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.”