The year ahead remains murky for investors even as the Qualified Mortgage (QM) rule takes effect and the Qualified Residential Mortgage (QRM) is hammered out, but there are signs of optimism for normalization.
Analysts and industry watchers say that the Dodd-Frank Wall Street Reform and Consumer Protection Act-mandated QM, which goes into effect Jan. 10, won’t have a major impact on the mortgage-backed securities (MBS) market, though it may slightly slow lending activity on certain jumbo and interest-only loans.
This comes even as housing market analysts say they expect a general slowdown for 2014 after the quick pace of 2013.
"I think QM will have limited impact on our market," says Sarah Hu, director of markets and international banking for Royal Bank of Scotland.
"Most the loans in the MBS market are GSE loans and as such automatically considered QM by definition."
"The majority of the RMBS market loans come from Fannie Mae and Freddie Mac. The jumbo market and interest-only loan market are not something we deal with," Hu says. "So it could reduce slightly lending activity overall when it takes effect Jan. 10, but it won’t have any real impact on the MBS market."
QM requires loans to have periodic payments without risky features. In addition, a QM loan comes with terms that don’t exceed 30 years; limits upfront points and fees to no more 3%, and is either insured or guaranteed by FHA or HUD.
Hu says outside of her prediction on the effect of the QM rule, she doesn’t want to be more specific on forecasting because there are too many dynamics going on, including what incoming Federal Housing Finance Administration director Mel Watt will do, given he has already said he is in favor of expanding credit availability and ensuring more modest income borrowers still have access.
"We’re entering a new year and there is a lot of rough terrain and policy uncertainty," Hu says. "Growth in the market will likely be determined by the purchasing sector because the re-fi volume is already down. There is just a lot of uncertainty in terms of all the rules coming out of federal agencies."
One of those uncertainties is the aforementioned QRM rule. While still in development, the latest version of the QRM is considered by most a smart compromise that balances accountability with reasonable access to credit, especially for those applicants who have good credit but don’t have large down payments.
QRM was first proposed in 2011 and then reissued for comment after criticism came from most corners over the proposed 20% minimum down payment requirement. The new version under consideration adopts the restrictions in the QM and this alignment is seen as a positive. QM and QRM were created separately to realign creditor/ borrower and securitizer/investor interests, but there is a common interest from all sides.
The QRM rule as proposed protects investors from faulty packaging of the loan when it is delivered to secondary mortgage markets, and encourages better due diligence from securitizers as it requires them to meet a certain standard or retain 5% ownership so that they have "skin in the game."
The idea is to protect investors from having to worry about mortgages with risky features and letting them make their judgments based on quantifiable, transparent measures like Loan-to-Value and credit.
Further, it should help bring private capital back into the residential mortgage investment so that the players aren’t limited to GSEs.
"We think regulations in the second iteration of QRM got it right," says Pete Mills, senior vice president of residential policy and member services at the Mortgage Bankers Association (MBA). "QM and QRM ought to be the same if you want a deep and liquid market and to bring private label capital back. The QRM market is where we think private label mortgage securities will come back into the space. But that market is held back by absence of (the final) QRM rule."
Ryan Dorbandt at Odeon Capital Group LLC says while the market will welcome a certain standardization of product and it would be the lure that private label capital needs, regulators need to strike a balance in their requirements.
"If the regulations they pass are too stringent, you’re back to square one," Dorbandt says. "The private label side wants the more vanilla product in their pipeline. But there has to be a balance."
"I think it’s positive that they are trying to align the QM with the QRM because it reduces the uncertainty you have when you have separate rules for lenders and securitizers. And it will be easier to implement as well," Hu says.
While QRM’s second iteration under consideration doesn’t have the same problems as the first proposal, it’s hard to say where the final version will land – or when it will.
"It surprised the market when they totally removed the LTV requirement. Everyone wondered if we were going back to 2006-2007 requirements where the rules were too lax. But then in the alternative rule they said they want 20% down, which may be too much and would hurt credit availability," Hu says.
Credit has become harder to get. The average credit score on purchase loans hovering at 750 – 50 points above the average credit score a decade ago. GSEs have increased down payment and credit score requirements on loans in a way that affects as many as 12 million borrowers. FHA also has raised its standards while lenders have backed away from its most generous underwriting rules.
"Ultimately there will be a compromise where it may be 10% down or so, and make sure the underwriting is reasonable but not limit credit availability," Hu says.
Mills says with six disparate federal agencies involved, it’s hard to say whether a final draft will come in the spring, summer or even later.
"It’s almost impossible to tell when those stars will align," he says.