March 2014 Mortgage Reform in 2014 The mortgage market will continue to undergo significant change in 2014 as banks refine loan products, underwriting requirements, and other aspects of their mortgage operations to ensure compliance with the CFPB’s new mortgage regulations. Strong compliance systems, coupled with improved efficiencies, will be key to the ability of banks to continue to meet the credit needs of their communities. In addition to implementing the new CFPB rules that went into effect in January, banks are closely monitoring regulatory and public policy developments related to fair lending, secondary market reform, and eminent domain. 1. Ability-to-Repay and “Qualified Mortgages” 2. Servicing 3. High Cost Mortgage Provisions 4. Higher-Risk Mortgage Appraisal Documentation 5. Appraisal Disclosure 6. Loan Originator Compensation 7. RESPA-TILA Reforms 8. Fair Lending 9. Risk Retention and Qualified Residential Mortgages 10. GSE Reform 11. Eminent Domain 12. Flood Insurance New Mortgage Rules The CFPB’s new mortgage rules are fundamentally changing all aspects of the mortgage business – from loan origination to loan servicing. The rules establish new lending and servicing standards for all industry participants and provide additional protections for consumers. They codify many of the conservative lending and high-quality servicing practices that banks have already put into place. However, the new rules are extraordinarily complicated and have been subject to ongoing and extensive amendments. Banks have been working to comply with the new requirements, but the volume and complexity of the rules has created uncertainty that banks are still working to address. In 2014, banks that finance and service residential real estate transactions will continue to make refinement of compliance and technology systems a top priority. 1. Ability-to-Repay and “Qualified Mortgages” CFPB regulations require creditors to make a reasonable and good faith determination, based on verified and documented information, that the borrower has a reasonable ability to repay the loan. The rule outlines the minimum requirements for making ability-to-repay determinations and provides guidance regarding the application of basic underwriting factors. Lenders can make Qualified Mortgage (“QM”) loans or non-QM loans. The CFPB has deemed QM loans to be particularly “safe” for consumers. As a result, those loans have special protections – or a safe harbor – from legal challenges. Overall, the Ability-to-Repay and QM regulations are highly technical and complex because their varying levels of legal protection and certain regulatory exemptions are based on a combination of lender characteristics, product pricing, loan features, and other factors. It is possible that some banks may curtail residential mortgage lending until they have confidence that their origination and compliance systems are fully reliable and have greater certainty with respect to how the new rules will be enforced by regulators, individuals, and state attorneys general. Other institutions may seek opportunities for providing “non-QM” mortgage loans in situations where they are comfortable with the legal risk in making such loans. ABA anticipates that the CFPB will continue to amend and clarify the Ability-to-Repay and Qualified Mortgage rules throughout 2014. For a brief overview of the final rules and subsequent amendments, as well as a staff analysis and a strategic guide, see aba.com. 2. Servicing: The CFPB servicing rules govern how banks are to process payments, notify borrowers of interest rate changes, resolve errors, and provide monthly statements, among other servicing functions. It also establishes a highly detailed timeline for communicating with delinquent borrowers and processing loss mitigation applications. Servicing was once largely an operational issue; now it is a compliance issue and is subject to regulatory enforcement. In addition, certain provisions in the servicing rules create new borrower rights that are enforceable through a private right of action. The increased regulatory burden and legal liabilities associated with the CFPB’s new servicing rules, combined with Basel III’s negative capital treatment of mortgage servicing assets, appears to be resulting in consolidation in the servicing industry and a shift of assets to non-bank servicers. For example, more banks may elect to sell mortgages into the secondary market “servicing released;” other banks may elect to divest their servicing portfolios. Still other servicers may opt to employ subservicers or component servicers to improve the economic value of their servicing rights. ABA expects that CFPB will issue additional servicing-related amendments and clarifications in 2014. See ABA Staff Outline: Mortgage Servicing Rules and ABA’s Servicing-At-A-Glance Matrix on aba.com. 2 The CFPB issued a separate final rule that amends Regulation Z’s existing requirements pertaining to the establishment of escrow accounts for higher-priced mortgage loans. The rule lengthens the period for which escrow accounts are required for higher-priced mortgage loans and adjusts the rate threshold for determining whether escrow accounts are required for “jumbo” loans. A staff analysis is available on aba.com. 3. High Cost Mortgage Provisions (effective Jan. 10, 2014): This CFPB rule expands the coverage of the “high cost” mortgage designation and increases the restrictions on these loans. The rule extends the Home Ownership and Equity Protection Act (“HOEPA”) to cover home-purchase loans and home equity lines of credit. It also revises the law’s rate and fee thresholds for coverage and adds a new coverage test based on a transaction’s prepayment penalties. The final rule also implements certain homeownership counseling requirements. First-time borrowers must receive counseling prior to committing to negative amortization loans and lenders must provide every mortgage applicant with disclosures containing location information for nearby counseling organizations. A staff analysis of the rule and subsequent amendments is available on aba.com. 4. Higher-Risk Mortgage Appraisal Documentation: This regulation establishes new appraisal requirements for higher-risk mortgage loans. Mortgage loans secured by a consumer’s home with interest rates above a certain threshold are considered higher-risk under the Dodd-Frank Act. Lenders making higher-risk loans must use a licensed or certified appraiser to conduct an inspection of the interior of the property and prepare a written report. The rule mandates additional valuations – at no cost to the consumer – if the seller acquired the property for a lower price during the previous six months. A staff analysis of the rule and is available on aba.com. 5. Appraisal Disclosure: The CFPB requires lenders to give applicants free copies of all appraisals and other written valuations developed in connection with an application for a first mortgage. The rule requires lenders to notify applicants in writing that copies of appraisals will be provided to them promptly. A staff analysis is available on aba.com. 6. Loan Originator Compensation: This CFPB rule builds upon existing restrictions on compensation that varies based on loan terms and conditions. The rule also revises previous regulatory commentary on loan originator compensation, including payments based on a proxy for a term of a transaction and permissibility of bonuses or other profit-based compensation arrangements. In addition, originators must meet new qualification and screening standards – including character and financial responsibility reviews, criminal background checks and training requirements. The rule also prohibits mandatory arbitration for disputes related to mortgage loans, and the practice of increasing loan amounts to cover credit insurance premiums. A staff analysis of the final rules and subsequent amendments are available on aba.com. 3 7. RESPA-TILA Reforms (will be effective August 1, 2015): This CFPB rule integrates residential mortgage disclosure forms required under RESPA and TILA. It is significant in scope and amends all core disclosures required in mortgage originations and settlement. The final rule generally mandates the use of two disclosures – the three-page Loan Estimate (which replaces the Good Faith Estimate and the initial Truth in Lending Disclosure) and the five-page Closing Disclosure (which replaces the HUD-1 and final Truth in Lending Disclosure). The final rule retains the fee and APR tolerance restrictions that apply under existing RESPA and TILA rules. The rule includes substantive changes to RESPA and TILA, including an amended definition of a “loan application” and the requirement that the borrower receive accurate Closing Disclosures at least three business days before closing. A staff analysis of the final rules will soon be available on aba.com. 8. Fair Lending: Fair lending issues will continue to be a top tier priority for bankers. In particular, lenders have questions regarding the fair lending and Community Reinvestment Act ramifications for banks that elect to engage in limited non-QM lending or opt out of making non-QM loans entirely. On October 22, 2013, the CFPB and the federal banking agencies stated that they “do not anticipate that a creditor's decision to offer only Qualified Mortgages would, absent other factors, elevate a supervised institution's fair lending risk.” The regulators took the same position with respect to CRA evaluations. While these statements provide some level of comfort to banks, ABA will closely monitor how these statements intersect with a February 15, 2013 final rule issued by HUD that explicitly allows private or governmental plaintiffs to challenge housing or mortgage lending practices that have a “disparate impact” on protected classes of individuals. HUD’s rule means that lawsuits can be brought against lenders even if their lending practices are facially neutral and non-discriminatory, and even where there is no direct evidence that the practice was motivated by a discriminatory intent. The DoddFrank Act has mandated new HMDA reporting requirements that are likely to increase the scrutiny in this area. Final HMDA rules implementing these legislative changes have not yet been issued. Click here for ABA’s Toolbox on Fair Lending, a free members-only guide to help bankers review the systems they have in place to continue their strong record of compliance with fair lending laws and regulations. 9. Risk Retention and Qualified Residential Mortgages: The Dodd-Frank Act requires securitizers of asset-backed securities to retain a portion of the credit risk of such transactions. It further directs regulators to craft exceptions to the risk retention requirements that incent securitization participants to originate soundly underwritten assets and align the interests of participants with borrowers and investors, consistent with improving access to credit on reasonable terms (the “Qualified Residential Mortgage” or “QRM” rule). On August 28, 2013, federal regulators re-proposed the QRM rule to align the definition of QRM with the existing Qualified Mortgage rule. ABA strongly supports the revised proposal, as it removes unnecessary risk retention and capital requirements for QM loans. The re-proposal also sets forth an alternative that would require QRM loans to be accompanied by larger 4 borrower down payments. ABA opposes higher down payment requirements for QRM loans. We anticipate that regulators will issue a final rule in early 2014 and continue to advocate for the QRM=QM approach without larger down payments. Other Mortgage Issues GSE Reform: Continued conservatorship of Fannie Mae and Freddie Mac is untenable both for the risk it poses to the taxpayer and for the long-term stability of the secondary mortgage market. ABA has proposed a housing finance market where federal support is limited to assisting targeted borrowers and to providing a limited and fully-priced backstop that ensures secondary-market access for all lenders. Equitable access is particularly important to community and regional banks seeking secondary market liquidity on competitive terms. The coming year will likely see a debate among multiple housing reform bills that have been introduced in the House and Senate. Senate Banking Committee Chairman Tim Johnson (D-SD) and Ranking Member Mike Crapo (R-ID) are expected to introduce a bill that builds upon an earlier effort from Senators Bob Corker (R-TN) and Mark Warner (D-VA). That bill, S. 1217 aligns with several of ABA’s policy recommendations for a new single-single family mortgage finance structure, but it lacks detail on how Fannie Mae and Freddie Mac would be wound down and replaced. The bill would retain a federal role in the regulation of the secondary market and would provide for a catastrophic backstop for a limited, well-defined segment of the market. The backstop would be explicit and priced to fully compensate for the guarantee being provided. In the House, H.R. 2767 would not provide a federal guarantee; however, it does contain regulatory relief provisions that exempt portfolio loans from the Dodd-Frank Act’s Ability-to- Repay standards. Both the House and Senate bills envision a new role for the Federal Home Loan Banks (“FHLBs”) to act as loan aggregators (and potentially issuers of securities). While this is an avenue for helping to ensure small-bank access to the secondary market, it is essential that nothing be done to harm the current, successful, advance business of the FHLBs. Additionally, because the FHLBs are memberowned cooperatives, no changes to the Federal Home Loan Bank System should be forced upon them without their consent and cooperation. The FHLBs must be sufficiently capitalized, and any new role must not cannibalize the existing capital of the FHLB system. Eminent Domain: In recent months, some localities and counties have contemplated using eminent domain to seize performing mortgages from investors to force a restructuring of the loans. ABA is strongly opposed to this use of eminent domain, which raises serious legal and constitutional issues and undermines the contractual obligation of a mortgage. This would significantly impair credit availability in these jurisdictions, ultimately harming the existing and future homeowners in the areas. In the summer of 2013, the city of Richmond, Calif. took steps to move forward with a plan to seize a number of mortgages through eminent domain. A number of entities filed suit against the City of 5 Richmond, including Wells Fargo. ABA has joined that suit in a friend of the court brief. Other jurisdictions in California and other states continue to explore similar uses of eminent domain. ABA and a large coalition will continue to engage at the local, state, and federal level to deter this unconstitutional and ill- advised approach. Flood Insurance: While ABA continues to support a move to actuarially sound rates for the National Flood Insurance Program, it has become apparent that action needs to be taken to maintain affordability in the program and to address unintended consequences of reforms passed in 2012. On March 21, 2014, President Obama signed ABA-backed flood insurance affordability legislation that cleared the House and Senate by large bipartisan majorities. The new law reinstates lower rates for grandfathered properties that were repealed by the Biggert-Waters Act. It also extends from July 6, 2014 to January 1, 2016 the effective date for new escrow rules required under Biggert-Waters. 6