In recent discussions with numerous compliance officers, it seems clear that many banks are struggling with the issue of whether or not they will seek to originate Qualified Mortgages. More particularly, banks are expressing some confusion about whether they will originate certain dwelling-secured loans that do not meet the definition of a Qualified Mortgage, and perhaps originate other loans that do satisfy Qualified Mortgage requirements.
The CFPB has recently released a Small Entity Compliance Guide to the Ability to Repay (ATR) Rule and the Qualified Mortgage (QM) Rule. While helpful, this Guide falls far short of setting forth a road map to compliance. Large and smaller banks, both, must come to grips with the issues surrounding the Ability to Repay Rule and make their own decision about whether they will choose to originate Qualified Mortgages.
It can’t be emphasized enough: Each bank must make its own informed decision regarding these issues. The risks are great; the policies and procedures may be complicated and expensive; and one size will not fit all.
At the request of the Steering Committees of both the MRCG and the MSRCG, we will undertake to outline the road map a bank can follow to reach its own particular destination. The road is long and the time is growing short. So, let’s begin.
Any discussion with Management and the Board of Directors regarding ATR and QM must start with an understanding of the risks that are involved. These risks cannot be ignored, nor can they be avoided. If the bank makes dwelling-secured loans (other than HELOC’s and construction loans), it will have to satisfy the ATR. If it fails to satisfy the ATR, it will incur the following possible consequences:
- A $4,000 penalty for every loan that violates the ATR;
- Possible class action liability up to $1 million;
- Forfeiture of all fees and finance charges collected during the first three years of the loan;
- Payment of the consumer’s attorney’s fees (and those of the bank);
- Use by a consumer of a violation of the ATR as a defense at any time to a collection or foreclosure action;
- Possible claims by trustees in bankruptcy; and
- Criticism from the bank regulators.
Regardless of whether plaintiffs’ lawyers or trustees in bankruptcy ever take some action against the Bank, your regulator(s) will surely question the level of risk you have in your dwelling-secured loan portfolio. If that risk is elevated, your compliance risk profile will be adversely affected. That could impact your compliance rating, which could impact one or more of the elements of your CAMELS rating. An adverse impact on the CAMELS rating could affect the level of capital regulators feel that you should carry. These issues could impact profitability, which could in turn impact the perceived value of the Bank in a sale or merger transaction. So, it is easy to see why these decisions are so important.
Management needs to understand that there is no way to avoid the ATR. It is part of the Truth In Lending Act and Regulation Z and applies to every dwelling-secured loan except HELOC’s and construction loans (the Truth In Lending Act prohibits structuring all loans as HELOC’s to avoid compliance). The ATR requires you to underwrite each dwelling-secured loan using the following criteria:
- Income and assets;
- Current employment status (if income from employment is relied upon);
- Monthly payment on the covered loan;
- Monthly payment on any simultaneous loan;
- Monthly payment for mortgage-related obligations;
- Current debt obligations, alimony and child support;
- Monthly debt-to-income ratio; and
- Credit history
In a companion article, we will delve into the additional guidance that the CFPB has put forth related to these underwriting criteria, the processes for verifying each one, and the challenges associated with documenting this information. For decision making purposes, Management and the Board of Directors simply need to understand that this is an “every loan” process. Every dwelling-secured loan originated must comply with the ATR requirements and these eight underwriting factors.
So far, Management and the Board of Directors has not had a decision to make. They simply need to understand the requirements of the ATR and the risks associated with non-compliance.
But now, it is decision time. The Bank can simply elect to continue making non-Qualified Mortgages (with balloon payments, etc.) and assume the risk that the Bank will be able to prove its compliance with the ATR using its consistently applied policies and procedures as well as its thorough documentation of all 8 underwriting criteria for each and every loan, or it could seek some level of protection by originating Qualified Mortgages.
The foregoing summarizes the risks of not originating Qualified Mortgages; the consequences of taking that path, no one knows.
So, if Management and the Board of Directors opt for the safer route, they will need to understand: (1) What a Qualified Mortgage is, and (2) what the impact of a decision to originate Qualified Mortgages will mean for the Bank.
Basically, a Qualified Mortgage is a dwelling-secured loan that does not:
- Allow negative amortization;
- Allow interest-only payments;
- Feature a balloon payment (with certain small creditor exceptions);
- Have a term longer than 30 years;
- Exceed the regulatory limits on points and fees (discussed below);
- Have a debt-to-income ratio determined through the underwriting process, greater than 43%.
The Qualified Mortgage must provide for regular periodic payments of substantially equal amount and must be underwritten using the monthly payment required for all mortgage-related obligations (e.g. insurance, taxes, etc.) and the maximum interest rate applicable in the first five years of the mortgage loan. Periodic payments of principal and interest needed to repay the loan must be used.
You will still be required to consider, verify and document the applicant’s income and assets using third party documentation, and current debts (including alimony and child support) will have to be similarly considered.
Two important issues will have an impact on bank profitability. The first is the points and fees limits for a Qualified Mortgage. To be a Qualified Mortgage, a dwelling-secured loan cannot have total points and fees that exceed:
- Loans greater than $100,000 – 3% of the total loan amount;
- Loans greater than $60,000, but less than $100,000 – $3,000;
- Loans greater than $20,000, but less than $60,000 – 5%;
- Loans greater than $12,500, but less than $20,000 – $1,000; and
- Loans less than $12,500 – 8%
This requirement will obviously involve an assessment of the fees and points the Bank currently charges.
The second point of impact comes as a result of which level of protection the bank wants to have when it originates Qualified Mortgages. The Qualified Mortgage Rule provides two different levels of protection for Qualified Mortgages: (1) a “safe harbor”; or (2) a presumption of compliance. Eligibility for one or the other is determined by the pricing of the loan. A “higher-priced” loan (i.e. one with a rate greater than 1.5% above the average prime offer rate) will only have a presumption of compliance. Loans with rates that do not exceed 1.5% above the APOR receive “safe harbor” treatment. A “safe harbor” loan supposedly cannot be challenged for compliance with the ATR. A loan with only a presumption of compliance could see that presumption rebutted.
A final issue for Management and the Board to consider is the question of balloon payment loans. Many banks have used balloon payment loans as a method of managing interest rate risk for decades. Now, however, balloon payment loans generally will not qualify as Qualified Mortgages. So, many Banks will have to develop other products, perhaps adjustable rate mortgages, that can substitute for balloon payment loans. You should ask whether your bank will need to develop new loan products.
Management and the Board of Directors should be aware of the so-called Small Creditor Exception to this general prohibition against balloon payment loans. To qualify, a Bank must have total assets less than $2 billion. It must originate no more than 500 covered loans annually, and 50% or more of those loans must be made in “rural” or “under-served” counties.
If the Bank clears those hurdles, then it could originate balloon payment loans so long as those loans do not have a term that exceeds 30 years, feature a fixed rate of interest and have a term of 5 years or longer.
Ask yourself first whether the Bank qualifies, and ask second what the effect on the Bank would be to originate dwelling-secured loans with the features described above.
After going through this exercise, Management and the Board of Directors should have an idea of which path they wish to choose. It is even conceivable that the Bank might choose to originate both Qualified Mortgages and non-Qualified Mortgages. However, either choice will entail a major effort to modify underwriting practices, create verification of information processes, establish documentation procedures and provide for monitoring of all of the above. Management and the Board of Directors must understand how much time, effort and expense will be involved and that short cuts won’t exist. The time to begin this process is now. The January, 2014 deadline for compliance is fast approaching.
We will devote a significant portion of the May Quarterly Meeting to the ATR and the QM Rules and their implementation.