The new year brought lenders in Mississippi and elsewhere face-to-face with one of the most difficult decisions of their time:
Whether to turn the faucet off on home mortgage lending.
Congress enacted the Dodd-Frank Wall Street Reform & Consumer Protection Act in 2010 but the early wave of regulatory change is only now arriving. The most recent rule came into play Jan. 10, with regulations set for qualified mortgages by the Dodd-Frank-created Consumer Financial Protection Bureau.
The qualified mortgage, a designation designed to ensure a borrower can repay a mortgage home loan, sets a bar reached by three-quarters of the home loans made in 2011, according to the CFPB.
The remaining quarter of loans fall into a non-conforming category that leaves the lenders that issue them open for borrower lawsuits in instances of default. Damages assessed can include nullification of the loan with the borrower keeping the property on which the lender made the loan.
So does the lender shut off the faucet on non-conforming loans?
Lenders may decide that is the prudent course once they take into account the cumulative effects of the International Basel III Accord’s new risk capital standards, the removal of legal protections for most non-conforming home mortgages and the uncertainty over the makeup of the 50 percent of Dodd-Frank rules yet to be written.
Long-term stagnant interest rates must also be considered.
As banking CPA James Gordon put it in a interview this month: “We’re in a land where more is unknown than known.”
Professionals such as Gordon and banking lawyer Debra Lewis are spending their work days laying out the alternatives and the risks, the upsides and downsides and possible scenarios that could develop. They tread unfamiliar ground almost daily.
“They look to me to tell them what the pitfalls are,” said Lewis, a partner in Birmingham-based Balch & Bingham’s financial institutions & services section.
Those pitfalls, especially ones created by the “qualified mortgage” rules that went into effect Jan. 10, have led Lewis’ clients among the regional-size banks to shut down lending that falls outside of qualified mortgage standards, she said.
The standards include a borrower debt-to-income ratio of 43 percent or below, specific credit score ranges, specified down payments, fixed 30-year-rates and points and fees that don’t exceed 3 percent.
Some clients from the ranks of community banks, Lewis said, are getting out of mortgage lending “all together.”
Other lenders may become surprisingly resourceful. The market demand isn’t going away, after all, but the flow of mortgages in the market is sure to diminish. Ways will have to be devised to meet demand. “I am curious to see if somebody is going to come out with different products,” Lewis said.
Or different ways to keep the loan income flowing while covering increased compliance costs. That’s when smaller banks fold into larger ones, the Balch & Bingham attorney said. “I don’t think there’s any question we’re going to have more consolidation.”
HORNE CPAs’ Gordon said most of the banks he works with have large mortgage operations. He expects them in the short term to retreat to the safe harbors offered by qualified mortgages.
“In the longer term they’ll see how to treat some of their non-conforming products and how to fit these within the rules and still be allowed the growth they need,” said Gordon, a Memphis-based partner in HORNE’s financial institutions & financial services section.
“The bigger issue is the cumulative effect of everything going on in these regulations,” Gordon said. “It would be easy enough for banks to deal with were this only one thing to deal with.”
Advisers such as Lewis and Gordon say they are further handcuffed by having to give guidance without knowing the shapes and details of lending regulations to come. Thus, the safe play for the time being may be to leave the game.
“The safe tactical course is not to take the risks if you don’t know what rules you’re ultimately going to have to play by,” Gordon said.
Only half of Dodd-Frank rules are in place. “And there’s the uncertainty of how the Consumer Financial Protection Bureau will regulate going forward,” the banking CPA noted. “Are they really going to defer to the primary regulators? How is that going to play out?”
Mortgage companies did not escape the reach of the qualified mortgage. Once an option for borrowers looking for non-traditional home loans, mortgage companies will no longer find secondary markets for the non-conforming loans they previously made, Gordon said, and noted they’ll also take on the same legal risks as other mortgage lenders.
“If the big, bad banks turned you down, you might be able to go to a mortgage company. But now they are all playing by the same rules.”
At no point has the “proverbial 80-20 rule” been more prominent, Gordon said, explaining that typically you can follow 80 percent of the business without a lot of difficulty.
“Now the 20 percent is much harder and you have to decide do you want to take those chances.”
In the way of resourcefulness, some smaller Mississippi banks can make conforming loans and “move them, upstream even if they haven’t traditionally done that,” Gordon said. “Maybe they can do this by partnering with larger banks.”
Such moves may be prompted by the new difficulties community banks will encounter making 30-year, fix-rate non-conforming loans and keeping them on their books, according to Gordon.
Such 30-year, non-qualified loans “are going to be the exception and not the rule,” he said, citing risks that interest rate increases will leave the bank holding mortgages that lose value. “Even 15-year loans” that banks keep in-house could be headed for the dustbin, Gordon added.
Basil III, qualified loan standards, the blurred regulatory future – all this is arriving “at a relatively bad time” for lenders, he said. “It’s coming as rates are going up and originations are going down.”
Banks that are all the way in the mortgage business are probably staying in, he said. “If you are on the fence, you’re probably pulling back.”