Last fall’s conjecture from the financial services sector that new rules coming out of Washington could jeopardize certain types of home mortgage lending is proving correct.
The writing went up on the wall with last November’s Consumer Finance Protection Bureau release of new criteria for making so-called “qualified loans” that would receive legal protections against borrower default suits under federal “Ability to Repay” rules. Congress, in passing the 2010 Dodd-Frank financial reform law, included the Ability to Pay provision and a mandate for more thorough documentation of mortgage loans.
As the extent of the new QM standards became better known in October, bankers, lawyers, consultants and others in the money-lending business predicted a pullback in non-conforming loans, a mainstay of mortgage lending in rural Mississippi and other regions with sparse development.
The non-conforming loans are typically ones that do not meet standards for selling on the secondary market, at least initially, and often are carried as balloon loans for periods of three-five-to-seven years. The loans frequently go to borrowers whose credit standing, down payment and collateral fall short of bank guidelines.
In some instances, where a home is situated may make it impossible for a lender to issue a conforming loan to a would-be-buyer of the house.
The infrequent turnover of houses in the countryside and distances between homes make meeting the requirement for “comparable sale” appraisals nearly impossible. Such appraisals require comparisons with sales of nearby similar properties that occurred within a set time, usually the past 90 days. Lenders thus resort to non-conforming loans.
Rules for making qualified mortgage loans went into effect Jan. 10. Consequences have been quick to arrive, the Federal Reserves’ Board of Governor’s reported in a Jan. 15 release of the Fed’s Beige Book, a collection of anecdotes from economists and business executives representing the main business sectors in each of the 12 Fed districts.
Beige Book reports for the Atlanta District, which includes Central and South Mississippi, said worries over the qualified lending standards have caused some community banks in the South to swear off residential mortgage lending.
Said the Fed: “Community bank contacts expressed continued concern about the implementation of qualified mortgage requirements in 2014 and the possible negative effect on mortgage lending, particularly as some mortgage lenders exit the mortgage lending business altogether or change their business models because of the added risks.”
Some lenders, according to the Federal Reserve report, indicated they are shifting their focus from residential loans to small business and commercial real estate loans.
The move away from residential lending was among the predictions longtime Mississippi banker and current chair of the Mississippi Bankers Association Odean Busby made three months ago. “Most banks aren’t going to accept the liability at that level,” Busby, chairman of Priority One Bank, said in October.
While Busby said his $510-million, Magee-based community bank and its 11 locations from Brandon to Hattiesburg would continue making mortgage loans, no longer could it make non-conforming loans.
“Those are going to be essentially eliminated,” he said, and noted Priority One’s home county of Simpson did not make the list of “under-served” counties the federal government for the time being exempted from the qualified mortgage rules.
Concern on the Potomac
Flack is already starting to fly in Congress, with some lawmakers questioning whether the rules over-reach and will shut too many borrowers out of the home-buying market. Reacting to the worries, the Consumer Financial Protection Bureau insisted the qualified mortgage rule “strikes a careful balance between providing bright lines to give certainty and clarity to creditors while also allowing flexibility for the mortgage market evolve and innovate in ways that encourage the provision of responsible credit.”
In a nod to lawmakers, lenders and borrowers who worried the mortgage reforms were too much too soon, the CFPB wrote in exemptions for banks with assets of $2 billion or less for mortgage lending in under-served counties, at least for the time being. Approximately 50 of Mississippi’s 82 counties are among those exempted.
While the final rule specifies minimum requirements for creditors making good faith determinations of consumers’ ability to repay their mortgages, it does not dictate that they follow particular underwriting models. In fact, the guidelines are also almost wishful in expressing hope that lenders will continue to make non-traditional loans to borrowers they deem deserving. The catch is that such loans won’t enjoy the “safe harbor,” or protection from borrower lawsuits, that the conforming variety will have.
Without safe harbor, lending executives must justify to boards of directors the added risks they are bringing aboard, lawyers and bankers say. By contrast, the protections qualified loans get from borrower lawsuits calm board jitters and also make them attractive to investors in the secondary market.
The CFPB said it wrote the safe harbor rules in following a mandate in Dodd-Frank to strengthen borrower protections, For instance, loans can’t have features that often have harmed consumers in the past, such as excess points and fees.
Community bankers in interviews last fall worried that courts may invoke the safe harbor rules to order banks to pay a host of costs, including punitive damages and, ultimately, having to forgive the loan without foreclosing on the property that secured it. You can still make loans but you’re leaving your bank wide open, they said.
That’s just one of the risks, according to the American Bankers Association. It warned last fall that a single non-conforming loan deemed in violation could have a ripple effect through a bank’s loan portfolio by raising fears that other loans in the portfolio bear the same defects.
More than six months ahead of the Jan. 10 official start of QM era, the U.S. House Financial Services Subcommittee voiced fears that the mandates will reduce access to credit that qualified borrowers need to buy homes. “Banks and credit unions have already pulled back on extending mortgage credit and have tightened underwriting standards in response to the financial crisis,” the subcommittee said in a press statement. “The qualified mortgage rule may well exacerbate this reduction in access to credit.”
Similar bipartisan concern over a weakening of American home-purchasing power came at a hearing of the subcommittee Jan. 15. Rep. Spencer Bachus, an 11-term Alabama Republican, said the new regulations reflect a far too “extreme” reaction to the lax mortgage underwriting that led to the collapse of the housing market near the close of the last decade.
“Making mortgage credit scarcer through a ‘one-size fits all’ regulatory policy will negatively affect the very people it allegedly purports to help,” he said. “Regulators must be careful about overreach that denies financial opportunity.”