Small mortgage lenders express reform worry

WASHINGTON (Reuters) - Lenders and community bankers sounded the alarm to lawmakers on Tuesday over proposed federal rules aimed at reducing risk-taking on mortgage lending, saying the guidelines could hurt small banks and impair credit markets.

The rules -- mandated by the passage of the Dodd-Frank Wall Street overhaul bill -- are under consideration by regulators to establish guidelines for originators of securitized loans, the types of instruments that are blamed for fueling the 2007-2009 financial crisis.

Regulators intend to reduce risk-taking by forcing lenders to hold a 5 percent stake in any debt instrument pooled in the secondary market.

"Should this proposal be adopted, it will surely drive many banks from mortgage lending and shut many borrowers out of the credit market entirely," Christopher Dunn, chief operating officer of South Shore Savings Bank in South Weymouth, Massachusetts, told a Senate Banking Committee hearing on behalf of the American Bankers Association.

The current guidelines "fly in the face of workable and clear standards," he said. This type of "regulatory burden is significant" to smaller institutions, and will impair access to credit for consumers.

The law created an exemption for mortgages deemed to be safe enough and gave regulators the task to define such suitable loans. Regulators proposed an exemption for the so-called qualified residential mortgages when borrowers make 20 percent down payments. A comment period on the proposed rule expires on August 1.

"We have to come up with an appropriate balance," said Senator Jack Reed, a Rhode Island Democrat, during the hearing. "If you don't have any of these rules of the road, you get exactly what we had -- which was gaming and no money down."


The panel representing smaller lenders also expressed unease about proposals to wind down Fannie Mae <FNMA.OB> and Freddie Mac <FMCC.OB>.

The government-sponsored enterprises are critical to the housing market because they provide financing to banks and lenders by purchasing mortgages and either keeping them on their books or packaging them for sale to investors.

"I have concerns about going from a GSE market into a private market. You have to put a system in place," said Jack Hartings on behalf of the Independent Community Bankers of America.

"The GSEs must not be turned over to the Wall Street firms that fueled the financial crisis with sloppy underwriting, abusive loan terms, and an endless stream of complex securitization products," he said.

Senate lawmakers have not produced a legislative approach to overhaul the housing finance system. The Republican-led U.S. House of Representatives, however, has introduced a variety of bills which aim to dampen the government's role in the mortgage system, including legislation that would create private entities to replace Fannie and Freddie altogether.

Many small institutions worry that if Fannie and Freddie were eliminated, large banks would have an advantage over smaller competitors.

Hartings told the committee community banks and smaller institutions represent about 20 percent of the mortgage market and provide access to loans for borrowers underserved by larger banks.

Lawmakers agreed small banks should not be harmed by new regulations.

"We just have to make sure that we do not create regulatory barriers that place small banks at an unfair competitive disadvantage," said Senator Richard Shelby of Alabama, the panel's top Republican.

(Reporting by Margaret Chadbourn; Editing by Andrea Ricci)