Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA) mandates that mortgage originators have “skin in the game” by retaining at least 5 percent of the credit risk when mortgage assets are securitized.  DFA does this by adding Section 15G to the Securities Exchange Act of 1934.  The purpose of this is to provide a disincentive to packaging loans that are poorly underwritten.  However, retaining 5 percent credit risk on the balance sheet may be a significant burden to smaller institutions with marginal capital, which is why the law creates several exemptions, the most notable of which is the qualified residential mortgage (QRM) exemption. 

The definition of a qualified residential mortgage first appears in the proposed credit risk retention rule issued by the Federal banking agencies, SEC, HUD, and Federal Housing Finance Agency.  The QRM rule sets a maximum loan-to-value ratio of 80 percent for home purchases, 75 percent for refinancings, and 70 percent for cash-out refinancings.  Securitizations comprised entirely of QRMs are exempt from risk retention.  Former FDIC chairman Sheila Bair has stated emphatically that this definition is an exemption to the risk retention requirement; it is not intended to set a new national standard for mortgages.  However, the proposed rule has sparked heated controversy among industry and consumer groups alike.  From the comment letters, there emerged a broad-based consensus that the definition is too narrow and at odds with the realities of today’s housing market.  According to the National Association of Realtors “Profile of Home Buyers and Sellers 2010,” only 16 percent of first-time home buyers and 37 percent of repeat buyers would have qualified for QRM status.

The comment period was set to close on June 10, 2011, but amidst the strong opposition from industry and consumer groups, it has been extended until August 1.  Meanwhile, further adding to the controversy is the fact that the draft rule exempts Fannie Mae and Freddie Mac (the GSEs), and the Federal Housing Administration from the 5 percent risk-retention requirement.  Many commentators view this as an unfair cost advantage to the GSEs at the very time Congress and the Administration are attempting to encourage private-sector players to take their place.  Additionally, the high down payment requirement is receiving criticism because of its perceived effect of driving smaller institutions out of the business and further concentrating mortgage lending amongst the largest institutions. 

One thing is for sure, the QRM rule – whether finalized as is or modified – is sure to play a significant role in the unfolding story of the housing market recovery and GSE reform.        

Author:  Robert W. Cardwell, Jr., Esq., Director for ICS in the PA/NJ region.