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Community Bankers and Mortgage Lending Reforms

By: Penny Showalter

It has been five years since the financial crash spawned by a real estate and mortgage meltdown caused huge losses of money and confidence in the national and world economies. While Congress moved quickly to enact laws designed to thwart future crises of this sort, regulatory change has taken longer as the Consumer Protection Financial Bureau has transformed the massive conceptual reforms in the Dodd-Frank Act into usable directives that can be integrated into the country’s banking system.

Now, however, implementation of CFPB’s rules takes place January 2014 — three short months from the publication of this piece — and mortgage lenders are facing a new regulatory environment in which their businesses must operate.

That community bankers were not responsible for the overzealous real estate financing that created the fiscal predicament which, in turn, triggered these new obligations is a moot point. The new mortgage regulations affect all lending institutions regardless of business model.

The Malignant Fallacy

First, it is essential to dispel the comforting but dangerous myth that the CFPB’s actions have little effect on community bankers.

As is true with most widespread misunderstandings, there is a germ of truth supporting this fallacy: It is true that the CFPB does not have direct authority over the vast majority of industry players. The CFPB directly oversees only those institutions with above $10 billion in assets or 5,000 serviced loans, meaning only a few hundred of the 7,000+ FDIC-insured banks. This creates the illusion that community banks have immunity from the CFPB’s actions.

The Reality

In terms of pragmatic, real-world regulation and enforcement, all mortgage lenders and servicers are subject to the rules created by the CFPB.
First, the CFPB has the option to participate in prudential banking regulator examinations on what is termed “a sampling basis” and can recommend enforcement actions based on discovered violations of the CFPB regulations. Will your less than $10 billion in assets institution be one of those somehow selected “on a sampling basis” for a CFPB examination? Unless the slogan your community bank has engraved on its pediment is, “I’m feeling lucky,” the assumption as you plan for enactment of rules by the agency must be, “Yep, they might choose us.”

Community banks also have CFPB exposure because of the consumer complaint database. Filling out a five-page form qualifies any borrower with any size loan to enter an official grievance with the CFPB about any financial institution, regardless of its size or business model, which becomes a matter of record.

On its website, the CFPB points out, “We also report to Congress about the complaints we receive and post some consumer complaint data.” At this point, “some consumer complaint data” translates into more than 72,000 mortgage complaints in the consumer complaint database, none of which have much detail except the lender’s name. There are over 500 unique organizations in the mortgage complaint section including small banking entities. Is your bank one of those? Will it be tomorrow?

Bank Employees and Loan Officer Compensation Rules

One of the clearest directives that has come out of mortgage regulatory reform is the prohibition against rewarding loan officers and originators based on unique terms of a loan such as interest rate, YSP or the sale of affiliated services. (Paying commission on loan amounts is clearly allowed as is profit sharing in the form of certain types of bonuses and retirement benefits.)

What remains murky is the definition of a “loan originator” and the effect of compensation and MLO registration rules on other bank employees who may perform functions that cross into the definition of origination.

Community banks provide customers a vast array of financial services. In delivering these varied services, bank employees have the opportunity to cross-sell and offer other products to customers: During a typical bank transaction, for example, a teller may see that a customer is paying an unnecessarily high interest rate on his mortgage and offer him the opportunity to speak with an MLO; other bank employees will also be in a position to refer clients for real estate financing opportunities; an MLO may have an assistant that relays loan terms to a potential borrower; a bank may have a translator to help explain terms and conditions to overcome language barriers; bank managers may be in a position to resolve customer service issues by changing loan terms.

Does participation in these events qualify the bank employee as an originator under the new mortgage rules? It is unclear, and the CFPB is reviewing industry comments to provide further guidance as the January 2014 implementation date approaches.

QM and the Ability to Repay

The rules defining a qualified mortgage and the ability-to-repay standards have been among the most heavily debated topics coming out of the Dodd-Frank legislation.

The industry was looking for a “safe harbor,” i.e., a QM standard that, if met by a loan, automatically fulfills the obligation of the lender to ensure the borrower has an ability to repay. It also was looking for a rebuttable presumption for higher-cost loans that met the attributes of a qualified mortgage. This would give lenders some safety in a lawsuit claiming a borrower did not have the means to repay the loan.

Both of these appear to be addressed in the CFPB’s final clarifications. The easiest way to meet the QM threshold is by issuing an agency-approved product — Fannie Mae, Freddie Mac, HUD, VA, USDA products — at least while Fannie and Freddie remain under government supervision. Lending outside of this box creates a non-QM transaction that may require the community bank to portfolio the loan and thus open itself to closer regulatory scrutiny. This particularly affects the loans made by many community banks to depositors with balloon payments, unless the bank can show that it meets a specific exemption by serving rural/underserved areas.

QRM and Risk Retention

One of the more confusing issues to come out of Dodd-Frank is the differentiation between a qualified mortgage and a qualified residential mortgage.

Many in Congress believe that a major reason for the mortgage meltdown was the securitization market and the ability for lenders to quickly sell a loan to divest themselves of long-term risks. In an effort to ensure a lender has “skin in the game,” Dodd-Frank put in a risk-retention requirement that mandated the originating lender hold 5 percent of a loan in portfolio. Fortunately, an amendment was added to exempt loans that met a QRM definition from risk retention. The industry has been pushing the CFPB to align the definition of QM and QRM more closely. And there is progress. A revised proposal by six regulatory agencies does more closely align QM and QRM and also removes a 20 percent down payment requirement from QRM, which would have severely limited consumers access to mortgage capital.

A Mindset for Charting Your Future Course

The CFPB has done a good job of providing transparency in its rule-making process and providing industry participants with appropriate comment periods. The agency has appeared receptive to industry concerns and fortunately many of the concerns of banks are shared by consumer advocacy groups who fear strict rules will prevent home ownership.

But community bankers would be wise to keep in mind that lawmakers and regulators are primarily focused on preventing another financial system failure and are consequently loathe to grant blanket exemptions for any group of financial institutions — regardless of that group’s historical reputation.

Former Congressman Brad Miller from North Carolina put this notion in striking and dramatic terms when he testified to Congress in July on community banking. While Miller spoke in favor of some applying differing rules to the various types of banks, he specifically pointed out:

“Community banks are not incapable of bad conduct. In the movie ‘It’s a Wonderful Life,’ George Bailey was a community banker, but so was Mr. Potter.”

So, do not ever assume that a CFPB rule does not cover your community bank. Get involved with the CFPB by monitoring consumer complaints and reacting quickly to issues. Take advantage of rule comment periods and ensure your voice is heard on specific effects to community banking. Engage your legislative representatives so they understand the issues.

The burden of regulatory compliance has always been a difficult one, but education, transparency and careful due-diligence will ensure the ongoing success of the community banking model.

Penny Showalter is a certified mortgage banker and managing director for Cognitive Options Group. Contact her at pshowalter(at)

Copyright (c) October 2013 by BankNews Media