In a letter to the SEC and federal banking agencies, a bi-partisan group of seven House members urged that credit scores be part of the qualified residential mortgage equation in the Dodd-Frank risk retention regulations. Credit risk retention is intended to help foster a strong and healthy securitization market, said the Representatives, and, it is important that elements of the regulation are done right. Thus, if the qualified residential mortgage equation is to include credit history standards, credit scores should be incorporated in the final rule. Section 941 of Dodd-Frank exempts qualified residential mortgages from the new risk retention requirement. The letter was signed by Representatives John Campbell (R-CA), Erik Paulsen (R-MN), Robert Dold (R-IL) Ed Royce (R-CA), John Carney (D-DE) Gregory Meeks (D-NY) and Keith Ellison (D-MN)
While congressional commenters have raised issues related to the proposed definition of qualified residential mortgage, the Members believe that attention also must also be focused on the proposed qualified residential mortgage credit history standards that, in their view, will not serve as a strong predictor of default risk. They want the reasonable use of credit scores that reflect the need for strong credit risk standards without posing an unreasonable barrier to accessing qualified residential mortgages to be incorporated into the standards.
The proposed credit history standards are limited to a set of derogatory factors that appear on the borrower's credit report. While the proposal fails to include any specific data that demonstrates the effectiveness of using these derogatory factors to measure credit risk, concerns exist that the proposed credit history standards would actually result in some of the riskiest borrowers being included under the qualified residential mortgage, while excluding other low-risk borrowers. These distorted outcomes are neither desirable nor appropriate, said the Members, and do not support the Congressional intent of creating a pool of high quality, accessible, low risk loans that warrant exemption from risk retention requirements.
However, these same low risk and high risk consumers are easily identified by the empirically derived, credit scoring models that have been used in the market for decades to effectively manage credit risk and avoid unfair or illegal discrimination. Here, the Members cited a Federal Reserve Board 2007 Report to Congress on "Credit Scoring and Its Effects on the Availability and Affordability a/Credit," which concluded that credit scoring promotes a more efficient marketplace and provides valuable benefits to consumers.
Further, the Members noted that, while not all borrowers have high credit scores, most can improve their scores over time and actively reduce their risk profile. Also, by building credit scores into the criteria for determining qualified residential mortgage eligibility, costs and risks associated with manual underwriting can be reduced. A manual review of derogatory factors in the credit file can be accompanied by added costs, delays, errors and transparency concerns.
The House members also noted several implementation challenges to the proposed credit history standards. Some of the data relied upon in the proposed standards, such as the timing of short sales and repossessions, is not readily available to lenders at the time of underwriting. The proposed standards also permit lenders to determine qualified residential mortgage status on data that is up to 90 days old, which could lead to many of these important decisions being made based on stale information. The Members are also concerned that small and medium size financial institutions with scarce compliance resources will be forced to comply with an ineffective, check-the-box regulatory requirement that could result in some institutions taking the disastrous step of substituting the proposed standards for sound underwriting practices.
Finally, they observed that Regulation B sets standards for lenders to use approved credit scoring models that are empirically derived, demonstrably and statistically sound. As a result, guidance and oversight exist to try and make certain these scoring models operate effectively and provide an objective assessment of a borrower's credit risk. The members pledged that Congress will continue to work to ensure that the current system further benefits consumers and all other participants in the residential mortgage market.