Battle Over Down Payment Requirements Still Looms in New QRM Plan

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WASHINGTON — Bankers breathed a sigh of relief Wednesday after regulators unveiled a new proposal on securitization standards that omitted a controversial down payment requirement. But the agencies also made it clear that the debate over that issue is far from over.

Tucked away inside the new, softer proposed criteria for "qualified residential mortgages" — which are exempt from credit risk retention — was a question about whether regulators should restore a down payment restriction, this time effectively suggesting a tougher 30% ratio.

Although it was just a question — the reproposal included no down payment requirement — some regulators said it still deserved attention, and observers indicated it could be a sign the agencies may restore some kind of down payment restriction in a final rule. During a Federal Deposit Insurance Corp. board meeting on the issue, Vice Chairman Thomas Hoenig specifically cited the question, which asked whether regulators should set a maximum 70% loan-to-value ratio to qualify for QRM status.

"I'm very pleased that the 70% LTV is a question" in the proposal, Hoenig said. "That really does change the issue of whether or not there is risk retention. That is the whole goal here."

At issue is a provision in the Dodd-Frank Act calling for securitizers to retain 5% credit risk of loans they sell to the secondary market. The law gave regulators authority to define an ultra-safe class of loans — known as QRMs — that could skip risk retention.

But the regulators' first proposal in 2011 drew heaps of criticism, mostly because it would have limited QRM treatment to loans with a maximum 80% loan-to-value ratio and a 20% down payment. Bankers and housing advocates argued that that requirement risked creating a "gold standard" mortgage that only wealthy people could afford. The 2011 plan also set a maximum debt-to-income ratio for QRMs of 36%.

Following many months of deliberation, Wednesday's "re-proposal" was much more to the industry's liking. It essentially would say QRMs are the same as the "qualified mortgages" defined by the Consumer Financial Protection Bureau as meeting the bureau's ability-to-repay standards. Under the CFPB rule, "QMs" include a 43% maximum DTI, exclude certain nontraditional mortgages such as interest-only loans and limit total points and fees to 3% of the loan amount, among other features. But, notably, the QM standard includes no down payment requirement.

Aligning the two mortgage designations "streamlines compliance and reduces potential costs by providing the mortgage market with a uniform regulatory framework for underwriting and securitizing mortgages that have demonstrated lower risk of default," said Rae-Anne Miller, associate director in the FDIC's risk management supervision division, in a presentation to the FDIC's board.

(The proposal was also issued by the Office of the Comptroller of the Currency, Federal Reserve Board, Department of Housing and Urban Development, Federal Housing Finance Agency and the Securities and Exchange Commission.)

Banking and housing advocates hailed the reversal.

"The re-proposed Qualified Residential Mortgage rule announced this morning is a victory for homebuyers and the future of homeownership in this country," Gary Thomas, president of the National Association of Realtors, said in a press release.

But Hoenig said regulators should continue to look at whether just equating QM with QRM was adequate for the securitization rule. Under an alternative approach, indicated in the regulators' question for comment, securitizers attaining QRM would have to comply with a "QM-plus" standard. The more stringent requirements would add the 70% maximum LTV — and therefore a 30% down payment requirement — to the core QM criteria, and include other additional benchmarks as well.

"Do we get more out of LTVs that are higher or do we get a satisfactory answer with the common definition of QM and QRM?" Hoenig said. "Is that sufficient to give us good underwriting standard where we don't need additional LTVs?"

In a note following the release of Wednesday's proposal, noted bank regulatory analyst Karen Shaw Petrou predicted deliberations between regulators about whether to include a down payment option will continue with a final outcome likely somewhere between the 2011 proposal and the latest version.

"Several key regulators remain committed to a much tougher approach, including a significant down payment requirement not offset by the use of private mortgage insurance," said Petrou, managing partner of Federal Financial Analytics Inc. "The proposal sets this at 30%, but we anticipate the final rule will strike a middle path. This will be between the no-down payment proposal and the 30% option, ending up at 10%."

But Sheila Bair, the former FDIC chair who favors a down payment requirement, said such a provision faces a "steep, uphill battle" given the constituencies arrayed against it. Still, she said a 30% down payment made more sense from a policy standpoint.

"The 30% down is a way to require almost all securitizers to keep skin in the game in the mortgages they package and sell off to investors," she said. "That is a good thing for market stability as well as for homeowners as it will give securitizers added incentives to make sure mortgages are affordable and sustainable over time. By covering such a small slice of the market, this new alternative also helps to avoid stigmatizing non-QRM loans, a key concern of community groups."

The proposal released Wednesday was actually tougher than the original 2011 plan in how securitizers would have to hold on to the required 5% credit risk for non-QRM loans they securitize.

Under the previous proposal, a securitizer's share of the credit risk could be calculated on the basis of "par," which generally refers to the numerical face value of a security but which can be susceptible to manipulation. The proposal Wednesday requires that share to be calculated based on "fair value," a more accurate economic representation of the security's value.

CFPB Director Richard Cordray, meanwhile, said regulators should keep evaluating whether aligning risk retention measures — which are meant in part to protect investors — with the QM rule is appropriate.

"The CFPB's ability-to-repay rule is consciously designed to protect consumers from unaffordable credit," said Cordray, who sits on the FDIC board. "It is not itself a credit risk rule designed for investor protection. So we will be keen to see and monitor how closely these goals align as the mortgage market continues to evolve with potential other changes."

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