Over the course of 2013, every bank in the mortgage business has been working to prepare for compliance with the raft of mortgage-related regulations published by the Consumer Financial Protection Bureau.
Though some indications of understanding, should implementation not be 100% perfect, have been given, Jan. 10 most compliance requirements were scheduled to go into effect. We interviewed community bankers to see how community banks were faring and preparing. (Highlights of this article are presented in the January 2013 Banking Exchange magazine.)
Why the challenge looms so large
Joseph Potwora has been in mortgage credit for over 30 years, and he has never seen anything quite like the massive changes in mortgage regulation that CFPB introduced under the Dodd-Frank Act.
“The cost of being wrong has never been more material, in my mortgage banking career,” says Potwora, senior vice-president at $121.6 million-assets Willamette Valley Bank, Salem, Ore. “It would take a lot of selling for anybody to convince me to make a non-qualified-mortgage loan.” (Basics of this part of the new rules are summarized at the end of this article.)
As Potwora points out, being tagged for noncompliance is no longer the sole risk a mortgage lender faces. Under the law and new rules, banks not falling completely under the safe harbor that’s created under the “qualified mortgage” (QM) framework face risks of private legal actions by borrowers’ attorneys.
Not all banks contacted feel so strongly about staying in the “QM zone,” but that’s a calculated risk they’ve decided to take, generally in the name of customer service. No one really knows what the debtor bar will do, but the legal profession has a long history of finding the weak spots and targeting banks’ supposed deep pockets.
The potential for private legal challenge, says Potwora, “is a real game changer.”
Willamette Valley’s mortgage operation chiefly runs like a mortgage banking shop, with mortgages sold off and servicing of the mortgages released. So, while the bank is small enough by asset size to qualify for the general small creditor QM provision of the rules, its originations exceed that provision’s limit of 500 or fewer first mortgages originated in a year.
Virtually all of the bank’s loans are fixed-rate, and it has never made loans using structures frowned on under the rules. A study made of past pricing convinced management that future lending would fall within the range prescribed by the new rules to qualify for general QM status, which incorporates an eight-point Ability-to-Repay test. Likewise, the bank’s fee structure results in charges far below the maximum prescribed—generally, 3% or less of the loan amount. And because the bank has long maintained standards within those required by secondary market agencies, Potwora says the bank is confident that the Ability-to-Repay requirements will be met, going forward.
Getting ready under pressure
This is a taste of the analysis all bank mortgage lenders have gone through. ABA pressed for more time for the industry to prepare, but CFPB resisted that request. Among the reasons cited were the Bureau’s extensive revisions and presentation of aids to implementation online and in print as sufficient, it believed, to ensure compliance. At ABA’s Annual Convention, Director Richard Cordray unveiled a one-page, thumbnail guide for lenders, for example, both as an aid and as proof of CFPB’s belief that no extra time was needed to obtain compliance on schedule.
As a result, staff at every bank contacted for this article has been working feverishly. So detailed has the labor been that many CEOs contacted consulted with mortgage staff prior to being interviewed to be sure they could speak with full assurance. Ultimately, none had decided to leave mortgage lending—early on this was feared—but some chose to narrow their offerings, at least initially, to safeguard the bank against compliance and legal risk.
Some, with obvious breaths of relief, found that their mortgage operations fell under one of the CFPB’s carveouts.
“We qualify for the small-bank exemption and we operate in an underserved area,” says Sue Eno, president and CEO at $249.7 million-assets Citizens National Bank, Cheboygan, Mich. “So for us, it’s pretty much been business as usual.” (Operating in an undeserved or rural area doesn’t impact QM status, but affects other aspects of the numerous rule changes implemented by CFPB.)
“Business as usual” hasn’t meant sitting idly by, however. Processing is key, and in mid-December Eno’s bank was still awaiting software updates from its third-party vendor. And Eno points out that simply wading through all the rules, revisions, and guidance has been a challenge for a small bank with no in-house attorney.
By asset size and mortgage flow, $424.6 million-assets Farmers & Merchants Bank of Western Pennsylvania qualified for exemptions, a relief to Richard Krauland, president and CEO at the Kittaning, Penn., institution. “We are definitely prepared,” says the portfolio lender.
“I don’t have a problem with the law,” adds Krauland, though the bank will have additional work to do under the rules’ stricter requirements for verifying borrower information, contained in the Ability-to-Repay requirements.
Based in the greater Chicago market and doing too many loans, $1 billion-assets Inland Bank & Trust, Oak Brook, Ill., doesn’t qualify for small bank exemptions others benefit from. A review of the bank’s program convinced Howard Jaffe, president and CEO, that the bank would be in compliance with standards. But he says management became convinced that staying so would require more processing muscle.
So the bank has already converted to a new loan operating system. Another concern was whether the bank, which sells most home loans made, would still have outlets for non-QM loans—which make up about 10% of the bank’s production. In the fourth quarter Jaffe received assurances that those channels would remain open.
To be absolutely secure, the bank has held extensive training for anyone touching the mortgage process.
So, overall, says Jaffe, “I’m hoping this is going to be a big nonevent.”
“We feel the regulations pretty much codify what a community bank does,” says Michael Quinn, president and CEO at $604.2 million-assets Rhinebeck Bank, Poughkeepsie, N.Y. However, the bank is among those that have decided to avoid making many non-QM loans, to be absolutely safe at the beginning of the new framework.
Similarly, “our policies have been a little stricter than what the rules are calling for under ability-to-repay,” says Glenn Buddin, president and CEO at $99.7 million-assets Blue Ridge Bank, Walhalla, S.C. The bank’s mortgage lending historically would fit under the QM umbrella, he adds.
Buddin’s biggest concern lies not in the burden on the bank but on the impact on consumers. He believes the additional procedures and added documentation that the bank considers necessary to stay in compliance will result in customer complaints. This will be a cumulative result of all the post-crisis changes to mortgage lending documentation, through to the January implementation of the CFPB rules.
“We used to be able to close a loan in a week and a half,” says Buddin. “Now it will take a month or longer.”
Rethinking product lines
In the Boston market, community banker Frank Campbell says he’s seen a marketing piece sent to the real estate community by one of his larger competitors, a $1 billion-assets mortgage lender. That notice to brokers assures them that that bank will continue to make all of the types of loans it made before the CFPB rules were introduced. This includes a 40-year specialty mortgage. (QMs can’t run for more than 30 years.)
“They are the only lender that I’ve seen specifically marketing the fact that they are going to keep doing non-QM loans,” says Campbell, president and CEO of $171.9 million-assets Pilgrim Bank, Cohasset, Mass.
For his own bank, small bank exemptions permit it to continue to offer loans not fitting under the general QM standards. Campbell says management would have had some hard decisions to make without that advantage, because a good third to half of its typical mortgage production doesn’t fit that category. That would have been a lot of business to give up, says Campbell.
Even so, the bank has taken steps to make sure it can handle responsibilities under the new rules. For instance, Campbell has hired a consulting firm to periodically pull residential mortgages for compliance quality control testing.
But in Griffin, Ga., United Bank President and CEO Jim Edwards says his bank’s efforts are “still a work in progress,” because of a large commitment to mortgage character lending.
Historically, says Edward, the $1 billion-assets bank maintained two streams of mortgage lending. Conforming secondary mortgage market product was handled by mortgage specialists trained to handle such loans. But what the bank calls “in-house mortgages,” which didn’t fit in the secondary markets’ box, were handled by lenders who worked with a variety of customers.
At least at the start of the new rules, United Bank plans two key changes. First, it will avoid non-QM loans, and will work hard to get the customers who formerly were served with in-house mortgages with QMs. Second, to help keep matters in compliance, all flow will go through the mortgage specialists.
“We’re hoping these changes won’t impact customers too heavily,” says Edwards. The bank services over $300 million in mortgages sold to Freddie Mac, and its portfolio mortgages represent about 10% of the bank’s lending.
What the future holds
The last word on what the mortgage business will look like for community banks under the new regulatory regimen remains to be seen.
Unclear is how much “forgiveness” regulators will give to those who are among the first to be examined under the new framework.
And, ever since CFPB took over rulemaking authority in this area, over traditional banking regulators, there has been concern about how those longstanding regulators will interpret and enforce them. While CFPB directly supervises banks over $10 billion, the other agencies play that role, albeit under CFPB rules, for the vast majority of banks.
“It’s going to be kind of like Obamacare,” says South Carolina’s Glenn Buddin. “You don’t know how it will unfold until it happens.”
Resources: Basics about QM and ability-to-repay
Starting Jan. 10, 2014, mortgage lenders must assess borrowers’ ability to repay virtually all closed-end residential mortgage loans. (By contrast, not covered are home equity lines of credit, which are open-end credit.) The following is a simplified summary of voluminous rules with many special provisions, and not a detailed guide. You can find extensive materials on CFPB’s website here. ABA members can find additional help and information here.
• Eight Ability-to-Repay standards have been set up by the Consumer Financial Protection Bureau. These include: income and/or assets to be used to repay; employment status; monthly payment; monthly payment on other loans secured by same property; property taxes, insurance, and other mandatory household expenses; debts, alimony, and child-support obligations; debt-to-income ratio; and credit history. You must make a reasonable, good-faith determination before or when you consummate a covered mortgage loan that the consumer has a reasonable ability to repay the loans,” CFPB states.
• Qualified Mortgage, in general. In broad terms, under the general definition of the rules, this is a mortgage that satisfies several key requirements:
1. Points and fees must be 3% or less of the loan amount, in general.
2. The debt-to-income ratio can’t exceed 43%, generally.
3. No “risky features,” in CFPB’s words, can be included, such as negative amortization, interest-only payments, or balloon payments. (Regarding balloons, see the exception, below.)
4. Maximum loan term of 30 years.
• Qualified Mortgage, eligible for GSEs. These are mortgages made according to the rules and standards of government agencies and quasi agencies such as Fannie Mae and Freddie Mac. Any loan conforming to those programs—even if not actually sold—qualifies as a QM. (This is a temporary provision.)
• Qualified Mortgage, small creditors. Portfolio lenders’ mortgages can qualify as QMs so long as the lender verifies debt-to-income ratio. To come under this exception, the bank must be smaller than $2 billion in assets and originate 500 or fewer first mortgages annually.
• Qualified Mortgages, balloon loans by small creditors. Under the rules, for a limited time, certain balloon-payment loans can be considered QMs. They must be made by small creditors to qualify, for two years. After that, small creditors continue to qualify if they do more than 50% of their lending in rural or underserved counties.
Now, here’s a key point: A bank doesn’t have to offer QMs. What is the advantage?
As banker Joseph Potwora points out in the main article, Dodd-Frank allows a delinquent borrower to sue a lender on grounds that the loan was unaffordable for that individual. However, under the Ability-to-Repay rule, a lender that made a loan that is a QM and not “higher-priced” has a safe harbor, legally. A QM that is higher-priced, as defined in the rules, has a “presumption of compliance” that is legally rebuttable by the debtor’s attorney. The only grounds they are supposed to be able to pursue are lending that leaves too little income to live on.