Bank Director | Mortgage Archives

Commercial Real Estate Threatens to Crack Current Calm

Posted on May 1, 2023 at 12:01 am.

While credit quality at banks remains high, it may not stay there.

At the end of the year, noncurrent and net charge-off rates at the nation’s banks had “increased modestly,” but they and other credit quality metrics remained below their pre-pandemic levels, according to the Federal Deposit Insurance Corp. However, rising interest rates have made credit more expensive for borrowers with floating rate loans or loans that have a rate reset built into the duration.

Commercial real estate, or CRE, is of particular focus for banks, given changes to some types of CRE markets since the start of the pandemic, namely office and retail real estate markets. Rising interest rates have increased the monthly debt service costs for some CRE borrowers. An estimated $270.4 billion in commercial mortgages held at banks will mature in 2023, according to a March report from Trepp, a data and analytics firm.

“If you’ve been able to increase your rents and your cash flow, then you should be able to offset the impact of higher financing costs,” says Jon Winick, CEO of Clark Street Capital, a firm that helps lenders sell loans. “But when the cash flow stays the same or gets worse and there’s a dramatically higher payment, you can run into problems.”

Some buildings are producing less income, in the form of leases or rent, and their values have declined. Office and traditional retail valuations may have fallen up to 40% from their purchase price, creating loan-to-value ratios that exceed 100%, Chris Nichols, director of capital markets for SouthState Bank, pointed out in a recent article. SouthState Bank is a unit of Winter Haven, Florida-based SouthState Corp., which has $44 billion in assets. If rates stay at their mid-April levels, some office building borrowers whose rates renew in the next two years could see interest rates grow 350 to 450 basis points from their initial level, Nichols writes, citing Morgan Stanley data.

JPMorgan & Co.’s Chairman and CEO Jamie Dimon said during the bank’s first quarter 2023 earnings call that he is advising clients to fix exposure to floating rates or address refinance risk.

“People need to be prepared for the potential of higher rates for longer,” he said.

Banks are the largest category of CRE lenders and made 38.6% of all CRE loans, according to Moody’s Analytics. Within that, 9.6% of those loans are made by community banks with $1 billion to $10 billion in assets. CRE exposure is highest among banks of that size, making up over 24% of total assets at the 829 banks that have between $1 billion and $10 billion in assets. It’s high for smaller banks too, constituting about 18.3% of total assets for banks with $100 million to $1 billion in assets.

“Not surprisingly, we’re seeing delinquency rates for office loans starting to increase. … [It’s] still moderately low, but you can see the trend has been rising,” says Matthew Anderson, managing director of applied data and research at Trepp, speaking both about year-end bank data and more current info about the commercial mortgage-backed securities market. He’s also seen banks begin increasing their credit risk ratings for CRE segments, notably in the office sector.

Bank boards and management teams will want to avoid credit surprises and be prepared to act to address losses. Anderson recommends directors at banks with meaningful CRE exposure start getting a handle on the portfolio, the borrowers and the different markets where the bank has exposure. They should also make sure their risk ratings on CRE credits are up-to-date so the bank can identify potential problem credits and workout strategies ahead of borrower defaults.

They will also want to consider their institution’s capacity for working out troubled credits and explore what kind of pricing they could get for loans on the secondary market. While banks may have more capital to absorb losses, Winick says they may not have the staffing to manage a large and rapid increase in troubled credits.

Working ahead of potential increases in credit losses is especially important for banks with a concentration in the space, which the FDIC defines as CRE that makes up more than 300% of a bank’s total capital or construction loans in excess of 100% of total capital.

“If a bank has a CRE concentration, they’re definitely going to get more scrutiny from the regulators,” Anderson says. “Any regulator worth their salt is going to be asking pointed questions about office exposure, and then beyond that, interest rate exposure and refinancing risk for all forms of real estate.”

Risk issues like these will be covered during Bank Director’s Bank Audit & Risk Conference in Chicago June 12-14, 2023.

A Third Option for Banks Considering M&A

Posted on March 31, 2022 at 12:01 am.

Written by Erin Register

“When you come to a fork in the road, take it.” – Yogi Berra, American baseball legend

Clearly, Yogi Berra didn’t quite see the fork in the road as a binary choice. The industry has seen more than 250 bank acquisitions over the past few years, and experts predict M&A activity could ramp up in 2022 as deals that were put on hold due to the Covid-19 pandemic finally come to fruition. But rather than exploring paths that could lead banks to either be a buyer or seller in a transaction, what if there was another option? A door number three, like in “Let’s Make a Deal.”

Bankers could embrace Yogi’s wisdom; that is, they could take a pass on buying or selling while opting for continued independence as a high-performing bank. Without being naive nor blind to the imminent wave of M&A activity, there are an abundance of strategic options and partnerships banks can employ to maintain independence and fuel growth.

As anyone who has been on either side of the M&A equation knows, absorbing and combining banks is a messy business full of complexity, unforeseen challenges and risk. Institutions that expect to be involved in a transaction would be well advised to consider alternate service delivery models for some of their existing lines of business to reduce M&A friction.

At the same time, digital transformation continues to be a recurring theme for the industry. What is your bank’s digital strategy? Is your bank curating the right digital experience for your customers? Is your bank exploring strategic partnerships that can streamline the back office while leveraging the customer-facing tech?

Mortgage is an ideal candidate for this due to the level of complexity, compliance risk and volatility it inherently poses. Merging two mortgage operations into a cohesive unit or injecting mortgage operations into an institution where it did not previously exist can be massive undertakings that only add to the difficulty of completing a merger or acquisition.

Regardless of what side of the M&A transaction a bank is on, a mortgage offering helps banks find scale to drive technology or other investments, expand their geography, acquire new customers and grow revenue. Offering this foundational financial product cost-effectively through an outsourced fulfillment partner allows banks to progress on those goals by eliminating what could be a significant source of potential friction.

Outsourcing back-office mortgage operations also provides substantial benefits to both potential acquirers and acquirees. From an acquirer’s perspective, a fulfillment service maximizes their mortgage profitability and portability, enabling them to seamlessly extend their operations into the target bank without the hassle of integrating systems or solving for staffing issues. Acquirers can immediately enhance the franchise value of its acquisition by introducing mortgage services and begin generating an entirely new revenue stream without establishing new operational infrastructure.

On the flip side, partnering with a mortgage fulfillment provider can enhance the attractiveness of banks looking to sell. Outsourcing mortgage fulfillment enables banks to reduce the overhead and expenses required to maintain a full-fledged mortgage operation in-house, which can improve the liabilities side of the balance sheet, making them a more financially attractive acquisition target.

Outsourcing mortgage also enables banks to stabilize their staffing needs, avoiding the industry’s traditional “hire-and-fire cycle” of staffing up during high volume periods to keep up with demand and severely reduce staff when volume inevitably slows. Outsourcing the labor-intensive fulfillment portion of the mortgage process allows prospective sellers to redeploy their internal resources and ensure maximum staff retention post-M&A.

Improving scale, efficiency, profitability and stakeholder value are always the objectives for any bank, whether they engage in M&A or choose to stay independent. Regardless of strategy, outsourcing mortgage fulfillment using innovative technology can be a critical strategy for banks looking to grow their product offerings and revenue in the short term while setting themselves up for sustainable high performance.

It’s tempting to aim for the fences with a grand slam when it comes to digital transformation. But maximizing the profitability of a key product segment like mortgage could be a nice, achievable win.

Making a Profit in the Volatile Mortgage Market

Posted on June 12, 2013 at 9:57 pm.

Written by npatankar

The current mortgage market is in a state of flux. The prolonged low interest rate environment is creating an extended boom for mortgage companies and providing tremendous profitability for banks. Fueled by attractive rates, heavy refinancing activity and a temporary surge in the influx of applications under a recently modified version of the Home Affordable Refinance Program (often referred to as HARP2), yield spreads are high for portfolio investment, and the gain on sale margins is also high.

Banks need to take advantage of this boom in the short term without losing out in the long term. Many financial institutions are successful at this, while other—fearing a repeat of the 2008 mortgage crash—are scratching their heads and wondering what to do. Should they join the party while the mortgage climate is hot, or take the ultra-conservative approach and stay on the sidelines?

To skip the party altogether is like leaving money on the table–and there is, indeed, money to be made in today’s bustling mortgage market. However, banks have to figure out a longer term strategy for building a sustainable business model that prepares them for the future, while allowing them to be profitable today.

To that end, here are three strategies to consider:

Tactic #1

As market volumes are likely to decline, banks should right-size and right-shore their models to bring down the overall costs of production by 30 percent to 50 percent.

While 2012 mortgage volumes were healthy at $1.8 trillion, they are likely to decline to $1.5 trillion and $1.3 trillion in 2013 and 2014 respectively. Shrinking volumes will reduce market requirements and create challenges for banks that built up underwriting and production capacity to accommodate the boom. Over the next several months, banks need to create models to manage their production costs and create efficiencies that will help them prepare for a lower-volume environment.

Begin by building a model with a 12- to 18-month window for restructuring, and take steps to lower the overall cost of production by 30 percent to 50 percent. Lowering operating costs is critical, because the overall profitability per loan will shrink as volumes drop. While the net cost to originate is currently trending at about $3,800 per loan, banks will need to reduce their per-loan costs to around $2,800, or even less.

Another critical step is to adjust the headcount down by 20 percent to 30 percent. Right-sizing and right-shoring is a smart tactic whereby banks can split their processes into two different environments: Base the regulated processes and customer facing processes on-shore in the U.S., and shift non-regulated, back-office tasks to a more cost beneficial off-shore location such as India.

Tactic #2

Design products that help gain business and make money in the marketplace.

In today’s competitive mortgage market, it is important to design products that are flexible, convenient and accommodate the needs of the core audience. It all circles back to Customer Management 101: Give customers what they want, not what you want to sell them.

This is especially important for community and regional banks because their footprint is local and they know their consumers, often by name. Instead of one-size-fits-all mortgage products, they can tailor to specific demographics and affordability profiles to retain their customers and prevent them from straying to the big national banks.

Examples of flexible products include mortgages that allow customers to choose the duration, such as 15, 20 or 30 years; the payment structure, which can be bi-weekly or monthly; and the interest rate, either variable, fixed or a combination. So long as you cross the threshold of affordability on the basic mortgage criteria, there is latitude for creativity. That said, no need to revert to exotic products: Think back to the era of option-ARM mortgages and negative amortization–both designed to fail, because they were created in a market that was not going to last forever.

Tactic #3

Focus on customer experience management to improve margins and retain customers.

The customer experience is in addition to creating products based on your knowledge of the customer’s needs, it is essential to streamline the customer experience. Build a one-touch (maximum, two-touch) process from the initial application to the closing.

Establish a single point of contact—no bouncing customers from one processor to another—and manage the process every step of the way to ensure that it is a seamless, pleasant experience for the customer. Educate applicants upfront by thoroughly explaining the expectations—right down to every piece of documentation and forms they will be expected to provide.

Minimize delays: No long waits for underwriting. Do not take 120 days to close. Nothing is more frustrating to customers than missing a targeted closing date or receiving yet another request for a pay stub or bank statement. An efficient process yields a satisfied customer. And the banks that successfully attract and retain mortgage business amidst the up-and-down momentum of today’s market are the ones most likely to be profitable in the long run.

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Small Banks Chafe Under New Mortgage Rules

Posted on March 1, 2013 at 10:49 pm.

Written by Naomi Snyder

The 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.”

The New Proposed Mortgage Regulations: One Size Fits All?

Posted on October 31, 2012 at 3:19 pm.

Written by Kelsey Weaver

New rules coming out of Washington, D.C., will impact the mortgage market and banks big and small. Among them, the Consumer Financial Protection Bureau (CFPB) has proposed rules regarding mortgage disclosures. The agency says it is attempting to simplify and write plain English disclosures for consumers. Comments on the proposals are due Nov 6. In addition, the CFPB will require lenders to make sure a mortgage holder qualifies for a mortgage, or has the ability to repay the loan, creating what’s essentially a series of check boxes for lending departments, as well as restrictions on loan terms.

Because banks both large and small will be required to comply, Bank Director asked attorneys to weigh in on the CFPB’s proposed mortgage regulations.

Should community banks be exempted from the Consumer Financial Protection Bureau’s proposed rules on mortgage disclosure and qualifying mortgages?

Yes. Community banks need to be exempted from the Consumer Financial Protection Bureau’s proposed rules on mortgage disclosure and qualifying mortgages, as community banks have been and are subject to regulatory oversight on mortgage disclosures rules. There is no need for the CFPB to be involved in the supervision of community banks. Why do we need two regulators to oversee this issue and many other banking issues when federal bank regulators were adequately doing their jobs? One major problem that lead to the current crisis revolved around unregulated mortgage originators, not disclosure rules. Let bankers and their prudential regulators continue with regulatory oversight of mortgage disclosure rules and keep the CFPB out of community banks.

—Bob Monroe, Stinson Morrison Hecker

First, the current proposed definitions of qualified mortgages and qualified residential mortgages will continue the current inequity in the mortgage market. Essentially, people like me can refinance their mortgage to 3 percent with zero closing costs, while other people who desperately need to refinance cannot qualify. Thus, there needs to be some overall sanity brought to mortgage regulation. Beyond that, mortgage regulation needs to cover the entire food chain. The CFPB can reduce the burden on smaller financial institutions regarding such matters as assessing a customer’s ability to repay a loan. If the system of regulation mandates a cost structure that only large financial institutions can absorb, then the result will be the unintended (and the CFPB says undesirable) consequence of a market in which only the multi-trillion dollar institutions can participate.

—Peter Weinstock, Hunton & Williams

Small banks are struggling to keep up with the new rules, and already, we’ve seen some small institutions enter into what amounts to mortgage referral relationships with bigger banks that have enough horsepower in their compliance departments to keep up with all of the new rules. The CFPB needs to implement reasonable accommodations for these smaller institutions. Otherwise, they may very well regulate these banks out of a fundamental piece of their business.

—Jonathan Wegner, Baird Holm

Regulatory compliance costs have always fallen more heavily on community banks than on large banking companies because of the smaller volume of transaction over which community banks must distribute compliance costs. These costs make it more difficult for community banks to compete with larger banks on the basis of price. These considerations argue in favor of exempting community banks from proposed rules on mortgage disclosure and qualifying mortgages. On the other hand, when dealing with consumer protection issues, consumer advocates may argue that it is unfair and confusing to consumers to exempt anyone from consumer protection requirements. Despite these arguments, the presence of unregulated providers in a market provides a point of reference and a practical check on the potential for regulatory requirements to lead to a diminution in, or even unavailability, of key services and should ultimately benefit consumers.

—Oliver Ireland, Morrison Foerster