Elizabeth L. McKeen
Dixie Noonan
This is the latest in a series of columns by O’Melveny & Myers attorneys, focusing on key legal issues specific to a variety of U.S. industries.
Now that the Consumer Financial Protection Bureau has finalized the “qualified mortgage” definition that forms the heart of the new ability-to-repay (ATR) mortgage rule mandated by the Dodd-Frank Act, mortgage lenders and regulators are shifting their focus to implementing these new underwriting requirements. In coming months, in-house counsel and compliance staff should be on the lookout for key publications and guidance expected to be issued by the CFPB and the Federal Financial Institutions Examination Council (FFIEC) that are designed to help financial institutions conduct self-assessments of their lending processes and build effective compliance programs before the ATR rule kicks in next January. With the definition finalized, banks are also bracing for looming announcements on reforms of the secondary market for mortgage financing.
Under the new ATR rules, lenders will be required to verify a borrower’s ability to repay a home loan using specified criteria, including documentation of employment, income, and debt. To satisfy the “qualified mortgage” definition, among other requirements, the loan will have to be prime (not high-priced) and the borrower’s back-end debt-to-income ratio cannot exceed 43 percent. In return for complying with these standards, lenders will receive the benefit of an industry-backed safe harbor, protecting them from litigation and defenses to foreclosure if a borrower challenges the legality of the mortgage. The CFPB’s endorsement of the safe harbor was seen as a win for industry participants worried about fresh waves of consumer mortgage litigation stemming from the new provision for private causes of action in Dodd-Frank.
Higher-priced qualified mortgages that exceed the 43 percent debt-to-income ratio will still enjoy a presumption of compliance, which borrowers can rebut by showing they could not, in fact, afford the mortgage payments when the loan was made. The industry, however, is gaining a new tool for reinforcing the presumption of compliance. Under the CFPB’s guidance, the longer the borrower makes timely payments (thus demonstrating an actual ability to repay), the more difficulty the borrower will have rebutting the presumption.
CFPB Director Richard Cordray announced the final ATR rule at a January field hearing, during which he acknowledged his agency’s struggle to formulate a policy that does not unduly restrict access to credit in the housing markets while still protecting consumers. Cordray commented that “you cannot have responsible lending unless you have lending in the first place . . . . We can draw up the greatest consumer protections ever devised, but if consumers cannot get credit, then there is nothing to protect.” Cordray also announced that he was hiring a “mortgage industry veteran” as part of a pledge to “help lenders implement the rule smoothly and minimize unnecessary burdens.”
With an eye to that transition, the CFPB on February 13 revealed a blueprint for implementing the ATR rule. The plan includes a coordinated effort to work with other government agencies that regulate mortgage lenders to develop a “shared understanding” of the new rule, as well as a consumer education campaign that the CFPB will roll out as the January 2014 effective date approaches.
Perhaps most relevant to industry participants, the CFPB intends to publish guides and interpretations aimed at helping lenders comply. Financial institutions should be alert to the release of these publications, which will likely give important insight into how the CFPB plans to ensure ATR compliance through exams, investigations, and, potentially, enforcement proceedings.
First, this spring, the CFPB plans to publish plain-language summaries of the ATR regulations, including videos, aimed at small companies with limited compliance staff.
Second, over the course of the year, the CFPB will issue updates of the “official interpretations,” designed to address specific concerns raised by industry or consumer groups about how to comply with the rule. According to the CFPB, it will prioritize publishing guidance on issues that “critically affect mortgage companies’ implementation decisions.”
Finally, this summer, the CFPB will publish “readiness guides” that include checklists for mortgage originators and servicers on ATR compliance issues. Financial institutions should particularly look for the CFPB’s commentary on revising policies, procedures, and staff training initiatives. Similarly, the FFIEC expects to publish in-depth examination procedures later this year. The CFPB has suggested that companies use the examination procedures to conduct self-assessments of their readiness to comply. With the broad parameters of the rules established, we suggest that firms begin self-assessments now to identify business practices likely to be impacted, thereby allowing affected business lines ample time to comply before the ATR rule takes effect next January.
Looking ahead, Congress and other federal regulators must now turn to reforming the secondary market for mortgage financing, as mandated by Dodd-Frank. How the federal banking regulators come to define a “qualified residential mortgage”—i.e., loans exempt from Dodd-Frank’s risk retention requirement—will be the most awaited component. For loans that do not meet this standard, lenders will be required to retain a percentage on their books in order to have some “skin in the game.”
Federal Reserve Board Chairman Ben Bernanke recently testified to Congress that adopting a qualified residential mortgage definition that is as broad, or nearly as broad, as the qualified mortgage definition adopted by the CFPB’s ATR rule “is very much on the table.” One open question is whether the qualified residential mortgage definition will include a down payment requirement, which the CFPB’s rule does not.
In anticipation of the secondary mortgage market reforms yet to come, the CFPB’s ATR rule allows for a transitional period during which compliance with certain parts of the rule, most importantly the 43 percent debt-to-income ratio requirement, is not required to enjoy safe harbor status for loans eligible to be purchased, guaranteed, or insured by Fannie Mae, Freddie Mac, or certain other government agencies. This means that most mortgages with debt-to-income ratios of up to 45 percent (which is consistent with Fannie Mae’s and Freddie Mac’s underwriting standards) can qualify for the safe harbor during the transitional period of up to seven years.
The CFPB’s ongoing publications and guidance on the ability-to-repay rules over the next several months, as well as forthcoming rules on secondary mortgage market reforms, will identify important steps that lenders should take as compliance deadlines approach.
Elizabeth L. McKeen is a partner in O'Melveny's Newport Beach office and a member of the Financial Services Practice. Dixie Noonan is counsel in O'Melveny's San Francisco office and a member of the Financial Services and White Collar Defense and Corporate Investigations Practices. The opinions expressed in this article do not necessarily reflect the views of O'Melveny or its clients, and should not be relied upon as legal advice.
