The Consumer Financial Protection Bureau’s ability-to-repay rules go into effect on January 10, 2014, and many community bank heads believe that the qualified mortgages (QM) required by the law will have a negative impact on their bank’s business strategy.
Mark Field, president of Liberty, Illinois-based Farmers Bank of Liberty, with $85 million in assets, thinks the new rule could prompt consumer lawsuits against community banks, targeting those that offer non-qualified mortgages.
“The CFPB tells us, ‘Oh, it’s OK, go ahead and make a loan even if it’s not QM’,” Field says, but “what a bank would be doing in that case is painting a big target on its bank.”
Bank Director polled 24 chief executive officers of community banks by phone in December 2013, asking for their insight on the regulatory issues facing their banks in 2014. When asked about the impact of QM on their institutions, half of those polled feel the impact will be negative, forcing changes to the bank’s mortgage business strategy. Twenty-nine percent expect to see little impact on the way they do business. Community bankers were also asked about how they plan to prepare for the Basel III standards in 2014.
When asked for his opinion on QM, Field believes the rules are too restrictive, and will result in harm to the very consumers the new rule aims to protect, like those in his rural community. “My main office is in a town of 600 people. We try to help people, and there are times when it makes perfectly good sense to help someone with a home loan based on things you know,” he says. “They’re removing the bank’s ability to use the borrower’s character [and] the personal knowledge that the loan officer has of the situation or the borrower.”
“The net effect will be that they will hurt more consumers than they will help by implementing these rules,” says Field. “Most community banks were not the cause of the mortgage meltdown.”
The home loans offered at Farmers Bank of Liberty are typically balloon mortgages with three-year terms, which stay in the bank’s portfolio. The bank’s mortgages are funded by certificates of deposit, which, due to consumer preference in the continued low interest rate environment, typically mature within 12 months. The CFPB will temporarily allow balloon mortgages for banks with less than $2 billion in assets that do fewer than 500 first lien mortgages per year, but the agency requires a term of at least five years for a balloon mortgage to be a qualified mortgage. Field says that places the bank at odds with regulators like the Federal Deposit Insurance Corp. that have renewed concerns about interest rate risk.
“The CFPB is forcing us to do one thing, and the FDIC and the Fed and the OCC [Office of the Comptroller of Currency] are beating banks down [in] the other direction. So I don’t know what the net effect will be, [whether] banks will have to scale back on their portfolio loans in order to monitor their interest rate risk,” Field says.
A survey by the Independent Community Bankers of America (ICBA) conducted in February of 2013 found that 73 percent of community banks offer balloon mortgages. Most community banks offer balloon mortgages that don’t have the onerous terms that got balloon mortgages such as bad rap before the financial crisis. Community bankers typically refinance the loans without fees at the end of the three- or five-year terms.
In the meantime, will the new international standards for bank and thrift capital, Basel III, be a hardship for community institutions, who have to get ready next year? Almost all banks and thrifts except those with more than $250 billion in assets were given until January 1, 2015, to comply with the capital standards, and all community bank CEOs polled by Bank Director in December say they’re ready. However, feeling ready and being ready may be two different things. Field feels that his bank is prepared for Basel III, though he remains uncertain about the capital conservation buffer of 2.5 percent, which the standards require on top of the 8 percent minimum total capital requirement. The buffer will be phased in beginning in 2016. According to the FDIC, banks not meeting the buffer could be penalized and certain payments, like dividends, could be restricted.
Regal Financial Bank, a $102-million asset institution based in Seattle, Washington, is ready for Basel III, says Randy James, the bank’s chairman and CEO, but he thinks many community banks may be caught unprepared. “If they’re not preparing for it, I think they’ll be caught short. It’s very difficult for a community bank to change its [capital] ratios quickly,” he says. “If they’re close, if they think they’re scratching by the guidelines, then I think they need to be better prepared.”
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The 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.
While 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.
Although 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.
There 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.” 
The 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.
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.