Bank Lawyer's Blog

Father Knows Best

Personal Finance Columnist Pamela Yip of The Dallas Morning News recently talked to Matt Fellowes, a scholar at the liberal "think tank" Brookings Institution, and discovered something quite amazing: liberals think poor people have too much access to credit.

It used to be that low-income consumers didn't stand a chance of getting a loan.

But today, lenders aggressively court this market with subprime mortgages and payday loans.

"It's a boom market," said Matt Fellowes, a scholar at the Brookings Institution, a liberal think tank, who recently completed a study on lending to low-income consumers. "Where 40 years ago lenders were being accused of redlining lower-income markets, now they are awash in credit. In fact, families in the bottom half of the income distribution have been the fastest-growing part of the credit market over the past 20 years."

But have we gone too far in extending credit to low-income consumers – especially those who don't have much wiggle room if the slightest hiccup throws off their finances?

Definitely, according to Mr. Fellowes. The trouble is, federal policy is stuck in the 1960s, when credit was difficult to get, he said.

"Federal policymakers need to get their foot off the gas pedal in promoting access to credit and start addressing the hard reality that millions of Americans now have too much access to credit," he said.

Let that one sit there and settle for a minute. Aw, to heck with that! Let's just keep skipping down the yellow brick road!

More than 55 percent of lower-income households held debt in 2004, up from 50 percent in 1989, Mr. Fellowes said.

"Total debt held by these households increased by 308 percent during this period, now adding up to over $481 billion," he said. "Nearly all of this debt is for mortgages and home-related installment trades."

Not surprisingly, Mr. Fellowes said, more than 32 percent of lower-income borrowers struggle to pay bills on time, and about 27 percent spend more than 40 percent of their income servicing debt.

"Congress can't just regulate its way out of this problem," Mr. Fellowes said. "There are deep, systemic problems with America's understanding of how to manage money effectively."

I had to re-read this several times before I was able to convince myself that I wasn't having an LSD flashback (which was odd, since I've never done LSD). A liberal intellectual proposes not only that poor people have too much access to credit, but also that this is a problem that big government can't solve by passing a law to kiss the booboo and make it all better. What's next, James Carville appearing on CNN and defending Don Imus?

So what does Mr. Fellowes propose, other than turning off the spigot to easy credit? That's already happening, thanks to bank regulators' "guidance," hearings and press conferences by politicos threatening legislative crackdowns, and, curiously, by the free marketplace going all Darwinian on certain of its weaker participants. Strangely, Mr. Fellowes calls not for bank lawyers (usually the perfect accessory with any outfit) but rather for another band of superheroes: "financial intermediaries."

Mr. Fellowes says what's lacking is an "intermediary," such as a financial planner, who would stand between "lenders and borrowers today in low-income markets – someone who basically can take all the options that families have today and evaluate what those different options are and what would make the most sense."

The concept is good, but I don't know many low-income consumers who can afford a financial planner.

Neither do I, Pamela, unless you pluck the planners from the ranks of roadside warriors holding cardboard signs saying "Will Plan For Food." A person who can't afford to pay the mortgage or a credit card is going to pay a "financial planner"?

But, you have to get up darn early in the morning to catch this fellow Fellowes without a ready answer.

One thing Congress could do is to give employers incentives to offer financial planning services at their workplace.

Companies already offer this to top executives, and many bring in financial advisers to help workers plan for retirement, Mr. Fellowes said.

Yes, well, due to the outrageous disparity in income between top executives and the average worker, top executives actually have assets and income that require planning, while the average worker considers himself lucky to be able to answer in the affirmative when he's asked, "You want fries with that?"

Ms. Yip doesn't get the "yips" under pressure. She's got a suggestion of her own.

I'd add another source: counselors from Consumer Credit Counseling Service agencies, which offer basic money management courses.

I assume that those agencies also charge a fee, however. Again, will the needy pay for the help?

James Ballentine of the American Bankers Association has the final word on the difficulty of trying to counsel people on the use of credit when they simply don't have the financial resources to pay back what they borrow.

The challenge is talking about prudent use of credit to those workers who are already living hand-to-mouth and going into debt, Mr. Ballentine said.

"It's a particularly difficult conversation when you're talking about low-income communities, because they're living paycheck to paycheck."

We've come a long way when folks on the left scream that lenders are too liberal in making credit available to poor people. Whether the distance we've come has been in the right direction, I'm not certain.

Expect this type of analysis to be used to support legislative "remedies" like the "suitability" standard proposed by (Up)Chuck Schumer and Barney Frank and the mandatory credit counseling legislation in Texas that we recently discussed.

On the other hand, banks should bring this theory to the attention of the bank regulators whenever possible. "Get your foot off the gas pedal and off my back, OCC." "What decade are you living in, FDIC, the 1960s?" "CRA? We don't need no stinkin' CRA!" "How many loans did I make in Cook County last year? Haven't you read the latest Brookings report? Those folks in Cook County have got WAY too much credit as it is!"

I know: I'm a glass-half-full kind of guy.

Window Dressing

Were you as excited as I was when you read the federal banking regulators "Statement on Working with Mortgage Borrowers"? I couldn't believe how flexible the banking agencies are becoming at letting banks work out whatever arrangements they desire with subprime mortgage borrowers who turn out to be subprime mortgage borrowers. More flexible than figure skater Sasha Cohen, if that's humanly possible.

You know subprime mortgage borrowers, don't you? They're the ones who don't pay the loans back as they promised they would, because, of course, THEY'RE LESS THAN PRIME MORTGAGE BORROWERS!!!!

The purported impetus for the Statement involves the interest rate "reset" that will cause "payment shock" in borrowers who didn't read their disclosure statements or loan documents when they borrowed money in the form of adjustable rate mortgages. In case you've been in a coma for the past year, that's a hot topic. "These borrowers may not have sufficient financial capacity to service a higher debt load, especially if they were qualified based on a low introductory payment." Sound like perfect candidates to roll those puppies over into another 2/28 with a teaser rate, eh?

No, that's not what the regulators have in mind.

Such arrangements can vary widely based on the borrower’s financial capacity. For example, an  institution might consider modifying loan terms, including converting loans with variable rates into fixed-rate products to provide financially stressed borrowers with predictable payment requirements.

In bureaucrat-speak, "for example" means "this is what we're talking about, idiot."

The Statement is full of cheery reminders that refinancing ARMs into fixed rates is the right thing to do.

The agencies encourage financial institutions to consider prudent workout arrangements that increase the potential for financially stressed residential borrowers to keep their homes.

[...]

The agencies will not penalize financial institutions that pursue reasonable workout arrangements with borrowers who have encountered financial problems. Further, existing supervisory guidance and applicable accounting standards do not require institutions to immediately foreclose on the collateral underlying a loan when the borrower exhibits repayment difficulties.

[..]

Financial institutions may receive favorable Community Reinvestment Act (CRA) consideration for programs that transition low and moderate income borrowers from higher cost loans to lower cost loans, provided the loans are made in a safe and sound manner. Financial institutions, working alone or in conjunction with reputable organizations such as the Center for Foreclosure Solutions sponsored by NeighborWorks, can assist borrowers in avoiding foreclosure through credit  counseling. Such programs also help financially stressed borrowers avoid predatory foreclosure rescue scams.

The bloom comes off the rose, however, when you read all the qualifiers.

Prudent workout arrangements that are consistent with safe and sound lending practices...

[...]

However, there may be instances when workout arrangements are not economically feasible or appropriate...

[...]

Institutions should identify and report credit risk, maintain an adequate allowance for loan losses, and recognize credit losses in a timely manner...

In other words, "we encourage you do a good deed, but we'll have a 23 year-old kid fresh out of examiner's training review those good deeds one or two years later and cite you for violating safe and sound banking practices for doing so. Why? Because we can, that's why."

Last Tuesday, the same day the Statement was issued, FDIC Chairman Sheila Bair testified before the House Financial Services Committee (paid subscription required), and blathered about the need to refinance ARMs into 30-year, fixed-rate mortgages. However, she also noted the fatal flaw in her call for banks to solve this problem: they don't own the loans.

But roughly 75% of subprime loans were packaged and sold as securities in 2006, so there are limits to how many troubled loans can be modified. With subprime loans being purchased and sold in global securities markets, it can be difficult to track down loans so they can be extracted and restructured. Moreover, agreements governing the creation of mortgage-backed securities can limit the ability of loan servicers to modify mortgages.

In addition, it's already been established that banks and other institutions regulated by the federal banking agencies did not originate a majority of subprime loans. In fact, only 23% of subprime loans were originated by banks. Those other lenders don't give a rip what Sheila Bair, or any other regulator who has no power over them, has to say.

This entire exercise seems to be addressing a problem, but doesn't accomplish a thing of practical value. It's nothing more than window dressing. What a kabuki dance these D.C. folks put on.

All We Need Is Love (And The CRA)

In a surprising twist of the old adage that "the enemy of my enemy is my friend," the president of Western New York's largest credit union is reaching out to small community banks to gather them together in a coalition of the "kinda, sorta" willing, in order to battle a common foe: the Community Reinvestment Act.

When it comes to CRA, Michael Vadala, president of Summit Federal Credit Union, thinks that credit unions and some banks -- especially smaller institutions -- should be allies instead of enemies.

"I'm not going to help banks because they certainly don't want to help us," he says. "But I would not be opposed to giving small community banks regulatory relief from CRA. If smaller banks sought it, we wouldn't fight them."

"We wouldn't fight them." Wow, ratchet back the enthusiasm, Mike, before you embarrass yourself!

Community banks should keep firmly in mind all those Christian and democratic partisans in Yugoslavia during WW II who grasped the helping hand of Communist partisan leader Tito and then found themselves on the wrong end of the gun barrel after the Nazis were defeated. Strange bedfellows make...well...strange love.

CRA bubbled up after the November election because with Democrats taking control of Congress, bankers groups and some consumer organizations have begun expressing optimism about forcing CRA-like requirements onto credit unions as they have been applied to banks for years.

[...]

Vadala says credit unions are united in their opposition to CRA, but he also thinks that small banks can make a case for being exempted.

"It's a huge compliance burden for a small-community bank," he said. "And I think an argument can be made that small banks should not be subject to CRA. It's pretty hard to imagine small banks taking money out of a town and investing it, say, in Texas, for example."

I nearly fell out of my chair laughing at that one, having knowledge of a small community financial institution (under $100 million in assets) that raises money from deposits and lends it all over the country, including a whopping portion right here in, say, the Lone Star State, for example.

"Hard to imagine"?

Hardly.

Of course, small banks are responding to Mr. Vadala's "goodwill hunting" gesture like Dick Cheney in a field full of quail.

Salvatore Marranca, president of Cattaragus County Bank, has been a longtime outspoken critic of what he calls credit unions' special privileges that create unequal competition for banks.

"He's (Vadala) right. Small banks should not have to deal with CRA. But we do and it is a burden and helps cause an uneven playing field which credit unions don't have," Marranca said.

Marranca, a former president of the Independent Bankers of New York State, said his Little Valley-based bank is examined by state and federal CRA examiners about four weeks every year. It's time-consuming and costly, he said.

So are taxes that banks have to pay, but not credit unions. Marranca said taxes are a major contributor to the disadvantages small banks face in competing with credit unions.

"Three of my branches have credit unions right across the street. This year I am paying approximately $490,000 in taxes. My competitor 291 yards away is not paying a penny," he said.

In other words, thanks for the support, but I still hate your tax exemption AND your guts!

Vadala said he believes that the war between credit unions and banks is being waged by their respective trade associations more than by individual institutions.

"Having been an NAFCU director for nine years, I've seen it from that perspective. Credit unions and small banks both serve their communities and small businesses, and there are a lot of common interests. There should be less fighting," he said. "I get along well with bankers, though there are some issues like taxation and CRA that we don't talk about."

Unfortunately, as Salvatore's rant proves, regardless of the topic that you start out discussing, the subject will eventually turn around to the credit unions' tax status and then the whole kit and caboodle goes sliding downhill faster than Kirstie Alley's butt when she's off the Jenny Craig diet plan. Pretty soon, you're right back to where the enemy of your enemy is your enemy.

Don Powell Tells Banks: Be Creative. Take Risks

The former Chairman of the FDIC, now with a different set of priorities, tells banks that they had "record profits" the last few years, so they should be generous and take some risks. He forgot to add: "in a safe and sound manner, of course."

The Bush administration's Gulf Coast recovery chief urged bankers Thursday to be "risky" and to open their accounts to help jump-start rebuilding of the hurricane-ravaged region.    

"The American public knows that the banking sector has had record profits for the last four years," said Donald Powell, the coordinator of federal efforts for the area. "It's an opportunity to be generous."

Powell, the former chairman of the Federal Deposit Insurance Corp., said banks constitute the "heart and soul" of societies and play a critical role in the Gulf Coast during the current economic turmoil.    

"Be innovative and take risks," he told conferees. He said extending credit is essential to spark infrastructure renewal.

The federal banking regulators are also urging banks to do what they can, and are offering CRA "credit" (with important qualifications) to banks who loan or invest in disaster areas. It all sounds nice, but banks need to be sure that they are taking care of their own assessment areas first before venturing into disaster areas. Also, "being innovative and taking risks" might be fine to a small degree, but consider Don Powell's current job. He's no longer in a position to help a bank that travels off the safety and soundness reservation to get a safe conduct pass back home just because it had pure intentions.

What fascinated me about the story was the tale of Mississippi's Hancock Bank shipping in, storing and dispensing to employees, gasoline in secret so that it wouldn't be seized by FEMA. And getting away with it!

Fuel was a hot commodity after Katrina hit Aug. 29, and it was trucked to banks incognito because of the risk it could be commandeered by the Federal Emergency Management Agency.   

John Hairston, Hancock's chief operating officer, said banks needed the fuel so employees could get to and from work. Hancock Bank trucked fuel in at night and stored it in a secret location to avoid having it seized by FEMA or robbed, he said.

One more blow to the solar plexus of FEMA.

Bankers said FEMA should allow banks to give workers fuel allotments without fear of it being commandeered.

[...]

Bankers also suggested to Powell that it would help them if regulators eased rules during disasters on such things as requirements to report large cash transactions and following all the minutiae in lending laws.   

It would also make sense, bankers said, for federal authorities to endorse a special identity card for bank workers that would allow them to move without restraints in disaster areas cordoned off by the military.

Those are all good suggestions. With Powell's connections, he should be able to communicate them to the right people. Perhaps the next time we have a natural or man-made disaster of this magnitude, the recovery and relief efforts won't be a disaster of equal magnitude.

Extra CRA Credit

Last Tuesday, the Office of Thrift Supervision issued an advisory to "confirm" that the OTS will give favorable CRA consideration to activities by institutions that are supervised by the OTS "that provide lending, investment, or service activities to revitalize or stabilize" areas affected by Hurricanes Katrina and Rita, and will also recognize activities that benefit displaced individuals. Although the OTS cautions institutions not to "overlook local neighborhoods and needy individuals" within their normal assessment areas, it "will favorably consider such activities" and will "give significant weight to activities that benefit low-to moderate-income individuals or areas."

This "extra credit" for CRA assessment purposes is justified by "the magnitude of these disasters and their impact on the country." The advisory indicates that the areas affected are not just in the Gulf States, but on other "local economies" throughout the U.S. I assume that, for example, investments, loans and services meant to aid Katrina or Rita victims who have been evacuated to other areas (Houston, San Antonio and Dallas, for example) would be given "favorable consideration."

To answer one sardonic inquiry I received, I do not think that investing in a new "land-based casino" in Mississippi, is exactly the type of investment CRA the OTS had in mind (although I can't state flatly that it would not be), but that investments, loans or grants to aid in the building of affordable housing for the service personnel that would work in the casino would appear to be exactly the type of investment that would be covered. I'm sure your local OTS Regional Office would be happy to clarify the issue for you.

OTS Reduces The Regulatory Burden

On November 24, 2004, the OTS published in the Federal Register a proposed regulation concerning the Community Reinvestment Act, and an Interim Final Rule to reduce the burden of application and regulatory reporting requirements. The proposed CRA changes have garnered the press coverage. The OTS proposes to allow large (over $1 billion) savings associations to change the manner in which they are judged for CRA compliance purposes, including permitting them to elect to be judged solely by the lending test (as are smaller thrifts), as opposed to the present limitation of 50% (with 25% being based on "community service" and 25% on investments). The proposed changes would also permit the thrift to allocate the percentages among the 3 categories. In so doing, the OTS is again breaking ranks with the other federal bank regulatory agencies, which do not allow such flexibility.

Effective October 1, 2004, the OTS raised the asset limit for being evaluated under the CRA "small lender test" to $1 billion. That change was controversial enough. The latest proposal has already brought howls of protest from community development groups and from Democratic lawmakers. Expect the howls to grow louder.

Of perhaps more interest to smaller thrifts are some of the changes made by the Interim Final Rule issued on the same day. The Interim Final Rule is effective January 1, 2005 (comments must be received by January 24, 2005). Among those are the following:

• Elimination of the requirement for prior OTS approval to re-designate a home office or branch.
• Elimination of prior OTS approval for certain "highly rated institutions" to change the location of a branch or home office, or to establish a new branch office. A notice of the proposed change will have to be published in a local paper, and an application or notice filed if a comment letter is received that opposes the action (unless the OTS decides that such an application is not required).
• Elimination of notices for short-distance relocations.
• Elimination of restrictions on the establishment of drive-in or pedestrian offices.
• Elimination of the requirement for OTS approval to approve loans and contracts at agency offices.
• Elimination of the requirement to display the equal housing lender logotype and legend only where the ad is for loans made for the purpose of purchasing, constructing, improving, repairing, or maintaining a dwelling, or for loans secured by a dwelling.

There are other beneficial changes incorporated with the Interim Final Rule, and the rule should be reviewed to determine all of them.

As only one example of the importance of such seemingly minor changes is the benefit to those thrifts that use "agency offices" to originate mortgage loans. The ability to approve loans and contracts at such offices gives the thrift much more flexibility in its operations. Prior to this change, all loan approvals could take place only at the home office or a branch office. While the advisability of delegating loan approval to an agency office must otherwise "make sense" from business operations and safety and soundness standpoints, it gives added flexibility to thrifts.

These changes are further evidence that the OTS continues to attempt to reduce the regulatory burden on its decreasing base of thrifts, and to thereby enhance the attractiveness of the federal thrift charter.
---Kevin Funnell

OTS Actions Enhance Federal Thrift Charter's Attractiveness

Several recent stories in the news highlight efforts of the OTS to enhance the attractiveness of the federal thrift charter, in the face of the continuing decline in the number of federal savings associations and recent actions of the OCC that have stolen some of the thunder of the OTS as the regulator that most forcefully promotes the federal preemption of state laws.

On July 13, the United States Court of Appeals for the District of Columbia upheld a lower court ruling that, in turn, upheld OTS regulations adopted in 2002, that made its prepayment and late fee regulations inapplicable to state chartered housing creditors. Prior to the 2002 regulations, state chartered housing creditors, pursuant to the Alternative Mortgage Transaction Parity Act, had been able to “piggyback” federal preemption of state restrictions on prepayment penalties and late fees, and to follow the more favorable OTS regulations that applied to federally chartered thrifts. The stated reasons for the OTS actions were to discourage predatory lending practices and we’ll take the OTS at its word. On the other hand, this change puts state chartered housing lenders at a competitive disadvantage to federally chartered thrifts and, obviously, gives those lenders an additional incentive to “switch charters” to a federal thrift charter.

On July 16, the OTS announced that it intended to increase the thresholds for lenders to qualify for the “small lender” test under the Community Reinvestment Act from $250 million to $1 billion. The OCC and the FRB announced that they had decided to withdraw their proposals to increase that threshold for institutions under their supervision from $250 million to $500 million. The OCC and FRB had come under intense criticism by community activists to back down from the proposed increase in the threshold and they caved in to that pressure. The FDIC is expected to support the OTS position, which will ironically make benefit federally chartered thrifts and state chartered, non-FRB member commercial banks (mostly small, locally-oriented institutions). In my view, that gives the OTS charter another advantage, especially for growing financial institutions in the $250 million to $1 billion range.

Many residential mortgage lenders have been aware of the advantages of operating as a federally chartered thrift, particularly those lending on a multi-state basis. An article in the July 19, 2004 edition of the American Banker discusses NetBank Inc.’s decision to fold its Meritage Mortgage Corp. subsidiary into its NetBank FSB subsidiary. Among the reasons were the ability to fund the mortgage operations with insured deposits rather than outside warehouse lines of credit, with an immediate 50 basis point reduction in funding costs. Another important advantage was the ability to avoid state licensing and other laws that hindered its subprime mortgage lending operations, with an annual savings of $215,000 in state licensing fees and legal advice concerning compliance with state laws, and a savings of a portion of the 2,000 hours of personnel’s time spent on state licensing matters. The article also notes that HSBC Holdings PLC’s US subsidiary and J.P. Morgan Chase Bank have decided to convert from state charters to national charters.

We’ve previously posted about concerns that the OTS charter may be losing its attractiveness. These recent events indicate that there still exist strong incentives to operate as an OTS-regulated thrift.
---Kevin Funnell