Banks Sound Alarms Over Consumer Bureau

Banks that want to set up mortgage conduits are suddenly wondering if their efforts could be hindered by a yet-to-be-issued directive from a U.S. government agency that still doesn't exist.

At issue is how the Consumer Financial Protection Bureau will define “qualified” mortgages deemed to satisfy a Dodd-Frank Act requirement that lenders verify borrowers' repayment ability. After seeing the FDIC, Federal Housing Finance Agency, Federal Reserve, HUD, SEC and Treasury Department jointly propose a narrower-than-expected classification for qualified loans on March 29, industry players say prospective conduit operators including Bank of America, Barclays, Credit Suisse, RBS and Wells Fargo now must consider the possibility that the bureau also will grant little leeway.

Buyers of credits that don't meet the bureau's criteria would have to re-check the underlying individuals' incomes, debt loads and other financial measures — essentially, going through the mortgage-underwriting process over again. That would introduce a host of unanticipated work and associated costs for conduit operators, which purchase home loans with securitization as an exit strategy.

The added expenses could sap much of the appeal from conduits, whose underlying mortgages presumably would include those at the greatest risk of missing out on qualifying status. Loan originators wouldn't feel the same effects, as they verify borrower quality anyway. But they could lose an important source of secondary-market demand for their credits as conduits cut back on their investments or fail to materialize.

There's no word of any specific lobbying efforts.

The bureau's standards would be separate from those addressed in last week's proposal, which applies to conditions under which mortgage bonds would be exempt from a Dodd-Frank requirement that issuers or underwriters retain 5% of their deals.

Of course, market participants have known ever since Dodd-Frank became law last July that the bureau's rules were in the making. But the unexpected lack of wiggle room on the risk-retention side clearly has thrust the matter to the forefront, just as conduit efforts are beginning to re-emerge from a credit-crisis-induced slumber.

Purchasers of loans that don't meet the bureau's definition of a qualified mortgage can be sued by borrowers seeking to rescind their debts or called upon by regulators to demonstrate that they've verified borrowers can repay. Hence, the need for a second layer of reviews.

While it's unclear what types of mortgages the bureau will deem qualified, the Dodd-Frank provisions that created the agency leave the window open for it to include a range of credits. The standards could be broad enough to encompass such uncommon arrangements as reverse mortgages.

However, the sense among lenders is that White House advisor Elizabeth Warren, who has spearheaded the bureau's creation, only looks favorably on the simplest loans and could take her cues from last week's risk-retention proposal. That measure promises to set limits for loan-to-value ratios, debt-to-income ratios among borrowers, changes in required payments and principal-balance increases that are more stringent than expected.

Many prime-quality jumbo mortgages would be left out of the qualified-loan criteria under that scenario, along with subprime and alternative-A products. “Elizabeth Warren thinks people have been loaded down with mortgages they can't afford,” one securitization attorney said.

The new agency, which begins operations July 21, is required to finalize its qualified-mortgage definition within 18 months of that date. The rule would take effect a year later, meaning compliance might be unnecessary until December 2013. However, indications are that the bureau will try to have the matter settled sooner. “There's going to be a lot of pressure on the CFPB to deal with this, and I think it's going to happen relatively quickly,” Dechert attorney Robert Ledig said.

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