The Future of the Small Time Mortgage Banker

It is entirely possible that proposed Legislation aimed at protecting consumers from “too big to fail” lenders could actually shutter community banks nationwide, putting thousands of out of work and making it even more difficult for prospective home buyers to find affordable mortgages.

A draft of the Financial Stability Improvement Act is currently making its way through the U.S. House. There’s a similar piece of legislation being considered in the Senate. The overarching goal of these measures is to curb the risks associated with lending behemoths like Bank of America and Wells Fargo.

But broad risk-retention provisions in the drafts would effectively kill community lenders, who account for about 40 percent of all home mortgage originations nationwide. Instead of minimizing risk, this new legislation would simply pave the path to home mortgage monopoly for the same “too big to fail” lenders who helped trigger the current financial crisis, according to a joint statement recently issued by the Community Mortgage Banking Project and the Community Mortgage Lenders of America.

“The result would be reduced competition and choice for consumers — an ironic and counterproductive result for a bill intended to mitigate ‘too-big-to-fail’ concerns,” the statement read in part.

The problem is rooted in risk retention. Legislators want to emphasize risk management for lenders and ensure a disaster like the subprime mortgage collapse will never be repeated.

But the House bill requires lenders to retain up to 10 percent of the credit risk on any loan sold into the secondary market. Hundreds of community-based mortgage bankers would likely go out of business overnight if they were required to retain just 5 percent. A company that originates $100 million each year — a normal figure for a small to mid-size firm — would have to have an astounding $5 million in cash reserves.

In contrast, Wells Fargo originated about $230 billion in residential mortgages in 2008. But those cash reserves are easier to maintain for lenders that also serve as depository institutions.

Community-based lenders are the lifeblood of the U.S. housing market. These smaller lenders provide secure, affordable mortgage products to buyers in search of personal service and local expertise.

These crippling risk-retention requirements could put thousands of Americans out of work. Home buyers would likely see a spike in rates and fees, part of a wave of increased cost created by the new requirements and the elimination of competitive pricing.

The country’s three largest mortgage lenders — Wells Fargo, Bank of America and J.P. Morgan Chase — accounted for 52 percent of all new home mortgages in the first half of 2009, according to Inside Mortgage Finance.

In 2007, the trio had a market share of 37 percent. In 1990, no company had more than 5 percent of the market.

Legislation without exclusions and exemptions for qualified lenders would put almost all of the nation’s home mortgages in the hands of the “too-big-to-fail” firms.

“These regulations would thus unnecessarily deprive consumers and businesses of competition for safe and sustainable mortgage options and reduce the available funds for home financing by billions of dollars,” John A. Courson, president and CEO of the Mortgage Bankers Association (MBA), recently said in a news release.

The House Financial Services Committee recently agreed to exempt government loans (VA, FHA, USDA, SBA) from the risk-retention requirement. The Senate Banking Committee draft has similar exemptions for government-backed loans.

But there’s no guarantee that these exemptions — or any future exclusions — will make the final piece of legislation brought to President Obama.

The committee is expected to begin marking up the bill in the next few weeks. Now is the time to make your voice heard if you are so inclined – you can stand up and blog, tweet, make phone calls, or anything else and hopefully someone will hear. Also, if you’re alarmed and inclined to join the organization who is trying to make their voice heard in this matter you can also join CML America, an organization whose mission is protecting small mortgage bankers.