What Are the Prospects for Regulatory Reform?


regulation-6-7-17.pngEditor’s note: The House passed the CHOICE Act Thursday 233-186 but it isn’t expected to earn enough votes in the Senate to become law.

Financial regulatory reform is a priority for President Donald Trump and his administration, which views burdensome and costly regulation as a significant impediment to lending and economic growth. However, more than 100 days into the Trump presidency, neither the president nor Congress has taken meaningful action on financial regulatory reform. While it is impossible to predict what the administration’s legacy will ultimately be on regulatory reform, its actions thus far with respect to regulation generally, proposals introduced in Congress by Republicans, and the president’s power to appoint agency officials may offer some clues of what’s to come.

Financial CHOICE Act
The Financial CHOICE Act, which House Financial Services Committee Chairman Jeb Hensarling, R-Texas, has called a blueprint for financial regulatory reform, passed the House Financial Services Committee on a party line vote on May 4. The current version of the CHOICE Act would, among other things:

  • Transform the Consumer Financial Protection Bureau (CFPB) from an independent agency to an executive agency, subject to Congressional oversight and the Congressional appropriations process, with its director removable at will by the president.
  • Make the CFPB an enforcement agency without a bank supervisory function.
  • Eliminate the CFPB’s authority to enforce unfair, deceptive or abusive acts and practices.
  • Provide regulatory relief to community banks and those engaged in residential mortgage lending.
  • Repeal the Volcker rule, which prohibits banks from proprietary trading.
  • Provide regulatory relief for banks that maintain a 10 percent leverage ratio.
  • Overturn the U.S. Second Circuit Court of Appeals’ decision in Madden v. Midland Funding.

While the CHOICE Act is likely to pass the House in some form, its chances of passage are remote in the Senate since 60 votes are required to overcome a filibuster. Nevertheless, some targeted reforms, including regulatory relief for community-based institutions, could be enacted.

Executive Orders
With material changes to the Dodd-Frank Act likely to die in the Senate, President Trump’s executive orders may form the basis of the administration’s regulatory reform strategy. President Trump has signed six executive orders impacting the financial services industry. Among other things, these executive orders:

  • direct the Treasury secretary to consult with the nine member agencies of the Financial Stability Oversight Committee and draft a report to the president analyzing current laws and regulations for their consistency with the seven so-called core principles of financial regulation;
  • require each agency to repeal two regulations for each new regulation implemented;
  • require a cost/benefit analysis before new regulations are adopted; and
  • require agencies to establish regulatory reform task forces and appoint regulatory reform officers whose job will be to identify burdensome regulations and evaluate their consistency with the core principles.

However, executive orders can accomplish only so much. Just as President Obama could not unilaterally repeal legislation, President Trump will not be able to roll back statutory provisions of Dodd-Frank without acts of Congress. Further, while it may be possible to soften the impact of certain Dodd-Frank regulations, the Administrative Procedures Act generally requires that any regulations implemented through a notice and comment process go through a similar process before they can be repealed.

Appointments
President Trump’s broadest impact on financial regulatory policy may come from his appointments to federal agencies. Treasury Secretary Steven Mnuchin has been confirmed. Three vacancies currently exist on the seven-member Federal Reserve Board of Governors. Former Treasury Undersecretary Randy Quarles is expected to be appointed as the first vice-chair of supervision, filling one of these vacancies. When the terms of Chair Janet Yellen and Vice-Chair Stanley Fischer expire in February 2018, the president will have the opportunity to reshape the central bank. Likewise, the comptroller of the currency has been replaced on an acting basis by banking attorney Keith Noreika and may be replaced by former One West CEO Joseph Otting on a permanent basis. If CFPB Director Richard Cordray is removed or leaves of his own accord later this year to run for Governor of Ohio, as many suspect he may, the president would have the ability to appoint a new CFPB director. Further, there is currently a vacancy on the Federal Deposit Insurance Corp. board and current chair Martin Gruenberg’s term as director will end in November. Since the comptroller of the currency and the director of the CFPB also sit on the FDIC’s board, the president soon will have an opportunity to appoint four of the FDIC board’s five members.

While the president can’t order officials at these agencies to take particular actions, and his ability to remove agency officials may be limited, his appointees will likely exercise a more restrained approach to regulation than Obama-era appointees. Over time, we expect a tangible difference in how banking agencies approach supervision and enforcement. At the end of the day, the president’s appointment power may be the most effective tool in his tool box.

Can We Say Goodbye to Fair Lending Cases?


lawsuit-6-2-17.pngOne of the potential impacts of a new administration in Washington, D.C., is a lot less fair lending enforcement. For a number of banks, that would be a very good thing. Banks have been hit with fines, bad press and enforcement actions in the last few years, as the Justice Department and the Consumer Financial Protection Bureau have brought cases alleging everything from indirect auto loan discrimination to redlining, the practice of carving out minority neighborhoods to exclude from loans.

Institutions such as Fifth Third Bank and Ally Bank have been hit with the auto finance accusations, and Tupelo, Mississippi-based BancorpSouth Bank last year paid $10.58 million in fines and restitution to settle a case accusing it of redlining in Memphis. The $13.9 billion asset bank said it had taken several steps to improve its commitment to affordable lending products in low and moderate income and minority areas.

Many of the accusations have relied on the disparate impact theory, which has been upheld by the Supreme Court. The idea behind it is that no intentional discrimination has to occur for a violation of the law. Bank managers, as a result, must stay vigilant not only on their own lending policies and staff training, but they have to research lending patterns and loan terms to make sure that a disproportionate number of minorities aren’t stuck with loans on worse terms than non-Hispanic whites. If they are, there has to be a justifiable reason why this was so. Marketing efforts can’t exclude minority neighborhoods.

The most recent case was when the U.S. Department of Justice sued KleinBank, a small community bank in the suburbs of Minneapolis, accusing it of redlining. The bank’s CEO said the lawsuit had no basis in fact, and challenged the idea that the $1.9 billion asset bank has a duty to serve the urban areas of Minneapolis and St. Paul.

One of the odd aspects of the case is that it was filed on Jan. 13, 2017, right before President Donald Trump was inaugurated. Now, the new attorney general, Jeff Sessions, is in an excellent position to influence the case and whether it moves forward at all.

I would expect fair lending cases to be less a priority under Jeff Sessions,’’ says Christopher Willis, a fair lending attorney and partner at Ballad Spahr. “And the cases that would be brought would be less eager to explore new ground.”

John Geiringer, a partner at the law firm Barack Ferrazzano in Chicago, agreed. “Presumably, under the Trump administration, fair lending is not going to be on the front burner as much as it was in the Obama administration.”

But that’s not a pass-go card, not quite yet. The Consumer Financial Protection Bureau (CFPB) is moving ahead with plans to implement an expansion of the requirements for mortgage data under the Dodd-Frank Act. Basically, there are 25 new data points banks must send to the bureau, starting January 2018, on everything from the borrower’s credit score, to the parcel number of the property, to a unique identifier for the loan originator who originated the loan, according to the American Bankers Association, which has argued the rule should be repealed because of increased cost to banks and data security concerns. The Home Mortgage Disclosure Act already mandates 23 data points, the association says.

The fear is that the data will be used to initiate even more fair lending cases against banks, although regulators have said the data could be used to weed out unnecessary fair lending reviews. The CFPB and the Justice Department did not respond to a request to comment.

So far, it’s not clear that the rule will be thrown out, despite the change at the White House. The CFPB is led by Director Richard Cordray, whose term doesn’t end until 2018.

For now, bankers must assume that regulations due to go into effect will indeed do so. Fair lending enforcement won’t go away under the Trump Administration. It’s not just that the CFPB’s leadership is still in place. The agency’s goal from the Fair Lending Report for 2016, published in April, 2017, is to increase “our focus on markets or products where we see significant or emerging fair lending risk to consumers, including redlining, mortgage loan servicing, student loan servicing, and small business lending.” The banking agencies also can continue to pursue enforcement actions, even if the Justice Department doesn’t.

But the tone has changed. The former head of the Justice Department’s civil right division, Vanita Gupta, told The New York Times in January 2017 that “the project of civil rights has always demanded creativity… It requires being bold. Often that means going against the grain of current-day popular thinking. Or it requires going to the more expansive reading of the law to ensure we are actually ensuring equal protection for everyone.”

There’s a good chance that the creativity Gupta described is gone.

2017 Risk Practices Survey: Surprising Support for Dodd-Frank


dodd-frank-3-20-17.pngConventional wisdom holds that bankers dislike the Dodd-Frank Act, but most financial leaders don’t want Congress and President Trump to totally dismantle the law, according to Bank Director’s 2017 Risk Practices Survey, which is sponsored by FIS.

Eighty-two percent of the 167 independent directors and senior executives of U.S. banks above $500 million in assets surveyed by Bank Director in December 2016 and January 2017—following Trump’s election but before his inauguration—expect to see regulatory relief this year. When asked about the aspects of Dodd-Frank that should be scaled back, respondents focus on the Consumer Financial Protection Bureau: 70 percent want to change the CFPB’s structure, and 66 percent seek to scale back the bureau’s considerable enforcement authority. Banks have invested a lot at this point to meet the requirements laid out by the law, and while the majority want to see Dodd-Frank changed in some way, few—just 20 percent—believe it should be repealed entirely. A surprising 7 percent—all from banks under $5 billion in assets—say it should remain unchanged.

Other key findings:

  • Forty-eight percent would like to see the Durbin amendment restrictions on debit interchange fees at banks with $10 billion or more in assets scaled back. Home Mortgage Disclosure Act rules, for 43 percent, and qualified mortgage rules, for 39 percent, are also identified as regulatory pain points.
  • Eighty-four percent believe that bank regulators are open to the implementation of innovative products and services through relationships between banks and third-party financial technology firms.
  • Eighty-three percent believe that lowering corporate tax rates would be the best way to encourage economic growth in the U.S.
  • Preparing for cyberattacks continues to be another key challenge for the industry, according to 51 percent of respondents. Financial institutions have made considerable improvements to cybersecurity programs, including investments in technology to better detect and deter cyber threats (82 percent), improved training for bank staff (81 percent) and increased focus on cybersecurity at the board level (80 percent).
  • Employee susceptibility to phishing or other types of social engineering schemes is the area in which the majority of respondents think the bank is least prepared for a cyberattack or data breach, at 57 percent.
  • Seventy-seven percent say their board has discussed the Wells Fargo cross-selling scandal and its potential impact on the bank. Of these, 42 percent have evaluated their bank’s incentive compensation programs, and the same number evaluated the bank’s retail sales culture or goals. Eight percent eliminated cross-selling programs.

To view the full results to the survey, click here.

Handling Today’s Top Risk Challenges

Election Results Could Mean Less Regulation for Banks


Regulation-11-10-16.pngIt’s an understatement to say Republican presidential nominee Donald Trump’s surprise victory shook up the world Tuesday. Trump got elected promising change in Washington and made statements that portrayed a confusing mix of anti-bank and anti-regulation rhetoric. But with the House and Senate now controlled by Republicans, many industry observers are optimistic that the election will mean the appointment of more bank-friendly regulators, while the Consumer Financial Protection Bureau (CFPB) could also be weakened.

Although many economists feel Trump’s policies would be bad for the national economy, bankers by and large felt Trump would actually be good for the economy, according to a Bank Director poll in September.

“We think the main result of Donald Trump’s election will be that Trump will be able to appoint regulators who are more industry friendly than regulators appointed by President Obama,’’ wrote Brian Gardner, an analyst with investment banking company Keefe, Bruyette & Woods, in a note to investors Wednesday. “The regulatory implications are more important than what might come out of Congress but are broadly positive for financials in our view.”

CFPB
As far as banking regulations, the biggest thing in jeopardy may be the CFPB. President Trump will be able to appoint someone to head the agency, and a Republican-led Congress may make a move to gut or end it. That’s not to say such a move would be easy to do, but if Congressional elections in 2018 remove even more Democrats from office, it’s a possibility. The existence and approach of the CFPB has been a thorn in the side of many.

The Dodd-Frank Act
It’s unlikely the Dodd-Frank Act will be gutted entirely even with a Republican-controlled Congress. Democrats still will have at least 47 seats in the Senate and be able to block legislation that they don’t support, as 60 votes are needed to pass legislation in the Senate, Gardner wrote.

Even some industry lobbyists will be advocating against that, as it would create even more uncertainty. “Our industry has spent billions implementing Dodd Frank and complying with the CFPB,’’ said Richard Hunt, the president and CEO of the Consumer Bankers Association, in an interview Wednesday. “The last thing the banking industry needs is a whipsaw effect of uncertainty.”

Instead, some lobbyists are advocating for measures that would ease regulation on community banks, especially. The Independent Community Bankers of America “believes the unified Republican control of the executive and legislative branches presents a unique opportunity for enacting significant community bank regulatory relief and fully intends to leverage this opportunity for the benefit of community banks, their customers, and the communities they serve,” the group wrote in a memo to members and published on its website.

Wall Street Reform
The Republican Party platform this year, which former Trump campaign manager Paul Manafort said was in fact Trump’s platform, supported the return of the Glass-Steagall Act, which forbid banks from having both commercial and investment banking businesses. It was a surprising move, as the other person supporting the return of Glass-Steagall was Massachusetts Democratic Senator Elizabeth Warren. But few expect Trump to actually push hard for this, let alone be successful.

Aite Group senior analyst Javier Paz, who covers assets managers, wrote in a note that there was talk of President Trump leaning hard on Wall Street, but “we believe this was a tactical shift to keep Hillary Clinton from outflanking him on the topic of Wall Street reform. Time will tell, but we highly doubt new pieces of legislation building on what Dodd-Frank started will be forthcoming under President Trump.”

Hunt says he counted about 35 seconds of anti-bank rhetoric during four presidential and vice presidential debates. “There is campaigning and then there’s governing,’’ he says. “This is where Speaker Ryan, McConnell and the president will get together and come up with a shared vision for what they want the first 100 days and first year to look like to show the American people that Washington can work.”

Federal Reserve
There is a lot of uncertainty about what impact a Trump presidency will have on the Federal Reserve. Trump has been critical of Fed Chairwoman Janet Yellen and the central bank’s policies. He has said the Fed has been artificially keeping rates too low but his views on the Fed have not been consistent. He will be able to appoint two members to the Federal Reserve after he takes office, and Yellen’s term ends in January 2018, according to Gardner. Although the Fed was widely expected to raise rates in December, some predict that won’t happen now, as uncertainty about the markets could lead the Fed to delay a rate hike.

Poll: Bankers Sound Off on Election


election-10-19-16.pngA majority of bankers believe that Republican presidential candidate Donald Trump will have a more positive impact on the nation’s economy than Democratic nominee Hillary Clinton if he’s elected to the Oval Office on November 8, although many professional economists disagree. And he’s probably got their vote, too, according to Bank Director’s 2017 Bank M&A Survey, sponsored by Crowe Horwath LLP. However, fewer say they support Trump, compared to bankers who said they’d vote for Mitt Romney in 2012.

  • Fifty-five (55) percent believe that a Trump presidency would be best for the United States economy.
  • Fifty-eight (58) percent plan to vote for Trump, compared to 10 percent for Clinton. Twenty-one percent are unsure which candidate, if any, has their vote.
  • Sixty-six (66) percent believe that Trump is more likely to reduce the industry’s regulatory burden.

More than 200 bank executives and directors participated in the survey. Bank Director’s survey was conducted in September, before the debates took place and allegations of sexual assault surfaced against Trump. During the survey period, Real Clear Politics, which aggregates poll averages across the country, had Clinton polling ahead of Trump by 0.9 to 3.9 percent. The news outlet predicts a Clinton victory at this time.

Economists are not all in agreement about the impact that a Trump presidency would have on the U.S. economy, in part due to his ideas on taxes and trade. Several have predicted a dire outcome if Trump prevails on Election Day. The advisory firm Oxford Economics, based in Oxford, England, predicted in September that the economic policies outlined by Trump could shrink the U.S. economy by $1 trillion by 2021. The rating agency Moody’s Analytics stated in June that a Trump administration will isolate the U.S. economy, incur more government debt and result in the loss of 3.5 million jobs. A month later Moody’s predicted that Clinton’s economic policies would “result in a somewhat stronger U.S. economy.”

In contrast, David Woo, head of global interest rates and currencies research at Bank of America, told Bloomberg in September that in a Trump presidency “the U.S. economy would probably take off in a big way,” due to the candidate’s proposed fiscal policies, including extensive spending on infrastructure and tax cuts.

Richard Hunt of the Consumer Bankers Association says bankers don’t put a lot of faith in these sorts of wonkish pronouncements. Bankers see an experienced CEO in Trump, not a career-long politician like Clinton. “[Clinton would be] a continuation of [President] Obama’s policies, and a lot of bankers are frustrated,” says Hunt. The CBA doesn’t endorse a specific candidate for the nation’s top office.

Trump’s statements indicate a consistent distaste for regulation. “Dodd-Frank has to be either eliminated or changed greatly,” Trump told CNBC in May 2016. “The regulators are running the banks.”

Clinton plans to defend the Dodd-Frank Act. Her campaign also advocates new reforms for the financial sector, including a so-called “risk fee” for big banks that would scale higher for banks with larger amounts of and riskier forms of debt, compensation rules to curb risky behavior and a strengthened Volcker rule. Breaking up big banks is also on the table.

Bankers aren’t as in love with Trump as with past Republican nominees. In a survey conducted in advance of the 2012 election, Bank Director found that 79 percent supported Mitt Romney, compared to 8 percent for President Obama and 13 percent undecided. Support for Romney was 21 points higher than for Trump. It’s not that Clinton is seeing significantly more support—more bank executives and board members are unsure of whom to support, if anyone, compared to four years ago.

In a recent twist for the industry, this year’s election could be crucial to the future of the Consumer Financial Protection Bureau. On October 11, a federal appeals court found the bureau’s structure to be unconstitutional, and ruled that its directorship should fall under the control of the president, a decision that could be appealed by the Obama administration. If that decision isn’t overturned, it’s likely that a Clinton presidency would strengthen the agency. A Trump administration is likely to weaken the CFPB.

“It has to be Trump,” says Blair Hillyer, the chief executive officer at First National Bank of Dennison, a $221 million asset community bank in Dennison, Ohio. He’s a lifetime Republican that isn’t thrilled with either candidate, but he believes that Dodd-Frank has been too damaging to the industry. Under Hillary Clinton, “the regulation would continue, and we’ll continue to lose community banks,” he says.

The complete results of the 2017 Bank M&A Survey will be available on BankDirector.com in November.

When The CFPB Is After You: How to Respond to Threatened Enforcement Actions


4-30-14-covington.jpgWhen the Consumer Financial Protection Bureau (CFPB) sends a letter to the board of directors, it is rarely good news. It often means the institution is facing a potential or actual enforcement action. Enforcement actions can unfold quickly. They typically require an institution to respond, at least on certain preliminary matters, within a matter of days.

The board of directors should be involved in the institution’s handling of virtually any threatened enforcement action. The CFPB, like the prudential regulators, holds an institution’s board of directors ultimately responsible for the institution’s conduct. Thus, it is in the board’s interest to provide direction and oversight throughout the enforcement process. Such an approach will help directors fulfill their regulatory obligations and assist in ensuring that the enforcement matter is handled appropriately.

In addressing a CFPB enforcement action, directors should bear in mind five key principles:

  1. Assemble a response team. It is important to develop a comprehensive and strategic approach to responding to the CFPB’s enforcement action. Ideally, an institution already has in place a plan that specifies the individuals responsible for coordinating the institution’s response. The response team typically includes a member of executive management, the bank’s chief legal officer, a senior officer from the affected line of business and outside counsel. The team also may include, depending on the nature of the enforcement action, additional representatives, such as from human resources, information technology, finance or compliance.
  2. Inform the board and determine appropriate board involvement. Once the institution is notified of the contemplated enforcement action, a member of the response team should immediately alert the board’s audit committee chair, and in consultation with the audit committee chair, decide when and how to inform the remainder of the board. Although the entire board should be kept apprised and consulted, as necessary, throughout the enforcement process, the board often designates one or more directors as the primary contacts with management and their outside advisors as the institution develops its response strategy.
  3. Develop a coordinated short-term plan. CFPB enforcement actions often require immediate tactical decisions that can have long-term strategic implications. For example, an institution usually has only 20 days to decide whether to object formally to any provisions in a CFPB civil investigative demand. The institution should consult with legal counsel to weigh the benefits of filing such a petition against the possible risks, including the impact of such a filing on the institution’s interactions with the CFPB and the likelihood that the institution’s legal arguments will succeed.

    The bank also should determine whether any public disclosures are required—such as under the securities laws or customer notification laws—or whether any disclosures should be made to preserve relationships with business partners and customers and, if so, how these disclosures may be made in accordance with restrictions on the disclosure of confidential supervisory information. Such decisions must account for the fact that an enforcement action may create multiple areas of exposure, including follow-on private litigation, reputational harm, and customer relations issues. The board should be briefed on these disclosure obligations and ensure that the various disclosures are handled in a coordinated manner.
  4. Develop a longer-term strategy. While the institution likely will be required to make some decisions immediately, those decisions should be made in the context of the institution’s longer-term strategy. The development of this strategy should take into account such factors as the strength of the institution’s defenses, the magnitude of the institution’s exposure, factors affecting the institution (e.g., a possible acquisition), and whether the institution is likely to reach a better result through a cooperative approach (while still advancing the institution’s defenses) or by assuming a more aggressive stance. In all events, the board should understand what this strategy is and make sure management is informing the board of any major developments.
  5. Adopt long-term reforms. One of the best ways to avoid regulatory scrutiny and enforcement is to adopt lessons learned from past violations. At a minimum, the board should determine whether other areas present similar risks, review the adequacy of internal controls and compliance policies, and assess the frequency and thoroughness of management reports to the board.

An effective response to a CFPB enforcement action requires a coordinated strategic approach that is overseen and monitored by the institution’s board of directors. Bearing in mind these five key principles will help board members lead their institutions successfully through CFPB enforcement actions.

Small Banks Chafe Under New Mortgage Rules


3-1-13_CFPB.pngThe Consumer Financial Protection Bureau (CFPB) is trying to crack down on some of the biggest contributors to the financial crisis: mortgage loans with balloon payments, high-interest loans, no-doc loans and loans that exceed 43 percent of a borrower’s income. 

The agency’s newly finalized rule that goes into effect in January 2014 creates a qualified mortgage standard and ability-to-repay rule that forbids those kinds of loans, that is, unless the lender wants to get sued for making them.

The trouble for small community banks and rural lenders is they often make some of those loans and they’re not trying to fleece customers.

Community banks sometimes make balloon payment loans of about five or seven years to hedge against interest rate risk. It sounds like a bad deal for the consumers, but these loans are kept in the bank’s portfolio and then simply refinanced without fees when the term is up–so no balloon payment is ever made and the borrower isn’t socked with a hefty reappraisal fee and other fees normally associated with a refinance.

People who don’t qualify for a loan under Fannie Mae and Freddie Mac underwriting standards–they work for themselves and don’t have a steady paycheck, or they own property that doesn’t qualify for a Fannie or Freddie loan for example—might be interested in getting such a loan from a community bank.

The banks don’t sell these loans in the secondary market or to a governmental authority. The bank keeps these loans, and their inherent risk, on their books. The logic is the bankers know their customers (in fact, their families have probably known each other for upward of 50 years).

One such banker is Jeff Boudreaux, the president and CEO of The Bank, in Jennings, Louisiana, a community of about 12,000 people about 36 miles from Lake Charles. 

“We can’t make 20- to 30-year fixed-rate loans because we don’t know what will happen with CD rates,’’ he says. “We cannot box ourselves in and have that interest rate risk.”

The CFPB recognized that some small banks and lenders serve rural areas and other parts of the country that don’t have good access to credit. The agency said it wants to mitigate the risk that the new qualified mortgage rules would cut access to credit for people in those areas.  The agency is carving out some exceptions for rural and small lenders. Yet, some community banks may still fall through the cracks.

For instance, rural lenders can make qualified mortgages with a balloon payment as long as they stay on the bank’s portfolio and the lender makes more than 50 percent of their mortgages in a designated rural or underserved area. The definition of rural will come from the U.S. Office of Management and Budget, but lenders such as The Bank won’t qualify. Despite its rural nature, Jennings falls in the metro area of Lake Charles. Only about 9 percent of the U.S. population lives in a designated rural area, says Matt Lambert, senior manager and policy counsel for the Conference of State Bank Supervisors (CSBS). 

In a separate proposed rule available on the CFPB’s web site, the agency proposes creating a fourth category of qualified mortgages for borrowers who don’t meet the required 43 percent debt to income ratio or will be getting an interest rate that exceeds 150 basis points of the prime lending rate. The only entities that qualify to make such loans would be certain non-profit or designated housing organizations, or small lenders with less than $2 billion in assets that made fewer than 500 first-lien covered loans the previous year. Those lenders will be able to charge as much as 350 basis points above the prime rate.  They must keep those loans in their portfolios, however.

But those lenders still can’t do interest only, negative amortization or balloon payment loans, or charge more than 3 percent in total fees and points (a higher fee is allowed for loans below $75,000), otherwise the mortgage is no longer a qualified mortgage. The rule has not been finalized.

Michael Stevens, senior executive vice president at the CSBS, points out that non-qualified mortgages are still allowed. They just don’t carry the newly created legal protection for lenders against lawsuits. 

The question is whether a lot or very little lending will take place outside the definition of a qualified mortgage.  Stevens thinks that if a lot of good borrowers are left out of the mix, the market will find a way to serve those people. 

Richard Cordray, the director of the CFPB, this week encouraged the audience at a Credit Union National Association meeting to make loans outside the qualified mortgage rule.

“Of course, we understand that some of you–or your boards or lending committees–may be initially inclined to lend only within the qualified mortgage space, maybe out of caution about how the regulators would react,’’ he said in written remarks. “But you should have confidence in your strong underwriting standards, and you should not be holding back.” 

Chris Williston, the president and chief executive officer of the Independent Bankers Association of Texas, is not satisfied. He wants a two-tiered system of regulation: one for small banks and one for larger banks that have the resources for complying with a deluge of government regulations.

The new qualified mortgage rule alone has more than 800 pages in it, and a concurrent proposal has more than 180 pages.

“All of our bankers are just weary and frustrated,’’ Williston says. “We have a lot of banks that are ready to throw in the towel.”

How Will the CFPB’s New Mortgage Rules Impact the Market?


Starting in January of 2014, the mortgage market could be in for some major changes. In an effort to protect consumers, the Consumer Financial Protection Bureau has issued final rules for a qualified mortgage (QM), providing safe harbor for lenders who issue such mortgages. Mortgages that don’t qualify could expose lenders to lawsuits from borrowers. We asked a panel of attorneys to address the following question.

 “How will the Consumer Financial Protection Bureau’s new final rule on qualified mortgages – including the requirement that lenders ensure that borrowers have the ability to repay their loans – impact the mortgage market? ”

Podvin_John.pngThe reality of this rule will likely be that if a borrower does not fit within the box of a qualified mortgage, then the cost of credit will be much higher, if that person can find a lender who will lend the money. The QM rule is just one of several rules that need to be digested and integrated (some of them have not been finalized yet) in order to understand the full impact on the mortgage market. Once all these rules are finalized, institutions will need to look at the costs versus the benefits of offering mortgages and servicing mortgages in the new environment and make informed business decisions concerning whether and to what extent they should continue making residential mortgage loans in a profitable manner.

 John Podvin, Haynes and Boone, LLP

Veta_Jean.pngNonaka_Michael.jpgWhile mortgage lenders may not be thrilled with every provision in the CFPB’s new rule on qualified mortgages, most would agree that the rule provides much-needed certainty in an area that has been subject to debate and criticism. The rule’s safe harbor for qualified mortgages and the ability-to-pay standards give lenders a clear sense of what is required. This, in turn, hopefully will lead to increased mortgage lending. At the same time, the perceived heightened risk for non-qualified mortgages may make the secondary market even more skittish about these loans, thus driving more lenders to focus primarily, if not exclusively, on qualified mortgages.

— Jean Veta and Michael Nonanka, Covington & Burling, LLP

Lenet_Sara.pngDouglas-McClintock.jpgAlthough there are many valid reasons for the CFPB to provide incentives to lenders to make less risky loans and ensure a borrower’s ability to repay, the new rules might well disproportionately affect low-income and middle-income borrowers, which could lead to separate issues, such as fair lending and Community Reinvestment Act issues. Lenders will need to find the right balance in order to comply with the CFPB’s new rules and protect themselves from potential liabilities and penalties for noncompliance by making qualified mortgages, while still addressing the needs of their communities. Although the impact of the new rules on the mortgage market is not yet known, it should be noted that the mortgage market has already changed significantly since the subprime mortgage crisis, with increased regulation and lending standards, so the effect of these new rules is likely not to be as drastic as it would have been before the crisis, although it will certainly affect the mortgage market in a variety of ways.

— Sara Lenet and Doug McClintock, Alston & Bird

Marlatt_Jerry.pngThere can be little doubt that the Dodd-Frank Wall Act, particularly Title XIV?on mortgage reform and anti-predatory lending, was designed to reduce the availability of mortgage credit. One of the themes of Dodd-Frank is that undisciplined underwriting standards in the sub-prime mortgage market created or contributed to a bubble in housing prices by making excessive mortgage credit available. It is not a surprise then that the Consumer Financial Protection Bureau’s new rule on qualified mortgages will rein in mortgage credit in the private sector. The bureau itself has expressed the concern that its rule “could curtail access to responsible credit for consumers.”

In a very complex rule, the bureau tries to draw a line between responsible and irresponsible credit. The result leaves private sector creditors with significant compliance challenges and litigation risk. In recognition of the possibility that the rule will overly restrict mortgage credit, the bureau has built in a transition period in the hope that it will “help insure [sic] that sustainable credit will return in all parts of the market over time.” What seems clear is that there will be a sustained period of significantly reduced mortgage credit.

— Jerry Marlatt, Morrison & Foerster LLP

Lamson_Don.pngThe market is resilient and will respond to the new requirements, but there is a danger that the requirements concerning repayment ability will by their nature constrict access to credit for those who may need it the most.

— Don Lamson, Shearman & Sterling LLP


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It is possible that when the rule becomes effective in January 2014, lenders may be reluctant to make loans that do not qualify for the Qualified Mortgage (QM) safe harbor. Non-QM loans will carry significantly higher litigation risks and may be more difficult to securitize. According to the bureau, as of 2011, non-QM loans would have amounted to about 22 percent of the market. In order to ease the transition to the new rule, the bureau is permitting lenders to obtain QM treatment for loans that would be eligible for purchase by Fannie Mae or Freddie Mac while they remain in conservatorship. Over time it is possible that the rule will result in a substantial reduction in the availability of mortgage credit.

— Robert Ledig, Dechert LLP

A Five-Pronged Approach to Dealing with the New Regulatory Landscape


bsns-maze.jpgWhen it comes to compliance, the first step in preparing for the year ahead is to look at the immediate past. Regulators now have higher expectations. There is very low tolerance, if any, for regulatory infractions. Banks face a high degree of pressure to keep residual risk in check while still conducting business profitably. There will likely be mistakes, but the mistakes must be kept to manageable ones that do not fundamentally affect consumer rights. Examinations are tougher. The supervisory focus is on fairness to consumers. Regulators scrutinize data for accuracy and meaning.

The consequences of noncompliance are severe.  In 2011 and 2012, we saw financial institutions reach settlements with the Consumer Financial Protection Bureau (CFPB), the Department of Justice, and the prudential bank regulators for violations of consumer protection and other laws in excess of $1 billion. Not only are the settlements larger than ever, but they include refunds to affected customers as well as penalties. Even more than in the past, the reputational damage from enforcement actions can take years to recover from.

The Year Ahead

The year 2013 will bring continued concern about the daunting challenges posed by regulatory change for U.S. financial institutions. Of the nearly 400 rules required by the Dodd-Frank Act, only about one-third have been finalized, and another third have yet to be proposed, according to Davis Polk & Wardell LLP.  The new requirements are likely to trickle out for years to come. They, along with the adjustments financial institutions must make to accommodate the newly-formed CFPB, will surely test the mettle of even the strongest companies and keep continued pressure on the bottom line. During the year ahead, this consumer-focused scrutiny will take the form of not only deeper and more probing examinations, but more expensive penalties for noncompliance. 

High Risk Areas with Increased Vulnerability

Indications are this trend of focusing on consumer risk will continue in 2013.  We will continue to see supervisory interest in a number of key areas, such as:

  • Fair and responsible products and services
  • Mortgage origination and servicing
  • Treatment of consumer complaints
  • Data integrity
  • Servicemembers Civil Relief Act issues
  • Lender compensation
  • Overdraft protection programs
  • Student lending
  • Reverse mortgage lending
  • Compliance management systems

Governance Guidance for 2013

Successfully navigating the consumer-focused scrutiny in 2013 will depend on whether your institution adopts an integrated, proactive approach to compliance risk management.  To get started, directors must set the tone. First, take responsibility and ownership of your bank’s risks. Know where your bank’s risks are. Understand what your data says about you—including consumer complaints. Wherever possible, control and prevent problems; be confident that you will know where the next problem will surface. And we can’t emphasize this point strongly enough: Manage risks on an integrated basis across the enterprise.

Five Prong Approach to Preparing for 2013

There are a number of actions institutions can take to prepare themselves for 2013 and the regulatory and supervisory deluge to come. We recommend a five-prong strategy for preparing your institution to successfully meet these challenges.

One: Compliance Culture.  Instill a culture that embraces a consumer-centric, principles-based regulatory model. 

Two: Compliance Management System.  Build an integrated system of compliance management with board oversight, a comprehensive program, complaint management, and compliance audit.  

Three: Risk Assessments. Assess risk to the institution as well as the impact of products and services on the consumer.

Four: Fair Lending Risk Assessments. Subject lending data to in-depth statistical analysis, and give products and practices intensified review.

Five: Enterprise Reporting.  Implement a system of compiling information across the risk spectrum on an integrated basis and reporting the right level of detail to the right audience.

Understanding risk is an essential component of any proactive program. When it comes to predicting what will happen in 2013, we can all reasonably expect today’s trends to continue into the foreseeable future. The best strategy is to proactively prepare.

A New Risk on the Horizon


How should your bank’s compliance program adapt to the new demands of The Consumer Financial Protection Bureau?  In this video, Wolters Kluwer’s Christina Speh offers some best practices for creating a customer-centric compliance program and implementing it from the top down.

Highlights include:

  • Creating a culture of compliance
  • Preparing for the change—shifts in standards and practices
  • Empowering internal staff

Click on the arrow to start the video.