On June 12, 2017, the U.S. Treasury issued its first report to the President examining the U.S. financial system. The report includes a discussion of the residential mortgage market and it identifies regulatory changes that, in the eyes of the treasury, could stimulate the mortgage market and expand credit availability to consumers. This article provides summaries of the report’s findings and recommendations for regulatory changes as applicable to mortgage industry.
Recognizing the importance of the housing market as a basic need of all families and its substantial share of the US GDP, the Treasury report makes the following finding concerning the mortgage market and with respect to the regulations promulgated as a result of the Dodd-Frank Act:
- The revised regulatory regime disproportionately discourages private capital from taking mortgage credit risk and instead encourages lenders to channel loans through federal insurance or guarantee programs (e.g. FHA/VA/RHS), or through Fannie Mae or Freddie Mac;
- Regulatory requirements have significantly and unnecessarily tightened the credit box for new mortgage originations, denying many qualified Americans access to mortgages;
- Increased regulatory requirements have significantly increased the cost of origination and servicing activities, which, when passed on to borrowers in the form of higher mortgage rates, have decreased the number of Americans that can qualify for mortgages;
- Some regulatory regimes or approaches are viewed by industry participants as having inadequate transparency and mutual accountability, thus creating uncertainty and risk aversion among lenders in serving certain market and client segments; and
- Capital, liquidity, and other prudential standards, in combination with a wide range of capital market regulations, have inhibited both private originate-to-hold lenders as well as lenders focused on origination and secondary sale in the private-label securitization market.
In light of these finding the report makes several recommendations for revisions of current mortgage market regulations and expansion of mortgage credit box. The following are summaries of these recommendations:
Mortgage Loan Origination
Adjust and Clarify the ATR/QM Rules
The report identified the Dodd-Frank Act ability to repay (ATR) and qualified mortgage (QM) rules as the most significant post-crisis regulation impacting loan origination. The ATR rule is intended to ensure that lenders make loans to borrowers who have the ability to repay them and the QM rules define loan standards that are considered presumptively “safe” for borrowers and thus presumptively meet the ATR requirements. Loans that do not meet the ATR requirements are illegal.
Importantly, however, the report acknowledges that while the QM rules were not intended to eliminate the markets for loans that did not meet the QM standards, the reality is that the vast majority of lenders remain unwilling to make loans that do not meet those standards. Therefore, eliminating access to mortgages for many credit worthy borrowers.
The report found that because the QM rules provide a favorable QM status – referred to in the report as the “QM Patch” – for loans eligible for purchase by the GSEs (Fannie Mae/ Freddie Mac) or loans eligible for government insurance or guaranty (HUD/VA/USDA), the QM Patch creates an unfair advantage to GSE and government mortgages without providing additional consumer protection, exposes taxpayers to potential losses and restricts consumer choice by restricting private investors flexibility and participation.
- Author Note 1: In an article discussing developments challenging investors in the mortgage market – Residential Secondary Market IICLE Article September 13, 2016 – this author submitted that current ATR/QM rules impose legal risk on investors in rebuttable QM and in non-QM loans, and as a result investors remain averse in investing in Private Label Residential Mortgage-Backed Securities (PL-MBS) backed by rebuttable QM and non-QM which is reflected in the level issuance of PL-MBS. The article submits that revival of the PL-MBS market would depend, in part, on investors ability to accept the new legal risks involved in investing rebuttable QM and non-QM loans in light of the implication of the ATR rules.
The report recommends that the CFPB review the ATR/QM rules and work to align the general QM requirements with GSEs eligibility requirements and eventually phase out the QM Patch and subject all market participants to the same QM requirements. The report recommends that such requirements be flexible to accommodate compensating factors that would allow a loan to remain a QM even if one particular criterion is not met, e.g., higher DTI loan with compensating factors would still be a QM loan. Nevertheless, the report makes clear that any changes to the QM requirements must prioritize consumer protection.
- Author Note 2: Surprisingly the report did not address a fundamental hurdle posed by the Dodd-Frank Act ATR rule, namely, the civil liability provision related to ATR which lacks a time limit on right of consumers to bring a claim/defense of ATR violation in the event of foreclosure. Currently, a consumer in foreclosure may bring an ATR claim/defense without time limit. A court finding that the loan did not meet the ATR requirement means that the loan is illegal and carries TILA civil liability remedies and other possible downstream legal implications. Loans that meet a rebuttable presumption of QM and loans that are not QM are most susceptible to ATR legal risk.
The simplest way to stimulate return of private investment in the mortgage market, to create flexibility in mortgage products and to create liquidity through the PL-MBS market, is for Congress to amend and balance the civil liability provision related to the ATR rule. Such amendment should limit the right of consumers to bring an ATR claim/defense to a reasonable period of time, by subjecting it to a statute of repose and by deeming that ATR requirement was met at origination if an ATR claim defense is not brought within a reasonable time period (e.g. within 3 years).
Modify Appendix Q of the QM Rule
The report found that the QM rules in Regulation Z, Appendix Q, are too rigid and opaque and offer inadequate guidance with respect to borrowers with non-traditional income sources. The report states that such rigidity and opacity are likely contributing to the tighter lending environment. The report recommends that the CFPB simplify Appendix Q by releasing much clearer, binding guidance for its use and application. It also recommends that the CFPB review Appendix Q standards for determining borrower debt and income levels to mitigate overly prescriptive and rigid requirements, particularly with respect to self-employed, small business owners, seasonal workers, and retirees.
Revise the Points and Fees Cap for QM Loans
The report recommends that the CFPB increase the $103,000 dollar loan amount threshold for application of the 3% points and fees cap, to encourage additional lending in the form of smaller balance loans. The report also recommends that the CFPB scale the points and fees caps in both dollar and percentage terms for loans that fall below the adjusted loan amount threshold for application of the 3% points and fees cap.
Increase Maximum Asset Threshold Small Creditor QM
The report acknowledged that smaller depository institutions, which generally follow conservative underwriting practices and are often very familiar with their local market, may be better positioned than larger institutions to determine the creditworthiness of local borrowers. The report recommends raising the total asset threshold for making Small Creditor QM loans from the current $2 billion to a higher asset threshold of between $5 and $10 billion. In the alternative, the report reiterates its recommendation to for the CFPB to undertake a rulemaking to amend the ATR/QM rules for all lenders regardless, which could resolve issues experienced by smaller lenders.
Clarify and Modify TRID
With respect to the TRID rules implemented by the CFPB, the report recommends clear written guidance from the CFPB that would help lender and investors have greater degree of certainty in determining compliance with TRID requirements. The report states that uncertainties in the TRID rule could be resolved by the CFPB through notice and comment rulemaking and/or through the publication of more robust and detailed FAQs in the Federal Register. In addition, the report recommends that the CFPB should allow: (i) a more streamlined waiver for the mandatory waiting periods, and (ii) creditors to cure errors in a loan file within a reasonable period after closing.
Increase Flexibility and Clarify Enforcement of the Loan Originator Compensation Rule
The report recommends that the CFPB improve the flexibility of the Loan Originator Compensation rule, particularly where an error is discovered post-closing, in order to facilitate post-closing corrections of non-material errors. It also recommends that the CFPB establish clear standards and enforcement priorities through notice and comment rulemaking, before proceeding with enforcement of the Loan Originator Compensation rule.
Delay Implementation of HMDA Reporting Requirements
The report acknowledges mortgage industry and privacy advocates concerns about the efficiency of the HMDA regime, borrower privacy, and competitive harm to lenders through disclosure of proprietary information. The report recommends that the CFPB delay the 2018 implementation of the new HMDA requirements until borrower privacy is adequately addressed and the industry is better positioned to implement the new requirements. It also recommends that the new HMDA requirements should be examined for utility and cost burden, particularly on smaller lending institutions.
Mortgage Loan Servicing
Place a Moratorium on Additional Mortgage Servicing Rules
The report recommends that the CFPB place a moratorium on additional rulemaking in mortgage servicing while the industry updates its operations to comply with the existing regulations and transitions from HAMP to alternative loss mitigation options. In addition, the report recommends that the CFPB work with prudential regulators and state regulators to improve alignment in both regulation and examinations, which could help in decreasing the cost of servicing in general.
Exempt Community Depository Institutions from Risk-Based Capital Requirements
To allow community depository institutions to retain servicing and thus serve borrowers within their communities, the report recommends that the banks and credit union regulators should explore exempting community depository institutions from certain risk-based capital requirements, including from the capital treatment of mortgage servicing assets that after the Basel III amendments was increase to 250% of the mortgage servicing rights.
Private Sector Secondary Market Activities
Repeal or Revise the Residential Mortgage Risk Retention Requirement
The report calls for the repealing or substantially revising the residential mortgage risk retention requirement, which it considers to be aligned with its recommendation to review the QM standards. If only revisions are made, the report recommends that the legislation also designate one agency to be responsible for the interpretation of the risk retention rule.
Enhance PL-MBS Investor Protections
The report recommends that Congress consider legislation providing additional protections for investors in PL-MBS. In addition, market-led and regulatory initiatives that improve transparency as well as standardization of documentation and data should be encouraged.
Clarify Limited Assignee Liability for Secondary Market Investors
The CFPB should clarify assignee liability for secondary market investors related to errors in the origination process where such errors are not apparent on the face of the disclosure statement and are not asserted as a defense to foreclosure. (see Author Note 2 above)
Improve the Alignment of the Regulatory Capital Framework for Structured Mortgage Products
The report recommends that prudential regulators review the regulatory framework for risk-weighting applicable to securitizations in order to better align the framework with the risk of the asset and with international standards for securitized products. At a minimum, the report recommends that regulators should calibrate standards to resolve this type of counterintuitive result.
Amend Reg AB II
The report recommends that the SEC amend Reg AB II as it applies to registered securitizations of PL-MBS to reduce the number of required reporting fields and standardize definitions. The report states that fewer fields and standardized definitions may provide sufficient transparency without placing excessive burden on the issuer.
Evaluate Impact of Liquidity Rules on the PLS Market
Current risk-based capital requirements make it more attractive, under certain scenarios, for depositories to invest in holding the mortgage loan asset as opposed to the PL-MBS. The report recommends that prudential regulators consider the impact that capital and liquidity rules implementing Basel III standards would have on secondary market activity and calibrate them to reduce complexity and avoid punitive capital requirements.
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