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Harmonizing Regulations Can Help Jumpstart the Mortgage Market

Harmonizing-RegulationsBy Bill Cosgrove

There’s no longer any doubt about the effect of overly complicated and burdensome rules on the mortgage market. This entangled web of overlapping regulations is stifling the mortgage markets and is ultimately affecting lenders’ abilities to best serve their customers. Harmonizing regulations can and will help jumpstart today’s sluggish housing market.

On the federal level alone, every day lenders decipher a complex web of dozens of regulations from six federal regulators.  For my independent bank, I also have to add regulations from 22 different states–imagine if I was operating in all 50 states! Then add requirements by Fannie Mae, Freddie Mac, FHA (Federal Housing Administration) and Veterans Affairs on top of federal and state regulations.  Getting a messy picture?

Let me be clear from the outset. Lenders support following the rules and complying with necessary regulations. We agree that improved regulations were necessary to protect consumers and ensure that the mistakes of the past never happen again.  But there’s a pivot point where regulatory overreaction becomes counterproductive to the ultimate goal of providing the consumer a safe, sound, and AFFORDABLE loan.  Even the U.S. Department of Housing and Urban Development (HUD) Secretary Julian Castro talked about the regulatory pendulum swinging too far to the detriment of consumers at MBA’s Annual Convention last fall. 

A strong marketplace requires balance –  a balance of consumer protection and access to credit for qualified borrowers.  Therefore, matching borrowers with affordable, sustainable loans must be a priority.  On the residential side, MBA’s focus is first-time homebuyers.  For commercial and multifamily, we’re focused on ensuring sufficient liquidity to support a robust commercial and multifamily marketplace.

The Outlook

A strong U.S. economy, job growth, and increasing wages are expected to fuel further expansion in the real estate markets.  But despite this encouraging forecast, a significant gap persists of first-time homebuyers in the marketplace. New generations of potential borrowers who are ready to buy simply can’t, in part because federal regulations keep them on the outside looking in waiting for the perfect loan.

Look at just one growing segment being kept out of the mortgage market – Millennials.  According to a recent story in Barron’s magazine, Millennials are the largest population cohort the U.S. has ever seen and already account for $1.3 trillion of consumer spending annually, or 21 percent of total consumer spending.  Apartment demand is strong around the country thanks largely to this Millennial surge. Effective apartment rent growth reached 5 percent in February, the second time in three months that it reached that significant threshold. Housing could be the next major industry to benefit from this cohort’s size and maturation.  But we have to get the rules right and have a clear path to responsible lending and homeownership.

Cost of Compliance

When that pendulum Secretary Castro mentioned swings too far, the cost of servicing each loan drastically increases. This compliance cost directly impacts the average American family trying to purchase a home.  In 2008, the cost to service one loan was $85.  By 2013, those costs had jumped to $205 per loan–that’s a nearly 250 percent increase!  We’re down a little today, to around $170 per loan, but that’s still more than twice what it was six years ago. 

We can see the same trend in originations.  The average cost for lenders to produce a loan in 2014 was nearly $7,000; in 2009 the cost was nearly half this amount at $3,500.  Add up the costs of origination and servicing and you can clearly see how it’s becoming increasingly difficult for some lenders, particularly smaller independent and community banks, to remain in business.  These costs also get transferred to borrowers, pricing many of them out of the mortgage market or, at a minimum, leaving them sitting on the sidelines much longer saving for that perfect loan. 

Another cost often overlooked is reduced competition in the marketplace. This can lead to fewer choices for consumers.  For example, more and more families and borrowers are looking to their local community banks and independent mortgage banks to get financing to purchase their homes.  In 2013, 42 percent of total purchase originations were generated by independent mortgage banks, a rise of nearly 15 percent since 2008.  But the number of independent banks has fallen over 15 percent since 2008, and one of the likely reasons is thatthey could not operate in today’s heavily regulated marketplace. 

Reshaping Business Models

The current overly complicated regulatory environment is reshaping the way lenders conduct business, but sometimes not for the better.  Various policies have had significant consequences and often unintended ones.  For example, Basel III, Mortgage Servicing Rights guidelines, bank versus non-bank regulations, and other rules affect each business model in very different ways.  The real problem is that regulators disagree about exactly what problems need solving.  Some focus their efforts on protecting community and small banks; some focus their efforts on “too big to fail” banks; others focus on independent mortgage banks and non-depositories; and, finally, let’s not forget about the reinsurance models.

The problem is that this effectively leads to regulators picking winners and losers in the marketplace through public policy.  It also leads to massive confusion in the marketplace by segregating different roles for different business models.  It reduces competition, leading to less liquidity and fewer choices for borrowers. 

Let’s take, for instance, national servicing standards that continue to evolve.  The rule has extensive provisions governing loss mitigation requirements when a consumer is unable to make payments as well as requirements regarding an institution’s response to consumer inquiries and when a consumer must receive certain notices. 

Implementing the servicing rule’s requirements demanded significant system changes and staff training that has been time consuming and costly for the industry. There is also an ongoing effort to obtain guidance and clarification in areas where the rule is unclear.  Additionally, responding to CFPB (Consumer Financial Protection Bureau) investigations, often in conjunction with multiple state examinations, has required a significant resource commitment from servicers.  These federal regulations alone forced some lenders to sell off their servicing business and some servicers left the marketplace entirely.  

Adding to the complication are state regulators who want to instill their own servicing rules and investigations on top of the national standards.  Simply put, there is no need to reinvent the wheel 50 different ways for loan servicing.  Let’s leverage the CFPB and the newly released GSE (Government-Sponsored Enterprise) standards first.  Let them serve as a template so all regulators and lenders, and, most of all, consumers know that everyone should abide by the same rules of the road.  Additionally, the CFPB’s supervision activities should take into account possible parallel state investigations and provide more timely feedback to servicers when examinations have concluded. 

MBA and its members believe every consumer is entitled to quality customer service, timely communication, and a fair hearing if they fall behind on their mortgage payments.  Consumer-facing rules need to hold servicers accountable, but they also need to recognize the complexity of the default servicing business and the need to avoid conflict and confusion where possible.

It’s critically important that state and federal regulators understand the importance of servicing to the mortgage value chain and the risks of overreacting.  Excessive and punitively high capital standards relative to the risk of the asset drive up costs to consumers.  Capital standards that are too high will mean fewer servicers, more concentration, and greater systemic risks. 

As federal and state regulators move forward on new servicing standards, it’s important that they take the time to get it right.  We need uniform standards, not balkanized standards that differ between federal regulators as well as between state and federal regulators.  Capital and liquidity rules should not be punitive. Finally, we need to recognize the benefits of a diversified base of servicers and servicing business models to diversify risk in the system and encourage companies to invest in their servicing platforms.  All of this translates to improved and protected customer service. 

Allow me to address a few other specific rules that impact the mortgage market and would benefit from harmonization:

TILA/RESPA Integration Rule

I would be remiss not to specifically talk about the elephant in the room, CFPB’s rule change and model disclosures that combine and integrate the disclosures under the Truth in Lending Act (TILA) and the Real Estate Settlement Procedures Act (RESPA). The final rule was issued on November 20, 2013 and implementation is required on August 1.   This is the most sweeping change to ripple through the home-purchase process in decades. 

The final rule requires the use of new, integrated disclosure forms for consumers at the time of mortgage application and settlement, known as the Loan Estimate and the Closing Disclosure, respectively. In addition to new forms, the rule brings major changes to the mortgage origination and closing process, including changing the definition of “application,” clarifying responsibilities for providing the forms, establishing tighter tolerances or limits on cost increases from application to closing, and installing a three-day period between provision of the Closing Disclosure and consummation of the loan. If a creditor makes certain specific changes between the time the Closing Disclosure form is provided and closing, a new form must be generated and an additional three business days must be allowed before closing.

This rule constitutes a sea change for lenders, settlement service providers, real estate agents, and consumers. Lenders and assignees face significant liability for failures to comply.  Making the changes required by the rule has necessitated considerable expense for systems and business process changes, training, and other needs, and, unfortunately, some of these costs are ultimately borne by consumers.

To date, the CFPB has provided only limited verbal guidance and clarifications on the rule. MBA has urged the CFPB to provide authoritative written guidance–developed with stakeholder input–on difficult implementation issues as they arise. The CFPB also must, once again, resolve conflicts between this federal rule and state law.  If it does not, state laws and practices threaten to add undue complexity and confusion for lenders and borrowers alike.

Lenders and other settlement service providers, including community banks and smaller independent mortgage bankers, rely heavily on vendors to build and maintain systems necessary to comply with regulations. Therefore MBA urges the CFPB to expand its outreach to industry vendors to better enable them to develop tools to facilitate compliance.

SAFE Act

The Secure and Fair Enforcement for Mortgage Licensing  Act of 2008 (SAFE) created two parallel  but asymmetrical regimes for mortgage loan originators (MLOs) that have resulted in uneven consumer protections and an unlevel playing field for mortgage originators.

The SAFE Act created three serious issues:

1)   The absence of a national testing requirement deprives consumers of the assurance that they are served in all cases by MLOs who have demonstrated minimum standards of competency via a comprehensive examination;

2)   An uneven playing field where banks and bank affiliate lenders can recruit MLOs who don’t have to withstand the rigors of testing. Pass rates on the SAFE Act test demonstrate that exams are rigorous; only about two-thirds of MLOs pass on the first try; and

3) Depository lenders and affiliates could be exposed to adverse selection by MLOs that cannot pass the test. In addition, state licensing of MLOs can be a slow and burdensome process, which creates a disincentive for MLOs who are already employed at bank and bank affiliated lenders from moving to non-bank lenders.

Congress should amend the SAFE Act to require uniform testing standards for all MLOs regardless of the business model for which they work; require the states to provide for speedy licensure of qualified MLOs moving from a bank or bank affiliate lender to a non-bank lender; and require that, if a state is unable to grant a license within seven business days, it would be required to provide a transitional license to its MLOs. 

Together these steps would ensure for consumers that all MLOs have met minimum standards of competency, prevent adverse selection of MLOs at banks, and ensure non-bank lenders can fairly compete for talented MLOs.

Ability to Repay/Qualified Mortgage Rule

The Ability to Repay/Qualified Mortgage (ATR/QM) rule must be improved to ensure that more qualified borrowers can access safe and sustainable credit.  For a loan to qualify as a QM and meet the ATR requirement, it may not contain certain “risky” features, such as interest-only or negative amortization terms, and it must meet specified underwriting standards.  These standards also include a debt-to-income (DTI) ratio cap of no more than 43 percent, or, in the alternative, eligibility for the GSEs’, FHA, or other government programs (the so-called “QM patch”). 

Considering the significant potential liability and litigation expenses for an ATR violation, many lenders have limited themselves to making only QM loans generally and QM safe harbor loans in particular. As a result, some categories of borrowers that should qualify for a QM are have trouble gaining access to safe, sustainable, affordable credit. MBA believes that the ATR/QM rule must be revised to ensure that as many qualified borrowers as possible have access to safe and sustainable mortgage credit.  Specifically, we’re working to expand the safe harbor, increase the small loan definition, broaden the right to cure for DTI, replace the patch and the default QM, and revise the points and fees definition.  Accomplishing these goals will allow more qualified borrowers to obtain the access to credit they need for the homes that suit them best.

Basel III – Treatment of Mortgage Servicing Rights

The punitive treatment of mortgage servicing rights under the Basel III risk-based capital standards threatens to undermine the value of this important asset with adverse implications for the entire mortgage finance chain.  Performance, capacity, and service should be the primary drivers of who gets market share in servicing, not excessively high capital standards on one segment of the industry. The new Basel III rule increases the risk-weighting of mortgage servicing rights (MSRs) held by banks from 100 percent to 250 percent. The unnecessarily punitive treatment of MSRs makes them one of the most costly asset classes in the entire Basel III framework.

In significant part, due the new Basel rules, banks of all sizes are shedding MSR assets at a record pace, and moving these assets to banks with smaller MSR exposures and to non-bank servicers.  Many of these transfers are driven by Basel-related issues, not necessarily by the core competencies of the parties involved.  As a result, many banks that are good at servicing and want to remain in the business are forced to dramatically increase capital levels or shed the asset.

U.S. bank regulators should reject the Basel III limits on MSRs.  MSR capital treatment should continue under the current capital framework without imposing a 10 percent cap or a 250 percent risk-weighting under Basel III.  If bank regulators insist on moving forward with the Basel III treatment of MSRs, they should change the risk-weighting back to 100 percent, increase the 10 percent cap, and exclude MSRs from the 15 percent cap.

Basel III – High-Volatility Commercial Real Estate

While we’re on the subject of Basel III, let’s not forget about compliance and regulations that affect commercial real estate.  Basel III is a global regulatory framework for bank capital adequacy, stress testing, and market liquidity risk agreed to by the Basel Committee on Banking Supervision, an international body in Basel, Switzerland. The Basel III High-Volatility Commercial Real Estate (HVCRE) Rule became effective January 1.

Under the HVCRE rule, acquisition, construction, and development loans that do not meet certain underwriting criteria are considered “HVCRE exposures.” This includes loans with a loan-to-value ratio of less than 80 percent or contributed capital to the project through cash or unencumbered readily marketable assets of less than 15 percent of the real estate’s appraised “as completed” value among other things.

For HVCRE exposures, the risk weight is 150 percent compared to 100 percent risk weight for commercial and industrial loans, resulting in higher capital requirements. For risk-based capital reporting purposes, banks will be required to determine the HVCRE status for each of their acquisition, construction, and development loans for the first quarter.

To comply, commercial lenders need to modify their regulatory reporting systems to evaluate the HVCRE status for each loan in their acquisition, construction, and development portfolio.  MBA identified several issue areas that require clarification, including the 15 percent equity requirement measured under the Basel III HVCRE rule; how to satisfy the unencumbered readily-marketable assets/sources of 15 percent contributed capital; reclassifying HVCRE to Non-HVCRE; permitted withdrawals; credit facilities that should be characterized as HVCRE Exposure if they meet the HVCRE criteria; and repo loan facilities and loan facilities secured by HVCRE loans. This change in systems costs time and money, but nothing can happen without clarifications to the HVCRE rule.

The Solution

We have a bright future ahead with the rise in household formation and an improving economy and job market.  The housing market desperately needs a good jumpstart to continue supporting growing communities and businesses.  As compliance professionals, MBA needs your input and first-hand knowledge on the direct impacts to business models, access to credit, and costs to businesses and consumers. Join our advocacy efforts and lend your voice to help clarify and streamline state and federal regulations so lenders of all sizes can continue providing quality customer service. 

We have two choices. We can continue searching for the “perfect loan,” allowing real estate finance to be a drag on the economy, or regulators can fix the rules and return real estate finance to be the driving force of the American economy.  The layered regulations state-to–state, federal-to–state, and among federal agencies continue to stifle mortgage market growth.  If they are going to regulate us, regulators have a duty to harmonize the regulations and remove unneeded bureaucracy that does nothing to further protect consumers and only serves to limit their options. 

cosgrove_b_lgBill Cosgrove, Chairman of the Mortgage Bankers Association, is the Owner and CEO of Union Home Mortgage Corp. headquartered in Strongsville, Ohio.  Mr. Cosgrove has  served as president of the Ohio MBA, chairman of MBA’s MORPAC Committee, on the  MBA Board of Governors, and been a long-time member of the MBA Board of Directors.

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