CFPB Mortgage Changes Would Help Small Banks

It's now been more than a year since lenders became subject to the ability-to-repay rule and related qualified mortgage standards. While it's still too early to tell what kind of impact this rule will have on the financial services industry in the long term, so far the effects appear to be manageable for many lenders and for the overall industry. Community banks, however, have faced more challenges — and that's troubling news for the Americans in low-income and rural areas that tend to rely upon smaller lenders.

In January 2014, the Consumer Financial Protection Bureau enacted the ability-to-repay rule, which aims to protect homebuyers by requiring mortgage originators to "make a good faith, reasonable determination of a consumer's ability to repay" the loan.

At first, financial institutions were concerned the rule would put them between a rock and a hard place. On one hand, the Community Reinvestment Act encourages lenders to meet the borrowing needs of all segments of the communities in which they operate, including low- and moderate-income neighborhoods. On the other hand, the Dodd-Frank Act imposed tighter underwriting standards on banks, raising the bar for credit access.

Early indications suggest that many larger banks seem to be managing the rule's inherent challenges and opportunities relatively well. But small banks, which play a disproportionately large role in the U.S. residential mortgage origination market, have felt more of an effect.

One of the most significant outcomes of the ability-to-repay rule has been the strengthening of credit underwriting standards. Many banks see the benefit of the rule and have welcomed tighter lending requirements.

It's easy to see how stronger credit standards could help to prevent some of the issues that led to the economic downturn and housing market crash of last decade. For example, requiring that the source of repayment for a mortgage loan be commensurate with potential fluctuations in loan terms can help to improve banks' balance sheets by reducing the amount of past-due and other problem loans.

However, the shift toward tighter credit standards is not without its challenges. As lenders are required to comply with more regulations, it becomes increasingly difficult and costly to qualify borrowers. This could lead to less credit availability for homebuyers as banks reduce the amount and variety of loans that they offer to borrowers. And those who are able to qualify for a loan may face higher borrowing costs, especially if interest rates rise. Potential conflicts with the CRA pose another challenge.

All of these challenges are compounded for community banks, which have seen a declining market share in several key areas, a significant decline in residential activity, and significant losses over the past few years, according to a Harvard paper published in February 2015. Indeed, community banks in several states view qualified-mortgage and ability-to-repay rules as burdens to community lenders and impediments to individuals seeking residential loans, according to a 2014 survey by the Federal Reserve System and Conference of State Bank Supervisors.

There does seem to be hope for struggling community banks. In response to some of the issues facing community banks, the CFPB issued a proposal in January that would relax rules for some small mortgage lenders to allow more community banks and credit unions to grant home loans to borrowers with high levels of debt. Under the proposal, more banks and credit unions would be able to qualify as small lenders, allowing them to expand lending through riskier loans. If finalized, the proposed rules will generally benefit the smaller community banks that play a significant role in lending to rural and underserved areas.

Ivan Garces is a risk advisory services principal in Kaufman Rossin's Miami office. He can be reached at igarces@kaufmanrossin.com.