Coping Mechanisms


Nationwide, community banks respond differently to the new mortgage lending regulations. Some are backing off lending, and others are charging ahead

By Howard Schneider

Many community bankers woke up with headaches in January—and they weren’t due to any New Year’s celebrations. Instead, the bankers were anticipating a barrage of regulatory changes involving residential home loan originations and servicing.

After community banks scurried with their vendors to prepare for nearly a year, several new mortgage lending mandates from the Consumer Financial Protection Bureau took effect in January. The so-called ability-to-repay and qualified mortgage rules covering loan underwriting, loan servicing standards and loan officer compensation guidelines were included in the new consumer regulations.

Community bankers report that it has been a towering effort to meet the implementation deadlines with only five months notice. “We’ve done a lot of training over the last year” to prepare staff and software systems for the wide range of changes the mortgage rules wrought, says Ken Friedel, senior vice president at Mediapolis Savings Bank, a $130 million-asset community bank in Mediapolis, Iowa.

Mediapolis Savings typically maintains a portfolio of balloon mortgages and sells fixed-rate loans into the Federal Home Loan Bank system under its Mortgage Partnership Finance secondary market program. Although primarily an agricultural-lending bank, residential mortgages make up about one-third of the Mediapolis Savings’ overall loan portfolio.

Eight separate underwriting factors make up ability-to-repay calculations. Community bankers are documenting each of these elements to ensure mortgages held in portfolio aren’t downgraded in an examination and thus subject to increased capital requirements. Echoing other community bank executives, Friedel says he believes Mediapolis Savings is in full compliance with the mortgage rules, “but we won’t know until our first exam.”

Other community bankers want to avoid any compliance uncertainty. “We’re avoiding mortgages at all costs,” reports Henry Homsher, president and CEO of Los Angeles-based National Bank of California. About two years ago, the $350 million-asset community bank quit producing home loans in response to the additional compliance burdens stemming from the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Homsher says many community banks will struggle to stay in the mortgage business unless they have adequate loan volume to support the necessary compliance infrastructure. He says that further regulatory changes since National Bank of California stopped originating home loans have confirmed “that we made the right decision.”

Working for Additional Mortgage Relief

By educating Congress and the Consumer Financial Protection Bureau about our industry’s relationship-based business model, ICBA and community bankers have obtained several important accommodations under the Dodd-Frank Act and the ability-to-repay mortgage lending rules for community banks.

Last year ICBA unveiled a Plan for Prosperity legislative platform to provide community banks with a range of targeted relief from costly and unnecessary regulations. Providing community banks with additional regulatory accommodations from the CFPB’s ability-to-repay and qualified-mortgage lending rules, particularly provisions to grant the greater legal protection under qualified-mortgage status for all community bank home loans held in portfolio, is a major component of the platform.

In the Senate and House of Representatives, lawmakers have introduced several bills that would achieve these objectives.

ICBA-backed bills that have been introduced would provide qualified-mortgage safe harbor status for loans originated and held in portfolio for the life of the loan by banks with less than $10 billion in assets, including balloon mortgages. Introduced bills would also exempt banks with assets below $10 billion from escrow requirements for loans held in portfolio, increase the “small servicer” exemption threshold to 20,000 loans (up from 5,000) and reinstate the FIRREA exemption for independent appraisals for portfolio loans of $250,000 or less made by banks with assets below $10 billion.

Another Plan for Prosperity provision seeking more influence in CFPB rulemaking by other banking agencies has also resulted in lawmakers introducing constructive bills. Those bills would change the governance structure of the CFBP to a five-member bipartisan commission, rather than a single director, and require those CFPB commissioners to serve staggered five-year terms and be confirmed by the Senate. In addition, bills have been introduced that would strengthen the Financial Stability Oversight Council’s ability to amend or stop detrimental CFPB rules.

For more information on ICBA’s Plan for Prosperity regulatory relief efforts, visit the Advocacy section of the association’s website at

Proceeding with caution

Strategies used by community bankers to cope with increased residential mortgage regulation vary depending on several individual factors. The community bank’s mortgage loan volume and capacity, as well as its community lending needs are among the most prominent.

Additional time-consuming work is necessary to satisfy qualified mortgage requirements, states Tom Turner, vice president and mortgage officer at Farmers & Merchants Bank, a $300 million-asset community bank serving Upperco, Md., an exurban bedroom community northwest of Baltimore.

Two months were spent last year testing software which was added to the bank’s loan origination software to determine whether applications meet qualified mortgage guidelines. Processors run those modules when there are changes to a file and again right before closing, says Turner.

Turner set up Farmers & Merchants’ mortgage lending operations 15 years ago, pointing out that the bank makes “loans our customers can thrive in.” The bank’s lending follows the typical pattern of community banks by producing mortgages that rarely default, and the bank has never had to buy back a loan it sold into the secondary mortgage market. Even during the housing boom, Farmers & Merchants Bank didn’t originate stated income or no-doc home loans.

“We’ve always done the right thing,” Turner says, pointing out how community banks “are being penalized for something we never did.”

Two loan officers, an underwriter and two processors work with Turner to originate home loans at Farmers & Merchants. Last year they produced 95 mortgages totaling $18 million in loan volume. All of those home loans and servicing are sold to larger banks. Even though Farmers & Merchants was approved to sell directly to Fannie Mae and Freddie Mac, Turner notes that “it’s not cost efficient to sell directly” to the government-sponsored housing enterprises.

Turner is not afraid of losing borrowers to the sales and marketing efforts of larger lenders that purchase originations from Farmers & Merchants. “We know our customers,” Turner explains. “We get a tremendous amount of repeat business.”

Turner also points out other mortgage lenders aren’t known for returning customers’ phone calls the same day as Farmers & Merchants does. “We’re not about the numbers,” he says. “We’re about the customers.”

In 2014, Turner expects the bank’s mortgage loan volume to be at least $24 million. Although market conditions dictate production levels more than regulations do, the new guidelines will lower the profitability of mortgage lending. He notes that “more expense and time” are required to process a loan now. “In the long run, it’s costing the consumer.”

But strict lending guidelines for the qualified mortgage loans that Farmers & Merchants originates means “we have to turn away a lot of customers” looking for a home mortgage, Turner says. That’s a regulatory cost that invisibly harms the customers, neighborhoods and economies that community banks serve.

Being a small creditor in a rural area allows Mediapolis Savings Bank to count balloon notes held in portfolio as qualified mortgages. Turner notes that while the bank also is a small creditor, its ability to portfolio mortgages could be hampered two years from now because its community was not officially designated as a rural area under federal guidelines.

However, Mediapolis Savings is already “tightening up” its lending processes to doubly ensure that loans in its portfolio maintain qualified mortgage standards, Friedel says. One change has been to lower its margins so that none of the home loans it issues fall into the “high-cost mortgage” category for regulatory purposes.

“We want to keep our loan portfolio squeaky clean,” Friedel explains, “but if [borrowers] have got good credit, we’re making loans.”

Mediapolis Savings is also pursuing new opportunities. The bank has started providing home equity credit lines, a product the bank has never offered before. Friedel sees a legitimate demand for home equity loans into the future. Even many homeowners who refinanced into long-term, fixed-rate mortgages will still need to tap their home equity to pay college tuition or buy a vehicle, he says.

In keeping with its conservative lending principles, Mediapolis Savings’ new equity lines of credit will be held in portfolio.

However, higher compliance costs and risks are driving other community banks to view home lending as less of an opportunity and even potentially more as a liability. Some community banks are moving out of mortgage lending altogether. The Bank of Commerce in Sarasota, Fla., closed its residential lending department in January, says President and CEO Charles Murphy.

One full-time loan officer and an outside processor made up Bank of Commerce’s residential lending department. This year it doesn’t plan to originate any mortgages. Currently its mortgage department is shut down, and the loan officer was laid off.

Real estate is an important economic activity in the Sarasota area, a resort and retirement destination. Bank of Commerce, a 14-year-old community bank with $200 million in assets, had maintained a presence in home lending up until this year. Yet Murphy cites “an inordinate number of regulations focused solely on the residential arena,” which results in more attention from examiners on those assets. The Bank of Commerce concluded it couldn’t ensure compliance under the new ability-to-repay rules, while generating same amount of lending volume, without adding to its staff.

“You can’t just barely be in [the mortgage business],” Murphy says. “You have to be in whole hog or not at all.” Home loans “were not a primary product” for Bank of Commerce, he notes.

Other factors contributed to Bank of Commerce’s decision to exit residential lending. The transaction-treadmill megabanks are strong competitors in Sarasota’s home loan market and can easily absorb higher compliance burdens and risks. Murphy also believes Internet lending has created a situation where “the residential mortgage is no longer a product of loyalty.” It’s not essential for community banks to offer home loans to cement customer relationships, he argues.

Anticipating ‘little change’

While that theme of avoiding regulatory costs and risk is echoed by other community lenders, many remain committed, even determined, to continue providing mortgage loans for their customers. But those community banks tend to be larger community banks with relatively more resources, larger staffs and greater mortgage origination volumes.

“Little change” operationally, for example, is expected for mortgage lending at Great Plains National Bank, says Terry Shelby, president and chief lending officer of the $600 million-asset community bank headquartered in Elk City, Okla. However, compliance costs in mortgage lending are rising faster than revenues, he adds.

Even while the new mortgage rules won’t substantially change Great Plains National Bank’s mortgage lending practices, they will require new policies and procedures, forms and staff training material to ensure the bank remains in compliance with the letter of the rules. Great Plains National Bank is doing the same things they were doing before the new ability-to-repay regulations came into effect, Shelby says. But the added documentation needed to determine that a loan application meets the ability-to-repay guidelines “makes our job harder,” he adds.

About $75 million in residential mortgages are in Great Plains National Bank’s $380 million loan portfolio, Shelby says. Most of those are either 15-year, fixed-rate mortgages or three-year, adjustable-rate loans.

The residential mortgages generated for the community bank’s portfolio generally don’t meet the qualified mortgage standards, according to Shelby. Farmers and other self-employed borrowers often can’t provide the necessary income documentation. Property appraisals are also challenging, due to a lack of comparable sales for valuation purposes.

Yet Great Plains National Bank is performing a crucial service in rural communities by providing homeowners with access to credit. Large national banks aren’t interested in serving western Oklahoma, Shelby finds, and he continues making good mortgage loans that help his customers.

Mortgage lending growth has emerged over the past three years as Great Plains set up a division to originate and sell home loans into the secondary market. After Congress enacted the Dodd-Frank Act, the bank “decided to get into secondary market lending, because everybody was getting out,” Shelby recalls. Fee income is the rationale behind originating mortgages for sale into the secondary market, he adds. Servicing rights are sold on these loans as well.

Last year about 2,000 loans, totaling $300 million in production, were generated by Great Plains National Bank’s mortgage division. Construction loans are a growing segment of that production, Shelby says.

The various ability-to-repay residential mortgage lending regulations are “non-issues” for Fremont Bank in Fremont, Calif., according to Brad Seibel, the community bank’s vice president of residential lending sales. The regulatory changes are actually producing opportunities for the bank, he reports.

Home loans are a core product for the $2.5 billion-asset community bank. Its mortgage origination volume totaled $5.3 billion in 2013, from 20,576 mortgages. That volume accounted for 93 percent of the bank’s total loan production last year. Ninety percent of its residential mortgage originations were sold into the secondary market.

Fremont Bank obtains about three-fourths of its home mortgage production through retail loan officers. Most of the balance comes from a four-year-old wholesale division which purchases from mortgage brokers. A call center also handles refinancing requests from existing customers, notes Seibel. Almost all of the bank’s loans are on California properties, and most are purchase loans.

Typically, Fremont Bank issues A-paper mortgages, Seibel says. “We’re not one to dabble on the fringes [of products or rates].”

The bank moved into wholesale lending when it saw bigger banks leaving that space. However, its retail loan officers commonly are competing against large national lenders.

Developing more of a “hands-on” approach than mega-lenders provide builds loyalty with real estate agents and borrowers, Seibel contends. The bank processes refinancing and purchase business differently to ensure top-quality customer service, such as quickly generating an approval letter, which removes contract contingencies for homebuyers.

Some new procedures have been adopted to ensure that all compliance requirements are met, says Seibel. But the implementation of ability-to-repay and qualified-mortgage guidelines “hasn’t impacted our lending philosophy.”

Fremont Bank expects to originate $2.6 billion in home loans this year, Seibel says. Since the bank has other income sources, the mortgage division doesn’t feel pressured to keep growing in difficult market conditions. Staying focused on quality loans and excellent service allows the bank to keep thriving in today’s difficult mortgage environment. From the perspective of this community bank, industry fears about the effects of qualified mortgage guidelines “may be somewhat overblown,” Seibel comments.

However, Fremont Bank appreciates being able to compete on a level playing field, Seibel adds, where all of its lenders are producing quality mortgages. “It’s brought discipline,” he says, “and that’s not a bad thing.”

Howard Schneider is a writer in California.