For eight years, provisions of the Dodd-Frank Act have made offering home mortgages more difficult and time-consuming. But those rules are changing, creating more opportunity and competition for community banks in the mortgage market.
By Karen Epper Hoffman
Consumer mortgages are a key business for community banking: a critical loan product that often brings in new customers, strengthens ties with existing customers and defines the bank as an individual’s most significant financial provider.
However, since the emergence of the Dodd-Frank Act in 2010 and its heightened consumer protections, community banks have struggled with meeting its significant demands on reporting and its limitations on helping their borrowers. But the tide is turning. A decidedly more bank-friendly Congress, administration and Consumer Financial Protection Bureau (CFPB) have aligned to introduce new legislation to lighten the qualified mortgage burden—just as the housing markets in many regions are heating up again.
The qualified mortgage kerfuffle
Signed into federal law in July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was intended to limit the likelihood of another financial crisis or subprime mortgage debacle. Unfortunately, as many community bankers and their supporters point out, many of these regulations placed disproportionate pressure on the wide swath of banks with less than $10 billion in assets—banks that contributed relatively little to the financial crisis of 2008-09.
In particular, many community bankers saw Dodd-Frank’s so-called qualified mortgage rule as far too restrictive. In addition to requiring significantly more reporting on the processing of every home mortgage—which could add weeks and dozens of employee hours to the process—the core of this rule states that the borrower’s debt should not exceed 43 percent of their income. As community bank lenders know, that can be a challenge in dealing with major customer segments, such as small-business owners or retirees, who may have a limited or diverse income but boast other assets and collateral.
For community banks, this legislation created a dichotomy in their mortgage business: Some borrowers met the qualified mortgage rule, and others did not. Those in the latter camp, whose income did not allow them to meet the qualified mortgage standard, were often very responsible borrowers. But under this legislation, their mortgage options were more limited. Community bank lenders were also forced to accommodate the greater amount of working, tracking and monitoring this fast-growing segment of non-QM loans demanded. Indeed, mortgage-backed securities that do not meet the qualified mortgage standard have grown more than tenfold from $369 million in 2015 to $3.9 billion last year, according to Nomura Securities.
“[The qualified mortgage rule] limited banks from making reasonable credit decisions for borrowers that exceeded the 43 percent debt-to-income threshold.”
—Todd Hopkins, CorTrustBank
“It limited banks from making reasonable credit decisions for borrowers that exceeded the 43 percent debt-to-income threshold,” says Todd Hopkins, president of the mortgage subsidiary of $852 million-asset CorTrust Bank in Mitchell, S.D. “Lending on character went out the door. Banks simply wouldn’t make these loans because of the risk associated with having a non-qualified mortgage loan on their books.” In the long run, Hopkins adds, this had a “detrimental effect on many smaller community banks, as well as the communities they serve.”
Ron Haynie, ICBA senior vice president for mortgage finance policy, agrees that “all community banks were negatively impacted” by Dodd-Frank’s qualified mortgage requirements. “If you wanted to be a community bank mortgage lender, there were limitations on how many [mortgages] you could sell and how big your bank could grow,” Haynie says. In particular, the higher level of review for exceptions to the QM rule forced many community banks to ignore their better judgment.
“Even if you knew the borrower and it was a good risk, and maybe the bank was already lending to the [borrower’s] business, it was difficult to approve them,” Haynie adds. “And that loan might be an exception to the policy, and so there would be a lot of caution about making that loan, and the bank might be exposed to legal liability.”
MBSs that did not meet qualified mortgage rule in 2017
Indeed, says Hopkins, “Currently, a lot of smaller community banks in rural areas won’t originate mortgage loans because of the risk and complexity of complying with Dodd-Frank rules related to mortgage lending.”
Loosening the QM rules
But with the shift to a more bank-sympathetic administration and Congress after the 2016 election, there has been more focus on changing the qualified mortgage rule, at least to take the bulk of the regulatory pressure off community banks. In a presentation at the National Association of Realtors conference in Washington, D.C., earlier this year, the acting director of the CFPB, Mick Mulvaney, commented, “Our duty is to look at unduly and overly burdensome regulations, and our statutory interest is to see markets function. You’re going to see us try to bring some sanity to the larger market, including QM.”
On May 24, 2018, President Donald Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act. It makes several changes aimed at reducing the regulatory burden on small and mid-sized banks with less than $10 billion in assets, including, notably, the QM rule under the Dodd-Frank Act. The new legislation effectively excludes mortgage loans made by financial institutions with less than $10 billion in assets from escrow requirements under the Truth in Lending Act (TILA, or Regulation Z).
According to ICBA, the act will simplify capital rules, offering relief from red tape on mortgages and a short-form call report for community banks. The new legislation allows community banks to offer mortgages outside the typical QM rule so long as they don’t sell that mortgage but keep it in-house. Haynie says this new legislation will allow community bank mortgage lenders to return to “using their own internal credit policy that they used before Dodd-Frank, based on their specific risk appetite and [giving] them the ability to better meet the needs of their customers.”
Appraising the issue
With a population of less than 1 million, South Dakota is one of the most sparsely populated states in the country.
Community banks therefore serve a vital role in serving the state’s widely dispersed populace, often by offering them mortgage loans.
“In many cases, particularly here in South Dakota, our bank is the only financial institution in the community,” says Todd Hopkins of CorTrust Bank, which has 22 locations in South Dakota and a handful in neighboring Minnesota.
With the previous limiting QM rules in place, Hopkins maintains that many local South Dakota banks “cannot serve the customers and citizens of these communities as well as they could. Clearly, any loosening of Dodd-Frank rules would be very beneficial to these banks and the communities they serve.”
Hopkins says the Dodd-Frank Act made “a huge impact on mortgage lending. … Not all of it has been bad; there has been some good that has come out of it.” One of the effects of these rules is that they’ve slowed down the process of buying a home—not necessarily a bad thing for consumers, according to Hopkins. However, the easing of mortgage appraisals, particularly in the rural markets that CorTrust Bank serves, would give the bank much more flexibility in its mortgage lending.
But concerns remain. “The problem is the cost of having appraisers go out to these areas,” Hopkins points out. “We have appraisers in or near most of these areas that can do the appraisal, but the rule states that there need to be three in that market that ‘need to be available within five days of a reasonable time frame.’” Hopkins says that there are many areas, particularly in South Dakota, where there are not three appraisers in business, “so this exemption is good, but could be better.”
“It is so expensive to have an appraisal done in these areas relative to what it costs in larger communities,” he adds. “I think if it’s a smaller loan, it would be easier to use a BPO [broker price opinion] or tax-assessed valuation to determine value. These are loans that, in many cases, we are putting on our books and have exposure to their risk anyway.”
Karen Epper Hoffman is a writer in Washington state.