OCC’s Walsh: “I feel your pain”


The Dodd-Frank Act is unlikely to be repealed, although it may be tweaked, according to John Walsh, the acting comptroller of the currency, who spoke before a crowd of about 400 bankers and bank directors at the 2012 Acquire or Be Acquired conference Monday in Phoenix.

The banking industry has been pushing for a repeal of Dodd-Frank, or at least major changes.

The Office of the Comptroller of the Currency (OCC) supervises about 2,000 banks and federal savings associations, most of them community institutions with less than $2 billion in assets. 

Walsh said he didn’t see how Dodd-Frank could be repealed because some of the work of implementing it has already been done, including the merger of the Office of Thrift Supervision and the OCC.

“We just spent a year and a half joining the OTS and the OCC,’’ he said. “I’m not sure how you just send everybody back to their two buildings.”

Walsh said there may be pieces that could be changed, although that would be up to Congress.

Even though many of Dodd-Frank’s new rules apply only to banks and thrifts above $10 billion in assets, some will impact community banks as well. For example, the new Consumer financial Protection Bureau (CFPB) will have minimum standards for mortgages, new disclosure requirements, a new regime of standards and oversight for appraisers and an expansion of the Home Mortgage Disclosure Act requirements for lenders.  The bureau also must define and ban “unfair or abusive” practices.

“Each change will have a proportionately larger impact on community banks due to their small revenue base,’’ Walsh said.

He said checking accounts will be impacted as debit card fee income falls as a result of the Dodd-Frank Act. Also as a result of the law, banks of all sizes will have to evaluate the quality of securities investments they make, without relying on the rating agencies to evaluate the appropriateness of such investments. Small, community banks don’t have the resources of larger banks to do such assessments in-house.

Walsh said economic weakness and regulatory burdens are putting more pressure on bank management and told the crowd: “Believe me when I tell you that I feel your pain.”

He also acknowledged that more decisions are being made in Washington, D.C., decisions that formerly would have been made in local OCC district offices when economic times were better.

“In difficult times or in particular when difficult decisions are being made…. we do subject more of those decisions to review,” he said.

Joe Kesler, the president and chief executive officer of First Montana Bank in Missoula, Montana, who attended the conference, said he would most like to have the Consumer Financial Protection Bureau disbanded.

Even though the CFPB’s rules are supposed to apply to banks of $10 billion in assets or more, and Kesler’s bank has about $300 million, he thinks the bureau’s decisions will trickle down to banks of his size. First Montana Bank has a mortgage business, and the CFPB has begun putting together new rules for residential mortgages.

“The big uncertainty cloud is the impact of the CFPB,’’ he says. “It’s troubling we can’t plan for the future.”

Why We Need the CFPB


capitol.jpgFew pieces of legislation in recent years have riled up the financial services industry as thoroughly as the Dodd-Frank Act. And the white hot center of that controversial law is probably the new Consumer Financial Protection Bureau (CFPB), which the Act created to police the marketplace for personal financial services. If you’ve been reading the news lately, you know that the CFPB has a new director—former Ohio Attorney General Richard Cordray—who received a sharply-criticized recess appointment recently from President Obama. Senate Republicans had refused to hold confirmation hearings on Cordray until certain changes were made to the agency’s organizational structure, and Obama finally lost his patience and made Cordray’s appointment official while Congress was in recess.

If you have been paying attention, you also know there’s a difference of opinion between Senate Republicans like Majority Leader Mitch McConnell (R-Kentucky) and the White House over whether Congress was technically still in session, so the legality of Cordray’s appointment might be challenged in court. It’s also entirely possible—perhaps even likely—that the CFPB will be legislated out of existence should the Republican Party recapture the White House and both houses of Congress this fall. No doubt many bankers, their trade associations and the U.S. Chamber of Commerce would like to see that happen.

On the other hand, if the president wins reelection, I am sure he would veto any such bill that might emerge from a Republican controlled Congress, should the Republicans hold the House and retake the Senate this fall, which is possible but by no means assured. And if you give Obama a 50/50 chance of being reelected—which is my guess at this point having watched the Republican presidential race closely—then you can reasonably assume the CFPB has a 50/50 chance of surviving at least until January 2016.

And I think that’s a good thing.

cfpb-richard-cordray.jpgThis probably puts me at odds with most of Bank Director magazine’s readers. There’s no question that Dodd-Frank, combined with a variety of recent initiatives that have come directly from agencies like the Federal Reserve, will drive up compliance costs for banks and thrifts. And the CFPB‘s information demands alone will be a component of those higher costs. However, I have a hunch that what scares some people the most is the specter of a wild-eyed liberal bureaucrat imposing his or her consumer activist agenda on the marketplace. I don’t think Cordray quite fits that description, based on what I’ve read about him, but obviously we won’t know for sure until he’s been in the job for a while, so the naysayers’ apprehension is understandable. At the very least he seems determined to get on with the job, so we should know soon enough what kind of director he will be.

Here’s my side of the argument. Among the primary causes of the global financial crisis of 2008, which was precipitated by the collapse of the residential real estate market in the United States, were some of the truly deplorable practices that occurred during—and contributed to—the creation of a housing bubble. Chief among them were the notorious option-payment adjustable rate mortgages and similar permutations that allowed borrowers to pay less than the amortization rate that would have paid down their mortgages, which essentially allowed them to buy more house and take out a bigger mortgage than they could afford to repay. Some of these buyers were speculators who didn’t care about amortization because they planned on flipping the house in two years. But many of them were just people who wanted a nicer, more expensive house than they could afford and figured optimistically that things would work out. And the expansion of the subprime mortgage market brought millions of new home buyers into the market just when housing prices were becoming over inflated.

I’m not suggesting that the CFPB, had it been in existence during the home mortgage boom, could have single-handedly prevented the housing bubble. The causes of the bubble and the financial panic that eventually ensued were many and varied, including the interest rate policies of the Federal Reserve, the laxness on the bank regulatory agencies when it came to supervising the commercial banks and thrifts, the laxness of the Securities and Exchange Commission when it came to supervising the Wall Street investment banks and the fact that no one regulated the securitization market. But an agency like the CFPB, had it been doing its job, would have cracked down on dangerous practices like the so-called liar loans, or loans that didn’t require borrowers to verify their income. It would have put an end to phony real estate appraisals that overstated a home’s worth, making it easier for borrowers to qualify for a mortgage. And it would have been appropriately suspicious of option-ARMs if a super-low teaser rate and negative amortization were the only way that a borrower could afford to buy a home.

The CFPB is not a prudential bank regulator and will not focus on bank safety and soundness like the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. But in cracking down on some of these dangerous marketplace practices, the CFPB might have reigned in institutions like Wachovia, Washington Mutual, IndyMac and Countrywide that ultimately failed, or were forced to sell out, because it would have discouraged many of the shenanigans that helped feed the housing bubble.

Of course, many of the unsound practices that helped inflate the bubble were widespread outside the banking industry, and one of the CFPB’s principal—and I would say most important—duties will be to regulate the mortgage brokers and nonbank mortgage originators who accounted for a significant percentage of origination volume during the housing boom. Banks and thrifts should benefit greatly from this effort if it leads to the creation of a level playing field where nonbank lenders can no longer exploit the advantages of asymmetrical regulation.

A truism of our financial system is that money and institutional power will always be attracted to those sectors that have the least amount of regulation. For all intents and purposes, both the gigantic secondary market and the large network of mortgage brokers and nonbank mortgage lenders went unregulated during the boom years, and this is where the greatest abuses occurred. (Dodd-Frank also addressed the secondary market, although the jury is out whether its prescribed changes will work. Indeed, at this point it’s unclear whether the secondary market for home mortgages will ever recover.)

In hindsight, having two mortgage origination markets—one highly regulated, the other unregulated—was asking for trouble. And that’s exactly what we got.

Which is why we need the CFPB.

Trust in the banking system: How should banks respond to Occupy Wall Street?


occupy-sign2.jpg“The corporations get what they want and the people don’t get anything,’’ says Elizabeth Johnson, with two pieces of duct tape stuck to her shirt with the words “Occupy Nashville” written on them.

She is taking part in Nashville’s version of Occupy Wall Street, where a loose group of protestors hang out on War Memorial Plaza playing the guitar, holding signs, and conducting organizational meetings to plan their marches and policies: keep the plaza clean, be respectful, don’t destroy property.

Johnson says she was originally in favor of the $700 billion rescue of the financial system until she realized the banks “kept that money for themselves.”

Other protestors include a call center worker who says she is disappointed her $100,000 in student loans for a master’s degree in communications landed her in call center doing customer service; a financial planner who says he is concerned about the future of Social Security, low wages and the loss of American jobs to developing countries; and a machinist who disagrees with the Federal Reserve’s control over monetary policy.

Occupy Wall Street’s protests in cities across the world over the weekend unveiled a groundswell of frustration against corporations, political systems, the global economy and the banking system, all rolled into one. Should the banking industry care? If so, what should be done about it?

After all, there doesn’t seem to be a lot of evidence that angry consumers are voting with their feet. The biggest banks in the country control most of the deposits. Account balances in checking and savings accounts are growing, not declining.

Bank of America just reported Tuesday deposits at the bank grew by $3 billion in the third quarter to $1.04 trillion. JP Morgan Chase & Co. reported deposits grew by $44 billion in the quarter to $1.09 trillion.

Still, many people think a bad image for banking isn’t good for business.

In June, GfK Custom Research North America, a division of market research company GfK Group, reported an online survey of 1,000 Americans where the financial services industry ranked third lowest for trustworthiness, ranking above only state and federal governments.

Only 35 percent found financial companies trustworthy. (Retail companies and packaged food manufacturers got the highest marks—71 percent and 65 percent, respectively—out of the 12 public and private sectors in the survey.)

“The fact is that the vast majority of financial services companies still generate substantial profits by fooling customers, or by capitalizing on their mistakes, or by taking advantage of them when they simply aren’t paying attention,’’ says a new report from the management consulting firm Peppers & Rogers Group. The group recommends increased transparency and practices that keep the customers’ best interests in mind, as a way to survive a future where customers can increasingly publicize their frustrations and bad experiences on everything from Facebook to Twitter.

In fact, making consumers happier could do something to push back the tidal wave of increased regulation of the banking industry, some think. Where did the Credit Card Act of 2009 come from, if not consumer frustration?

Plus, the volatile stock market, crashing home values, low wages and high unemployment set the stage for people to be angry at banks, says Gregg Poryzees, vice president, Consulting – GfK Financial Services.

“When the economy takes a hit, people are now unhappier with the financial firms they deal with,” Poryzees says. “This really is an opportunity to rise to the occasion. This is a great time to say ‘What can we do in terms of communication with our customers and designing innovative products, with brand positioning, managing the brand in a volatile market and a volatile consumer market?’”

Another GfK survey in July found that 88 percent of respondents strongly agree or moderately agree that consumers need an agency such as the Consumer Financial Protection Bureau to oversee the practices of banks and other financial institutions.

Waiting for new regulation from the Consumer Financial Protection Bureau is not a plan, Poryzees says. Getting ahead of regulation with consumer-friendly changes is a solution.

 “The implications are that the banking industry can turn this frustration into an opportunity, not so much different fees, but innovations that are more customer focused,’’ he says.

One can only wonder if the recent decisions of some large banks, including Bank of America and JP Morgan Chase to offset new restrictions on debit card interchange fees by charging customers a monthly fee, has further tarnished the industry’s image.

William Mills III, the CEO of Atlanta-based financial public relations firm the William Mills Agency, says bankers should think about how they will respond to the concerns of Occupy Wall Street and others. Community bankers in particular may have an opportunity to differentiate themselves from the bigger banks because they didn’t participate in the marketing and sale of risky bonds, equities and subprime mortgages.

“I hope bankers are thinking about how they would respond if a member of the media calls or a customer asks about it,’’ he says.

Scott Talbott, the senior vice president of government affairs at The Financial Services Roundtable, which represents 100 of the largest financial institutions in the country, says the industry understands the anger reflected in the Occupy Wall Street protests. The financial industry is carrying more capital, is safer, and has eliminated a lot of risky practices, such as subprime lending.

“We are working hard to restore the economy and trust in the banking system,’’ he says.

But the problem lies deeper than trust.

“What am I supposed to tell my children about what their goals should be?’’ says Felisha Cannon, the 33-year-old call center worker, saying she’s not sure there’s a better future for them.  “I can’t tell them to buy a house, because it might not be worth anything. What should they be working for? Should they go to (college) and have $200,000 in debt?”

New regulation puts additional burdens on compliance staff


overwhelmed.jpgIn the current economic climate, banks are rightly focusing on safety and soundness issues. Banks must ensure, however, that they also effectively manage their compliance function because banking regulators are increasingly focused on this area in response to the numerous regulatory changes that have recently occurred and are likely to occur in the near future. Even if a bank’s compliance practices have not been criticized in the past, there is no guarantee that they will be approved by regulators at the bank’s next examination. Here are some highlights from a recent report by the Financial Institutions Group of the law firm of Barack Ferrazzano Kirschbaum & Nagelberg LLP, in Chicago:

  • Banking regulators are significantly downgrading many banks’ consumer compliance ratings because they are concerned that their compliance management systems are not equipped to handle the potentially numerous regulatory changes to be implemented by the Consumer Financial Protection Bureau. Banking regulators view violations of recent regulations and/or repeat violations, even if such violations are minimal in number and the bank engages in minimal consumer banking activities, as being especially indicative of an ineffective compliance management system. Importantly, banks with weak compliance systems will likely have their management ratings downgraded as well.
     
  • Banking regulators are conducting in-depth reviews of lending practices and are increasingly referring cases of alleged discrimination by banks to the Department of Justice. Even long-standing lending practices have recently been criticized by examiners. Banking regulators are concerned with:  1. the extent to which banks give their loan officers discretion regarding pricing and underwriting, 2.  whether any pricing variances in any lending activity reflect discrimination against a particular group or in favor of another group, 3. if lending policies or practices may have a disparate impact on a protected class, 4. if assessment areas are appropriate, and the extent to which banks are lending throughout their entire assessment areas, 5. if changes in assessment areas reflect potential redlining, and 6. if banks are steering certain borrowers to particular loan products.
     
  • Section 5 of the Federal Trade Commission Act (the “UDAP law”) prohibits unfair or deceptive trade practices, and the Dodd-Frank Wall Street Reform and Consumer Protection Act expands this area further by prohibiting “abusive” acts or practices. It is increasingly common today for banking regulators to evaluate violations of compliance regulations under the UDAP law as well, and we will now likely see banking regulators evaluate such violations under the new “abusive” standard.
     
  • Banking regulators are delving deeply into mortgage loan originator compensation under the Truth in Lending Act and Regulation Z. Effective for compensation earned on applications received on or after April 1, 2011, a mortgage originator’s compensation cannot, with few exceptions, be based on any factor other than the amount of the credit extended. One general prohibition is the payment of compensation based on the profitability of the branch, division or entire bank.
     
  • Recently, several large banks settled lawsuits with the Department of Justice for allegedly violating the Servicemembers Civil Relief Act (the “SCRA”). These banks allegedly foreclosed on service members without obtaining court orders and/or charged service members interest rates in excess of the 6 percent interest rate cap under the SCRA. These settlements will likely prompt additional service members to file lawsuits against banks, or file complaints with their military offices for improper treatment under the SCRA.

Download the full report in PDF format.

Consumer Financial Protection Bureau chief faces Republican critics


Elizabeth Warren, the special advisor setting up the new Consumer Financial Protection Bureau, fought back challenges from Republicans during a subcommittee hearing Wednesday of the House Financial Services Committee.

Warren, who declared that the foreclosure crisis would not have occurred if the Consumer Financial Protection Bureau had been in place six years ago, kept her poise during a barrage of questions from Republican lawmakers concerned about her authority and the potential impact on banks.

“You are directing perhaps the most powerful agency that’s ever been created in Washington,’’ said Rep. Spencer Bachus, R-Alabama, who is chairman of the House Financial Services Committee, saying Warren or the person ultimately appointed to head the agency will get to decide what’s an abusive practice in financial services and what’s not.

“We almost have to have good faith in your integrity and judgment,’’ said Bachus, who introduced legislation today that would create a five-member bipartisan commission to run the bureau instead. “That’s quite a burden for you and quite a burden for us.”

He pointed out that the agency has a $300 million annual budget, about the size of the Federal Trade Commission.

Other Republicans questioned why Warren was involved in discussions with the U.S. Department of Justice and 50 states attorney generals about a possible settlement over mortgage fraud accusations with mortgage servicers, even though the Consumer Financial Protection Bureau doesn’t have enforcement powers yet.

Warren defended her actions, saying she had been asked for advice by the Department of Justice and the U.S. Treasury, and she was simply giving her advice, although she declined to divulge details of the conversations.

She also said the Congress set up the Consumer Financial Protection Bureau to be headed by one person, instead of a board, to increase efficiency.

It is crucial, she said, that “we have a real cop on the beat.”

She said the consumer protection authority of the Federal Reserve and other banking regulators will be transferred to the Consumer Financial Protection Bureau on July 21.

In answer to a question about current financial regulators efforts to protect consumers, she said:  “The evidence is fairly clear that they did not do their job.”

She also sought to emphasize that the agency’s goal was to make financial products’ pricing and risk clear to consumers; and that her agency didn’t have the authority to regulate financial products such as mutual funds.

“There are many people who have figured out how to return incredible profits and revenues, into the tens of billions of dollars, selling products, car title loans, remittances, we could go on and on, without making the risks and pricing clear upfront,’’ she said, “making it impossible to compare one product with two or three others.”

Republican Steve Pearce, from New Mexico, lambasted her for not giving the straightforward and clear, concise answers to the committee members she was demanding of financial companies.

“What damn business is it of yours if I want to borrow $100 and pay back $120?” he asked.

Will National Banks Lose the Protection of Federal Preemption?


justice.jpgIf you are the director of a nationally chartered bank or thrift, there’s a date coming up real fast that you must pay attention to. 

One of the many changes mandated by the Dodd-Frank Act is a significant restriction in the protection that banks and thrifts with national charters have enjoyed from many state consumer protection laws. That protection—under a legal principle known as federal preemption—is set to change significantly on July 21. While much angst has been expressed over the disruptive impact that the new Consumer Financial Protection Agency could have on the banking industry, that agency is still getting organized and its impact at this point is—at best—speculative. The end of federal preemption, on the other hand, could have immediate ramifications for national banks and thrift.

The idea of federal preemption in banking is a creature of the National Bank Acts (there were actually two, one in 1863 and another in 1864 which superseded the original law), which among other things created a federal charter for commercial banks and placed them under the control of the Office of the Comptroller of the Currency (OCC). Preemption received a huge boost in 1996 when the U.S. Supreme Court issued a landmark ruling that invalidated a state law that prohibited national banks from selling insurance in small Florida towns. 

And in 2004, under former Comptroller John D. “Jerry” Hawk, the OCC issued rules that preempted national banks and their operating subsidiaries from state laws that “obstruct, impair or condition” their ability to make loans and take in deposits, and also granted sole authority to examine and supervise national banks to—itself!

An apt description of this royal doctrine might have been: “The divine right of the OCC,” and it comes as no surprise that legitimate state interests have railed against the agency’s protective stance ever since. Consider this one example: During the home mortgage boom some years back, national banks doing business in Georgia were exempted from that state’s robust anti-predatory lending law while state chartered banks were forced to comply. Needless to say, state attorneys general and legislatures have been among the most vocal opponents of the OCC’s stand on preemption.

Although Dodd-Frank does not invalidate federal preemption altogether, it does state that the OCC can no longer issue sweeping rulings like it did in 2004, but instead will have to make preemption decisions on a case-by-case basis. It’s also possible that the scope of protection under federal preemption will end up being more narrowly constructed under Dodd-Frank, although it might take years of litigation before national banks and thrifts know exactly how much protection they have against state laws.

Who should be most concerned about the Dodd-Frank restrictions on federal preemption, set to take effect on July 21? Logically, it would be large national banks and thrifts with multi-state operations that include branch banking, home mortgages and/or servicing, home equity lending, auto finance, student lending and credit cards–in short, practically any consumer lending or servicing business.

Being forced to comply with multiple—and differing—state laws will drive up operating and compliance costs for large multi-state banks. Worse yet, it will expose them to the wrath of state attorneys general who couldn’t touch them before. As Arthur J. Rotatori, a Cleveland, Ohio-based member at the McGlinchey Stafford law firm puts it, “The purpose of this provision in Dodd-Frank is to empower state attorneys general to go after national banks.”

And no doubt they will.

Top lobbyist to bankers: When the economy improves, the beatings will stop


Public officials will spend less time slugging bankers when the economy improves, but Dodd-Frank will stick around, changing the rules in fundamental ways, says one of the top lobbyists in Washington D.C., for the financial industry, Steve Bartlett.

Bartlett, the head of The Financial Services Roundtable, represents 100 of the nation’s largest financial companies, including Fidelity Investments and JP Morgan Chase.

Speaking to a crowd of hundreds of bankers at Bank Director’s Acquire or Be Acquired Conference in Scottsdale, Arizona two weeks ago, Bartlett said politicians have been criticizing the financial industry because the economy is hurting.

bartlett.jpg

“The beatings will stop when morale improves,’’ he said. “It helps a lot for you to tell your story to members of Congress. Go to their town hall meetings and sit in the front row. They will be less inclined to beat the hell out of you the next time they make a public statement.”

Bartlett said he’s already noticed a change of tone in the Obama administration in the hiring of the president’s new economic advisor, Gene Sperling, and chief of staff Bill Daley, a veteran of JP Morgan Chase. Sperling once consulted for The Goldman Sachs Group. The Obama administration also has announced plans to review government regulations to weed out rules that seem burdensome to business and ineffective.

But the Dodd-Frank legislation passed by Congress last year is going to stick around, perhaps with only some changes here and there, Bartlett said.

He called the Durbin amendment’s limits on debit fees a “shocking” part of the legislation that will limit bank access to low and moderate income customers. (Editor’s note: Some bank analysts say more regulation is doing away with products like free checking for everyone, although free checking without a minimum balance requirement was getting dropped before Congress passed Dodd-Frank last year anyway).

But another fundamental change in Dodd-Frank is the shift away from simply requiring disclosure of the terms for financial products, Bartlett said. The new legislation requires that customers actually understand them, he said.

Dodd-Frank requires the new Consumer Financial Protection Bureau to end “abusive” practices and requires that disclosures be written in “plain language.” It goes on to say that the bureau should rely on consumer testing to figure out if those disclosures are understood. The specific language of Dodd-Frank asks the agency to consider evidence of “consumer awareness, understanding of, and responses to disclosures or communications about the risks, costs, and benefits of consumer financial products or services.”

Bartlett said Dodd-Frank will not just impact subprime loans, but other types of financial products.

“It’s no longer what you say to your customers but what your customers understand,’’ he said. “The statute says that you as a regulated entity will be held to the standard: Did the customer understand it? Not whether you said it plainly.”

Travis Plunkett, the legislative director at the Consumer Federation of America, did not attend the conference, and he disagrees with Bartlett.

“He is vastly overstating the impact,’’ Plunkett said, adding that he doesn’t believe companies will be punished just because a customer misunderstands something. He said the law is taking care of a minor gap in regulation that has allowed companies to create products that are so complex, they are designed to hide fees and charges from consumers, he said.

Elizabeth Warren, who is charged with setting up the Consumer Financial Protection Bureau, has said she wants to clean up disclosures and get rid of the “shrubbery” inside credit card disclosures. To see the interview she gave last month on the topic, read the Associated Press interview.

Banking regulation: what’s in the works and how to respond


dugan_mon.jpgJohn Dugan, the former Comptroller of the Currency, said Monday during a banking conference that his biggest fear during the financial crisis came in late 2008, during a meeting with the largest banks in the nation. He wondered whether they would accept billions of dollars and agree to let the federal government become major shareholders in their companies, as a way to stem the financial crisis.

“What struck me was how fast it was before everyone agreed to take the money,” Dugan said at Bank Director’s annual Acquire or Be Acquired conference in Scottsdale, Arizona.

Dugan said the quick consensus showed him that the financial crisis was even worse than he had thought. (Merrill Lynch CEO John Thain is on the record saying the federal government did not give the banks a choice).

“Things would be way worse now if that had not occurred,’’ Dugan said, defending the actions of federal regulators.

Dugan, who was appointed Comptroller in 2005 by then-president George W. Bush, went back to his former law firm, Covington & Burlig LLP, after leaving his job at the OCC in August.

During his speech Monday, Dugan detailed the aftermath of the financial crisis: the Dodd-Frank regulation for the financial sector that followed and what banks should do about it.

Dodd-Frank represents a fundamental shift in regulation: away from requiring disclosures and more toward telling financial institutions what products to offer and what to charge, he said. The pending regulation of interchange fees on debit cards is the biggest example of that.

“This was especially ill considered in my view,’’ he said.

Plus, it will take a long time for regulators to actually come up with rules based on the more than 800-page Dodd-Frank legislation, he said.

“I think you should prepare yourself for a relatively long period of uncertainty,’’ he said.

Not surprisingly, upcoming appointments for key regulatory positions will be important to how these rules turn out, Dugan said. A new head must be appointed for the OCC and for the Consumer Financial Protection Bureau.

One benefit of the CFPB is that its rules will apply to all financial institutions, he said. But they still have to define what practices are “abusive” to consumers, as well was what “abusive” means.

“The agency will have a single focus and purpose” and look at bank products in a way that a “prudential regulator would not do,’’ Dugan said.

Bottom line: greater regulation is here to stay, although there may be an opportunity to change things as time goes on, Dugan said. Capital requirements will be higher for banks and commercial real estate loan portfolios will undergo greater scrutiny on bank balance sheets.

Dugan told community bankers to “think hard” before making commercial real estate a major part of their strategy for the future. “In the post Dodd-Frank world, like it or not, regulation will play a bigger role for transactions or capital raising,” he said. “The center of the world is moving more toward Washington. I’m not saying that’s a good thing.”

Loan Origination: Dodd-Frank And Your Lending Compensation Practices


The Dodd-Frank Wall Street Reform and Consumer Protection Act has a lot to say about banking practices. From systemic risk to consumer protection, the Act will have a major impact. But in light of the fact that many of the provisions require regulations or the completion of the Consumer Financial Protection Bureau, most of the requirements will not affect banks for a year or more. The limits on how you compensate your lenders, however, must be on your radar earlier.

Dos and Don’ts Paying Your Lending Staff

The Federal Reserve recently announced its final rule on compensation for loan originators. The rule will both implement some of the requirements of Dodd-Frank and do what the federal agencies have been anxious to do for quite a while—outlaw interest rate-based yield spread premiums. Effective April 1, 2011, the final rule will prohibit the practice of paying mortgage brokers, loan officers and others who originate mortgage loans based on the interest rate that is paid by the borrower, or any other term or condition of the loan other than the amount of credit extended. Further, while many banks may assume that the rules only apply to mortgage brokers, it is considerably broader, covering loan officers within the bank and even payments to the bank itself in table-funded transactions.

In addition to prohibiting compensation that is based on the terms of the loan, a bank also may not pay a loan originator based on a proxy for such terms. For example, a loan originator may not be paid based on loan terms, such as the interest rate, APR, or loan-to-value ratio. However, compensation that is based on proxies for the terms of the loan, such as the borrower’s credit score, debt to income ratio, or credit risk, is also prohibited. What is allowed is compensation that does not vary based on the loan’s terms and conditions, such as a fee based on:

  • The total number of loans originated;
  • The total amount of credit that was extended;
  • The long-term performance of the loans;
  • An hourly fee for the actual hours worked;
  • Legitimate business expenses, such as overhead;
  • Whether the borrower is a new or existing
  • The percentage of applications submitted by the originator that result in closed loans;
  • The quality of the loan files;
  • A payment that is fixed in advance for every loan arranged; and
  • A fixed percentage of the loan amount.

The new limits on compensation do not apply if a loan originator is paid by the consumer. However, the new rules prohibit an originator who is compensated by the consumer from being paid by anyone else. The Federal Reserve also explained that the final rule is not intended to prohibit creditors from changing their compensation arrangements with mortgage brokers, their loan officers, and other loan originators. However, the creditors cannot change the agreements or selectively enforce them in a way that will result in the loan originators’ payments varying based on the terms and conditions of the loan.

Lender Compensation vs. Terms of Loans Offered

The new regulation also includes an anti-steering provision that prohibits loan originators from steering a borrower to a mortgage loan based on the fact that the originator will receive higher compensation, unless the loan is also in the consumer’s interest. Loan originators may offer a loan that results in them receiving the same amount or less compensation than they would receive with other loan options. However, if they offer a loan that results in them receiving more compensation than they would with other loan options, they will be required to establish that the loan that was offered was in the consumer’s best interest. The rule provides a safe harbor that an originator may use to meet these requirements, but the documentation and procedures that will be required to rely on the safe harbor will be extensive and cumbersome.

More Compensation Rules to Come

The Federal Reserve’s final rule will significantly change the way that banks and other creditors compensate mortgage brokers and their own employees. However, it’s important to note that more changes are on the way. Under the Dodd-Frank Act, there are restrictions on the kinds of loans that a loan originator may offer, how they “steer” the consumer to loan products, and how they are compensated when the consumer pays upfront fees. As a result, the Federal Reserve’s final rule is a major change in lender compensation, but it is not by any means the last.