WASHINGTON — 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.

"The issuers will very much appreciate the ability to choose the form of risk retention for their transaction," said Tom Deutsch, executive director of the American Securitization Forum. "There are some investors who will be very concerned about those choices. Some investors would like to see a one size fits best approach but different issuers in different asset classes would be very concerned with that."

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.

The question of how to structure retained risk may be of more importance depending on how regulators structure another part of the plan — the qualifying residential mortgage test, which exempts loans fitting certain criteria from any risk retention requirements. At the very least, credit card loans and student loans — which are also covered by the risk retention plan — would not be eligible for QRM. But the industry is also concerned that regulators are drafting QRM requirements very narrowly, leaving many mortgages outside of the exception.

"If you exempt the range of low risk mortgages that we think should be exempted in safe harbor the question of vertical versus horizontal becomes somewhat less significant," said Bob Davis, executive vice president of government relations for the American Bankers Association. "If you get that question right, I think the decision on the vertical versus horizontal becomes less critical. To the extent there is a narrower safe harbor, the decision on vertical versus horizontal will become more important."

Federal regulators signaled early on they were aware how much difference it could make.

"If a securitizer or originator retains a piece of each tranche of securities sold to investors (a vertical slice), the securitizer or originator will retain exposure to the varying degrees of credit risk of the tranche holders," the Federal Reserve Board wrote in an October report to Congress. "Likewise, an originator or securitizer can retain credit risk by retaining a portion of the subordinate piece of the security (a horizontal slice). Credit risk is concentrated in this security, so retaining even a small part of the subordinate piece exposes the seller to a relatively larger share of the deal's total credit risk."

Having a choice will benefit banks since different institutions likely differ on which they prefer. Taking a vertical slice of risk is likely to help banks that do not want to hold more risk-based capital since their overall exposure is not as great as taking a horizontal piece of the risk. But the horizontal option may benefit institutions that deal in consumer securities, such as student loans and credit cards, as well as nonbanks.

"Whether a party favors risk retention in the form of a vertical slice or a horizontal slice depends on which market they are in, what role they play in the servicing or securitization process, and other factors like cash constraints and risk based capital constraints," said Jim Gross, Mortgage Bankers Association associate vice president of accounting, tax and bank regulation.

"For example, an issuer who is concerned about the amount of cash required to make a 5% investment in all tranches of a securitization and is not risk-averse, would likely favor a horizontal strip which would require a much smaller investment of cash," Gross said. "In contrast, if you are a bank and concerned about risk based capital and are risk adverse, the vertical strip might be more attractive because there would be less probability of consolidating all of a securitization's assets and liabilities on your balance sheet and you take only a 5% portion of the first loss tranche."