When House Bill 4173 and Senate Bill 3217 (the two financial reform bills) are reconciled in committee starting next week, one extremely important consideration for the mortgage industry and all of the smaller players including small to midsize banks and certainly mortgage brokers is going to be risk retention. If you recall, risk retention by originators was one of the policy recommendations made by consumer advocacy groups. Based on the theory that originators will tend to originate better loans if they have to hold on to a percentage of that loan for life, risk retention assumes that by forcing all players to maintain a stake in the game, originators will screen their applicants more carefully.
The problem with risk retention mandates is that, as with so many other aspects of the financial reform bill, it favors large players over small and midsized ones. HR 4173 requires 5% risk retention for all mortgage loans. On a $200,000 loan, an originator would have to be able to retain $10,000. In order to originate 10 loans at $200,000 each, he would have to be able to retain $100,000.00. Not only would the small, cash-strapped broker not be able to this, but the better capitalized small bank would also struggle because essentially they would have to retain servicing on every loan they originate. (Can you imagine receiving a letter from your mortgage company reading: "We have transferred your loan, so you will henceforth make all payments to company XYZ, except for the payments on $10,000 you owe us.")
Risk retention mandates deny the necessity of the secondary market by forcing originators to tie up cash and resources in loans, which will ultimately restrict access to capital.
When the Senate Bill was being debated, the Landrieu/Isakson amendment was approved which provides exemptions for certains loans from the 5% risk retention requirement. Senators Mary Landrieu (D. LA) and Johnny Isakson (R. GA) introduced the amendment to counter some of the problems inherent in risk retention. SA 3956 creates the following safe harbor for mortgages which will not fall under the 5% risk retention guidelines:
"The Federal banking agencies, the Commission, the Secretary of Housing and Urban Development, and the Director of the Federal Housing Agency shall jointly define the term 'qualified residential mortgage' for purposes of this subsection, taking into consideration underwriting and product features that historical loan performance data indicate result in a lower risk of default, such as--
'documentation and verification of the financial resources relied on to qualify the mortgagor;
standards with respect to--the residual income of the mortgagor after all monthly obligations; the ratio of the housing payments of the mortgagor to the monthly income of the mortgagor; the ratio of the total monthly installment payments of the mortgagor to the income of the mortgagor; mitigating the potential for payment shock on adjustable rate mortgages through product features and underwriting standards; mortgage guarantee insurance obtained at the the time of origination for loans with combined loan to value ratios of greater than 80% and prohibiting or restricting the use of balloon payments, negative amortization, prepayment penalties, interest only payments, and other features that have been demonstrated to exhibit a higher risk of borrower default."
What does that mean exactly? For example, the amendment calls for mortgage guarantee insurance on loans with combined loan to values over 80%. Right now, all conventional loans over 80% utilize mortgage insurance unless the loan has a first and a second lien (which would then be a combined loan to value). Would the new rules require a consumer to purchase mortgage insurance even with the presence of a second lien? Do the Senators who drafted this amendment know what mortgage insurance is?
Senator Isakson is quoted in Housing Wire on May 12, as saying, "What Senator Landrieu is saying is we're not going back when we make zero-down, interest only, reverse amortization loans anymore, but we are going to make the good old days loan, where there is a down payment, where there's skin in the game, where there's an income-to-debt ratio and where the borrower is qualified to borrow the money that they're borrowing....The only risk retention that will be required is when somebody is making a bad loan which means people will stop making bad loans which means that this bill and this amendment will address the measure that led to the failure in the housing market."
Zero down loans led to the failure of the housing market? Really? I wonder whether Senator Isakson knows that the U.S. government is still backing zero down loans through the VA and, if funds are ever reauthorized, through USDA. FHA requires a 3.5% down payment and an amendment which would have raised that down payment to 5% was defeated. Would these loans be subject to risk retention requirements? If these are "bad loans" that led to the housing meltdown, why is government still insuring them? The people with the highest level of risk retention in government insured loans is the American taxpayer.
Perhaps if the people writing these bills had even the vaguest notion of what they were talking about, the new laws coming out of Washington would make a lot more sense.
The text of the amendment actually does not say anything about down payment other than apparently requiring mortgage insurance on all loans despite the presence of a second lien. Maybe that will be worked out among HUD, the federal banking agencies and the Bureau of Consumer Financial Protection as they define what a "qualified residential mortgage" actually is. And as for the rest of us, maybe as Nancy Pelosi famously said of healthcare, we have to wait for them to pass the bill before we can find out what's in it.
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