Why bank liability could reinforce Fannie and Freddie as mortgage guarantors

Author: | Published: 29 Aug 2012
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Proposed amendments to Regulation Z of the Truth in Lending Act could increase investment in residential mortgages guaranteed by Fannie Mae and Freddie Mac just as the US government moves to unwind the government sponsored enterprises (GSEs).

Title 14 of the Dodd-Frank Act creates bank liability when a customer defaults on a residential mortgage that is not deemed to be a qualified mortgage. The Consumer Financial Protection Bureau (CFPB) has been tasked with defining the criteria of a qualified mortgage.

Loan performance is thought to be the favoured solution to determine repayment ability. Banks and legislators have lobbied the CFPB to establish a safe harbour for all qualified mortgages. But the CFPB is also considering rebuttable presumption as another viable alternative.

Joseph Lynyak, partner at Pillsbury Winthrop Shaw Pittman, said it was a little unclear what rebuttable presumption means or how it would operate if it was adopted.

“It may end up being a burden of proof evidentiary concern,” Lynyak said. “That’s something courts will have to work out.”

“If there is any type of discretion built into the system (for measuring repayment ability), that becomes more problematic in terms of what you go about proving,” said Lynyak.

US lawyers said it was important for repayment ability to include some room for discretion outside of bright-line loan performance standards. Credit-worthy customers who do not meet performance metrics could then still qualify for a mortgage. But this could discourage banks from originating loans because it would be more difficult to defend claims based on a qualitative assessment of a customer’s ability to repay.

In comments made to the CFPB, bankers said most of their mortgage originations would be qualified mortgages if the proposed regulations were implemented, because the costs of potential litigation over mortgages that do not qualify would outweigh returns.

Robert Davis, executive vice president of Mortgage Policy at the American Bankers Association, said the rules could inhibit development of non-guaranteed privately funded mortgages.

If the majority of the mortgage investment pool was made-up of similar mortgages, then presence of a GSE guarantee and a loan’s yield would be two of the only remaining differentiating qualities, Davis said. Risk adverse investors are expected to flock to those guaranteed mortgages.

Paul Hastings partner Kevin Petrasic said Basel III capital requirements could enhance the impact CFPB rules have on GSE guarantees, because banks will want to limit risky debt counting against capital requirements.

“Institutions will be looking to minimise the capital they hold, making the safest loans,” Petrasic said. “Fannie and Freddie will be looking to purchase the safest loans. Where we end up is a potentially greater and expanded role for Fannie and Freddie.”

The comment period on the definition of qualified mortgages and other aspects of Truth in Lending Act amendments mandated by Dodd-Frank was re-opened earlier this year and closed on July 9. The CFPB has until January 21, 2013 to finalise a rule on qualified mortgages.




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