Lenders dread prospect of Fannie, Freddie losing CFPB exemption
Mortgage lenders are fearful that the bottom will fall out of the housing market if the Consumer Financial Protection Bureau’s proposal to revise underwriting rules reduces the volume of loans sold to Fannie Mae and Freddie Mac.
The CFPB is soliciting feedback on a plan released last week to revise its "qualified mortgage" rule. Loans backed by Fannie and Freddie are now exempt from the rule but the bureau said it plans to let that temporary exemption expire.
Many lenders say the exemption known as the QM "patch" has helped enable the slow but steady housing recovery of the past decade, but that a new level of regulatory burden could reverse that progress.
“It doesn’t necessitate a change to the current system to put additional government regulation on something that isn’t broken,” said Kevin Marconi, chief operating officer at United Fidelity Funding, a a wholesale and retail lender in Kansas City, Mo.
The CFPB wrote the underwriting rule in 2013 to require lenders to verify borrowers' ability to repay. It also carved out a segment of ultra-safe “qualified mortgages” that are protected from liability. To get QM status, a loan must have a debt-to-income ratio below 43%. But to avoid disruption when the rule went into effect in 2014, the CFPB gave the QM patch to all loans backed by the government-sponsored enterprises, even with higher DTIs.
The two mortgage giants dominate the housing finance system. With the patch expiring in January 2021, lenders are scrambling to figure out what will happen to loans with high DTI ratios that are being sold to Fannie and Freddie. Those loans could take up as much as third of the GSE-backed market, according to some estimates. DTIs for some GSE-backed loans hover around 50%.
“Unless they eliminate having any threshold for QM, it will be material for the market,” said Ivy Zelman, CEO of Zelman & Associates, a housing research firm. “If you take even 5% of the market away, it will have a catastrophic downside on home prices. To me, that’s significant and I don’t think it makes any sense.”
Around 15% of home loan volume would be affected by eliminating the patch, said Warren Kornfeld, a senior vice president at Moody’s Investors Service. That amounts to $200 billion to $300 billion.
Marconi said mortgages backed by Fannie and Freddie are safe, but eliminating the patch will just lead to unneeded disruption.
The mortgage industry "is in a different time right now, it has adjusted, we’ve already self-regulated,” he said. “Removing the patch is putting the regulation in place, which means the government is meddling in the free market.”
In announcing the plan last week, CFPB Director Kathy Kraninger said she would consider a short extension of the patch to “facilitate a smooth and orderly transition.”
But Kraninger is likely to face pressure to extend the patch even more, eliminate the 43% DTI limit altogether, or raise the DTI limit to 50% or higher to maintain the status quo.
The mortgage market is already nervous about the effects of more comprehensive GSE reform. A legislative plan aimed at releasing Fannie and Freddie from their federal conservatorships and developing an alternative housing finance framework has stalled for years, heightening focus on what the Trump administration could do without Congress.
Some believe the 2020 election makes it unlikely that the Trump administration will release the GSEs from conservatorship anytime soon, to avoid economic fallout that could turn off voters.
But maintaining the GSEs' current footprint also is unlikely given that Mark Calabria, the director of the Federal Housing Finance Agency, which oversees Fannie and Freddie, has publicly supported private capital taking over some of the GSEs' market share.
“The mortgage market has been terrified all along that someone would take precipitous abrupt steps that would jar the market,” said Richard Cordray, the former CFPB director, who is writing a book about the bureau to be published next year by Oxford University Press. “They are terrified that ideology will trump practicality and there will be a free-market jolt.”
Fannie and Freddie control roughly 45% of the origination mortgage market, while the Federal Housing Administration and Department of Veterans Affairs insure another 20% to 25%. The remaining 30% is primarily jumbo loans of $500,000 or more.
Meanwhile, private-sector funding for higher-priced loans — including private-label securitization — has largely dried up since 2008. Nonbanks including specialty real estate investment trusts originated between $50 billion to $75 billion of non-QM loans in 2018, sources said.
“We’ve all been surprised that five to six years on there’s been no private-label market securitizing mortgages,” Cordray said.
If the patch expires without any changes to the QM rule — something lenders think is unlikely — many of the loans that would have been sold to Fannie or Freddie instead could be insured by the FHA. But most of those loans are made to low- and moderate-income borrowers who would have to pay higher prices because FHA loans require upfront and annual mortgage insurance premiums.
Kornfeld of Moody's said a shift of CFPB-approved mortgages away from the GSEs could lead to a market of loans with stronger underwriting.
“A large percentage of the loans will go to FHA, another percent will go to the private market and others won’t be made,” he said. “There might be short-term headwinds, but that could very well be a positive."