In an article by Joseph Lawler in the Washington Examiner [1], Sam Vallandingham, President and CEO of his Barboursville, West Virginia-based First State Bank, explains how he had to revamp his business structure in order to continue making and servicing home loans. The numerous rules made for an extremely difficult time for banks when it came to lending, but on top of that, it imposed a fear of litigation.
For some background, while the housing bubble inflated, more and more mortgage lenders were making loans without establishing borrowers income or keeping in mind what would be in the means of the buyer for payments, according to the article. When the bubble finally burst and the foreclosure crisis followed, a nationwide investigation on paperwork and procedure led to the five biggest banks coming to a settlement. At that point, it was decided that servicing loans wasn’t going to be what it had been, the CFPB released new mortgage rules, and the Federal Reserve finalized new capitol rules for banks that put mortgage servicing at a disadvantage.
Of all the changes, the article said the requirements to maintain a higher level of capital in banks were the single most important modification. There was a mandate to have a minimum of 10 percent of capital relative to assets. For example, if the bank lends $100 worth of loans, or assets, it can have at most $90 of it own debt to creditors. So, 10 percent of its funding must come from ownership stakes.
Losses to bondholders equals crises—they cause panics, according to the article. Losses to shareholders do not cause panics, so higher capital ratios mean that shareholders have more to lose before the bondholders feel vulnerable. Vallandingham said his banks bottom line has taken a hit because of these rules because they are related to, but distinct from their bread-and-butter asset of the home loan. According to many mortgage bankers, the rights to serve mortgages are weighted strictly because they must have 2.5 times the capital for each dollar in mortgage servicing assets.
Vallandingham said this is a major hit. They are in the small end, as far as banks go, with just under $200 million in assets, but it services a book of $700 million. When these rules were put in place, it decreased their regulatory capitol by $2 million. This limited the bank’s ability to offer new loans without being in jeopardy of breaking the capitol ratio minimum laws.
As far as the future goes, Vallandingham said you either have to sell off you mortgage servicing rights or find a way around it like restructuring so you can continue to service mortgages without incurring capital charges.
To read the full article, click here [1].