Credit union mortgage organizations and trade associations are casting a wary eye on a proposed regulation meant to encourage issuers of mortgage-backed securities to use safer mortgages to back their bonds.
On the surface this would not seem to be a credit union issue. Credit unions do not issue mortgage-backed bonds. But credit unions do issue mortgages, and, from time to time, seek to sell those mortgages in the secondary market that will be directly impacted by this regulation.
The proposed rule, issued by almost all federal financial regulators except the NCUA, uses a two-pronged approach to reach its goal of encouraging more mortgage-backed securities backed by safer mortgages. The first tine is the so-called "skin in the game" rule that does not have much of an impact on credit unions. The second tine is the "qualified residential mortgage" that is liable to have a significantly greater impact.
In the wake of the collapse of the housing finance market, critics charged that in too many cases some firms were issuing mortgages that they knew were almost sure to go into default and then other firms used those mortgages to back securities they then sold to investors.
Federal lawmakers wrote the skin in the game part of the Dodd-Frank Act to try to keep this from happening again by requiring that any issuer of a mortgage-backed security had to retain at least 5% of the risk of that security. This, Congress hoped, would more closely align the interests of the firms that built and sponsored the mortgage-backed security with the interest of investors who invested in it. If the security fails, the thinking went, the 5% guarantee makes sure the bond originators also lost something.
The qualified residential mortgage part of the proposed rule is meant to give mortgage bond issuers who use the least risky sorts of mortgages an additional incentive to do so. If an issuer of a mortgage-backed security backs the security only with mortgages that meet the definition of a QRM, it will be exempt from the 5% skin in the game part of the rule, a powerful incentive to any MBS issuer.
Once finalized, the proposed rule would set up, in effect, a second standard for mortgages that could be sold in the residential market, a mortgage alongside the mortgage standards set up and used by Fannie Mae and Freddie Mac when they purchase mortgages and use them to back securities.
This could have significant impact on credit unions, especially when they start issuing mortgages and try to sell them on the secondary market. If mortgage security issuers respond to the rules incentives and start creating significant numbers of securities backed by QRMs, credit unions could find a significant new market for their mortgages–that is, if the definition of QRM is not made so restrictive no borrower can qualify for one.
According to the proposed rule, a QRM would could only be a first mortgage on a one-to-four-family structure that does not have any other liens on it. Construction loans and reverse mortgages could not be QRMs.
QRM mortgages could not be interest-only loans, the regulators said and, most controversially, QRMs are proposed to require a 20% down payment.
Reaction to the proposed rule has been very cautious. Carrie Hunt, general counsel for NAFCU, said the association would read and consider the proposed rule carefully before making a comment in June.
Mary Dunn, deputy general counsel for CUNA, said much the same, but added that CUNA would be very alert for unintended consequences from the rule.
"We don’t know all the effects yet but will definitely be going over this with a fine-toothed comb, including the proposed terms of the QRMs. Generally, the burdens will be on securitizers based on a very quick initial reading, not as much for originators," she said.
Cliff Rosenthal, CEO of the National Federation of Community Development Credit Unions, said the National Federation was concerned that the 20% down payment requirement would effectively prevent many CDCU members from being able to get a mortgage. He noted that none of the existing individual development account programs designed to help lower-income people save up for things like a mortgage down payment would be sufficient to meet a 20% down payment requirement.
As with other parts of the secondary mortgage market, one remaining wild card is the future of Fannie Mae and Freddie Mac. Under the proposed rule, mortgage securities issued by Fannie Mae and Freddie Mac will not have to hold the 5%, but Congress is expected to reduce their role in the secondary mortgage market sometime this year.