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TH E M R EP O RT | 63 SECONDARY MARKET THE LATEST O R I G I NAT I O N S E R V I C I N G DATA G O V E R N M E N T S E C O N DA R Y M A R K E T What to Do With the QM Patch An expert critiqued the topic of the expiring QM patch, and here's what he had to recommend. T he American Enterprise Institute's Edward Pinto, Co-Director of the AEI Center on Housing Markets and Finance, recently addressed the topic of the expir- ing QM patch, and specifically criticized possible solutions put forward by the Urban Institute, calling their analysis a "classic case of bad economics." According to Pinto, Urban Institute's recommended loan pric- ing standard cannot work, and the recommended Annual Percentage Offer Rate (APOR) would pro- mote higher risk, rather than con- strain it. Pinto notes that in order for a loan's pricing to reflect risk, the loan must be priced for risk. "As I noted back in 2013, FHA, the riskiest lender in the mar- ketplace, does not price for risk," Pinto said. "Thus its loans, no matter how risky, will easily and conveniently meet the APOR plus 150 basis point test." As for Fannie Mae and Freddie Mac, the APOR is based on the current offer rate for conven- tional, conforming mortgages with 20% down. According to Pinto, these are precisely the mortgages that the GSEs purchase in huge quantities. But government policy effectively requires the GSEs subsidize higher risk loans by charging higher rates on lower risk ones. This amounts to about $5 billion per year. In the process, the APOR is raised and most, if not all, subsidized higher risk loans are under the APOR plus 150 basis point test. "The result? Nearly all, if not all, of government insured loans (about 85% of the home loan market), will pass the APOR test regardless of risk. This is the test touted by UI as "reflect[ing] credit risk more holistically," Pinto said. Pinto concludes that the Urban Institute's APOR recommenda- tion to the CFPB is dangerous, especially to low- and moderate-in- come borrowers. He suggests that the best option would be to just let the patch expire in 2021, which, according to FHFA director Mark Calabria, is key to bringing the GSEs out of conservatorship. Patch usage has grown in the last few years, and according to Calabria, changing the patch would be a key tool to shrink Fannie and Freddie without a full overhaul, though he states that he does not intend to do away with it entirely. In a recent interview with the Wall Street Journal, Calabria stated that he wants to put the now-prof- itable GSEs back into private hands, something that has been tried and failed by lawmakers in the past. "I see my goal as setting a path to end the conservatorship" for the companies, he said, adding that "they have to be stronger, healthier companies" compared to before the 2008 housing crisis. "My objective is to get us to a spot where we don't have to worry about the system blowing itself up," he said. A New Benchmark What will Ginnie Mae, HUD's moving to a new rate index mean for the industry? G innie Mae and the Department of Housing and Urban Development (HUD) have discussed ways to implement a change to their rate index, and move away from the current London InterBank Offered Rate (LIBOR) standard, according to a report by Reverse Mortgage Daily. Michael Drayne, SVP of the Office of the President of Ginnie Mae, presented this topic at the National Reverse Mortgage Lenders Association (NRMLA) Eastern Regional Meeting in New York recently. The report states that interna- tional investigations found LIBOR was vulnerable to manipulation efforts identified between 2003 and 2012, and global regulators started actively advising financial institutions to move away from the LIBOR standard by 2021. The Federal Reserve Bank of New York, in 2014, convened the Alternative Reference Rates Committee (ARRC) to identify best practices for alternate rates, while also developing an imple- mentation plan. "We're looking at this, HUD is looking at this, and we're all par- ticipating in the industry working group convened by the Federal Reserve ARRC," Drayne told NRMLA conference attendees. "The amount of time we have to figure everything out is less reassuring the more you look at how complicated this problem is. We at Ginnie Mae have indirect exposure to this issue. In the end, on the government side, it's up to the Secretary of Housing to determine what the main rate is going to be." Drayne said Ginnie Mae's pur- pose in the process is to deter- mine how to facilitate the transi- tion to whichever rate is chosen. Since Home Equity Conversion Mortgage-backed securities (HMBS) issuance is focused on adjustable-rate mortgages, this will play into the decision. A rising LIBOR index could also result in lower principal limit factors, further decreasing the issuance volume of HMBS, according to Reverse Mortgage Daily. "To the extent a Ginnie Mae issuer wants to be in this market, we think that should be part of a diversified business plan," Drayne said. "We want to make sure that they're committed to the reverse mortgage business and committed to helping senior homeowners." "The amount of time we have to figure everything out is less reassuring the more you look at how complicated this problem is." —Michael Drayne, SVP of the Office of the President, Ginnie Mae