"Qualified Residential Mortgage" on the Hot Seat

Check out my twice-a-month blog at the STRATMOR Group web site located at www.stratmorgroup.com. The current blog takes a look at QRM and shares doubts about its passage. Below is the text. If you have both the time and inclination, make a comment on what I have written, or on other comments so that folks can learn what's going on out there from the other readers.

Early in June we discussed the provisions of QRM (“QRM” stands for “Qualified Residential Mortgage”). It is an issue that just won’t go away, and it did not help matters when the regulators extended the end of the comment period to August 1 – about one week away. The intention of the proposal is good: to limit “risky” loans from being originated and sold to investors and to force companies that securitize loans to “keep skin in the game.”  QRM loans are expected to perform better, and therefore be subject to fewer risk requirements, with outliers being labeled as non-QRM.  The loans falling outside this definition require the securitizer to hold 5% of the loan as a reserve (more on this later) - this is the risk retention component.  And although it sounds relatively simple, it is very complex. And, as it turns out, a wide range of organizations have banded together to denounce it – more on that later also.

The core requirements for a loan to meet the definition of QRM are a maximum 80% LTV for purchases, less for refinances, 28/36 debt ratios, and 0x30 on all debts in last 24 months. Some studies have found that some 40% of recent originations wouldn't qualify under these guidelines in spite of current production being the “cleanest” it has been for several years. Given the 40% number, politicians, mortgage originators, home builders, minority rights groups, and so on have rallied against the provisions.

So the "40% of loans wouldn't qualify under QRM and therefore require the risk retention trigger" makes a great headline but that's a bit misleading - it's maybe a half-truth.  The rule allows for all government or agency backed loans (Fannie/Freddie and FHA) to be exempt from the risk retention.  So at a time where 90% of loans are agency eligible, this 40% figure is incorrect - in the short-term, the QRM restrictions mean little. But in the longer term, should Congress ever fully address the future of Freddie and Fannie, the QRM restrictions will be felt by the industry, and by the currently fragile housing market.  Many in the industry wonder exactly why Fannie & Freddie must be dissolved, but if we're to believe that they will be taken out of conservatorship or restructured, FHA will become the de facto program as it'll be the only option to qualify for the exemption (>70 or 80 LTV and 28/36 ratios).

But unfortunately, HUD is continuing to shy away from increasing its market share (by increasing mortgage insurance premiums and lowering its loan limits). So mortgage originators may be left with either succumbing to the restrictions and setting aside 5% for risk retention purposes, or defining themselves as “non-securitizers.” The first alternative is grim, so the focus has turned to the second alternative. In the QRM rules currently open for public comment, the “banker” is the one who pools and securitized the mortgage loan.  This means that correspondent lenders who sell to aggregators will NOT have to abide by the 5% rule, but the investor or aggregator will. But if the investors have to retain the 5% capital for risk retention, they'll have to pull funds from other uses and put them toward the mortgage.  They'll be looking for similar returns in this capital and therefore it's expected these non-QRM loans will have significant price adjustments, perhaps a 1-2% higher mortgage rate. And analysts suggest that aggregators will not absorb this, and that the cost will be passed down to the correspondent seller and/or the borrower. And is this good for the housing market?

In addition, many believe that the QRM rule promotes further growth of the larger "too big to fail" banks.  They gain a competitive advantage as they have a larger asset base to be leveraged when compared to the community banker or credit union.  The smaller lenders who have acted responsibly to serve their local markets over the years are negatively impacted as the 5% retention rule is enough to possibly change their business model and force them to move away from securitizing and servicing platforms toward the correspondent channel.

Fortunately, for these reasons and others, an incredibly wide range of special interest groups have come out with a united front against the existing QRM restrictions. Groups ranging from the American Securitization Forum, credit unions across the nation, and a diverse coalition of 44 consumer organizations, civil rights groups, lenders, real estate professionals and insurers, along with 44 Senators and 282 members of the House of Representatives have voiced their concern that such a requirement would hurt, rather than help, a housing recovery (per the Santa Ana Business News). So at this point, look for the QRM question to drag on well into the foreseeable future, much to the temporary relief of the mortgage and housing industry.