How QM-QRM rules could unnecessarily--and unintentionally--disqualify good Homebuyers.
When it comes to underwriting standards, the proverbial pendulum has swung from ludicrously lax to unrealistically rigid. But the new Qualified Residential Mortgage (QRM) and Qualified Mortgage (QM) definitions now being considered by various government agencies could mean that the pendulum and our industry may be stuck in this extreme position indefinitely.
That could have severe, unintended consequences for the nascent real estate recovery, prospective homebuyers, current homeowners and, eventually, the American taxpayer.
How good is too good?
To understand just how far the pendulum has swung, let's look at two documents: the first is a new report released by loan origination system (LOS) provider Ellie Mae Inc., Pleasanton, California, on the characteristics of loans that ran through its software platform in February; the second is an analysis by New York based Fitch Ratings of the latest Redwood Trust Inc. private-label deal.
In February, according to Ellie Mae, the average approved loan had a 750 FICO [R] score, a loan-to-value (LTV) ratio of 76 percent and a debt-to-income (DTI) ratio of 2 3/ 3 4. Very pristine. Want to guess what the average denied loan looked like? If you guessed a 580 FICO with 3.5 percent down, you were way off. The average denial was a 699 FICO with an LTV of 83 percent.
Keep in mind, those numbers were for Home Mortgage Disclosure Act reported) (HMDA-reported) denials. There were probably many more loans that didn't close (the pull-through rate that month was 47.9 percent overall) where the borrower was offered a less-attractive rate on a refi and the application is still sitting in a lender's pipeline somewhere.
If that's what's being originated, what's being securitized? It's tempting to say not much, because, for the fourth year in a row, only a handful of publicly rated deals have been done. This is a far cry from 2005, the peak of private-label issuance, when total non-agency securitizations topped $1.2 trillion--a number greater than the forecast for all single-family mortgage originations in 2012.
Recently, Fitch released the details of the latest Redwood deal: a $327.9 million offering made up of 366 loans. The weighted average FICO was 769 and weighted average combined LTV was 66 percent. All of the loans had 66 percent documentation. And the borrowers were high earners: The weighted average annual income was $527,000.
Since 2010, Redwood has brought five deals to market. Of the 1,800 loans in those deals, Fitch said one loan is delinquent. But even that loan probably won't go into foreclosure--it has a 5o percent LTV.
Now the new proposals that are circulating around Washington for both QRM and QM have the potential of unintentionally making underwriting more restrictive and private-label securitization less attractive.
Last year, the original definition of QKM was quietly withdrawn after a broad coalition of industry and consumer advocacy groups, including the Mortgage Bankers Association (MBA), raised concerns that it would put homeownership out of the reach of millions of first-time borrowers and underwater homeowners. The proposal would have required homeowners to have down payments of at least 20 percent, low DTIs and unblemished credit. It also gave no credit for private mortgage insurance--a vehicle that over the last 50 years helped millions of creditworthy borrowers qualify for mortgages.
From a securitization standpoint, loans that met the QRM definition would be exempt from capital retention requirements. To securitize non-QRM loans, the issuers would he required to retain 5 percent as "skin in the game."
QRM should be back later this year, likely after the Consumer Financial Protection Bureau (CFPB) issues its QM final rule. The CFPB has indicated that it will issue the rule at the end of June. The industry is anxious to see what modifications are made to the original QRM definition beyond the one change that most everyone anticipates, which is a lower down-payment percentage requirement.
Even more worrisome for lenders is its sister acronym: QM. Like QRM, QM is mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act. It exposes lenders to new liabilities for making a mortgage loan that is not a QM unless the originator makes a reasonable determination, in good faith, that a consumer has a reasonable ability to repay the loan, including applicable taxes, insurance arid assessments.
At first blush, this sounds simple and reasonable. Particularly when you remember the products and practices that it was designed to prohibit--pay-option adjustable-rate mortgages (ARMs), 2-365, piggybacks, no-income/no-assets (NINA) documentation, etc. But those loans and lax underwriting standards are gone.
$70,000 per violation
The Federal Reserve Board has proposed two alternatives to define QM--a "legal safe harbor" or "rebuttable presumption of compliance"--and it turned the final rulemaking project over to the Consumer Financial Protection Bureau.
The main difference is that the safe harbor focuses on product, while the rebuttable presumption focuses on the consumer. For example, safe harbor looks at loan terms (such as a 30-year maximum term, no interest-only or negative-amortization payments, no balloon, 3 percent point and fee cap) and verified income and assets.
In addition to loan terms, rebuttal presumption would additionally require lenders to evaluate other factors in determining ability to repay.
The Mortgage Bankers Association and American Securitization Forum (ASF) are actively advocating a bright-line safe harbor construct as opposed to a rebuttable presumption.
Securitization is the point at which QM and QRM intersect. That's because most observers believe that only QRM loans (read: low LTV, perfect credit) will be securitized and non-QRM loans will end up in bank portfolios and on balance sheets--if they are made at all.
So this brings into question the availability of credit to creditworthy borrowers who don't have substantial savings for down payments or who have had even a minor credit problem in the past.
Because QM will apply to loans securitized as well as loans held by the lender or sold in private sales, it will potentially have a wider impact than the QRM rule.
The impact will be great, whichever final version of the rule is adopted. But if the rebuttable presumption rule is adopted, then the potential liability on each loan, as well as the headline risk to the institution, is much greater. And this could mean that only plain vanilla loans made to high-credit-quality borrowers will be originated, especially by the largest lenders.
Under this scenario, the lender would have to worry that if its regulator or a judge determines that the loan does not meet the QM standard, then it is also likely that they would decide that the loan does riot meet the repayment ability standards. (By the way, the penalties for violating the QM rule would be harsh--as much as $70,000 per violation, according to MBA.)
If the safe harbor standard is adopted, then at least the lender will be assured that so long as the bright-line standards are met, then the loan will qualify as a QM. There is still the question of whether lenders will make loans outside of the QM standards, and if so, how they'll be priced. It does not seem to be a stretch to say that non-standard loans and reduced-documentation loans will be rare, and when they are made, it will be more sophisticated, high-income borrowers that will get them.
Once again, the rule will seemingly have an enormous impact on the availability of credit to those with blemished credit histories or to borrowers who are commonly referred to as "underserved."
Given the painful lessons learned from the mortgage market crisis, no one is surprised about the flight to quality that we are seeing in originations and in the first tentative steps to restarting non-agency securitizations. But at the same time, most knowledgeable observers had assumed housing finance would evolve from the "new normal" of perfect-only-need-apply to a more normal acceptance of reasonable risk levels. Because if we don't, that means millions of good-but-not-perfect homeowners and buyers would be shut out of the market. Arid that agency securitization is really the only scalable option, which means the U.S. government and U.S. taxpayers, either directly or indirectly, would be responsible for 95 percent of all housing finance--indefinitely.
Tom Donatacci is executive vice president of Clayton Holdings LLC in Shelton. Connecticut. He can be reached at email@example.com.
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|Title Annotation:||Executive Suite|
|Comment:||How QM-QRM rules could unnecessarily--and unintentionally--disqualify good Homebuyers.(Executive Suite)|
|Date:||May 1, 2012|
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