On February 7, 2014, the Office of the Comptroller of the Currency (OCC) published a 232-page Mortgage Banking component to the Comptroller’s Handbook, its primary source of guidance for national banks and federal savings associations. Mortgage banking has not been comprehensively addressed by the OCC since 1996. This publication also replaces the Mortgage Banking section of the Examiner’s Handbook published in 2008 by the former Office of Thrift Supervision.
A Mortgage Banking Primer for Banks
From the outset, the OCC recognizes that the Consumer Financial Protection Bureau (CFPB) has issued an array of regulations, guides and examination procedures covering various aspects of mortgage banking that govern its constituent institutions, yet it makes clear that this booklet is not intended to address the specific requirements established by the CFPB. Nonetheless, the OCC leaves no room for doubt that it subscribes to the same principles of safety and soundness reflected in the CFPB rules.
Ratcheting Up Enforcement
Banks would be well-advised to recognize that the reinforced focus on mortgage banking is not the OCC’s alone. Because the CFPB is not given direct enforcement authority over banks with less than $10 billion in assets, it is not readily apparent that the CFPB, with its substantial resources, has considerable influence in this sphere of compliance. As intended by its enabling law, the CFPB rides alongside the OCC and the other federal banking agencies in examining operational deficiencies, as well as issues brought to light by consumer complaints at banks of all sizes. More than that, in practice the OCC and other agencies often defer to the CFPB in meting out enforcement action. This fact becomes all the more important in light of recent CFPB statements indicating a growing concern over widespread failure to observe heightened consumer protection standards for conduct of the mortgage banking business.
Recognizing that mortgage banking is a cyclical business where earnings can be volatile, the OCC underscores its expectation that a bank’s board and senior management will allocate significant oversight to ensuring consistent profitability. Careful management of mortgage banking includes monitoring of earnings in each segment of operations, structuring operations so that expenses move in scale with volume, and balancing outsourcing strategies with maintenance of a core group of high-quality back-office personnel for production and servicing in both the primary and secondary markets.
The OCC makes a special point that, to effectively manage profitability, management needs to develop a cost center reporting system that aggregates the individual components of the mortgage banking operation. This business-line profitability reporting system breaks out key income and expense metrics and, because of today’s greater complexity and competitiveness of mortgage banking, the OCC encourages detailed stratification of segment components (e.g., breaking down production into retail, wholesale, and Internet; secondary marketing into derivative recognition, hedging impact, recourse, and indemnification impact and gain/loss-on-sale recognition; and servicing into mortgage servicing rights (MSR) valuation changes, hedging activities, and portfolio types). A special caution is given that business-line profitability reporting is very different from parent-affiliate expense-sharing reports and quarterly MSR valuation reports.
Eight Levels of Risk
Considerable attention is devoted to the risks associated with mortgage banking.
Credit risk rises as loan quality deteriorates, affecting both the ability to sell originated loans and the market value and profitability of the servicing portfolio. A form of credit risk, concentration risk, arises if loans are concentrated within a geographic region.
Interest rate risk affects fee income and reduces the willingness of homebuyers to take loans.
Liquidity risk stems from failure to underwrite or service loans according to investor and insurer requirements.
Price risk reacts to changes in market factors that affect the buying and selling of loans and MSR.
Operational risk reflects the strain on operating systems as supported by internal controls, information systems, employee capability and integrity and operating processes, including oversight of third-party providers.
Compliance risk is rooted in standards established by the extensive array of consumer protection laws, with special emphasis on the quality of information given to consumers, deterrence of steering consumers to particular mortgage products, and procedures for promoting fair lending.
Strategic risk reflects management’s understanding of market conditions that affect the cost structure and profitability of each major segment of their mortgage banking operations.
Reputation risk recognizes how essential public trust can be undermined by negative publicity and market concerns over unfair mortgage lending practices claims, excessive loan defaults, or improperly executed foreclosures.
Centrality of Risk Management
With the framework of the mortgage banking business and its risk carefully constructed, the OCC declares as a cardinal principle its expectation that each bank “identify, measure, monitor and control risk by implementing an effective risk management system appropriate for its size and the complexity of its operations.” Designated as essential for successful risk management are “proper corporate governance, effective policies, strong internal controls, effective compliance management processes, relevant strategic plans, and comprehensive management information systems.” Risk management program components that are extensively discussed and merit careful study include management and supervision, internal and external audits, information technology, loan production activities, secondary marketing, servicing and loan administration, and mortgage servicing assets and MSR.
In addition, a description of Examination procedures provides valuable information, along with useful Appendices analyzing mortgage banking accounting, structures, and risk assessment factors.
Issuance of the publication signals an intensified regulatory focus on mortgage banking activity and should be taken as a strong incentive for banks to reevaluate their policies and procedures in anticipation of revitalized examiner scrutiny and potential enforcement activity.
Two powerful forces converged to move mortgage banking to the OCC’s center stage. The Great Recession of 2008-2009 was triggered by the collapse of the mortgage banking bubble, while the legislative response of the Dodd-Frank Act gave the OCC primary supervisory authority over thrifts, the traditional financial mainstay of the housing industry.
On February 19, 2014, the deputy director of the CFPB delivered a scathing address to the Mortgage Bankers Association, expressing deep disappointment over the lack of progress in improving the performance of the mortgage banking industry, with particular emphasis on mortgage servicing practices. Citing billions of dollars in penalties already imposed, the official declared, “[W]e will be vigilant about overseeing and enforcing these rules ... We have raised the bar in favor of American consumers and we are ready, willing and able to vigorously enforce that bar.”