Banks Win Flexibility from Regulators on Risk-Retention Rule

By Cheyenne Hopkins

Although bankers are likely to have significant concerns about the risk retention proposal due next week, they appear to have won at least one victory already: a choice over how to structure risk that must be retained. Under the plan, lenders must retain 5% of the risk of any loan — or pool of loans — they sell into the secondary market. But it has been unclear until now how that risk must be structured; namely, whether lenders must retain 5% of the overall risk or 5% of each tranche. According to sources familiar with the risk retention proposal, regulators are expected to give lenders a choice on that critical question, a move that will please bankers but is likely to raise concerns about whether they are giving institutions too much leeway. At issue is whether lenders must retain a so-called “horizontal” or “vertical” slice of the risk. A horizontal slice would require lenders to take a 5% first loss interest in the overall securitization structure, while a vertical, or pro-rata piece, would require lenders to keep 5% of every piece of it, such as subordinated and senior tranches. When the Federal Deposit Insurance Corp. Board meets on Tuesday, the proposal is expected to let lenders take either approach or an “L shaped” combination. Karen Shaw Petrou, managing director of Federal Financial Analytics Inc., was cautiously optimistic with the flexibility, given how much else is in the rule, although she warned bankers will still likely have several other objections to the plan. “It may ameliorate some concerns but it certainly won’t send them off celebrating,” she said.