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ED WILMESHERR — Life in the post-subprime mortgage era 


Butler Snow

Banks in general, and community banks in particular, have experienced eight years of challenges, beginning with the first days of the great recession in 2007.

The years 2007 and 2008 were a time of liquidity crisis and fallout from the housing bubble and the so-called subprime mortgage crisis. Bank regulatory agencies imposed extraordinary scrutiny upon banks, their loan portfolios, their credit concentrations, policies and procedures. Identifying risks and managing for those risks became the order of the day.

As always seems to happen, Congress reacted to the extraordinary situation by enacting game-changing legislation in the form of the Dodd-Frank Act in 2010 — easily the most comprehensive reform of banking and banking practices in the last decade, perhaps ever.

The Dodd-Frank Act created a new regulatory agency, the Consumer Financial Protection Bureau. The CFPB was unique in many respects, but the biggest difference was in its perspective. Previously, the agencies regulating financial institutions conducted a balancing act, trying to regulate banks for safety and soundness with an eye towards risk management and bank profitability, while examining those same banks for compliance with consumer protection laws and regulations.

Reading between the lines of the Dodd-Frank Act, it was easy to see Congress was not satisfied with the job the bank regulatory agencies had done in the run up to the 2007-2008 banking crisis. As a result, the Federal Reserve Board was stripped of its regulation writing authority for most existing consumer protection laws, and that authority was given to the CFPB.

Under Dodd-Frank, the CFPB primary duty was to protect consumers first. A bank’s reputation, regulatory risk and profitability ran a distant second. The CFPB was established and functional by 2011 and began to implement regulatory changes the Dodd-Frank Act mandated.

Much has been written about the numerous regulations the CFPB was tasked with writing. Literally thousands of pages of regulations have been issued and finalized, and more are yet to come. However, a relatively small number of these regulations have had the greatest impact on banks — particularly community banks.

The first major regulatory change from a compliance perspective was the Ability to Repay Rule, which was aimed at the questionable practices of some lenders that offered mortgage loans to consumers who could not afford to repay. Those loans often contained features detrimental to consumers but profitable to lenders. The laws existing at the time allowed lenders originating those loans to securitize them, sell them to investors, and thus escape the risk of those questionable lending practices. The CFPB set out to change that process.

The Ability to Repay Rule in a nutshell requires lenders to determine if a loan applicant has the ability to repay the loan he or she applies for without resorting to a sale of the property in question.

For the first time, banks were required by regulation to determine a comprehensive list of credit criteria and assess those criteria before making a loan. The consumer’s income, employment status, credit history, and debt to income ratio, among others, had to be determined and documented. Failure to satisfy this Ability to Repay Rule is a violation of the Truth in Lending Act (TILA) and Regulation Z. Violation of Regulation Z carries with it damages that can be recovered through a lawsuit.

To lessen some of the regulatory impact of the Ability to Repay Rule and the attendant liability for any violations, the CFPB created a series of four loan products called qualified mortgages, which offered certain protections depending on a lender’s size, product features and loan pricing. The intricacies of the Qualified Mortgage Rule go far beyond the scope of this article, but suffice it to say, the level of complexity when originating mortgage loans was and remains unprecedented.

The Ability to Repay and Qualified Mortgage Rules were quickly followed by a series of Mortgage Loan Servicing Rules aimed at problems consumers experienced when trying to refinance or restructure loans made leading up to the subprime mortgage crisis. These rules dealt with a number of common loan servicing practices. While smaller banks were exempt from some of these requirements, banks of all sizes were forced to examine and modify the way they serviced mortgage loans.

The Dodd-Frank Act also required the CFPB to streamline the mortgage loan origination process by combining a confusing series of early and final disclosures required by the TILA and the Real Estate Settlement Procedures Act (RESPA) into a single set of two disclosures. This regulation was referred to as the TILA/RESPA Integrated Disclosure Rule or TRID, which became effective Oct. 3.

While streamlining and consolidating sound like good things, the CFPB’s approach required extreme detail when disclosing costs to consumers. It imposed strict timing requirements for delivery of disclosures and limits on changes that could occur to costs imposed on consumers during the closing process. Since many of these requirements are imposed under TILA, there is again the risk of liability for violations if lenders make mistakes.

Although there have been only a few months since the TRID implementation date, some mortgage loan purchasers are reporting a slowdown in the number of mortgage loans being delivered, raising the question of whether the mortgage lending process has been slowed or lessened altogether as a result of the imposition of these complex and cumbersome regulations.

The facts will soon be known, but it seems reasonable to believe any slowdown is temporary and mortgage lending will continue as it has in the past, but with the possible benefit that the loans created will be less risky to banks and better for consumers. Banks, especially community banks, always seem to find a way to comply and continue to meet the credit needs of their communities.

Looking into 2016 and beyond, it would be nice to say all of the regulatory changes for banks are behind them and their only challenge in the coming year is to continue to improve their compliance practices for the regulatory changes just mentioned – but when has that ever been the case?

Over the next two years, banks will be challenged on two additional regulatory fronts. Congress learned in the process of drafting the Dodd-Frank Act that there was insufficient data related to the mortgage loan origination process that put so many bad mortgage loans on the books. In response, Congress amended the Home Mortgage Disclosure Act (HMDA) to greatly expand the amount of information that must be reported annually about the mortgage loans that all but the smallest banks originate. This reporting requirement has been on the books for a number of years, but the CFPB recently finalized a revised Regulation C that increases the number of data points to be reported from nine to approximately 25. Many of these new data points touch on loan data that can be used by the bank regulatory agencies in various ways.

These changes to HMDA will affect banks in two ways. First, there is the burden of greatly increased data collection, data recording and data reporting. Existing regulations allow very little, if any, leeway in terms of errors in data reporting. The more items of data required, the more room there is for error and the more work banks must do to ensure errors do not happen. As always, there is a potential for monetary penalties if a bank’s data reporting is found to be flawed.

Secondly, every bank that reports HMDA data will find that its next fair lending examination will be scoped using that data. This means the bank’s reported data will be subjected to a sophisticated regression analysis using each of the data points provided and cross referenced to protected groups by race, ethnicity, gender and age. The more information the regulators have to review, the more potential there is to detect a pattern or practice of discrimination.

Finally, there will be new reporting requirements for HMDA-like data related to a bank’s small business loans, especially focusing on loans to minority and female borrowers. Those regulations are yet to be proposed.

Much speculation has perculated on the impact of all of these regulations on banks of all sizes. The ability of community banks, with fewer resources, particularly comes into question.  But if history is any measuring stick, banks, community banks included, will do fine. They always find a way to succeed and they will continue to do so in 2016 and beyond.


» Law Elevated explores the latest trends, issues and perspectives facing the legal industry and is written by the attorneys of Butler Snow. For more information, visit www.butlersnow.com or follow Butler Snow on Twitter @Butler_Snow.


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