Non-Agency Lending Limited by QRM Rules

The proposed regulations governing the Qualified Residential Mortgage (QRM) exemption from risk retention rules constitute a "devastating, unnecessary and very expensive wrench (thrown) into the American dream" according to a white paper released Wednesday by a consortium of housing industry groups.

The paper was published in advance of a scheduled hearing of the House Subcommittee on Capital Markets and Government Sponsored Enterprises on "Understanding the Implications and Consequences of the Proposed Rule on Risk Retention".  Two of the groups in the consortium, the Mortgage Bankers Association and the Center for Responsible Lending addressed the committee along with other trade groups and a panel of representatives of the regulatory agencies which drafted the regulations. 

Under Dodd-Frank lenders must retain five percent of the credit risk on loans packaged and sold as mortgage securities.  However, certain qualifying mortgages will be exempt from risk retention, making loans with the QRM designation highly sought after assets by lenders.  Last month federal agencies including FDIC, the Federal Reserve, Securities and Exchange Commission and Federal Housing Finance Administration proposed QRM rules which will qualify FHA, Fannie Mae and Freddie Mac loans by definition and require non-agency loans to have down payments of 20% or more and Debt to Income (DTI) ratios of 28% / 36% or less.  QRM may not include products or terms that add complexity and risk to mortgage loans such as negative amortization or interest-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.

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

The down payment requirement will also present a sizeable bar to homeowners hoping to refinance.  Based on data from CoreLogic, the paper estimates that nearly 25 million existing homeowners lack sufficient equity in their home to meet the 80 percent loan-to-value requirement.  Even at 90 percent LTV, 34 percent or over 16 million homeowners could not refinance into qualifying mortgages.

Analysis of CoreLogic data on loans originated between 2002 and 2008, a period which includes the loans that recently defaulted at record rates, shows that raising down payments in 5 percent increments had only a negligible impact on default rates but significantly reduced the pool of borrowers that would be eligible for QRM loans.   For example, where borrowers already met strong underwriting and product standards, moving from a 5 percent to a 10 percent down payment reduced the default rate by only 0.2 to 0.3 percent but reduced the pool of eligible borrowers by 7 to 15 percent.  Jumping the down payment from 5 to 20 percent changed the default rate by 8/10ths of a percent while knocking out 17 to 28 percent of borrowers depending on the year of the loan.    

Removing so many potential buyers from the pool of borrowers eligible for qualified mortgages "could frustrate efforts to stabilize the housing market," the report says, and to date the regulators have not put a price on the cost of risk retention to the consumer.  "This should be done before finalizing a rule that imposes 5 percent risk retention across such a broad segment of the market."  A JP Morgan Securities Inc. estimate put the cost of 5 percent risk retention at a three-percentage point rise in interest rates for loans funded through securitization.  While that estimate may be high, the report says, even a one percentage point increase in interest rates could be devastating to a fragile housing market.  The National Association of Home Builders (NAHB), another member of the consortium, estimates that every percentage point increase in interest rates means that 4 million households would no longer qualify for a median priced home.  Any QRM-related costs, the report points out, would be in addition to a general interest rate increase anticipated over the next 12 to 18 months.

Any of these effects will carry greater impact in those states that have already been hardest hit by the housing downturn.  For example, in the five states that have seen the most foreclosures and greatest price decreases (Nevada, Arizona, Georgia, Florida, Michigan) between 59 and 80 percent of homeowners do not have 20 percent equity in their homes.  Six out of ten homeowners would not be able to move and put 20 percent down on their next home.

These borrowers, the paper says, have already put significant "skin in the game" through down payments and years of timely mortgage payments, "but the proposed QRM definition tells them they are not 'gold standard' borrowers and they will have to pay more." 

With major regional housing markets ineligible for lower cost QRMs many states and metro areas that have seen the biggest price declines will now face higher interest rates, reduced investor liquidity, and fewer originators able or willing to compete for their business.  "These areas face long-term consignment to the non-QRM segment of the market."

The paper concludes that the proposed rules will also negatively impact the private lending market.  The vast majority of loans will be non-QRMs subject to the higher costs of risk retention and without regulations that mandate sound underwriting standards.  The statutory exemption for FHA and VA loans will give them a significant market advantage over fully private loans.  This will delay or even halt the return of private capital into the market. 

While the inclusion of GSE loans mitigates the immediate adverse impact of the rule on the housing market, it is not a viable long-term solution and does little to establish the certainty the secondary market needs.  "Rather than rely solely on a short-term fix the regulators should follow Congressional intent and establish a broadly available QRM that will create incentives for responsible liquidity that will flow to a broad and deep market for creditworthy borrowers."

Risk-retention is not a viable option for smaller institutions and will reduce the ability of community-based lenders to compete in the mortgage market.  The top three-FDIC insured banks already control 55 percent of the single-family mortgage market and this consolidation will only intensify.  "In short, the proposal creates real systemic risk while doing little to relieve it."

Congress intended QRM to provide creditworthy borrowers access to well underwritten products, provide a framework for responsible private capital to support housing recovery and to shrink government presence in the market while restoring competition and mitigate the potential for further consolidation.  Instead the proposed rule is so narrow that it will force a majority of both homebuyers and homeowners to either forego purchasing/refinancing or pay higher rates, and will hamper competition and accelerate consolidation in the market.

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