Dodd-Frank and the New World of Residential Mortgage Lending · 2015. 5. 4. · • Monthly payment...

September 12, 2013

Presented by:

Dodd-Frank and the New World of Residential Mortgage Lending

Today’s Agenda

• 8:30 am – 9:45 am Overview of Qualified Mortgage (QM) and Other 2013 Dodd-Frank Mortgage Rulemakings Paul Schieber, Stevens & Lee

• 9:45 am – 10:45 am Valuing and Assessing Mortgage Company Acquisitions: Is This the Market to Enter/Expand Residential Lending? Mark McCollom, Griffin Financial Group

• BREAK

• 11:00 am – 12:00 pm New and Creative Insurance Coverages for Mortgage Operations Ken Maher, Pinnacle Risk Services

• 12:00 pm – 1:00 pm Lunch Q&A

2

Paul H. SchieberStevens & Lee610.205.6040

[email protected]

Overview of Qualified Mortgage (QM) and Other 2013 Dodd-Frank

Mortgage Rulemakings

“The future ain’t what it used to be” − Yogi Berra

STEVENS & LEE 4

CFPB UDAP/UDAAP Authority, Enforcement New and Imminent Residential Mortgage Lending Rules Additional Consumer-Credit Rules Expected in 2013 CFPB Final Rulemakings HOEPA Rule Loan Officer Compensation Rule Servicing Rule Escrow Rule Appraisal Rule for Higher Risk Loans Disparate Impact Rule (HUD) Qualified Mortgage – Ability to Repay Vendor Oversight CFPB (and Other Regulator) Examinations

Contents

STEVENS & LEE 5

• Section 1031 of Dodd-Frank Empowers the CFPB to Take Enforcement Action to Prevent: • A covered person or service provider • From committing or engaging in an unfair, deceptive, or abusive act or

practice under Federal law • In connection with any transaction with a consumer for a consumer

financial product or service • Or the offering of a consumer financial product or service

• UDAP is now “UDAAP”

CFPB UDAP/UDAAP Authority, Enforcement

STEVENS & LEE 6

• Risk Areas • The areas with the greatest potential for unfair or deceptive acts or

practices include: • Advertising and solicitations • Account and loan disclosures • Servicing and collections • Managing and monitoring of third-party service providers • Consumer complaints

• Consumer complaints can indicate to the CFPB weaknesses in an institution’s compliance management system, such as:

• Training • Internal controls and/or • Monitoring

CFPB UDAP/UDAAP Authority, Enforcement (cont’d)

STEVENS & LEE 7

• Enforcement Actions • The CFPB’s first public enforcement action required a major institution to

• Refund approximately $140 million to two million customers and • Pay an additional $25 million penalty

• Action resulted from an examination that identified deceptive marketing tactics used by the institution’s vendors

• Now focusing on debt collection practices, student lending

CFPB UDAP/UDAAP Authority, Enforcement (cont’d)

STEVENS & LEE 8

• ATR/QM Rule – Ability to Repay/Qualified Mortgage; Proposal Issued May, 2011, originally to come out in final 4/12 – Final Rule issued January 10, 2013, implementation date January 2014; Detailed discussion below

• HOEPA Rule – High Cost Mortgage Loans (Reg Z) Proposal issued July 9, 2012, Comments deadline September 9 – Final Rule issued January 10, 2013, implementation date January 2014

• Loan Officer Compensation Rule – Mortgage Originator Standards (Reg Z) Proposal issued August 17, 2012, Comments were due October 16, 2012 – Final Rule issued January 20, 2013, implementation date January 2014

New and Imminent Residential Mortgage Lending Rules

STEVENS & LEE 9

• Servicing Rule – Mortgage Servicing (Regulations X and Z) Proposal issued August 10, 2012, Comments were due October 9, 2012 – Final Rule issued January 17, 2013, implementation date January 2014

• Escrow Rule – Requirements for Escrow Accounts (Reg Z) Final Rule issued January 22, 2013, implementation date January 2014

• ECOA/TILA Appraisal Disclosure Rule – Final rule issued January 18, 2013, implementation date January 2014

• Appraisals for High Risk Mortgages Rule – Final rule issued January 18, 2013, implementation date January 2014

• HUD Disparate Impact Rule – Final rule issued February 9, 2013

New and Imminent Residential Mortgage Lending Rules (cont’d)

STEVENS & LEE 10

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• QRM Rule – Six rule makers (not including CFPB) Final rule can now be published since ATR/QM has been issued in final. Effective date unknown

• RESPA-TILA Integration Rule – TILA/RESPA Mortgage Disclosure Integration (Regulation X; Reg Z) Proposed rule issued July 9, 2012, First comments due and submitted September 7, 2012, Second (main set) comment deadline was due November 6, 2012. Final rule and effective date unknown

• HMDA Pre-Rule – Home Mortgage Disclosure Act (Reg C) Proposal and final rule dates unknown

• Loan Originator Anti-Steering Rule – Proposal and final rule dates unknown

Additional Consumer-Credit Rules Expected in 2013

STEVENS & LEE 12

HOEPA Rule

Extends HOEPA restrictions to HELOC’s and purchase money loans

High Cost Mortgage Thresholds:

• The annual percentage rate exceeds the applicable average prime offer rate by more than 6.5 percent for most first-lien mortgages, or by more than 8.5 percent for a first mortgage if the dwelling is personal property and the transaction is for less than $50,000;

• The APR exceeds the applicable average prime offer rate by more than 8.5 percentage points for subordinate or junior mortgages; or

• The points and fees exceed 5 percent of the total transaction amount or, for loans of less than $20,000, the lesser of 8 percent of the total transaction amount or $1,000

2013 CFPB Final Rulemakings

STEVENS & LEE 13

New restrictions and duties on high-cost loans and lenders: • Balloon payments are generally, but not always, prohibited

• Lenders cannot finance points and fees

• The creditor cannot charge a prepayment penalty more than 36 months after the loan closing nor may such penalty total more than 2 percent of the amount prepaid

• Late fees are restricted to 4 percent of the overdue amount

• Fees for payoff statements are restricted

• Fees for loan modifications or payment deferrals are prohibited

• A home equity line of credit lender must assess the borrower’s ability to repay the loan

• Lenders and mortgage brokers are prohibited from encouraging a consumer to default on a loan that will be refinanced by a high-cost mortgage

• The lender must give a loan applicant a list of counseling organizations within three business days of the loan application

• A creditor must obtain certification from an appropriate counselor that the borrower has obtained homeownership counseling before the loan can be made

2013 CFPB Final Rulemakings (cont’d)

STEVENS & LEE 14

Loan Officer Compensation Rule

• LO comp may not be based on or a proxy for rate/fee structure of loan

• No steering to less advantageous (to consumer) loan products

• Restrictions on dual compensation

• OK to pay based on loan amount, quality, volume

• No LO concessions unless unforeseen event

• OK to have different pricing for different LO’s BUT raises fair lending issues

• Limits on profit sharing plans


STEVENS & LEE 15

Servicing Rule

• New ARM notices

• Revised billing statement format

• Prompt payment crediting

• Restrictions in forced-place hazard insurance

• Early intervention on delinquent borrowers

• Dedicated and consistent remediation staff contacts

• No dual tracking


STEVENS & LEE 16

Escrow Rule

• Must keep escrows longer for higher priced loans

• Small, rural lender exemption (unless subject to forward sale commitments)

• > 50% of loans in rural or underserved counties

• ≯ 500 covered 1st lien loans

• ≯ $2b in assets

• Cancellation at 80% or lower of original principal balance; not delinquent or in default


STEVENS & LEE 17

Appraisal Rule for Higher Risk Loans • Thresholds:

• A higher-risk mortgage is defined as a residential mortgage loan secured by a consumer’s principal residence with an annual percentage rate that exceeds the average prime offer rate:

1. By at least 1.5 percent in the case of a first-lien loan with an original principal of no more than the Freddie Mac limit for a home of the same size;

2. By at least 2.5 percent in the case of a first lien loan with an original principal balance that exceeds the Freddie Mac limit; or

3. By at least 3.5 percent in the case of any junior lien loan • Excluded from coverage:

• Qualified mortgages; qualified reverse mortgages; loans secured by new manufactured homes, mobile homes, boats or trailers; and construction loans and bridge loans with maturities of less than a year


STEVENS & LEE 18

Appraisal Rule for Higher Risk Loans

• Require a 2nd appraisal, without cost to borrower, if property sold for less w/in prior 6 months and

• New price > 10% of prior if w/in 3 months

• New price > 20% of prior if w/in 3-6 months

• The 2nd appraisal must include an explanation and analysis supporting the new higher price


STEVENS & LEE 19

Disparate Impact Rule (HUD)

• Surprising lack of attention, probably due to all of the other new rules

• Reduces to regulation application of existing ECOA disparate impact rule to the Fair Housing Act

• Defense: Bona fide business objective

• 3 part test

1. Consumer alleges discriminatory effect

2. Lender establishes a sufficient legal justification

3. Consumer establishes an alternative means with less discriminatory impact


STEVENS & LEE 20

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Qualified Mortgage – Ability to Repay

“Higher Priced” Rate Thresholds (FFIEC.gov/ratespread/aportables.htm)

• 1st Lien: APR 1.5 percentage points over APOR

• Jr. Lien: APR 3.5 percentage points over APOR

STEVENS & LEE 22

Point and Fees Thresholds (goes to whether you rely on QM vs. ATR standard)

• For loans ≥ 100k, not in excess of 3% of loan amount in points and fees

• Include inside LO loan level compensation (including incentives, bonuses)

• Outside originator compensation

• If paid to affiliates, include fees otherwise excluded, e.g.,

• Title insurance

• Escrowed hazard insurance

• Prepayment penalty

• PMI over FHA amounts

Qualified Mortgage – Ability to Repay (cont’d)

STEVENS & LEE 23


Points and Fees Thresholds • But for loans ≥ 60k but < 100k, threshold is $3,000

• For loans ≥ 20k but < 60k, 5% of loan amount

• For loans ≥ 12.5k but < 20k, $1,000

• For loans < 12.5k, 8% of loan amount

• Exclude bona fide discount points:

• Up to 2 for loans ≯ 1 percentage point over APOR

• Up to 1 for other loans

STEVENS & LEE 24

Option 1:

Creditor may comply by determining that consumer has reasonable ability to repay a loan through consideration of eight underwriting factors:

• Current or reasonably expected income or assets, other than value of collateral;

• Current employment status (if the consumer will rely on income as repayment source);

• Monthly payment on the covered transaction (calculated on basis of fully amortizing loan having substantially equal payments, and using greater of introductory rate or fully indexed rate. Special rules apply to balloon, interest-only and negative amortization loans);

• The monthly payment on any simultaneous loan;


STEVENS & LEE 25

• The monthly payment for mortgage-related obligations (property taxes, insurance, etc.);

• Current debt obligations, alimony, and child support;

• The monthly debt-to-income ratio, or residual income (no specific DTI prescribed) or residual income; and

• Credit history (no particular credit score is mandated)

Creditors must verify information using third-party records that provide reasonably reliable evidence of income or assets


STEVENS & LEE 26

Option 2:

• Regular periodic payments must be substantially equal (no negative amortization, increase of principal balance, deferral of repayment of principal, interest-only payments, no balloons)

• No Terms exceeding 30 years

• Points and fees may not exceed 3% of total loan amount (other thresholds apply to loans under $100,000)

• Full documentation and verification of income, assets and current debt obligations

Qualified Mortgage Standard

STEVENS & LEE 27

• Consider consumer’s debt obligations, alimony and child support

• Take into account monthly payment for mortgage-related obligations (property taxes, insurance, etc.)

• Must consider maximum interest rate that may apply during the first five years

• Debt-to-income ratio ("back-end") must be 43 percent or less1

• Fair lending implications

__________

1 Credit history is the one underwriting factor that must be considered under the ATR option but not under this 43% DTI alternative for QM loans

Qualified Mortgage Standard (cont’d)

STEVENS & LEE 28

Option 3: Creditors may comply by accessing a temporary QM provision if loans are eligible for purchase or guarantee by the GSEs, or Government insurance programs. To qualify:

• Loans must carry regular periodic payments that do not allow increase of principal balance, deferred repayment of principal, negative amortization, or balloon payments

• Loan term may not exceed 30 years • Points and fees may not exceed 3% of total loan amount (other thresholds

apply to loans under $100,000) • Loans must satisfy underwriting requirements of (and therefore be eligible to

be purchased, guaranteed or insured by) either (i) The GSEs while they operate under Federal conservatorship or receivership; or (ii) The U.S. Department of Housing and Urban Development, Department of Veterans Affairs, or Department of Agriculture or Rural Housing Service

Temporary GSE/Federal Agency Qualified Mortgage Standard

STEVENS & LEE 29

Option 4:

Certain small creditors may access special Qualified Mortgage aimed at balloon loans. To access this QM, the transaction must meet lender and product feature requirements:

• The creditor must (i) operate in "rural or underserved" areas; (ii) extend 500 or fewer first-lien, covered transactions in the preceding calendar year (loans by affiliates are counted); (iii) have total assets that are less than $2 billion, adjusted annually for inflation. (The thresholds must include loans made by affiliates)

• The loan must be held in portfolio

Balloon-Payment Qualified Mortgage Standard

STEVENS & LEE 30

• The product underwriting requirements:

• Creditor must consider and verify consumer's monthly debt-to-income ratio or residual income in accordance using the calculation methodology described in Ability to Repay requirements, together with all mortgage-related obligations and excluding the balloon payment2

• Creditor must determine that consumer can make all scheduled payments, together with the consumer's monthly payments for all mortgage-related obligations and excluding the balloon payment, from consumer's current or reasonably expected income or assets other than the dwelling that secures the loan

___________

2 The rule does not impose a 43% or other specific debt-to-income or residual threshold for this category of qualified mortgages

Balloon-Payment Qualified Mortgage Standard (cont’d)

STEVENS & LEE 31

• The product feature requirements:

• Must provide for regular periodic payments (no increase in balance) as required by QM

• Scheduled payments on loan must be calculated using amortization schedule that does not exceed 30 years, as required by QM

• Total points and fees cannot exceed 3 percent (or other applicable measures for lower amount loans), as required by QM

• Balloon must have term of at least five years

• Loan must have fixed-interest rate during the term

Balloon-Payment Qualified Mortgage Standard (cont’d)

STEVENS & LEE 32

Option 5:

Additional exemption for small creditors with an increased threshold of up to 3.5 percent over the APOR to define safe harbor QMs and an increase in the same threshold applicable to balloon loans

Background: The CFPB has created an additional category of QM for loans held in portfolio and originated by small creditors - those with less than two billion in total assets and who originated fewer than 500 first lien mortgages. The mortgage would lose its status as a QM if it is held in portfolio for less than three years after closing unless it is sold to a similarly situated community lender. Such a loan would have to conform to every aspect of the general definition of a QM except for the 43% back end DTI limit

Additional Exemption

STEVENS & LEE 33

Qualified Mortgages

Prohibited Features • Interest only

• Negative amortization

• > 30 year term

• Balloon payment (except for certain loans made by small lenders in rural or underserved markets)

• PPP after 3 years; and ≯ 2% years 1-2; 1% year 3 (fixed rate, not higher priced loans and lender offered non-PPP option)

• Using a HELOC to “disguise” a closed end loan

STEVENS & LEE 34

Qualified Mortgages (cont’d)

Presumptive v. Safe Harbor • For higher priced loans, compliance with the ATR provides merely a

“rebuttable presumption” of QM status

• For lower priced loans, compliance with the ATR provides a “safe harbor” from challenges by consumers (or investors) (i.e. a conclusive presumption that the loan met the ATR requirement for QM status)

Question: Is this a distinction without a difference?

What if consumer alleges lender did not fully and in good faith perform all

underwriting tests?

STEVENS & LEE 35

• What is the difference between safe harbor and rebuttable presumption in terms of liability protection?

• QMs can receive two different levels of protection from liability. Which level they receive depends on whether the loan is higher-priced or not

• Safe Harbor

• QM’s that are not higher-priced have a safe harbor, meaning that they are conclusively presumed to comply with the ATR requirements

• Under a safe harbor, if a court finds that a mortgage you originated was a QM, then that finding conclusively establishes that you complied with the ATR requirements when you originated the mortgage


STEVENS & LEE 36

• Safe Harbor

• For example, according to the CFPB, a consumer could claim that in originating the mortgage you did not make a reasonable and good-faith determination of repayment ability and that you therefore violated the ATR rule. If a court finds that the loan met the QM requirements and was not higher-priced, the consumer would lose this claim

• The consumer could attempt to show that the loan is not a QM (for example, under the general QM definition that the DTI ratio was miscalculated and exceeds 43 percent), and therefore is not presumed to comply with the ATR requirements). If the loan is a QM that is not higher-priced, the consumer has no recourse under this regulation


STEVENS & LEE 37

• Rebuttable Presumption

• QMs that are higher-priced have a rebuttable presumption that they comply with the ATR requirements, but consumers can rebut that presumption

• Under a rebuttable presumption, the CFPB states that if a court finds that a mortgage you originated was a higher-priced QM, a consumer can argue that you violated the ATR rule. However, to prevail on that argument, the consumer must show that based on the information available to you at the time the mortgage was made, the consumer did not have enough residual income left to meet living expenses after paying their mortgage and other debts

• The rebuttable presumption provides more legal protection and certainty to you than the general ATR requirements, but less protection and certainty than the safe harbor


STEVENS & LEE 38

Certain Limited Exemptions • Refi’s of risky “nonstandard” mortgages exempt from ATR, e.g., ARM,

interest only, negative amortization − 6th option for compliance

• Reverse mortgages

• Bridge loans (but still subject to PPP prohibition)

• Timeshare secured loans


STEVENS & LEE 39

General Comparison of Ability-to-Repay Requirements with Qualified Mortgages1

ATR Standard General QM Definition

Agency/GSE QM

(Temporary) Balloon-Payment QM Small Creditor QM

Small Creditor Balloon-payment QM

(Temporary)

Loan feature limitations

No limitations No negative amortization, interest-only, or balloon payments

No negative amortization, interest-only, or balloon payments

No negative amortization or interest-only payments

No negative amortization, interest-only, or balloon payments

No negative amortization or interest-only payments

Loan term limit No limitations 30 years 30 years No more than 30 years, no less than 5 years

30 years No more than 30 years, no less than 5 years

Points & fees limit No limitations 3% 3% 3% 3% 3%

Payment Underwriting

Greater of fully indexed or introductory rate

Max rate in first 5 years

As applicable, per GSE or agency requirements

Amortization schedule no more than 30 years

Max rate n first 6 years

Amortization schedule no more than 30 years

Mortgage-related obligations

Consider and verify Included in underwriting monthly payment2 and DTI3


Included in underwriting monthly payment2 and DTI3



Income or assets Consider and verify Consider and verify As applicable, per GSE or agency requirements

Consider and verify Consider and verify Consider and verify

Employment status Consider and verify Included in underwriting DTI


No specific requirement



Simultaneous loans Consider and verify Included in underwriting DTI


Included in underwriting DTI



Debt, alimony, child support

Consider and verify Consider and verify As applicable, per GSE or agency requirements


DTI or Residual Income

Consider and verify DTI ≤ 43 percent As applicable, per GSE or agency requirements


Credit History Consider and verify Included in underwriting DTI





CFPB

STEVENS & LEE 40

1 This chart compares the general ATR requirements with the requirements for originating QM loans. Additional requirements may apply, particularly for small creditor and balloon-payment QM loans. This chart is not a substitute for the rule. Only the rule and its Official Interpretations can provide complete and definitive information regarding its requirements. The complete rule, including the Official Interpretations and small entity compliance guide, is available at http://www.consumerfinance.gov/regulations/ability-to-repay-and-qualified-mortgage-standards-under-the-truth-in-lending-act-regulation-z/.

2 “Included in underwriting monthly payment” means that the rule does not require the creditor to separately consider and verify this factor. However, a creditor must consider this factor when underwriting the consumer’s monthly payment under the rule.

3 “Included in underwriting DTI” means that the rule does not require the creditor to separately consider and verify these factors. However, a creditor considers and verifies these factors when calculating the consumer’s debt-to-income ratio.

General Comparison of Ability-to-Repay Requirements with Qualified Mortgages1

(cont’d)

CFPB

STEVENS & LEE 41

CFPB Bulletin 2012-03 • Vendor compliance violations = your violations

• CFPB has examination authority over vendors to banks and nonbanks subject to CFPB supervision

Vendor Oversight

STEVENS & LEE 42

Bank, nonbank obligations:

• Due diligence of vendors

• Obtaining and reviewing vendor policies and procedures, training materials and internal control plans

• Contract language indemnifying for violations of consumer protection laws

• Internal controls and ongoing monitoring of vendor compliance

• Taking prompt corrective action; contract termination if appropriate (drafting issue)

Vendor Oversight (cont’d)

STEVENS & LEE 43

Primary objectives:

1. Compliance management, especially matters exposing consumer to risk

2. Unfair, deceptive or abusive practices

3. Fair lending

Note: CFPB may bring counsel

• May be jointly run with state examiners and other federal agencies

CFPB (and Other Regulator) Examinations

STEVENS & LEE 44

What CFPB will request:

• Policies and procedures on topics ranging from consumer complaint processing to record retention to training to the alphabet regs to vendor management

• Product descriptions and eligibility standards, loan pricing

• Management meetings

• Ongoing explanations

CFPB (and Other Regulator) Examinations (cont’d)

STEVENS & LEE 45

• What CFPB (and other regulators) will do if problems found:

• Remedial action

• Payments to consumers

• Revise P&P’s

• Referrals to DOJ

• Issue civil investigative demands, which require sworn answers

• Request staff interviews or testimony

• Fines – civil penalties

• ≯5k/day for any violations

• ≯25k/day for reckless disregard of compliance obligations

• ≯1m/day for intentional violations


STEVENS & LEE 46

Test Scores and Report

• Scores will range from 1 to 5

• Score is appealable

1 = Strong compliance

2 = Generally compliant

3 = Less than satisfactory compliance

4 = Requires ongoing supervisory attention to correct problems

5 = Requires strongest continuing supervisory attention

• Report will be issued with findings


STEVENS & LEE 47

Mark R. McCollomGriffin Financial Group

[email protected]

Valuing and Assessing Mortgage Company Acquisitions:

Is This the Market to Enter/Expand Residential Lending?

49

I. Mortgage Banking: Past, Present, Future

II. Recent Mortgage Banking Operating Performance

III. Other Considerations in Entering Mortgage Banking

IV. Mortgage Banking: Regulatory Actions

V. Schedule RC-P Analysis

VI. Valuation Considerations

VII. Building or Buying a Mortgage Banking Operation

VIII. Acquisition Study – A Sample Mortgage Banking Acquisition

Contents

50

Mortgage Banking | Past – Present – Future

Volumes – Mix – Rates

51Source: Freddie Mac Investor Presentation

Home Price Performance (2012 vs. 2006)

Mortgage Banking Environment

The housing bubble burst in 2007, halting new and existing home sales. In some states, home owners lost more than 40-50% of their home values.


Home Price Performance (2012 vs. 2011)

Mortgage Banking EnvironmentHousing prices have recently shown positive momentum, except for New Jersey where foreclosures are subject to long delays arising from “New Jersey’s Judicial Review Process”.

53

0

200

400

600

800

1,000

1,200

1,400

The volume of mortgage originations declined precipitously under the weight of the Recession, residential housing depression and mortgage market abuses.

Quarterly 1 – 4 Family Mortgage Originations

Mortgage Banking EnvironmentO

rigin

atio

ns ($

billi

ons)

Source: Mortgage Banking Association Mortgage Finance Data

54


The “Private-label” MBS Market collapsed, thereby ceding the residential mortgage market to the GSE’s.

MBS Issuance and Volume

Source: Freddie Mac Investor Presentation

55

0

100

200

300

400

500

600

2011Q1 2011Q2 2011Q3 2011Q4 2012Q1 2012Q2 2012Q3 2012Q4 2013Q1 2013Q2

10.49% compound quarterly growth rate




Originations have shown signs of improvement since the beginning of 2011.

Orig

inat

ions

($bi

llion

s)

56

But, the strength of the mortgage market has been driven by “refinancing activity” which made up 70% of total originations in 2012 compared to 48% in 2006. This trend is expected to reverse in 2013 and 2014, but total originations will decline.



Mortgage Banking EnvironmentO

rigin

atio

ns ($

billi

ons)

49%

51%

52%

67%69%

66%71% 61%

36%

0

500

1000

1500

2000

2500

3000

2006 2007 2008 2009 2010 2011 2012 2013 2014


30-Year Mortgage Rates

Borrowers have been enticed to refinance mortgages by historically low rates

Mortgage Banking Environment$s

Out

stan

ding

58Source: Mortgage Daily News. “8.6 Million Mortgage Originations in 2012, Highest Since 2007” By Jann Swanson

Refinancibility

Low interest rates, and improved employment, economy, home prices and home equity have increased the number of those eligible to refinance their mortgages.

Mortgage Banking Environment$s

Out

stan

ding

59

316

189

111 105 102 96 85

2.5%

2.7%

2.9%

3.1%

3.3%

3.5%

0

50

100

150

200

250

300

350

2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4

Quarterly 1 – 4 Family Mortgage Originations (Refi Only) vs. 10-year Treasury Yield


Yet, the Mortgage Banking Association projects a sharp decline in refinance related originations.


$s o

f Ori

gina

tios

10-year Treasury Yield

60

0

50

100

150

200

250

2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4

Quarterly 1 – 4 Family Mortgage Originations (Purchase Only)


While purchase activity is expected to increase modestly, this will NOT be enough to offset the expected decline in refinancing activity.


$s o

f Ori

gina

tios

61

0

200

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800

1,000

1,200

1,400

2000

Q1

2000

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Q4

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2014

Q4

Purchase Refinance



The Mortgage Bankers Association estimates total originations to fall from $1.8 trillion for 2012 to $1.5 trillion in 2013 and in $1.1 trillion in 2014


$s o

f Ori

gina

tios

Forecast

$1,750 originations

$1,592 originations

Actual

$1,100 originations

62

Mortgage Banking Environment NO UPDATED SLIDE

The MBA estimates a 37% decline of all mortgage originations and 69% drop of refinanced mortgages (2012 vs 2014) .


63

♦ Since the beginning of the “Great Recession”, overall mortgage origination activity has dropped considerably:• Mortgage originations related to purchase activity have dropped from a high of $432 billion in the 2nd quarter

of 2005 to $123 billion in the 4th quarter of 2012• Mortgage originations related to refinance activity has remained strong as low absolute interest rates and

Government programs have bolstered volume

♦ Both the Mortgage Bankers Association and Moody’s Analytics expect a sharp decline of mortgage originations starting in the second half of 2013:• Mortgage activity related to purchases will remain depressed relative to historical levels, but will show signs

of improvement over the next few years with new household formation• Mortgage activity related to refinancing is expected to fall by approximately 75% from the 4th quarter of 2012

to the 4th quarter of 2013

♦ The growth rates of mortgage banking revenue looks to be unsustainable going forward (and may have peaked in 2012Q3), as the decline of volume will reduce revenue and profitability (fewer loans to absorb fixed costs)

Summary of Current and Forecasted Origination Activity

64

♦ “Wells Fargo, Citigroup Slash Mortgage Jobs as RefisTank” – American Banker, July 2013

♦ “JPMorgan Chase to Slash $1 Billion in Costs; Cut Staff by 4,000” – CNBC, February 2013

♦ “Bank of America to cut 1,000 Mortgage Jobs” –American Banker, August 2013

Right-Sizing the Business Model?

65

Recent Mortgage Banking Operating Performance

66

Operating Performance

Average Profit Per Loan

The MBA reports “average profits per loan” have decreased from $2,465 in Q3 2012 to $1,528 in Q2 2013 and from 120 to 75 basis points per loan, respectively

Source: Mortgage Banking Association

2nd '13 1st '13 4th '12 3rd '12 2nd '12 1st '12 4th '11 3rd ' 11 2nd '11Key Findings

(current quarter versus prior linked quarter)

Total Loan Production Expense per loan: commissions, compensation, occupancy & equipment, other production expenses and corporate allocations

$ 5, 818 $ 5, 779 $ 5, 603 $ 5, 163 $ 5, 128 $ 5, 292 $ 5, 118 $ 5, 315 $ 5, 644

Net Cost to Originate per loan: all production operating expenses + commissions, minus all fees (excluding secondary marketing gains, capitalized servicing, servicing released premiums and warehouse interest spread

$ 4, 207 $ 4, 182 $ 3, 813 $ 3, 353 $ 3, 224 $ 3, 413 $ 3, 324 $ 3, 360 $ 3, 513

Avg. profit per loan 1,528$ 1,772$ 2,256$ 2,465$ 2,152$ 1,651$ 1,093$ 1,263$ 575$Avg. production profit (net production income) 75 bp 86 bp 107 bp 120 bp 107 bp 82 bp 59 bp 66 bp 33 bpAvg. secondary marketing income 263 bp 274 bp 279 bp 271 bp 257 bp 243 bp 215 bp 229 bp 210 bp

Avg. production volume per company (millions) 439$ 442$ 488$ 450$ 371$ 301$ 313$ 237$ 174$Avg. volume by count per company 1921 1954 2,132 2,010 1,700 1,380 1,093 1,263 866

MBAQuarters

For The 311 Companies Reporting

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Operating Performance – 4th Quarter 2012 vs. 4th Quarter 2011

Profit Metrics 4th Quarter 2012 vs. 2011

The MBA most recently reports profits per loan of $2,256 vs. $1,093 or 107 vs. 58 basis points on the strength of Net Secondary Marketing Income.


Basis Points Dollars Per Loan Basis Points Dollars Per Loan % Change

Revenues: Total Loan Production Revenues: 60% origination fees, and 32% underwriting, processing, adm fees (a) 82 1,790$ 83 1,794$ -0.2%Expenses: Total Personnel: 46% sales, 24% fulfillment, 19% production 162 3,569$ 158 3,226$ 10.6% Occupancy & Equipment 11 247 14 287 -13.9% Technology 4 91 4 87 4.6% Total Other Direct 60 1,311 59 1,225 7.0%Direct Loan Production Expenses 238 5,218$ 235 4,825$ 8.1%Corporate Allocation 18 385 14 293 31.4%Total Loan Production Expenses (b) 255 5,603$ 249 5,118$ 9.5%

Net Loan Production Operating Income (Loss) (a-b) (173) (3,813) (160) (3,325) 14.7%Net Interest Income - Warehousing 1 23 3 62Net Secondary Marketing Income 279 6,046 215 4,344 39.2%

Total Net Production Income 107 2,256$ 58 1,093$ 106.4%

2012 2011

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Operating Performance – By Type of Mortgage Banker

Profit Metrics 4th Quarter 2012

The MBA most recently reports banks having the lowest Net Loan Production Operating Income (Loss), but also the lowest Net Secondary Marketing Income.


Bank / Thrift Independents Others Total

Total Loan Production Revenues 66 85 85 82

Total Loan Production Expenses 194 272 234 255

Net Loan Production Operating Income (Loss) (128) (187) (148) (173)

Net Secondary Marketing Income 229 288 287 279

Total Net Production Income 107 101 140 107

2012 - Roll-up (basis points)

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♦ While the mortgage market has typically been very efficient, investors clawing for yield have bid up mortgages in the secondary market. The spread between the 30-year current coupon yield and the average mortgage rate reached 170 bps in September 2012. Today the spread is around 110 bps.

Secondary Market Spreads Are at Historical Highs

30-Year FNMA Current Coupon Yield vs. National Avg. Mortgage Rate

170 bps

Data source: Bloomberg

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Other Considerations in Entering Mortgage Banking

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♦ Mortgages are considered in the “pipeline” from the point of application until the loan is either (1) is sold into the secondary market, (2) is put into the originators loan portfolio or (3) “falls out”• A mortgage “falls out” when the customer does not close on the mortgage after being granted a “rate

lock”

♦ Pipeline Risk is a function of potential rate movements between application and closing, and the possibility the loan falling out• If the loan is being sold into the secondary market, there is also risk that the secondary market yield

will move against the “rate lock” before closing

♦ In order to hedge the interest rate risk, an institution can use several strategies to “lock in” the sale of the loan at prevailing market rates. The institution then either locks the loan and rate in with an investor and commits to deliver the loan if settlement occurs (“Best Efforts”) or commits to deliver the locked loan in a binding (“Mandatory”) delivery program with an investor• The most common forward delivery tool is the “To Be Announced” market. This is the forward

mortgage backed security pass-through market• Some mortgage divisions will use futures contracts and over the counter mortgage options as well

Other Mortgage Banking Considerations - Pipeline Risk

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♦ The model has typically been to sell loans that conform to secondary market standards and hold loans that do not conform as to principal or documentation• It is important to understand the liquidity issues that arise from holding non-conforming mortgages in

that they may be tough to unload when your institution needs liquidity or capital• Additionally, there are increased risks in selling into the secondary market

♦ The scarcity of earning assets for banks encourages some to also hold conforming loans

♦ The profile of the mortgage origination market has changed drastically since the “Great Recession”• Most loans originated are refinance• Very few ARMs• Very low rates and long tenors• Pressured borrowers• Increased risk of “put back liabilities” due to scrutiny of underwriting standards – longer and more

aggressive put back terms• Increased scrutiny by Regulators on all aspects of origination and documentation and greater risk of

fines and penalties• Reputation risk associated with lending to lesser credit worthy customers

♦ The combination of these factors have resulted in increased risk: credit risk (which goes without saying) and an enormous increase in interest rate risk

♦ In today’s new mortgage banking environment, greater understanding and consideration needs to be taken before originating mortgages – whether they are sold immediately or not!

Other Mortgage Banking Considerations - Hold or Sell the Loans

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Other Mortgage Banking Considerations - Servicing

♦ There is economic value in holding the Mortgage Servicing Rights (MSRs) associated with originated mortgages. The originator can monetize the value of these rights in two ways:• Selling the loans as “servicing released.” This allows for better initial price execution (i.e. you get paid more for

releasing the rights)• Selling the loans “servicing retained.” This allows the originator to collect the fees associated with servicing the loans

♦ A mortgage servicer earns a percentage of each mortgage payment made by a borrower to a mortgage servicer as compensation for keeping a record of payments, collecting and making escrow payments, passing principal and interest payments along to the noteholder, etc. Servicing fees generally range from 0.25-0.50% of the remaining principal balance of the mortgage each month.

♦ Mortgage servicers also benefit from being able to invest and earn interest on a borrower's escrow payments as they are collected until they are paid out to taxing authorities, insurance companies, etc.

♦ The business of mortgage servicing has also come under the pressure of regulators and legislators. Compliance costs have increased substantially as additional rules and procedures have been put in place to protect consumers.

♦ As a result, many of the larger banks have sold down their MSR portfolios. Most notably, Bank of America has sold a large portion of its MSR portfolio in the past year.

♦ The draft final rules on Basel III have made it impossible for small banks to be significant players in mortgage servicing, due to capital haircuts required as MSR’s exceed certain capital thresholds.

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Mortgage Banking | Regulatory Actions

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♦ In many ways, the residential loan market is much different than it used to be. Perhaps the most significant of these changes, especially for those looking to enter the space, is the increase in compliance needed to operate a mortgage banking business.• Since the onset of the “Great Recession”, we have witnessed an increased role in how the government

interacts with banking and mortgage finance:• TARP, TALF, SBLF, etc…• Dodd-Frank• Quantitative Easing (unprecedented in scale and scope)• HARP and HAMP• SAFE Act (licensing of mortgage officers)• GSE reform• Consumer Financial Protection Bureau• Regulation Z

♦ The result is a need for more resources dedicated to compliance, which translates into higher costs.

Compliance

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Truth in Lending Act, Regulation Z, Dodd Frank and the CFPB

Originator Qualification and Compensation (Regulation Z):

♦ The new rule (generally effective January 10, 2014) prohibits a loan officer or broker from being compensated based on loan terms (other than size)

♦ Prohibits the loan officer or broker from being paid by both the consumer and the lender i.e. dual compensation

♦ Sets uniform standards for qualifying and screening loan originators:• Must meet character, fitness, and financial responsibility reviews; • Must be screened for felony convictions; and,• Required to undertake training to ensure they have the knowledge about the rules governing the types

of loans they originate

♦ Extends recordkeeping requirements to both the creditors and mortgage brokers for three years

♦ Prohibits mandatory arbitration (effective June 1, 2013)

Regulatory Landscape

Source: Mortgage Bankers Association, Consumer Financial Protection Bureau

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♦ Qualified Mortgages that have a safe harbor status, are generally lower-priced, prime loans that are given to consumers who are considered to be less risky.

♦ These loans require documentation of the borrower’s ability to repay, but will offer lenders the greatest legal certainty that they are complying with the new Ability-to-Repay rule.

♦ Under the Ability-to-Repay rule, all new mortgages must comply with basic requirements that protect consumers from taking on loans they don’t have the financial means to pay back. • Financial information has to be supplied and verified• A borrower has to have sufficient assets or income to pay back the loan• Teaser rates can not mask the true cost of a mortgage

♦ Two Tests: (1.) P&I equal to or less than 43% of pre-tax income, or (2.) a “Pass Grade” when fed into the automated underwriting engines maintained by Fannie Mae, Freddie Mac or the FHA which test will be eliminated when those agencies come out of bankruptcy. Subject to the government loan ceilings which stand at $417,000 nationally, but rise to as high as $729,750 in high-cost housing markets such as New York, Los Angeles and San Francisco.

♦ CFPB grants the strongest level of legal (creditor rights) protection to loans that carry a prime mortgage rate, or a rate within 1.5 percentage points of the national average.

CFPB – Qualified Mortgages

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Licensing Costs

♦ States have traditionally licensed mortgage companies; however a growing number of states are moving beyond corporate licensing and requiring the licensing of loan officers and even support staff. Additionally, an increasing number of states are adding onerous requirements to existing mortgage company licensing. These new laws and regulations are adding significant costs to mortgage companies, particularly for national and multi-state lenders. In NJ:• Company is required to have a net worth of $50,000 and a surety bond for $150,000 • Control persons are required to undergo federal and state criminal background checks• Individuals must pass a written exam• Individual pre-licensing requirements include approved education courses of 20 or more hours,

including 4 hours of New Jersey specific courses

Employee vs. Sub Contractor

♦ Qualification requirements and the complex safe harbor provisions of Regulation Z, along with the state licensing issues, team up to effectively require many brokers to become employees of the originator. This generates a host of legal, tax and administrative issues, that all translate into higher costs.

Fines & Penalties

♦ Fines and penalties assessed to the mortgage industry for poor documentation or practices like robo signing, improper foreclosures and collection practices, liberal loan products, etc. have become more severe and more commonplace.

Other Issues

Source: Mortgage Bankers Association, Consumer Financial Protection Bureau, NJ Department of Banking & Insurance

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Schedule RC-P Analysis

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♦ Schedule RC-P is to be completed by 1. all banks with $1 billion or more in total assets, and 2. those banks with less than $1 billion in total assets where any of the following (domestic) residential

mortgage banking activities exceeds $10 million for two consecutive quarters for: Closed and Open Ended First and Junior liens 1-4 family residential mortgage loans originations, sales or held for sale or trading.

♦ If the bank is less than $1 billion, complete Sch. RC-P beginning the 2nd quarter in which the $10 million threshold is exceeded and continue schedule through the end of the calendar year.• Open-end mortgages (HELOCs) should be reported using the “total commitment under the lines of

credit”.• Closed end 1-4 family residential mortgages are defined in Schedule RC-C, part 1.c.(2), and Open-end

1-4 family residential mortgages are defined in Schedule RC-C, part I, item 1.c.(1). And, held for trading are defined in Schedule RC-D and RC, item 5, “Trading assets”.

• Open-end loans Sch. RC-P (1) “total commitment under the lines of credit” means the total amount of the lines of credit granted to customers at the time originated; (2) for originations of such open-end loans, “principal amount funded under the lines of credit” means the total amount at initial funding of newly established lines of credit, and (3) open-end loans purchased, sold, held for sale or trading, and repurchased or indemnified, “principal amount funded under the lines of credit” means the principal balance outstanding of loans at the transaction date or at quarter-end, as appropriate.

Schedule RC-P – Reporting B&T Mortgage Banking Activities

Instruction to complete Call Report Schedule RC-P “1-4 Family Residential Mortgage Banking Activities”: link http://www.ffiec.gov/PDF/FFIEC_forms/FFIEC031_FFIEC041_201203_i.pdf

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♦ B&T - Retail and Wholesale Originations♦ The volume of 2012 B&T Originations reached 1.5 trillion a +43% increase over the prior year after declines of

(16%) and (11%) in 2011 and 2010, respectively and a +78% increase in 2009 versus 2008♦ 2008 represents the low point♦ The Top 25 B&Ts (based on 2012 rankings) Share of Market declined to 79% after topping 87% earlier, and ♦ The Top 25’s mix of Direct versus Wholesale originations declined to 43% and 57%, respectively in 2012, after

having ranged 43 – 52% Direct and 57 – 48% Wholesale, in the past

♦ Top 25 standings:♦ Wells Fargo topped the charts every year since 2007 with 2012 originations totaling $461 billion. That’s twice the

volume of its nearest rival JP Morgan♦ Bank of America’s volumes continues to decline precipitously. Countrywide’s acquisition was heralded as a

“Milestone”, but continues to be a “Millstone” ♦ Six Thrifts joined the ranks of the Top 25 as they are now required to file Call Reports and Sch. RC-P:

♦ Flagstar Bancorp, Inc., MI ♦ United Services Automobile Association, TX♦ Viewpoint Financial Services Group, Inc., TX♦ EverBank Financial Group, Inc., FL♦ Union Savings Bank, OH♦ Silver Queen Financial Services, Inc., CO

Schedule RC-P – Observations

SNL DataSource | Schedule RC-P 1-4 Family Residential Mortgage Banking Activities

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Top Bank & Thrift Mortgage Originators

Company Name State Rank 2012 2011 2010 2009 2008 2007

6,689 Banks & Thrifts919 Banks & Thrifts reporting Mortgage Volumes

Volumes Top 25 Share 79% 85% 86% 87% 86% 81% Top 25 Volume 1,194,938,375 897,775,673 1,075,398,721 1,219,142,818 676,550,603 626,317,700 Total Volume 1,505,858,835 1,050,447,227 1,250,065,596 1,397,897,791 786,209,966 775,781,851 Y-O-Y Changes 43% -16% -11% 78% 1%

Mix for Top 25 Direct 43% 48% 52% 52% 48% 46% W holesale 57% 52% 48% 48% 52% 54%

Top 10Wells Fargo & Company CA 1 461,246,000 327,008,000 357,979,000 401,061,000 206,185,000 217,289,000JPMorgan Chase & Co. NY 2 230,417,000 169,085,000 149,450,000 148,002,000 128,712,000 112,495,000U.S. Bancorp MN 3 77,974,000 44,236,000 51,866,000 52,777,000 31,825,000 25,884,000Flagstar Bancorp, Inc. MI 4 53,504,669 - - - - -Citigroup Inc. NY 5 52,833,000 51,572,000 57,141,000 71,255,000 83,052,000 105,334,000Texas Capital Bancshares, Inc. TX 6 51,110,694 27,234,903 22,821,981 16,373,682 7,421,878 3,905,519Bank of America Corporation NC 7 44,499,974 114,769,007 243,640,760 350,204,150 136,789,531 71,324,391Ally Financial Inc. MI 8 30,252,000 54,580,000 67,994,000 - - -SunTrust Banks, Inc. GA 9 26,581,016 17,646,222 24,302,635 47,609,369 36,822,602 57,925,722BB&T Corporation NC 10 26,394,946 17,445,415 20,167,246 32,134,942 13,610,577 7,850,035

Retail and Wholesale Originations

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Valuation Considerations

84

♦ Mortgage banking revenues are volatile as the fundamentals change rapidly with interest rates and economic factors:• Interest rates drive refinance activity and purchase activity• The economy, household formations and demand for housing drive purchase activity• Government programs (as we have seen in this last recession) can drive both refinance (HOPE,

HARP, Obama Mortgages – Making Home Affordable) and purchases (loans and equity subsidies, First Time Home Buyer Tax Credits in the Housing and Economic Recovery Act 2008 repayable over 15 years)

♦ As revenues are volatile, institutional investors often look at mortgage banking income differently than income driven by core banking and apply a discount to that earnings stream in determining valuations

♦ Griffin identified banks having mortgage banking revenue as a significant contributor to revenue. Virginia banks appear to have significant mortgage banking businesses among the 10 largest by Net Gains to Assets.


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♦ While Mortgage Banking may be a significant contributor to the top line its contribution to the bottom line may be muted!

♦ Mortgage banking is less expense efficient than community banking as Non-interest Expense to Total Income ratios for mortgage banking exceeds those of community banks by a wide margin.

♦ Mortgage banking grosses-up both revenue and expenses.

Valuation Considerations – Segment Analysis

Select Segment Reports SummaryMonarch Financial Holdings, Inc Banking

Mortgage Banking

Net interest income 39,677,512$ 874,720$Provision expense (4,831,133) -Non-interest income 5,222,612 86,056,021Non-interest expense (24,168,712) (81,604,729)Pre-tax net income 15,900,279$ 5,326,012$Efiiciency Ratio -54% -94%

Access National Corporation BankingMortgage Banking

Net interest income 30,975,000$ 1,196,000$Provision expense - -Non-interest income 2,664,000 51,319,000Non-interest expense (18,909,000) (36,859,000)Pre-tax net income 14,730,000$ 15,656,000$Efficiency Ratio -56% -70%

Cardinal Financial Corporation BankingMortgage Banking

Net interest income 89,472,000$ 2,365,000$Provision expense (6,865,000) (285,000)Non-interest income 5,868,000 54,794,000Non-interest expense (43,495,000) (29,529,000)Pre-tax net income 44,980,000$ 27,345,000$Efficiency Ratio -46% -52%

2012

2012

2012

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♦ Community banks having significant mortgage banking operations are valued differently than community banks without mortgage banking revenue:

Valuation Considerations: Banks with Significant MB Revenue

Banks & Thrifts With Significant Mortgage Banking Operations

Price/EarningsPrice/ Tangible

Book Value 2012 ROAE

Significant Mortgage Banking 8.8x 120% 11.51%

Some Mortgage Banking 13.6x 130% 8.16%

No Mortgage Banking 15.4x 118% 7.99%

Public B&T Between $1 B & $20 B 13.4x 128% 8.13%

SNL U.S. Bank & Thrift Index* 11.8x 147%

Data source: SNL Financial. Population includes public banks & thrifts between $1 billion and $20 billion in total assets“Significant”: mortgage banking loan sales > 25% of total assets“Some”: mortgage banking loan sales > 0 and <25% of total assets* SNL U.S. Bank & Thrift Index is weighted by market cap

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♦ Banks with a concentration in mortgage banking revenues don’t get full credit – and trade lower as a multiple of earnings


Price / LTM Earnings

Source: SNL Financial

P/E

Mul

tiple

VGBK ANCX MNRK SNL US Bank and Thrift

88

Building or Buying a Mortgage Banking Operation

89

Cons

♦ Building will be costly and time consuming. Must hire the right people, sign the right contracts and get the infrastructure in place

♦ It may take a good amount of time to ramp-up the amount of volume needed to cover fixed costs and be profitable

♦ Expertise to manage the business may not be resident in-house, and be costly to acquire

Building a Mortgage Banking Business – Pros & Cons

Pros

♦ Entering slowly will allow time for bank management to adjust, building upon existing infrastructure

♦ Many banks have the right community contacts resident within the bank and board: sourcing through local relators, accountants, financial planners and lawyers is key

♦ Small changes in the bank’s business model will meet with a more favorable reaction from the primary regulator

♦ Growth and focus can be more easily controlled and directed

♦ Overall costs can be less, providing it is well planned and executed

♦ Complementary businesses (i.e. title insurance) can be added as the business grows

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Cons

♦ Risk of overpaying is high, as sellers’ price expectations are very high, despite the uncertainty in the future of originations

♦ Likely will add goodwill and intangiblesand be dilutive to tangible book value

♦ Maintaining purchased origination volume generally means that principals and brokers need to be retained and incented

♦ Mortgage banking is a relationship driven business, and purchased relationships are often difficult to maintain

♦ A stock merger as opposed to a purchase could potentially expose the buyer to pre-transaction repurchase or put obligations

♦ Thorough due diligence is required

Pros

♦ The infrastructure is already built, saving management a great deal of time and effort in hiring people, bidding out contracts, etc.

♦ The mortgage bank will have licenses and a track record with GSEs

♦ A transaction may be accretive to earnings immediately depending upon consideration paid and structure

♦ Immediate revenue enhancement opportunities as you will be able to cross sell the mortgage banking platform to current customers

Buying a Mortgage Banking Business – Pros & Cons

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♦ Valuing a mortgage bank based on comparable transactions is generally difficult, given that there are few in number, and most transactions involving small mortgage originators are generally:• Not public with little information publicly disclosed• Originators with varying business models and concentrations, and distribution channels• Constituents with different interests, motivations and varying levels of post transaction involvement

and incentive

♦ However, if a relevant comparable transaction or group can be established, this can serve as a data point

♦ Using publicly traded companies as an input for value can also be helpful, but also is subject to similar constraints:• Larger mortgage operations have different economies of scale, and often reach different markets for

originating, acquiring and selling loans • May have other operations such as servicing and wealth management, investment banking, etc.• [Trading] prices exclude any change of control premium associated with a sale of a company

♦ A discounted cash flow model is often the most useful for valuing a mortgage business, and this requires in-depth knowledge of the company, as well as the basis for future expectations for the host of environmental factors that will influence the company’s future performance

♦ Science? No, “Art” at best!

Buying A Mortgage Bank: Valuation

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♦ Given the prognosis for volatility of future earnings, including a portion of the purchase price as an earn out is prudent.

♦ Earn outs can be tied to future origination volumes, revenues, EBITDA, or other metrics, and sometimes comprise 50% or more of the purchase price.

♦ Typically the principals are critical to continued success, and their continued employment is generally required. Non compete agreements for other key personnel are also commonplace.

♦ Non competes with former owners generate intangible assets that are valued as part of the consideration and amortized over the term. Non competes with employees are compensation expense recorded during the period.

♦ The fair value of the earn out is also part of the purchase price. The estimated value is recorded at the close of the transaction (typically on a probability weighted and discounted basis), with changes in value recorded in earnings over the earn out period. Introduces more earnings volatility than community banking.

♦ A “win-win” structure effectively incents the seller to stay and grow the business, while the buyer provides a platform to grow the business better.

Buying A Mortgage Bank: Earn Outs & Incentives

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Acquisition Study – A Sample Mortgage Banking Acquisition

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♦ Yadkin Financial Corporation acquired Sidus Financial LLC | First Mortgage Corp., Greenville, NC, on October 1, 2004. Sidus offered Title, Reinsurance and mortgage brokerage.Sidus had 2005 originations of $838 million.

♦ Purchase price totaled $6.9 million consisting of 0.347 :1.0 shares of common stock (699k new shares issued) plus $4.82 cash per share, plus certain performance based consideration, Sidus had tangible equity at close of $3.0 million.

Yadkin Financial Acquisition of Sidus Mortgage – IRR

IRR: 17.1%Purchase Price (6,900)$

Net Income:2005 763$ 2006 874$ 2007 907$ 2008 2,800$ 2009 7,900$ 2010 2,400$

2011* (2,900)$

Cash Flows and IRR:

* The 2011 net loss of $2.9 million excludes a $5 million goodwill impariment charge

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♦ The purchase of a home is typically the largest financial decision a consumer ever makes. If your bank aligns itself strategically as a consumer bank, addressing this segment in some fashion seams to be a foregone conclusion. That being said…

♦ Origination volumes are expected to fall from recent years during 2013 and 2014

♦ Secondary market spreads and overall profitability will likely continue to fall from recent levels

♦ Valuations on this kind of business line are subject to discounts due to volatility of earnings

♦ Mortgage banking can provide a bank with meaningful tangible book value creation; however, consider limiting mortgage banking operations in order to control earnings volatility and potential negative impact on valuation

♦ Building or buying a mortgage bank requires thoughtfulness around strategy, structure and cultural dynamics that result from this kind of business

Summary of Thoughts

Ken MaherPinnacle Risk Services

[email protected]

New and Creative Insurance Coveragesfor Mortgage Operations

Mortgage Impairment Insurance • Also referred to as:

• Mortgage Interest Insurance

97 PINNACLE RISK SERVICES

Who Maintains this Kind of Insurance? • Banks

• Savings & Loan Associations

• Credit Unions

• Mortgage Bankers

• Mortgage Brokers

Any organization that originates, holds and/or services mortgages


Who Provides this Form of Insurance? • Lloyd’s, London – Developed the coverage

• StarNet

• Zurich

• Chubb (as part of a Package Policy)

• Travelers (as part of a Package Policy)

• Others


What are the Benefits to the Lender? • Protects your interest in the mortgaged property

• Protects you from claims where you are found to be legally liable in connection with an act, error or omission in associated with your escrow responsibilities and/or loan servicing responsibilities

PINNACLE RISK SERVICES 100

What Does it Cover? • Residential Mortgages

• Commercial Mortgages

• Manufactured Homes

• Mobile Homes

• 2nd Mortgages

• Home Equity Loans


Mortgageholder’s Interest


Mortgageholder’s Interest • Insurers you against loss to your “mortgageholder’s interest*”

resulting from an “uninsured” physical loss of or damage to “mortgaged property” caused by a Covered Cause of Loss, which occurs during the policy period and the mortgage is in default

* Means the unpaid principal balance of the mortgage plus accrued interest up to the date of default of the mortgage. It does not pay late fees, penalty interest, or costs associated

with enforcing the terms of the mortgage or collecting outstanding debt.

• Will not pay more than the lesser of the amount of physical damage or loss: • In accordance with the policies that would have covered the loss of or

damage if the “mortgaged property” had not been uninsured; or

• The amount of your mortgageholder’s interest; or

• The applicable limit of insurance shown on the Declarations Page of your policy


Security Interest Errors and Omissions Coverage • Insures you against loss to your “mortgageholder’s interest” caused

by you or your representative’s negligent act, errors, or omission in the operation of your customary procedures in preparing, recording, or releasing your security interest in a “mortgaged property”

• The policy will not pay more than the least if the following amounts: • The amount you would have been able to recover from the “mortgaged

property” if the negligent act, error or omission had not occurred;

• The amount of loss to your “mortgageholder’s interest”; or

• The applicable limit of insurance shown in the Declarations Page of the policy


Conditions • You require the mortgagor to obtain and maintain physical damage

insurance on the “mortgaged property” for the duration of the mortgage

• The limit of the required insurance shall at least be equal to the lesser of: • The outstanding balance of the mortgage; or

• The replacement cost of the real property identified in the mortgage

• You or your representatives confirm prior to releasing or disbursing funds on the mortgage that the required insurance is in place

• You will not represent or imply to any person the insurance required by the mortgage is unnecessary or need not be maintained

• You will upon receipt of any information that the insurance required by the mortgage agreement will, for any cause, terminate, you will procure, within 90 days, insurance coverage for you for at least the minimum requirements of the mortgage so as to prevent lapse in protection required by the mortgage on the covered property


Mortgageholder’s Liability


Failure to Maintain Property Insurance on the “Mortgaged Property”

• Pays those sums you become legally obligated to pay as damages due to your failure to purchase or maintain property insurance on the “mortgaged property” for the benefit of the mortgagor


Failure to Maintain Other Insurance • Pays those sums you become legally obligated to pay as damages

due to your failure to purchase or maintain insurance other than property insurance on the “mortgaged property” for the benefit of the mortgagor

• Does not include Life, Health or Accident


Failure to Pay Real Estate Taxes • Pays those sums you become legally obligated to pay as damages

due to your failure to pay real estate taxes and other mandatory assessments on behalf of the mortgagor


Failure to Determine Flood Zone • Pays those sums you become legally obligated to pay as damages

due to your failure to determine whether the “mortgaged property” is located in a Special Flood Hazard Area


Real Property Held in Trust • Pays those sums you become legally obligated to pay due to your

accidental failure to obtain or maintain insurance on real property you hold in trust


Mortgage Life and Disability Coverage • Pays those sums you become legally obligated to pay as damages

due to your failure to obtain or maintain Mortgage Life or Disability Insurance on behalf of the mortgagor


Document Custodian • Pays those sums you become legally obligated to pay as damages

due to your failure to provide the following mortgage document custodial services to others under a written contract: • Certification of documents; or

• Filing, maintaining and safeguarding of document; or

• Releasing and transferring documents


Title Insurance Errors and Omissions • Pays those sums you become legally obligated to pay as damages

due to your failure to: • Require title insurance; or

• Procure or maintain Title Insurance on behalf of the mortgagor


Balance of Perils Coverage • Insures you against loss to your “mortgageholder’s interest” resulting

from direct physical loss or damage caused by a peril not required to be insured, to “mortgaged property”, but only to “mortgages” that you own • Example: Earthquake, sink hole, etc.


Miscellaneous Investor Endorsements • Any lender who originates for, sells to or who provides servicing

needs to have their policy amended to include Freddie Mac, Fannie Mac and Ginnie Mac endorsements that do the following: • Name the investor as a loss payee on payment drafts issued on losses

in which the investor incurs in connection with acts covered under the policy

• Permit the investor to file “claim” directly with the insurer for losses the investor incurs in connection with acts covered under the policy

• Provide the investors with notice of cancellation and/or non-renewal


Mortgage Bankers/Brokers Insurance • Similar coverage except that it responds to claims that have to do

with loans owned by others (i.e., investors)

• Recourse is problematic as it is excluded and means any demand in any form, including a claim, based upon, arising out of, directly or indirectly resulting from or in any way involving any actual or alleged:

• Duty or obligation to repurchase a loan, transaction in the nature of a loan or other extension of credit;

• Duty or obligation to provide indemnity with respect to a loan, transaction in the nature of a loan or other extension of credit;

• Damages


Mortgage Bankers/Brokers Insurance (cont’d)

• Asserted by or on behalf of a mortgage owner, or other purchaser, investor or lender against you, whether under any legal or equitable theory, including tort or contract, unless such demand is for damages only and results from a wrongful act in your performance of or failure to perform servicing


Mortgage Fraud Insurance • London has developed a new product designed to address the recourse

exposure which typically involves the following: • Occupancy misrepresentation

• Undisclosed debts

• Appraisal issues

• Income misrepresentation

• Straw borrowers

• False Verification of Deposits

• A core insuring agreement responds to what is known as “Scratch and Dent” Loss

• Defined as any loss suffered by the insured as a result of a contractual obligation to provide indemnity for direct financial loss (but not any assessment, fee, fine, penalty, costs or expenses) arising from a scratch and dent loans sale pursuant to a loan sale/purchase or securitization agreement


Mortgage Fraud Insurance (cont’d)

• Policy limits of up to $100,000 is available

• Loans closed within 90 days prior to policy inception can be covered under the policy

• Further the policy responds to losses that occur within a coverage window, defined as 36 months from the first day of the month in which the loan closed

• The standard retention applicable to Scratch and Dent loss is 10% of the unpaid principal balance, although it can be reduced and/or increased in order to fit your risk retention appetite

• The one requirement is that a “fraud screen” be used


Thank you!

Disclosure Statement

This presentation is not considered complete without the accompanying oral presentation made by Griffin Financial Group (“Griffin”), Pinnacle Risk Services

("Pinnacle) and Stevens & Lee.

The information contained in this presentation and attached exhibits have been obtained from sources that are believed to be reliable. Neither Griffin nor Pinnaclenor Stevens & Lee make any representations or warranties as to the accuracy or completeness of the information herein.

The material set forth in this presentation should not be considered legal advice.

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