The New Residential Mortgage Origination and Servicing Regulatory Landscape

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1 The New Residential Mortgage Origination and Servicing Regulatory Landscape September 27, 2013 Robert R. Davis American Bankers Association 1120 Connecticut Avenue, NW Washington, DC (202) Michael R. O Donnell Riker Danzig One Speedwell Avenue Morristown, NJ (973) [email protected]

2 The Dodd Frank Wall Street Reform and Consumer Protection Act Signed into law July 21, 2010

3 Consumer Financial Protection Board Established by Title X of Dodd Frank to prevent unfair, deceptive or abusive act[s] or practice[s] in connection with a consumer financial product or service The CFPB has passed new residential mortgage origination and servicing regulations, effective January 10, 2014 The most recent amendments to the rules were announced on September 13, 2013, and are expected to be final

4 Key Provision: Standards for Mortgage Origination Title XIV of Dodd Frank and the new CFPB provisions establish minimum Ability to Repay ( ATR ) standards for issuing residential mortgages Borrowers have a private right of action against a lender who violates these rules The CFPB may also penalize lenders for these violations, and these penalties are essentially not appealable There is a three year statute of limitations, and liability terminates upon the pay off of the loan Violations, however, can also be used by a borrower as a set off/defense to foreclosure at any time

5 Qualified v. Non qualified Mortgages The CFPB defines mortgages as either qualified ( QM ) or non qualified ( non QM ) Non QM must meet an 8 factor ATR test Failure to do so may affect the value and marketability of these mortgages, and may result in the bank s inability to collect on the loan or foreclose on a timely basis QM are given either a safe harbor from the 8 factor test, or, if the loan is a Higher Priced Mortgage Loan ( HPML ), a rebuttable presumption that they met the 8 factor test

6 The 8 Factor Test Current or reasonably expected income/assets Employment status Consumer s monthly mortgage payments for this loan Consumer s monthly mortgage payments for other loans Consumer s monthly mortgage payments for all mortgage related obligations Consumer s current debt obligations, alimony, child support Consumer s monthly debt to income ratio, or residual income after debt obligations are paid Credit history

7 Qualified Mortgage Defined A consumer credit transaction secured by a dwelling (a covered transaction ) in which: Periodic payments are substantially equal, do not cause the principal balance to increase, do not allow for the deferred payment of principal and do not contain a balloon payment Loan term does not exceed 30 years Total points do not exceed 3% for loans over $100,000 (indexed if the principal is lower) Creditor accounts for borrower s ability to repay the loan during the period in which it has its maximum interest rate Creditor verifies the borrower s income and debt Ratio of total monthly debt to total monthly income does not exceed 43%

8 Qualified Mortgage: Safe Harbor If the previous standards are met, and the loan is not a HPML, there is a safe harbor from ATR. That is, the loan will be deemed to have complied with the ATR requirements Note that the borrower can still challenge whether the loan was a QM A HPML is a loan in which the interest rate exceeds 1.5% of the prime rate for a comparable transaction if the loan is a first lien, or 3.5% if it s a subordinate lien The key issues, both for the safe harbor and the rebuttable presumption, are likely to be the cap on points and fees and the debt to income ratio

9 Qualified Mortgage: Rebuttable Presumption If the previous standards are met, and the loan is a HPML, there is a rebuttable presumption that the loan met the ATR requirements The rebuttable presumption means that the burden of proof shifts to the borrower to prove that the lender did not make a reasonable and good faith determination that the borrower had the ability to repay the loan It has yet to be determined whether this burden will be honored in practice by either the CFPB or the courts

10 Qualified Mortgage Exceptions: Small Creditors A loan will also qualify as a QM if it meets the first 5 requirements (not the 43% debt to income ceiling) and: The creditor is a small creditor, meaning that, in the previous calendar year, it issued fewer than 500 covered transactions and had assets of under $2 billion, and At consummation, the loan was not committed to another party, unless that party also meets the small creditor requirements The loan will lose its qualified status if it is sold, unless one of these four requirements are met: At least three years have passed The transferee is a small creditor The transfer is part of a capital restoration plan or under the instruction of a conservator/trustee It is transferred as a result of the creditor s involvement in a merger/acquisition

11 Qualified Mortgage Exceptions: Balloon Payments to Rural or Underserved Areas Loans with balloon payments will not be QM unless: Payments do not result in an increase of balance, the term does not exceed 30 years, points do not exceed 3% on loans greater than $100,000 and the creditor verifies and considers the consumer s current or reasonably expected income and debt obligations, as well as that the consumer can make all payments Creditor is a small creditor and more than 50% of the properties on which it has covered transactions are in rural or underserved areas These areas are defined by the CFPB, which does not list any New Jersey counties in its 2014 list Loan will lose its qualified status if sold, unless it meets one of the same criteria as for a small creditor Balloon loans made on or before January 10, 2016, will be treated as qualified for creditors that do not meet the rural/underserved area requirements, if they meet the other balloon loan requirements

12 Strategic Considerations Underwriting standards Will the bank be able to implement underwriting standards and loan approval and review standards that will be sufficient to withstand borrower ATR challenges? Evaluate the application of the Bureau s guidance to the bank s planned program Consider the need for changes to current underwriting and loan approval practices Consider the extent to which the bank may have to obtain and analyze additional information from borrowers Will the bank have sufficient time to take the steps necessary to commence non QM lending on January 10, 2014? New regulations go into effect 15 weeks from today Even if limited to QM loans, consider whether to conduct backup ATR determinations

13 Strategic Considerations (cont.) Vendor management Work with vendors to identify the practical options that are available and the changes to the bank s mortgage origination systems that will be required Evaluate the period that be necessary to accomplish these changes Develop contingency plans in the event of unanticipated delays Consider potential costs involved in the implementation process and how the bank can best protect itself

14 Strategic Considerations (cont.) Competitiveness and profit potential Evaluate the business impact of a decision regarding the types of loans a bank will make Consider the percentages of the bank s current distribution of lending in the various categories of loans under the ATR Rules To the extent competitors are reluctant to make non QM loans, this may offer a competitive opportunity for a bank May also offer an opportunity for a bank to make loans that have a higher yield because of the additional risk involved

15 Strategic Considerations (cont.) Ability to sell residential mortgage loans Loan purchasers will develop new standards May be reluctant to buy non QM Safe Harbor loans Uncertainties will require a bank to evaluate the impact of the ATR Rules on the bank s liquidity plans The FHFA directed GSE s to limit their mortgage loan purchases to loans that are QM loans Not permitted as of January 10, 2014, to purchase any loans if they are subject to the ATR Rules and are: A loan that is not fully amortizing (no negative amortization or interest only loans); A loan with a term in excess of 30 years; or A loan with points and fees in excess of 3% of the total loan amount

16 Strategic Considerations (cont.) Fair lending considerations A bank that limits its lending to the QM Safe Harbor may find this has a disproportionately adverse impact If so, bank should develop a strong rationale for why the limitation to the QM Safe Harbor is important to achieving a legitimate business objective and why other less discriminatory alternatives would not adequately achieve those objectives Bank might cite higher credit quality associated with QM Safe Harbor loans, pro consumer features and the high level of business and legal risks associated with non QM loans

17 Bringing It All Together Management should: Evaluate and document in the record the options available and the business and legal pros and cons of each Develop a presentation and recommendation for the board Ensure that the bank is fully considering the risks, rewards and options available, including potential legal challenges Simultaneously, or after a mortgage program is developed, conduct a legal and financial stress test of that program which assists management and the board: To fully appreciate the range of business and legal risks and costs of mortgage programs and products

18 Bringing It All Together (cont.) Management should also conduct a stress test to assist management and the board to fully document the corporate record to evaluate and respond to Bank regulatory challenges based on unsafe and unsound lending practices and CRA non compliance CFPB challenges based on failure to adhere to the law DOJ, bank regulatory, HUD and CFPB challenges based on Fair Lending discrimination actions Customer nonpayment based on non compliance with ATR Rules Customer complaints and litigation alleging discrimination in the bank s lending policies and procedures The demands of the secondary market, GSE s and other purchases of the bank s mortgage products regarding mortgage products originated, sold or serviced

19 Bringing It All Together (cont.) Management should evaluate the bank s compliance and risk management functions to evaluate the bank s capacity to effectively deploy the proposed recommendations Board determines the strategic direction that the bank will take and authorizes management to implement its decision Management and the board should monitor the bank s implementation of its ATR Rules strategy and any industry and regulatory developments that could call for changes to the bank s selected strategy Following the effective date of the ATR Rules, the board should request that management monitor and report on the business results, costs, legal consequences and regulatory issues and work with management to adjust the bank s policies as appropriate

20 Questions?