CRA Impact on IMBs
The Community Reinvestment Act (CRA) is a hot topic that is not well understood. It’s going to be an issue, it’s starting to be an issue, and independent mortgage banks (IMBs) need to know about it. Some states have enacted CRA requirements for IMBs, which don’t take deposits or have readily apparent ways to invest in their communities, making it hard for these IMBs to execute on the requirements.
Regulators originally created the CRA to encourage banks, depositories, and financial institutions that benefit from FDIC insurance (and other federal programs) to reinvest or contribute back to their community. This would, in theory, help meet the credit needs of the communities in which they do business, including low- and moderate-income (LMI) neighborhoods. The intention was originally good, but the CRA has not kept up with advancements in technology and other significant changes that have taken place in the banking world.
Opponents of CRA for IMBs argue that the business model of a nonbank mortgage lender is not like that of a depository lender (IMBs do not take deposits from a community) and therefore should not be subject to CRA requirements. “Reinvestment” of deposits makes no sense in the context of IMBs. IMBs are nondepository institutions and typically use short-term borrowings mainly from warehouse lines of credit to originate their loans. The borrowing is secured by the funded loans until the loans are sold to an investor (typically Fannie Mae or Freddie Mac) or issued as securities (typically guaranteed by Ginnie Mae). As a result, the mortgage banking business model serves as an “importer” of capital to local communities, moving investment dollars from the capital markets on Wall Street to make home mortgages available on Main Street.
IMBs utilize capital streams other than deposits to make affordable mortgage credit widely available within the communities they serve – importing funds from national and global capital markets to lend in these communities. They do not obtain deposit insurance or other benefits that federal- or state-chartered banks enjoy. The CRA is designed to cover a different business model and is therefore a poor fit for IMBs. IMBs are typically focused exclusively on providing home mortgage financing, mortgage servicing, and other closely related services. They operate through all market cycles and across all delivery channels (retail, broker wholesale, and correspondent).
CRA requirements on IMBs could potentially have the unintended consequences of providing a disincentive for IMBs. IMBs are highly regulated by the Consumer Financial Protection Bureau (CFPB), which imposes strict guidelines relating to fair lending. IMBs are subject to the same limits and restrictions on high-risk mortgage products as depository institutions (and even greater restrictions in those states that have enacted laws that go beyond the CFPB’s rules).
The CFPB’s ability-to-repay and Qualified Mortgage requirements, Loan Originator Compensation and anti-steering rules, and fair lending and servicing requirements all apply equally to IMBs. Negatively amortizing adjustable-rate loans; loans with prepayment penalties; stated-income loans; and no-income, no-job, no-assets (NINJA) loans all represent high-risk products that have been largely eradicated from the market for banks and IMBs alike. IMB lending practices are reported through the Home Mortgage Disclosure Act (HMDA). That data is publicly available through the CFPB. Greater mortgage lending to LMI and minority borrowers is more straightforwardly being achieved without their policy prescription as available HMDA data makes it clear that IMB’s are already providing the vast majority of home purchase mortgages to minority and low- and-moderate income borrowers.
There is a general consensus from both sides, the banking industry and the regulators, that the regulatory burdens have not kept up with modernizations in the banking industry and are, therefore, outdated and in need of overhaul. The modernization plan would make it easier for banks to serve the community by encouraging more lending and investment, evaluating the CRA more consistently and effectively, and providing more clarity on the CRA activities taking place. The federal banking agencies are currently making efforts geared towards such an overhaul of the regulations – with the OCC issuing a proposal requesting input from stakeholders.
To assist our clients, MCT offers a proprietary geocoder that geocodes all loans going into BAM and then runs batches to the large banks. We’re also able to leverage our geocoder to provide the MSA information on bid tapes to the aggregators so that they can identify loans in the footprints they may need.
For our BAM Marketplace buyers, we’ve incorporated this into the pricing tools they can leverage to run their bids so that they can easily add payups to their footprints and AMI buckets to specifically target these loans and not pay-up on others. Another function of our BAM Marketplace allows buyers to peer into our clients’ hedged production and filter by MSA tracts and AMI buckets to see what will be available before it comes up for sale. We’ve even added functionality for these buyers to be able to make offers on loans still in the hedge and we’re starting to get a lot of traction on this type of transaction as it can help buyers strategically target sellers who originate in their footprints. If you have any questions, contact your trader.
How Hawkish Will the Fed Be?
As recently as two weeks ago, there was consensus of a 50-basis point rate hike at the March FOMC meeting, a Fed funds rate target range of 1.75-2.00% by year-end, and aggressive balance sheet runoff to go with the end of quantitative easing. That has all changed with the Russian invasion of Ukraine, now in its second week. The question that has not changed in the minds of many market participants is: Just how hawkish will the Federal Reserve be this year?
The Fed last raised rates in 2018 and has not hiked interest rates at successive policy meetings, which occur once every six weeks, since 2006. Despite the war in Ukraine casting uncertainty into markets and wage growth stalling in February’s employment situation report, U.S. Federal Reserve officials have signaled it remains committed to raising interest rates this month by a quarter-point. Federal Reserve Chair Jerome Powell told Congress as much last week, saying that the central bank is on track to raise interest rates a quarter-point this month. In addition to the raise, Powell told Congress that considering the nature of Russia’s invasion of Ukraine means the Fed will move “carefully”.
The two main issues of war abroad and economic uncertainty at home are causing two different sets of problems for the Fed. The longer the conflict drags on, the more likely financial markets are to be disrupted, either hurting global growth prospects or stoking already-high prices due to disruptions of raw materials and food. The severity of Western sanctions and the possibility that Russia might retaliate via methods like cyberattacks also increase uncertainty. The pandemic has left the global economy vulnerable due to high inflation and jittery financial markets, both of which could be worsened by aftershocks from the invasion. Domestically, the Fed is worried about stagflation, the type we saw in the 1970s when the economy experienced an increase in inflation and a simultaneous slowing of economic output. Growth-inflation trade-offs raise the potential for policy mistakes from Fed rate hikes.
If anything, developments over the last two weeks mean that the Fed now has a path to be cautiously hawkish, rather than taking the highly hawkish approach many market participants were expecting. Record inflation was the reasoning behind a 50-basis point rate hike. Still, the return to the workforce, evidenced by the addition of 678k jobs in February (mostly in low-paying industries), has already started to moderate wage pressures and will help throw some cold water on the argument that inflation has gotten away from the Fed. Fed members will likely breathe a sigh of relief; the economy does not appear to be facing an immediate wage-price spiral similar to the 1970s.
The twin challenges of managing prices and keeping their economies growing have gotten even harder for central bankers. In the immediate aftermath of the invasion, the bond market effectively eased financial conditions as if the Fed had cut rates by 25 basis points, and it has since taken it back. Households spending an ever-larger chunk of their incomes on fuel and heating would mean less cash for other goods and services. If wealth and confidence dip, it would be harder for firms to tap funds for investment. And there is still the school of thought that the Fed will tighten too much over the next few months, leading to a sluggish economy.
With economic activity looking resilient to Omicron in early 2022, COVID has clearly taken a back seat. Fed Chair Powell has said that with each coming variant, the economy learns how to live and adapt to it and it has been less damaging throughout each wave that hits the US. “What we’ve seen is with successive waves of Covid over the past year and some months now, there has tended to be less in the way of economic implications from each wave.”
Minutes from the most recent FOMC meeting laid out a potential course for the Fed to start shrinking their balance sheet later this year. Asset purchases (quantitative easing or QE) will end this month, and the minutes noted that “current economic and financial conditions would likely warrant a faster pace of balance sheet runoff than during the period of balance sheet reduction from 2017 to 2019. Participants observed that, in light of the current high level of the Federal Reserve’s securities holdings, a significant reduction in the size of the balance sheet would likely be appropriate.” The minutes also state that “a number of participants commented that conditions would likely warrant beginning to reduce the size of the balance sheet sometime later this year.”
The Fed’s balance sheet is currently just shy of $9 trillion, up from around $4 trillion pre-pandemic, which had been around 20% of GDP. Returning the balance sheet to that proportion of GDP would imply a balance sheet of $5 to $6 trillion in 2025. The Fed is likely to begin balance sheet reductions by the end of this year, starting by allowing up to $10 billion per month in maturing bonds to roll off the balance sheet, then ramping up the monthly limit to $70 billion to $100 billion by the second half of 2023. The Fed has done its best to telegraph its movies ahead of time to have them gradually priced into market expectations.
One other thing to keep in mind is that the U.S. central bank’s policy-setting committee welcomes three new historically hawkish voters this year (Kansas City’s Esther George, Cleveland’s Loretta Mester, St. Louis’s James Bullard). Along with the three is a new president of the Boston Fed, who will replace four individuals that happen to be rather dovish (Chicago’s Charles Evans, Atlanta’s Raphael Bostic, Richmond’s Thomas Barkin and San Francisco’s Mary Daly). Bullard said he’d like to see 100-basis points in rate hikes through June, with a 50-basis point hike in March, putting him out significantly ahead of many FOMC participants even with their recently hawkish tilts. Mester recently opined that “If by mid-year, I assess that inflation is not going to moderate as expected, then I would support removing accommodation at a faster pace over the second half.”
While the market might be volatile, it’s forward-looking, which means it often has a better pulse on where things are headed than any single perspective. Fed Chair Powell has made it clear that policymakers will move carefully due to uncertainty created by the Russian invasion of Ukraine as they commence a series of rate hikes to confront the hottest inflation in 40 years. The results of Fed meetings are usually priced into rates weeks before a meeting, meaning that rates are already reflective of expected shifts in the coming weeks.
Solid economic growth confirms that the Fed can move forward with higher interest rates, while Inflation says it needs to. Downside growth risks from the geopolitical backdrop mean that they are likely to proceed gradually and cautiously. Markets still see around six quarter-point increases by the Fed this year, but bets on other central bank’s hiking cycles have been pared in recent days.