In January, the Consumer Protection Finance Bureau (CFPB) announced “new rules” to enhance consumer protections for high-cost mortgages. But these rules are not so much new as they are enhancements to the Home Ownership and Equity Protection Act (HOEPA).
This law was enacted in 1994 to address problems in home-equity lending and refinances in the subprime mortgage market. Since then, HOEPA has been an attempt to tamp down high-rate and high-fee lending, but it obviously did not go far enough. After all, the financial crisis of 2008 started in the subprime mortgage business and the contagion spread through the financial system by way of securitizations and credit default swaps.
The new rules are part of the Dodd-Frank provisions that set up the CFPB. The reform measure tightened HOEPA provisions by lowering rates and free thresholds for coverage. Furthermore, there is a new coverage test based on a transaction’s prepayment penalties. The reforms also place limitations on high-risk loan features and new protections for high-cost mortgages.
Moreover, banks and other lenders will be barred from making home loans with “deceptive” teaser rates or require no documentation from borrowers, also known as “Liar Loans.” This means that lenders will need to ensure that borrowers can repay.
Finally, mortgage originators will be restricted from charging excessive upfront points and fees and from making loans with balloon payments. Loans with total debt to income ratios greater than 43 percent of income are also prohibited. The rules are slated to take effect in January 2014.
So what’s the play for investors?
Many non-depositary lenders have already shifted their business lines away from wholesale lending (where mortgage brokers “arrange” for loans between lenders and borrowers) to retail lending – that is, when lenders deal directly with borrowers. So the high cost loans typical in the mortgage broker/subprime game could be a thing of the past.
But the mortgage lenders have another problem lurking on the horizon: an ongoing probe by the Manhattan DA Preet Bharara in conjunction with the Obama Administration’s task force on mortgage fraud. And while the Sheriff of Wall Street has previously been busy with the insider trading probe in the hedge fund sector since 2010, the mortgage lending business may be in for a long year.
In light of this, regional banks may offer a safe haven in the banking sector.
For example, New York Community Bancorp, Inc. (NYSE:NYCB) could be worth a look. Despite the fact that this regional bank is close to the $50 billion threshold that defines so-called “systematically important financial institutions” (SIFIs) and the additional regulatory burdens of tighter capital requirements and annual stress tests that come with that designation, NYCB has a conservative portfolio, quality long-term management, and a healthy dividend.