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Investments / The Ticker

Qualified Mortgage rule impacts severities, not defaults

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In January the Consumer Financial Protection Bureau issued a final rule establishing ability-to-repay standards for originating residential mortgages and defining the criteria for a qualified mortgage loan. 

The new rule is scheduled to go into effect on Jan. 10, 2014.

Morningstar explored some of the potential effects the new rule will have on rating residential mortgage-backed securities, including the impact of default and loss severity projections and the expected changes to data provided in securitizations backed by residential mortgages subject to the rule.

"Morningstar uses its proprietary loan-level transition credit model to determine the rate and timing of defaults, severities and prepayments in the expected and stressed scenarios. Inputs into the model include the characteristics of the mortgage loan as well as projected economic scenarios," said analysts for the ratings firm.

However, classifying a loan as QM-safe harbor, QM-rebuttable presumption or non-QM will not affect the projected defaults, but will impact the projected severities. 

The fact that a mortgage qualifies as QM does not ensure that its expected to default rate will be lower than a mortgage that does not qualify as such.

Furthemore, if a mortgage loan qualifies as QM-safe harbor, the ability of the borrower to challenge that the underwriting followed the ATR requirements is limited, Morningstar noted.

"For mortgage that are QM- Rebuttable Presumption and non-QM, the borrower’s ability to challenge the ATR can lead to longer foreclosure timelines and increased costs due to fees related to defending the challenge and the recoupment that can result if the challenge is upheld," analysts explained.

When implemented, the CFPB rule establishing the ATR standards and the QM definition will have an effect on Morningstar's projections of mortgage performance. 

Even if a mortgage qualifies as a QM loan, it does not mean that the mortgage necessarily has a lower default expectation than a non-QM loan.

"Morningstar will need to be informed of which mortgage loans qualify as QM, and will depend on due diligence results to confirm this data through a representative sample," the report concluded.

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