The Impact of Risk Retention Regulation on the Underwriting of Securitized Mortgages

Abstract

The Dodd-Frank Act requires securitization sponsors to retain not less than a 5% share of the aggregate credit risk of the assets they securitize. This paper examines whether loans securitized in deals sold after the implementation of risk-retention requirements look different from those sold before. Using a difference-in-difference empirical framework, I find that risk retention implementation is associated with mortgages being issued with markedly higher interest rates, yet notably lower loan-to-value ratios and higher income to debt-service ratios. These findings suggest that the risk retention rules have made securitized loans safer, yet at a significant cost to borrowers. Further evidence suggests that the risk-retention rules are binding, with the amount of risk being retained following implementation roughly three times that of before, while lenders also seemed to accelerate the securitization of originated loans during the months immediately before the rules took effect.

Keywords: Dodd-Frank, Securitization, Risk retention, Mortgages, CMBS

JEL Classification: G14, G21, G23