Bank Lawyer's Blog

Cornfed Consideration

A thoughtful reader from the heartland pointed out to me that while grandstanding New "Yawkers" may be making grand gestures to draw attention to the fact that credit unions are (gasp) tax exempt competitors of banks, slow-paced Kansans are taking a more deliberate and, perhaps, more ominous approach. Ominous, that is, if you're a credit union in Kansas.

The 2007 legislative session is nearing its end. But the year's key policy debate appears just to be starting for the state's credit unions.

The chairwoman of the Senate Financial Institutions and Insurance Committee says she plans to ask legislative leaders to create a special committee later this spring to study credit unions' "fields of membership."

A 2006 study by the Legislative Division of Post Audit said the Kansas Department of Credit Unions had been too liberal in its application of the state's law regarding membership for credit unions. The results, the study said, are credit unions that serve too broad a range of consumers.

Sen. Ruth Teichman, R-Stafford, agrees.

"They've overstepped," says Teichman, a banker and leader of the financial institutions committee. "It appears to me they are violating the law."

In the end, the Kansas Bankers Association -- long a competitor of the state's credit unions -- asked for a special legislative committee to study the issue. The Senate committee agreed earlier this year. Teichman says she plans to make the request of legislative leaders, who are expected to comply.

[...]

The bankers association says credit unions have left their traditional roles of serving low- and moderate-income Kansans through what state law calls a "common bond" of membership, such as through an employer or church.

Many credit unions -- the post-audit study declared -- don't have a single "common bond," such as serving only teachers or union mechanics. Many serve a variety of employees from a variety of industries.

Sounds familiar, eh?

Credit Union regulators and trade groups disagree, to no one's surprise.

The Kansas Department of Credit Unions says of the state's 90 credit unions, 43 of them have a single common bond. But 47 of them have multiple common bonds.

But John Smith, the department administrator, says the KDCU has applied the law the same since it was created by the state banking commission in 1968. In fact, the department says credit unions have been chartered with multiple common bonds since the 1950s.

"That has always been the practice," Smith says. "We have a real mixture of fields of membership. A lot of that continues today."

Many credit unions have expanded their fields of membership through mergers that have helped credit unions remain viable, Smith says. He says if the Legislature decides the law hasn't been followed, it should alter the law to reflect the department's practices.

"I don't think you could unwind what's been done," he says.

Yet, that may happen. I assume that the "special committee" will consider that factor, among others.

Credit union supporters point out that credit unions only control about 5% of the market. That's 5% too much for bankers, who believe that if credit unions are going to stretch "common bond" boundaries to the limits of elasticity, and compete with commercial banks for the same base of depositors and borrowers, they ought to pay the same taxes. Anyone who shops for rates realizes that credit unions offer better rates on deposits and loans than their local commercial banking competitors, due to the tax free nature of their income. It's a tremendous competitive advantage.

I speak from personal experience. My wife joined a local credit union, open to residents of the state of Texas (how's that for a narrow common bond), because it offered the best interest rate on an IRA certificate of deposit with the term she desired. I would have called her a traitor to my cause, but the fringe benefits our relationship then would have been endangered and--with all due respect to commercial banks--I'm a weak man when it comes to fringe benefits.

At any rate, while a bold statement made solely to gain publicity may make the loudest public splash, the beneath the waves, "silent running" of a special committee might be a more productive method to craft a legislative "fix" to a problem that continues to irk community banks.

We'll keep our eyes on the land of waving wheat to see how it goes. The fact that the fight against credit unions is being led by the chair of the Financial Institutions and Insurance Committee of the Kansas Senate, a woman described by her web page as a "banker/farmer," means that credit unions in Kansas won't take the threat lightly.

The Borrower's Pants Are On Fire

Texas Tech Professor Ann Graham over at Banking Law Prof Blog has some tough words for purveyors "liar loans."

Comptroller of the Currency John Dugan addressed the problems with "stated income loans" - observers call them "liar's loans". He reiterates the obvious:  When lenders don't verify income, they wink at borrowers who provide the income number necessary to get the loan. That's bad for borrowers who really can't support the payments that will come with the loan and bad underwriting on the part of lenders, inviting loan defaults and charge-offs.  These blunt comments are actually mine.  If you want to see the Comptroller's more polite version, here's the link: 

http://www.occ.gov/ftp/release/2007-48.htm

That's a Texas thing (or "thang," as we say it down here) that Ann has going for her. It's called plain speaking.

No doubt, both Professor Graham and Comptroller Dugan are correct in raising an eyebrow (or four) at the fact that half of subprime loans were "stated income" loans, where income stated by the borrower on his or her loan application is simply accepted "as is" by the lender with no independent income verification. Yet, am I the only person in the country that understands that "stated income" loans and other variations of "quick and dirty" underwriting have been around for years now? When a lender makes a "stated income" loan, it does so knowing that the stated income may be inaccurate. Of course, a borrower who misstates income on a loan application may very well be committing a federal (and state ) crime. Not that criminal offenses are likely to deter people who fail to read their loan documents or their loan disclosures, because it's likely that they won't read the notice on the loan application that false statements on the application are a criminal offense. Thus, I can't argue that these loans don't present a higher risk that the borrower's income may not be sufficient to support the loan payments. They do.

In other words, they're higher risk loans. Which is one of the reasons why they bear higher interest rates and fees. High risk is factored into the pricing. It's called free market, risked-based product pricing. Legitimate lenders make these loans in reliance on other factors (credit scores, credit history, assets, etc.), and expect that a certain percentage of the loans made in this manner will go into default. Not all of them, certainly, although more of them than would be expected with more conventional loans. The lenders who purchase them build the higher expected losses into their pricing models, and as a result price the loans higher than conventional loans.

Professor Graham and Comptroller Dugan are rightly concerned that the abusive use of "stated income" by mortgage originators was, in many cases, part of a scheme to book fees on loans that the originator knew, in his or her heat of hearts, were being made to borrowers who could not repay them. Such abuse needs to be stopped.  There's basically no sensible pricing for a loan that is certain not to be repaid. At least, there's no sensible pricing that any borrower could actually afford to pay. Again, such abusive practices need to be stopped.

On the other hand, Comptroller Dugan is speaking for any agency that regulates national banks, and national banks have not been the problem with stated income loans, or subprime loans in general for that matter. Nor are any of the other financial institutions regulated by the other federal baning regulators. Most of the  abuses have been found outside the banking business, in the land of the wild and woolly (relatively) unregulated mortgage banker and broker. All the good intentions, guidance and other "crackdowns" by the OCC, FRB, OTS, FDIC and NCUA aren't going to correct the problem of abusive stated income loans.

Let's hope that we don't come to the point where the risk-based pricing of loan products will be so severely constrained, by overreaction to past abuses, that you will kiss subprime residential mortgage lending goodbye. There then will be a segment of the political and consumer activist special interest classes who will be outraged that high risk loans to those with poor credit have dried up. I suppose they'll turn to the government to make or guarantee such loans. The FHA on steroids.

I agree that a "cleanup" is in order. Let's just not throw the baby out with the (admittedly dirty) bath water.

Land of the Futile Gesture

I grew up in New York State, as did both of my parents and both sets of grandparents, so I have fond memories of the Empire State. I just thank G-d that today, I'm a Texan. And screw you, Natalie Maines.

Current Governor and perennial school yard bully, Eliot ("Fritz") Spritzer, wants to know how to preserve New York City as the financial hub of the known universe. Naturally, he's appointed a blue ribbon panel to answer this burning question.

New York Governor Eliot Spitzer's office said he has signed an executive order creating a commission to identify ways for New York to retain and enhance its status as a world financial capital.

The panel, known as the New York State Commission to Modernize the Regulation of Financial Services, will review all current financial-services statutes, regulations, rules and policies and propose legislative and other necessary changes, Spitzer's office said Tuesday.

This, from a guy who spent most of his time as Attorney General hounding the most innovative financial geniuses on cleaning up corruption in Wall Street for the sake of his political ambitions good of the common man. I've got a short answer for you Fritz: urge Congress to repeal SOX and then move to California. That ought to boost the standing of New York into the ionosphere.

Not to be outdone by the Democratic thug in Albany, a grandstanding Republican state legislator from Orange County, New York has introduced a bill that he, and every proponent and opponent, agree is not l ikely to become state law and, if it should become law, is preempted by federal law.

A bill proposed in New York state to tax federally chartered credit unions has little chance of becoming law, a Western New York banker and credit union CEO concede, but it should raise public awareness of the issue.

"This is a step in the right direction. It might take a lot of time but it should shed light on the merits of the issue that banks need a level playing field and on what is fair," says Salvatore Marranca, president and CEO of Cattaraugus County Bank. He also is a former president of the Independent Bankers Association of New York State.

He and Ann Brittin, president and CEO of Cornerstone Community FCU - though they are on opposite sides of the issue - agree that a law in New York, or any other state, has little chance of passage because it would be trumped by a federal law that grants the tax exemption to credit unions.

The bill, introduced in April by state Sen. Thomas Morahan, a Republican representing Rockland and Orange counties, would eliminate the exemption that allows federally chartered credit unions to do business in the state tax-free.

"Many federal credit unions have become very large with hundreds of millions of dollars in assets, often equal in size to regular banks," Morahan said in a memorandum accompanying the bill. "However, credit unions are not required to pay the same taxes that regular banks are."

The National Credit Union Administration, which regulates federal credit unions, said federal law would Prue-empty any state law that attempts to revoke the exemption.

Bankers groups, while they oppose the exemption, also agree that federal law takes precedence.

Yes, I see now: by introducing a bill that will never pass and if passed will be preempted, Rep. Morahan has brought to the public's attention the previously unknown facts that some credit unions are large and all are tax exempt. Right now, I'm vibrating like a tuning fork with fury at this outrageous state of affairs. I'm certain that New York voters feel the same.

We pay these people. Well, "we" don't. New Yorkers pay these people. I feel their pain.

In Texas, we periodically cull the political herd of the stragglers and runts. Usually, we try to pawn them off on D.C. Failing that ruse, I suggest that New Yorkers either retire these chowder heads or find a "bridge to nowhere" project to keep them occupied.

Virtual Reality

This post has to do with the practice of law, not the banking business, although I think that it should be of interest to not only private practitoners, but in-house counsel and those bankers who purchase outside legal services without the "middleman" of in-house counsel. It's about how the practice of law is changing, and how business clients, including banks, recognize that the traditional law firm model simply doesn't work for banks and other businesses any longer.

The first post was by Sun Microsystem's General Counsel, Mike Dillon, on his blog, The Legal Thing. It's entitled "The Way of the Mastodon," and the "Mastodon" to which he refers is the traditional "one-stop-shopping" big law firm. It's a relatively brief post, so I'll quote it in full.

Let me begin by asking - what is the function of the law firm? My view is that law firms serve primarily as aggregators of specialized legal expertise. The premise has been that by combining multiple legal disciplines you can provide “one stop shopping” for current and prospective clients. This structure previously made sense. If you were an individual or business with a legal problem, it wasn't efficient nor effective to try to identify an individual attorney with the technical skills that you required. So, you would turn to a law firm and rely on them to direct you to the appropriate attorney within their firm to solve your issue. The problem is that this model relies on growth (the need to add additional attorneys) to maintain profitability rather than focusing on efficiency gains. In this respect, it is at odds with what I need as a client and General Counsel.

As with so many things, the Internet is changing this business model. It is getting increasingly easier to move the aggregation function in-house. To find an attorney in a specialized area, I don't need to turn to a large law firm. Instead, I send out an email to my network of other in-house attorneys or within professional associations like the ACC and get referrals. Not only that, but I get true “customer feedback” that is more objective than what I would get from a firm. There is now a proliferation of materials available on the web – judicial opinions, legal commentary and press articles that also provide information about attorneys.

The result is that we are increasingly able to identify and engage specific legal talent directly. Here's an example. Like all large companies, we have a certain amount of employment litigation. Almost all of the large firms have strong employment law practices. But, we use a very small firm for much of this work. Why? They focus only on employment law, are very good at what they do, understand our business, get excellent results and are very cost effective. They don't have the overhead of supporting attorneys practicing in other areas.

My point is that the epoch of the current law firm model - which derives its profitability from growing scale and raising hourly rates - will soon be over. The firms that will survive and thrive are those that recognize this change and focus on how to maintain margins by focusing on efficiency. In the future, I'll describe some the things we are doing in this area, but I'll point out that we recently selected a small number of law firms to support us as "preferred partners" during the next fiscal year. We believe that these firms "get it" and are receptive to looking at new ways to drive down their (and our) cost structure. Hopefully, more firms will embrace this change. If they don't, I fear they will go the way of the Mastodon.

John Walker, a business consultant, lawyer and (in the interest of full disclosure) friend, had a related post the same day on his blog Minding the Law's Business called "Virtually An Advantage." In his somewhat longer post, John refers to a recent article in The National Law Journal called "The Rise of the New Model Firm," that discusses how innovative alternatives to the traditional law firm model are being pursued by a number of players. John discusses a particular variation that relies heavily on the Internet, called "the Virtual Law Firm." While John's ultimate conclusion that the operational efficiencies that he outlines do not, standing alone, offer a true, long-term "competitive advantage" to the virtual law firm business model (because other firms can duplicate it) is correct, the virtual firm does permit its members to drastically lower their operational costs. All things otherwise being equal (especially experience and expertise), the firm with the lower fixed operational costs has the advantage in pricing flexibility.

To be sure, those VLFs on the scene first, especially those that focus on sophisticated business clients whose work requires experience and/or expertise and then match their assets (lawyers) with the demands of their clients’ business base, should be able to “perform similar activities better than rivals perform them” – thus gaining an initial operational effectiveness advantage.  This early VLF advantage likely would stem from:

• Lower infrastructure costs from little or no facilities costs and reduced administrative costs.
• Lower financial capital costs for, and greater speed in executing, geographic expansion.
• Reduced lawyer-related costs as (1) the business demand requirements (experience and/or expertise) would eliminate the need for “warehousing” and training young lawyers whose costs (particularly at today’s outrageous starting salaries) exceed their revenue generating capability, and (2) the network character of the firm would enable it to associate with lawyers outside the firm who have special expertise on a project-by-project basis and therefore avoid carrying the overhead expense for that expertise when it’s not needed.
• Greater pricing flexibility than firms carrying higher infrastructure and lawyer-related costs.
• Greater opportunity to deliver higher value to clients resulting from better positioning within the professional asset capability matrix combined with the improved cost structure.

To be sure, over the long term you need more than lower costs to gain and sustain a competitive advantage. Nevertheless, the flexibility in pricing that results from such a lowering of operational fixed costs is a real advantage for "early adopters." This is especially true where high expertise, low "body count" type of legal work is open for competition.

I set out in 1992 to try to deliver sophisticated legal services to banks and certain other business clients in an environment free from the constraints that large law firms imposed. Four years later, after experimenting with a couple of different business models, my partner, Bill Parsons, and I founded a virtual firm, and (after a couple of detours) in 2003, Valerie Chisholm Berke, joined us. By following three basic rules, KISS ("Keep It Simple, Stupid"), NAA ("No A**holes Allowed"), and MUT ("Maimize the Use of Technology"), and a number of other easy-to-follow guidelines (the author of Bank Lawyer's Blog is capable of following no other type of guideline), the virtual law firm we've forged has permitted each of us to attain the maximum flexibility in lifestyle and work-style choices, while affording us the ability to bill our services at hourly rates (and on other client-oriented bases) that have been substantially less than had we had to support the conventional "infrastructure" of a traditional law firm. Perhaps we've merely been lucky. Luck, too, can be a competitive advantage over pure intelligent. I like to think that we've been a little lucky and a little smart and that the business trends moved in our favor.

We're not unique, by any means. A number of lawyers have discovered the same model (for example, fellow Texan Chuck Newton, who preaches "The Third Wave" law practice model). Moreover, as The National Law Journal article reveals, the variations on this theme, and other, unrelated, yet innovative, business models are being employed. Nevertheless, if you work for a bank and are responsible for purchasing legal services from outside counsel, you should consider seriously the lessons that people like Mike Dillon, and Cisco's General Counsel, Mark Chandler, are trying to teach you. If you're a partner in a big-firm and are between the ages of 35 and 55, you ought to give the alternative business models careful consideration. A virtual firm doesn't make sense for everyone, but it, or another alternative, may be dictated by the marketplace, and you don't want to see the train leaving the station before you've hopped on board.

Working For The Weekend

Sure, we could end the week with a pithy sound bite about the new Reg Z amendments proposed yesterday by the Federal Reserve Board. After all, we've had 24 long hours to absorb all 800 pages, analyze them, and spit out the same cursory analysis that I've been reading all day ("They concern me," says bank trade association executive X.) ("We intend to spread out the cost of our review among many banking clients," says big firm bank attorney Y. "Of course, we'll multiple bill them all for the same time. It's the American way.") ("My gawwwwd, that's a lotta papah to look at," says Bank Lawyer's Blog "legal intern" Lola, stage name "Devine."). But, no, our eyes glaze over and our narcolepsy kicks in at the mere thought of that Sisyphean task. An associate will do it.

We might end up a long work week before a long holiday weekend with a wisecrack about Minnesota (the land of "Yah, Sure" and "You Betcha!," or close enough) beating Texas, Massachusetts and the rest of America to enact the nation's first law (the Plastic Card Security Act) that makes merchants liable to customers and banks for the kind of security breaches that plagued TJX. However, like all other areas of commercial life, and eventually personal life, we expect this field to be preempted by, and ruled over by, the monolithic monstrosity that is known by three feared letters: O...C...C. So, what's the use? Resistance is futile and all state laws are merely academic.

No, we've set our sights on an issue that burns within us with a blue-white heat we've not experienced since the horror of the suggestion that Paris Hilton might be (like Poke Salad Annie's mama) forced to work on a chain gang. It's the news that made the three hairs left on the top of our head stand up straight and bay at the moon: Bank of America launches NASCAR checking program. 

Hoping to build on its newfound expertise in credit cards and on NASCAR fans' loyalty, Bank of America Corp. has begun offering a NASCAR checking account to try to drive more retail business to its automated teller machines and branches.

The new account will feature NASCAR designs on checks and statements, and special interest rates on some certificates of deposit and other nvestments.

The bank also will offer affinity banking products linked to alumni associations, special interest groups and nonprofit causes, such as Habitat for Humanity International.

"Drive more business." Heh.

I realize that the 12 million illegal immigrants undocumented guest workers that BofA has been pursuing (to sign them up for a BofA credit card) may enjoy Mexican and South American soccer teams more than All-American NASCAR, and it's likely that most NASCAR fans would hunt illegal immigrants undocumented guest workers for sport (were it legal, of course), so this is what might be called "separate sector targeted marketing." It's a natural outgrowth of Bank of America becoming, last year, "The Official Bank of NASCAR." And we know how well NASCAR drivers like their tracks, and their checks, "safely banked" don't we?

I thought that I'd seen the epitome of marketing savvy when I viewed the marvelous re-write of U2s "One" that we shared with you not long ago. Now that BofA is firmly in the land of hot smokin' tires and even hotter smokin' babes, it's only appropriate that we also pay tribute to the new, best, archetype BofA customer: Ricky Bobby.

Y'all have a wonderful holiday weekend.

A Bully Pulpit or A Bully's Pulpit?

It's always interesting to hear a federal banking regulator tell banks that he's not really certain that his agency will ever actually penalize a bank for not following a set of gudelines promulgated by his banking agency. Instead, he admits that what the regulators are really doing is using their "bully pulpit" to bully the banks into doing the "right thing." You know, a little arm twisting? But in a nice, non-threatening manner, of course.

That appears to be the case with the Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices issued by the FRB, OCC and FDIC last December (the OTS issued separate guidance that was less restrictive). While the regulators aren't saying that they  were bluffing, they appear to be saying that, contrary to some cries of alarm that we heard at the time, they aren't going to "go medieval" on banks, either.

New guidelines effective this year come complete with suggested limits -- not to be confused with caps -- on construction and development lending and total commercial lending.

If banks exceed those limits, officials with the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Federal Reserve Bank say they'll scrutinize banks more critically and could make banks withhold additional capital or curb lending.

Regulator Steve Fritts said the guidelines are a reaction to rapid growth in commercial real estate lending in the past half-decade, though loan losses stayed manageably low.

"As we saw portfolios grow, we saw that management of portfolios, and the building of systems to support that, didn't always keep pace," said Fritts, the FDIC's associate director for risk management policy and examination oversight. "We wanted to address an issue before it became a problem, and while we believe most banks have done a good job growing that business and building the infrastructure to manage that business, anytime you have rapid growth, it's a little bit of a flag that you want to control the systems growing with it."

[...]

Regulators and bankers said they're not anticipating stricter audits for banks that practice prudent underwriting standards. And they say they've always had the power to instruct banks to limit their risk since their institutions insure bank loans. Annual examinations of bank lending shouldn't be too different than in years past, they said.

[...]

And while Fritts said the guidelines don't give examiners any new legal authority, they are a wake-up call to banks and a reminder not to relax any underwriting standards.

"I think it is sort of the bully pulpit to say, 'this is something we're watching as a supervisor,' so when we issue things like this, bankers pay attention," Fritts said.

No new audits. No new powers. Nothing different during an annual examination. So, Steve, how's that bully pulpit working so far? Any of the banks with their arms twisted behind their backs screaming "uncle" (or "auntie" for that matter)?

Half of the more than 5,000 federally insured banks that make commercial loans exceed the regulatory criteria, according to the FDIC.

About 24 percent, or 1,198 institutions, exceeded both ratios. Sixteen percent of banks, or 803 institutions, exceeded just the construction and development ratio and 495 institutions, or 10 percent, exceeded the total commercial real estate suggested ratio and had at least 50 percent growth in real estate lending in three years, according to 2006 FDIC data.

Hmmm. Looks like we're going to hear more yelling and screaming form the bully pulpit as the year wears on if those numbers actually indicate that their is an "undue concentration" problem. What might be the result? The American Bankers Association's Mark Tenhundfeld has an idea (suggested, naturally, by the guidelines themselves).

While the final guidelines are less stringent than those originally proposed, the American Bankers Association expects banks will be required to prove they're managing their risk using stricter testing methods during future regulatory exams.

Banks can count on regulators asking them to stratify their portfolios, or categorize loans according to different factors such as geography or type of construction or by each builder so regulators can more easily see where there are concentrations, Tenhundfeld said.

When the CRE guidance was proposed, I thought that the concern expressed by some community bankers was overblown. Thus far, I think that I'm correct. I realize that many community banks find, as Tenhundfeld observes in the article, that commercial real estate lending is a "sweet spot," where they are able to compete locally with the big boys. That makes a threat to that sector one more reason for community bankers to reach reflexively for the Rolaids. Thus far, however, I'd say the bark coming from the "bully pulpit" is worse than its bite.

Then again, we'll give this time to see if any horror stories shake out.

Updates

I mentioned in March that Texas was on its way to becoming a member of the group of states that have banned commercial businesses that own ILCs from branching in their state. That law, HB 944, was passed by the Texas legislature and sent to the Governor for signing on May 15, 2007. Welcome to the Wal-Mart Smackdown Republic, Big Tex!

At the federal level, H.R. 698, which would prevent companies with more than 15% of their gross revenues derived from commercial activities from owning an ILC passed the House yesterday (paid subscription required). An identical bill in the Senate is expected to be savaged by a rampaging T. Rex known as Bob Bennett of Utah, who has successfully blocked such efforts in the past and who has vowed to hunt down and eat not only the supporters of this bill, but their families and their SUVs, as well. The fact that Utah is home to many high profile ILCs is completely coincidental.

"I don't think enactment of new legislation is a foregone conclusion," said Lawrence Kaplan, a lawyer with Nelson Mullins Riley & Scarborough LLP.

Neither do I, although I've never been quoted in The American Banker, so take my concurrence with Mr. Kaplan's opinion with a grain of salt.

Between the states and the federales, things are looking grim for commercial ILCs owned by the likes of Home Depot (Wal-Mart: Never!). There's still talk that certain industries, like the auto industry, might be exempted from a ban, although it appears that a compromise (if Bennett's willing to accept one) would be based upon the type of financing activity conducted by the ILC (such as financing goods produced by the holding company or an affiliate) rather than upon the industry of the holding company.

In another update to previous posts, it appears that mortgage fraud in Colorado is beginning to drop from the lofty heights we noted last year.

Colorado slipped to ninth place nationwide in terms of mortgage fraud in 2006, continuing a decline seen since 2004, according to a report released by theMortgage Asset Research Institute.

Colorado's latest ranking compared with a fifth-place showing in 2005 and third place in 2004, according to a report delivered on May 16 by MARI to the Mortgage Bankers Association in Washington, D.C.

[...]

Colorado's fraud problem, as measured by MARI's Mortgage Fraud Index (MFI) also declined. In 2006, Colorado had an MFI of 108, meaning its number of loans with misrepresentation was 8 percent higher than what MARI would have expected based on its origination volume. In 2005, Colorado's MFI was 154, meaning its fraud rate was 54 percent greater than expected given its loan volume. In 2004, the state's MFI was 205.

Although it remained in the top 10, Colorado -- along with Georgia, Illinois and Michigan -- reported fewer fraud cases than in 2005.

In terms of subprime loan origination, Colorado's rank slipped to 10th in 2006, with an MFI of 120. That was down from seventh place in 2005 (MFI: 176) and fourth in 2004 (MFI: 173).

Poor Colorado. When  it comes to mortgage fraud, it simply has no staying power. It definitely needs a mortgage fraud pick-me-upper, doesn't it?. Isn't there a little blue pill for that? Yes? No?

C'mon, Colorado! Try harder! Import more felons! Like Beat-Box Blake on American Idol, we know you can hang in there even when the competition seems formidable.

Ohio Anti-Predatory Lending Law Pushes Mortgage Brokers Into The Arms Of Banks

The current craze to crack down on the crooked cretins who purvey predatory  loans to credulous consumers, in addition to presenting me with an opportunity to satisfy my near-fetishistic fascination with alliteration, may soon prove to be a boon to banks, if Ohio's experience is a precursor of what things may come. SB 185, the Ohio predatory lending bill that took effect January 1, 2007, has prompted previously "free and easy" mortgage bankers to hire on as hired guns to regulated financial institutions.

For some, not renewing a mortgage broker license doesn't mean the end of peddling mortgages in Ohio. It just marks the start of working for a bank.

In Ohio, only nonbank mortgage brokers must be licensed with the state and adhere to the new rules laid out in Senate Bill 185, a comprehensive mortgage lending bill.

So some mortgage brokers, to avoid the potential effects of S.B. 185, closed up shop and joined the staffs of banks, where they fall under state and federal banking regulations and not those of the new bill.

Michael Reeve, the owner of a private mortgage banking company in Ohio, closed up shop and moved his entire operation over to a commercial bank because he thought that the disparity of treatment under the law between banks and non-banks created an "uneven playing field." An unlevel playing field also bugs me, especially when I'm playing football, and some young female ball carrier blows by me before I can snag her flag. I always blame that on turf problems.

"I think that over time on the broker side that pricing is going to get worse because of the increased risk, and it also creates liability for the company's owner," he said.

Reeve worries the bill could open the door for litigation from borrowers looking to get out of their mortgages by alleging violations of the new laws.

Also of concern is that the secondary market - investors who buy loan portfolios from lenders, essentially providing capital to the mortgage market - will either pay less for Ohio loans or won't buy them out of fears of lawsuits.

Reeve's solution was to take his 16 brokers and four loan processors to Guernsey Bank, which created a division for the mortgage unit, said bank President Bob Patrella. By switching to the bank, Reeve and his brokers didn't need to renew their licenses with the state because they're no longer needed. They also retained their Zanesville office, which is now a part of Guernsey.

A thinking man's mortgage broker might also want to consider a variation on the above theme: an operating subsidiary of a national bank or federal savings bank. After Watters v. Wachovia, what little doubt remained as to federal preemption applying to operating subsidiaries has been removed. Thus, the mortgage operations will be free from state laws like SB 185 that explicitly exempt financial institutions, and also from many other pesky state laws that do not. Perfect for a multi-state operation. Plus, as an operating subsidiary, up to 49% of the voting ownership interest (and all of the non-voting "preferred ownership interest") could be owned by the owners of the mortgage banking company that comes on board. The bank or thrift has to have "operational control" of the operating subsidiary, but that leaves plenty of leeway for structuring "equity upside" and "incentives" for mortgage bankers. There are other issues (like RESPA compliance) that can complicate life, but it's one option to consider.

I wonder if Ohio legislators thought that when they passed SB 185, they would be pushing mortgage brokers into the arms of financial institutions that were exempt form the law, and, perhaps ultimately, into nationally chartered financial institutions, to the detriment of locally regulated lenders. What are the odds? Ohio may end up with a "law to nowheresville." Great consumer protections, and no one subject to them.

For anyone interested in SB 185 (and we assume that Ohio attorneys are already familiar with it), the Ohio Mortgage Bankers Association web site contains a page with links to the law and to a summary and an analysis prepared by local firms.

Rush To Misjudgment

A couple of recent experiences prompt me to remind bankers who read this blog (you two guys know who you are, but I'll never tell) that the FFIEC Guidance entitled Authentication in an Internet Banking Environment requires multi-layered security, mutli-factor authentication or "another control" only where (1) a risk assessment performed by the bank indicates that single-factor authentication is inadequate and (2) the solution selected by the bank to address the risk is "reasonably calculated to address those risks." The first obvious step that the bank must take is to perform a risk assessment. Without that assessment, the bank won't be able to show the bank's regulator that the solution selected was logically chosen to address the risk assessed by the bank.

In other words, merely running out and buying the first multi-factor authentication solution that the bank's existing data processing vendor offers to the bank because it was there (and besides, the vendor always comes through with Dallas Cowboys tickets on the 50 yard line) is not going to cut it. At least, it shouldn't cut it, although a number of bankers seem to buy into the "philosophy" of  banking known as the Alfred E. Neuman  School: "What, Me Worry?" That's the same school that asserted that compliance with the guidance by year end 2006 was a matter of complete indifference.

OCC IT Analyst Kimberly Cahill tried to make all this clear in a BAI-hosted "webinar" in March.

"[The FFIEC guidance] promotes a risk management process," Cahill said. "It does not mandate multi-factor authentication."

[...]

Since the Federal Financial Examination Council (FFIEC)   issued its online authentication guidance   in October 2005, there's been a perception in the industry that compliance primarily means adopting more than   one technology for authenticating online customers. Many bankers looked to technologies such as password-generating   tokens to provide that extra level of authentication.      

But Cahill said the guidance, which became effective in December 2006, is aimed at getting financial service providers to embrace a more comprehensive strategy for handling their risk.   She said it calls for banks to assess the risk inherent in their online products and services, implement   a strategy to mitigate those risks (which may incorporate multiple forms of authentication), make   customers aware of these plans and then review and adjust their strategy as necessary.

Cahill stressed that the guidance was not "prescriptive or technology-specific"   and must "be dynamic and change over time."

Bank consultant Tripp Johnson of Cornerstone Advisors had more to say on this in an excellent three-part series on the blog Gonzo Banker, the last part of which (also containing links to the first two parts) is here. Ms. Cahill and Mr. Johnson both emphasize that as part of the bank's decision on a solution, the bank must take into account the effect of the solution on the bank's customers. In other words, the process of risk assessment and solution selection must be well thought out. It also ought to be well documented, so the bank can prove that it was well thought out.

GonzoBankers, I do not take this guidance lightly.  I firmly believe that a simple user name and password are totally ineffective in protecting access to customers’ information and their online accounts. I also think blindly implementing a multifactor authentication technology solution that causes repeated customer impact is just as pointless and actually borders on naive.

I'd also add "and as a matter of practice, on the unsafe and unsound."

By the way, I have no affiliation with Cornerstone Advisors. I simply have to give a hat tip to any consulting firm that uses the term "gonzo." It's so Hunter S. Thompsonesque.

I Think We're All Bozo's On This Bus

Ben Bernanke spoke today with moderation and caution, as befits the Chairman of the Federal Reserve. Unfortunately, his audience consisted of a herd of uncomprehending, clapping, barking seals.

Federal Reserve Chairman Ben Bernanke says the central bank is considering tougher rules to crack down on abusive practices by mortgage lenders. But he says the economy should escape without significant harm from the problems in the subprime market.

Facing criticism from members of Congress about lax regulation, Bernanke said Thursday that the Fed was reviewing all of its options from bolstering disclosure requirements on what lenders must tell prospective borrowers to writing tougher rules to guard against fraud.

"We at the Federal Reserve will do all that we can to prevent fraud and abusive lending and to ensure that lenders employ sound underwriting practices and make effective disclosures to consumers," Bernanke said in a speech to a banking conference in Chicago.

I suppose Bernanke thought that it was unnecessary to remind his listeners of a fact that he's repeated on numerous occasions: the Fed doesn't regulate the majority of subprime mortgage lenders. He wasn't counting on the Tourette's-like ejaculatory squawking of Senators Dolt Dodd and Schoo-fly Schumer.

Senate Banking Committee Chairman Christopher Dodd, D-Conn., who earlier called the whole episode a "chronology of regulatory neglect," welcomed Bernanke's announcement of Fed hearings.

"It's past time for action," Dodd said in a statement, which urged the central bank to "move expeditiously" to promulgate tougher rules.

To what end, Chrissy? So that lenders who aren't making predatory loans won't make them? Is that what you're saying? What good are tougher rules going to do IF THEY DON'T APPLY TO THE LENDERS WHO NEED TO BE SUBJECT TO THEM?

Logic: it's a bitch.

The people of Connecticut would have been better off electing Chris Evert to the Senate. By now, she would have backhanded this subprime "crisis" for a winner from the baseline. Plus, she always looked great in a short skirt.

Sen. Charles Schumer, D-N.Y., who has introduced legislation to help homeowners avoid foreclosures, said Congress needed to act in time to deal with thousands of homeowners facing the threat of foreclosure.

"I hope Chairman Bernanke is right when he says that a slumping housing market will not affect the broader economy, but I would not bet the house on it," Schumer said in a statement.

That Chuckles: he's quite the clown. Did you know that he created the Firesign Theatre's line, "I think we're all bozos on this bus"? True story.

I think that the Chrissy and Chuckles press conference would have gone off better if, right in the middle of Chrissy's remarks, Chuckles hadn't broken into the monotone mantra: "Three minutes to Wapner. Three minutes to Wapner. Three minutes to Wapner."

While Chuckles wanders in the intellectual desert, searching for the Neverland of lost cerebrums, another New Yorker is taking a look at the cold realities of federal preemption and speaking truth to power (paid subscription required). Well, he's also got power, but it's so cool to say "speaks truth to power" that I use that phrase even when it's meaningless. Just like Nancy Pelosi. In fact, I like to use it so much that I think I'll apply for a job as a caddy on Al Sharpton's golf team. As long as they don't make me wear plaid plus fours. Or one of those Superfly tam o'shanters.

In his first speech to a banking industry group since his confirmation in April, New York State Superintendent of Banks Richard H. Neiman said Friday that his tenure will be defined by subprime lending and federal preemption of state banking laws.

These issues "will not only have a lasting impact during my term," but they also "may result in significant market and structural changes long after I am gone," he told the New York Bankers Association at the Waldorf-Astoria Hotel in New York.

Mr. Neiman was most outspoken about his reaction to the Supreme Court's April 17 decision in the Watters v. Wachovia case, which reinforced the Office of the Comptroller of the Currency's power to preempt state oversight of national banks.

"In addition to making the national charter more attractive, the decision is likely to chill state regulation and/or encourage the migration of state institutions to states with less regulation," he said.

"No state wants to put their own state institutions at a competitive disadvantage. Certainly with New York's vibrant financial markets, this is a critical issue for us."

He's obviously right, the Watters v. Wachovia decision is one more heavy weight on the side of the scale tipping in favor of the national bank charter versus the state bank charter. If you can shield the bank's balance sheet from the legal risks of performing certain activities like, for example, residential mortgage lending, yet perform those activities free from all those annoying state laws and regulations that make residential mortgage lending, especially on a multi-state basis, as pleasant an experience as Dustin Hoffman underwent sitting in Laurence Olivier's dentist chair in Marathon Man, well, you've got your self a serious advantage. If you don't mind being regulated by the OCC versus a state regulator who actually recalls your given name, that is.