By most statistical models, the majority of the nation’s 7,000-plus community banks weathered the financial crisis pretty well and are growing in most markets. A study released last month by the Federal Reserve Bank of St. Louis even shows that about 10% of the community banks showed strong performance during the most stressful period from 2006 to 2011 and were characterized as thriving during the economic downturn. Among the most interesting discoveries in the report is that the thriving institutions had a higher concentration of one-to-four family mortgage loans in their portfolio. So as the real estate market continues to show improvement and rates remain historically low, it appears to be green lights ahead for community banks to expand their mortgage lending practices. But there is a blinking yellow caution light on the highway—compliance to new mortgage lending laws, regulations and investor guidelines.
The Dodd-Frank legislation and plethora of rules under revision at the Consumer Financial Protection Bureau were crafted in response to questionable lending principles practiced throughout the industry but the corrective regulations are geared more towards “Wall Street” and the largest financial institutions and investment banks. Certain parts of Dodd-Frank such as the ability-to-repay provision and the definition of a safe harbor originally ignored the fact that many of these small community banks hold non-standard mortgage loans in portfolio to serve their customers and, while do not meet the definition of a QM, are typically underwritten soundly as the originating bank is holding 100% of the asset. The CFPB has addressed some of the problem but most industry experts do not think they have gone far enough.
Federal Reserve Gov. Elizabeth Duke said in a November 2012 speech that regulatory burden is reaching a point that is discouraging community banks from making mortgage loans to their customers. The Independent Community Bankers of America organization, representing about 5,000 members, issued a letter to the CFPB in February echoing Duke’s concerns and asking for certain accommodations to small bank lenders. These recommendations include expanding QM to include balloon payment mortgages originated by small creditors in non-rural markets, increase the portfolio loan limit to 1,000 per year for community bank classification, extend safe harbor conclusive presumption of compliance for community bank mortgage loans held in portfolio with higher APRs, expand the definition of “rural” for balloon mortgage loans and escrow requirements and do not include LO compensation in the total fee calculations for QM loans.
The CFPB has been very open to comments and trying to accommodate industry concerns while meeting their consumer protection mission. Community bankers need to continue to educate the regulators on their unique business model and advocate for special considerations.
While we are optimistic in that the CFPB will make necessary and prudent accommodations, community banks need to recognize the depth of the new regulatory world and understand all the underlying details of each mortgage lending rule. It is vitally important to review all mortgage lending practices within the bank and test all products, forms, documents, reports and data elements against current rules to ensure you could pass a CFPB audit and sell a loan to an investor with limited buyback risk. This should include prefunding audits of the pipeline and post-closing reviews of loans available for sale or staying in the portfolio. Community bankers should not just rely on their technology vendors to ensure systems are processing mortgages correctly as product setup, fee allocation, document generation and business rules are often created and maintained by the bank’s mortgage and IT staff.
As the St. Louis Fed pointed out, a key to a thriving community bank is an expansive, yet prudent, mortgage lending practice. So while that caution light ahead should make the community bank pause and be diligent in their compliance reviews, serving loyal customers with diverse mortgage programs should continue to be a staple of the financial services offered by the community banker.
Penny Showalter is managing director for Cognitive Options Group, a regulatory compliance consulting firm that also provides companies with operational, transactional and outsourcing services.
