How will you mitigate the risks involved with non-QM lending?
For those institutions that will offer residential mortgage loans outside of the "qualified mortgage" box, we're wondering how your institution will mitigate the risks involved. Please let us share some thoughts on what we're seeing out there.
For those institutions willing and able to do so, non-QM lending may represent a significant competitive advantage during the period of uncertainty and fear over the ATR regulations. But non-QM lending presents risks of non-liquidity, buybacks, liability, and even new concerns with fair lending.
We've seen numerous ideas for mitigating the risks involved with non- QM lending. Some general ideas include--
Training
Strengthening your quality control program (and, if you outsource QC, partnering with a company with a good reputation that is prepared for the new regulations)
Policy & procedure development
Considering residual income (see previous newsletter)
Research and documentation of the historical soundness of your underwriting standards
That is just to name a few. But let us continue to discuss a couple of "dos and don'ts."
"DO"... have a written non-QM policy
Many institutions plan to issue non-QMs on an exception basis, i.e., will normally stick to QM-only, but will make exceptions for certain customers. Regulators have identified this as a red hot fair lending concern, and will be looking closely at who gets non-QM loans. For example, there may be a problem if most of your non-QM loans went to non-minority, married couples (to the exclusion of everyone else), as this may look like discrimination against borrowers based on race and/or marital status. We want to point out, the inter-agency statement released on QM-only policies and fair lending is no protection here - that addressed strict QM-only policies, not policies under which non-QM loans are given under limited circumstances.
An easy way to mitigate this is through a clear, written policy on your standards for non-QM lending. Support this with legitimate business justifications. When the regulators come-a-calling, you can easily point to this and say, "here is who we do non-QMs for, and why. As you can
see, our non-QM lending policy is non-discriminatory." As you know, policies and procedures should ideally be clear enough for employees to understand and actually follow. Not only does this make it easier for employees to do their jobs (and get new hires up to speed), but it increases the likelihood that your stated policies will be carried out correctly.
A detailed discussion of what these standards should be is a story for another day. But for example, we've heard of institutions increasing required credit histories and other underwriting standards as compensating factors. However, if you believe that your underwriting standards produce quality loans, here is a simple question for you - why not write the loan regardless of ATR/QM if it would have passed muster under your historical underwriting standards? With such a policy, perhaps the only "compensating factor" necessary is that you charge more for the loan to compensate for the increased risk. Why limit non- QM lending any more than that? Isn't it good business to make good loans?
From a business perspective (no, it's still not all about compliance), it makes no sense to arbitrarily limit non-QM lending anyway. In our view, business is bad enough already. For those of you planning to stick to a QM-only policy, let's be realistic - if your best client's daughter comes in for a mortgage, are you really going to turn her away because her DTI comes in at 43.1%? And if that's a quality loan, why not make that loan no matter who she's related to?
[As a qualifier, we recognize that some institutions will not be able to originate non-QMs (non-depositories or depositories with liquidity concerns) right away because of uncertainty over whether a secondary market exists for such loans. Hopefully, this is still interesting to you as an indicator that such a market should develop.]
"DO NOT"...have borrowers sign verifying ability-to-repay
One idea for mitigating non-QM lending risks frequently pops up and should be shot down. The idea is as follows - why not have the borrower sign a statement agreeing that he/she has the ability to repay the loan?
Let us be clear, be very careful with this. We're not saying there will never be a benefit to having a borrower sign something in regards to ATR/QM (e.g., with residual income), but the practice identified above is probably a bad idea. In determining whether an institution has made a reasonable ability-to-repay determination in good faith (as required to comply), the consumer's promise that he/she has the ability to repay is expressly NOT considered as proof - such a statement or attestation is expressly made irrelevant for purposes of ATR. Look at Comment 1026.43(c)(1)-1.i if you don't believe us.
So what would the benefit be of having the borrower sign to verify that she has the ability to repay? There is none. But what is the harm, right? Wrong. The harm is that this may appear to a regulator that your institution is trying to trick the borrower into thinking she signed away her right to challenge ability to repay. As you know, regulators have more flexibility than ever in regards to things that might not technically violate the rules, but that just look bad--such a practice (again, with no benefit) merely serves to make your institution look bad, and at worst, may itself be considered unfair, abusive, or deceptive.
Just a final note ... your prudential regulator may have promised to "go easy on you" regarding ATR/QM compliance during the implementation period. Many regulators have made similar statements. But we want to offer our opinion that such an assurance is cold comfort - the real risk of ATR/QM is not in regulatory penalties, but instead in the decreased liquidity and increased liability risks arising out of the consumer's ability to challenge any ATR determination for the life of the loan. Maybe the regulators will cut you some slack in the next year or so, but don't expect the same from the borrower's attorney five years from now in a foreclosure action, or from an investor looking to buy the loan.
Anyone tired of complaining about the new mortgage regulations? You may be interested in the following excerpt regarding entrepreneurs and the "no-entitlement attitude" from "How the Best Get Better: The Art and Science of Entrepreneurial Success," by Dan Sullivan:
Since the end of World War II, Americans and Canadians, especially, have been living in the "age of entitlement." ... After World War II ... there was extraordinary economic growth for a 25-year period. There was so much wealth and opportunity for bureaucratic expansion that government, corporate, and union leaders began claiming that modern society could be perfected - and in the very near future. It seemed then as if there would always be more than enough money to do and fix everything. The problems of society - poverty, inequality, crime, disease, unemployment, and others would all be solved through government programs and employment in large bureaucracies.
People were promised perfect, and most took the promises seriously. Any obstacles they faced as individuals should now be eliminated, wrongs righted, and deficiencies remedied by someone else.... But as these foolish and unrealistic promises made by bureaucratic leaders could not be fulfilled, many people felt outraged and cheated. They looked for someone to blame. The period since 1970, with its incessant budget cuts and downsizing, has been shocking and infuriating to those who believe in the entitlement society. Many individuals and groups - regardless of the entrepreneurial prosperity and progress that exists around them, have come to see themselves as permanent victims of society.
I'm sure there is a lesson in there somewhere. Thoughts?
Thanks so much for reading our weekly newsletters. We're not always going to be perfect, but because we always do our best and try not to overpromise, we hope that we're always going to be trustworthy. Your calls and e-mails are very helpful - please keep contributing.
**These are our opinions. We're not authorized, or willing, to express those of others.**