available only for the most prudently underwritten CRE loans, the
agencies believe it is appropriate to consider the risks of an overly
long amortization period for a QCRE. In balancing those risks with
commenters' concerns, the agencies are proposing to increase the
amortization period to 30 years for multifamily residential QCRE loans
and to 25 years for all other QCRE loans.
    The agencies are continuing to propose to set a 10-year minimum
maturity for QCRE loans. The agencies are concerned that introducing
terms shorter than 10 years, such as three or five years, may create
improper underwriting incentives and not create the low-risk CRE loans
intended to qualify for the exemption. When making a short-term CRE
loan, an originator may focus only on a short timeframe in evaluating
the stability of the CRE underlying the loan in an industry that might
be at or near the peak of its business cycle. In contrast, a 10-year
maturity CRE loan allows for underwriting through a longer business
cycle, including downturns that may not be appropriately captured when
underwriting to a three-year time horizon.
2. Loan-to-Value Requirement
    The agencies proposed in the original proposal that the combined
loan-to-value ratio (CLTV) for QCRE loans be less than or equal to 65
percent (or 60 percent for certain valuation assumptions).
    Many commenters recognized the value in setting LTV ratio
requirements in CRE underwriting. While some commenters supported the
agencies' proposed ratios, others did not. Some commenters suggested
that higher LTV ratios should be allowed in the QCRE standards,
generally between 65 percent and 80 percent, particularly for
properties in stable locations with strong historical financial
performance. One commenter suggested lower LTVs for properties that may
be riskier. Numerous commenters suggested taking a different approach
by setting maximum LTVs at origination and maturity, with a maturity
LTV aimed at controlling the risk that the borrower would not be able
to refinance. A number of commenters also objected to setting the CLTV
ratio at 65 percent. These commenters said that many commercial
properties involve some form of subordinate financing. Some commenters
proposed eliminating the CLTV ratio entirely and thus allow borrowers
to use non-collateralized debt to finance the properties. Other
commenters proposed establishing a higher CLTV ratio (such as 80
percent) and allow for non-QCRE second liens on the properties.
    The agencies have considered the comments on LTV for QCRE loans and
are proposing to modify this aspect of QCRE underwriting standards from
the standard in the original proposal by proposing to establish a
maximum LTV ratio of 65 percent for QCRE loans. The agencies also are
proposing to allow up to a 70 percent CLTV for QCRE loans. The more
equity a borrower has in a CRE project, generally the lower the lender
or investor's exposure to credit risk. Overreliance on excessive
mezzanine financing instead of equity financing for a CRE property can
significantly reduce the cash flow available to the property, as
investors in mezzanine finance often require high rates of return to
offset the increased risk of their subordinate position. In proposing
underwriting criteria for the safest CRE loans that would be exempt
from risk retention requirements, the agencies believe a 70 percent
CLTV cap is appropriate, which would require the borrower to have at
least 30 percent equity in the project to help protect securitization
investors against losses from declining property values and potential
defaults on the CRE loans.
    The agencies are also proposing to retain the requirement that the
maximum CLTV ratio be lowered by 5 percent if the CRE property was
appraised with a low capitalization (cap) rate. Generally, assuming a
low cap rate will inflate the appraised value of the CRE property and
thus increase the amount that can be borrowed given a fixed LTV or
CLTV. Therefore, such a loan would have a maximum 60 percent LTV and 65
percent CLTV. In addition, to address the commenters' concerns about
high cap rates, the agencies are proposing that the cap rates used in
CRE appraisals be disclosed to investors in securitizations that own
CRE loans on those properties.
    The agencies are declining to propose requirements for LTVs or
CLTVs at both origination and maturity. The agencies are concerned that
introducing the concept of front-end and back-end LTV ratios, rather
than using straight-line amortization, would allow borrowers to make
nominal principal payments in early years and back-load a large
principal payment toward maturity. The effect would be to significantly
increase the riskiness of the CRE loan at maturity, rather than if the
loan had been underwritten to provide straight-line amortization
throughout its life. Therefore, the agencies have decided not to
propose to include this amortization approach in the revised proposal
and instead continue to propose the straight-line amortization
requirement.
3. Collateral Valuation
    In the original proposal, the agencies proposed to require an
appraisal and environmental risk assessment for every property serving
as collateral for a QCRE. Commenters strongly supported both the
valuation appraisal and environmental risk assessment for all QCRE
properties. Many commenters indicated this is already standard industry
practice. The agencies are continuing to include this requirement in
the proposed rule.
4. Risk Management and Monitoring
    The original proposal would have required that a QCRE loan
agreement require borrowers to supply certain financial information to
the sponsor and

servicer. In addition, the agreement would have had to require lenders
to take a first lien in the property and restrict the ability to pledge
the property as collateral for other loans.
    Many commenters supported the risk management provisions for
supplying financial information. Some commenters requested
clarification that such information should relate to the property
securing the QCRE loan rather than financial information on the
borrower. These commenters said that most CRE loans are non-recourse,
making the property the sole source of repayment and thus its financial
condition as far more important than the borrower's condition.
    Commenters supported the first-lien requirement. In addition, some
commenters requested removing the restriction on granting second liens
on the property to allow borrowers access to subordinate financing.
These commenters suggested establishing a CLTV to restrict the total
debt on the property. Finally, some commenters supported the
requirement that a borrower retain insurance on the property up to the
property value, while other commenters supported a requirement to have
insurance only for the replacement cost of the property.
    The agencies are proposing to modify the requirement in the
original proposal that the borrower provide information to the
originator (or any subsequent holder) and the servicer, including
financial statements of the borrower, on an ongoing basis. The agencies
believe that the servicer would be in the best position to collect,
store, and disseminate the required information, and could make that
information available to holders of the CRE loans. Therefore, to reduce
burden on the borrowers, the agencies are not proposing a requirement
to provide this information directly to the originator or any
subsequent holder.
    The agencies are retaining the proposed requirement from the
original proposal that the lender obtain a first lien on the financed
property. The agencies note that most CRE loan agreements allow the
lender to receive additional security by taking an assignment of leases
or other occupancy agreements on the CRE property, and the right to
enforce those leases in case of a breach by the borrower. In addition,
the agencies observe that standard CRE loan agreements also often
include a first lien on all interests the borrower has in or arising
out of the property used to operate the building (for example,
furniture in a hotel). The agencies believe these practices enhance
prudent lending and therefore would be appropriate to include this
blanket lien requirement on most types of borrower property to support
a QCRE loan. There would be an exception for purchase-money security
interests in machinery, equipment, or other borrower personal property.
    The agencies continue to believe that as long as the machinery and
equipment or other personal property subject to a purchase-money
security interest is also pledged as additional collateral for the QCRE
loan, it would be appropriate to allow such other liens. In addition,
the proposal would restrict junior liens on the underlying real
property and leases, rents, occupancy, franchise and license agreements
unless a total CLTV ratio was satisfied.
    The agencies are continuing to propose a requirement that the
borrower maintain insurance against loss on the CRE property at least
up to the amount of the CRE loan. The agencies believe that the
insurance requirement should serve to protect the interests of
investors and the qualifying CRE loan in the event of damage to the
property. Insuring only the replacement cost would not sufficiently
protect investors, who may be exposed to loss on the CRE loan from
significantly diminished cash flows during the period when a damaged
CRE property is being repaired or rebuilt.
    Although commenters were concerned that few CMBS issuers will be
able to use this exemption due to the conservative QCRE criteria, the
agencies are keeping many of the same underwriting characteristics for
the reasons discussed at the beginning of Part V of this Supplementary
Information.
Request for Comment
    81(a). Is including these requirements in the QCRE exemption
appropriate? 81(b). Why or why not?
    82. The agencies request comment on the proposed underwriting
standards, including the proposed definitions and the documentation
requirements

C. Qualifying Automobile Loans

    The original proposal included underwriting standards for
automobile loans that would be exempt from risk retention (qualifying
automobile loans, or QALs). Some commenters proposed including an
additional QAL-lite option, which would incorporate less stringent
underwriting standards but be subject to a 2.5 percent risk retention
amount based on a matrix of borrower FICO scores, loan terms and LTVs
of up to 135 percent. The agencies are declining to propose a QAL-lite
standard to avoid imposing a regulatory burden of monitoring multiple
underwriting standards for this asset class. However, as discussed
below, the agencies are proposing to allow blended pools of QALs and
non-QALs, which should help address commenters' concerns. The
definition of automobile loan in the original proposal generally would
have included only first-lien loans on light passenger vehicles
employed for personal use. It specifically would have excluded loans
for vehicles for business use, medium or heavy vehicles (such as
commercial trucks and vans), lease financing, fleet sales, and
recreational vehicles such as motorcycles. The underwriting standards
from the original proposal focused predominately on the borrower's
credit history and a down payment of 20 percent.
    While some commenters supported the definition of automobile loan,
others stated it was too narrow. These commenters suggested expanding
the definition to include motorcycles because they may not be used
solely as recreational vehicles. In addition, commenters suggested
allowing vehicles purchased by individuals for business use, as it may
be impossible to monitor the use of a vehicle after sale. Commenters
representing sponsors also supported allowing automobile leases to
qualify as QALs, with corresponding technical changes. In addition, a
few commenters supported expanding the definition to include fleet
purchases or fleet leasing, on the basis that these leases or sales are
generally with corporations or government entities with strong
repayment histories.
    The agencies have considered these comments and are proposing a
definition of automobile loans for QAL underwriting standards that is
substantially similar to the definition in the original proposal. The
agencies believe it continues to be appropriate to restrict the
definition of automobile loan to not include loans on vehicles that are
more frequently used for recreational purposes, such as motorcycles or
other recreational vehicles. The agencies also do not believe it would
be appropriate to expand the exemption to include vehicles used for
business purposes, as the risks and underwriting of such loans differ
from those of vehicles used for personal transportation. For example, a
car or truck used in a business may endure significantly more wear and
depreciate much faster than a vehicle used only for normal household
use.
    The agencies are not proposing to expand the definition to include
automobile leases. While the difference between an automobile purchase
and a lease may not be significant to a customer, leases represent a
different set of risks to securitization investors. As

one example, at the end of a lease, a customer has the right to return
the automobile, and the securitization may suffer a loss if the resale
price of that automobile is less than expected. In an automobile loan
securitization, the customer owns the vehicle at the end of the loan
term, and cannot return it to the dealer or the securitization trust.
    In the original proposal, the agencies proposed conservative
underwriting standards, including a 36 percent DTI requirement, a 20
percent down payment requirement, and credit history standards.
Generally, commenters opposed the QAL criteria as too conservative, and
asserted that less than 1 percent of automobile loans would qualify.
Even those commenters who otherwise supported the conservative QAL
underwriting suggested some revisions would be necessary to bring them
in line with current market standards. Automobile sponsor commenters
acknowledged that the agencies' proposed terms would be consistent with
very low credit risk, or ``super-prime'' automobile loans, but believed
that the standard should be set at the ``prime'' level, consistent with
low credit risk. In addition, commenters criticized the agencies for
applying to QALs underwriting criteria similar to those they applied to
QRMs and unsecured lending. Automobile sponsor commenters stated that
automobile loans are significantly different from mortgage loans, as
they are smaller and shorter in duration and have readily-salable
collateral. Investor commenters supported a standard that was above
``prime,'' but indicated that they could support a standard that
included loans that did not meet the very conservative ``super-prime''
QAL criteria proposed by the agencies.
    Although the agencies have taken into consideration the comments
that these standards do not reflect current underwriting practices, the
agencies generally do not believe it would be appropriate to include a
standard based on FICO scores in the QAL underwriting standards.
Further, as discussed in Part III.B.1 of this SUPPLEMENTARY
INFORMATION, the agencies have revised the risk retention requirements
to address some of the concerns about risk retention for automobile
securitizations to better enable sponsors of automobile securitizations
to comply with the risk retention requirements in a manner consistent
with their existing and current practices.
1. Ability To Repay
    The agencies proposed in the original proposal for QALs a debt-to-
income (DTI) ratio not in excess of 36 percent of a borrower's monthly
gross income. Originators would have been required to verify a
borrower's income and debt payments using standard methods. Many
commenters opposed including a DTI ratio as part of the underwriting
criteria for QALs. These commenters believed that the significant
additional burden of collecting documents to verify debts and income
would far outweigh any benefit, and could have the unanticipated result
of only applying the burden to the most creditworthy borrowers whose
loans could potentially qualify for QAL status. A few commenters
asserted that it was nearly impossible to check information such as
required alimony or child support. In addition, these commenters were
concerned about potentially changing DTIs between origination and
securitization. Commenters also asserted that in practice, only the
most marginal of automobile lending used income or employment
verification. Some automobile sponsor commenters said the industry does
not use DTIs in prime automobile origination because they do not
believe it is predictive of default, and that the agencies should
instead adopt the established industry practice of setting FICO score
thresholds as an indicator of ability to repay.
    The agencies have considered these comments, but continue to
believe that assessing a borrower's ability to repay is important in
setting underwriting criteria to identify automobile loans that would
not be subject to risk retention. DTI is a meaningful figure in
calculating a customer's ability to repay a loan, and therefore the
agencies continue to propose the same DTI requirement as in the
original proposal. As discussed in more detail, the agencies also
observe that they generally do not believe it would be appropriate to
include a standard based on FICO scores in the QAL underwriting
standards, because it would tie a regulatory requirement to third
party, private industry models.
2. Loan Terms
    Under the original proposal, QAL interest rates and payments would
have had to be fixed over the term of the loan. In addition, the loan
would have had to be amortized on a straight-line basis over the term.
Loans could not have exceeded five years (60 months); for used car
loans, the maximum term would have been one year shorter for every year
difference between the current year and the used car's model year.
Furthermore, the terms would have required that the originator, or
agent, to retain physical possession of the title until full repayment.
    While commenters supported the proposed requirements for fixed
interest rates and fixed monthly payments, most commenters opposed one
or more of the additional proposed QAL loan terms. The straight-line
amortization requirement was the most problematic issue for commenters.
Commenters asserted that automobile loans are generally amortized using
the simple interest method with fixed, level payments and that the
simple interest method provides that earlier payments would amortize
less principal, and later payments would amortize more principal,
rather than a straight-line amortization as proposed by the agencies.
    In addition, many commenters were concerned that numerous states
require the vehicle's owner (borrower) to retain the physical title,
and that some states are moving to issue electronic titles that cannot
have a physical holder. These commenters suggested revising the
proposed rule to either remove the requirement, or condition it on
compliance with applicable state law.
    Many commenters also opposed the 60-month maximum loan term,
stating that current industry standards allow for 72-month loans. Some
commenters believed that the used-car restrictions were too harsh,
citing the ``certified pre-owned'' programs available for most used
cars and longer car lives in general. These commenters suggested either
removing the used car term restriction, or else loosening the standard
to exclude from QALs used cars over six years old, rather than over
five years old, as proposed by the agencies. Commenters also suggested
a technical change to require the first payment within 45 days of the
contract date rather than on the closing date.
    The agencies have considered these comments and are proposing the
QAL standards with some modifications to the original proposal's
standards. Instead of a straight-line amortization requirement, the
agencies are proposing a requirement that borrowers make level monthly
payments that fully amortize the automobile loan over its term. Second,
the agencies are replacing the requirement in the original proposal
that the originator retain physical title with a proposed requirement
that the lender comply with appropriate state law for recording a lien
on the title. Third, the agencies are proposing to expand the maximum
allowable loan term for QALs to the lesser of six years (72 months) or
10 years less the vehicle's age (current model year less vehicle's
model year). Due to this modification, there would no longer be a
distinction between new vehicles and

used vehicles for the QAL definition. Finally, the agencies are
proposing that payment timing be based on the contract date.
3. Reviewing Credit History
    In the original proposal, an originator would have been required to
verify, within 30 days of originating a QAL, that the borrower was not
30 days or more past due; was not more than 60 days past due over the
past two years; and was not a judgment debtor or in bankruptcy in the
past three years. The agencies also proposed a safe harbor requiring
the originator to review the borrower's credit reports from two
separate agencies, both showing the borrower complies with the past-due
standards. Also, the agencies proposed a requirement that all QALs be
current at the closing of the securitization.
    Commenters were concerned that these criteria in the original
proposal were so strict as to require them to follow the safe harbor.
They indicated substantial risk that they may make a QAL, but then
within 30 days after the loan, review the credit history and note a
single 30-day late payment, thus disqualifying the loan for QAL status.
To avoid this outcome, commenters (including some investors) suggested
removing the 30-day past due criteria, also citing their belief that
many otherwise creditworthy borrowers could have inadvertently missed a
single payment within that timeframe. Some sponsor commenters favored
elimination of the credit disqualification standards entirely in favor
of a FICO cutoff; some investor commenters acknowledged the established
role of FICO but favored maintaining most of the disqualification
standards in addition to FICO.
    On the assumption that all originators would rely on the credit
report safe harbor, commenters asserted that the requirement to obtain
reports from two separate credit reporting agencies unnecessarily
increased costs. These commenters stated that so much information is
shared among the credit reporting agencies, that two credit reports are
no more predictive than one report of the creditworthiness of a
borrower. The commenters also stated that this report should be
obtained within 30 days of the contract date, rather than within 90
days as proposed.
    Some commenters also opposed the requirement in the original
proposal that borrowers remain current when the securitization closes.
These commenters stated that securitizations have a ``cutoff'' date
before the closing date, when all the QALs would be pooled and
information verified. It would be possible for a loan to become late
between the cutoff and closing date without the sponsor knowing until
after closing. Instead, sponsors suggested replacing the proposed rule
requirement with a representation made by the sponsor that no loan in
the securitized pool is more than 30 days past due at cutoff, with the
securitizer being required to verify that representation for each loan
no more than 62 days from the securitization's closing date.
    The agencies believe that a QAL should meet conservative
underwriting criteria, including that the borrower not be more than 30
days late. However, to reduce the burden associated with reviewing
credit reports for those delinquencies, the agencies are proposing to
require only one credit report rather than two, and that the report be
reviewed within 30 days of the contract date, as requested by
commenters. The agencies are proposing the same requirements as in the
original proposal for verification that the automobile loan is current
when it is securitized. The agencies believe a securitization exempt
from risk retention should contain only current automobile loans.
    Finally, the agencies are not proposing requirements that would
rely on proprietary credit scoring systems or underwriting systems. The
agencies recognize that much of the current automobile lending industry
relies heavily or solely on a FICO score to approve automobile loans.
However, the agencies do not believe that a credit score alone is
sufficient underwriting for a conservative automobile loan with a low
risk of default. Furthermore, the agencies do not believe it is
appropriate to establish regulatory requirements that use a specific
credit scoring product from a private company, especially one not
subject to any government oversight or investor review of its scoring
model. The agencies believe that the risks to investors of trusting in
such proprietary systems and models weighs against this alternative,
and does not provide the transparency of the bright line underwriting
standards proposed by the agencies.
4. Loan-to-Value
    In the original proposal, the agencies proposed to require
automobile loan borrowers to pay 100 percent of the taxes, title costs,
and fees, in addition to 20 percent of the net purchase price (gross
price less manufacturer and dealer discounts) of the car. For used
cars, the purchase price would have been the lesser of the actual
purchase price or a value from a national pricing service.
    Most commenters opposed the down payment and loan-to-value
requirements. These commenters cited current automobile industry
practices where up to 100 percent of the purchase price of the car is
financed, along with taxes, title costs, dealer fees, accessories, and
warranties. Some commenters proposed eliminating the LTV entirely, or
replacing it with a less conservative standard.
    The agencies have considered the comments and the underwriting
standards and have concluded that a lower down payment could be
required without a significant decline in the credit quality of a QAL.
Therefore, the agencies are proposing a down payment of at least 10
percent of the purchase price of the vehicle, plus 100 percent of all
taxes, fees, and extended warranties. The agencies do not believe that
a collateralized loan with an LTV over 90 percent would be low-risk,
and that a customer should put some of the customer's own cash into the
deal to reduce risks for strategic default and incent repayment of the
loan. The agencies would also define purchase price consistently across
new and used vehicles to equal the price negotiated with the dealer
less any manufacturer rebates.
Request for Comment
    83(a). Are the revisions to the qualifying automobile loan
exemption appropriate? 83(b). If not, how can they be modified to more
appropriately reflect industry standards?
    84. Are all the proposed underwriting criteria appropriate?

D. Qualifying Asset Exemption

    As discussed above, numerous industry and sponsor commenters on the
original proposal for reduced risk retention requirements for
commercial, CRE, and automobile loans asserted that the requirement
that all assets in a collateral pool must meet the proposed
underwriting standards (qualifying assets) to exempt the securitization
transaction from risk retention was too stringent. These commenters
stated that requiring every asset in a collateral pool to meet the
proposed conservative underwriting requirements would make it difficult
to obtain a large enough pool of qualifying assets to issue a
securitization in a timely manner, and therefore some originators would
not underwrite to the qualifying asset standards. These commenters
suggested that the agencies allow a proportional reduction in required
risk retention for those assets in a collateral pool that met the
proposed underwriting standards. For example, if a pool contained 20

percent automobile loans that are qualifying assets and 80 percent of
other automobile loans, only 80 percent of the pool would be subject a
risk retention requirement.
    Commenters representing investors in securitization transactions
generally opposed blended pools of qualifying assets and other assets.
These investors stated that blending could allow sponsors too much
latitude to mix high-quality qualifying assets, which may pay down
first, with low-quality non-qualifying assets, which would create
significant risk of credit loss for investors over the course of the
transaction.
    The agencies have carefully considered the comments and are
proposing to apply a 0 percent risk retention requirement to qualifying
assets, where both qualifying assets and non-qualifying assets secure
an asset-backed security.\128\ Any non-qualifying assets that secure an
asset-backed security would be subject to the full risk retention
requirements in the proposed rule, including hedging and transfer
restrictions.
---------------------------------------------------------------------------

    \128\ Under 15 U.S.C. 78o-11(c)(1)(B)(ii), the agencies may
require a sponsor to retain less than 5 percent of the credit risk
for an asset that securitizes an asset-backed security, if the asset
meets the underwriting standards established by the agencies under
15 U.S.C. 78o-11(c)(2)(B). Accordingly, the agencies are proposing
to require 0 percent risk retention with respect to any asset
securitizing an asset-backed security that meet the proposed
underwriting standards for automobile loans, commercial loans, or
commercial real estate loans. See 15 U.S.C. 78o-11(c)(1)(B)(ii). The
agencies also believe that exempting qualifying assets from risk
retention would be consistent with 15 U.S.C. 78o-11(e) and the
purposes of the statute. The agencies believe the exemption could,
in a direct manner, help ensure high-quality underwriting standards
for assets that are available for securitization, and create
additional incentives under the risk retention rules for these high-
quality assets to be originated in the market. The agencies further
believe such an exemption would encourage appropriate risk
management practices by securitization sponsors and asset
originators, by establishing rigorous underwriting standards for the
exempt assets and providing additional incentives for these
standards to take hold in the marketplace.
---------------------------------------------------------------------------

    The agencies believe that applying a 0 percent risk retention
requirement to assets that meet the proposed underwriting standards
would be appropriate given the very high credit quality of such assets.
In addition, allowing both qualifying and non-qualifying assets to
secure an asset-backed security should promote liquidity in the
relevant securitization markets without harming the goals of risk
retention requirement. The agencies understand that a lender may not be
able to originate, or a sponsor aggregate, an entire pool of qualifying
assets within a reasonable amount of time to promote efficient
securitization. The agencies believe that the proposal to apply a 0
percent risk retention requirement to qualifying assets would likely
enhance the liquidity of loans underwritten to the qualifying asset
underwriting standards, thereby encouraging originators to underwrite
more qualifying assets of high credit quality.
    The agencies recognize that section 15G is generally structured in
contemplation of pool-level exemptions, and that investors, whom the
statute is designed to protect, expressed some preference during the
agencies' initial proposal for a pool-level approach. The agencies
believe the structure of the proposal could offset these concerns. The
agencies are proposing to reduce the sponsor's 5 percent risk retention
requirement by the ratio of the combined unpaid principal balance (UPB)
of qualified loans bears to the total UPB of the loans in the
pool.\129\ The agencies believe this method is more appropriate than a
system based on the absolute number of qualifying loans in the pool, as
a sponsor could create a pool with a large number of small value
qualifying loans combined with a few low-quality loans with large
principal balances. The agencies have also considered an ``average
balance'' approach as an alternative, but are concerned that it could
be used to reduce overall risk retention on pools of loans with
disparate principal balances skewed towards a few large non-qualified
loans.
---------------------------------------------------------------------------

    \129\ If a $100 million pool of commercial mortgages included a
sum total of $20 million of qualified commercial mortgages (by UPB),
the ratio would be 1/5, and the sponsor could reduce its 5 percent
risk retention requirement by one-fifth, for a retention holding
requirement of 4 percent.
---------------------------------------------------------------------------

    To address transparency concerns, the agencies are proposing that
sponsors of asset-backed securities that are secured by both qualifying
and non-qualifying assets disclose to investors, their primary Federal
regulator (as appropriate), and the Commission the manner in which the
sponsor determined the aggregate risk retention requirement for the
pool after including qualifying assets with 0 percent risk retention, a
description of the qualified and nonqualified assets groups, and any
material differences between them with respect to the composition of
each group's loan balances, loan terms, interest rates, borrower credit
information, and characteristics of any loan collateral.
    The agencies would not make blended pool treatment available for
securitizations of loans from different asset classes (i.e., automobile
and commercial) that secure the same asset-backed security. The
agencies believe that blending across asset classes would significantly
reduce transparency to investors. In addition, the agencies are also
considering imposing a limit on the amount of qualifying assets a
sponsor could include in any one securitization involving blended pools
through a 2.5 percent risk retention minimum for any securitization
transaction, but the agencies are also considering the possibility of
raising or lowering that limit by 1 or more percent. The agencies
recognize that it might be useful for sponsors acting on a transparent
basis to attempt to allay moderate investor reservations about some
assets in a pool by including other high-quality assets. However, one
consistent theme in the agencies consideration of risk retention has
been to require sponsors to hold a meaningful exposure to all assets
they securitize that are subject to the full risk retention
requirement. The agencies are concerned that providing sponsors
unlimited flexibility with respect to mixing qualifying and non-
qualifying collateral pools could create opportunities for practices
that would be inconsistent with this over-arching principle.
    The agencies also acknowledge investor concerns about mixing
qualifying and non-qualifying assets, as noted above. For example, some
investors commenting on the original proposal expressed concern that
sponsors might be able to manipulate such combinations to achieve
advantages that are not easily discernible to investors, such as mixing
high-quality shorter-term assets with lower-quality longer-term assets.
In this regard, the agencies observe the Commission's current proposal
on loan level disclosures to investors in asset-backed securities
represents a mechanism by which investors would obtain a more detailed
view of loans in the pool than they sometimes did in prior
markets.\130\ However the agencies remain concerned about potential
abuses of this aspect of the proposed rule and seek comment on how to
address this issue beyond the disclosure requirements already included
in the proposed rule. For example, an additional requirement that
qualifying assets and non-qualifying assets in the same collateral pool
do not have greater than a one year difference in maturity might
alleviate some investor concerns.

Additional disclosure requirements might also alleviate this concern.
---------------------------------------------------------------------------

    \130\ See Asset-Backed Securities, Release Nos. 33-9117, 34-
61858, 75 FR 23328 (May 3, 2010), and Re-proposal of Shelf
Eligibility Conditions for Asset-Backed Securities and Other
Additional Requests for Comment, Release Nos. 33-9244, 34-64968, 76
FR 47948 (August 5, 2011).
---------------------------------------------------------------------------

    In addition, the agencies are proposing (consistent with the
original proposal) that securitization transactions that are
collateralized solely by qualifying assets (of the same asset class)
and servicing assets would be exempt from the risk retention
requirements of the proposed rule.
Request for Comment
    85. Commenters on the QRM approach contained in the agencies'
original proposal requested that the agencies permit blended pools for
RMBS. The agencies invite comment on whether and, if so how, such an
approach may be constructed where the underlying assets are residential
mortgages, given the provisions of paragraph (c)(1)(B)(i)(II) and the
exemption authority in paragraph (c)(2)(B), (e)(1) and (e)(2) of
Section 15G.
    86(a). How should the proportional reduction in risk retention be
calculated? 86(b). What additional disclosures should the agencies
require for collateral pools that include both qualifying and non-
qualifying assets? 86(c). How would these additional disclosures
enhance transparency and reduce the risk of sponsors taking advantage
of information asymmetries? 86(d). Should a collateral pool that
secures asset-backed securities be subject to a minimum total risk
retention requirement of 2.5 percent? 86(e). If not, what would be an
appropriate limit on the amount of qualifying assets that may be
included in a collateral pool subject to 0 percent risk retention?
86(f). What other limiting mechanisms would be appropriate for mixed
collateral pools?
    87(a). Would a maturity mismatch limit such as the one discussed
above (such that qualifying and non-qualifying assets do not have a
difference in maturity of more than one year) be an appropriate
requirement for collateral pools containing qualifying and non-
qualifying assets? 87(b). How should such a limit be structured? 87(c).
What other limits would be appropriate to address the investor and
agency concerns discussed above?

E. Buyback Requirement

    The original proposal provided that, if after issuance of a
qualifying asset securitization, it was discovered that a loan did not
meet the underwriting criteria, the sponsor would have to repurchase
the loan. Industry commenters asserted that if the agencies retained
this requirement, it should include a materiality standard.
Alternately, these groups suggested that the agencies allow curing
deficiencies in the underwriting or loans instead of requiring buyback.
Finally, industry commenters stated that they should not be responsible
for post-origination problems with qualifying loans, and expressed
concern that investors may seek to use the buyback requirement to make
the sponsor repurchase poorly performing assets that met all the
requirements at origination. Investor commenters, on the other hand,
supported the buyback requirement as the sole remedy, and they opposed
relying solely on representations and warranties.
    The agencies have observed that during the recent financial crisis,
investors who sought a remedy through representations and warranties
often struggled through litigation with the sponsor or originator.
Requiring the prompt repurchase of non-qualifying loans affords
investors a clear path to remedy problems in the original underwriting.
Therefore, the agencies are again proposing a buyback requirement for
commercial, CRE, and automobile loans subsequently found not to meet
the underwriting requirements for an exemption to the risk retention
requirements. However, the agencies also agree with the sponsor
commenters that buyback should not be the sole remedy, and therefore
are proposing to allow a sponsor the option to cure a defect that
existed at the time of origination to bring the loan into conformity
with the proposed underwriting standards. Curing a loan should put the
investor in no better or worse of a position than if the loan had been
originated correctly. Some origination deficiencies may not be able to
be cured after origination, and so for those deficiencies, buyback
would remain the sole remedy.
    The agencies also agree that buyback or cure should occur only when
there are material problems with the qualifying loan that caused it not
to meet the qualifying standards at origination. The agencies are not
proposing any specific materiality standards in the rule, but believe
that sponsors and investors could be guided by standards of
materiality.\131\
---------------------------------------------------------------------------

    \131\ See, e.g., TSC Industries, Inc. v. Northway, Inc., 426
U.S. 438 (1976).
---------------------------------------------------------------------------

    Finally, as the agencies explained in the original proposal, the
underwriting requirements need to be met only at the origination of the
loan. Subsequent performance of the loan, absent any failure to meet
the underwriting requirements at origination or failure of the loan to
be current at the time of origination, would not be grounds for a loan
buyback or cure. The borrower's failure to meet its continuing
obligations under the loan document covenants required for qualifying
loan treatment, such as the requirement for periodic financial
statements for CRE loans, would also not be grounds for a buyback or
cure if the loan terms at origination appropriately imposed the
obligation on the borrower.
Request for Comment
    88. The agencies request comment on the buyback provision for
qualifying loans, including on the proposed changes discussed above to
allow cure and to incorporate a materiality standard.

VI. Qualified Residential Mortgages

A. Overview of Original Proposal and Public Comments

    Section 15G of the Exchange Act exempts sponsors of securitizations
from the risk retention requirements if all of the assets that
collateralize the securities issued in the transaction are QRMs.\132\
Section 15G directs the agencies to define QRM jointly, taking into
consideration underwriting and product features that historical loan
performance data indicate result in a lower risk of default. In
addition, section 15G requires that the definition of a QRM be ``no
broader than'' the definition of a QM.\133\
---------------------------------------------------------------------------

    \132\ See 15 U.S.C. 78o-11(c)(1)(C)(iii).
    \133\ See id. at section 78o-11(e)(4).
---------------------------------------------------------------------------

    In developing the definition of a QRM in the original
proposal,\134\ the agencies articulated several goals and principles.
First, the agencies stated that QRMs should be of very high credit
quality, given that Congress exempted QRMs completely from the credit
risk retention requirements. Second, the agencies recognized that
setting fixed underwriting rules to define a QRM could exclude many
mortgages to creditworthy borrowers. In this regard, the agencies
recognized that a trade-off exists between the lower implementation and
regulatory costs of providing fixed and simple eligibility requirements
and the lower probability of default attendant to requirements that
incorporate detailed and compensating underwriting factors. Third, the
agencies sought to preserve a sufficiently large population of non-QRMs
to help enable the market for securities backed by non-QRM mortgages to
be relatively liquid. Fourth, the agencies sought to implement
standards that would be

transparent and verifiable to participants in the market.
---------------------------------------------------------------------------

    \134\ See Original Proposal, 76 FR at 24117.
---------------------------------------------------------------------------

    The agencies also sought to implement the statutory requirement
that the definition of QRM be no broader than the definition of a QM,
as mandated by the Dodd-Frank Act.\135\ Under the original proposal,
the agencies proposed to incorporate the statutory QM standards, in
addition to other requirements, into the definition of a QRM and apply
those standards strictly in setting the QRM requirements to ensure that
the definition of QRM would be no broader than the definition of a QM.
The agencies noted in the original proposal that they expected to
monitor the rules adopted under TILA to define a QM and review those
rules to determine whether changes to the definition of a QRM would be
necessary or appropriate.
---------------------------------------------------------------------------

    \135\ See 15 U.S.C. 78o-11(e)(4)(C). At the time of issuance of
the original proposal on April 29, 2011, the Board had sole
rulemaking authority for defining QM, which authority transferred to
CFPB on July 21, 2011, the designated transfer date under the Dodd-
Frank Act.
---------------------------------------------------------------------------

    In considering how to determine if a mortgage is of sufficient
credit quality, the agencies examined data from several sources.\136\
Based on these and other data, the agencies originally proposed
underwriting and product features that were robust standards designed
to ensure that QRMs would be of very high credit quality.\137\ A
discussion of the full range of factors that the agencies considered in
developing a definition of a QRM can be found in the original
proposal.\138\
---------------------------------------------------------------------------

    \136\ As provided in the original proposal, the agencies
reviewed data supplied by McDash Analytics, LLC, a wholly owned
subsidiary of Lender Processing Services, Inc. (LPS), on prime
fixed-rate loans originated from 2005 to 2008, which included
underwriting and performance information on approximately 8.9
million mortgages; data from the 1992 to 2007 waves of the triennial
Survey of Consumer Finances (SCF), which focused on respondents who
had purchased their homes either in the survey year or the previous
year, and included information on approximately 1,500 families; and
data regarding loans purchased or securitized by the Enterprises
from 1997 to 2009, which consisted of more than 78 million
mortgages, and included data on loan products and terms, borrower
characteristics (e.g., income and credit score), and performance
data through the third quarter of 2010. See 76 FR at 24152.
    \137\ The agencies acknowledged in the original proposal that
any set of fixed underwriting rules likely would exclude some
creditworthy borrowers. For example, a borrower with substantial
liquid assets might be able to sustain an unusually high DTI ratio
above the maximum established for a QRM. As this example indicates,
in many cases sound underwriting practices require judgment about
the relative weight of various risk factors (e.g., the tradeoff
between LTV and DTI ratios). These decisions are usually based on
complex statistical default models or lender judgment, which will
differ across originators and over time. However, incorporating all
of the tradeoffs, that may prudently be made as part of a secured
underwriting process into a regulation would be very difficult
without introducing a level of complexity and cost that could
undermine any incentives for sponsors to securitize, and originators
to originate, QRMs. See Original Proposal, 76 FR at 24118.
    \138\ See Original Proposal, 76 FR at 24117-29.
---------------------------------------------------------------------------

    The agencies originally proposed to define QRM to mean a closed-end
credit transaction to purchase or refinance a one-to-four family
property at least one unit of which is the principal dwelling of a
borrower that was not: (i) Made to finance the initial construction of
a dwelling; (ii) a reverse mortgage; (iii) a temporary or ``bridge''
loan with a term of 12 months or less, such as a loan to purchase a new
dwelling where the borrower plans to sell a current dwelling within 12
months; or (iv) a timeshare plan described in 11 U.S.C. 101(53D).\139\
In addition, under the original proposal, a QRM (i) must be a first
lien transaction with no subordinate liens; (ii) have a mortgage term
that does not exceed 30 years; (iii) have maximum front-end and back-
end DTI ratios of 28 percent and 36 percent, respectively; \140\ (iv)
have a maximum LTV ratio of 80 percent in the case of a purchase
transaction, 75 percent in the case of rate and term refinance
transactions, and 70 percent in the case of cash out refinancings; (v)
include a 20 percent down payment from borrower funds in the case of a
purchase transaction; and (vi) meet certain credit history
restrictions.\141\
---------------------------------------------------------------------------

    \139\ See id. at 24166.
    \140\ A front-end DTI ratio measures how much of the borrower's
gross (pretax) monthly income is represented by the borrower's
required payment on the first-lien mortgage, including real estate
taxes and insurance. A back-end debt-to-income ratio measures how
much of a borrower's gross (pretax) monthly income would go toward
monthly mortgage and nonmortgage debt service obligations.
    \141\ In order to facilitate the use of these standards for QRM
purposes, the original proposal included as an appendix to the
proposed rule (Additional QRM Standards Appendix) all of the
standards in the HUD Handbook 4155-1 that are used for QRM purposes.
(See HUD Handbook, available at http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/handbooks/hsgh/4155.1.) The only modifications made to the relevant standards in
the HUD Handbook would be those necessary to remove those portions
unique to the FHA underwriting process (e.g., TOTAL Scorecard
instructions). See discussion in the Original Proposal, 76 FR at
24119.
---------------------------------------------------------------------------

    The agencies sought comment on the overall approach to defining QRM
as well as on the impact of the QRM definition on the securitization
market, mortgage pricing, and credit availability, including to low-to-
moderate income borrowers. The agencies further requested comment on
the proposed eligibility criteria of QRMs, such as the LTV, DTI, and
borrower credit history standards.
    The scope of the QRM definition generated a significant number of
comments. Some commenters expressed support for the overall proposed
approach to QRM, including the 20 percent down payment requirement of
the QRM definition. These commenters asserted that an LTV requirement
would be clear, objective, and relatively easy to implement, and
represent an important determinant of a loan's default probability.
    However, the overwhelming majority of commenters, including
individuals, industry participants (e.g., real estate brokers, mortgage
bankers, securitization sponsors), insurance companies, public interest
groups, state agencies, financial institutions and trade organizations,
opposed various aspects of the originally proposed approach to defining
QRM. In addition, many members of Congress commented that the proposed
20 percent down payment requirement was inconsistent with legislative
intent, and strongly urged the agencies to eliminate or modify the down
payment requirement.
    Many commenters argued that the proposed QRM definition was too
narrow, especially with respect to the LTV and DTI requirements. Many
of these commenters asserted that the proposed QRM definition would
prevent recovery of the housing market by restricting available credit,
and as a result, the number of potential homebuyers. These commenters
also argued that the proposed definition of QRM, especially when
combined with the complexities of the proposed risk retention
requirement that would have applied to non-QRMs, would make it
difficult for private capital to compete with the Enterprises and thus,
impede the return of private capital to the mortgage market. Many also
asserted that the proposed LTV and DTI requirements favored wealthier
persons and disfavored creditworthy low- and moderate-income persons
and first-time homebuyers. A number of commenters believed that LTV and
DTI elements of the proposed QRM definition would not only affect
mortgages originated for securitization, but would likely also be
adopted by portfolio lenders, magnifying the adverse effects described
above. Other commenters claimed that the proposed QRM definition and
proposed risk retention requirements would harm community banks and
credit unions by increasing costs to those who purchase loans
originated by these smaller institutions.
    Some commenters urged the agencies to implement a more qualitative
QRM standard with fewer numerical thresholds. Others argued for a
matrix

system that would weigh compensating factors, instead of using an all-
or-nothing approach to meeting the threshold standards. Commenters
stated that requiring borrowers to put down more cash for a rate-and-
term refinancing may prevent them from refinancing with safer and more
economically desirable terms. Commenters were also critical of the
proposed credit history requirements (in particular, the 30-day past
due restriction), and the points and fees component of the proposed QRM
definition.
    Although a few commenters supported the inclusion of servicing
standards in the QRM definition under the original proposal, the
majority of those who submitted comment on this subject opposed the
proposed servicing standards for a variety of reasons. For example,
commenters asserted that servicing standards were not an underwriting
standard or product feature, and were not demonstrated to reduce the
risk of default. In addition, commenters stated that the proposed
standards were too vague for effective compliance, and that the
proposed rule's approach of requiring them to be terms of the mortgage
loan would prevent future improvements in servicing from being
implemented with respect to QRMs.
    Many commenters urged the agencies to postpone finalizing the QRM
definition until after the QM definition was finalized. Many commenters
also advocated for the agencies to align the QRM definition to the QM
definition.

B. Approach to Defining QRM

    In determining the appropriate scope of the proposed QRM
definition, the agencies carefully weighed a number of factors,
including commenters' concerns, the cost of risk retention, current and
historical data on mortgage lending and performance, and the recently
finalized QM definition and other rules addressing mortgages. For the
reasons discussed more fully below, the agencies are proposing to
broaden and simplify the scope of the QRM exemption from the original
proposal and define ``qualified residential mortgage'' to mean
``qualified mortgage'' as defined in section 129C of TILA \142\ and
implementing regulations, as may be amended from time to time.\143\ The
agencies propose to cross-reference the definition of QM, as defined by
the CFPB in its regulations, to minimize potential for future conflicts
between the QRM standards in the proposed rule and the QM standards
adopted under TILA.
---------------------------------------------------------------------------

    \142\ 15 U.S.C. 1639c.
    \143\ See Final QM Rule.
---------------------------------------------------------------------------

    The risk retention requirements are intended to address problems in
the securitization markets by requiring securitizers to generally
retain some economic interest in the credit risk of the assets they
securitize (i.e., have ``skin in the game''). Section 15G of the
Exchange Act requires the agencies to define a QRM exception from the
credit risk retention requirement, taking into consideration
underwriting and product features that historical loan performance data
indicate result in a lower expected risk of default. The requirements
of the QM definition are designed to help ensure that borrowers are
offered and receive residential mortgage loans on terms that reasonably
reflect their financial capacity to meet the payment obligations
associated with such loans. The QM definition excludes many loans with
riskier product features, such as negative amortization and interest-
only payments, and requires consideration and verification of a
borrower's income or assets and debt. This approach both protects the
consumer and should lead to lower risk of default on loans that qualify
as QM.
    As discussed more fully below, the agencies believe a QRM
definition that aligns with the definition of a QM meets the statutory
goals and directive of section 15G of the Exchange Act to limit credit
risk, preserves access to affordable credit, and facilitates
compliance.
1. Limiting Credit Risk
    Section 129(C)(a) of TILA, as implemented by 12 CFR 1026.43(c),
requires lenders to make a ``reasonable and good faith determination''
that a borrower has the ability to repay a residential mortgage loan.
The QM rules provide lenders with a presumption of compliance with the
ability-to-repay requirement. Together, the QM rules and the broader
ability-to-repay rules restrict certain product features and lax
underwriting practices that contributed significantly to the
extraordinary surge in mortgage defaults that began in 2007.\144\
---------------------------------------------------------------------------

    \144\ See Christopher Mayer, Karen Pence, and Shane M. Sherlund,
``The Rise in Mortgage Defaults, Journal of Economic Perspectives,
23(1), 27-50 (Winter 2009).
---------------------------------------------------------------------------

    The QM rule does this, in part, by requiring documentation and
verification of consumers' debt and income.\145\ To obtain the
presumption of compliance with the ability-to-repay requirement as a
QM, the loan must have a loan term not exceeding 30 years; points and
fees that generally do not exceed 3 percent; \146\ and not have risky
product features, such as negative amortization, interest-only and
balloon payments (except for those loans that qualify for the
definition of QM that is only available to eligible small portfolio
lenders).\147\ Formal statistical models indicate that mortgages that
do not meet these aspects of the QM definition rule are associated with
a higher probability of default.\148\
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    \145\ See generally 12 CFR 1026.43(c).
    \146\ The QM definition provides a tiered-cap for points and
fees for loan amounts less than $100,000. See id. at 1026.43(e)(3).
    \147\ See 78 FR 35430 (June 12, 2013). In addition, the loan
must have consumer debt payments that represent 43 percent or less
of a borrower's income, or the loan must be eligible for purchase,
guarantee or insurance by an Enterprise, HUD, the U.S. Department of
Veteran Affairs, the U.S. Department of Agriculture, or the Rural
Housing Service. See 12 CFR 1026.43(e)(2)(vi).
    \148\ See Shane M. Sherlund, ``The Past, Present, and Future of
Subprime Mortgages,'' Finance and Economics Discussion Series, Paper
2008-63 available at http://www.federalreserve.gov/pubs/feds/2008/200863/200863pap.pdf; Ronel Elul, Nicholas S. Souleles, Souphala
Chomsisengphet, Dennis Glennon, and Robert Hunt. ``What `Triggers'
Mortgage Default?'' American Economic Review 100(2), 490-494 (May
2010).
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    Consistent with these statistical models, historical data indicate
that mortgages that meet the QM criteria have a lower probability of
default than mortgages that do not meet the criteria. This pattern is
most pronounced for loans originated near the peak of the housing
bubble, when non-traditional mortgage products and lax underwriting
proliferated. For example, of loans originated from 2005 to 2008, 23
percent of those that met the QM criteria experienced a spell of 90-day
or more delinquency or a foreclosure by the end of 2012, compared with
44 percent of loans that did not meet the QM criteria.\149\
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    \149\ For purposes of this calculation, mortgages that do not
meet the QM criteria are those with negative amortization, balloon,
or interest-only features; those with no documentation; and those
with DTI ratios in excess of 43 percent that were not subsequently
purchased or guaranteed by the Enterprises or the FHA. Because of
data limitations, loans with points and fees in excess of 3 percent
and low-documentation loans that do not comply with the QM
documentation criteria may be erroneously classified as QMs. The
default estimates are based on data collected from mortgage
servicers by Lender Processing Services and from securitized pools
by CoreLogic. These data will under-represent mortgages originated
and held by small depository institutions and adjustable-rate
mortgages guaranteed by the FHA. The difference between delinquency
statistics for QM and non-QM mortgages is consistent with a
comparable tabulation estimated on loans securitized or purchased by
the Enterprises. In the Enterprise analysis for loans originated
from 2005 to 2008, 14 percent of those that met the QM criteria,
compared with 33 percent of loans that did not meet the QM criteria,
experienced a 90-day or more delinquency or a foreclosure by the end
of 2012.
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    In citing these statistics, the agencies are not implying that they
consider a 23

percent default rate to be an acceptable level of risk. The expansion
in non-traditional mortgages and the lax underwriting during this
period facilitated the steep rise in house prices and the subsequent
sharp drop in house prices and surge in unemployment, and the default
rates reflect this extraordinary macroeconomic environment. This point
is underscored by the superior performance of more recent mortgage
vintages. For example, of prime fixed-rate mortgages that comply with
the QM definition, an estimated 1.4 percent of those originated from
2009 to 2010, compared with 16 percent of those originated from 2005 to
2008, experienced a 90-day or more delinquency or a foreclosure by the
end of 2012.\150\
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    \150\ The higher default rate for the loans originated from 2005
to 2008 may reflect the looser underwriting standards in place at
that time and the greater seasoning of these loans in addition to
the changes in the macroeconomic environment. The estimates are
shown only for prime fixed-rate mortgages because these mortgages
have made up almost all originations since 2008.
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    In the original proposal, the criteria for a QRM included an LTV
ratio of 80 percent or less for purchase mortgages and measures of
solid credit history that evidence low credit risk. Academic research
and the agencies' own analyses indicate that credit history and the LTV
ratio are significant factors in determining the probability of
mortgage default.\151\ However, these additional credit overlays may
have ramifications for the availability of credit that many commenters
argued were not outweighed by the corresponding reductions in
likelihood of default from including these determinants in the QRM
definition.
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    \151\ See Original Proposal, 76 FR at 24120-24124.
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    Moreover, the QM definition provides protections against mortgage
default that are consistent with the statutory requirements. As noted
above, risk retention is intended to align the interests of
securitization sponsors and investors. Misalignment of these interests
is more likely to occur where there is information asymmetry, and is
particularly pronounced for mortgages with limited documentation and
verification of income and debt. Academic studies suggest that
securities collateralized by loans without full documentation of income
and debt performed significantly worse than expected in the aftermath
of the housing boom.\152\
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    \152\ See Benjamin J. Keys, Amit Seru, and Vikrant Vig, ``Lender
Screening and the Role of Securitization: Evidence from Prime and
Subprime Mortgage Markets,'' Review of Financial Studies, 25(7)
(July 2012); Adam Ashcraft, Paul Goldsmith-Pinkham, and James
Vickery, ``MBS Ratings and the Mortgage Credit Boom,'' Federal
Reserve Bank of New York Staff Report 449 (2010), available at
http://www.newyorkfed.org/research/staff_reports/sr449.html.
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    The QM definition limits the scope of this information asymmetry
and misalignment of interests by requiring improved verification of
income and debt. An originator that does not follow these verification
requirements, in addition to other QM criteria, may be subject under
TILA to potential liability and a defense to foreclosure if the
consumer successfully claims he or she did not have the ability to
repay the loan.\153\ The potential risk arising from the consumer's
ability to raise a defense to foreclosure extends to the creditor,
assignee, or other holder of the loan for the life of the loan, and
thereby may provide originators and their assignees with an incentive
to follow verification and other QM requirements scrupulously.\154\
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    \153\ See sections 130(a) and 130(k) of TILA, 15 U.S.C. 1640.
    \154\ There are limits on the exposure to avoid unduly
restricting market liquidity.
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    Other proposed and finalized regulatory changes are also intended
to improve the quality and amount of information available to investors
in QRM and non-QRM residential mortgage securitizations and incentivize
originators and servicers to better manage mortgage delinquencies and
potential foreclosures. These improvements may help to lessen the
importance of broad ``skin in the game'' requirements on sponsors as an
additional measure of protection to investors and the financial
markets. For example, the Commission has proposed rules that, if
finalized, would require in registered RMBS transactions disclosure of
detailed loan-level information at the time of issuance and on an
ongoing basis. The proposal also would require that securitizers
provide investors with this information in sufficient time prior to the
first sale of securities so that they can analyze this information when
making their investment decision.\155\ In addition, the CFPB has
finalized loan originator compensation rules that help to reduce the
incentives for loan originators to steer borrowers to unaffordable
mortgages \156\ as well as mortgage servicing rules that provide
procedures and standards that servicers must follow when working with
troubled borrowers in an effort to avoid unnecessary foreclosures.\157\
The Enterprises and the mortgage industry also have improved standards
for due diligence, representations and warrants, appraisals, and loan
delivery data quality and consistency.
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    \155\ See Asset-Backed Securities, Release Nos. 33-9117, 34-
61858 75 FR 23328 at 23335, 23355 (May 3, 2010).
    \156\ See Loan Originator Compensation Requirements Under the
Truth in Lending Act (Regulation Z); Final Rules, 78 FR 11280 (Feb.
15, 2013).
    \157\ See Mortgage Servicing Rules Under the Truth in Lending
Act (Regulation Z); Final Rule, 78 FR 10902 (Feb. 14, 2013);
Mortgage Servicing Rules Under the Truth in Lending Act (Regulation
Z); Final Rule, 78 FR 10696 (Feb. 14, 2013).
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2. Preserving Credit Access
    Mortgage lending conditions have been tight since 2008, and to date
have shown little sign of easing. Lending conditions have been
particularly restrictive for borrowers with lower credit scores,
limited equity in their homes, or with limited cash reserves. For
example, between 2007 and 2012, originations of prime purchase
mortgages fell about 30 percent for borrowers with credit scores
greater than 780, compared with a drop of about 90 percent for
borrowers with credit scores between 620 and 680.\158\ Originations are
virtually nonexistent for borrowers with credit scores below 620. These
findings are also evident in the results from the Senior Loan Officer
Opinion Survey. In the April 2012 Survey, a large share of lenders
indicated that they were less likely than in 2006 to originate loans to
borrowers with weaker credit profiles. In the April 2013 survey,
lenders indicated that their appetite for making such loans had not
changed materially over the previous year.\159\
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    \158\ These calculations are based on data provided by McDash
Analytics, LLC, a wholly owned subsidiary of Lender Processing
Services, Inc. The underlying data are provided by mortgage
servicers. These servicers classify loans as ``prime,''
``subprime,'' or ``FHA.'' Prime loans include those eligible for
sale to the Enterprises as well as those with favorable credit
characteristics but loan sizes that exceed the Enterprises'
guidelines (``jumbo loans'').
    \159\ Data are from the Federal Reserve Board's Senior Loan
Officer Opinion Survey on Bank Lending Practices. The April 2012
report is available at http://www.federalreserve.gov/boarddocs/SnLoanSurvey/201205/default.htm and the April 2013 report is
available at http://www.federalreserve.gov/boarddocs/SnLoanSurvey/201305/default.htm.
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    Market conditions reflect a variety of factors, including various
supervisory, regulatory, and legislative efforts such as the
Enterprises' representations and warrants policies; mortgage servicing
settlements reached with federal regulators and the state attorney
generals; revised capital requirements; and new rules addressing all
aspects of the mortgage lending process. These efforts are far-reaching
and complex, and the interactions and aggregate effect of them on the
market and participants are difficult to predict. Lenders may

continue to be cautious in their lending decisions until they have
incorporated these regulatory and supervisory changes into their
underwriting and servicing systems and gained experience with the
rules.
    The agencies are therefore concerned about the prospect of imposing
further constraints on mortgage credit availability at this time,
especially as such constraints might disproportionately affect groups
that have historically been disadvantaged in the mortgage market, such
as lower-income, minority, or first-time homebuyers.
    The effects of the QRM definition on credit pricing and access can
be separated into the direct costs incurred in funding the retained
risk portion and the indirect costs stemming from the interaction of
the QRM rule with existing regulations and current market conditions.
The agencies' estimates suggest that the direct costs incurred by a
sponsor for funding the retained portion should be small. Plausible
estimates by the agencies range from zero to 30 basis points, depending
on the amount and form of incremental sponsor risk retention, and the
amount and form of debt in sponsor funding of incremental risk
retention. The funding costs may be smaller if investors value the
protections associated with risk retention and are thereby willing to
accept tighter spreads on the securities.
    However, the indirect costs stemming from the interaction of the
QRM definition with existing regulations and market conditions are more
difficult to quantify and have the potential to be large. The agencies
judge that these costs are most likely to be minimized by aligning the
QM and QRM definitions. The QM definition could result in some
segmentation in the mortgage securitization market, as sponsors may be
reluctant to pool QMs and non-QMs because of the lack of presumption of
compliance available to assignees of non-QMs. As QRMs cannot be
securitized with non-QRMs under the proposed rule,\160\ the QRM
definition has the potential to compound this segmentation if the QM
and QRM definitions are not aligned. Such segmentation could also lead
to an increase in complexity, regulatory burden, and compliance costs,
as lenders might need to set up separate underwriting and
securitization platforms beyond what is already necessitated by the QM
definition. These costs could be passed on to borrowers in the form of
higher interest rates or tighter credit standards. Finally, in addition
to the costs associated with further segmentation of the market,
setting a QRM definition that is distinct from the QM definition may
interact with the raft of other regulatory changes in ways that are
near-impossible to predict. Cross-referencing to the QM definition
should facilitate compliance with QM and reduce these indirect costs.
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    \160\ See 15 U.S.C. 78o-11(c)(1)(B).
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    The agencies recognize that aligning the QRM and QM definitions has
the potential to intensify any existing bifurcation in the mortgage
market between QM and non-QM loans, as securitizations collateralized
by non-QMs could have higher funding costs due to risk retention
requirements in addition to potential risk of legal liability under the
ability-to-repay rule. The agencies acknowledge this risk but judge it
to be smaller than the risk associated with further segmentation of the
market.
    If adopted, the agencies intend to review the advantages and