Agencies Still Pondering QRM
The set of federal agencies tasked with determining which residential mortgage loans may be exempt from credit risk retention in securitizations are continuing to think about it. Late last month, the Securities and Exchange Commission, Comptroller of the Currency, Federal Deposit Insurance Corporation, Federal Reserve Board, Federal Housing Finance Agency (“FHFA”), and the Department of Housing and Urban Development (together, the “Agencies”) announced that they hope to have more answers by the end of this year. It seems likely those Agencies will continue to define those exempt mortgage loans (called “qualified residential mortgages,” or “QRMs”) in a manner that is fully aligned with the “qualified mortgage” (“QM”) definition of the Consumer Financial Protection Bureau (“CFPB”) (which interestingly is not among the Agencies tasked with the QRM/risk retention rules). If it were that easy, though, the Agencies probably would have done that by now. Of course, the CFPB’s QM definition has been a moving target itself.
In 2014, the Agencies issued a final rule, in accordance with the Dodd-Frank Act (the “Act”), requiring a securitizer of asset-backed securities (“ABS”) to retain not less than five percent of the credit risk of the assets collateralizing the securities. Sponsors of securitizations that issue ABS interests must retain either an eligible horizontal residual interest, vertical interest, or a combination of both. The Act and the Agencies’ rule established several exemptions from that requirement, including for securities collateralized exclusively by residential mortgages that qualify as QRMs. The Agencies defined QRM to be fully aligned with the CFPB’s definitions of QM. (QMs are deemed to comply with the CFPB’s ability-to-repay rule.) Accordingly, any changes the CFPB makes to the QM definition automatically modify the QRM definition.
The Act requires the Agencies, in defining QRMs, to consider “underwriting and product features that historical loan performance data indicate result in a lower risk of default,” including some familiar factors (documentation and verification of income and assets, standards for residual income or debt-to-income ratios, and mitigation of payment shock). The Act also directs the Agencies to consider the presence of “mortgage guarantee insurance or other types of insurance or credit enhancement obtained at the time of origination,” a factor that neither the Act nor the CFPB address in connection with QMs. In the end, the Act expressly provides that the definition of QRM can be no broader than the definition of a QM. As indicated above, the Agencies concluded that alignment between QRM and QM was necessary to protect investors, enhance financial stability, preserve access to affordable credit, and facilitate compliance. Their credit risk retention rule became effective for securitization transactions collateralized by residential mortgages in 2015 (and for other transactions in 2016).
The Agencies committed to a periodic review of their QRM definition, and they began that process in 2019 by requesting public input. At that time, many commenters simply asked the Agencies to wait until the CFPB finalized its review of its QM rule, which was feverishly underway since the QM status for Fannie Mae and Freddie Mac-eligible mortgages was set to expire in January 2021. The Agencies then announced in June 2020 that they were extending their review period until June 20, 2021. During that time, the CFPB settled on a transition toward a new QM definition based largely on a loan’s annual percentage rate, which the CFPB determined is better predictive of default risk than underwriting features, and away from QM categories based on whether the loan is eligible for sale to Fannie Mae or Freddie Mac (the “GSEs”) or has a debt-to-income ratio of no more than 43%.
At stake, among other issues, is the proper role of the GSEs in the residential mortgage securities market. The prior QM category for GSE-eligible loans was a temporary post-financial crisis measure to ensure the availability of affordable mortgage credit while the economy recovered and private-sector capital re-emerged. However, as late as 2019, the CFPB found that, contrary to its expectations, the GSEs continued to play a “large and persistent” role in the mortgage market. One goal of the FHFA at that time, in addition to strengthening the GSEs’ capital standing and removing them from conservatorship, was to level the playing field, including through a QM standard without special advantages for the GSEs. More recently, the FHFA (under former director Mark Calabria) imposed certain mortgage purchase limits to address the GSEs’ risk exposure. Those efforts seem designed to make room for a more robust private-label securities market for residential mortgages.
Of course, since the 2020 election, we have new leaders at the CFPB and FHFA, as well as at several of the other Agencies. Pundits expect that the new administration will prioritize using the GSEs to promote affordable and equitable housing goals, and may place somewhat less emphasis on ending the conservatorships. The FHFA and the Department of Treasury may even agree to reverse the GSEs’ recent mortgage purchase limits. The “new” CFPB, for its part, stated that it is considering further rulemaking on certain aspects of its QM definition.
What does all that mean for the future of QRM? As mentioned above, while the Agencies likely are starting from a position of continued alignment between QRM and QM, the Agencies may be waiting to see what changes, if any, the CFPB makes to QM. Moreover, while a loan’s pricing (i.e., its annual percentage rate) was the CFPB’s principal factor in measuring the risk of default when it revised QM, the Act does not expressly require the Agencies to consider a loan’s price when setting QRM. Thus, notwithstanding a general desire for alignment, there is a mismatch between the CFPB’s price-based QM on one hand and the Agencies’ statutory factors for QRM on the other.
Still, the public policy goals behind risk retention hold that only high credit quality assets should quality for an exemption from that requirement. During the Agencies’ last QRM rulemaking, they tried to strike the correct balance between not excluding creditworthy borrowers, preserving the right population of non-QRMs, and setting transparent and verifiable boundaries. The Agencies will likely examine extensive data on loan performance, the cost of risk retention, and the extent to which those costs are passed on to borrowers. The Agencies surely cannot ignore prevailing market conditions – including the pandemic and its continued effects on the economy in general, and housing in particular. In the end, there are significant and important justifications for continuing alignment of QRM with QM, notwithstanding the differences noted above.
