Wednesday, June 2, 2010

The Merkley Amendment, Safe Harbor Provisions, and Small Business

Now that financial reform bills have passed both houses of Congress, industry groups are going to be lining up to influence the final draft of the bill. And with Congress scheduled to reconvene next Monday, conflicts in Washington DC this June will likely be hot.

A primary issue for the mortgage industry will likely be the Merkley/Klobuchar amendment, sponsored by Senators Merkley (D OR) and Klobuchar (D. MN). This amendment was introduced after business hours on a Tuesday evening and approved early the following Wednesday morning before industry groups had a chance to weigh in. Both the National Association of Mortgage Brokers and the Mortgage Bankers Association have expressed concerns about the amendment, although unquestionably, the mortgage broker community has the most to lose in this debate.

The Merkley/Klobuchar amendment is an eleven page document which both mandates that a consumer's ability to repay a loan be taken into consideration in underwriting a loan and at the same time caps originator compensation. The amendment bans the use of Yield Spread Premiums--the spread on interest rates--as compensation for a mortgage loan originator unless the mortgage loan originator is not receiving any other compensation. Yield Spread Premiums are used to reduce the amount of upfront fees that the consumer pays to get his mortgage loan by allowing the originator to be compensated through the rate.

Banks also earn a spread on the interest rates of loans which they sell, but the Merkley amendment expressly does not limit or prohibit these: "No provision in this subsection shall be construed as limiting or affecting the amount of compensation received by a creditor upon the sale of a consummated loan to a subsequent loan purchaser."

The amendment mandates that determination of a consumer's ability to repay the loan must include, "consideration of the consumer's credit history, current income, expected income, current obligations, debt to income ratio, employment status," or financial resources other than the equity in the subject property.

Interestingly the amendment creates a safe harbor for compliance. A loan is presumed to be in compliance with this statute if the creditor has verified the consumer's ability to repay and used the maximum rate permitted under the loan during the first 5 years. However, the presumption of compliance cannot be applied to any loan where the total points and fees exceed 3%, which includes up to 1% of financed mortgage insurance or FHA premiums.

Industry lobbyists are going to argue that such a provision will make it almost impossible to originate loans under $150,000.00. However, they appear to be basically ignoring the blatantly anti-business nature of the amendment. Why does limiting total fees to 3% create a presumption of compliance for any mortgage loan? I once refinanced a loan that had been done with no charges at all by the previous loan originator who had financed the house a couple of years before. The previous loan originator had refinanced a real estate agent's home free of charge in the hopes of building a relationship with her. However, the loan had been done totally incorrectly and was actually illegal under the Texas Home Equity statute. So being free did not make it legal. (Actually, that was one of the factors that made it illegal because under RESPA no loan originator could render a service without charges in expectation of future business.) A low origination charge, or no origination charge, does not mean that the loan itself is affordable or that the consumer is going to make the payments, so to tie compensation to a safe harbor provision is ridiculous, particularly on a purchase loan where the consumer is taking on new debt and not financing his or her closing costs.

Having said that, the reality of the loan origination business is that conventional loans have to be salable to Fannie Mae and Freddie Mac, and they, therefore, have to be underwritten to comply to Fannie Mae and Freddie Mac guidelines. By creating a safe harbor that presumes compliance, Senators Merkley and Klobuchar are setting up a situation in which no loan with origination charges, including financed MI, of more than 3% will be eligible for sale. What this means, essentially, is that wholesale lending and the small mortgage brokers who are left will go out of business.

What is most interesting to me about this whole situation is that the key provisions of the financial reform bill and its amendments as they relate to mortgage lending are coming out of a study that the Center for Responsible Lending completed in April of 2008 regarding mortgage lending and subprime loans. Entitled, "Steered Wrong: Brokers, Borrowers, and Subprime Loans," the study asserted that mortgage brokers steered unsuspecting borrowers into high interest rate subprime loans. The study made three policy recommendations:

1. Ban yield spread premiums and prepayment penalties on subprime loans;
2. Create a system of accountability where lenders and investors share responsibility for brokered loans; and
3. Establish clear broker duties to their clients.

All of these policy recommendations are included in either the two financial reform bills HR 4173, SB 3217 or the amendments. Now, this is the interesting part. The recommendations were made regarding subprime loans. This same study concluded that prime brokered loans were no more expensive than retail loans and that for borrowers with better credit scores, brokered loans were an average of $900 to $1600 per $100,000 loan amount cheaper over the life of the loan as opposed to a retail loan. Today, there really is no subprime market left. However, the Center's anti-broker, anti-small business proposals are being codified into law with regard to all loans even though their own study showed that mortgage brokers were a more competitive choice than retail lenders on prime loans.

NAMB's talking points do assert that the Merkley Amendment "would treat origination channels differently, picking winners and losers in the mortgage industry." And that is really at the heart of this amendment; it is not about protecting the consumer. It is really just about squeezing out the competition.

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