Non-Agency Lending Limited by QRM Rules

The proposed regulations governing the Qualified ResidentialrnMortgage (QRM) exemption from risk retention rules constitute a “devastating, unnecessary and very expensive wrench (thrown)rninto the American dream” according to a white paper released Wednesday byrna consortium of housing industry groups.</p

The paper was published in advance of a scheduled hearing ofrnthe House Subcommittee on Capital Markets and Government Sponsored Enterprisesrnon “Understanding the Implications and Consequences of the Proposed Rulernon Risk Retention”.  Two of therngroups in the consortium, the Mortgage Bankers Association and the Center forrnResponsible Lending addressed the committee along with other traderngroups and a panel of representatives of the regulatory agencies which draftedrnthe regulations.  </p

Under Dodd-Frank lenders must retain five percent of the credit risk on loans packaged and sold as mortgage securities. rnHowever, certain qualifying mortgages will be exempt from riskrnretention, making loans with the QRM designation highly sought after assets by lenders.  Last month federal agencies including FDIC,rnthe Federal Reserve, Securities and Exchange Commission and Federal HousingrnFinance Administration proposed QRM rules which will qualify FHA, Fannie Mae andrnFreddie Mac loans by definition and require non-agency loans to have down paymentsrnof 20% or more and Debt to Income (DTI) ratios of 28% / 36% or less.  QRM may not include products or terms that addrncomplexity and risk to mortgage loans such as negative amortization orrninterest-only payments or present significant payment shock potential. While FHA and the GSEs currently dominate the lending landscape, they are expected to reduce their market share in the year’s ahead.  The argument presented in this White Paper is QRM rules will limit the ability of Non-Agency lenders to compete with the GSEs and FHA in the future, therefore limiting the incentive for private investors to enter the sector; making it harder for the governemnt to reduce its footprint in the mortgage market in the process. </p

The White Paper takes particular exception to the 20 percentrndown payment requirement.   Based on 2009rnhome price and income data it says it would take 15 years for an average familyrnto save the $43,000 down payment on a median priced home compared to only sixrnyears to save 5 percent to put down on the same house. This requirement, itrnsays, would deny millions of responsible borrowers any access to the lowestrnrate loans with the safest loan features.  rn</p

The down payment requirement will also present a sizeablernbar to homeowners hoping to refinance. rnBased on data from CoreLogic, the paper estimates that nearly 25 millionrnexisting homeowners lack sufficient equity in their home to meet the 80 percentrnloan-to-value requirement.  Even at 90rnpercent LTV, 34 percent or over 16 million homeowners could not refinance intornqualifying mortgages.</p

Analysis of CoreLogic data on loans originated between 2002 andrn2008, a period which includes the loans that recently defaulted at recordrnrates, shows that raising down payments in 5 percent increments had only arnnegligible impact on default rates but significantly reduced the pool ofrnborrowers that would be eligible for QRM loans.   For example, where borrowers already metrnstrong underwriting and product standards, moving from a 5 percent to a 10rnpercent down payment reduced the default rate by only 0.2 to 0.3 percent butrnreduced the pool of eligible borrowers by 7 to 15 percent.  Jumping the down payment from 5 to 20 percentrnchanged the default rate by 8/10ths of a percent while knocking out 17 to 28rnpercent of borrowers depending on the year of the loan.    </p

Removing so many potential buyers from the pool of borrowersrneligible for qualified mortgages “could frustrate efforts to stabilize thernhousing market,” the report says, and to date the regulators have not putrna price on the cost of risk retention to the consumer.  “This should be done before finalizing arnrule that imposes 5 percent risk retention across such a broad segment of thernmarket.”  A JP Morgan SecuritiesrnInc. estimate put the cost of 5 percent risk retention at a three-percentagernpoint rise in interest rates for loans funded through securitization.  While that estimate may be high, the reportrnsays, even a one percentage point increase in interest rates could berndevastating to a fragile housing market. rnThe National Association of Home Builders (NAHB), another member of thernconsortium, estimates that every percentage point increase in interest ratesrnmeans that 4 million households would no longer qualify for a median pricedrnhome.  Any QRM-related costs, the reportrnpoints out, would be in addition to a general interest rate increasernanticipated over the next 12 to 18 months.</p

Any of these effects will carry greater impact in thosernstates that have already been hardest hit by the housing downturn.  For example, in the five states that havernseen the most foreclosures and greatest price decreases (Nevada, Arizona,rnGeorgia, Florida, Michigan) between 59 and 80 percent of homeowners do not havern20 percent equity in their homes.  Sixrnout of ten homeowners would not be able to move and put 20 percent down onrntheir next home. </p

These borrowers, the paper says, have already putrnsignificant “skin in the game” through down payments and years ofrntimely mortgage payments, “but the proposed QRM definition tells them theyrnare not ‘gold standard’ borrowers and they will have to pay more.”  </p

With major regional housing markets ineligible for lowerrncost QRMs many states and metro areas that have seen the biggest price declinesrnwill now face higher interest rates, reduced investor liquidity, and fewerrnoriginators able or willing to compete for their business.  “These areas face long-term consignmentrnto the non-QRM segment of the market.”</p

The paper concludes that the proposed rules will alsornnegatively impact the private lending market. rnThe vast majority of loans will be non-QRMs subject to the higher costsrnof risk retention and without regulations that mandate sound underwritingrnstandards.  The statutory exemption forrnFHA and VA loans will give them a significant market advantage over fullyrnprivate loans.  This will delay or evenrnhalt the return of private capital into the market.  </p

While the inclusion of GSE loans mitigates the immediaternadverse impact of the rule on the housing market, it is not a viable long-termrnsolution and does little to establish the certainty the secondary marketrnneeds.  “Rather than rely solely onrna short-term fix the regulators should follow Congressional intent andrnestablish a broadly available QRM that will create incentives for responsiblernliquidity that will flow to a broad and deep market for creditworthyrnborrowers.”</p

Risk-retention is not a viable option for smallerrninstitutions and will reduce the ability of community-based lenders to competernin the mortgage market.  The toprnthree-FDIC insured banks already control 55 percent of the single-familyrnmortgage market and this consolidation will only intensify.  “In short, the proposal creates realrnsystemic risk while doing little to relieve it.”</p

Congress intended QRM to provide creditworthy borrowersrnaccess to well underwritten products, provide a framework for responsible privaterncapital to support housing recovery and to shrink government presence in thernmarket while restoring competition and mitigate the potential for furtherrnconsolidation.  Instead the proposed rulernis so narrow that it will force a majority of both homebuyers and homeowners torneither forego purchasing/refinancing or pay higher rates, and will hamperrncompetition and accelerate consolidation in the market. </p

In addition to MBA, NAHB, and the Center for ResponsiblernLending, the members of the consortium are Community Mortgage Banking Project, thernMortgage Insurance Companies of America, and the National Association ofrnRealtors®.

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