A coalition of mortgage, housing and banking organizations on Monday urged regulators to avoid a disconnect between certain pending standards for home loans sold to consumers and those in securitized pools.
The groups sent the letter to six federal regulators in response to the upcoming end of a periodic review done to determine whether the boundaries of the risk-retention exemption for securitized loans are adequate. Securitizers must retain at least 5% of the credit risk from loans pooled to create bonds unless all the mortgages involved meet certain standards. Risk retention was put in place in the wake of the Great Recession’s housing crash to incentivize securitizers to pool loans that would perform well even after the bonds were sold.
Under the Dodd-Frank Act, the risk-retention exemption standard can’t be broader than the qualified mortgage definition that serves as an indication that a loan satisfies the legal mandates of the ability-to-repay rule. (ATR is a separate Dodd-Frank regulation aimed at ensuring borrowers aren’t approved for loans they can’t afford.) To date, there has been little difference between the risk-retention exemption and the QM standard. Signatories to the letter want to ensure that remains the case as QM changes in a way that could encourage lending within a broader credit box.
“We strongly support the continued alignment,” the Mortgage Bankers Association, the Housing Policy Council and other groups representing Realtors, builders, bankers, mortgage insurers said in the letter.
“It’s worked well for these past several years and we see no reason to move away from that,” Dan Fichtler, associate vice president, housing finance policy, at the Mortgage Bankers Association, added in an interview. “We’ve looked at this new definition of QM and we think it’s quite reasonable.”
The letter was sent to the Federal Housing Finance Agency, Department of Housing and Urban Development, Treasury, Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp.
Quantitative criteria these groups may look at in determining whether the QM definition is appropriate for the risk retention standard could include the performance of loans based on the extent they’re priced above certain benchmarks, said Kris Kully, a partner in Mayer Brown’s Washington, D.C., office and a member of the firm’s Consumer Financial Services group. The pending change to QM rolls back several other indicators of borrowers financial profile, such as a maximum debt-to-income ratio, in favor of criteria based on loan pricing.
“When looking at risk retention, they’ll likely be looking at what borrowers are included that were excluded and whether they have the capacity to repay,” Kully said.
Delinquency rates generally do rise by 1.5% to 3% as price tiers rise above a certain level, an Urban Institute analysis of Fannie Mae data released last year shows. Those increases come into play when rates are at a spread of 51 basis points or more and are a better predictor of default than DTI ratios, according to the study. The institute generally looked at 50 basis-point buckets in its analysis within the range pertinent to the QM change. Loans with an annual percentage rate that is 225 basis points above the average prime offer rate can be included within the new QM definition. The new definition also preserves a safe harbor for loans with a 150 basis point rate spread.
Market participants and attorneys also have been working to clarify other nuances regarding how the pending change to the QM definition will impact home loans purchased in the government-related and private markets.
For example, there is some confusion around the Treasury’s conservatorship contracts with government-sponsored enterprises because they call for the GSEs’ temporary QM exemption to end in July, prior to the phased-in mandatory implementation of the new definition by the Consumer Financial Protection Bureau next year. However, because the new definition can be adopted on a voluntary basis prior to its implementation date and was designed to broaden the scope of QM such that it minimizes disruption from the removal of the GSEs’ exemption, there’s hope any impact from that confusion will be marginal, and primarily limited to a new rate-spread requirement.
The risk-retention exemption for qualified residential mortgages, which is known as QRM, is unlikely to be of concern to the government-related market as it’s positioned more to address risks that arise in private securitizations. Private residential mortgage-backed securities generally have represented a relatively small part of the securitized home lending market since the mid-aughts financial crisis.