Wednesday, March 30, 2011

The FDIC Announces the New Qualified Residential Mortgages

Yesterday, as most of us in the residential loan origination community waited for the outcome of the request for an injunction for the Federal Reserve's loan originator compensation rule, the FDIC made some news of its own.  FDIC chairwoman Sheila C. Bair issued a press release that the FDIC is ready to issue a proposed rule on the new qualified residential mortgages (QRMs) which will be exempt from the 5% credit risk retention rules which are required as part of the Dodd Frank bill.  

The actual proposed rule itself has not yet been published in the Federal Register.  Look for that to happen in a few days, followed by the 60 day proposed comment period.  There is so much in this rule in terms of standards for a loan to meet the criteria of a qualified residential mortgage that comments from industry participants are going to be very critical.  We will report back on that when the proposed rule is published.

Today I just want to focus on the tone of Ms. Bair's statements, because I think that her remarks in the press release speak volumes about the future, or lack thereof, of the independent mortgage originator or mortgage broker, in the brave new world of mortgage lending.

You may recall that Dodd Frank requires that the originator of the residential mortgage retains 5% of the loan as risk retention for the life of the loan.  This "skin in the game" approach is supposed to guard against making risky loans that are likely to default.  But, as with just about everything else that is happening right now in residential loan origination, the new rules work heavily in favor of large banking entities like Wells Fargo and JP Morgan Chase who can afford to retain 5% securitization.  The rule works against the smaller community banks who cannot afford to keep 5% of the mortgages on their books, and they are death to the small mortgage broker who has made his or her living by originating and selling mortgages.  Small companies like mine cannot afford to keep any part of the loans that we originate, so we are out of the game.

The caveat is the "qualified residential mortgage".  Loans that are classified as QRMs, which includes FHA, VA and, as long as they remain in conservatorship, Fannie Mae and Freddie Mac, are exempt from the 5% risk retention rule.  So these mortgages can be originated and sold as they are today.  That is the reason that the definition of the QRMs is so critical; these are the only loans that the smaller players in the real estate market will be allowed to originate.

That is what makes Sheila Bair's comments so telling. "The general rule set out in Dodd Frank is to require issuers of securitized loans to retain 5 percent interest in the risk of loss. The law provides an exception to that rule and directs the agencies to set a standard for underwriting and product features, that, as shown by historical data, result in lower risk of default such that risk retention is not necessary. The QRM is the exception, not the rule, and as such I believe it should be narrowly drawn....Because QRM loans are exempt from risk retention, the proposed QRM definition sets appropriately high standards regarding documentation of income, past borrower performance, a low debt-to-income ratio for monthly housing expenses and total debt obligations, elimination of payment shock features, a maximum loan-to-value or LTV ratio, a minimum down payment and other quality underwriting standards.  This does NOT mean that under the rule, all home buyers would have to meet these high standards to qualify for a mortgage. On the contrary, I anticipate that QRMs will be a small slice of the market, with greater flexibility provided for loans securitized with risk retention or held in portfolio."  (All emphasis in bold lettering added).

What we do know is that the new rule requires a 20% down payment, which has led the mortgage insurance company PMI to ask what role the mortgage insurance companies will play, if any, in the new mortgage world that is being written today.  What we also know is that loans sold to Fannie and Freddie will be QRMs as long as they remain in conservatorship; however, as the Obama Administration moves to shut down Fannie and Freddie and reduce the size of their portfolios as they announced in February, we will see fewer and fewer loans selling to the two agencies.

What is most amazing about this, however, is the blatant way that the federal government is redirecting the mortgage delivery system in the United States.  Five years ago, mortgage brokers originated between 65 and 70% of mortgages in the United States.  By last year that number had declined to between 10-12%.  Barring an injunction from a federal judge later today, April 1 will see a new rule implemented that will change the compensation of loan originators nationwide, most affecting the few independents left and the smaller community banks.  Now with the QRM standards, Bair is saying outright that these are to be a small slice of the market--the exception, not the rule.  That delivers the major slice of housing market pie to the banking giants.

The irony here is amazing.  Three years ago we were told that Wells Fargo and JP Morgan Chase were too big to fail.  Very little TARP money, if any, went to small regional banks or community banks.  None went to small businesses like mine.  Now three years later, the mega banks are just fine and we are too small to be of any importance.  The fact that small players are being beaten and pushed out of the residential housing market is heralded as a consumer safety issue!

Stay tuned as we examine the proposed rules in detail as more information becomes available.

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