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Battle over home-loan rules could greatly affect mortgage availability

At issue is a provision in the Dodd-Frank Act that requires banks to have "skin in the game" by retaining some of the risk of loans they package and sell.

December 30, 2010|By Ronald D. Orol

Reporting from Washington — A behind-the-scenes battle is forming over a provision of the sweeping bank reform law that will affect mortgage availability.

At issue is a provision in the Dodd-Frank Act that requires banks to have "skin in the game" by retaining some of the risk of loans they package and sell.

The goal of the measure is to eliminate one problem that led to the financial crisis: lenders packaging and selling subprime mortgages they knew would fail. Lawmakers drafting the legislation included a measure that would exempt certain mortgages from the risk retention rule if they met certain high underwriting standards.

But reaching an agreement on what the criteria will be for these high-standard loans dubbed "qualified residential mortgages" (QRM) is expected to be difficult. Depending on how regulators rule, a huge slice of the mortgage market could be exempted from risk retention — or only a small piece of the market.

That could have a major effect on what kinds of mortgages are available, and for what price. Mortgage rates have remained near historical lows, but mortgage activity is near decade depths.

A group of prominent investors and academics has urged top U.S. officials to move quickly to enact the provision, citing the "chaotic situation in the mortgage market today."

Ernest Patrikis, a partner at White & Case in New York, said regulators must balance how conservative they want underwriting standards to be against how much lending they want to see. What they decide will have a major effect on the kinds of interest rates that borrowers with various capabilities will receive.

"The borrower that passes the test for a zero-risk retention mortgage will likely get a lower rate on their mortgage than someone that must buy a mortgage that doesn't get exempted because banks will have to retain some risk there," he said.

Bank regulators and the Treasury Department are required to work together to draft rules under the watchful eye of a newly formed Financial Stability Oversight Council made up of the heads of banks and securities regulators. A soon-to-be-formed Consumer Financial Protection Bureau, which will write rules for mortgages and other consumer-credit products, will want to be involved as well. Regulators aren't expected to introduce a proposal for this measure until January.

Washington observers say that regulators, consumer groups and bankers generally already agree to prohibit more exotic or problematic loans from qualifying for the risk retention provision. Specifically, those with negative-amortization potential, pre-payment penalties or balloon payments — many of the problematic structures that helped drive the financial crisis — won't be permitted. Strong credit scores will also be a must as well as effective verification of borrower income.

However, squabbles are already taking place among banks, investors and consumer groups over whether the loans approved under the exemption should have down payments, and if so, how much money down is necessary. Other points of dispute: How many months of verification should be required for a borrower's income (12 months? 24 months?) and how much debt a borrower can handle. The Mortgage Bankers Assn. is seeking to include interest-only loans in the definition, but consumer groups are passionately opposed.

Big banks are seeking some sort of significant down payment, perhaps as much as a 30% stake by borrowers, arguing that it means homeowners have some skin in the game and would be less likely to abandon the mortgage.

Alternatively, consumer groups are either opposed to having any down-payment requirement or prefer a small down-payment condition.

Finally, smaller banks would like to see a 5% or a similarly small down-payment requirement if borrowers obtain private mortgage insurance and have high credit scores.

Kathleen Day, spokeswoman at the Center for Responsible Lending in Washington, said having a high down-payment requirement for the QRM, in the realm of 30% down, would limit a lot of responsible lending.

"Non-standard, non-traditional and predatory products would become part of the universe of the common loan, and it would mean we have the status quo where bad loans are sold as legitimate products," Day said.

Lisa Rice, president of the National Fair Housing Alliance, a consumer advocacy organization, said a small down payment doesn't mean the borrower will be more likely to default on the loan.

"There are many things that impact a mortgage," Rice said. "You could take a person who only puts 3% down but got their loan at a safe deposit institution or credit union and that loan is better performing than someone who put 20% down, got a payment option [adjustable-rate mortgage] and the appraisal was overinflated."

Jaret Seiberg, an analyst at MF Global Inc. in Washington, said he believes regulators will agree to a down payment of 5% for fully documented loans with private mortgage insurance.

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