The U.S. Consumer Financial Protection Bureau (the “Bureau”) has released a proposal (the "Proposal") to amend the Bureau's recently issued final rules (the “Rules”) on the definition of a qualified mortgage (“QM”) and the establishment of ability-to-repay requirements (“ATR”). See our DechertOnPoint, U.S. Consumer Financial Protection Bureau Issues Rules on Qualified Mortgages and Ability to Repay, for a more in depth discussion of the Rules. The Proposal aims to preserve access to credit for certain categories of consumers who may otherwise be adversely affected by the Rules. The Bureau is seeking public comments on the Proposal, which must be received by February 25, 2013. A discussion of the key aspects of the Proposal follows.
Exemption from the ATR Requirement
The Bureau proposes to exempt from the ATR requirements loans made or administered by, or related to:
a program administered by a housing finance agency;
certain types of non-profit creditors, including: (i) those designated by the Department of Housing and Urban Development as either a Community Housing Development Organization or a Downpayment Assistance Provider of Secondary Financing; and (ii) those designated under 501(c)(3) of the Internal Revenue Code, subject to certain restrictions;
an Emergency Economic Stabilization Act program, such as a State Hardest Hit Fund program;
a refinancing that is eligible to be insured, guaranteed or made pursuant to a program administered by the Federal Housing Administration, the Department of Veterans Affairs, or the Department of Agriculture, until that federal agency prescribes its own ATR refinance rules; and
a refinancing that is eligible to be purchased or guaranteed by Fannie Mae or Freddie Mac, so long as it is made: (i) pursuant to an eligible targeting refinancing program; (ii) such entities are operating under conservatorship on the date the refinancing is consummated; (iii) the existing obligation satisfied and replaced is owned by Fannie Mae or Freddie Mac; (iv) the existing obligation satisfied and replaced was not consummated on or after January 10, 2014; and (v) the refinancing is not consummated on or after January 10, 2014.
The Bureau explained the need for these exemptions from the ATR requirement in a number of ways. Principally, the Bureau does not want access to credit to be overly restricted for the populations targeted by the Proposal. The Bureau felt that the specified organizations benefit the community as a whole. Additionally, the Bureau found that the programs offered by these entities have complex and comprehensive underwriting requirements, are already subject to significant government monitoring and will still ensure that consumers have a general ability to repay without requiring them to comply with the ATR requirements. Additionally, with respect to programs aimed at preventing foreclosure and other housing-stabilization initiatives, the Bureau cited the need to continue to help consumers and communities recover from the aftermath of the financial crisis. The Bureau also stated that many of the organizations that administer these programs are small and lack the resources and flexibility to implement the ATR requirements.
Creation of an Additional Class of QM
The Bureau cited a number of factors for adding another category of loans that are eligible for QM status. This category would consist of certain loans made by a small creditor that (a) had total assets of $2 billion or less at the end of the previous calendar year, (b) which together with all affiliates, originated 500 or fewer first-lien covered transactions during the previous calendar year, and (c) had more than 50% of its total covered transactions during the preceding calendar year secured by properties that are in rural or underserved areas (“Small Creditor”). These loans would have to comply with all of the requirements under the general definition of a QM except the 43% limit on the monthly debt-to-income ratio, although the Small Creditor would still have to consider and verify the consumer’s income and assets and consider the consumer’s debt-to-income ratio and residual income. A loan would lose its status as a QM if it is held in portfolio for less than three years after consummation, with certain exceptions, including if it is transferred to another Small Creditor, if it is transferred pursuant to a supervisory action or by a conservator, receiver or bankruptcy trustee, or if it is transferred as part of a merger or acquisition of the creditor.
The Bureau explained the need for this additional class of QM in a number of ways. It noted that many Small Creditors have stated that they will be unwilling to make loans under the QM and ATR Rules. The Bureau recognized that Small Creditors often fill a niche by considering loans to consumers or properties that do not conform to standardized underwriting criteria used by larger creditors, and that such loans may be viewed as illiquid by larger lenders and therefore entail greater risk. While larger creditors may be unwilling to make such loans, the Bureau noted that Small Creditors are often willing to evaluate the merits of unique consumers and properties, using flexible underwriting criteria to make highly individualized underwriting decisions. Small Creditors would also hold these loans on their balance sheets, retaining the associated credit, liquidity and other risks, thus creating an additional incentive to responsibly underwrite these loans.
The Bureau also stated that Small Creditors are a significant source of credit in rural areas and are more likely to lend on a “relationship basis,” and must engage in responsible underwriting to preserve their reputations in their communities. The Bureau commented that Small Creditors as a group have consistently experienced lower credit losses for residential mortgage loans than larger creditors,1 which the Bureau interpreted as evidence of historically responsible lending practices. It is interesting to note that the Bureau, in the ATR rule, stressed the need for consistent application of an institution’s underwriting policies. However, in the Proposal, the Bureau takes a different approach. The Bureau suggested that underwriting based on “qualitative information, often referred to as ‘soft’ information, that focuses on subjective factors such as consumer character and reliability, which ‘may be difficult to verify, and communicate through the normal transmission channels of a banking organization’”2 may have contributed to Small Creditors’ historically responsible lending practices.
Changes to the Safe Harbor v. Rebuttable Presumption Threshold
As part of the new type of QM that would be available to Small Creditors, the Bureau has proposed to raise the annual percentage rate these creditors could charge and still benefit from a safe harbor. The Bureau has proposed to make the same change applicable to Small Creditors operating predominantly in rural or underserved areas who offer first-lien balloon loans that will be held in portfolio (“Small Rural Creditors”).
Under the Rules, a QM safe harbor is given to first-lien qualified mortgages with an annual percentage rate less than or equal to the average prime offer rate plus 1.5 percentage points (3.5 percentage points for subordinate-lien loans). Under the proposed rules, Small Creditors and Small Rural Creditors would qualify for the safe harbor as long as the annual percentage rate is less than or equal to the average prime offer rate plus 3.5 percentage points for both first-lien and subordinate-lien loans.
The Bureau explained the need for a higher threshold rate on the grounds that Small Creditors and Small Rural Creditors may charge consumers higher interest rates and fees than larger creditors for several legitimate business reasons. According to the Bureau, these creditors may pay more for funds than larger creditors. Small Creditors and Small Rural Creditors generally rely heavily on deposits to fund their lending activities and therefore pay more in expenses per dollar of revenue as interest rates fall and the spread between loan yields and deposit costs narrows. The Bureau stated that Small Creditors and Small Rural Creditors may also rely more on interest income than larger creditors, as they often do not receive as much additional income from non-interest sources such as trading, investment banking or fiduciary services. The Bureau also raised the concern that Small Creditors and Small Rural Creditors need to charge higher rates to compensate for their exposure to interest rate risk, credit risk, and liquidity risk. Finally, the Bureau noted that these types of creditors may be particularly burdened by the time, effort and cost of ATR litigation and that it may be particularly difficult for small creditors to absorb the cost of adverse judgments.