The housing and mortgage banking industries face increasing anxiety this year over a growing set of uncertainties. There are fundamental business concerns related to lower volumes and an over-supply of lending and lenders. Combined with an unclear interest rate path, the insecurity has caused margin compression (and outright losses), leaving all lenders concerned about profitability – or even survival.
To make matters more challenging, the policy regime in Washington is dealing with everything from the GSE future state, the role of government in lending, new leadership at key regulators and the GSEs themselves, and a void in leadership at HUD and GNMA. And at the CFPB there are questions about enforcement, the need to modify the LO Compensation rule, and more.
But perhaps one of the greatest short term risks that could upset the entire ecosystem of lending between bank and non-bank, where mortgage volumes go in the capital/secondary market, and what happens to credit availability in this country, is the renewed focus on the QM Rule. Particularly, on “the patch,” the provision established under the previous CFPB Director that exempts loans eligible for sale to the GSEs from the limitations of the written rule itself.
Ed Pinto from the American Enterprise Institute (AEI), as well as Laurie Goodman and her team at the Housing Finance Policy Center at the Urban Institute, have both called for an end to the patch. Others have cited adverse selection and execution bias towards the GSEs that results from the patch being in place. AEI goes further in its call to end the patch, expressing concerns that it is leading to increased credit risk in a pro-cyclical manner, as the GSEs continue to look for ways to expand the credit box for consumers.
The fact is, without an alternative, if the patch were eliminated in isolation non portfolio lenders who depend on an execution path through the GSEs would find themselves even more dependent on the GNMA programs, thrusting even greater risk upon the government backed loan programs offered there. Lenders with portfolios, particularly larger banks, would likely have a significant opportunity to increase their market shares as they could cream off the better credit and convexity attributes of the loan market by offering a bid in the space voided by the patch elimination.
The Urban Institute issued a thoughtful paper in late 2018 highlighting the void that would be created by a patch elimination combined with a recommendation for alternatives.
In short, the patch debate needs focus on these key points among many others:
- The patch is set to expire on January 10, 2021 or should the conservatorship end prior to.
In addition, the new Director could simply change the rule and eliminate the patch altogether either replacing it with a newly written QM rule or simply leaving the void unfilled.
- Through May 2018 Fannie Mae purchased 29% of its loans with DTI’s exceeding 43%, the key line in the sand provision in the QM rule. Freddie purchased 24.9%. If the patch were eliminated, roughly 1/4 to 1/3 of all loans would need a new home. This would result in a likely surge in FHA/VA/USDA production, a flow to portfolios of depositories, and potentially a new regime of non-agency investors eager for yield who could tap into the riskier credit metrics of that void.
- As noted in the Urban research 55% of FHA loans in that same period had DTI’s exceeding 43%. With FHA exempted by statute from the CFPB QM rule the risks of piling onto FHA loom large here.
Many, including this writer, have long advocated that the QM rule should stand on it’s own and not depend on the patch. The challenge with all of these housing policy debates, whether about the QM patch, the GSEs, the size and scope of FHA, and other relevant housing topics inside the beltway is that talk of change of any policy cannot be done in isolation. The ecosystem of lending supports a multi trillion dollar housing finance system with implications to the economy if mismanaged as we all know too well.
Policy changes in isolation could impact lender viability, shifting of investors, adverse selection, credit access and more resulting in ripples or perhaps more significant disruption in the housing sector altogether.
The Urban institute proposed a change to the QM rule that would eliminate the 43% cap. I applaud that effort. A 43% DTI cap is a blunt instrument that does not accurately reflect credit worthiness for all buyers. For some it may be too high, and for other too low. I have long advocated that the QM patch needs to go, but it must be removed only with a rewritten rule that reflects the nuance of credit metrics that contribute collectively to the combined performance of a borrowers ability to repay their mortgage.
The QM rule eliminates no-doc and stated income loans. It eliminates interest only, negative amortization, and balloons. It sets caps on points and fees and APOR. It’s a good rule that became complicated when regulators tried to bluntly write underwriting requirements to a rule where it was not needed. Consumers are protected today by a labyrinth of new provisions not seen prior to Dodd-Frank. The Know Before You Owe Rule (TRID), the product, point/fee, and rate (APOR) restrictions, servicing standards, and more amply protect consumers.
The QM rule as it was written distorted the realities of underwriting credit risk and enlarged the role of government-backed mortgage programs in a manner unseen in the history of mortgage finance.
In the effort to simplify and execute, policy makers often make decisions that do not take into account the nuance of complex issues. The housing finance sector needs that nuance in determining the next step for the QM rule.
To get the balance back, lets start with a new QM rule.
By David Stevens, Senior Advisor at Mortgage Media
David H. Stevens, CMB, is Senior Advisor at Mortgage Media, and former SVP of Single Family at Freddie Mac, former EVP at Wells Fargo Home Mortgage, former President and COO of the Long and Foster Realty Companies, former Assistant Secretary of Housing and FHA Commissioner, former CEO of the Mortgage Bankers Association