If the Consumer Financial Protection Bureau existed in 1946 and had enacted the Ability-to-Repay and Qualified Mortgage Rule, would the Martini family in the film classic It’s a Wonderful Life still be renting in Potters Field or would they realize their dream of home ownership in Bailey Park? In other words, would George Bailey’s Building & Loan still have originated what was most likely a non-QM mortgage? Possibly not.
It may be too early to predict the lasting impact of the Jan. 10, 2014, implementation of ATR/QM rules on the housing industry, but in all likelihood, borrowers such as those represented by the Martinis, would face higher interest rates, fewer choices of mortgage products, and, perhaps, not even qualify for a mortgage at all.
ATR/QM rules may have unintended consequences that no one—including CFPB—is certain about. “Time will tell what the impact of QM will be on the housing industry, says Jeff Plagge, chairman of ABA’s board of directors and president and CEO of Northwest Financial Corp. “But my guess is that it won’t expand it.”
No lender consensus
Some lenders, including Cape Bank in Cape May, N.J., have announced they will exit the residential mortgage business, citing as reasons the low interest-rate environment and increasing regulatory burden. Others will limit mortgage lending to QM loans. Still others, like Wells Fargo, JPMorgan Chase, and Bank of America, have publicly stated they will continue to issue non-QM loans. Wells Fargo even announced the reassignment of 400 underwriters to handle the non-QM loan volume the bank expects.
Richard Cordray, CFPB director, has stressed in several presentations that the agency’s intent is for banks to continue to make non-QM loans, telling a gathering at the American Mortgage Conference that “there are plenty of good loans made every year that are non-QM.”
But even with Cordray’s attempts to comfort banks, bankers are wary. Says Brenda Hughes, senior vice-president and retail lending administrator of First Federal Savings Bank, a $511 million-assets bank in Twin Falls, Idaho, “We are still at risk for customer litigation with non-QM loans. No one can protect us from that.”
Dan Vessely, president of Iowa Bankers Mortgage Corp., highlights a lack of consistency and clarity from CFPB as a major challenge for banks in navigating ATR/QM lending. “Issues, such as what fees are included in the points and fees calculation, the definition of an affiliate company, and an absence of standardized documents, are causing confusion,” he says.
Robert Davis, ABA EVP of mortgage markets, financial management, and public policy, agrees. “There is still ambiguity and judgment calls surrounding ATR/QM that is forcing banks to make decisions in an uncertain business.”
Key points on ATR/QM loans
Given the hundreds of pages CFPB took to spell out ATR/QM rules, summarizing them here would be difficult. ABA’s website (aba.com) has numerous resources devoted to this. Nevertheless, to give context to bankers’ opinions on this subject, there are several key aspects of ATR/QM rules that need to be understood.
One is that, for QM, borrowers must demonstrate a debt-to-income (DTI) ratio of 43% or less, and banks must limit points and fees to 3% of the entire loan amount (for loans in excess of $100,000). Banks also must underwrite loans using a fully amortizing schedule and calculate loan payments based on the highest payment that will apply in the first five years, including any amounts escrowed for taxes and insurance. Exceptions exist to the 43% DTI test for small creditors or for loans eligible for sale to GSEs, but those exceptions are expected to be limited.
Also, loans featuring negative amortization, interest-only payments, balloon payments, terms over 30 years, or no-documentation loans would likely not meet QM guidelines.
ATR/QM rules do not cover home equity lines of credit, reverse mortgages, timeshare mortgages, or temporary or bridge loans.
QM loans do have several advantages for lenders. First, they provide lenders with some certainty about potential liabilities in the form of a safe harbor legal protection against consumer claims. Non-QM loans do not receive the same legal protection. For example, if a bank makes an error in calculating the borrower’s ATR and writes a non-QM loan, the bank could be legally forced to repay fees to the borrower or face borrower litigation in the event of a default. The bank also is liable for penalties from CFPB and from the state attorney general.
Meeting QM requirements for safe harbor protection can be tricky. An otherwise complying QM loan with an APR 1.5 percentage points or more above the Average Prime Offer Rate would fall outside safe harbor protections. It would be regarded as a “pseudo-QM” loan and would be covered under the legal framework of “rebuttable presumption,” a lower level of protection.
A second advantage for banks is that QM loans can be sold into the secondary market—specifically to Fannie Mae and Freddie Mac. While there is no ruling prohibiting lenders from selling non-QM loans to investors, it’s a moot point since there isn’t a secondary market for such loans at present, so they must be retained in the lender’s portfolio.
Calculating the impact
The question for many banks is whether the mortgages they typically originate fall into the QM or non-QM bucket. The answer remains somewhat elusive and varies from bank to bank. In remarks made last September, Cordray estimated only 5% of loans are non-QM. Others estimate 20% of mortgage loans are non-QM, says ABA’s Davis.
The latter estimate is spot on for Arvest & Central Mortgage Company, part of $11.5 billion-assets Arvest Bank, Bentonville, Ark. It discovered that about 20% of its loans written in the prior 12 months would be considered non-QM loans under the new regulations and would not quality for safe harbor protection or the secondary market, says William Roehrenbeck, chairman and CEO.
He notes that the percentage of impacted loans is even higher at other institutions, with some banks estimating that QM requirements would eliminate up to 35% of loans made in the previous 12 months.
With such a high percentage of potential non-QM loans in the industry, Plagge believes most banks will continue to originate QM and non-QM loans. All bankers interviewed, whose banks will remain in the mortgage business, state that they will continue to originate good quality loans regardless of whether they meet QM requirements.
Hughes notes that QM won’t have a significant impact on First Federal Savings Bank, but expresses concern that the QM restrictions will force lenders into a DTI box that may not be appropriate for every borrower. “ATR/QM will restrict credit on some level since it removes the lenders’ ability to make a quality lending decision.” She also warns that First Federal Savings Bank may be unable to offer a borrower the same interest rate they would be able to if they could sell the loan into the secondary market. QM does construct a tight box, agrees Roehrenbeck. “The 43% DTI doesn’t consider the assets or reserves a borrower may have. The rule may be well-intended, but it will exclude some borrowers from getting lower interest-rate loans.”
By the skin of their teeth
Although banking associations, including ABA, requested a deadline extension, CFPB would not budge. But Cordray has stated several times that CFPB would be understanding of the challenges for compliance in the short term, saying, “If you’re making good faith efforts to come into compliance and are pushing your vendors, we’re not going to expect perfection.” Banks en masse have decided to not take chances and worked diligently to fully meet the deadline.
How did banks fare? By most reports, the majority were able to meet the deadline for ATR/QM compliance, but not without a struggle. Hughes calls getting ready for January 10 “brutal.” She doesn’t blame the bank’s vendors, acknowledging that last-minute changes by regulators and general industry confusion caused system delays. Lack of vendor readiness was especially taxing for smaller institutions that tend to rely more on outside vendors, adds Davis.
Even though vendors delivered QM-ready loan originations systems, banks still needed to complete testing and train staff. And since many systems were not delivered until mid-December, that testing and training happened during a holiday period in which many employees take time off.
Those struggles played out at United Bank Mortgage Company, a subsidiary of United Bank of Michigan, Grand Rapids, which received its system updates the second week of December. The bank then needed to create its own tools using Excel spreadsheets to test the calculations, explains Cynthia Lowman, president.
Arvest & Central Mortgage Company received its system updates in late December with the caveat from its vendor that more changes and corrections would be forthcoming. The bank made the deadline, but as Roehrenbeck notes, “It wasn’t smooth, and it wasn’t easy.”
“At the end of the day, banks have tried extremely hard to get up to speed,” says Plagge. “The intent of the industry is to make this work.” Even with systems in place, compliance work and understanding ATR/QM’s impact is just beginning. “The biggest component is training employees, realtors, and consumers,” says Plagge. “That’s still in its infancy.”
Ensuring loans are acceptable to the secondary market means cost and effort, adds Roehrenbeck. “I hate to think how much more this is costing the industry.”
Secondary market impact
Because Fannie Mae and Freddie Mac will not purchase non-QM loans, banks must either keep such loans on their books or look to an as-yet nonexistent secondary market. “Since the liabilities impact anyone who touches these loans, including the securitizer, we know of no investors that will buy non-QM loans,” says Davis.”
The lack of a secondary market is a significant issue for banks concerned about interest-rate risk and the potential need to meet higher capital requirements, Davis adds.
Hughes believes that a secondary market will develop, but warns that banks will need to charge higher fees and interest rates for higher risk non-QM loans. Ghazale Johnston, managing director with Accenture Credit Services, agrees that investors will begin to enter the secondary market, but there will be a lull. “We will see a small group of investors, such as hedge funds, come back first, but it won’t happen overnight,” she predicts.
Limits on the jumbo market
With the QM DTI ratio capped at 43%, lenders in high-cost housing markets, such as New York City and San Francisco, may find 43% too limiting since loan amounts above the conventional loan limit of $417,000 are common in metropolitan markets.
“The jumbo loan market presents an interesting opportunity for lenders,” says Johnston. “Some lenders see providing non-QM loans to the jumbo market as a way to remain relevant to high-net-worth consumers.”
While some banks see opportunity, others see risk. Lowman believes many banks will be more cautious with jumbo mortgages and write them to risk, rather than base lending decisions on a more complete borrower profile.
To meet QM guidelines, points and fees for loans in excess of $100,000 are limited to 3% of the total loan amount. Included in the 3% calculation are loan originator compensation, non-interest financial charges, real estate-related fees, premiums for insurance, PMI premiums, prepayment penalties, and Loan Level Price Adjustments charged by Fannie Mae and Freddie Mac.
It’s the LLPA inclusion that irks Iowa Bankers Mortgage Corp.’s Vessely. As he explains, LLPA can easily push points and fees past the 3% limit. “The biggest factor impacting whether or not certain loans will be within QM points and fees limits is not lender charges, but the LLPAs charged by Fannie Mae and Freddie Mac and passed on to the borrower,” he says. To remain in the QM box, lenders will be forced to increase the interest rate on the loan. “Even if the borrower wants to pay the LLPA fees upfront, the lender cannot allow them to do so and maintain QM status,” he adds.
The points and fees test is causing angst for a number of banks, including United Bank Mortgage Company. “Without historical data, we don’t have the answers we need, says Lowman. “We’re going to be nervous.”
Bottom line, says Vessely, is that it would be better both for the industry and consumers if lenders were not required to include LLPA as part of the points and fees test. “The biggest interest rate increase for consumers will be from government fees,” he attests. “It’s ironic. The CFPB is supposed to protect consumers, but it’s the government which is either intentionally or unintentionally driving up interest rates.”
Fair lending conundrum
Although CFPB has stated that making only QM loans will not open a bank up to fair-lending violations, most bankers are not convinced. “The statement from the CFPB doesn’t alleviate banker concerns about fair-lending violations,” says ABA’s Davis. “Making only QM loans will have measurable impact on certain protected classes.”
Plagge notes that banks have expressed concern about fair-lending violations. “If you make one-off exceptions to QM loans, do you trap yourself in a fair-lending debate? No one can answer that question. What is clear is that consistency and documentation will be key,” he says.
Hughes agrees, arguing that letting even one or two non-QM loans through can result in a fair-lending violation. Says Lowman about the CFPB statements: “Not one of us feels comfortable. We are looking at our fair-lending guidelines and analyzing our data.”
How does the consumer fare?
The intention of ATR/QM is to protect consumers, but that protection will come at a cost for those same consumers CFPB seeks to help. Like many banks, First Federal Savings Bank has added staff to handle increased regulations. “Compliance costs are great, and banks will need to pass those costs on to the consumer for banks to remain financially viable,” says Hughes. “As more regulations are passed, the issue will become compounded.”
Lowman believes the true impact of ATR/QM won’t be clear for several years. “As to whether all this will protect the consumer, we really don’t know yet.”
Roehrenbeck is more direct. “There is no question that ATR/QM will impact consumers from qualifying for the most efficient interest-rate loans on 30-year fixed mortgages,” the banker predicts. “Consumers will be limited in terms of financing to buy a home. ATR/QM will have a dramatic impact.”