Can a law that has yet to be fully implemented force a company to shut down a line of business? Some smaller banks say yes — that the Dodd-Frank Act is forcing them to discontinue products such as mortgages.
"While it sounds like a talking point on a Sunday talk show, the majority of the mortgage regulations tied to Dodd-Frank have yet to be written, and a big swath of those regulations have missed their deadlines," says Peter Wannemacher, an analyst at Forrester Research.
"That could be good, because it gives you more time to comply," Wannemacher says. "But it also means there is a huge unknown about the law. It's hard to make a quick, agile, flexible move to comply with an old law that's adding a new rule."
Shelter Insurance of Columbia, Mo., recently joined a growing list of insurance companies to leave the banking business, blaming regulations such as Dodd-Frank. And State National Bank of Big Spring in Texas says it has left the consumer mortgage business and has joined a lawsuit against Dodd-Frank that also includes the Competitive Enterprise Institute, a libertarian think tank based in Washington.
Jim Purcell, State National's chairman and chief executive, says the $300 million-asset bank makes mostly smaller, shorter-term loans that are held in portfolio by the bank instead of packaged and sold, which he contends makes the bank responsible for the credit quality of the loans. Purcell says the added escrow and data collection provisions of Dodd-Frank cut into the business case for residential mortgages because of the compliance expense.
"The law says we have to" create a tax escrow account for loans clearing a certain price hurdle, he says. "To buy the software to create the escrow account makes no economic sense for us," he says.
Purcell says the bank's local ties and relationship-building strategy allow it to track borrower health and loan performance. But he worries that pooling resources to manage compliance would dilute the bank's local touch.
"People would lose the incentive to do business with a particular place," he says. He says the credit risk solution should be for banks to require higher down payments for residential mortgages. "People are more responsible if they have cash in the project, too."
Wannemacher says there's a gap between large and smaller banks when it comes to IT spending/deposit ratios that impacts the tech scale of small banks. "These guys are also playing catch-up with the larger banks in retail banking. So there's already a fair amount of tech investment. The prospect of having to put more IT resources into back end stuff for compliance and disclosure is very tough," he says.
One example of how pending regulations can hit the back office of a smaller lender is the Consumer Financial Protection Bureau's qualified mortgage rule, set to go into effect in 2014.
It will require more spending on compliance technology, since it will entail a deeper dig into data on a potential borrower.
Under the rule lenders must locate information such as employment status, income, asset, debt and credit history, and must document that borrowers have enough income or assets to pay a mortgage. Lenders are also required to verify a borrower's debt-to-income ratio or residual income (cash left over after a borrower has paid debts and housing payments each month). Additionally, there are disclosure requirements on pricing that are designed to discourage mortgages with lower initial or advertised rates that increase over time — or so-called teaser rates that make the mortgage more expensive in reality than it may appear.
Verifying income and other information that measures a borrower's ability to meet specific mortgage terms digitally calls for a mix of imaging and digital signature technology linked to customer relationship management systems and other customer databases. That technology and other digital processing measures may have to be deployed to procure the information necessary for a mortgage to attain "qualified" status.
Some smaller lenders have turned to outsourcing, resource sharing or the data cloud to manage mortgage regulation compliance. "The larger banks have the lawyers, the staff and the technology to handle a larger compliance burden" but "smaller banks don't have that," says John Berlau, a senior fellow at the Competitive Enterprise Institute.
Even given the burden on small banks and the temptation for insurers to distance themselves from banking because of regulatory stress, Wannemacher says it's a stretch to contend that the pending regulations will force an otherwise healthy company out of business entirely.
"What's more likely to happen is some company that has dabbled in one or two banking products will reduce their investment in that line of business," Wannemacher says.