Compliance Blog

Posted by Anthony Demangone

Earlier this week, the FDIC issued its proposal on risk retention, which it is issuing jointly with the Federal Reserve.  You can read a bit more about that proposal here. (NAFCU Today.)  

The proposal was mandated by Dodd-Frank to cure a perceived flaw in our financial system.  What was the flaw?  Issuers of securitized loans had no requirement to retain any risk regarding the assets that they bundled and sold.  Had they retained the risk, perhaps the quality of securitized loans would have been better. Perhaps.  Such a system should not seem that foreign.  NCUA has a requirement for originating credit unions selling loan participations to retain an interest of at least 10 percent in the loan.  The thought behind this is simple. Chefs that have to eat what they cook are incentivized to prepare better meals.  

The FDIC/Fed proposal, if finalized in its current form, will mandate that issuers of securitized mortgage loans retain at least 5% interest in the risk of the loan's loss.  Nearly every rule has an exception, and the risk retention rule has one that is very important. The 5% retention requirement will not apply to "qualified residential mortgages" or QRMs. (For the purposes of this post, I'll talk about QRMs that are purchase money mortgages.  The proposal has even more stringent requirements for a refinance transaction to qualify as a QRM.)  QRMs for are deemed to be so low in risk, that no risk retention is necessary.  What do QRMs look like?  Borrowers will have to put 20% down. (And PMI can't be used to make up for lower down-payments.) There must be documented income. These mortgages must have stable payment terms that do not provide the possibility of substantial "payment shock."  There are other requirements as well. 

So, this rule creates a "golden" category of mortgages, QRMs, that can be bundled, securitized and sold without the need for risk retention. Generally speaking, any other loan, anything that isn't a QRM, cannot be bundled and securitized without risk retention unless it fits within an exception.  So the market for QRMs could increase, while the ability of an originator to sell a non-QRM should decrease. 

How will this proposal affect credit unions?  It is hard to know for sure at this point.  But let me paint you a picture of perhaps the worst-case scenario.  In the future, the secondary market for mortgages will greatly favor QRMs.  Some mortgage purchasers will not buy non-QRMs at all, and those that will, will pay much less for non-QRMs - as they'll have to retain some repayment risk for these loans.  Due to this repayment risk, purchasers of non-QRMs will be forced to perform a good deal of additional due diligence to understand what risk they are accepting.  Originators of loans will have a choice.  They can make QRMs, which should be easier to sell. They can offer non-QRMs, but those will be less valuable.  Originators will have to sell them at a discount, or they'll have to keep them on their books.  For that reason, non-QRMs may have higher interest rates, or may have variable rate features to protect the balance sheets of the originators.

In other words, this proposal could funnel a large portion of the mortgage market into the QRM category.  For that reason, your credit union needs to follow this rulemaking process and understand how it may affect your credit union's mortgage process.

Now, this post was a very crude overview of the proposal.  I didn't try to get into every nuance of the issue. For example, loans that are government insured or loans purchased by Fannie or Freddie while they are in conservatorship, would not be subject to the risk retention requirements under the proposal.  The bottom line is this: If your credit union does mortgages, you'll have to devote some resources to closely follow this developing story. 

Never a dull day, eh?

***

After that post, I think we need some glimmer of hope.  No matter what Dodd-Frank may do to us, there isn't one provision within its 1,000+ pages that affects one of our cherished annual rites of Spring - the opening day of major league baseball.  Today, I'll be sitting in the bleachers rooting for my Washington Nationals as they take on the annoyingly-always-good-and-how-do-they-find-all-these-great-young-players Atlanta Braves.  I will not think about QRMs, Dodd-Frank, although I may consume a frankfurter or two. 

Opening day means a few things to me.  

1. While many things change, some do not.  This is the game my Grandfather played.  The game that I played. The game that my nephews play.  And while Briggs may not know it, the game that I hope he plays.
2. While the Nationals and Pirates may not have great teams, they are tied for first place today.  And you never know.
3. I grew up playing this game. The crack of the bat. The murmur of the crowd. The green of the field.  (I'm channeling George Will, I know) How the crowd erupts in a second as a little white ball rockets toward the gap. It all feels like home to me. 

Baseball may not be your thing. But in these days of constant change at work, find your "baseball" and enjoy it.  Life is too short.