Lenders Feel Paralyzed by Flurry of Mortgage Rules
While Comptroller Tom Curry made it clear that regulators will not back down from a push for higher capital levels, he suggested the agencies are considering other ways to reduce the burden of the Basel III proposal for community banks.
Without one, community banks will face increased risk of litigation they cannot afford. This could push many of them out of the mortgage market.
With just three and a half months left until 2013, regulators are under pressure to release a boatload of new regulations, including some of the most contentious items on their plate.
David Berenbaum, a consumer activist, finds himself in rare agreement these days with bankers who claim that a proposed mortgage rule that takes effect next year would hit low- and moderate-income consumers hardest.
Berenbaum, the chief program officer at the National Community Reinvestment Coalition, is best-known for filing complaints against banks and mortgage lenders claiming high minimum FICO scores on Federal Housing Administration loans have cut off access to credit to African-Americans, Hispanics and immigrants.
But these days Berenbaum is siding squarely with banks, warning that a proposal in the Dodd-Frank Act, the so-called qualified residential mortgage rule, would discourage banks from lending to minorities and the poor.
"Never in my life would I believe I would have the exact same position as banks and mortgage lenders. It's a very unusual turn of events," Berenbaum says. "But we do not want to see a restriction of credit. We want the standards to promote responsible lending but not to restrict credit for qualified homebuyers."
Berenbaum's issue is with a provision that would essentially require higher down payments from borrowers. But it's one of just a slew of proposed policy changes — from Basel capital standards to rules governing a borrower's ability to repay to Fannie Mae and Freddie Mac guarantee fees - that could further suppress mortgage origination activity. Lenders, with an assist from community activists, are fighting hard to water down some of the new rules, which they argue are so onerous that they could force them out of the mortgage lending business.
Jaret Seiberg, a managing director and senior policy analyst at Guggenheim Partners' Washington Research Group, has identified at least eight mortgage regulations that he claims increases the risk "of an unintended housing credit crunch in 2013."
Topping the list is the qualified mortgage rule, which requires the Consumer Financial Protection Bureau to define standards for ultra-safe loans to meet the Dodd-Frank Act's requirement that lenders ensure a borrower has the "ability-to-repay" a loan. The CFPB is under pressure to have the rule, which is different from the qualified residential mortgage rule, written by Jan. 21.
Next in line is Basel III, which dictates how much risk-based capital banks must hold against certain assets including residential mortgages. Home-equity lines of credit, first liens with balloon features and adjustable- rate mortgages have the highest risk weightings, which is causing banks to pullback from originating such assets.
While the rule-making for Basel III takes effect Jan. 1, most banks have a phase-in schedule that doesn't require full compliance until 2015 at the earliest.
Aside from those potentially game-changing rules, banks are also facing higher guarantee fees by Fannie Mae and Freddie Mac and higher premiums for Federal Housing Administration loans. Lending could be also further constrained by two long-shot issues: eminent domain proposals by a few local governments that want to seize and restructure mortgages of underwater borrowers, and the mortgage interest deduction, a widely-popular tax credit that some lawmakers want to eliminate to reduce the deficit.
"The market might be able to overcome any one of these but it's the collective weight that's frightening," says Seiberg.
Handicapping the regulatory process is no easy feat, but the good news for lenders is that sentiment on some of the regulations appears to be shifting in their favor as regulators balance the need for safety and soundness with the desire for the largest number of consumers to have access to credit. Community banks in particular appear to have the ear of Comptroller of the Currency Thomas Curry, who has said regulators may ease the burden of pending Basel III requirements for small banks.
"We will be taking a fresh look at the possible scope for transition arrangements, including the potential for grandfathering, to evaluate what we could do to lighten the burden without compromising our two key principles of raising the quantity and quality of capital and setting minimum standards that generally require more capital for more risk," Curry said in a speech at the American Bankers Association's annual convention..
But on qualified mortgages, banks may not necessarily get exactly what they want, which is a "safe harbor" from litigation on all loans that fit the CFPB's definition of a qualified mortgage. The CFPB may end up compromising by giving banks relief from litigation on a small segment of loans.
Either way, banks see themselves in a Catch-22. If the rules are too rigid, banks will have little choice but to restrict lending. But if they are ill-defined or too loose, banks say they face higher compliance costs and increased risk of litigation.
Like many banks, the $634 million-asset First Capital Bank in Midland, Tex., sells most mortgages it originates to free up capital to make more loans. But Ken Burgess Jr., the bank's chairman, says a clause in the proposed Basel regulations that would require banks to set aside capital for potential buybacks of loans, would simply be too big a hit to its capital base for the bank to continue originating mortgages. Even if they were allowed to grandfather existing mortgages, "we'd still have to exit the business," Burgess said in a panel discussion at the ABA conference.
On the same panel, John Ikard, the president and chief executive of the $12 billion-asset FirstBank Holding in Lakewood, Colo., said his company has only foreclosed on 20 of the 17,000 to 18,000 mortgages on its books, instead preferring to work with borrowers to avoid such a drastic step. "Under Basel III, I'm not sure if it makes sense to avoid foreclosures. It could change how I run my company," he said.
Andy Sandler, chairman and executive partner at the law firm BuckleySandler, says banks are fearful that tight standards, particularly on the qualified mortgage rule, will expose them to accusations of discrimination against minorities. They are preparing for more penalties, lawsuits and investigations from regulators not necessarily from lawsuits filed by borrowers themselves.
"In the current environment, all of these rules are going to restrict product and the availability of credit to the credit-impaired. The result is going to be fewer and more expensive loans to lower- and moderate income and minority borrowers," Sandler says. "There are better ways to ensure against predatory lending."
He cited two recent lawsuits as examples of lenders' increased litigation risk. Earlier this month, the Federal Housing Administration filed a civil fraud suit against Wells Fargo alleging more than 10 years of misconduct including "reckless" origination and underwriting of FHA loans, and "intentional concealment" of loans that had deficient underwriting and disclosures. (FHA loans have the loosest underwriting requirements with a minimum 580 FICO score and 3.5% down payment.)
In September, Luther Burbank Savings in Santa Rosa, Calif., agreed to settle a lawsuit claiming it discriminated against minorities because it set a $400,000 minimum loan amount for jumbo mortgages that resulted in too few loans being made to black and Hispanic borrowers over a four-year period.
If anything is certain about the slew of regulations, it's that credit tightening and loosening both come at a hefty price either in higher litigation costs or a possible reduction in lending volume and profits.
"On one side they're telling us things are crazy and we need to get our underwriting in check, and then they come after us for imposing standards," says Richard Andreano, a partner at law firm Ballard Spahr. "It's the Goldilocks issue. When is it just right?"
Though banks are earning the highest profits in years from mortgage banking, thanks to a year-long refinance boom aided by government programs and ultra-low interest rates, banks want to sustain strong mortgage profits when the refinance boom eventually dries up. While that is not expected for several quarters, if not longer, banks are mindful that current home purchase volume is a fraction of what it was during the heady days of the housing bubble.
Ed Pinto, an industry consultant and former executive at Fannie Mae, says bankers' concerns are overblown and driven entirely by the desire to sell loans to the largest possible number of customers. He has been arguing for tough underwriting standards even if it means excluding underserved communities where defaults tend to be much higher and low FICO scores a predictor of a loan going sour.
"The goal should be to get people in houses for the long-term not just get them in houses, which is the goal of the housing lobby," Pinto says. "Flexible underwriting is a code word for loose lending. The history of the mortgage industry is to slide down a slippery slope in terms of moving up the credit curve."
Banks have been skittish about lending, and have already tightened credit standards considerably, for good reason. They have absorbed billions in losses, paid out massive amounts in lawsuits and are afraid of being forced by Fannie Mae, Freddie Mac and FHA to buy back loans that go bad.
But Berenbaum at NCRC says it is unlikely that banks will stop lending if they don't get the safe harbor. Bankers push for the most extreme position as part of their jockeying to at least some relief from litigation.
"Lenders will in fact continue to lend," Berenbaum says. "Given the excesses that led to the collapse of the housing market, we're hard pressed to find other industries that get a safe harbor from litigation."
Berenbaum agrees with banks, however, that a tighter credit parameters for the qualified mortgage would restrict many minorities and even moderate-income borrowers from becoming homeowners. He also wants banks to have more leeway in credit decisions.
Like a number of community groups, NCRC is concerned that lenders will simply not make a loan if it falls outside of qualified mortgage guidelines.
"In the unlikely event they are made, they will be far costlier, burdening families least able to bear the expense," the NCRC said in a letter to CFPB Director Richard Cordray earlier this year that was co-signed by more than 30 other community, bank and real estate industry trade groups.
Dave Stevens, the president and CEO of the Mortgage Bankers Association, continues to frame the issue as one in which access to credit particularly for blacks and Hispanics is in jeopardy. He is against one potential requirement that borrowers have a 43% total back-end debt-to-income ratio to meet the "ability-to-repay" standard.
"Hard-line underwriting doesn't work in the U.S. which is a melting pot of various demographics and cultures, and variable sources of income," says Stevens. "There is ultimately going to be a large segment of borrowers who do not have access to homeownership because of the fear that there is the slightest risk of default."
Debt-to-income ratios have been central to the qualified mortgage debate because data shows the higher percentage of a borrower's income that goes towards all debt from housing, credit cards and auto loans, the higher the likelihood that borrower will default.
A report last year from data provider CoreLogic found that nearly 12% of all loans sold to Fannie Mae and Freddie Mac in 2010 would not meet the 43% debt-to-income. If FHA loans were included, roughly 40% of all loans originated in 2010 would not meet the standard.
Still, what's wrong with toughening standards for borrowers who have a higher likelihood of default, asks
Bob Simpson, the president of IMARC, an Irvine, Calif., quality control and loan auditing firm. He says it's hard for lenders to argue that borrowers should have higher debt loads given past lax standards that led to the housing market's collapse.
"People may want pride of ownership but we just lived through the biggest crash since the Great Depression," Simpson says. "And here we are years after 2006 and we're still trying to figure out what to do with the overhang, debt forgiveness and underwater homeowners."
Paul Davis contributed to this story.