Small Banks Adjust to CFPB's New Mortgage Rules

Community bankers are scrambling to update their playbooks to comply with a litany of new mortgage rules.

The Consumer Financial Protection Bureau on Thursday issued updated examination procedures for mortgages, including regulations that govern ability-to-repay standards and qualified mortgages.

The regulatory update represents another headache for big mortgage lenders that are already coping with rising interest rates and a noticeable decline in refinance activity. Those banks are reviewing operations and pressing managers to prepare for the new rules.

The new rules are keeping Home Federal Bank of Tennessee busy, says Dale Keasling, the Knoxville bank's chairman, president and chief executive. Residential loans make up about half of the $2.1 billion-asset mutual thrift's $885 million loan portfolio.

"We're going to continue to make mortgage loans and we know that we'll be doing qualified mortgages," Keasling says. "We don't know how we're going to deal with [the new rules]. We've got to find a way to keep doing that business."

Many other small banks are in the same boat. The CFPB's mortgage rules are complicated and likely will require small banks to make major changes, says Rod Alba, vice president of mortgage finance and senior regulatory counsel at the American Bankers Association.

"Most of our lenders will have to recalculate risk," Alba says. "The ABA has many educational activities [on the new rules], and we know our materials are getting downloaded at a very high rate."

A CFPB spokeswoman declined to comment.

Thrifts are particularly vulnerable to changes in mortgage regulations because they are required by the Qualified Thrift Lender Test to keep more than half of their total assets in investments that include multifamily residential loans.

"It will be a challenge for us and for every other thrift," Keasling says. "It's going to limit what's available for [borrowers]. There's no getting around that."

Still, the new rules could provide opportunities for some community banks.

Orrstown Financial Services (ORRF) in Shippensburg, Pa., is looking to provide mortgage services to small banks that want limited exposure to the CFPB's regulations, says Jeffrey Seibert, the $1.2 billion-asset company's chief operating officer.

Residential loans make up 41% of Orrstown's $660 million loan book, and management thinks it can shoulder some of the regulatory load for other banks. "Some community banks may [determine that mortgages are] not a line of business that's appropriate for them," Seibert says.

Nonbank mortgage lenders have also set their sights on small banks as partners. However, lawyers, regulators and other bankers are unclear if community banks will be legally allowed to transfer any of their liabilities to nonbanks.

Community banks want alternatives to staying in the mortgage business without the headaches of CFPB compliance, says Tom Marinaro, president of Residential Home Funding, a mortgage lender in White Plains, N.Y. "Most banks need fee income from residential home mortgages" and would prefer to stay in the mortgage business, despite the new CFPB rules, he says.

Residential Home Funding offers several alternatives for small banks, including a private-label mortgage product. The company will also buy mortgage loans originated by community banks. Under some arrangements, community banks could hold "no financial risk in the event of any default of any loan at any time, unless there was fraud," Marinaro says.

Community banks should probably tread carefully in this area because the guidelines for liability surrounding the purchase and sale of mortgage loans are still being interpreted, Alba says.

Thrifts, compared to commercial banks, may have more difficulty forming partnerships with nonbank lenders, says Doug Faucette, a lawyer at Locke Lord. "No partnership can abdicate liability if the mortgage is originated in the thrift's name," he says.

Banks should thoroughly review their underwriting policies before agreeing to work with a nonbank mortgage lender, Seibert says. It is unlikely that a bank would be able to completely shift all of its liabilities by selling mortgages to third parties, he says.

A community bank would be better off working with another federally insured financial institution, Seibert adds. It is also a good idea for small banks to retain some equity in the loans they originate.

The CFPB "wants to see the bank have some skin in the game," Seibert says.