Qualified Residential Mortgages Add Risk Control Layer

Regulatory changes such as the pending definition of what consists of a qualified residential mortgage have increased perceived and real mortgage investment risk.

Meanwhile, the Dodd-Frank Act requirement—which could be described as a call to arms so the mortgage industry gets back to what used to be good old fashioned underwriting standards—is to some extent open for discussion.

The act set an end of April deadline for federal banking agencies, the Department of Housing and Urban Development and the Federal Housing Finance Agency to deliver the QRM definitions. Regulators require higher downpayments of up to 20% on these qualified residential mortgage loans to ensure lenders do not overlook loan risk since they would have to shoulder some of it upfront, instead seeing it as a possibility into the future if and when a loan forecloses and turns into a buyback charge. Also, it is an effort to settle the 80% loan-to-value as an industry norm.

Dodd-Frank requirements are designed to control both primary and secondary market risk and encourage issuers to securitize more loans and open up liquidity flows into the marketplace once they feel loan delinquency risk is under control.

Some insiders see the current changes in the distressed mortgage loan market is a necessary catharsis that will help improve market fundamentals. Others keep their focus on short-term challenges.

Rebecca Walzak, president of Walzak Consulting and a qualified residential mortgage and risk retention expert, warns there is a bigger issue at hand that goes beyond the waiting period until the definition is finalized in April.

“Lenders are not going to offer adjustable-rate mortgages,” for which they will have to reserve up to 5% in reserves, when they have the option to offer safer, lower-risk fixed-rate mortgage options that are qualified residential mortgages.

Another factor will be "much more conservative” lending criteria that is bound to decrease lending available to first-time homeowners and to further slow down an already slow recovery. It means young professionals who need “reasonable adjustable rates” such as three-year ARMs to get their careers off the ground before the payments are adjusted will not have that option.

In Walzak’s view, qualified residential mortgages created as “a risk protection to lenders” are not the solution to the crisis. Instead, she suggests the industry look for the positive and negative features of evaluating risk regardless of the loan type so reform can help “move more properties in inventory.”

Until a consensus is achieved, however, loan risk, or at least investor perception of mortgage risk, may hinge interest in securitizing mortgage loans lead to new liquidity shortages for mortgage lenders and servicers.

What concerns many market players, according to LendingTree’s chief executive Cameron Findlay, is “a short-term disruption effect” the new definition may have on the mortgage-backed securities market because investors will have to react to these changes in a way that minimizes investment risk.

“Perception is everything.” Many people will get scared, he says, even though the damaging effect these changes may have on mortgage asset values will not be so easy to predict.

Mortgage industry expert Ann Fulmer started the “Direct from D.C.” audio news podcast series empowered by Interthinx of Agoura Hills, Calif., with a commentary on issues surrounding regulatory reform such as QRM because it will have a “direct impact on risk retention” as QRM sold on the secondary market will affect the amount of reserves that must be kept on hand by an originator.

On the servicing side, on the other hand, the pressure will be to react fast to the first signs of loan delinquency and intervene with applicable workouts that can avoid the risk of serious delinquencies and foreclosures—which may eventually lead to demand for even higher reserves.

Fulmer is closely following recent discussions about resetting the downpayment requirement to 30% and the debates they have sparkled on both sides as the final decision day in mid-April approaches.

Interthinx executives said they invested in the podcast because given the amount of new financial regulations currently pending for industry and public discussion, “it is crucial for everyone to keep pace with reporting and disclosure changes” until they are finalized.