It is encouraging that Congress is now considering regulatory reform for community banks. But the effort has a major blind spot: it completely ignores the regulatory burden on small and midsize, community-based, nondepository mortgage lenders.
These lenders originated approximately 40% of all conventional loans and roughly 50% of all loans insured by the Federal Housing Administration and Department of Veterans Affairs in 2014, according to the American Enterprise Institute's International Center for Housing Risk. But the current regulatory burden is driving consolidation among midsize and small mortgage lenders. If that consolidation trend continues, consumers will face fewer choices and potentially higher costs.
The Dodd-Frank Act lacks the flexibility to distinguish the level of regulation necessary for lenders of different sizes, business models and performance records. Consequently, it levies the regulatory burden on everyone.
Vendor oversight requirements offer one good example of the excessive regulatory burden faced by midsize and smaller mortgage lenders. The Consumer Financial Protection Bureau's rules make no differentiation between the duties and responsibilities imposed on large banks and small to midsize mortgage lenders.
Since costs of conducting ongoing oversight and review of vendors are far more onerous for the latter group, smaller lenders tend to choose large, national vendors with good reputations. This decision provides smaller lenders with greater assurance of the vendor's integrity. Yet they must vet each of these national vendors on a regular basis, duplicating oversight that takes hundreds of man hours per year for each lender.
CFPB examinations, which can be conducted for no specific reason, also impose disproportionate costs on small and midsize lenders. Such audits are a routine expense for large, bank-owned lenders. But they can be prohibitive for smaller lenders that are already audited on a regular basis by a number of state and federal regulators. Therefore the Community Mortgage Lenders of America proposes exempting smaller lenders from random CFPB audits unless another regulator has recommended an examination.
Obviously, a very large bank can more easily absorb compliance costs. And it's just as obvious that there is greater need and justification for stronger regulation of a large bank's mortgage lending. As we saw before and during the financial crisis, large institutional lenders can drive market behavior, and their failures can have devastating financial consequences for the market. So a tighter regulatory check on their activities is amply justified.
By contrast, most small to midsize mortgage banking companies are independently owned, do not have a loan portfolio, and have no access to bank deposits to fund their operations and no access to the Federal Reserve window for liquidity. Instead, their lending operations are financed by warehouse lines of credit, which cost four to eight times more than insured deposits and require personal guarantees by the company owners. In effect, these lenders risk their own capital in making mortgages and thus, their lending practices and quality control constitutes their primary safety net should a loan fail.
Given their higher cost of funding, mortgage banking companies are more vulnerable, not less, to the higher fixed costs of legal and compliance operations mandated by Dodd-Frank. As just one example, the average independent mortgage banker with up to 250 employees has increased compliance staff from one to four at an average cost of $175,000 to $225,000 per year, according to data compiled by CMLA. Add to that an average cost of $75,000 to $100,000 in maintaining and managing expensive compliance systems, and the problem becomes painfully evident.
Some people argue that there is good reason to overlook mortgage bankers' need for regulatory relief. They say that since mortgage bankers sell all the loans they originate, and therefore have little or nothing at risk if the loans they originate perform poorly, they do not merit the same consideration.
But given the steady stream of repurchase demands issued in the aftermath of the financial crisis, there is clearly risk associated with the loans that mortgage bankers sell in the secondary market. This risk is quite personal to mortgage bankers, taking into account their personal guarantees and the fact that their own net worth is almost always tied up in their company.
We urge Congress to extend meaningful regulatory relief to all small to midsize community lenders, not just depositories, and to mandate common-sense regulations in the future.
Paulina McGrath is chair of the Community Mortgage Lenders of America, a trade association for community-based lenders, as well as president and co-owner of Republic State Mortgage in Houston.
