The plain vanilla mortgage LIVES! It’s just called ‘qualified’ | FT Alphaville

The plain vanilla mortgage LIVES! It’s just called ‘qualified’

Did any one catch this bit in the latest (and last?) draft of theUS financial reform bill?

From page 189 of Title IX :

‘‘(B) require a securitizer to retain— 16 ‘‘(i) not less than 5 percent of the 17 credit risk for any asset— 18 ‘‘(I) that is not a qualified resi19 dential mortgage that is transferred, 20 sold, or conveyed through the issuance 21 of an asset-backed security by the 22 securitizer;

Familiarise yourself with that term — for some say it could dictate the future of mortgage securitisation.

Put simply, the bill exempts banks from risk retention rules on their RMBS if the mortgages are deemed “qualified.” For all other RMBS securitisations, originators and issuers have to hold on to a 5 per cent slice of the asset. And they’ll have to do so permanently, and on an unhedged basis.

The idea in the ‘skin in the game‘ theory is that financials will make and manage better securities if they keep an interest in its credit risk, albeit forced. But retained risk also means the institutions will need extra capital — and a mountain of 5 per cent slices could add up to a significant impact.

Enter then, the qualified mortgage.

These lucky things don’t require any risk retention — and by extension any extra capital.

But who decides what qualifies as a qualified mortgage (ahem) or not?

The US government has yet to come up with a concrete definition. Instead, the draft bill states that various government branches “shall jointly define the term” over the next year or so, taking into consideration the kind of loan features that have historically lead to low default rates.

And here’s where things get interesting. For, as Deutsche Bank analyst Steven Abrahams notes, the definition of what constitutes a “qualified loan” will effectively be institutionalised:

It’s reasonable to assume that the committee will favor loans that look a lot like the bread-and-butter fixed-rate mortgages that Fannie Mae, Freddie Mac and prime jumbo issuers securitized in the 1990s. But, importantly, the definition of a qualified residential mortgage is no longer in the hands of any private entity or market. It’s in the hands of regulators.

As you might imagine, there are all sorts of consequences to this, though in some respects, things remain the same. There’s always been a distinction in markets between ‘good’ and ‘bad’ loans, ‘plain vanilla’ versus more exotic fare. And some of that’s still there, as Deutsche points out:

. . . If you set up different capital requirements between qualified mortgages and everything else, then you should expect differences in the cost and availability of mortgage money. Borrowers that qualify for qualified residential mortgages should be able to get slightly lower coupons and more loan offers than the unqualified, all else equal, and maybe that’s the point. Borrowers that qualified for agency eligible mortgages have traditionally enjoyed similar benefits, and qualified residential mortgages preserve that distinction.

But there are also new issues:

. . . The lack of required risk retention on qualified mortgages opens the market to players with limited capital. Originate, sell and repeat is a good business model—as long as you tic all the boxes around reps and warrants and so on. You don’t need to be a bank to do that, and right now banks are the only game in town.

And slightly more ambiguously:

If the housing market was the most politicized financing market in the U.S., then the new rules turn it up to 11. With regulators now defining and redefining qualified residential mortgages, the incentive to redraw the lines and sweep constituencies in and out of eligibility will be honey to the bee. Moreover, banks and other securitizers should have incentives to limit the future scope of Fannie Mae and Freddie Mac to get access to more of the qualified market. And with bank regulators on the committee that defines qualified mortgages, banks should have more leverage in the process than ever before.

Ironically, the transition out of financial crisis to a new normal for residential mortgages securitization may look a lot like the old normal: one market for low-risk borrowers, another for everyone else; securitization of low-risk loans at the center, securitization of other loans at the periphery; a healthy mix of politics around it all. It worked well from the infancy of residential securitization in the 1980s through the 1990s. There’s no clear reason why it can’t work again.

Err, let’s hope so.

And let’s hope there’s no repeat of that other, more recent, bit of mortgage market history.

Related links:
How risk-retention rules could boost FHA loans – WSJ Developments
Mortgage industry urges risk retention exemption in financial reform act – HousingWire
The return of the plain vanilla mortgage – Mortgages blog