Based on an underwriting-related portion of Dodd-Frank alone it sounds like loans on the secondary market are probably going to continue to be underwritten within relatively narrow parameters for some time.
Does this bode well for loan performance? It may. But as a Mortgage Bankers Association study last week noted, there’s room for doubt. Michael Lea, director of the Corky McMillin Center for Real Estate at San Diego State University, said in an interview that the MBA-sponsored study he did shows, for example, loans that have performed badly in the U.S., such as loans that allow limited variability in payment, have performed relatively well in some other countries. Some of these had tighter underwriting and more restrictions than their U.S. counterparts.
The report suggests the problem lies more in a mismatch of borrowers with products than the products themselves.
The study, combined with what a well-known industry attorney separately explained about some of Dodd-Frank’s underwriting rules at a recent American Securitization Forum seminar, shed some interesting light on the question of how or whether one can prove one has done that “matching” correctly. That is, how or whether one can prove “ability to pay.”
Larry Platt, partner, K&L Gates told ASF seminar attendees, “There are some really important issues that have arisen in connection with this that will be addressed in rulemaking. One is: What is the expected income that a borrower is reasonably assured of receiving in the future? Can lenders really make that determination?”
So far, the Dodd-Frank provisions suggest, “You must consider regularity of income, you may consider irregularity and seasonality of income, and if you’re wrong there’s some pretty big penalties,” Platt said.
Originators express frustration with this—mostly when it comes to serving the self-employed/small business owners who want to finance homes and have trouble proving regular income.
The following may suggest one of the latest reasons why lenders continue to shy away from this area.
An underwriting “safe harbor” discourages these loans, Platt said, noting that he is referencing the safe harbor for “qualified mortgages” as opposed to the safe harbor for “qualified residential mortgages” in risk retention rules. (As Platt noted, “a qualified residential mortgage can’t be broader than a qualified mortgage under the underwriting rules, but it may be narrower.”)
The underwriting safe harbor means that “in effect, you have to have a 30-year fixed-rate loan unless you underwrite in certain...ways,” he said. “If the loan has more than three total points and fees it won’t be a qualified mortgage,” he added, although he noted that there is an exception “for two bona fide discount points.”
“You’re not required to fall within the safe harbor,” Platt noted. “It just gets you out of...a presumption...ability to repay provisions have been satisfied. But in the event that you’re wrong, in the event you decide to make a loan that doesn’t satisfy the ability to repay requirements—in other words it’s not a qualified mortgage loan—there is a limited form of assignee liability.”
The secondary market tends to have bad flashbacks to 2007’s so-called predatory lending discussions when assignee liability comes up in any form, so, as Platt said, “The consequence of all of this is in the future we think it’s pretty unlikely that people are going to what I call 'color outside of the lines’ and make loans that aren’t 'qualified.’”
