Qualified Residential Mortgages and the Proposed Rule Implementing Dodd-Frank’s “Skin-in-the-Game” Requirements

in Asset-Backed Securities, Comptroller of the Currency, Federal Deposit Insurance Corporation, Federal Housing Finance Agency, Federal Reserve Board, Mortgage Lending, Securities and Exchange Commission, Securitization

by: Alex RadetskyCarlos Larkin

On March 29, 2011, the Office of the Comptroller of the Currency (“OCC’), the Board of Governors of the Federal Reserve System (“FRB”), the Federal Deposit Insurance Corporation (“FDIC”), the U.S. Securities and Exchange Commission (“SEC”), the Federal Housing Finance Agency (“FHFA”), and the Department of Housing and Urban Development (“HUD”) jointly issued a proposed rule to implement Section 941(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Proposed Rule”).  Althought this rule is extenstive, this post will be limited to a discussion of Qualified Residential Mortgages (“QRMs”), their exempt status and the underwriting standards that create this exemption.

The central purpose of section 941(b) of the Dodd-Frank Act is to ensure prudent lending behavior by requiring lenders and securitizers to bear the consequences of their risk taking. This section requires the OCC, FRB, FDIC and SEC to issue joint regulations that require securitizers to retain an unhedged economic interest of five percent (5%) in the credit risk of asset-backed securities issued to the secondary market. Section 941(b) also directs the agencies to define the appropriate form and amount of risk retention interests and to create rules addressing complex securitizations backed by other asset-backed securities (“ABS”). Finally, section 941(b) of the Dodd-Frank Act defines QRMs and exempts them (and other “qualified assets”) from risk retention requirements once they are underwritten according to the standards established by joint regulation.

Due to the QRMs exempt status, the proposed definition sets especially conservative underwriting standards to help ensure high-quality underwriting and to encourage appropriate risk management practices. The main underwriting standards for QRMs are as follows:

Historical Data: Borrowers must have a FICO score above 690 to satisfy the proposed QRM credit history standards.

Nontraditional Product Features. QRMs are generally prohibited from having product features that add complexity and risk to mortgage loans, such as terms permitting negative amortization, interest-only payments, or significant interest rate increases.

Underwriting Standards.

  • Maximum front-end and back-end borrower debt-to-income ratios of 28% and 36%, respectively;
  • A maximum loan-to-value (“LTV”) ratio of 80% in the case of a purchase transaction (with a 75% combined LTV for refinance transactions, reduced to 70% for cash-out refinance transactions);
  • A 20% down payment requirement in the case of a purchase transaction; and
  • Borrower credit history restrictions, including a requirement that the borrower has not had any 60-day delinquencies on any debt obligation within the previous 24 months.

Mortgage Insurance. The LTV ratio must be calculated without considering mortgage insurance.

Servicing Requirements. The originator of a QRM must incorporate certain requirements regarding servicing policies and procedures for the mortgage in the mortgage transaction documents. Examples include procedures for loss mitigation actions and procedures to address subordinate liens on the same property securing other loans held by the same creditor.

The full text of the Proposed Rule is available here, and comments on the Proposed Rule are due by June 10, 2011.  The Working Group will continue to monitor any developments with these proposed rules and provide timely coverage at Weil’s Financial Regulatory Reform Center.

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