Many community banks rely on balloon mortgages for the bulk of their profits, earning interest by holding the loans on balance sheet.
But balloon loans are inherently risky since they do not amortize, leaving a large "balloon" payment when the loan comes due. Balloon loans got a bad reputation during the financial crisis when unscrupulous mortgage lenders convinced borrowers they could afford the loans because of their lower monthly payments and interest rates.
The CFPB essentially banned balloon loans when it released its so-called qualified mortgage rule in January, but regulators gave an exemption to community banks in rural or underserved markets, where many properties and borrowers have special characteristics that disqualify them for loans that can be sold in the secondary market.
The problem, as community bankers tell it, is that regulators created so narrow a set of definitions for the exemption that some banks would be forced to stop originating balloon mortgages altogether, leaving their customers in the lurch when they need to refinance.
"It would completely break our business model," says Chad McClung, president of the $83.7-million-asset Colfax Banking Co. in Colfax, La.
McClung points out that while Colfax Banking is located in Grant Parish, a rural county with a population of roughly 20,000, it is not considered either rural or underserved by the CFPB because it is adjacent to Rapides Parish to the south, which is a metropolitan statistical area. But to its north, neighboring Winn Parish would qualify for the exemption, creating what McClung calls "an uneven playing field."
"If this goes through, banks in Winn parish can continue making loans and the people in our community will have a void of credit," says McClung. "This could lead to unfair competition among banks that may be only 20 minutes away from each other."
Kathleen Cook, president of the $76-million-asset Village Bank in St. Libory, Ill., shares the concern that the definition is too narrow and said so in a recent comment letter to the CFPB.
"We cannot survive if they take away our ability to make balloon loans," says Cook, whose grandfather founded Village Bank in 1919. "Balloon loans are the main way for us to make money. We can't stay in business just on originating and servicing fees."
To be sure, affordable housing advocates will shed no tears if balloon loans are eliminated. Consumer groups including the National Consumer Law Center and the Center for Responsible Lending view balloon loans as predatory because borrowers often cannot afford the loans and may suffer payment shock when the balloon payment comes due.
Community banks typically manage the interest rate risk of balloon loans by rolling the loan over to market rates when it matures. The CFPB also recognizes that mortgages on the books of community banks had few foreclosures and delinquencies because the banks retained the loan, as opposed to raking in fees and fobbing off the risk to Fannie Mae, Freddie Mac and the Federal Housing Administration.
Banks that make rural balloon loans can only receive the "qualified mortgage" stamp of approval—giving them a legal safe harbor from litigation—if they have less than $2 billion of assets, make no more than 500 first-lien loans a year and originate at least 50% of first-lien mortgages in counties that are rural or underserved. Banks also have to hold the loans in their portfolios for three years to maintain "qualified mortgage" status.
Ron Haynie, vice president of mortgage finance policy, at the Independent Community Bankers of America, says the CFPB should broaden the definition of what is considered "rural," and raise the 500-loan threshold. He wants to go a step further, saying all balloon loans held and retained in portfolio should get a legal safe harbor as well.
"The bank is taking 100% of the credit risk and the CFPB even says that community bank lending is so focused on customer service that it self-polices," Haynie says. "Community banks are not going to put a borrower into a property they can't afford."
Bank call reports do not break out the number of balloon loans held on bank balance sheets. A survey of community bankers last year found that balloon mortgages made up 75% of their portfolios, according to the ICBA.
The CFPB has sought input from bankers on the issue, including whether to create a new category of qualified mortgages for loans without balloon payment features that are originated and held in portfolio. That new category would not be limited to lenders that operated in rural or underserved areas.
"If they don't change the rule at all, there are a whole bunch of balloon loans out there on community bank balance sheets, and when they come due, the community banks may not be able to refinance them into a balloon loan, and they may not qualify for anything else," says Haynie. "Then you may end up forcing the borrower into an adjustable-rate mortgage and many community banks do not do ARM loans because they don't have the capability to service them."