R. MICHAEL MENZIES, SR.
on behalf of the
INDEPENDENT COMMUNITY BANKERS OF AMERICA (ICBA)
COMMITTEE ON SMALL BUSINESS
U.S. HOUSE OF REPRESENTATIVES
January 6, 2004
Chairman Manzullo and members of the Committee, my name is R. Michael Stewart Menzies, Sr. and I am pleased to have the opportunity to testify before you today on behalf of the Independent Community Bankers of America (ICBA)1 and its nearly 4,600 community bank members, to share with you our views on the Department of Housing and Urban Development's (HUD) proposed Real Estate Settlement Procedures Act (RESPA) rule. I serve as President and CEO of Easton Bank and Trust Company, a $ 100 million bank located in Easton, MD. We hold approximately $20 million of residential loans in portfolio. I also serve on the board of directors of ICBA's subsidiary, ICBA Mortgage, which facilitates banks selling mortgages into the secondary market.
ICBA would like to express its appreciation to Chairman Manzullo for calling this hearing during the congressional recess in light of HUD's transmittal of the final rule to OMB and the uncertainty over what the rule contains and how it will affect the mortgage market that has played such an important role in our economy. Mr. Chairman, we share your concerns about the effects of the rule on small business and in particular, small lenders.
Our testimony will address the rule as proposed, since parameters of the final rule transmitted to OMB are not known. On October 28, 2002, ICBA responded to the invitation to comment on the proposed rule, and submitted an extensive letter to HUD, a copy of which is attached for your reference.
ICBA strongly opposes the proposed rule because of the damage it will do to consumers, the mortgage finance system and small loan originators and small settlement service providers that participate in it. We believe the rule will create an environment where the largest originators and settlement service providers will drive out the smallest, and we are concerned about the ability of smaller banks and service providers to compete against the larger market participants. Larger market participants have a greater ability to negotiate volume discounts for services within the package than do smaller participants because of their size. The result will be less competition, less consumer choice and higher mortgage costs.
ICBA and its members place a high value on the importance of homeownership. Our current mortgage finance system has enabled a record number of Americans to realize that dream, and we fully support the administration's goal to further increase minority homeownership by 5.5 million families. It is a simple fact that the lower the costs of obtaining a mortgage, the more affordable homeownership becomes.
HUD's proposed rule has been presented as an attempt to simplify and improve the process of shopping for mortgage loans with the three main objectives being to: (1) improve the existing RESPA disclosure scheme; (2) remove regulatory barriers to enable the offering of packages of settlement services to borrowers; and (3) fundamentally change the way in which mortgage broker compensation is reported.
While the ICBA is a proponent of simplifying the mortgage loan process, and giving borrowers more choices, we have serious concerns with the proposed rule, because it will seriously undermine the mortgage finance process, and reverse the trend of overall homeownership growth. We firmly believe that should this rule be adopted as it stands, it will, at a minimum, result in borrower confusion, hidden fees, increased settlement costs, and fewer credit and settlement service options as small lenders and brokers and small settlement service providers are driven from the market because they simply will not be able to negotiate the necessary discounts from settlement service providers to compete with larger institutions -- in short, a serious disruption of the mortgage finance system.
You have asked for comments about HUD's process and procedures in developing the rule. Based on what we have seen, we fear that HUD's proposal overlooks the adverse impact of the rule on small businesses and small lenders. In its economic analysis accompanying the proposed rule, HUD simply states that it is difficult to reach a firm conclusion about the magnitude of the impact on small lenders, but acknowledges that a significant portion of cost transfers related to the Guaranteed Closing Cost Package would be to their detriment. HUD makes the unsupported assumption that these institutions are charging high prices for their services.
Bank Call Report data shows that banks with under $5 billion in assets-small institutions by size but the majority of insured depository institutions by number-hold close to $300 billion in mortgage loans in portfolio and have sold additional loans into the secondary market. While, this is a relatively small segment of the overall residential mortgage market, it represents residential mortgage loans made in communities large and small, and in urban, suburban and rural communities across the country. We find it difficult to believe that the majority of insured depository institutions are charging "high prices" for their services as HUD concludes in its analysis.
While HUD provides some estimates of cost savings it expects the proposal will bring, notably absent from HUD's economic analysis is a discussion of the cost to implement such dramatic changes to the mortgage industry that its proposed regulation would cause. Significant costs will be incurred related to the training of loan originators, and brokers, underwriters, compliance officers, information system changes, and document changes. While these would generally be one-time costs that would result should HUD issue a final rule substantially the same as its proposal, the costs would be passed to consumers over time and need to be factored into the analysis.
Costs to Package
HUD expects cost savings will be realized as companies spring up to package settlement services for resale to lenders, yet the introduction of the new packager layer will add additional costs as they will require compensation for their service, compensation that will cut into the cost savings HUD expects to benefit consumers. Also, lenders or originators that chose to use a third party vendor will need to conduct due diligence on the vender to ensure that it can truly perform its duties in providing settlement services. There will be costs associated with this process.
We continue to maintain, as we did in our comment letter to HUD, that if HUD goes forward with the final rule without significant changes, smaller loan originators and settlement service providers will not be able to compete to the detriment of the consumer. We find it odd that HUD, whose mission is to promote homeownership, support community development and increase access to affordable housing free from discrimination appears unconcerned that its proposed RESPA amendments may well decrease available credit options offered by small lenders and force out small businesses that provide settlement services in their local communities.
If HUD has indeed listened to the many concerns about its proposed RESPA amendment voiced by all sectors of the industry and thus has made significant changes to the proposal, we strongly believe that it should be published for public comment once again.
The remainder of our testimony addresses the following areas covered by the proposed rule: HUD's Good Faith Estimate (GFE) settlement cost disclosure; Guaranteed Mortgage Packages; and Mortgage Broker Compensation.
HUD's Good Faith Estimate Settlement Cost Disclosure
The proposed rule also calls for a change in the existing RESPA disclosure scheme through a new format for the Good Faith Estimate (GFE). The goal is to create a consumer friendly form providing borrowers with more useful and accurate information to assist them in the mortgage finance process. The rule proposes more precise cost estimates than what is currently required. These estimates would be grouped by category with a zero tolerance level for some items, except in the event of unforeseeable and extraordinary circumstances, and a ten percent tolerance level for others. While HUD considers this an enhancement to aid the borrower, we believe it will affect both borrower and lender by ultimately resulting in an increase to the cost of loan packages, and will negatively impact the ability of community banks to compete in this arena.
Certain costs are much easier for loan originators to estimate than others, and certain costs set by third parties are difficult for a lender to guarantee. For example, loan originators generally know, with certainty, the cost of a credit report. However, situations often arise for consumers with unusual credit histories when additional information must be verified causing the costs to unexpectedly increase. This may especially be the case with recent immigrants or minorities who do not have traditional credit histories, the very individuals the Bush administration is trying to reach, and the very individuals who reside in the communities served by our member banks. Similarly, a loan originator may order a property survey or appraisal expecting that, based on experience, it will cost a certain amount that can be guaranteed, but find that once work has begun, the property requires additional surveys or appraisals at an additional cost. Both of these are examples of costs that under the proposed rule would fall in the zero tolerance rate category, and would, therefore, have to be guaranteed by the loan originator who would also be required to absorb any and all unexpected or additional costs. Aside from the two previous examples, there are several other zero or ten percent tolerance rate items that may vary depending on the final loan amount and closing date, both of which can change at the request of the borrower, yet any resulting increase in costs will again be absorbed by the lender. This will naturally result in loan originators increasing the costs of packages to all borrowers to guard against such contingencies.
Moreover, all service providers do not charge the same amount for their services. Our community banks generally use the lowest cost provider. However, for reasons beyond the bank's control, that may not always be possible. There will be times when the preferred provider is unavailable or too busy to ensure that the requested work is completed according to the borrower's schedule. The precise cost estimates and guarantees required under the proposed rule will place banks between the proverbial rock and a hard place. They will either have to quote the highest rates and price themselves out of the competitive mortgage finance market or attempt to remain competitive while running the real risk of having to absorb those unexpected and additional costs. We believe that the firmness of the cost estimates proposed by HUD does not adequately reflect the variances that legitimately occur in the industry. Loan originators should be required to document changes to justify increases in the cost of items at settlement, but locking them into fees at the application phase can only result in increased costs.
Finally, the instructions to "Attachment A-1" of the revised forms requires loan originators to itemize services that the borrower can shop for, and estimate the cost of these services ". . .based on local market averages for the areas where the property is located." It is our view that the requirement to collect and maintain data to determine market averages is an unreasonable and burdensome expectation, particularly for small originators located in large metropolitan areas. We believe a better approach would be to require that the originator insert the estimated cost of the service as if they were providing it.
As you can see, the proposed enhancement to the GFE will impact both borrowers and originators in a manner that will be contrary to the rule's objectives.
Guaranteed Mortgage Packages
The proposed rule seeks to facilitate mortgage shopping and promote competition by removing the regulatory barriers to allow a safe harbor under RESPA for Guaranteed Mortgage Package transactions. A Guaranteed Mortgage Package (GMP) consists of a mortgage loan with a guaranteed interest rate and a package of settlement services required by the lender to close the mortgage. The settlement services would include, but are not limited to, all application, origination and underwriting services, the appraisal, pest inspection, flood review, title services, title insurance and any other lender required services except hazard insurance, per diem interest and escrow deposits.
Unlike the GFE, a GMP would not itemize the specific services to be provided. HUD believes that the GMP will make it easier for borrowers to shop for mortgages through simpler more transparent transactions, and will further reduce settlement costs as a result of market forces, borrower shopping and competition. It is our position that the GMP will take away the borrower's opportunity to shop for those items included in the package. Further, because all services are packaged, there would be no assurance to the borrower as to what will and will not be provided. This will, in effect, eliminate comparison shopping, one of the essential elements of the process that this rule seeks to promote.
In addition to the package of settlement services, a GMP must include a guaranteed interest rate that is tied to an observable index or other appropriate means that would assure borrowers that if the lender increased the rate, it was not driven by the lender's desire to increase its origination profits. This proposed change is simply unreasonable in that it does not reflect the realities of the mortgage industry, and how interest rates are set and how quickly they can change in the course of a day. The rule also assumes that lenders and brokers control the interest rates they offer which, in most situations, is simply not the case. Interest rates offered by community banks are often set by the secondary market organizations or lenders that purchase the loans. HUD's proposal that brokers or lenders guarantee rates without any type of financial commitment from the consumer while the consumer is free to shop for the best package, unreasonably exposes the brokers and lenders to interest rate risk. The cost of this risk will either be borne by the banks or the borrowers. To protect itself against interest rate risk the institution will incur additional expenses that can be recouped only if the consumer returns for the loan, or consumers may bear the cost of higher rates imposed by the institution.
Further, the requirement that loan originators must post and constantly update mortgage rates on their website would be very costly and highly burdensome for community banks. First, not all community banks have websites, and secondly of those that do, few offer the ability to apply for mortgage loans. ICBA recently completed its 2003 Annual Community Bank Technology Survey.2 Seventy seven percent of community banks responding maintain an Internet site, and of that group, seventy five percent offer some banking services through the site. However, most services offered by community banks through internet websites relate to account information with only about twenty two percent of respondents indicating that they offer their customers the ability to apply for loans through their website. Therefore, it appears that the larger lenders are in a better position than many community banks to comply with the proposed interest rate posting requirement.
Loan originators should not be forced to make unnecessary and expensive expenditures for technology. Requiring lenders to post an interest rate index is impractical, and may not serve as a reliable tool for consumers. Some loan originators offer only a handful of loan products, while others may have dozens of products and rates. Moreover, interest rates can change within a day during volatile periods. The effect of compliance on smaller financial institutions would be enormous, and would force many to exit the market altogether. The significant resources that would be needed to maintain current data, could be better allocated to originating and processing mortgage loans and marketing to minority and low- and moderate-income families and first time homebuyers. Finally, to allow packagers to offer the GMP, the rule provides a safe harbor from RESPA Section 8. Therefore, the very provisions that were developed to protect consumers from special fee arrangements between settlement service providers and loan originators do not apply. Proponents of this safe harbor provision believe that it is necessary in order to offer the GMP and lower mortgage costs. However, nothing in the proposed rule indicates that the cost savings would be passed along to the borrower. ICBA views this as a complete policy reversal, that exposes the mortgage finance system to the risk that we will return to the environment of abusive practices that RESPA Section 8 was originally designed to prohibit.
ICBA has repeatedly raised concerns about the effect the HUD proposal will have on the ability of smaller banks and service providers to compete against the larger market participants. We agree with HUD's premise that consumers benefit when they have choices. However, it is clear that the proposed rule will eliminate consumer choice in that the smaller, and lower volume generating lenders, brokers and settlement service providers will be driven from the market because they simply will not be able to negotiate the necessary discounts from settlement service providers to compete with the larger institutions in offering GMPs. We strongly believe that is it wrong for a government agency to regulate institutions out of an industry simply because of their size. This is clearly a rule that favors the largest institutions in the mortgage industry.
Community banks are also concerned that the GFE and GMP requirements will limit their ability to provide early credit counseling, and to offer alternative products that may better suit the borrower's needs. Should HUD feel compelled to move forward with the GMP, it should only do so as a test while making no changes to the current GFE. Currently, several institutions are marketing versions of a guaranteed package. We see this as the best way to proceed - allow the market to continue its evolution without regulatory mandates to package.
Mortgage Broker Compensation
Finally, the proposed rule calls for a change in the manner in which lender payments to brokers are recorded and reported to consumers. Specifically, the rule would require that for loans originated by mortgage brokers, any payments from a lender based on a borrower's transaction, would be reported on the Good Faith Estimate (GFE), and the HUD-1/1A Settlement Statement as a lender payment to the borrower, including payments based on an above par interest rate on the loan (including yield spread premiums). Similarly, any borrower payments to reduce the interest rate (discount points) in brokered loans must equal the discount points paid to the lender, and be reported as a borrower payment to the lender. HUD believes that this change will resolve disputes regarding broker compensation, and improve the process of obtaining a home mortgage.
ICBA fully supports disclosure of broker compensation in mortgage loan transactions. However, it is our view that this proposed change would neither resolve the current broker compensation issues, nor accomplish the goal of improving the process. Reporting broker compensation as proposed will not result in a simpler more transparent process, but will instead result in more confusion for the borrower. We believe that retention of the existing disclosure requirements would prove far less confusing.
In conclusion, the ICBA has grave concerns that HUD's proposed changes to RESPA will seriously undermine the mortgage finance process, and reverse the trend of overall homeownership growth. While HUD believes this rule will simplify and improve the process of shopping for mortgage loans, ICBA feels strongly that this will not be the case. This proposal will dramatically alter the manner in which mortgages are offered, making the process more confusing, impacting consumer choice in the selection of individual settlement services, and decreasing consumer options for mortgage products. It will also inevitably create an environment where the largest originators and settlement service providers will drive out the smallest.
If this rule is adopted, it will result in a serious disruption of the mortgage finance process, and increase, not decrease as HUD predicts, the cost of homeownership. ICBA opposes the proposed rule because of the damage it will do to consumers, the mortgage finance system, and the small loan originators and settlement service providers that participate in it. If HUD has significantly changed its proposal, the public should have another opportunity to comment on it before it is published as a final rule because of the dramatic affect it will have on the mortgage industry and how consumers seek mortgages. We urge Congress to address our concerns about the rule during its 60-day review period.
Thank you for the opportunity to submit testimony today. ICBA stands ready to work with the Committee on this important issue.
1 ICBA is the nation's leading voice for community banks and the only national trade association dedicated exclusively to protecting the interests of the community banking industry. ICBA has 4,600 members with branches in 17,000 locations nationwide. For more information, visit www.icba.org.
2 The survey was sent to over 9,000 community banks with over an eleven percent response rate. Those banks responding had an average asset size of $143.5 million.