CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

In the realm of mortgage reform, the Dodd-Frank Act was designed to prohibit lenders from steering any consumer toward a residential mortgage loan that the consumer cannot repay or that has predatory characteristics and from steering consumers away from QMs and toward non-QMs. Under the Dodd-Frank Act, a mortgage lender is presumed to have satisfied the ability-to-repay requirement and receives some protection from liability when it originates a QM (and exactly how much protection is still open to debate).  (See our OnPoint explaining the difference between the proposed safe harbor and rebuttable presumption alternatives for QM).

The GAO analyzed a proprietary database of loans originated from 2001 through 2010 from CoreLogic, Inc. to assess the potential impact of mortgage-related provisions in the Dodd-Frank Act on the availability and affordability of mortgage credit. The GAO notes up front that such analysis may not be fully representative of the mortgage market as a whole. It also reviewed housing and mortgage market research and interviewed mortgage industry stakeholders-- including those representing mortgage lenders, securitizers, investors and consumers. 

What I’ll call an “abstract” of this GAO report can be found on page 58.  Here, the report states that limited data and research show that certain provisions could provide benefits to homebuyers and the larger mortgage market, but that the ultimate impact of the Dodd-Frank Act’s mortgage-related requirements is not yet known and will depend, in part, on regulatory actions, decisions to fund housing counseling and mortgage market adjustments that have not yet occurred.

On the up side, it appears that the bulk of loans do meet QM criteria; on the down side, there’s a sizable hole in the data and final regs may exclude even more loans.

Let’s take a look at what the report says:

The Dodd-Frank Act specifies nine QM criteria, but gives regulators the authority to add, subtract or modify the QM criteria as they see fit. The GAO examined five of the nine QM criteria specified and states that it generally found that most mortgages would likely have met such individual QM criteria. However, the GAO notes that the impact of the full set of QM criteria is uncertain, partly because it could not analyze the other four QM criteria and partly because federal agencies could establish different criteria as final regulations are developed. Maybe I’m not grasping the extent of the usefulness of this examination because it seems rather useless. Moving on…

Generally, the Dodd-Frank Act requires securitizers of RMBS to retain at least five percent of the credit risk of any residential mortgage securitized that does not meet specified criteria. In its report (which focuses on risk retention for RMBS), the GAO notes that key decisions that have yet to be made (including the characteristics of mortgages that would be exempt from risk retention requirements, the form(s) of risk retention that would be allowed, the percentage that securitizers would be required to retain and risk sharing arrangements between lenders and securitizers) could affect the availability and cost of mortgage credit as well as the viability of a private mortgage securitization market. However, the GAO report makes a number of recommendations for rulemakers to consider when crafting the final risk retention requirement, including a recommendation that the requirement be tailored to each major class of securitized assets.

Additional uncertainty arises, the GAO notes, from provisions in the Dodd-Frank Act concerning homeownership counseling and regulation of high-cost loans which could enhance consumer protections and improve mortgage outcomes for some borrowers. As required under the Dodd-Frank Act, HUD has initiated plans to establish an Office of Housing Counseling to perform a number of functions related to homeownership and rental housing counseling, including establishing housing counseling requirements and standards and performance measures; certifying individual housing counselors; conducting housing counseling research; and performing public outreach. Findings from the GAO’s limited research on housing counseling for mortgage borrowers are reported to be mixed, with some studies suggesting that some types of counseling can improve mortgage outcomes and other studies’ findings less clear. 
 
Yet again, the GAO acknowledges data limitations and notes that although lenders have generally avoided making “high-cost loans,” additional information on mortgage costs would be needed to assess the extent to which a newly expanded definition of high-cost loans under HOEPA would affect mortgages that may be made in the future. In addition to expanding the definition of high-cost loans, the Dodd-Frank Act requires that borrowers undergo counseling with a HUD-approved counselor before taking out a high-cost loan. Industry stakeholders who spoke with the GAO indicated that the new definition of high-cost loans would further increase disincentives for originating mortgages with potentially predatory terms and conditions. Additionally, they said that lenders would likely continue to avoid offering high-cost loans because the strict penalties and liabilities attached to such loans make them risky to originate and difficult to securitize.

So far this birthday party leaves a lot to be desired. 

By Laurie Nelson.

Congressman Garrett noted in his remarks that the portfolios of the GSEs are a combined $1.5 trillion-- a book with a lot of interest rate risk and a lot of unrealized gain. He said this portfolio needs to be unwound sooner rather than later. He wants to see the GSEs on the federal budget-- on the books of the U.S. government-- and he noted that in private industry, there has been a movement toward on-balance sheet and questioned why this wasn't so in Washington.

Knowing his audience, he stressed that securitization has to play a huge, vital, integral part in the resurrection of the mortgage market, and he said that securitization is vital to the movement of capital around the country. He noted the unsustainability of FHA insuring 50% of new originations and the government underwriting 95% of the mortgage market. The Congressman stated he is firmly committed to a purely private U.S. mortgage market over time, free of government subsidies or guarantees. He acknowledged concerns associated with a purely private market but also said there are competing concerns with models that include government support.

Addressing assertions from critics, the Congressman asked whether home price increases and higher down payments would be so bad (possible results of the 30-yr fixed rate mortgage not surviving without a government guarantee). He questioned whether the government is able to price catastrophic credit risk and pointed to a shoddy track record. He posited that there are other ways to keep a TBA market viable aside from a government guarantee and noted that the government steps in at the end of the day perhaps because it is allowed to, and that allowing it to increases the chances the government will do so. He noted that a discussion of servicing standards in connection with QRM never came up in crafting Dodd-Frank and suggests regulators not take the servicing issue into account. In the Risk Retention breakout session later in the morning, Tom Boemio (Sr. Project Manager, Policy, Board of Governors of the Federal Reserve System) concurred and asked: Why have servicing standards in connection with the highest quality loans only-- and not the rest?

The Congressman said there is no role for government assistance except in connection with first-time home buyers, and such assistance should be on-budget and transparent. Finally, he said that the government has to play a big role because the private sector isn't-- the old chicken-egg thing. [His prepared remarks can be found here].

At the February 7 General Session that followed, Martin Hughes of Redwood Trust further addressed the chicken and the egg issue noting that "uber government support is stifling the return of private securitization." He acknowledged that government bids are attractive and there's been no incentive for banks to sell to non-agency, and that reducing the government's role would be a game changer. Addressing the circular problem, he did note that if the government backs out before the private sector is up and running, there are sure to be problems but he suggested the status quo needs to be tested. Stating that "issuance velocity leads to issuance velocity," he also noted there are too few prime loans to get real issuance velocity. Hughes agreed that, yes, investors are mad, and investors have demands and opinions with respect to servicing practices but he believes those demands can be met and that prime jumbo can have safe attractive yields.

Hughes summarized the general sentiment by stating we need the new rules of the road-- final rules so that market participants can adapt and move ahead-- because uncertainty has been an enormous headwind. And we have uncertainty as to what the rules are and, in addition, how those rules are to be interpreted. Stay tuned for more from ASF.

By Laurie Nelson.

Noting that the regulatory changes are aimed directly at improving asset quality, Dechert partner John Timperio summed up the regulatory mess by telling it like it is: the regulatory landscape is uncertain; and that uncertainty needs to be resolved. With respect to the ratings agencies, John Timperio said that the solution isn’t 17g-5 (and no one has heard of any unsolicited ratings as of yet), but investors realizing the limitations on what ratings mean and doing their own diligence.

The next group of panelists discussing Global Regulatory Initiatives and the Broader Impact on U.S. Securitization Practices reiterated much of the same—that regulation needs to be coordinated and clear and create a level playing field (between banks and non-banks for example). The hope is that there is a consistency of message and it would be ideal if all the relevant rules came out at once. And what the SEC is seemingly losing sight of is that the players are “big boys and big girls” and whatever part of a capital stack is purchased, investors know there’s no sure thing.

Overall, the conference didn’t feel like a job fair and attendees seem committed to getting things going again in our corner of the capital markets.

Next year: same time (thereabouts), same place.

By Ralph Mazzeo and Laurie Nelson.