OCT 23, 2012 10:43am ET

Mortgage Lenders of All Stripes Paralyzed by Flurry of New Rules


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 downpayments 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, Texas, 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.

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