What the Final QRM Rule Means for Banks

WASHINGTON — The final risk retention rule may appeal to bankers more than regulators' original proposal, but a comeback for the private-label securitization market still faces enormous obstacles.

The agencies, to the industry's delight, will not include a down payment requirement in criteria for being exempted from risk retention, though they will review the impact of the rule every four years. That is in stark contrast to their original 2011 plan to limit the exemption to borrowers who put down 20%.

But despite the lighter approach, several analysts say the rule will likely have little impact on jumpstarting the private-label market since the secondary market is still dominated by Fannie Mae and Freddie Mac, and the new regulation effectively frees the government-sponsored enterprises from doing any risk retention. The GSEs' popularity is only heightened by recent steps by the Federal Housing Finance Agency to allow the GSEs to back loans with down payments as low as 3%.

The QRM rule "further cements the role of Fannie, Freddie and the" Federal Housing Administration, part of a "confluence of events that push a lot of mortgage production to the GSEs," said Edward Mills, a policy analyst at FBR Capital Markets.

To protect investors, the Dodd-Frank Act required 5% credit risk retention for securitized loans, but instructed regulators to define a class of "qualified residential" mortgages excused from the requirement.

The rule approved Tuesday by the Federal Deposit Insurance Corp. and other regulators preserves the plan from last year's re-proposal equating QRM with the "Qualified Mortgage" standard, used by the Consumer Financial Protection Bureau to define well-underwritten loans. QM carries no down payment requirement. (The Federal Reserve Board and Securities and Exchange Commission will consider the rule Wednesday.)

Not surprisingly, industry groups hailed the outcome, saying the "QM-equals-QRM" approach makes the most sense.

"The 20%" down payment requirement in the 2011 proposal "was a killer for the first time homebuyer. … I think we as an industry are very pleased, bankers and Realtors," said Chris Polychron, president-elect of the National Association of Realtors. "You are going to see more competition in the marketplace"

The final rule also allows, in cases when risk retention does occur, more opportunity to avoid using fair value to measure the retention piece. However, banks lost a bid to get added relief in risk retention requirements for collateralized loan obligations, known as CLOs.

The QRM rule also includes a provision that requires the regulators to revisit the rule four years after it is enacted, and then every five years after that. It can also be revisited at any time if one of the six agencies that worked on the QRM rule requests a review for a specific reason. The CFPB has a similar schedule for revisiting the QM rule.

"Today's joint rule provides for strong consumer protections while allowing lenders to continue making the American dream of homeownership a reality and moving the mortgage market forward," said John Dalton, president of Financial Services Roundtable's Housing Policy Council.

While the industry won much of what it had wanted, the FDIC board was not unanimous in supporting the rule. Jeremiah Norton, an inside member of the board, opposed the plan over concerns it granted the CFPB — as the force behind QM — too much power to enact future QRM changes without influence from the other agencies.

"The decision by the agencies to tie QRM to QM 'as amended from time to time' by the Consumer Financial Protection Bureau … effectively subdelegates the agencies' rulemaking responsibility to define QRM to the CFPB," Norton said. "Such subdelegation has been called into question by courts unless explicitly authorized by the Congress."

Norton said the move by regulators to adopt a process to review the QRM rule's impact, starting in four years, was not sufficient.

"The insertion of a process through which to review the QRM definition … does not alter the fact that under today's rule, the QRM definition is tied to the CFPB's QM definition on a going-forward basis by operation of law," he said.

But the other board members countered that the QM — and therefore QRM — standard is demanding enough that many of the crisis-era mortgage problems that spurred the risk retention rule will be averted.

CFPB Director Richard Cordray, who sits on the FDIC board, said regulators had to take into account the fact that the mortgage market has tightened up significantly since the agencies had first considered including a down payment requirement.

"We have done lots of further work now around the rules in new market conditions and I think the situation is different now than it was then," Cordray said.

Even Vice Chairman Thomas Hoenig, who had sought a down payment requirement in the QRM standard, ultimately supported the final rule. He reiterated his view that "there is data out there that down payments do have an effect," but he said the rule will still be a positive for lending.

"While there are elements I am not completely satisfied with — for example — the down payment, on balance it provides standards that contain some of the excessive risk that was an important contributor to the crisis," he said.

Still, many observers say the rule will have a limited impact on a private-label rebound — or will even slow it down further — as long as Fannie and Freddie outshine their competitors.

The two mortgage giants get the advantage of the QRM rule granting GSE-backed loans an automatic exemption from risk retention. Meanwhile, observers say aligning QM with QRM will just lead to more standardization in the market, making it harder for private-label securitizers to keep up with the GSEs.

"With the QRM equaling the qualified-mortgage standard, floodgates will open for securitization through the GSEs for any and all loans they can purchase, including those with downpayments of as little as 3%," said Karen Shaw Petrou, managing partner at Federal Financial Analytics. "Congress' hurdles taking the secondary market private just got a lot higher."

Walter N. Schmidt, a senior vice president at FTN Financial Capital Markets, said the CFPB's QM rule had already tipped the market more in the favor of the GSEs, which are largely limited to backing loans that meet the CFPB's underwriting standard. Similarly to the risk retention rule, the QM rule said Fannie and Freddie are assumed to meet the standard.

"Just the very minute that QM came out and gave Fannie and Freddie MBS exemptions, that entrenched them," he said.

Mills said the private label market may be able to compete more for non-QRM loans, but the risk retention rule makes those loans less appealing.

"You're providing a disincentive to anyone to originate or securitize a loan outside of QM or QRM, and therefore you are discouraging any private label activity," he said.