Proposed across-the-board risk retention provisions for mortgages in the House Financial Reform bill and the draft Senate bill are no substitute for good underwriting, strong documentation standards and safe product design, according to a new study released by the Community Mortgage Banking Project (CMBP).
Examining more than 20 million loans made between 2002 and 2008, the study found that riskier mortgages performed 2.9 times worse, as measured by loans that were 90 or more days delinquent. It is the first analysis to measure the difference in default rates between higher-risk loans and traditionally underwritten, back-to-basics loans during the recent housing cycle, CMBP says.
Default rates were consistent across the seven years between the two types of loans, the study found. Traditionally underwritten mortgages performed 2.6 times better prior to the boom in 2002, and 3.25 times better at the peak in 2005.
‘This study confirmed what has long been suspected,’ says James Bennison, senior vice president of strategy and capital markets for Genworth Financial's U.S. mortgage insurance business. ‘Traditional underwriting standards, including full income documentation and straightforward loan features, yielded dramatically fewer defaults. Policymakers should be looking for ways to encourage liquidity for this type of lending. Unfortunately, the across-the-board risk retention would increase its cost and reduce its availability.’
The study was released as the Senate Banking Committee neared markup of financial reform legislation. The committee is expected to consider a proposal to impose across-the-board risk retention requirements for all loans sold in the secondary market. It would require the Securities and Exchange Commission and the federal banking agencies to issue regulations requiring creditors and issuers of asset-backed securities to retain 10% of the credit risk on whole loans and securitizations.
The CMBP says the provision would impact both traditionally underwritten mortgages and riskier mortgages, imposing additional costs on responsible borrowers using back-to-basics mortgage products.
Glen Corso, managing director of CMBP, says risk retention provisions are a reasonable approach for exotic mortgages, but not traditional products.
‘This study demonstrates why Congress should be careful not to impose an arbitrary risk retention requirement on all loans sold in the secondary market,’ Corso says. ‘Across-the-board risk retention will unnecessarily and unfairly raise costs on creditworthy borrowers seeking products that are demonstrably lower risk.’
CMBP has urged the committee to exempt low-risk ‘qualified mortgages’ with strong underwriting and documentation standards and safe product designs.
To define lower risk, the study examined eight traditional underwriting criteria that the CMBP says are easy for consumers to understand and easy for regulators to supervise.
The following criteria were highlighted:
- total debt-to-income ratio, including housing and other obligations, of 41% or less;
- fixed-rate loans and adjustable-rate mortgages with initial rates locked in for seven years or more;
- repayment periods of 30 years or less;
- no balloon payments;
- no interest-only features;
- no negative-amortization features;
- full income documentation of borrowers' income and assets; and
- mandatory mortgage insurance if the original loan-to-value ratio was greater than 80%.
Vertical Capitol Solutions of New York, an independent valuation and advisory firm, conducted the study for Genworth Financial Inc., in collaboration with CMBP.