The revised qualified residential mortgage (QRM) rule that federal regulators introduced Wednesday includes two separate and strikingly different approaches to establishing risk retention for securitized mortgage loans.
The so-called ‘primary’ or ‘preferred’ approach, as outlined in the revised proposal, is designed to bring the QRM rule – which was originally introduced by the Federal Reserve in 2011 and is part of the Dodd-Frank Act – in line with the qualified mortgage (QM) rule established by the Consumer Financial Protection Bureau (CFPB) in January.
The original QRM rule introduced in 2011 stipulated that loans could only qualify as QRM if the borrower made a 20% down payment. However, that provision met with stiff opposition from industry stakeholders, who argued that it would lead to an overly restrictive lending environment. As a result, regulators eliminated that provision in the recently revised rule.
Under the revised proposal, loans already classified as QM under CFPB standards would be able to move forward with no down payment requirement under the revised rule. In other words, QM loans would be exempt from the QRM risk-retention requirements.
The alternative – and much less popular – approach in the revised rule would require lenders to retain a stake in the credit risk when mortgages to be securitized are originated without at least a 30% down payment. What is interesting is that, even after stakeholders decried the 20% down payment requirement under the previous rule, regulators nevertheless ended up offering an alternate (and arguably more restrictive) rule requiring a 30% down payment.
So how did regulators end up proposing two separate approaches that, on the surface, seem diametrically opposed to one another?
Well, first of all, ‘the fact that there are two separate approaches is not inconsistent’ with the rulemaking process, says David Stevens, president and CEO of the Mortgage Bankers Association (MBA). He points out that the original QRM proposal introduced in 2011 included a ‘primary recommendation of a 20 percent down payment and an alternative that [regulators] wanted comments on, requiring a 10 percent down payment.’
But more importantly, the fact that there are two separate approaches outlined in the proposal indicates that there was a ‘significant minority’ in one or more of the agencies that wanted a more narrowly defined QRM rule.
‘It clearly comes from feedback from the capital markets and the securitization market,’ Stevens says, adding that ‘it's very difficult to explain to the average mortgage person or policymaker why they did it that way, but it was to appease the liquidity concerns of the mortgage-backed securities side of the market.’
‘One of the arguments against the 20% [down payment requirement presented in the original rule] is that it would impair liquidity, because it would be too small of a population of high-down-payment loans,’ Stevens explains. ‘By drawing it at 30%, you allow for a much bigger, homogenous, liquid population of loans that will likely have better securitization treatment.’
In other words, QM loans would need to meet certain requirements to qualify as QM – and QRM loans would need to meet an ‘additional layer’ of requirements, if you will, in order to qualify as QRM, one of which would be the required down payment amount.
The problem with this concept, Stevens explains, is that it creates unnecessary complexity by way of overlapping regulations. Not only would implementing this rule make the regulatory framework ‘overly complex,’ it would also ‘make the return of private capital to the housing system virtually impossible, because the GSEs get an exemption and so does the Ginnie Mae program,’ Stevens explains.
‘It would make the whole idea of bringing private capital back to the market almost laughable, if they implemented it that way,’ he adds.
Stevens further adds that there is no need for such a provision considering that, at this point, lenders ‘have completely eliminated risk from the mortgage market.’
‘We are the most conservative credit underwriting market that I've seen in the three-plus decades that I've been in this industry – and there is absolutely no need to go further, when we've created protections that go further than the 'safe and sound' environments of decades past,’ he says. ‘We're more conservative in origination standards today than we were in even those days. We've eliminated all the high-risk products – and between all the risk controls and oversight from all the regulators – the CFPB, the consent decrees, inspectors' general lawsuits and state attorneys general – there is more scrutiny on origination practices today than we've ever seen in the industry's history.’
‘There is just no rational reason to add this additional layer of cost, and exclusion, in the housing finance system,’ he says.
That's not to say that the 30% provision doesn't make sense. ‘The idea behind it is – if you have to apply risk retention, you might as well apply it to a very broad population of the mortgage market, not just a narrow strip,’ Stevens explains. ‘You might as well apply it to just about everybody. So, you put [the down payment requirement] at 30%, because that will ensure that what gets securitized in that risk retention side of the mortgage backed securities market – cause all of the risk retention loans will likely be securitized separately from the non-risk retention loans – will be very broad and that you have a large, liquid pool of loans. Because once you put it at 30%, you've precluded a majority of purchase transactions.’
Robert Davis, executive vice president, mortgage markets, financial management and public policy for the American Bankers Association (ABA), agrees that the 30% provision is unlikely to have much support.
‘The alternative proposal (i.e. 30% provision) would apply QRM to a fairly wide swath of low-risk loans,’ Davis explains. ‘It would take the QM universe and impose a 70 percent LTV requirement and other restrictions. So it would greatly reduce the scope of the QRM exemption. So, if there is no 30 percent down payment, then [a lender] would have to hold 5 percent capital.’
‘Considering that there is already widespread fear in the industry that the CFPB's QM rule will overly constrain credit availability – we think a step back to (30%) would be the wrong way to go,’ Davis says, adding that the provision ‘is even narrower than the 20 percent option previously proposed.’
‘This rule is so different from the original rule – it is a bit of an oddity because it so diametrically opposed to the goal of the primary proposal,’ Davis says. ‘So, obviously there was some disagreement among the regulators, [but] they had to put it out for comment anyway, so they said 'fine, it's an alternate rule.' I don't imagine it getting much favorable comment.’
‘At the end of the day, this would add a totally unnecessary level of cost and regulatory confusion on what is already a credit-constrained marketplace,’ Stevens says, adding that he is ‘very confident that when [the regulator] get feedback from the vast array of stakeholders, that we're all going to be unified, with one loud voice, with a few minor exceptions, that the 'QRM equals QM' version is the preferred outcome. And the only one that makes sense for a housing market that's trying to recover.’
The ‘preferred’ approach, which eliminates the down payment requirement entirely, on the other hand, ‘is the most consistent way to ensure that we don't have new layering of complexity on underwriting processes – and raising costs for consumers – through another rule that confuses the existing rules in the marketplace,’ Stevens says.
The six federal agencies that drafted the QRM proposal – including the Federal Reserve, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, Department of Housing and Urban Development, Federal Housing Finance Agency, and Securities and Exchange Commission – are now soliciting testimony from industry stakeholders, with an Oct. 30 deadline for all comments.
Stevens says he is confident that regulators – after holding a third round of testimony since the QRM rule was first introduced – will end up drafting a final rule based on the ‘preferred’ approach. While there is nothing stopping regulators from going back to the drawing board and coming up with yet another proposal that attempts to strike middle ground, it is highly unlikely, he says, particularly considering that the CFPB's QM rule is scheduled to go into effect in January.
‘I expect them to pick QM equals QRM,’ Stevens says. ‘This will produce a final rule, there's no question about it.’
Stevens anticipates that the review period after regulators receive the comments will be ‘fairly short, as they are hoping to issue a final rule before the end of the year.’ He adds, however, that it will be a tight timeline, and that a final rule might not come until the first quarter.
‘They have to get six regulators to all agree – and six regulators rarely agree on the color of the sky,’ he adds.
Stevens says the MBA would ‘be very pleased if the primary proposal is selected.’
‘I think this rule is completely consistent with what we advocated for publicly,’ he says. ‘It's a win for the industry – and it's a win for the consumer. It's exactly what consumer advocates and industry stakeholders all called for.’