LO Overtime Ruling; Jumbo vs. Conforming Rates; Mortgage Companies' Many Risks

Sure lots of depository and non-depository lenders made big bucks last year. But what about this year? Probably not.

Last week I was remiss in not reporting on an important HR and LO story: a Court of Appeals in Washington D.C. struck down a Department of Labor interpretation of the eligibility of loan officers to collect overtime. In Mortgage Bankers Ass'n v. Harris, the Court of Appeals for the District of Columbia Circuit invalidated the U.S. Department of Labor's 2010 interpretation of its regulations under the Fair Labor Standards Act ("FLSA"), which states mortgage loan officers must be paid overtime. Ruling in favor of the MBA, the court determined that the 2010 DOL interpretation must be vacated because the DOL did not comply with the Administrative Procedures Act when issuing the interpretation. The court's decision means that some mortgage loan officers may be exempt from wage and hour restrictions under the FSLA, based on the language and logic of a previous opinion letter issued by the DOL in 2006, which had been withdrawn by DOL as a result of issuing the 2010 interpretation.

The FLSA requires overtime pay to employees who work more than forty hours in a week, with some exceptions. Employees in an executive, administrative, or professional capacity, or in the capacity of outside salespersons, are not subject to the minimum wage and maximum hours requirements. Previously, in 2006, the standard ruling for the typical job duties of a mortgage loan officer fell within the administrative exemption to the Fair Labor Standard Act overtime requirements, according to a report from Lexology. But despite the past definition, the Obama Administration reversed its position and declared that mortgage loan officers are not exempt under the FLSA. The Court of Appeals for the D.C. Circuit ruled that an agency cannot revise an interpretation of a rule without notice and an open comment period.

Most management and loan officers recall that in 2010 the DOL stated that "inside" mortgage loan officers do not qualify as administrative employees, and are subject to the minimum wage and maximum hours provisions. (The 2010 interpretation was a reversal from a previous DOL opinion letter issued in 2006.) Congrats to the MBA!

Want to make your secondary guy mumble (even more) and scratch what's left of his hair? Tell him you think jumbo rates should be priced at the same level as conventional product.....and then just walk away. It's not completely unfounded according to a recent Bloomberg article. "Wells Fargo & Co. and JPMorgan Chase & Co. lead banks that are offering jumbo mortgages, those too big for government programs, at rates at or below taxpayer-backed loans. On average, the extra cost of 30-year fixed jumbo loans reached a six-year low of 0.16 percentage point last month, according to data provider HSH.com. Bigger adjustable-rate mortgages with payments that can rise after five years ended last week 0.09 percentage points cheaper, the most since at least 1998." Today, most jumbo loan product is placed on the originators books, and the scenario described above in the article is no different. Banks are seeking jumbo loans because there isn't enough lending opportunity elsewhere to support all the overhead at the larger banks. When the Federal Reserve alluded that they would be curtailing their investment in MBS last month, it caused the biggest losses in government-backed mortgage securities since 1994; in essence squeezing the implied spread between conventional and jumbo product. The trend still continues, but a very good article from a couple weeks ago can be found here.

When I was little and couldn't fall asleep, I would lie in my bed and think about the shortcomings of risk-weighted capital as a predictor of bank distress. Ironically, the FDIC Director Jeremiah Norton did too. In a recent statement the Director said, "I hold the view that we should implement a more streamlined capital standard that requires more and higher quality capital in the banking system," while noting that Basel III's Interim Final Rule (IFR) contains a number of provisions that fail to address known and potential risks to the banking system; such as: The U.S. housing market was at the center of the financial crisis - yet today we are not modernizing the risk-weights on banks' mortgage loans; GSE's such as Fannie Mae and Freddie Mac were placed into government-controlled conservatorships - yet the banking agencies continue to assign low risk-weights to GSE exposures; linkages between highly levered financial institutions are a significant risk to the financial system - yet, subject to deductions, exposures to supervised depository institutions carry a risk weight that is one-fifth of the risk weight of non-financial investment grade corporate exposures. Director Norton's comments can be found here.

Warehouse lending and servicing are arguably two of the keystones to the mortgage business; unfortunately these two business channels will be penalized under the risk-based capital regime the federal banking agencies are currently adopting. In an Origination News article written by Brian Collins, "The provisions in the new Basel III capital rule 'addressing mortgage servicing rights and warehouse line of credit are particularly problematic,' according to the Mortgage Bankers Association. The regulators have decided to treat warehouse lines of credit as commercial credits, which will increase the amount of capital banks must hold for warehouse lines. The Federal Reserve will give favorable capital treatment for collateralized transactions that are backed by deposits of cash, gold or short-term debt securities. But not warehouse lines that are backed by residential mortgages." 

Running a mortgage company involves managing risk from multiple sources. In fact, financial companies have plenty of risks, including credit, interest rate, liquidity, price, operational and compliance. Credit risk arises from an obligor's failure to perform as agreed. We typically think of loans in this context, but banks and lenders see this risk in several areas including the investment portfolio, derivatives partners, foreign exchange counterparties or indirectly through guarantor performance. This risk is found in all activities in which settlement or repayment depends on counterparty or borrower performance. Interest rate risk arises from movements in interest rates. This includes re-pricing risk, basis risk, yield curve risk and options risk. Banks and mortgage companies should consider interest rate risk from both an accounting perspective (earnings) and an economic perspective (the market value of the portfolio). Not to be confused with pricing risk (which focuses on the mark-to-market portfolio), interest rate risk focuses on the value implications for all portfolios in the bank, including held-to-maturity and available for sale.

But we're not done! Liquidity risk arises from an inability to meet obligations when they come due. This may come from an inability to access funding sources or to manage fluctuations in funding levels. It can also result from the bank's failure to address changes in market conditions that affect its ability to liquidate assets quickly and with minimal loss due to market fluctuations. Our industry, especially banks, is seeing an increase in complexity in managing liquidity risk due to off-balance sheet retail products and other factors. Price risk comes from changes in the value of a bank's trading portfolios. This doesn't usually impact community banks, but it does if any portfolios are subject to daily price movements or accounted for on a mark-to-market basis.

Price risk can arise from lending pipelines, OREO and mortgage servicing rights. Operational risk comes from inadequate or failed internal processes, human errors, misconduct or external events. The quality and effectiveness of a bank's (or mortgage bank's) system of internal control is a key factor in managing operational risk, as well as the due diligence process and business continuity planning. Compliance risk arises from violations of laws, rules or regulations or from non-conformance with prescribed practices, internal policies and procedures, or ethical standards.

Lenders and banks try to minimize all of these, of course. And examiners are alert to concentrations which can increase risk in any or all areas. Regulators are asked to focus on concentrations in business lines or related to geographic areas. Since the community bank business model by its nature is usually in a concentrated geographical area, with concentrated expertise, this is an additional concern. The rules don't mean a bank can't have concentrations, it just means you need to be able to adeptly demonstrate you can identify, measure, monitor and control risks within that context. If not, expect a demand for additional capital to perhaps follow.

Turning to interest rates, which are up slightly this morning, certainly it appeared a few weeks ago as if the market were "front weighting" to the extreme any future move in rates. It is important to keep in mind that there is a big difference between seeing signs in the economy that warrant taking one's foot off the gas versus putting your foot on the brake. Bernanke has stressed that rates are, and will remain, accommodating, and has told us that the QE timeline may have confused the markets.

In case investors aren't tired enough of the Fed yet, Bernanke will be giving a two-day testimony to Congress (Wed Jul 17 to the House and Thurs Jul 18 to the Senate - both at 10amET), making sure monetary policy stays front and center.  However, while there is still a lot of controversy, Bernanke and his colleagues have been consistent in delivering a few key messages to investors these last several weeks (and he will probably reiterate these points Wed/Thurs): 1) policy remains data dependent (this is probably the most important); 2) tapering isn't tightening (the Fed can curtail QE and won't be tightening policy); 3) "stock vs. flow" (Bernanke has emphasized in the past how the "stock" of assets is the method through which QE stimulates the market and not actual purchases.  Lately it has become clear the Fed won't be selling any assets soon and probably will never sell an MBS). 

But the economy is doing pretty good. As an example, as of July 1, 45 states have enacted fiscal year 2014 budgets. This year's budget season has been far less contentious and much timelier than a few years ago: there was no talk of California going bankrupt, government shutdowns (Minnesota, 2011), nor legislators fleeing to another state to prevent a quorum (Wisconsin, also 2011). Over the course of the last 12 months, many states had budgetary surpluses as revenues exceeded original forecasts, and only a handful of states struggled to close budget gaps. This is no guarantee of great times in the future, but we'll take it.

Economic data was light last week, which kept markets focused on the minutes from the FOMC's June meeting and a speech by Chairman Bernanke. As stressed previously, the meeting minutes and comments from Chairman Bernanke emphasized that any policy changes would be dependent on the data improving roughly in line with the FOMC's expectations.

Developments in the labor market are at the top of the Fed's watch list.

For news this week, today we had the Empire State Manufacturing Index (which shot higher) and June Retail Sales, +.4%. (I have never sat down and measured it, but plenty of smart folks out there say it accounts for about 70% of economic activity.) CPI will come out tomorrow, along with the Industrial Production & Capacity Utilization duo. Housing Starts and the Fed's Beige Book will be released on Wednesday; we'll also have the Philly Fed and Leading Economic Indicators. The 10-yr closed Friday at 2.60%; this morning it is at 2.63% and MBS prices are worse about .125.