Community banks "are being victimized by excessive regulation," Federal Reserve Bank of Dallas President Richard Fisher observed in a Jan. 16 speech. The qualified mortgage rule's restrictive definition of "rural" for balloon loans is a good example.
This month the Consumer Financial Protection Bureau issued the much-anticipated QM rule, which puts into practice Dodd-Frank Act provisions intended to ensure that borrowers can repay their mortgages. QM loan status gives lenders important legal protection by deeming them to have complied with Dodd-Frank's borrower ability-to-repay requirements (or, in the case of certain "higher-priced" loans, giving them a presumption of compliance).
Despite the legal protection in the rule given to lenders for many types of loans, I have serious concerns about the protection (or lack thereof) that the rule provides to many community banks in Louisiana and other states that make balloon payment loans and hold in their portfolios.
The CFPB noted that in many rural areas across the country, "some creditors may only offer balloon-payment mortgages." For a variety of reasons, many rural area loans may not qualify for sale into the secondary market. Reasons include insufficient borrower credit scores, irregularities in the property (especially large tracts), or lack of acceptable comparable properties in the area that meet federal appraisal guidelines. Balloon loans that are originated and held in portfolio by community banks are an alternative offered to consumers in these places. Since these loans are generally held for the life of the loan, their short duration helps community banks manage their interest rate risk.
Thus the balloon loan has been a core product of Louisiana banks. It is now jeopardized by the CFPB rule.
To receive QM status, a balloon loan must meet a number of exacting requirements. Among them, the lender that originates the loan must make at least 50% of its first-lien mortgages in counties (or parishes, the Louisiana equivalent) that are "rural or underserved."
So what is rural or underserved? The rule states that the CFPB will designate a list of "rural" or "undeserved" counties each year. However, in its commentary provided in the final rule, the CFPB states that its definition of "rural" is based on the "urban influence codes" of U.S. Department of Agriculture's Economic Research Service. If you use the current codes, just 19 out of 64 Louisiana parishes qualify as "rural." (The exact number might change, since the codes are expected to be updated this year, before the QM rule takes effect in January 2014).
I believe the use of the codes is unduly restrictive in defining rural areas for the purposes of the QM balloon loan. The CFPB said it had considered an alternative definition: The one used in the USDA's Rural Housing Loan program. That program subdivides counties and parishes into rural and non-rural areas. Under this approach, low-density portions of otherwise built-up counties qualify as "rural."
"Given the size of some counties, particularly in western States, this approach may provide a more nuanced measure of access to credit in some areas than a county-by-county metric," the bureau acknowledged. But the CFPB rejected the approach, noting that under the Rural Housing Loan program's definition, 37% of the country's population live in "rural" areas, with an average of 10 lenders serving each area.