As we approach January 2014, the entire mortgage lending industry is braced for impact in terms of compliance and operational issues related to the Dodd-Frank reform law. The “qualified mortgage” or QM and “qualified residential mortgage” or QRM designations related to mortgage lending now define the outer limit of risk taking for many bank lenders.

The rules for a mortgage that qualifies with the QM/QRM standards are a bit arcane and provide uneven incentives to borrowers and note holders alike. The good news is that regulators have chosen to equate the two standards, but that’s where the easy part ends.

There are at least three legs on the regulatory stool for lending at the federal level — state agencies are also heavily involved in the compliance and litigation equation, but that is a discussion for another day: The Consumer Financial Protection Bureau (CFPB); the Federal Housing Finance Administration (FHFA); Federal Housing Administration (FHA); and the federal bank regulators led by the Office of the Comptroller of the Currency (OCC) are all focused on both lending and servicing.

The CFPB is focused first and foremost on consumer protection, while the regulators of the federal housing agencies are looking at loss mitigation and compliance with the state foreclosure settlements. Just peruse the legal and regulatory turf controlled by the CFPB in the agency’s examination manual and you get some idea of the sweep of this new agency’s authority.

Notice in particular how many times the word “checklist” appears in the list:

Statutory- and regulation-based procedures 

Unfair, Deceptive or Abusive Acts or Practices 

• Narrative
• Examination Procedures 

Equal Credit Opportunity Act 

• Narrative
• Examination Procedures
• Interagency Fair Lending Examination Procedures
• Interagency Fair Lending Examination Procedures – Appendix 

Home Mortgage Disclosure Act 

• Narrative
• Examination Procedures
• Checklist 

Truth in Lending Act 

• Narrative
• Examination Procedures 

Real Estate Settlement Procedures Act 

• Narrative
• Examination Procedures
• Checklist 

Homeowners Protection Act 

• Narrative
• Examination Procedures 

Consumer Leasing Act 

• Narrative
• Examination Procedures
• Checklist 

Secure and Fair Enforcement for Mortgage Licensing (SAFE) Act 

• Narrative
• Examination Procedures 

Fair Credit Reporting Act 

• Narrative
• Examination Procedures 

Fair Debt Collection Practices Act 

• Narrative
• Examination Procedures 

Electronic Fund Transfer Act 

• Narrative
• Examination Procedures
• Checklist 

Truth in Savings Act 

• Narrative
• Examination Procedures
• Checklist 

Privacy of Consumer Financial Information (Gramm-Leach-Bliley Act) 

• Narrative
• Examination Procedures
• Examination Procedures Attachment
• Checklist

The CFPB announced the final amendments to what is now known as the “QM” rule in January 2013, which defines mortgages subject to a legal safe harbor. The CFPB amended Regulation Z, which implements the Truth in Lending Act (TILA). Regulation Z currently prohibits a creditor from making a higher-priced mortgage loan without regard to the consumer’s ability to repay the loan. The final rule implements sections 1411 and 1412 of the Dodd-Frank Act, which generally requires creditors to make a reasonable, good faith determination of a consumer’s ability to repay any consumer credit transaction secured by a dwelling (excluding an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan) and establishes certain protections from liability under this requirement for QMs. The final rule also implements section 1414 of Dodd-Frank, which limits prepayment penalties. Finally, the final rule requires creditors to retain evidence of compliance with the rule for three years after a covered loan is consummated.

The QM definition includes all conforming FHA and agency mortgages, meaning that two groups of loans are specifically excluded: 1) jumbo prime but nonagency, and 2) below prime loans. Both prime and below prime customers are cut out of the QM definitions. This is important for encouraging the return of private capital to the mortgage markets because of the “skin in the game” rules of Dodd-Frank related to “residential mortgage-backed securities” or RMBS, which were implemented by the major bank regulators in August. 

The six financial federal regulators (HUD, Federal Reserve, FDIC, FHFA, OCC, SEC) responsible for writing and implementing the QRM re-proposed the rule after receiving considerable pushback from National Association of Realtors (NAR), other housing industry groups, consumer groups and lawmakers. The previous proposal required borrowers to have a minimum 20% down payment to qualify for the most preferred and affordable mortgage products that come under the QRM rule. By equating QM with QRM, the Fed and other bank regulators backed down from a confrontation with NAR and other powerful Washington housing lobbies, but that does not mean this was a good decision. 

Ed Pinto, resident scholar at American Enterprise Institute, notes that equating the QM standard regarding lending standards with the QRM standard regarding skin in the game for RMBS securitizations defeats one of the chief goals of Dodd-Frank: “A QRM was intended to set a standard for loans placed in a mortgage- backed security that have a low credit risk as evidenced by their past performance. In their earlier March 2011 proposed QRM rule, the six agencies defined a QRM as a loan with a ‘low risk of default even in a stressful economic environments that combine high unemployment with sharp drops in home prices.’ They concluded based on substantial and rigorous research that to be a low-risk loan, it needed demonstrate three qualities: a substantial down payment of 20% (or low loan-to-value on a refinance loan), a clear demonstration of credit worthiness, and a DTI ratio of less than or equal to 36%. ‘QRM = QM’ clearly does not pass muster under any low risk standard.”

Pinto and other conservative critics of the QRM standard wanted to see a more limited QRM rule for new RMBS, a standard that would have been a subset of the QM rule for lending set by the CFPB. Equating the two gives the lending sector and especially the large banks some refuge from the torment of litigation, but the reality is that the Fed and other bank regulators punted on the QRM rule, believing instead that they can address prudential issues raised by RMBS through the supervisory process. Today the QRM safe harbor for loans sold into the RMBS market is the subset including 1) conforming and agency loans and 2) loans that are QM eligible. Otherwise the sponsor must retain an additional 5% interest in the RMBS deal above the equity interest that is normally retained in such transactions. 

The QM/QRM standard means that the large banks are going to being making two kinds of loans in 2014: 1) agency loans that can either be resold or retained with minimal risk, and 2) prime jumbos that have more theoretical liability and higher capital risk weights, but a still low probability of default. The largest banks will originate and buy prime jumbos primarily for their own portfolios, not for securitization. Below prime loans will be largely abandoned by the banks, as is the case today, leaving the below 700 FICO borrower to deal with nonbank lenders almost exclusively. Banks will not lend to below prime, non-QM/QRM customers for a number of reasons, including potential legal liability and Basel III capital and liquidity rules. But another obstacle to making loans to below-prime borrowers is the asymmetrical tax applied to non-QM/QRM loans by the “skin in the game” rules of Dodd-Frank. As I noted in a comment for Breitbart back in September:

“The whole idea of skin in the game is to keep a capital buffer inside the trust created for a given mortgage bond to protect investors from loss. If the QM rule issued by the Consumer Financial Protection Bureau is about safeguarding consumers, the QRM with the 5% risk-retention requirement is meant to shield bond investors. With the broad interpretation of Dodd-Frank in the QRM proposal, the vast majority of homeowners who qualify for a mortgage guaranteed by Uncle Sam are paying nothing to mitigate the risk of another subprime crisis. Meanwhile, the portion of the population who can’t qualify for an agency loan will carry the full load of the Dodd-Frank tax. My colleagues in the bond analytics world think the disproportionate impact on below-prime and nonconforming borrowers could be worth between half a point and a full point annually in higher loan costs.”

As lenders move forward in 2014, the non-bank lenders such as Carrington and others in this growing category represented by the HousingWire 30 are likely going to expand lending in the non-QM/QRM space, even as the commercial banks effectively flee this category. The effect of QM/QRM is likely to be less availability of mortgage credit, one reason why the Mortgage Bankers Association asked the FHFA to delay any reduction in the Fannie Mae/Freddie Mac loan limit.

Data from the Federal Reserve Board shows a sharp drop off in total mortgages outstanding as the high default rates of the 2007-2011 period overwhelmed the meager rates of new lending growth. The cumulative impact of the QM/QRM rules is likely to mean restricted growth of bank portfolios of 1-4 family loans of all types and descriptions, a fact that should trouble policymakers. Nonbank firms like Carrington are going to continue to grow in both the conforming/agency and nonagency lending categories, but the whole nonbank sector is still tiny relative to the commercial banks – less than 10% of total mortgage lending production. The cumulative impact of the Dodd-Frank QM/QRM rules on bank lending into the housing sector in 2014 due to regulations of all sorts is likely to be quite negative. Perhaps this is one reason why the MBA is predicting a sharp drop off in mortgage lending volumes in 2014, from $1.6 trillion in 2013 to just $1.1 trillion next year. If such a sharp drop in overall lending volumes occurs, the public policy narrative in Washington may shift to how to relieve regulatory obstacles to lending and securitization rather than on compliance with the Dodd-Frank regulations.