By John Hintze
The Consumer Finance Protection Bureau (CFPB) doesn't have a direct mandate over the securitization industry, yet it is one of the biggest regulatory wildcards, particularly for deals backed by residential mortgages in the foreseeable future.
Nearly two years after it was signed into law as a part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the bureau has finalized only three relatively minor rules, and it has yet to enforce any of the major consumer finance-related laws and related regulations that were officially placed under its umbrella last July.
Nevertheless, its mandate is broad, and almost certain to expand. It is expected to impact every aspect of consumer loans, the bulk of securitized assets, not least because it is tasked with writing what likely will become the next loan standard for residential mortgages.
"The CFPB is focusing on origination and servicing, but through oversight of originators and servicers it will have strong impact on ABS transactions," said Jeffrey Taft, a partner at law firm Mayer Brown who specializes in banking and consumer financial services regulation.
The bureau is spreading its wings at an important time for the securitization industry, which has yet to recover from the financial crisis. "There's great opportunity for the bureau to help build investor confidence and get these regulations right," said John Arnholz, a partner at law firm Bingham McCutchen who represents financial institutions in asset financings, securitizations and investment fund strategies.
Most recently, the CFPB has received attention for a complaint database for credit card customers that it launched on June 19. The first major test of its regulatory prowess will be a qualified mortgage (QM) rule, which aims to set standards for lenders to ensure that borrowers can repay their mortgage. This is important to the securitization industry because a separate proposed rule (see Regulators Prepping for Busy Summer story) would exempt sponsors of deals backed by QMs from a requirement to retain a portion of the risk, such as a 5% vertical slice.
The release of the final QM rule was originally expected this summer but has been postponed until later this year. The CFPB received additional data and extended the proposal's comment period to July 9 to gather more market input. The new data is from the Federal Housing Finance Agency (FHFA) tracking the performance of loans purchased or guaranteed by Fannie Mae and Freddie Mac as well as data on other securitized mortgage loans. In announcing the delay, the agency noted that the data can be used to model the relationship between borrowers' ability to repay and variables such as consumers' ratio of debt to income. Some have urged the agency to incorporate a debt-to-income threshold in its definition of "qualified mortgages."
Ultimately, the CFPB will affect the market in myriad and unforeseen ways, if only because its jurisdiction is so broad and likely to broaden further.
Matthew Yoon, a partner at law firm DLA Piper who focuses on mortgage banking and consumer financial regulation and compliance, noted that the CFPB's jurisdiction over all federal consumer financial laws includes specific purview for areas such as mortgage, student and payday loans. It is also mandated to supervise and examine commercial banks with more than $10 billion in assets. And that list can be expanded.
"There's a catchall, risk-based rule which permits the CFPB to start regulating a new area, although it must accomplish this through the rulemaking process," Yoon said.
Explaining the breadth of the CFPB's potential impact on consumer loan origination, Yoon pointed to a long list of major laws that has shifted under the agency's umbrella, including the Federal Reserve's Truth in Lending Act and Equal Credit Opportunity Act, and certain laws previously interpreted and enforced by the Federal Trade Commission (FTC), such as the Fair Credit Reporting Act. Other laws under the CFPB's purview include the Real Estate Settlement Procedures Act, and the SAFE Mortgage Licensing Act, a key component of the Housing and Economic Recovery Act of 2008 that requires the individual licensing of loan officers and brokers.
"The CFPB is now the primary rule-making authority for these laws, in place of the myriad agencies that previously interpreted them, such as the Fed or HUD (U.S. Department of Housing and Urban Development) or the FTC ," Yoon said.
Given the $10 billion threshold, the CFPB will be examining and supervising the 120 or so largest commercial banks catering to consumers.
Taft described the agency's jurisdiction over non-depository financial institutions as "a little fuzzier." He said there are five "statutory prongs the CFPB gets its hooks into [non-depositories] as far as examination and supervision."
They include anyone involved in mortgage lending, servicing or brokering, as well as firms offering or providing private-label student loans or payday loans. Its first proposed rules have addressed debt collectors and credit reporting agencies, detailing which of those entities will be subject to examination and supervision.
The CFPB also has supervisory authority over "larger participants" in certain consumer markets that will cover lenders over a specified threshold in total assets. Dodd-Frank left that to the agency to define through rulemaking, and it likely will capture some of the auto lenders and other larger nonbank financial companies, Taft said.
Taft noted that the agency issued a proposed fifth prong in mid-June that gives it the ability to begin supervising any company that it concludes presents a risk to consumers due to consumer complaints or other sources of information. The five prongs are mortgages, payday loans, student loans, size threshold and complaints.
"Under this proposed rule, an entity subject to a lot of complaints could be deemed to pose a threat and become subject to supervision and examination," Taft said.
What the CFPB does with its extensive powers remains to be seen. Taft said he's unaware of any moves the agency has made that could restrict securitization, and he noted that the first big test of its intentions will likely be the QM. In fact, the biggest challenge facing the securitization market, especially the virtually lifeless private-label RMBS market, might be the lack of rules so far.
Fitch Ratings said in June that it believes that uncertainty relating to Dodd-Frank, and in particular the definition of a QRM, has caused many traditional RMBS issuers to delay their issuance plans. The rating agency expects the CFPB to produce a revised proposal affecting QRMs, which would be subject to further public comment, in the third quarter.
"I think the biggest problem now in securitization is the uncertainty," said Stephen Ornstein, a partner at SNR Denton and a senior member of the firm's capital markets practice. "Even if it were a bad rule, the market would adjust," he said.
A bad QM rule, from the perspective of most mortgage lenders, servicers and probably private-label RMBS investors, would include a "rebuttable presumption" legal standard for lenders to defend themselves against borrower lawsuits, instead of a safe harbor. Yoon noted that a safe harbor would provide an objective standard of compliance. A rebuttable presumption, instead, gives borrowers the chance to disprove the presumption of compliance with the particular facts of a case, even if lenders can say they've met all the requirements to ensure that borrowers can repay their loans.
Which approach the CFPB will choose remains unknown. The industry fears disputes arising froma rebuttable presumption standard could tie up lenders in endless litigation and do little to revive new ABS issuance.
On the other hand, a QM rule that introduces a safe harbor standards would reduce the threat of litigation and ensure the broad availability of mortgage loans for borrowers and strong credit quality for lenders, and could go a long way toward reviving private-label issuance.
"If the QM is broad enough, it could become the predominant type of mortgage for the next generation," said Taft, noting that lenders may be hesitant to make loans outside of the QM safe harbor, and their cost to borrowers would be significantly higher.
Roelof Slump, Fitch's managing director for RMBS, believes the new proposal will largely resemble the initial proposal put forth in 2011. "However, certain features of the new proposal are likely to remain under close scrutiny and may be subject to further revision," he said in the commentary published last month.
While the QM rule may be six months away, the CFPB is expected to issue other important proposals sooner. One expected out this summer will provide servicing standards that the agency has said will be based on provisions of the $25 billion settlement hammered out earlier this year by the Justice Department and the five biggest servicers. That agreement, however, contains provisions that could be problematic for new ABS originations as well as existing ABS.
For example, the CFPB could propose loan modification standards with required elements, instead of providing investors with the flexibility to reach solutions independently with servicers and borrowers, such as a rate modification or something more extreme like a short sale. Another example might be the rules limiting prepayment penalties. Those types of changes could disrupt the payment waterfalls investors had calculated under various risk scenarios and require them to recalibrate the risks and returns in their portfolios.
Also expected this summer is a proposal by the CFPB to consolidate the two most important mortgage disclosures, Truth in Lending and the Good Faith Estimate, in an effort to streamline disclosures for borrowers and lenders. While the initiative will have little direct impact on the securitization market, it could very well slow down originations and thereby lessen the pools of assets available to securitize.
"HUD revised its RESPA disclosure just a couple of years ago, and it threw a huge wrench into the mortgage lending process back then. Combining the two disclosures now is probably going to start the cycle of confusion again for consumers and lenders alike, although it will likely be beneficial in the long term," Yoon said.
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