April 5, 2018
Bloomberg BNA quoted me in Community Investment Revamp for Banks Likely To Spark Fight (behind a paywall). It opens,
Community groups and banks agree that the Community Reinvestment Act needs an update, but with regulators beginning an ambitious overhaul of the 1977 law there is little agreement on how that update should look.
The Trump administration has been targeting the CRA — which measures how well banks lend to low- to middle-income areas — for a rewrite since last June. Comptroller of the Currency Joseph Otting said March 28 that the first draft would be coming in early April.
Otting set out some broad ideas that his agency, the Office of the Comptroller of the Currency, and the other regulators that oversee the CRA will present to the public. The Federal Reserve and the Federal Deposit Insurance Corporation also have responsibility for measuring banks’ compliance with the law, and the OCC says that it hopes the two agencies will sign on to the coming advanced notice of proposed rulemaking.
Banking industry experts and community groups all said that the broad strokes of the regulators’ plan sound promising, but few expect that comity to continue when the details come more into view.
“I think you can assume that everybody is not going to be happy,” Laurence Platt, a partner at Mayer Brown LLP, told Bloomberg Law.
The CRA’s Present
The Trump administration first put the CRA in its sights in a June 2017 Treasury Department report outlining its broader views on altering the rules banks operate under.
The law calls for the OCC, the Fed and the FDIC to periodically measure how much lending the banks they oversee do inside geographical assessment areas based on their branch and ATM locations. If banks are found not to do enough of such lending, regulators can stop some business activities or hold up branch expansions and mergers. But it hasn’t been updated for nearly two decades.
The Treasury Department followed up the June 2017 statement on the CRA with an April 3 report outlining its thinking on ways to modernize the law. The report largely aligns with the path laid out by Otting.
“Our recommendations will improve the effectiveness of CRA by enhancing the assessment and examination process, enhancing the ability of banks to deliver services in the communities they serve while considering technological advances in the financial industry,” Treasury Secretary Steven Mnuchin said in a statement accompanying the report.
Changes to the Community Reinvestment Act have already begun, with the OCC under former acting Comptroller of the Currency Keith Noreika in October declaring that the OCC examiners would no longer include enforcement actions that are not linked to a bank’s CRA compliance in their rating.
That change was minor, and affected only one of the three regulators responsible for the CRA. Otting on March 28 laid out a host of other changes likely coming in a new proposal.
The CRA’s Future?
The broad outline Otting provided on March 28 largely highlights the areas in the CRA that community activists and banks have said need to be addressed.
Among the changes Otting said will be put out for comment include expanding the types of lending that would be included in calculations of banks’ CRA compliance to encompass small business, student lending and other money going into a community.
“I think there’s a sense that community-based activities, beyond individual lending, should be given more credit, such as small business loans and infrastructure loans,” Mayer Brown’s Platt said.
Other areas that are going to be addressed in the proposal will touch on the way CRA information is calculated and reported to the public. Currently, banks are examined for compliance every three to five years, and the banks’ reviews take an additional year.
Overall, Otting said the changes would be significant.
“This is monumental change for America,” Otting said in an appearance March 28 at the Operation Hope Global Forum in Atlanta.
The changes Otting discussed all sound promising, but they are vague. So fights are likely to emerge when the details come out.
“The comments that were made were vague enough to give you both concern and possible joy,” Taylor said.
One other aspect of the CRA that is ripe for reform is the geographic assessment areas regulators use to evaluate banks’ lending efforts. Otting and other regulators have yet to specifically outline their ideas for making changes to that, but both the comptroller and Fed Vice Chair for Supervision Randal Quarles have discussed including mobile banking, online lending, and other financial technology tools into their reviews.
How they elect to make that change is likely to be contentious as well.
“If the assessment area is poorly defined, then the CRA will lose its teeth and that’s going to drive CRA policy for a long time to come,” said David Reiss, a professor at Brooklyn Law School.
April 3, 2018
Researchers at the Federal Housing Finance Agency have posted a working paper, Are Appraisal Management Companies Value-Adding? — Stylized Facts from AMC and Non-AMC Appraisals. The obscure title hides an important subject. AMCs, appraisal management companies, are intermediaries that prevent lenders from pressuring appraisers to give high appraisals. This was a big problem in the years leading up to the financial crisis as the mortgage securitization pipeline demanded to be fed and would not let something as unimportant as a low appraisal slow down mortgage originations. Not everyone agrees that AMCs have lived up to the hopes that reformers had for them:
AMC advocates believe that in addition to acting as firewalls between lenders and appraisers, AMCs contribute a quality assurance step to the appraisal process. Some advocates may believe additionally that the thriving of AMCs represents an increasing specialization of appraisal management and appraisal services. Each of these circumstances would lead to consumers acquiring less biased and better quality appraisal reports and consequently to lenders achieving reduced credit risk as well as reduced management time and effort. Those on the other side of the debate believe that AMCs offer no quality assurance contribution and in fact tend to hire the least expensive rather than the most suitable appraisers. They also claim that AMCs set unrealistic deadlines, effectively rushing appraisal reports. Under these circumstances, rather than having higher quality appraisals, AMCs could in fact reduce the overall quality of appraisals, and in doing so, increase credit risk in the long run. Opponents also cite the fact that because AMCs take a cut of prevailing appraisal fees, their prevalence has caused and will continue to cause an appraiser shortage, the result of which, ceteris paribus, is increasing appraisal costs for future borrowers.
The need for a lender-appraiser firewall has been documented in a number of papers. Research has highlighted that appraisers face pressure from lenders. Such pressure along with other factors have led to some appraisers viewing themselves more as price validators than as independent evaluators. If AMCs serve successfully as firewalls, they should be able to correct the established appraisal confirmation bias and lower the degree of overvaluation.
The second main way in which AMCs can theoretically increase appraisal quality is by serving as a fresh pair of eyes. An appraiser may be unable to catch many of her own mistakes; working autonomously, those mistakes could go undiscovered. An AMC can implement a review process to identify errors and inconsistencies and improve the overall quality. (3, citations omitted)
As noted in their abstract, the authors
find that compared to non-AMC appraisals, AMC appraisals on average share a similar degree of overvaluation despite being more prone to contract price confirmation and super-overvaluation. AMC appraisals also share a similar propensity for mistakes, despite employing a greater number of comparable properties. Our evaluation employs relatively simple statistical comparisons, but the results indicate no clear evidence of any systematic quality differences between appraisals associated and unassociated with AMCs.
So, it is not clear whether AMCs have brought all that much value to the mortgage business. Further research is warranted to see whether they are worth keeping in their current form or whether further reforms are called for in the appraisal industry.
April 2, 2018
The Urban Institute’s Housing Finance at a Glance Chartbook for March focuses on how rising interest rates have been impacting the mortgage market. The chartbook makes a series of excellent points about current trends, although homeowners and homebuyers should keep in mind that rates remain near historic lows:
As mortgage rates have increased, there has been no shortage of articles explaining the effect of rising rates on the mortgage market. Mortgage rates began their present sustained increase immediately after the last presidential election in November 2016, 20 months ago. Enough data points have become available during thisperiod that we can now measure the effects of rising rates. Below we outline a few.
Refinances: The most immediate impact of rising rates is on refinance volumes, which fall as rates rise. For mortgages backed by Fannie Mae and Freddie Mac, the refinance share of total originations declined from 63 percent in Nov 2016 to 46 percent today (page 11). For FHA, VA and USDA-insured mortgages, the refinance share dropped from 44 percent to 35 percent. In terms of volume, Fannie Mae and Freddie Mac backed refinance volume totaled $390 billion in 2017, down from $550 billion in 2016. For Ginnie Mae, refi volume dropped from $197 billion in 2016 to $136 billion in 2017. Looking ahead, most estimates for 2018 point to a continued reduction in the refi share and origination volumes (page 15).
Originator profitability: Of course, less demand for mortgages isn’t good for originator profitability because lenders need to compete harder to attract borrowers. They do this often by reducing profit margins as rates rise (conversely, when rates are falling and everyone is rushing to refinance, lenders tend to respond by increasing their profit margins). Indeed, since Nov 2016, originator profitability has declined from $2.6 per $100 of loans originated to $1.93 today (page 16). Post crisis originator profitability reached as high as $5 per $100 loan in late 2012, when rates were at their lowest point.
Cash-out share: Another consequence of falling refinance volumes is the rising share of cash-out refinances. The share of cash-out refinances varies partly because borrowers’ motivations change with interest rates. When rates are low, the primary goal of refinancing is to reduce the monthly payment. Cash-out share tends to be low during such periods. But when rates are high, borrowers have no incentive to refinance for rate reasons. Those who still refinance tend to be driven more by their desire to cash-out (although this doesn’t mean that the volume is also high). As such, cash-out share of refinances increased to 63 percent in Q4 2017 according to Freddie Mac Quarterly Refinance Statistics. The last time cash-out share was this high was in 2008.
Industry consolidation: A longer-term impact of rising rates is industry consolidation: not every lender can afford to cut profitability. Larger, diversified originators are more able to accept lower margins because they can make up for it through other lines of business or simply accept lower profitability for some time. Smaller lenders may not have such flexibility and may find it necessary to merge with another entity. Industry consolidation due to higher rates is not easy to quantify as firms can merge or get acquired for various reasons. At the same time, one can’t ignore New Residential Investment’s recent acquisition of Shellpoint Partners and Ocwen’s purchase of PHH. (5)
March 16, 2018
John Campbell et al. have posted Structuring Mortgages for Macroeconomic Stability to SSRN. They are not the first to propose a mortgage product that is designed to lessen its burden when times are hard, but that does not make their proposal any the less intriguing. The authors write,
Events in the last decade have shown that adjustable-rate mortgages (ARMs) have advantages over fixed-rate mortgages (FRMs) in stabilizing the economy, at least when the central bank has monetary independence and can lower the short-term interest rate in a recession. A lower short rate provides automatic budget relief for ARM borrowers and helps to support their spending. It can also provide some relief to FRM borrowers, but this requires both a decline in the long-term mortgage rate and refinancing, which may be constrained by declining house prices and tightening credit standards. Barriers to FRM refinancing in the aftermath of the Great Recession were an important concern of US policymakers and motivated the introduction of the Home Affordable Refinance Program. (1, citations omitted)
The authors are certainly right that mortgages were a big drag on households during the Great Recession and many of them (but not all) would have benefited from lower monthly payments. To address this, the authors
study mortgage design features aimed at stabilizing the macroeconomy. Using a calibrated life-cycle model with competitive risk-averse lenders, we consider an adjustable-rate mortgage (ARM) with an option that during recessions allows borrowers to pay only interest on their loan and extend its maturity. We find that this option has several advantages: it stabilizes consumption growth over the business cycle, shifts defaults to expansions, and lowers the equilibrium mortgage rate by stabilizing cash flows to lenders. These advantages are magnified in a low and stable real interest rate environment where the standard ARM delivers less budget relief in a recession.
While there have been some pilot programs that introduce countercyclical mortgage products, nothing has really taken off so far. Hopefully, papers like this will push lenders and regulators to keep looking for solutions to our next housing crisis, before it actually hits.
March 15, 2018
Researchers at the NY Fed have posted The Role of Technology in Mortgage Lending. There is no doubt that tech can disrupt the mortgage lending business much as it has done with others. The abstract reads,
Technology-based (“FinTech”) lenders increased their market share of U.S. mortgage lending from 2 percent to 8 percent from 2010 to 2016. Using market-wide, loan-level data on U.S. mortgage applications and originations, we show that FinTech lenders process mortgage applications about 20 percent faster than other lenders, even when controlling for detailed loan, borrower, and geographic observables. Faster processing does not come at the cost of higher defaults. FinTech lenders adjust supply more elastically than other lenders in response to exogenous mortgage demand shocks, thereby alleviating capacity constraints associated with traditional mortgage lending. In areas with more FinTech lending, borrowers refinance more, especially when it is in their interest to do so. We find no evidence that FinTech lenders target marginal borrowers. Our results suggest that technological innovation has improved the efficiency of financial intermediation in the U.S. mortgage market.
The report documents the significant extent to which FinTech firms have already disrupted the primary mortgage market. They also predict a whole lot more disruption coming down the pike:
Going forward, we expect that other lenders will seek to replicate the “FinTech model” characterized by electronic application processes with centralized, semi-automated underwriting operations. However, it is unclear whether traditional lenders or small institutions will all be able to adopt these practices as these innovations require significant reorganization and sizable investments. The end result could be a more concentrated mortgage market dominated by those firms that can afford to innovate. From a consumer perspective, we believe our results shed light on how mortgage credit supply is likely to evolve in the future. Specifically, technology will allow the origination process to be faster and to more easily accommodate changes in interest rates, leading to greater transmission of monetary policy to households via the mortgage market. Our findings also imply that technological diffusion may reduce inefficiencies in refinancing decisions, with significant benefits to U.S. households.
Our results have to be considered in the prevailing institutional context of the U.S. mortgage market. Specifically, at the time of our study FinTech lenders are non-banks that securitize their mortgages and do not take deposits. It remains to be seen whether we find the same benefits of FinTech lending as the model spreads to deposit-taking banks and their borrowers. Changes in banking regulation or the housing finance system may affect FinTech lenders going forward. Also, the benefits we document stem from innovations that rely on hard information; as these innovations spread, they may affect access to credit for those borrowers with applications that require soft information or borrowers that require direct communication with a loan officer. (37-38)
I think that the author’s predictions are right on target.
March 14, 2018
Senate Bill 2155 is looking like it will be enacted and reduce the amount of data collected pursuant to the Home Mortgage Disclosure Act. The Federal Reserve Bulletin includes a report that demonstrates just how useful that data is, Residential Mortgage Lending in 2016: Evidence from the Home Mortgage Disclosure Act Data. Key findings of the report include,
1. The number of mortgage originations in 2016 rose 13 percent, to 8.4 million from 7.4 million in 2015. For loans secured by one- to four-family properties, growth was strong in both home-purchase originations—which increased to 4.0 million from 3.7 million in 2015—and refinance originations—which increased to 3.8 million from 3.2 million in 2015.
2. Black and Hispanic white borrowers increased their share of home-purchase loans for one- to four-family, owner-occupied, site-built properties in 2016, the third consecutive annual rise for both groups. The HMDA data indicate that 6.0 percent of such loans went to black borrowers, up from 5.5 percent in 2015, while 8.8 percent went to Hispanic white borrowers, up from 8.3 percent in 2015. The share of home-purchase loans to low- or moderate-income (LMI) borrowers decreased to 26 percent in 2016 from 28 percent in 2015.
3. The average value of home-purchase loans rose 3.2 percent in 2016, to $257,000, with similar increases for loans made to borrowers of different racial and ethnic groups. The average value of home-purchase loans to Hispanic white borrowers remained well below the 2006 peak, while the averages for Asian, black, and non-Hispanic white borrowers were all above their 2006–07 peaks.
4. Black and Hispanic white borrowers continued to be much more likely to use nonconventional loans (that is, loans with mortgage insurance from the Federal Housing Administration (FHA) or guarantees from the Department of Veterans Affairs (VA), the Farm Service Agency (FSA), or the Rural Housing Service (RHS)) than conventional loans compared with other racial and ethnic groups. In 2016, among home-purchase borrowers, 69 percent of blacks and 60 percent of Hispanic whites took out a no-conventional loan, whereas about 35 percent of non-Hispanic whites and just 16 percent of Asians did so.
5. The share of mortgages originated by non-depository, independent mortgage companies has increased sharply in recent years. In 2016, this group of lenders accounted for 53 percent of first-lien owner-occupant home-purchase loans, up from 50 percent in 2015. Independent mortgage companies also originated 52 percent of first-lien owner–occupant refinance loans, an increase from 48 percent in 2015. For the first time since at least 1995, non-depository, independent mortgage companies accounted for a majority of each of these types of loans. (2-3)
It is important that HMDA data continue to provide a reliable overview of the mortgage market so that changes in the market can be identified and policies can be modified to respond to them. It remains to be seen just how much Senate Bill 2155 will reduce the usefulness of HMDA data. Time will tell.