Community Bank Mortgage Lending: Loans that Don't Fit the Box and Paying the Price for Others

The following is an excerpt from Chapter 3 of Volume I of The Mortgage Professional's Handbook:

LOANS THAT DON'T FIT THE BOX:
BALANCING CREDIT QUALITY WITH ACCESS TO CREDIT

Camden R. Fine, President and CEO
Independent Community Bankers of America

The community bank mortgage lender’s niche is making loans that don’t fit in the standard secondary-market box. Properties that are not cookie-cutter residential properties are common in rural markets. Many of these loans are of small-dollar amounts, or are made to first-time home buyers or borrowers with seasonal employment. Community banks serving larger urban and suburban markets also structure their mortgage-lending operations to meet their communities’ unique needs. For instance, some community banks in the Washington, D.C., area specialize in serving foreign nationals, while ethnic communities in cities such as New York, Los Angeles, and San Francisco have established minority community banks to serve their distinct borrowing needs.

Community bank mortgage lenders use their knowledge of the market and the customer to structure loans that will work for both the bank and the borrower. That might require structuring the loan with annual or semi-annual payments or a balloon feature, or using multiple pieces of property to collateralize the loan. A short-term loan to assist with renovation that is paid off with a sale of a crop happens often. Documenting assets and cash to close may look different. Livestock in a feedlot waiting for sale, and crops ready for harvest or in storage silos, may substitute for cash in the bank that would appear on a bank statement.

These are not loans that will be sold in the secondary market, and the bank will service them for the life of the loan. If the borrower experiences a financial hardship at some point during the loan, the community banker will work out a repayment plan or modification to prevent a foreclosure. This has been a common practice for community banks for many years, long before the CFPB and national mortgage settlements forced it on larger servicers.   

Community banks typically seek to charge low fees to customers for loans they retain in portfolio. But because they are retained in portfolio, the bank may charge higher interest rates than are charged for secondary market loans. This is especially true for smaller-balance loans, where costs are higher to originate and many times the credit risk is also higher. While these loans do not meet the regulatory definition of “High Cost” loans generally, they are “Higher Priced Mortgage Loans,” for which regulations require the bank to escrow for taxes and insurance. This creates challenges for many community banks with fewer staff or technology resources to support the escrow management process. Also, requiring the borrower to fund a portion of the escrow account at closing places an additional burden on the borrower and impacts the amount of cash they need to close. New appraisal rules also contribute to higher costs, especially for smaller-dollar loans.   

PAYING THE PRICE FOR THE SINS OF OTHERS

Regulators and policymakers frequently say: “We know community bank lenders didn’t make the toxic loans that blew up on consumers, triggering massive foreclosures, and driving the housing market and the U.S. economy into the deepest recession in over 80 years.” Unfortunately, the actions of regulators and policy makers do not recognize this fact. As the crisis unfolded, regulators, policymakers, government-sponsored enterprises (GSEs), and larger correspondent aggregators all treated community banks and their loans the same as those that caused the meltdown. Obviously, in a severe national economic downturn, unemployment spreads, housing values plummet, and defaults and loan losses will increase. Bankers understand that. Community bankers worked through as many defaulted portfolio loans as possible to restructure the loan, modify it, or use forbearance—whatever would make sense to keep the loan out of foreclosure and to minimize the impact on the borrower, the community, and the bank. Some community banks did have to foreclose, and some took extensive losses on construction loans to local builders. But for the most part, mortgage loans that community banks retained performed satisfactorily throughout the crisis.  

Community bank loans that were sold into the secondary market generally performed better than loans sold from other originators. However, community banks did not receive any better treatment from the secondary-market players, which sought to minimize their losses by forcing the repurchase of loans in default.  

The GSEs’ aggressive default quality-control processes used forensic appraisals and pushed back loans to community bank sellers for issues relating to the selection of comparable sales or distance or age of comparable sales. Community banks have always struggled with GSE and secondary-market guidelines that are more compatible with suburban or urban markets, where housing stock is of similar design, higher density, and higher volume of sales and in close proximity to comparable sales. Rural and small town market are the opposite, making appraisals more challenging—even in good economic times. Correspondent buyers were equally as aggressive in forcing buy-backs or, more frequently, “make-whole” demands, where the community banker was asked to reimburse, or “make whole,” the investor for any loss, usually after the property had been liquidated. These were the same investors who actively courted community banks to get their high-quality mortgage production. They as well as the GSEs withdrew customer support from community bank lenders in efforts to reduce costs. Small-volume community bank sellers were frequently cut off or dropped by correspondent investors and the GSEs for low volume or inactivity. As a result, many community banks turned to other secondary-market sources, such as the mortgage programs offered through various Federal Home Loan Banks. The Independent Community Bankers of America’s 2014 Community Bank Lending Survey showed that 25% of the survey participants use the FHLB secondary market programs.

As a result of the mortgage crisis, regulators and Congress swung into action to enact laws and adopt rules to prevent future mortgage loan defaults due to poor quality and fraudulent loan-originator behavior. While there have been many rules written, the following have had the biggest (negative) impact on community bank mortgage lending.

·         Qualified Mortgage (QM) Rule: Even with the small-creditor exemption, some community banks will be forced to offer adjustable-rate mortgages to replace the balloon-payment loans they have done traditionally. Balloon loans lose their QM safe harbor status for all non-rural small creditors in April, 2016. Because ARMs are more difficult and costly to service, community banks affected by this change may opt to exit the mortgage lending business altogether. Even though community bankers tend to know their customers, most are not comfortable with assuming the legal risk involved in making a mortgage loan that is not a qualified mortgage.

·         SAFE Act: The Secure and Fair Enforcement for Mortgage Licensing Act requires all mortgage loan originators who originate first- and second-lien 1-4 family mortgages to register with the Nationwide Multistate Licensing System and Registry. The law also requires banks to fingerprint and perform background checks on all registered loan originators and to update the registration on an annual basis. In some small community banks, the CEO may also be the primary loan officer and originator. In many cases, this individual has been employed by the bank for decades and now has to go to the local police station to get fingerprinted, while the HR manager has to do a criminal background check, to continue to do the same job they have done in a safe and sound manner for decades.

·         Mortgage Escrow Rules: The CFPB has imposed mandatory escrow requirements on all Higher-Priced Mortgage Loans and High-Cost mortgage loans. Many community bank mortgage loans can fall into the HPML category and now must have escrow accounts for taxes and insurance. Only those institutions that are small creditors and operate predominantly in CFPB-designated rural areas are exempt from these requirements.

·         TILA-RESPA Integrated Disclosures (TRID): Implementation of the new TRID regulations and forms has presented challenges for all lenders. For community banks that rely on third-party vendors to provide upgrades to their systems, the combination of the costs to upgrade, time to train all staff involved, and fear of legal and enforcement actions for minor errors will drive some out of the business.

The compliance burdens of the massive amount of new regulations have been felt across all lenders in the mortgage market. But for community banks that cannot spread the hard costs of compliance with these rules across a large book of business, it can be the straw that breaks the camel’s back. Compliance costs are the primary factor driving community banks out of the mortgage business, according to a recent ICBA mortgage lending survey. When that happens, access to credit in small towns and rural communities diminishes, because community banks are frequently the sole source of local mortgage credit in those areas. Most of the large national lenders don’t service those small markets, because there are not enough loans to support an office there.

Read the rest of this chapter in The Mortgage Professional's Handbook!

Camden R. Fine is president and CEO of the Independent Community Bankers of America® (ICBA), a national trade association representing the interests of more than 6,000 community banks of all sizes and charter types. ICBA has member banks in every state and territory in the United States. 

A native Missourian and career community banker, Fine came to ICBA in May 2003. Previously, Fine chartered and organized Midwest Independent Bank of Jefferson City, Mo., and served as its president and CEO for nearly 20 years. In addition, Fine owned MainStreet Bank of Ashland, Mo., a $50-million-asset community bank.

Fine was educated at the Virginia Military Institute and the University of Missouri-Columbia. He served as an officer in the United States Army and Missouri Army National Guard and was honorably discharged in 1992. He is a distinguished graduate and past chairman of the Stonier Graduate School of Banking. He currently serves on the President’s Committee of the World Savings Bank Institute headquartered in Brussels, Belgium. 

Fine has been featured and had opinion pieces published in The Wall Street Journal, Washington Post, Washington Times, New York Times, USA Today, Politico and The Hill newspapers. Fine has been a guest host on CNBC’s “Squawk Box” and has been featured on CNN, MSNBC, Fox Business, Bloomberg, PBS and NPR. He has been recognized by The Hill newspaper and CEO Update as one of Washington’s most effective and influential trade association CEOs and lobbyists for eight consecutive years.