By Stephen A. Fogdall
The newly enacted Economic Growth, Regulatory Relief, and Consumer Protection Act (also known by its Senate bill number S. 2155) includes a new category of “qualified mortgages” presumed to satisfy the Truth in Lending Act’s ability-to-repay requirement. This new category of QM loans, available only to federally insured banks and credit unions with less than $10 billion in assets, shares some features with existing categories of QM loans already recognized in regulations issued by the Consumer Financial Protection Bureau. However, the new category includes an important limitation: to qualify, a loan generally must be retained in the originating lender’s portfolio for the life of the loan rather than sold to a secondary market purchaser like Fannie Mae or Freddie Mac. On the one hand, this new QM option is intended to increase the availability of mortgage credit by providing a way for smaller community banks and credit unions to avoid TILA’s burdensome ability-to-repay restrictions. On the other hand, the new QM option potentially eliminates a source of liquidity for these lenders by prohibiting them from selling qualifying loans on the secondary market. The net effect of these arguably competing considerations remains to be seen.
The relevant regulatory landscape is familiar to many but worth briefly repeating. In 2010, in the wake of the financial crisis, the Dodd-Frank Act amended TILA to include an ability-to-repay (or “ATR”) requirement. Specifically, Dodd-Frank mandated that a lender originating a home mortgage loan must make “a reasonable and good faith determination, based on verified and documented information that, at the time the loan is consummated, the consumer has a reasonable ability to repay the loan” (15 U.S.C. § 1639c(a)). At the same time, it provided that any “qualified mortgage” would be presumed to comply with this ATR requirement. While Dodd-Frank imposed certain restrictions on such qualified mortgages — for example, negative amortizing loans could not qualify, and the total points and fees paid by the borrower could not exceed 3 percent of the total loan amount — it authorized the CFPB to “revise, add to, or subtract from the criteria that define a qualified mortgage upon a finding that such regulations are necessary or proper to ensure that responsible, affordable mortgage credit remains available to consumers” (15 U.S.C. § 1639c(b)(3)(B)(i)).
The CFPB issued regulations in 2013 defining a set of general requirements for QM loans, while specifying certain special categories of loans for which some of these requirements would be modified or eliminated. The general requirements include that the loan must be fully repaid in not more than 30 years, in “substantially equal” regular installments, without a balloon payment; the lender must verify the borrower’s debt and income in accordance with detailed requirements set forth in an appendix (called “Appendix Q”) to the regulations; and the ratio of the borrower’s total monthly debt to income (“DTI”) must not exceed 43 percent.
As noted, certain types of loans are excused from some of these requirements, at least temporarily. For example, loans eligible for purchase by Fannie Mae or Freddie Mac are currently not subject to the specific verification requirements in Appendix Q or the 43 percent DTI limit, though these exemptions will expire as soon as Fannie Mae and Freddie Mac are out of conservatorship or on January 10, 2021, whichever is earlier.
In addition, the CFPB’s regulations define a category of “small creditor portfolio” QM loans. While such small creditor portfolio loans qualify as QM loans, they need not comply with the 43 percent DTI limit or the verification requirements of Appendix Q, provided that the originating lender has less than $2 billion in assets, has sold fewer than 2,000 mortgages on the secondary market in the preceding year, and either retains the loan in its own portfolio for at least three years or sells the loan to another similarly qualifying small creditor. This category of small creditor portfolio loans reflects the CFPB’s belief that “small creditors excel at making highly individualized determinations of ability to repay that take into consideration the unique characteristics and financial circumstances of the particular consumer” and “portfolio loans made by small creditors are particularly likely to be made responsibly” (78 Fed. Reg. 6,539 (Jan. 30 2013)). Moreover, according to the CFPB, “the reputation of these community banks and credit unions is largely dependent on serving their community in ways that cause no harm,” and thus these lenders “have an added incentive to engage in thorough underwriting to protect their balance sheet as well as their reputation” (78 Fed. Reg. 35,437 (Jun 12, 2013)).
In the years since the CFPB issued its QM regulations, various industry groups and commentators have advocated for expanding QM status for any loan held by a lender in its portfolio rather than sold on the secondary market. For example, some commentators argued in congressional hearings that “any loan made by an insured depository,” regardless of its size, “and held in that lender’s portfolio” should be accorded QM status, because loans “held in portfolio are, by their very nature, loans which can be repaid.” Indeed, in 2014, a bill (H.R. 2673) providing that the “term ‘qualified mortgage’ includes a residential mortgage loan made by a creditor so long as such loan appears on the balance sheet of such creditor” was discussed in committees in the U.S. House of Representatives and Senate, but never made it to either chamber for a vote. In 2015, a more limited expansion of QM status for portfolio loans meeting certain documentation requirements and restrictions on loan terms, without regard to the type or size of the lender, was considered by the Senate banking committee as part of the would-be Financial Regulatory Improvement Act of 2015 (S. 1484), but that bill too never made it out of committee.
Although these more dramatic expansions of QM status for portfolio loans failed to gain traction, the newly created category in S. 2155 for QM loans originated by banks and credit unions with less than $10 billion in assets represents a significant extension of QM status beyond the previously recognized small creditor portfolio category.
The new QM category introduced in S. 2155 has the following features:
As noted, there are limited exceptions to the requirement that the lender hold the loan in its portfolio: the loan may be transferred as result of the bankruptcy of the lender; a qualifying entity may sell the loan to another such qualifying entity (i.e., another federally insured bank or credit union with less than $10 billion in assets), provided the purchaser in turn holds the loan in its portfolio; the loan may be transferred pursuant to a merger or acquisition; a qualifying lender may transfer the loan to a subsidiary, provided that the loan is still “considered to be an asset” of the qualifying entity “for regulatory accounting purposes.”
In addition to the restriction on transfers, there is a further important difference between the new QM category available to community banks and credit unions and the general category of QM loans. Under the general QM requirements, “the income and financial resources” of the borrower must be “verified and documented” (15 U.S.C. § 1639c(b)(2)(A)(iii)). As mentioned above, the CFPB has developed extensive procedures set forth in Appendix Q to its TILA regulations that generally must be followed to satisfy this verification and documentation requirement. However, the new QM category for community banks and credit unions expressly does not require verification. Instead, it requires that the lender “consider” and “document” the “debt, income, and financial resources” of the borrower, and permits the lender to use “multiple methods of documentation.” Congress’s word choice — “document” rather than “verify and document” — was presumably intentional. Congress may well have intended to allow some limited or alternative documentation loans by community banks and credit unions to qualify as QM loans.
Advocates of expanding QM status for portfolio loans argue that any such expansion increases the availability of credit by reducing the burden on lenders, particularly smaller lenders with fewer resources to spend on regulatory compliance. However, the benefits of this regulatory relief must be balanced against the potential loss of a source of liquidity as a result of a lender holding loans in its portfolio that it previously might have sold on the secondary market.
The CFPB opined when it first introduced the small creditor portfolio category of QM loans that smaller creditors’ “access to the secondary market was limited,” and such lenders “generally remained reliant on deposits” for funding rather than selling loans to Fannie Mae, Freddie Mac or other secondary market purchasers (78 Fed. Reg. at 35,437). However, Fannie Mae and Freddie Mac have noted a significant increase in loan purchases from smaller lenders since 2011. It should be emphasized that smaller lenders have always sold loans to Fannie Mae and Freddie Mac, but in the past such sales tended to be indirect. Smaller lenders would sell loans to larger lenders, which functioned as so-called “loan aggregators” by combining these loans with their own loans into pools and selling the pools to Fannie Mae or Freddie Mac. In part, the increase seen in direct sales to Fannie Mae and Freddie Mac by smaller lenders is due to a decrease in such sales by larger lenders, as these lenders have retreated from their historical loan-aggregating function. Thus, one long-term effect of the new QM category for community banks and credit unions may be a reversal in the recent trend of increased sales by these smaller lenders to Fannie Mae and Freddie Mac. This in turn may have some effect on the sources of funding available to these smaller lenders, which may counteract some of the positive effects of the intended reduction in regulatory burden.
Stephen A. Fogdall is a partner in the Philadelphia office of Schnader Harrison Segal & Lewis LLP, and chair of Schnader’s Financial Services Litigation Practice Group. Mr. Fogdall maintains a diverse litigation practice, with a focus in financial services litigation and class action defense. Mr. Fogdall has counseled mortgage companies, banks, mortgage insurers and other institutions in handling consumer protection claims, securities fraud claims, business-to-business disputes, shareholder disputes, government investigations, and many other matters. In addition to his litigation practice, he serves as chair of the firm’s Pro Bono Committee.
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