Risky Business

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Feature ability-to-pay rules, lenders will find such loans even less attractive. Lenders will err on the side of assuring they have no regulatory issues on loans, where a lender might in the past have exercised some discretion to approve a loan, which will generally not happen now. The qualified mortgage (QM) rule will thus make it harder than ever for the unusual borrower, such as those with uneven income histories or the self-employed, to obtain a mortgage." Risks and Limits N ot long after the Bureau issued its new rules, there were some hints of regulatory remorse. Speaking to the Credit Union National Association, less than two months after the rules were issues, CFPB Director Richard Cordray acknowledged that "the current mortgage market is so tight that lenders are leaving good money on the table by not lending to low-risk applicants seeking to take advantage of the current favorable interest rate climate." He went on to say that "plenty of responsible lending remains available outside of the qualified mortgage space," and added the CFPB "encourage[s] you to continue to offer mortgages to those borrowers you can evaluate as posing reasonable credit risk." That suggested an opportunity to Felt. "Longer term, I would expect more niche players to begin to increase lending in the nonQM market as the risks become clearer," he said. "At the end of the day, a QM violation puts at risk three years of interest payments and could require restructuring of a loan. It does not forgive the entire obligation to repay the debt. In recent years, lenders would be happy to resolve most of their defaulting loans on such terms. As pioneering lenders blaze the trail and begin to have some experience dealing with the ability-to-pay rules and how they 32 | The M Report are interpreted by the Bureau and the courts, others will follow." It will, according to Frost, shrink the overall market and, contrary to the goals of the CFPB, not necessarily help consumers. "An entity that securitizes will have to invest a significant amount of capital; therefore, the number of players who are able to participate in the market will be limited," he said. "Furthermore, this will increase the costs of lending, and the rates that consumers pay will shoulder the burden to cover the additional cost of capital." Private Capital Could Resurface A ccording to Cordray, lenders may be overly concerned about regulation. Lenders, he told the credit union association, may be "initially inclined to lend only within the qualified mortgage space, maybe out of caution about how the regulators would react," but, he added, that lenders "should have confidence in your strong underwriting standards, and you should not be holding back." The CFPB activity to date could promote a return of private capital to the mortgage industry. "Along with the new rules comes much-needed transparency in the market, which was previously missing," Indisoft's Dahiwadkar offered. "The presence of transparency should help the return of private capital to the market by facilitating better assessment of risk and improved decisions regarding investments. New regulatory initiatives may appear burdensome to the originators, who actually perform the transactions, but they are more focused on creating financial stability and better risk management through transparency. These efforts should help private capital to flow back into the market. It may take some time for private capital firms to understand the effect of these new regulations; however, once the dust settles, we will likely see more private capital return to the market that has more clarity and understand the risks before investing." George DeMare, managing partner at Midwest Mortgage Capital, agreed it might take awhile for private capital to return. "Private capital has been slow to enter the marketplace due to the uncertain regulatory environment and the vague definitions that been offered thus far," he said. "Once we have more clarity surrounding all the lending rules and regulations, we will see more players re-enter the marketplace." What might also re-enter the market, however, is more rule-making, which likely would further complicate matters. "Sometime this year, regulators will probably finalize a regulation to define qualified residential mortgages (QRMs)—that is, which loans can be sold in securities without a requirement that the lender or securitizing institution retain a 5 percent interest," Felt said. "The law requires that a QRM first be a QM, and the 43 percent backend ratio in the Bureau's QM rule already applies a stricter requirement than the 36 percent requirement in the QRM agencies' proposed rule, published in April 2011. If the proposed rule is unaltered, it will essentially create a class of prime loans with LTVs of 80 plus, high credit scores, and high backend ratios that are exempt from the retention rule." Differences, Large and Small A nd as with any changes, there will be winners and losers, with no consensus. "Companies that have adopted the right technology are thriving in this market," said Dahiwadkar. "Regulations are accompanied by extra business process steps, and unless companies have the right technology, the cost of these additional steps could break a business model." Larger institutions, though, appear to have an edge and have been the chief beneficiaries of the current environment, observed DeMare. "Right now, they are the primary resource for all mortgage funds and are acting as market makers," he said. "Due to their strong capital positions, they have provided much-needed liquidity." Smaller lenders might be forced out for another reason, according to Matt Doffing of Fredrikson & Byron P.A., a Minneapolis-based law firm. Legal liability caused by a disparity between the CFPB's ability-to-repay rule and the U.S. Department of Housing and Urban Development's fair lending statutes could force community banks to leave mortgage lending, Doffing wrote in his firm's CFPB Journal. The Fair Housing Act, he wrote, gave HUD the authority to make rules, which regulate discrimination in mortgage lending. As with the CFPB, HUD's proposed Fair Housing Rule treats disparate impact caused by lending practices as discrimination. HUD's rule also allows borrowers to sue lenders for disparate impact. "As with the CFPB, no actual intent to discriminate is needed as long as disparate impact can be shown," Doffing said. "The problem arises because there is no safe harbor for abilityto-repay lending practices that also cause disparate impact. As a result, unless the CFPB and HUD collaborate to create a safe harbor for disparate impact caused by the inability-to-repay rule, banks will find themselves in a regulatory Catch-22." Without a safe harbor, he added, "it's not hard to foresee an exodus of small banks from mortgage lending if this Catch-22 is not resolved. Without a safe harbor, banks might begin to wonder if it is all worth the risk."

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