MReport January 2020

TheMReport — News and strategies for the evolving mortgage marketplace.

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24 | M R EP O RT FEATURE I magine this scenario: Robert and Mary Smith have lived the American Dream. They have three kids, two in col- lege, and one in her senior year of high school. Mary, a full-time homemaker and mother, and Robert, a sought-after architect by trade with a successful practice— the pinnacle of success in family and business. Here is where things begin to unravel. Robert and Mary have been homeowners for nearly four decades, established significant net worth based on the value of his practice and equity in their family home. Robert has been approached with an opportunity to buy a complementary practice that would make his firm more valuable, positioning him as a leader in his market. Robert and Mary discuss the opportunity and decide together, as a family, that it is an opportu- nity too good to pass up. Robert and Mary decide to access some of the home equity they have accumulated in their home as part of their liquidity plan to purchase the complementary business. One problem: Crisis regulation born out of the Dodd-Frank leg- islation redefined the housing and residential credit markets, causing a scenario of unintended conse- quences that pushed the Mass Affluent (MAI) and High Net- Worth (HNWI) to the sidelines and forced an enormous amount of buying power out of the market. Unfortunately, Robert and Mary missed out on the opportu- nity offered to them—until now. How Crisis Legislation Created the Need for Specialization P rior to the credit crisis of 2008, residential lending was not only active but accommodative to the methods where borrowers earned income and in a manner that could support responsible lending. The two primary methods of income at that time were classi- fied as "wage" or "self-employed" earnings. The practice of determin- ing an "ability to repay" for wage earners was based on a variable of current pay stub review and the prior-year's W2 income. For the self-employed applicant, under- writing standards were modified and the adoption of the applicant "stating" the household income became normal practice. This accommodation came with strict offsetting factors to protect investors. Underwriting overlays, such as an adequate history of repayment on prior housing and credit obligations, liquid retirement and cash reserves to cover any periodic shortfalls in cash flow, and equity in the subject property, were offsets all implemented to protect the investors. This approach, albeit controversial post-crisis, made the credit markets very efficient and balanced for not only wage earners but for self-employed entrepreneurs, freelancers, contractors, and retired individuals. Fast forward to 2008 and beyond—post-Dodd-Frank, post-Qualified Mortgage Rules, post-risk retention, and postability to repay (ATR) legislation—a new approach was desperately needed. Dodd-Frank significantly affected lenders as regulations dic- tated all mortgages be divided into Qualified (QM) or non-Qualified (non-QM) mortgages. Potential home buyers would have to meet even stricter standards to qualify for a loan. Essentially, QM was traditional W2 wage earners and non-QM meant everybody else. The major obstruction clause out- lined in Dodd-Frank, ATR states the lender must: "Make a reason- able and good faith determination based on verified and documented information that the consumer has a reasonable ability to repay the loan according to its terms." Albeit a ridiculously vague and ambiguous statute, it did require the lending community to come up with acceptable methods to meet the litmus test to comply with ATR. In 2012, in anticipation of the securitization market and risk capital re-entering the market- place post credit crisis, non-QM lending was gently introduced to the market. As non-QM began to enter the market, several notice- able commercial underwriting methods were introduced to meet the high bar of the new law. Non-Bank Private Client Lending Is Born N early 32% of all U.S. house- holds would be classified as mass affluent and high net- worth—only 3% of them enjoy the credit flexibilities and benefits of private wealth management. The consequences of having such a large swath of the popula- tion with significant buying power shut out from the hous- Lending in the Era of Non-QM How did Dodd-Frank regulations redefine the housing and residential credit markets? By John R. Lynch

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