The ex-CFPB Deputy Director Raj Date has attracted criticism for creating a mortgage company which competes in nonqualified mortgages, a category of loan he helped create at the CFPB. While Date’s conduct has its critics and defenders, one thing is certain. Community banks have been pushed out of the mortgage business by the rules Date helped write, and Date’s company now plans to soak up the extra loans.
Questions about Date’s conduct began after CFPB Journal published an article about Date’s company on June 7. Then on July 31, House lawmakers sent a letter to CFPB Director Richard Cordray protesting Fenway Summer, the company Date founded in June which he and a team of ex-CFPB officials now plan to make the leading originator of nonqualified mortgages in the country.
The lawmakers’ suggested foul play in Date’s actions. “Simply put, it appears that former CFPB employees are now offering financial products in a market sector created by the very rules they were in a position to influence while working in senior leadership positions at the CFPB,” said GOP Reps. Darrell Issa, Jeb Hensarling, Shelley Moore Capito, Jim Jordan and Patrick McHenry in their letter. “This conduct raises serious questions about the integrity of the CFPB’s rulemaking process and the conduct of some of its most senior former officials.”
The American Banker defended Date in an August 6th article saying that “the unspoken, but heavily implied, accusation [of House lawmakers] is that Date and others somehow influenced the creation of the QM rule so that they could take advantage of it later.” American Banker calls these ethics charges “overblown.”
The American Banker is partially correct; there is no evidence that Date broke ethics laws in a long-conceived plot to manipulate the rule making process to his benefit. But what the American Banker downplayed and House lawmakers recognized is that “most lenders assert that, as a result of the CFPB’s new qualified mortgage rules, they will no longer issue non-qualified mortgages.” Date is responsible for those rules. The problem with his actions isn’t that Date broke ethics laws; it’s that he broke the law of ethics. His violation of the latter is not overblown.
The community banks affected by the CFPB’s rules are small businesses. Many are the financial equivalent to the family-owned hardware store on a small-town Main Street. Community banks’ claim that the QM rule is running them out of the mortgage business is not idle bluster. When the CFPB — with Date as second-in-command — finalized its ability-to-repay and qualified mortgage rule in January, mortgage lending became significantly more difficult for small banks.
The ability-to-repay and qualified mortgage rule split mortgage loans into two categories: qualified mortgages and non-qualified mortgages. While QM loans have many defining characteristics, most important to community banks is that they cannot have balloon payments or any other special terms like negative amortization, interest-only payments, or terms beyond 30 years. If a loan has special terms, or if it fails to meet other requirements, it is a nonqualified mortgage.
The type of mortgage a bank makes under the QM rule has legal implications. If a customer goes into default believing the bank did not properly determine their ability to repay, they can attempt to sue the bank. If a loan is a QM loan, the QM rule provides a safe harbor under which the borrower cannot challenge the bank’s decision to extend credit. This safe harbor will keep most loans out of court.
If the mortgage is not a QM loan, the bank has what’s called a “rebuttable presumption,” which gives the bank only an advantage in court. Under a rebuttable presumption, a court will assume the bank properly determined the borrower’s ability to repay, unless the borrower can prove otherwise. This means suits over non-QM loans will often end up before a judge.
The CFPB recognized that while balloon mortgage loans have special terms, they are used by community banks to manage interest rate risk. If borrowers could take a community bank to court over every qualified mortgage they make, the bank would no longer make the loans, thus leaving small towns without access to mortgage credit. For this reason, the CFPB created an exemption for small banks in small towns for balloon mortgage which they hold in portfolio. Community banks can make balloon mortgages that will be considered qualified mortgages and receive a safe harbor so long as the loan is made by a “small rural bank.” A lender is a small bank if it has no more than $2 billion in assets and makes no more than 500 mortgage loans per year. A bank is a rural (or underserved) bank if half of the loans it originates in a year are made in counties defined by the CFPB as rural or underserved.
Unfortunately, most of the mortgage market and much of the community banking industry received no benefit from this exception. In states like Minnesota, where the bureau defined 50 of the state’s 87 counties as rural, the great majority of the mortgage loans are not in those counties. Only 16 percent of Minnesotans live in areas defined as rural, according to Craig Foss, associate counsel for the Minnesota Bankers Association.
According to Bob Hartwig, legal counsel for the Iowa Bankers Association, even in states like Iowa where population is less centralized, community banks in metropolitan counties or in a neighboring county are still cut off from making balloon mortgages by the rule. The state’s 28 metro counties have approximately 62 percent of the population; the remaining 38 percent of the population live in Iowa’s 71 “rural” counties.
This rural restriction has caused community bankers to bring their concern before Congress. “The new ability-to-repay regulations will expose lenders to litigation risk unless their loans meet the definition of a qualified mortgage… [and] are made in rural areas under an unreasonably narrow definition of rural,” said ICBA Chairman William A. Loving, Jr., president of Pendleton Community Bank, Franklin, W. Va., when he testified before the House Committee on Financial Services on April 13.
The rural restriction will change the business model of Mitchell, S.D.-based CorTrust Bank, which originates more than half of its loans in a county not defined as rural. “That means any balloon mortgage loan we originate does not meet the rural and underserved definition,” said Jack Hopkins, president of the $694 million bank. “We absolutely will be making fewer balloon mortgage loans now. We cannot afford a default on them.”
The American Banker reported that CFPB officials, including Director Cordray, have insisted that there are ways for banks and other lenders to make profitable non-QM loans. Hopkins disagreed. “I cannot quantify the price of increased legal risk I have never seen before. I can underwrite credit risk, I can price credit risk but I cannot price legal risk,” he said. “If I can’t price the risk, I can’t make the loan.
“Most people in small towns are self-employed. How does one prove that you knew they could repay the loan?” Hopkins continued. On a nonqualified balloon mortgage “I have a rebuttable presumption. Ok, so I will ultimately win in court but I still have to pay for the legal cost. Why would I take on the legal costs when the balance of the loan is comparable to the legal costs?” he asked rhetorically.
There are other reasons community banks may discontinue offering balloon mortgage loans as well, according to Dick Behl president of the $26 million Farmers and Merchants State Bank in Scotland, S.D. While the CFPB made a concession for small banks on balloon mortgages, the loans must have at least a five year term. Behl’s bank has done two-year to three-year balloon mortgages for 20 years. As a small community bank, the shorter term allows the bank the control it needs over interest rate risk. “I’ve never had a loss,” Behl said. “Now, it would be very easy for me to drop mortgages and go on my way.”
For each of these banks, the rules created under Date have changed the community bank mortgage business model. For Cortrust Bank, the rules have blocked the bank from providing mortgage loans. Behl considers giving up the business.
Date knows his rules had this effect. “There are plenty of borrowers who are eminently responsible people but fall outside of the bright-line boundaries,” he told Bloomberg. “And there’s a meaningful-sized business that can be quite good for borrowers and for lenders and investors to be able to satisfy that need.” The borrowers he’s referring to are the previous mortgage customers of community banks.
It is true, Date did nothing illegal. He likely had no preconceived plot to take community banks’ market share. But his actions are unethical. The little guys are at a disadvantage; and now the man that put them at a disadvantage has a company ready to soak up their market share.