Category Archives: Commercial Banking

The Latest AVM QC Requirements for Lenders

With the greater adoption of artificial intelligence (AI) and other automated systems in the financial services industry, the federal financial regulators have shown increased interest in how financial institutions use these technologies. These systems can improve operational efficiency and customer service. However, the regulators have expressed concern that, without appropriate care, the deployment of these technologies can lead financial institutions to take on unnecessary risks that could result in the organization operating out of compliance with applicable laws and regulations, including but not limited to those related to safety and soundness and discrimination.

On June 21, 2023, the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System (Federal Reserve), Federal Deposit Insurance Corporation, National Credit Union Administration, Consumer Financial Protection Bureau, and Federal Housing Finance Agency (collectively, the Agencies) issued a Notice of Proposed Rulemaking (NPRM) that seeks comment on a proposed rule governing the use of AI and other algorithmic systems in appraising home values (proposed rule). The proposed rule implements the quality-control standards mandated by Section 1125 of the Dodd-Frank Act for the use of automated valuation models (AVMs) by mortgage originators and secondary market issuers to value single-family and one-to-four-unit multifamily homes. While four of the five proposed quality-control standards are based on those specified in the Dodd-Frank Act and are consistent with standards that are currently set forth in regulations and guidance for appraisals, the Agencies are proposing a fifth standard that AVMs comply with applicable discrimination laws.

This Advisory provides an overview of the proposed rule and includes key takeaways and other considerations for institutions that would be covered by the proposed rule.

What institutions would be covered by the proposed rule?

The proposed rule would apply generally to mortgage originators and secondary market participants and specifically to financial institutions; subsidiaries owned and controlled by a financial institution and regulated by a federal financial institution regulatory agency; credit union service organizations; and any party that creates, structures, or organizes a mortgage-backed securities transaction (Covered Institutions). Third-party service providers of banking organizations that provide related services may also be directly or indirectly affected by the proposed rule, based on the Bank Service Company Act and the newly released Interagency Guidance on Third-Party Risk Management. Similar to the Interagency Guidance on Third-Party Risk Management, the proposed rule is principle-based and does not prescribe particular quality-control standards. Unlike the guidance, however, the proposed rule would be binding and noncompliance could result in formal and informal enforcement actions against a Covered Institution for failure to have what the Agencies deem to be appropriate policies, procedures, and practices—even if there are no alleged violations of other laws or regulations. For more information about the Interagency Guidance on Third-Party Risk Management, check out our prior Advisory.

What transactions would be covered by the proposed rule?

The proposed rule would apply to transactions (Covered Transactions) that use AVMs to value collateral in connection with making a credit decision or covered securitization determination regarding a mortgage or mortgage-backed security. The term “automated valuation model” would be defined as any computerized model used by mortgage originators and secondary market issuers to determine the value of a consumer’s principal dwelling collateralizing a mortgage, even if the mortgage is primarily for business, commercial, agricultural, or organizational purposes. The proposed rule includes definitions for several other key terms, including but not limited to “control systems,” “covered securitization determination,” “mortgage originator,” and “secondary market issuer.”

What transactions would be exempt from the proposed rule?

The proposed rule distinguishes between using AVMs to determine the value of collateral securing a mortgage and using AVMs to monitor, verify, or validate a previous determination of value. Thus, the proposed rule expressly excludes the use of AVMs in monitoring the quality or performance of mortgages, reviewing already completed determinations of the value of collateral, or developing an appraisal. As such, the proposed rule would not apply to the use of AVMs in the (i) monitoring of the quality or performance of mortgages or mortgage-backed securities; (ii) reviews of the quality of already completed determinations of the value of collateral; or (iii) the development of an appraisal by a certified or licensed appraiser.

What are the proposed requirements?

Covered Institutions would need to have policies, practices, procedures, and control systems to ensure that AVMs used in the Covered Transactions adhere to quality-control standards to (1) ensure high-level confidence in estimates; (2) protect against manipulation of data; (3) seek to avoid conflicts of interest; (4) require random sample testing and reviews; and (5) comply with applicable nondiscrimination laws.

The Agencies propose to allow each Covered Institution flexibility to create its own quality-control standards that are appropriate for its size and the risk and complexity of its Covered Transactions. Accordingly, the proposed rule does not include prescriptive requirements for quality-control standards. Instead, the Agencies noted that the Covered Institutions may look to the existing guidance for assistance with compliance. The existing guidance relating to the use of AVMs includes Appendix B to the Interagency Appraisal and Evaluation Guidelines and Guidance on Model Risk Management. For institutions that use third-party service providers for AVMs and AVM services, the Agencies reminded such institutions that they remain responsible for ensuring that third parties, in performing their activities, comply with applicable laws and regulations, including the safety and soundness requirements.

The fifth factor—compliance with applicable nondiscrimination laws—is not specified in Section 1125 of the Dodd-Frank Act. Section 1125 expressly provides the Agencies with the authority to account for any other factor that the agencies determine to be appropriate. The Agencies propose to use this discretion to add the fifth factor because of their concerns that AVMs may produce discriminatory valuations due to the data used or a model’s development, design, implementation, or use. For instance, models trained on data reflecting systemic inaccuracies and historical patterns of discrimination may tend to yield discriminatory results. Notably, the Agencies propose to include the fifth factor despite their recognition that compliance with applicable nondiscrimination laws may be indirectly reflected in three of the first four quality control factors. The Agencies provided in the NPRM that including the fifth factor would create an independent requirement that specifically addresses nondiscrimination.

The Agencies’ proposal fits with the Biden Administration’s increased focus on the connection between nondiscrimination laws and AVMs. Last year, the administration established an Interagency Task Force on Property Appraisal and Valuation Equity (PAVE) to examine the various forms of bias in residential property valuation practices and identify ways the government and industry stakeholders can address such bias.1 As highlighted by PAVE, recent studies of home appraisals and the market value gap between majority-Black and majority-White neighborhoods indicate there may be appraisal bias in the U.S. housing market.2 There have been lawsuits against mortgage lenders alleging violations under the Equal Credit Opportunity Act (ECOA), Fair Housing Act (FHA), and other federal and state civil rights laws related to alleged discriminatory appraisals. The CFPB and DOJ have submitted a Statement of Interest in at least one case analyzing the legal questions related to a mortgage lender’s obligations under ECOA and FHA and specifically the consequences of relying on discriminatory appraisals.

The Agencies’ choice to make compliance with applicable nondiscrimination laws an express factor also follows the Biden Administration’s approach to AI regulation, as reflected in its Blueprint for an AI Bill of Rights, which includes algorithmic discrimination protections. For more information about Biden’s Blueprint, check out our prior Advisory.

Other Considerations for Covered Institutions

Many financial institutions and their third-party service providers rely on AVMs for efficiency and cost savings, and based on such, the Agencies are concerned that the use of AVMs may have unintended effects that would result in the Covered Institution operating in an unsafe or unsound manner or violating consumer financial protection laws. Additionally, in the NPRM, the Agencies are reminding Covered Institutions that use of third parties does not diminish their responsibility to oversee the activities of the third parties for compliance with applicable laws in the same manner as if they were conducted by the institution itself.

The Agencies are soliciting feedback on dozens of aspects of their proposed rule. Particularly important questions include the following:

  1. How should the Agencies define key terms such as “mortgage originator,” “consumer,” and “credit decision”?
  2. What, if any, additional clarifications would be helpful for situations where an AVM would or would not be covered by the proposed rule?
  3. What are the advantages and disadvantages of specifying a fifth quality-control factor on nondiscrimination? What, if any, alternative approaches should the Agencies consider?
  4. How might a rule covering only AVM usage by mortgage originators and secondary-market issuers disadvantage those entities vis-à-vis their competitors?
  5. To what extent do secondary-market issuers use AVMs to determine collateral value in securitizations?
  6. What are the advantages and disadvantages of exempting federally backed securitizations from the AVM quality-control standards?
  7. Are lenders’ existing compliance management systems and fair lending monitoring programs able to assess whether a covered AVM, including the AVM’s underlying artificial intelligence or machine learning, applies different standards or produces disparate valuations on a prohibited basis? If not, what additional guidance or resources would be useful or necessary for compliance?

The Agencies have also issued proposed Interagency Guidance on Reconsiderations of Value of Residential Real Estate Valuations. This proposal describes the risks of deficient residential real estate collateral valuations that remain uncorrected, including those that may involve discrimination, and provides guidance on how financial institutions can create or enhance policies, procedures, control systems, and complaint-resolution processes to address those risks.

Companies and trade associations concerned that the rulemaking’s outcome might challenge their (or their members’) business models should consider submitting comments, which are due by August 21, 2023.


Current State of the Housing Market

The newest Mortgage Monitor report from Black Knight portrays a residential real estate market that’s stuck in a vicious circle as declining credit availability adds to the affordability crisis exacerbated by high-interest rates and steep home prices.

As Andy Walden, Black Knight’s vice president of enterprise research, succinctly puts it, “in a sense, the gridlocked housing market has been feeding on itself.”

“While elevated interest rates continue to weigh on both affordability and demand, they’re simultaneously constricting supply as well as would-be sellers who locked in ultra-low rates early in the pandemic and continue to sit on the sidelines,” Walden added. “The combination of lower supply and demand in April led to both slowing sales and firming prices. In fact, while home sales dipped, April marked the fourth consecutive month of home price gains, which are now almost universally rising across the country again on a seasonally adjusted basis.”

Per Black Knight’s numbers, only one market is still seeing meaningful price declines: Austin, which is also the only market where inventory has eclipsed pre-pandemic levels.

“In today’s market, interest rates are acting as a double-edged sword, reducing or increasing both demand and supply as they rise and fall, making it challenging to find a rate-driven path to easing affordability and home prices,” Walden noted.

Such onerous fundamentals are holding back the normally fervent spring housing market, compounded by a new wrench in the works in the form of tightening credit. According to Optimal Blue rate lock data from Black Knight, average credit scores and downpayments are both on the uptick.

Additionally, Black Knight figures show April home purchase credit scores at their highest level since at least 2000, when the company first began tracking the metric. Such credit rigidity has only encouraged the ongoing slowdown in purchase locks, which fell 11% from the week ending March 25 to the week ending May 20 — a statistic that should be trending the opposite way as the spring market heats up.

Instead, after coming within 15% of pre-pandemic purchase-lock levels earlier in the year, locks have now slid back to more than 30% below this threshold.

“Demand is obviously suffering,” Walden said, “and the fact that this spring’s strengthening home prices have erased more than 60% of the ‘correction’ seen late last year isn’t likely to help much on that front.”


Thinking of a FinTech Solution for Your Mortgage Business ?

How Mortgage Lenders Should Evaluate Fintech Solutions

BLOG VIEW: As the mortgage industry continues to face the challenge of increasing origination costs – not to mention margin compression and rising interest rates – it’s becoming imperative for lenders to evaluate their current cost to produce, from both a technology and personnel standpoint.

Now is the time when CEOs and executives should be examining their technology production costs in comparison to their labor expenses with the aim of discovering ways to originate more with fewer employees and increased efficiencies.

Technology cannot solve for all, and lenders still need human expertise. So has the growing fintech stack really increased efficiencies and reduced origination costs? Or are lenders adding to their fintech stack without any real return on investment?

The following checklist can help lenders determine if the solution being considered is worth the price.

Does it align with your business strategy?

Established organizations always have dependable, tested and proven procedures in place and do not often embrace new technologies quickly. However, the technology driven world we live in today demands innovation. Therefore, if a lender’s business strategy includes scalability and sustainability, it is critical that it evaluate its current fintech solution to ensure it aligns with strategic initiatives.

Does it utilize data for sales strategy optimization?

If a company doesn’t have adequate computational resources, it won’t be able to monitor all the critical customer-facing activities like organizing, managing and strategically using large datasets to enhance sales procedures.

Does it have a user-friendly interface?

You’ve likely heard the expression that “time is money.” A fintech solution that is difficult to navigate or does not have features that reduce the time it takes to fulfill a loan will not achieve the end goal of reducing the cost to originate.

Does it offer built in compliance monitoring?

It’s challenging to originate loans in this heavily regulated industry. The technology under consideration should track compliance to the various rules such as initial disclosure, issuance of CD, tolerance cures, etc. It is imperative that a lender’s fintech solution help manage regulatory standards now, to avoid undesired outcomes later.

Does it support a fully digital origination process?

A fully digitized loan origination process allows mortgage bankers to immediately issue agency approval while talking to the borrower, which saves time and allows an increase in productivity on the number of loans that can be processed per day.

Does it offer a guided workflow?

There are several steps that take a loan from verification to approval faster. These steps can take over 30 days because of the validation necessary to complete the process accurately. When a fintech solution has a guided workflow, it allows automatic approval where possible and has built in tutorials to help both seasoned and new mortgage bankers streamline their procedures for faster completion.

Does it incorporate sales strategies in CRM?

Sales activities drive revenue and therefore the habits of loan officers are critical to meet and exceed revenue targets. When a fintech solution incorporates sales strategies in a lender’s CRM system, all customer data is organized to inform the highest value sales activities for the day based on previous actions and the stage of the customer journey.

Does it offer a single data warehouse?

When a fintech solution has one database for originations, processing, funding, marketing and sales activities, the lender will have a streamlined process that reduces errors and makes historical reporting and future projections easier to prepare.

The global fintech adoption rate rose to 64% in 2020. This reveals how important fintech technologies have become to the mortgage industry. We can expect that rate to be closer to 100% over the next couple years as the industry pivots to more online solutions.

Whether your company is part of the 64% that already have a solution or the 36% that will, it is critical to accurately assess every solution in order to get the most value for your investment. 

Lenders that evaluate fintech solutions using this checklist will align their business strategy with their sales strategy and create a seamless workflow that promotes employee engagement, agency and regulatory compliance, faster loan processing, and satisfied customers.


Do You Know The Latest HMDA Requirements?

HMDA purpose and coverage

The federal Home Mortgage Disclosure Act (HMDA) was passed in 1975 to address concerns that lenders were contributing to the decline of some urban areas by failing to offer adequate home financing to qualified applicants on reasonable terms and conditions, in violation of their bank charters. [12 United States Code §§2801 et seq.]

From 1988 to 1992, substantial changes were made to the HMDA under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) and the Federal Deposit Insurance Corporation Involvement Act (FDICIA). FIRREA and FDICIA required independent mortgage lenders who met certain loan volume criteria to collect HMDA data. Thus, federal and state banks, credit unions, savings associations and independent mortgage lenders can be required by the HMDA to compile home loan application and closed loan data.

HMDA rules are promulgated under Regulation C (Reg C). [12 Code of Federal Regulations §§1003 et seq.]

In 2015, the Consumer Financial Protection Bureau (CFPB) made changes to the HMDA and Reg C according to the requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Clarifying changes were made in 2017. Generally, these changes modified the types of institutions and transactions subject to HMDA and expanded the scope of the data required to be collected.

Modifications to reportable data

HMDA data added to reporting requirements in 2018 includes:

a) the property address;

b) the borrower or applicant’s age;

c) the borrower or applicant’s credit score;

d) total points and fees charged at the time of origination;

e) the total borrower-paid origination charges;

f) the total discount points paid to the lender;

g) the amount of lender credits;

h) the interest rate;

i) the term (in months) of any prepayment period;

j) the debt-to-income ratio (DTI);

k) the combined loan-to-value ratio (LTV);

l) the loan term (in months);

m) the introductory interest rate period (in months);

n) the presence of terms resulting in potential negative amortization;

o) the property value;

p) whether the property is manufactured housing;

q) the ownership of land when the property is manufactured housing;

r) the total number of units related to the property;

s) the total number of income-restricted units related to the property;

t) the lending channel, e.g., retail or broker;

u) the originator’s NMLS ID;

v) the automated underwriting system (AUS) used to evaluation the application, and the result generated by the AUS;

w) whether the loan is a reverse mortgage;

x) whether the loan is an open-end loan; and

y) whether the transaction is a business-purpose loan. [12 CFR §1003.4(a)]

Why more criteria? For example, the current HMDA data can tell regulators whether a loan exceeds high-cost loan thresholds, and by how much. Regulators can further break the data down to show how often APRs exceed the high-cost loan thresholds for different ethnicities and races, and pinpoint a potentially discriminatory pattern.


The Regulatory Challenges With Digital Closings

In a recent report aimed at identifying improvements to the regulatory landscape that will better support financial technology and foster innovation, the U.S. Department of the Treasury offered three key recommendations to improve the electronic closing and recording process.

In drafting the report, Treasury consulted with a wide range of stakeholders—including the American Land Title Association (ALTA)—focused on consumer financial data aggregation, lending, payments, credit servicing, financial technology and innovation. The Treasury said its recommendations should enable U.S. firms to more rapidly adopt competitive technologies, safeguard consumer data and operate with greater regulatory efficiency.

The different ways to close real estate purchase or refinance

The benefits of digital real estate closings

“We appreciate Treasury’s thoughtful approach, understanding the hurdles that exist in the market and for providing recommendations to improve electronic recordings and closings,” said Cynthia Blair NTP, past president of ALTA and founding partner of the law firm Blair Cato Pickren Casterline LLC. “As digital closings continue to evolve, ALTA and its members will continue to help lead the effort to improve the closing experience for consumers. Finding the right balance between convenience, security and risk are all issues we must consider as we build a road to smarter closings.”

To improve the electronic closing and recording process, Treasury offered these recommendations:

1. States that have not authorized electronic and remote online notarization (RON) should pursue legislation to explicitly permit the application of this technology and the interstate recognition of remotely notarized documents. Treasury recommends that states align laws and regulations to further standardize notarization practices.

2. Congress should consider legislation to provide a minimum uniform national standard for electronic and remote online notarizations. The Treasury believes such legislation would facilitate, but not require, this component of a fully digital mortgage process and provide more legal certainty across the country. Federal legislation is not mutually exclusive with continued efforts at the state level to enact a framework governing the use of electronic methods for financial documents requiring notarization, according to the Treasury report.

3. Recording jurisdictions that don’t recognize and accept electronic records should implement the necessary technology updates to process and record these documents and pursue digitization of existing property records.

Treasury said that while the Uniform Electronic Transactions Act (UETA) and Electronic Signatures in Global and National Commerce Act (ESIGN) e-commerce laws establish the validity of electronic signatures on consumer credit transactions, “additional legal clarity is needed to ensure compliance with state notary laws for use of electronic notarizations, specifically the sanctioning of digital notarizations in lieu of a physical signature and notarization.”

To date, 39 states have enacted laws establishing the legality of such e-notarization. In 2010, the National Conference of Commissioners on Uniform State Laws (also known as the Uniform Law Commission, or ULC) promulgated a revised model statutory framework for notarial acts, updating its original 1982 model act, aimed at facilitating interstate recognition of various types of notarizations.

Additionally, during its annual meeting in July, the Uniform Law Commission approved updates to its model state notarization law—the Revised Uniform Law on Notarial Acts (RULONA)—to allow remote online notarization. ALTA and the Mortgage Bankers Association (MBA) worked closely with the ULC drafting committee to ensure consistency between the RULONA amendments and the model RON bill.

Remote online notarization (RON) is one type of technology innovation that has become more prevalent in the industry. RON allows notaries to conduct notariziations using audio-visual technology over the internet instead of being physically present. Currently there are 22 states that have passed remote notary laws. Out of those states, 10 have laws that are in effect and six have fully implemented their remote notarization procedures. Arizona’s RON legislation goes into effect June 30, 2020.

“These electronic notarization statutes, enabling digital notary signature for in-person notarizations, provide insufficient legal certainty for the use of remote notarization conducted electronically via webcam, with the latter permitting both signatory and notary to be in different locations,” Treasury concluded.

The report mentioned the model legislation ALTA developed in 2017 with the Mortgage Bankers Association to provide a framework for states to use in adopting remote online notarization for real-estate transactions. ALTA does not specifically endorse online notarization, but wants to ensure any legislation that is passed is safe for consumers, that transactions are insurable and technology neutral. ALTA believes that without a model bill to help guide legislative discussions, different state standards are likely to result. That outcome is the last thing consumers and the industry need, as it will lead to inefficiencies, additional costs and a poor customer experience.

As more transactions are handled electronically, it’s important to ensure that documents are validly executed and in a recordable format. To ensure that the title insurance and settlement industry can protect property rights, a reliable land records system is needed that is free of any contamination of unlawfully executed and/or recorded documents.

In its report, Treasury said, “Despite state-level progress toward wider recognition of electronic notarization, the absence of a broad statutory acceptance across the country and uneven standards for remote and electronic notarization implementation has created confusion for market participants, slowing adoption of digital advances in mortgage technology by limiting the ability for lenders to complete a digital mortgage with an e-closing.”

The Treasury report noted that non-uniform state rules create a cost barrier for electronic notarization system vendors developing their platforms as well as uncertainty for investors considering purchasing digital mortgages.

“County-level acceptance of digital security instruments is a key determinant of whether a lender will pursue an electronic closing, as lack of acceptance of these documents renders such critical e-mortgage components, such as electronic notarization, moot,” according to the report.

In 2004, the Uniform Law Commission promulgated the Uniform Real Property Electronic Recording Act (URPERA), representing a model statutory framework to provide county clerks and recorders the authority to accept electronic recording of real property instruments.

To date, 36 states and U.S. territories have enacted URPERA. Arizona was among the first states to pass this legislation in 2005. Implementation has picked up pace over the past few years. Through 2019, more than 2,000 of the 3,600 recording jurisdictions in the U.S. offer electronic recording.

Risks and Compliance in Commercial Banking Today

In today’s news cycle, it seems barely a week goes by before another headline flitters across a social news feed about a data breach at some major U.S. or foreign company. Hackers and scams seem to abound across the marketplace, regardless of industry or any defining factor.

Cybersecurity itself has become an increasingly important issue for bank boards—84 percent of directors and executives responding to Bank Director’s 2018 Risk Survey earlier this year cited cybersecurity as one of the top categories of risk they worry about most. Facing the industry’s cyber threats has become a principal focus for many audit and risk committees as well, along with their oversight of other external and internal threats.

Technology’s influence in banking has forced institutions to come to terms with both the inevitability of not just integrating technology somewhere within the bank’s operation, but the risk that’s involved with that enhancement. Add to that the percolating influence of blockchain and cryptocurrency and the impending implementation of the new current expected credit loss (CECL) standards issued by the Financial Accounting Standards Board, and bank boards—especially the audit and risk committees within those boards—have been thrust into uncharted waters in many ways and have few points of reference on which to guide them, other than what might be general provisions in their charters.

And lest we forget, audit and risk committees still face conventional yet equally important duties related to identifying and hiring the independent auditor, oversight of the internal and external audit function, and managing interest rate risk and credit risk for the bank—all still top priorities for individual banks and their regulators.

The industry is also in a welcome period of transition as the economy has regained its health, which has influenced interest rates and driven competition to new heights, and the current administration is bent on rolling back regulations imposed in the wake of the 2008 crisis that have affected institutions of all sizes.

These topics and more will be addressed at Bank Director’s 2018 Audit & Risk Committees Conference, held June 12-13 at Swissôtel in Chicago, covering everything from politics and the economy to stress testing, CECL and fintech partnerships.

Among the headlining moments of the conference will be a moderated discussion with Thomas Curry, a former director of the Federal Deposit Insurance Corp. who later became the 30th Comptroller of the Currency, serving a 5-year term under President Barack Obama and, briefly, President Donald Trump.

Curry was at the helm of the OCC during a key time in the post-crisis recovery. Among the topics to come up in the discussion with Bank Director Editor in Chief Jack Milligan are Curry’s views on the risks facing the banking system and his advice for CEOs, boards and committees, and his thoughts about more contemporary influences, including the recently passed regulatory reform package and the shifting regulatory landscape.


Commercial Banks and Their Share of the Mortgage Industry

The five largest U.S. banks originated residential mortgages worth less than $87 billion in Q1 2018. This marks a sharp reduction from the figure of $110 billion in the previous quarter, and is also well below the $96 billion in mortgages originated a year ago. In fact, this was one of the worst quarters on record for these banks in the last twenty years. The only instance where these banks fared worse was in Q1 2014, when the end of the mortgage refinancing wave resulted in total originations dropping to $75 billion.

The sharp decline is primarily because of the reduction in overall activity levels across the mortgage industry from an increase in interest rates – something that can be attributed to the Fed’s ongoing rate hike process. While total mortgage originations for the industry also fell to $346 billion from $361 billion a year ago, a sharper decline in origination activity for the largest banks led their market share lower to 25% from 27% in Q1 2017.

We capture the impact of changes in mortgage banking performance on the share price of the banks with the largest mortgage operations in the U.S. – Wells FargoU.S. BancorpJPMorgan Chase and Bank of America – in a series of interactive dashboards. Total U.S. Originations includes fresh mortgages as well as mortgage refinances as compiled by the Mortgage Bankers Association

The mortgage industry in the U.S. witnessed a sharp reduction in origination volumes since Q4 2016, as a series of interest rate hikes by the Fed weighed on mortgage refinancing activity even as an increase in mortgage rates hurt the number of fresh mortgage applications. This led to total mortgage originations falling from $561 billion in Q3 2016 to just $346 billion in Q1 2018. There was a notable uptick in mortgage activity over Q2-Q3 2017, though, as a small reduction in long-term mortgage rates helped boost demand over this period.

Wells Fargo Maintains Its Lead

Wells Fargo has remained the largest mortgage originator in the country since before the economic downturn. While the bank was always focused on the mortgage business, it tightened its grip in the industry after the recession thanks to its acquisition of Wachovia – originating one in every four mortgages in the country in early 2010. Although weak conditions in the mortgage space dragged down Wells Fargo’s market share to a low of 11% in Q4 2015, the bank’s market share has largely remained around 12.5% over recent quarters.

That said, the combined market share of these five banks has fallen drastically from over 50% in 2011 to around 25% now. This was primarily due to a sizable reduction in mortgage operations by Bank of America and Citigroup to curtail losses they incurred in the wake of the recession. In fact, Bank of America’s mortgage banking division has shrunk to an insignificant part of its business model – leading to a decision by its management to no longer report mortgage banking revenues separately starting in Q1 2018.


Regulation Compliance Bruden Now Quantified

How much does your bank spend on regulatory compliance?

A recent Fed district bank study found that community bank compliance costs averaged 7.2% of non-interest expense. While significant by itself, that average hides a trend with significant implications—but let’s not get ahead of the story.

When S. 2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act was signed into law, the industry breathed a big sigh of relief. But getting rid of some of the Dodd-Frank Act rules, or easing them, won’t solve the totality of the regulatory burden banks face—not by a long shot. There was plenty to do before Dodd-Frank came about, and most previous relief laws merely nibbled around the edges of compliance duties.

Compliance isn’t fading away

In fact, it has been pointed out by some in the compliance fraternity that, in the wake of S. 2155, banks initially will face additional costs in unwinding systems and procedures built at a significant cost to handle the rules that have been eliminated or amended.

Indeed, in an analysis of S. 2155 on by Zach Fox of S&P Global Market Intelligence, “Still engulfed by regs,” the writer states:

“For smaller banks, the relief appears more modest. Some of the law’s provisions meant to ease regulatory burden will have little impact for a simple reason: Small banks were already exempt. Provisions, such as qualified mortgage status for loans held in portfolio, higher leverage at bank holding companies, a lengthier exam cycle, and a shorter call report, were already available to banks with less than $1 billion of assets.”

The hopes for further relief through Senate consideration of other financial legislation sent over by the House remain just that—hopes. Political promises from Senate leadership to House Financial Services Commission Chairman Jeb Hensarling have been made in a midterm election year that may exert unusual gravitational pull on legislation.

Burden’s costs and implications

And that makes the findings of a Federal Reserve Bank of St. Louis study about community banks’ regulatory costs especially interesting.

For those who predict that compliance costs will continue to encourage consolidation at the small end of the industry spectrum, the study provides more evidence.

Indeed, the study reports that 85% of bankers in the most-recent sampling in its database indicated that regulatory costs were important in considering acquisition offers.

The project makes it clear that regulatory burden hits smaller community banks harder than larger community banks, and that the impetus to merge for compliance efficiency will not go away, even though the recent regulatory reforms may help some institutions.

Major findings

The Fed study, entitled Compliance Costs, Economies Of Scale, And Compliance Performance, was published in April. The project was based on survey data compiled from among nearly 1,100 community banks by the Conference of State Bank Supervisors in 2015, 2016, and 2017. (All institutions in the sample were under $10 billion in assets.) Interestingly, the researchers also referenced multiple studies of banking compliance costs that have been performed in recent years by agencies, academics, and associations to give a full picture around their own findings and arguments.

The survey looked at regulatory costs in multiple ways and at multiple levels. Among the findings:

• Economies of scale exist in compliance.

Many forms of compliance have incremental costs—suspicious activity reporting, mortgage transactions, etc., cost more with increasing volume—but the ongoing fundamental systems costs and the costs of keeping current apply to all institutions.

“Banks with assets of less than $100 million reported compliance costs that averaged almost 10% of non-interest expense,” the study reports, “while the largest banks in the study reported compliance costs that averaged 5%. In other words, the compliance cost burden for the smallest community banks is double that of the largest community banks.” [Emphasis added.] The largest banks referred to were those with between $1 billion and $10 billion in assets.

• Bank Secrecy Act compliance costs lead the way among expenses tied to specific regulations.

In the 2017 survey results, based on 2016 numbers, BSA expenses dwarfed all other compliance costs, with the exception of those related to RESPA, TILA, and Regulation Z. This is interesting because Comptroller of the Currency Joseph Otting, a former banker, identified BSA costs early on as a priority. While banking agencies can’t directly change the rules, Otting has spearheaded efforts to discuss these issues with the agency that does, the Financial Crimes Enforcement Network, or FinCEN.

As the exhibit below indicates, mortgage-related rules would supplant BSA as the leading categories if the RESPA, TILA, and Regulation Z, Qualified Mortgage, and Ability to Repay rule bar were combined into one, totaling almost 36%.


Source: Compliance Costs, Economies Of Scale, And Compliance Performance

• Personnel expenses account for the majority of community bank compliance costs.

The study found that this was followed, in order, by data processing, accounting, consulting, and legal expenses. The report states that personnel costs—coming to 5.1% of average non-interest expense—represent almost seven times more than the other four categories combined.


Source: Compliance Costs, Economies Of Scale, And Compliance Performance

“Compliance expenses for personnel appear to be more subjective than expenses in the other categories,” the report says. “For example, it may be difficult to estimate just how much time a loan officer spends filling out compliance forms versus drumming up new business. Respondents may account differently for the time and attention devoted to compliance by chief executive officers or boards of directors.”

• Compliance spending and compliance ratings bear little relationship to each other.

For this analysis, the researchers looked at both compliance ratings and the M—for management—component of the CAMELS ratings, which includes consideration of the management and board oversight of the compliance function.


Source: Compliance Costs, Economies Of Scale, And Compliance Performance

The analysis found that “within a given size category, compliance expenses as percentages of non-interest expense do not appear to vary systematically for banks with different performance ratings. For banks with assets of less than $100 million, for example, relative compliance expenses at the highest-rated banks were lower than for other banks, while for banks with assets between $500 million and $1 billion, relative compliance expenses were higher for the highest-rated banks than for other banks. This suggests that compliance performance is based on factors other than what is spent on it.”


Is Banking Deregulation Starting to Work ?

Ed Mills, a Washington policy analyst at Raymond James, answers some of the most frequent questions swirling around the deregulation discussion working its way through Congress, the changing face of the Fed and other hot-button issues within the banking industry.

Q: You see the policy stars aligning for financials – what do you mean?
The bank deregulatory process anticipated following the 2016 election is underway. The key personnel atop the federal banking regulators are being replaced, the Board of Governors at the Federal Reserve is undergoing a near total transformation, and Congress is set to make the most significant changes to the Dodd-Frank Wall Street Reform Act since its passage. This deregulatory push, combined with the recently enacted tax changes, will likely result in increased profitability, capital return, and M&A activity for many financial services companies.

Perhaps no regulator has been more impactful on the implementation of the post-crisis regulatory infrastructure than the Federal Reserve. As six of seven seats on the board of governors change hands, this represents a sea change for bank regulation.

We are also anticipating action on a bipartisan Senate legislation to increase the threshold that determines if an institution is systemically important – or a SIFI institution – on bank holding companies from $50 billion to $250 billion, among other reforms.

Q: Can you expand on why Congress is changing these rules?
Under existing law, banks are subject to escalating levels of regulation based upon their asset size. Key thresholds include banks at $1 billion, $10 billion, $50 billion and $250 billion in assets. These asset sizes may seem like really large numbers, but are only a fraction of the $1 trillion-plus held by top banks. There have been concerns in recent years that these thresholds are too low and have held back community and regional banks from lending to small businesses, and have slowed economic growth.

Responding to these concerns, a bipartisan group in the Senate is advocating a bill that would raise the threshold for when a bank is considered systemically important and subjected to increased regulations. The hope among the bill’s advocates is that community and regional banks would see a reduction in regulatory cost, greater flexibility on business activity, increased lending, and a boost to economic growth.

The bill recently cleared the Senate on a 67-31 vote, and is now waiting for the House to pass the bill and the two chambers to then strike a deal that sends it to the president’s desk.

Q: What changes do you expect on the regulatory side with leadership transitions?
In the coming year, we expect continued changes to the stress testing process for the largest banks (Comprehensive Capital Analysis and Review, known as CCAR), greater ability for banks to increase dividends, and changes to capital, leverage and liquidity rules.

We expect the Fed will shift away from regulation to normalization of the fed funds rate. This could represent a multi-pronged win for the banking industry: normalized interest rates, expanded regulatory relief, increased business activity and lower regulatory expenses.

Another key regulator we’re watching is the CFPB (Consumer Financial Protection Bureau), which under Director Richard Cordray pursued an aggressive regulatory agenda for banks. With White House Office of Management and Budget Director Mick Mulvaney assuming interim leadership, the bureau is re-evaluating its enforcement mechanisms. Additionally, Dodd-Frank requires review of all major rules within five years of their effective dates, providing an opportunity for the Trump-appointed director to make major revisions.

Q: We often hear concerns that the rollback of financial regulations put in place to prevent a repeat of one financial crisis will lead to the next. Are we sowing the seeds of the next collapse?
There is little doubt the lack of proper regulation and enforcement played a strong role in the financial crisis. The regulatory infrastructure put in place post-crisis has undoubtedly made the banking industry sounder. Fed Chairman Jerome Powell recently testified before Congress that the deregulatory bill being considered will not impact that soundness.

Q: In your view, what kind of political developments will have effects on markets?
We are keeping our eyes on the results of the increase in trade-related actions and the November midterms. The recent announcement on tariffs raises concerns of a trade war and presents a potentially significant headwind for the economy. The market may grow nervous over a potential changeover in the House and or Senate majorities, but it could also sow optimism on the ability to see a breakthrough on other legislative priorities.



HMDA Trends To Watch That Could Prevent Fines

There were one million fewer mortgages originated in 2017 compared to 2016, according to new Home Mortgage Disclosure Act data released by the Federal Financial Institution Examination Council and Consumer Financial Protection Bureau.

The annual HMDA data is traditionally released in September for the previous year. But this year, the FFIEC and CFPB released “snapshot-level” data on 2017 originations to make the information available to the public sooner, and will update the data as needed later in the year.

The 2017 HMDA data tracked information on 12.1 million home loan applications, which resulted in 7.3 million loan originations, 2.1 million in purchased loans, and a total of over 14.1 million actions, according to the FFIEC. The data also includes information on about 481,000 preapproval requests for purchase mortgages.

Notably, for 2017, the volume of reporting institutions dropped 13% to 5,852 institutions compared to the previous year. This was most likely driven by changes to Regulation C, which altered guidelines on which depository institutions were required to report.

Also prevalent in the data were insights on borrowers of different racial backgrounds. Both purchase and refinance loans made to black borrowers grew in 2017, while refinance mortgages for Asian borrowers fell 1.5 percentage points. However, minorities saw greater denial rates overall for conventional home purchase loans.

By product type, the share of Federal Housing Administration loans for home purchases plummeted, part of an overall decline in the government-mortgage share of purchase volume.

From falling originations to market share shifts for nonbanks and government loans, here’s a look at eight key findings from the new HMDA dataset.


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