Community Banks Gain a Reprieve on Balloon Mortgages
Community banks with less than $2 billion in assets, and which originate fewer than 500 mortgage loans a year, have received a regulatory dispensation that will allow them to continue offering a certain type of home mortgage loan that tends to be popular in rural markets. In May, the Consumer Financial Protection Bureau (CFPB) amended the ability-to-repay standards in the Truth in Lending Act to create a fourth category of qualified mortgages that will permit these lenders to continue to offer balloon-payment mortgages over a two-year transition period.
The newly revised ability-to-repay standards, which take effect January 10, 2014, are intended to protect consumers by ensuring that lenders only give mortgages to borrowers that have the financial means to repay them. When they make “qualified loans,” which have to meet certain requirements intended to make them safer for consumers, lenders are presumed to have complied with the ability-to-repay rule. This automatic presumption has now been extended to balloon loans made by this particular category of banks.
Also included in the amended ability-to-repay rule is an exemption for small lenders to offer qualified mortgages to consumers that exceed the 43 percent debt-to-income ratio, and allow these lenders to charge a higher interest rate—up to 3.5 percentage points above the average prime offer rate, while other, larger lenders cannot go more than 1.5 percentage points above prime.
The amendment is “clearly an improvement,” says Ron Haynie, senior vice president of mortgage finance policy at the Independent Community Bankers of America (ICBA).
While this move allows community banks to conduct business as usual for the next two years, the CFPB plans to work with small lenders to shift to other products, like adjustable-rate mortgages. According to a survey of its member institutions published by the ICBA, one-third of the respondents do not currently offer adjustable-rate mortgages, while 73 percent offer balloon mortgages.
The ICBA hopes to use the next two years to make the CFPB more comfortable with balloon mortgages, which due to their short terms—typically five years—can help banks hedge against interest rate risk. Balloon mortgages can also help borrowers that might not qualify for a traditional mortgage—consumers who might not meet the underwriting standards of Fannie Mae or Freddie Mac, or who don’t have the right debt-to-income ratio. The ICBA says it supports the CFPB’s mission to prevent abusive practices that contributed to the collapse of the housing market, but believes that restricting the types of loans available to consumers could prove harmful. “If everything has to look like a 30-year, fixed-rate loan,” says Haynie, “you are going to constrain credit.”
Community banks have offered balloon mortgages for decades in some cases, and unlike national lenders that are more focused on volume, they typically offer a more personal touch to find the right loan for their customers. “It’s not like [balloon mortgages are] bad loans,” says Haynie. “They’re just unique situations.”
Community banks with less than $2 billion in assets that generate more than 500 first-lien mortgages annually could still face a significant hurdle since they will not fall into this new qualified mortgage category. According to the ICBA survey, for 24 percent of banks that have between $251 million and $500 million in assets and 46 percent of banks with more than $500 million in assets, balloon mortgages will not be categorized as a qualified mortgage because these banks generate too many loans. Five percent of banks with less than $250 million in assets would not get the exemption either.
Haynie believes that the loan origination cap of 500 per year is too restrictive. The cap is based on total loan originations—not the number of loans in a bank’s portfolio—so banks that originate loans but also sell in the secondary market to Fannie Mae and Freddie Mac may find themselves cutting back on loan originations. If the CFPB wants to encourage the availability of loans for consumers, this could have the opposite effect. The ICBA hopes to encourage the CFPB to raise the cap on loan originations, or apply this cap solely to the bank’s loan portfolio and not count those sold into the secondary market.
Why can’t community banks just offer another product, like adjustable-rate mortgages, as encouraged by the CFPB? Haynie, drawing on prior experience as a lender, argues that balloon mortgages offered by community banks are more consumer-friendly.
“Balloon loans,” says Haynie, “are actually fairly simple to explain to a consumer.” The interest rate remains unchanged for the term of the loan and when the loan is due, the banker meets with the borrower, renews the loan and reassesses the financial needs of that consumer. An adjustable-rate mortgage, with rates linked to indices like LIBOR and changing payments for the borrower, can confuse even savvy borrowers. “It’s a difficult product, in many ways, for a consumer to understand,” says Haynie.
In the survey, 65 percent of respondents indicated that they would increase or consider offering adjustable-rate mortgage loans. But for community banks that rely on balloon mortgages as a vital part of business, the amended rules provide some room to breathe.
A New Requirement for More, Better Capital
The Federal Reserve Board has approved a final rule that will greatly strengthen the capital foundation of the U.S. banking industry, and impose even tougher capital requirements on the nation’s largest banks. The new rule essentially implements the long awaited Basel III capital framework, as well as certain related changes mandated by the Dodd-Frank Act. As this issue went to press, the Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. were expected to soon approve the rule as well.
Banks will be required to have more capital, and the capital they have must be of a higher quality. Specific changes include an increase in the minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5 percent, along with a “capital conservation buffer” of 2.5 percent, for a total of 7 percent. The Federal Reserve says that based on March 2013 data, 90 percent of U.S. banks with assets under $10 billion already meet this standard.
Large U.S. banks will find much to worry about in the new rules—particularly eight “systemically important” bank holding companies that will have to maintain a minimum 5 percent leverage ratio, and their insured depository subsidiaries 6 percent. The investment banking firm Keefe Bruyette & Woods Inc. estimates that only two of the eight holding companies currently meet the 5 percent standard. The phase-in period for the eight banks begins January 2014—less than six months away.
The phase-in period for smaller institutions won’t begin until January 2015, and they will be spared from some of the more onerous provisions in an earlier Basel III proposal, including a change in the risk weight calculations for mortgage loans.
But for even the smallest banks, this much is clear: Capital is now king.
New York Bans Deloitte
The New York Department of Financial Services came down hard on Deloitte Financial Advisory Services in June over Deloitte’s consulting work at Standard Chartered, the British bank that was fined over money laundering violations earlier this year. Deloitte agreed to a $10 million fine, and one unit of the company, Deloitte FAS, will refrain for up to a year from new consulting gigs among New York-supervised institutions. The agreement does not pertain to Deloitte’s auditing business.
Clearly, the state hopes the action will go much further and create a model for reforming conflict-of-interest problems in the industry. The state accused Deloitte of disclosing confidential information about other banks to Standard Chartered when it was supposed to be doing investigative work for the state Department of Financial Services, and also said Deloitte omitted from its report a recommendation on the request of Standard Chartered.
The back story on all this is that state and federal agencies frequently engage consultants to do reviews and audits of banks and other financial institutions because the agencies themselves don’t have the manpower to do them, said Francine McKenna, a certified public accountant and Forbes columnist who previously was a director for PricewaterhouseCoopers. The bank under review has to pay for this work, even though the consultant is working for the regulator. One case in point was a group of consultants who conducted foreclosure reviews of mortgage servicers mandated by the Office of the Comptroller of the Currency and the Federal Reserve in 2011 over alleged abuses. The case-by-case reviews dragged on, came to no conclusion and racked up $1.5 billion in consulting fees. They ending early this year with a new regulatory settlement to simply estimate damages for foreclosed families, McKenna said.
In the second quarter issue of Bank Director magazine, the asset size of Valley National Bank—which placed third in the core noninterest income category of the 2013 Growth Leaders Ranking—was stated incorrectly. As of the first quarter of this year, Valley National had $16 billion in assets. We regret the error.