Risk Retention Is No Substitute for Good Underwriting

With Senate Committee Nearing Markup, Study Finds Traditional Mortgages Performed Almost Three Times Better Between 2002 and 2008

WASHINGTON, March 3 /PRNewswire-USNewswire/ -- Proposed across-the-board risk retention provisions for home mortgages in the House Financial Reform bill and the draft Senate bill are no substitute for good underwriting, strong documentation standards and safe product design, according to a new study released today by the Community Mortgage Banking Project (CMBP).

The analysis of the loan performance data in the study shows that the application of a handful of common sense underwriting standards improves loan performance dramatically. The finding makes clear that policymakers should focus efforts on ensuring that financial reform legislation has significant incentives for home mortgages with strong underwriting standards, rather than sweeping risk retention provisions that treat risky and non-risky mortgages equally. Industry analysts and some regulators have recently raised concerns that risk retention is a blunt tool that could significantly raise the cost of home mortgages.

Examining more than 20 million loans made between 2002 and 2008, the study found that riskier mortgages performed 2.9 times worse, as measured by loans that were 90 or more days delinquent. It is the first analysis to measure the difference in default rates between higher risk loans and traditionally underwritten, back-to-basics loans during the recent housing cycle.

Default rates were consistent across the seven years between the two types of loans, the study found. Qualified mortgages – that is, traditionally underwritten mortgages – performed 2.6 times better prior to the boom in 2002, and 3.25 times better at the peak in 2005. Qualified mortgages performed significantly better in each of the nation's Top 25 metropolitan areas.

"This study confirmed what has long been suspected," said James Bennison, Senior Vice President, Strategy & Capital Markets for Genworth Financial's U.S. mortgage insurance business. "Traditional underwriting standards, including full income documentation and straightforward loan features, yielded dramatically fewer defaults. Policymakers should be looking for ways to encourage liquidity for this type of lending. Unfortunately, the across-the-board risk retention would increase its cost and reduce its availability."

The study was released as the Senate Banking Committee neared markup of financial reform legislation. The committee is expected to consider a proposal to impose across-the-board risk retention requirements for all loans sold in the secondary market. It would require the SEC and the federal banking agencies to issue regulations requiring creditors and issuers of asset-backed securities to retain 10 percent of the credit risk on whole loans and securitizations. The provision would impact both traditionally underwritten mortgages as well as riskier mortgages, imposing additional costs on even the most responsible borrowers using back-to-basics mortgage products.

Glen Corso, managing director of CMBP, said risk retention provisions are a reasonable approach for exotic mortgages that carry higher risks of default. That is not the case, however, for traditionally underwritten mortgages such as the ones offered by community-based mortgage banks, local bankers and credit unions, he said.

"This study demonstrates why Congress should be careful not to impose an arbitrary risk retention requirement on all loans sold in the secondary market," Corso added. "Across-the-board risk retention will unnecessarily and unfairly raise costs on creditworthy borrowers seeking products that are demonstrably lower risk."

CMBP has urged the committee to exempt low-risk "qualified mortgages" with strong underwriting and documentation standards and safe product designs.

To define lower risk, the study examined eight traditional, "back-to-basics," underwriting criteria that are easy for consumers to understand, easy for lenders to apply, and easy for regulators to supervise. Qualified Mortgages were those that included all eight of the following factors.

• Total debt-to-income ratio, including housing and other obligations, of 41 percent or less,
• Fixed rate loans and ARMs with initial rates locked in for 7 years or more,
• Repayment periods of 30 years or less,
• No balloon payments,
• No interest-only features,
• No negative-amortization features,
• Full income documentation of borrowers' income and assets
• Mortgage insurance required if the original loan-to-value ratio was greater than 80 percent

Vertical Capitol Solutions of New York, an independent valuation and advisory firm conducted the study for Genworth Financial, Inc., in collaboration with CMBP. The study may be downloaded at: http://www.communitymortgagebankingproject.com/Press.html.

Community Mortgage Banking Project is a public policy organization representing the interests of independent mortgage bankers. For decades, the community-based mortgage banker has delivered value and choice to consumers by leveraging local market expertise, quality service, and lower costs for borrowers. The CMBP supports financial market reforms that promote consumer access, borrower and investor transparency, local competition and choice, and a value added mortgage chain. For more visit www.communitymortgagebankingproject.com.

SOURCE Community Mortgage Banking Project