All community banks that currently engage in interest rate swaps (or are considering doing so in the near future) should be aware of the June 10, 2013 deadline for compliance by all financial institutions with the clearing requirement for interest rate swaps.
As background, Section 723 of the Dodd-Frank Act added section 2(h) to the Commodity Exchange Act and thereby established a clearing requirement for interest rate swaps. (The term “clearing” refers to the process by which an intermediary is interjected between a bank and its swap counterparty. A cleared swap is subject to continuous collateralization of swap obligations, real time reporting, additional agreements and other regulatory constraints. It is generally a more cumbersome process than the typical “bilateral” swap directly between a bank and its counterparty, which is a purely private contractual arrangement.) Under Dodd-Frank, it is illegal for a bank to enter into a certain swaps without clearing it unless an exception or exemption applies.
Generally speaking, the types of interest rate swaps that are subject to clearing are “plain vanilla” fixed-to-floating interest rate swaps based on LIBOR. (Other types of derivatives are subject to clearing, but these are generally not relevant to the average community bank.) The “big players” (swap dealers, major swap participants and certain private funds active in the swaps market) became subject to clearing requirements on March 11, 2013.
On May 29, 2013, the Consumer Financial Protection Bureau (CFPB) issued a final rule amending the Ability-to-Repay (ATR) and Qualified Mortgage (QM) rules it issued on January 10, 2013. Within this final rule are two new categories of small creditor QMs. The first, for small creditor portfolio loans, was adopted exactly as proposed alongside the January ATR rule and permits small creditors in all markets to make portfolio loans that are QMs even though the borrower’s DTI ratio exceeds the general QM 43% cap. As a reminder, small creditors for these purposes are those with less than $2 billion in assets at the end of the preceding calendar year that, together with their affiliates, made 500 or fewer covered first-lien mortgages during that year.
The second new QM is a welcome even if only temporary category of balloon mortgages. Unlike the small creditor portfolio QM, this interim QM was not an express part of the so-called “concurrent proposal” issued in January. This is simply but significantly a QM that meets all of the existing rural balloon-payment QM requirements except the controversial limitation that the creditor operate primarily in “rural” or “underserved” areas.
As written, the new balloon QM category expires two years after the ATR rules take effect on January 10, 2014. The CFPB characterizes this two-year window as a “transition period” useful for two purposes: (1) it will give the CFPB time to consider whether its definitions of “rural” and “underserved” are in fact too narrow for the needs of the rural balloon-payment QM rule and (2) it will give creditors time to “facilitate small creditors’ conversion to adjustable-rate mortgage products or other alternatives to balloon-payment loans.” The CFPB took pains to argue that Congress “made a clear policy choice” not to extend QM status to balloon mortgages outside of rural and underserved areas, and the agency reiterated its belief that adjustable-rate mortgages pose less risk to consumers than balloons: “The Bureau believes that balloon-payment mortgages are particularly risky for consumers because the consumer must rely on the creditors’ nonbinding assurances that the loan will be refinanced before the balloon payment becomes due. Even a creditor with the best of intentions may find itself unable to refinance a loan when a balloon payment becomes due.” For these reasons, creditors may expect future CFPB scrutiny intended to bury, not save, balloon mortgages. (more…)
Community bank lenders have responded to the CFPB’s Ability-to-Repay and Qualified Mortgage rules with questions about adjustable-rate mortgages (ARMs), balloon-payment qualified mortgages, and non-standard mortgage refinances. The CFPB’s implementation of Dodd-Frank’s balloon-payment qualified mortgage concept, for example, turns on a narrow definition of the types of lenders that qualify to make such loans. ARMs may be a viable alternative to balloon mortgages, but these loan products pose compliance and operational risks of their own. Finally, lenders may still be considering the types of transactions that qualify for the special “non-standard mortgage” refinancing exemption from the general Ability-to-Pay rule.
For a uniquely focused discussion on making these types of loans in light of the CFPB’s new mortgage regulations, join attorneys John ReVeal and Barry Hester for the latest installment of Bryan Cave’s webinar partnership with compliance training leader BAI Learning & Development. This free presentation will be held on Wednesday, May 8, from 3-4 pm Eastern. More information and registration are available here. Participants should walk away with a solid roadmap for managing existing portfolio balloons and ARMs now and for originating these types of mortgages once the CFPB’s rules take effect in 2014.
The mortgage servicing rules issued by the CFPB in January, 2013, implement another wave of Dodd-Frank reforms and outline best practices even for institutions not subject to these new requirements. Join Bryan Cave attorneys Barry Hester and Karen Neely Louis on Tuesday, April 9, from 3-4 pm Eastern, as they dissect these new rules and outline the higher servicing, foreclosure and eviction management expectations that follow.
More information and registration information for this free event, entitled “Servicing, Foreclosure and Eviction Management: Best Practices in the CFPB Era,” is available here.
On Tuesday, March 19 (3-4 pm Eastern), Bryan Cave attorneys John ReVeal and Barry Hester continue their 2013 webinar partnership with compliance training leader BAI Learning & Development. This free event will build on their January 22 overview of the new CFPB mortgage regulations and will specifically explore important exemptions and ambiguities within the final Ability-to-Repay and Qualified Mortgage rules.
Event and registration details are available here: http://www.bai.org/bai-events/EventDetails.aspx?ec=0767 .
Many community banks are reluctant to consider interest rate swaps due to perceived complexity as well as accounting and regulatory burdens. But, in a record low interest rate environment, the most desirable customers almost universally demand something that is hard for community banks to deliver: a long-term, fixed interest rate. Large banks are eager to accommodate this demand and usually do so by offering such a borrower an interest rate swap that, together with the loan facility, delivers the borrower a net long-term, fixed rate obligation and the lending bank a loan with an effective variable rate.
The alternatives to using swaps are not appealing. A community bank can limit its product offerings to only variable rate loans or short-term, fixed rate loans and thereby lose many good customers to larger competitors. The bank can offer a long-term fixed rate on the loan and then (a) sell the loan and lose ongoing earnings and the customer relationship, or (b) borrow long-term funds from the Federal Home Loan Bank to match that asset with appropriate liabilities, a choice that significantly erodes profit on the loan and uses up precious wholesale liquidity.
If a community bank wants to compete using interest rate swaps, then there are three general methods for packaging an interest rate swap with a typical loan offered by a community bank. There are several regulations that apply to swaps, including changes to the Commodities Exchange Act enacted by the Dodd-Frank Act and the numerous related rules and regulations promulgated by the U.S. Commodity Futures Trading Commission (the “CFTC”). If the community bank is under $10 billion in assets, then all three swap methods described below should qualify for an exemption from regulatory requirements that interest rate swaps be cleared through a derivatives exchange. Avoiding clearing requirements saves considerable costs and operational effort.
The first is a one-way swap in which a community bank simply makes a long term, fixed-rate loan to its borrower and then executes an interest rate swap with a swap dealer (such as a broker-dealer affiliate of a larger commercial bank) to hedge against rising interest rates. In a one-way swap, the community bank is subject to fair value hedge accounting, which requires the bank to mark the swap to market on its balance sheet and run changes in fair value through its income statement.
As part of its recent wave of rulemaking, the CFPB issued its final rule implementing a Dodd-Frank amendment to the Equal Credit Opportunity Act (ECOA) on January 18, 2013. Under the new rule, lenders must automatically provide copies of any written appraisal reports and valuations developed in connection with an application for credit that is to be secured by a first lien on a dwelling. The current version of this rule only requires this disclosure upon an applicant’s request, although it applies to junior lien credit applications, as well. The new rule takes effect January 18, 2014. As it does now, and as the ECOA does generally, the rule will be equally applicable to business and consumer credit applications.
On the same day, the CFPB and five other financial regulatory agencies jointly issued a separate appraisal rule for “higher-risk mortgages”. The interagency rule, which implements an amendment to the Truth in Lending Act also contained in Dodd-Frank, applies to mortgages with an APR exceeding the APOR by certain statutory thresholds – what the relevant Dodd-Frank provision calls higher-risk mortgages but the rule calls “higher-priced mortgage loans” to avoid the introduction of a seemingly new class of Regulation Z mortgages. For these loans, lenders must obtain a written appraisal performed by a licensed or certified appraiser who conducts an interior site visit of the subject property and then share this appraisal with the applicant. Taking aim at fraudulent flipping, the interagency rule also requires a second, more detailed appraisal on homes that were sold in the last 6 months for less than the current purchase price. This new rule is also effective on January 18, 2014.
Qualified mortgages under the CFPB’s final Ability to Repay rule; transactions secured by new manufactured homes, mobile homes, boats or trailers; loans on construction of new homes; and bridge loans will be exempt from the interagency rule. The agencies also announced their intent to publish a supplemental proposed rule to also exempt “streamlined” refinance programs and small dollar loans.
In addition, the agencies noted that they may consider tying the definition of “higher-priced mortgage loans” to the “transaction coverage rate” or TCR, a term which would exclude all prepaid finance charges not retained by the lender, instead of the APR. This change will likely depend on the CFPB’s final TILA-RESPA disclosure integration rule.
One can’t fault the CFPB’s production level in the past two weeks. Since January 10, the Bureau has issued seven distinct final rules - the lion’s share of what it considers ”a single, comprehensive undertaking” to implement Dodd-Frank mortgage reforms. By our count, this work includes over 3,100 pages of rulemaking text not to mention the press releases and the various summary materials and social media campaigns. Final rules were issued on the following:
As a reminder, we’ll provide an overview of these rules and a focused analysis of the Ability to Repay and Qualified Mortgage Rules during a free webinar on Tuesday, January 22, at 3 pm Eastern, and future webinars will unpack the rest of these new requirements. Still to come in 2013 are the Bureau’s final rules on TILA-RESPA disclosure integration.
A couple of themes dominate this wave of rules. First, it’s an understatement to say that Dodd-Frank and these Bureau regulations institutionalize the GSEs and tight prevailing credit standards. Is anyone surprised that these rules effectively kill no-doc and NINJA loans? The rules effectively draw a box around the only mortgage loans most creditors are willing to make now anyway. This convergence may limit the Fair Lending and CRA implications of the rules themselves, as there is less room than ever for discretion and exception. Other themes include the Bureau’s efforts to accommodate the realities of rural markets and smaller creditors and servicers as well as its sensible preference for loans held in portfolio (i.e., skin in the game).
On the other hand, the new Servicing standards are going to demand a high level of customer service and multi-party coordination. We attended both the Baltimore and Atlanta release parties (a.k.a. Field Hearings) for the biggest of these new rules (including Servicing). One take-home could not be missed: in the wake of the financial crisis, the Bureau continues to emerge as a sounding board for the distressed mortgage borrower and an advocate for consumer rights both real and imagined. Its public relations efforts this year on the mortgage front are undoubtedly going to lead to more complaints and more lawsuits against lenders.
The good news is that the Bureau can’t compete with your own relationship with your customer base. And the easiest complaints to resolve are those that are never filed. So to avoid paying for the sins of crisis-era lenders and practices that are now long gone, take a lesson from the CFPB and stay ahead this year on customer service and your institution’s brand. Reinforce the distinction between your organization and the abuses that gave rise to the Bureau, and you may actually benefit from its rules.
The CFPB continues to finalize a high volume of new mortgage rules required by Dodd-Frank. Join compliance training leader BAI Learning & Development and Bryan Cave attorneys John ReVeal and Barry Hester as they provide an overview of final Qualified Mortgage and Ability-to-Repay rules and other new and proposed requirements. This informative webinar will be offered on Tuesday, January 22, from 3-4 pm Eastern.
Here’s also a recent bulletin John and Barry developed on some of these new rules.
We previously covered the CFPB’s issuance of final rules on Ability-to-Repay and Qualified Mortgages together with the expansion of HOEPA coverage under the Dodd-Frank Act (DFA). Here we review the final escrow rules and suggest that they reveal a line the Bureau intends to consistently draw—under its exemption authority—between large and small mortgage lenders (at $2 billion). The Bureau’s final escrow rules take effect on June 1, 2013.
“Higher-priced mortgage loans” are a class of mortgages carrying APRs that are comparatively high but not high enough to trigger the full HOEPA protections implicated by “high-cost mortgages” (a.k.a. “HOEPA loans”). Under 2008 Federal Reserve amendments to Regulation Z, however, creditors must meet a number of requirements in conjunction with the origination of higher-priced mortgage loans, including the establishment and maintenance of escrow accounts for at least one year after origination. These escrow accounts set aside consumer funds on their behalf to pay property taxes, mortgage insurance premiums, and other mortgage-related insurance required by the creditor.
In its 2008 rulemaking, the Federal Reserve concluded that it was “unfair for a creditor to make a higher-priced loan without presenting the consumer a genuine opportunity to escrow.” The agency’s evidence suggested then that few subprime mortgage creditors provided for escrow accounts.
Congress liked these Fed rules enough to codify them, with certain differences, through Dodd-Frank. (more…)