What Do the CFPB’s New Mortgage Rules Mean for Investors?

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In January, the Consumer Protection Finance Bureau (CFPB) announced “new rules” to enhance consumer protections for high-cost mortgages. But these rules are not so much new as they are enhancements to the Home Ownership and Equity Protection Act (HOEPA).

This law was enacted in 1994 to address problems in home-equity lending and refinances in the subprime mortgage market. Since then, HOEPA has been an attempt to tamp down high-rate and high-fee lending, but it obviously did not go far enough. After all, the financial crisis of 2008 started in the subprime mortgage business and the contagion spread through the financial system by way of securitizations and credit default swaps.

The new rules are part of the Dodd-Frank provisions that set up the CFPB. The reform measure tightened HOEPA provisions by lowering rates and free thresholds for coverage. Furthermore, there is a new coverage test based on a transaction’s prepayment penalties. The reforms also place limitations on high-risk loan features and new protections for high-cost mortgages.

Moreover, banks and other lenders will be barred from making home loans with “deceptive” teaser rates or require no documentation from borrowers, also known as “Liar Loans.” This means that lenders will need to ensure that borrowers can repay.

Finally, mortgage originators will be restricted from charging excessive upfront points and fees and from making loans with balloon payments. Loans with total debt to income ratios greater than 43 percent of income are also prohibited. The rules are slated to take effect in January 2014.

So what’s the play for investors?

Many non-depositary lenders have already shifted their business lines away from wholesale lending (where mortgage brokers “arrange” for loans between lenders and borrowers) to retail lending – that is, when lenders deal directly with borrowers. So the high cost loans typical in the mortgage broker/subprime game could be a thing of the past.

But the mortgage lenders have another problem lurking on the horizon: an ongoing probe by the Manhattan DA Preet Bharara in conjunction with the Obama Administration’s task force on mortgage fraud. And while the Sheriff of Wall Street has previously been busy with the insider trading probe in the hedge fund sector since 2010, the mortgage lending business may be in for a long year.

In light of this, regional banks may offer a safe haven in the banking sector.

For example, New York Community Bank (NYSE: NYCB) could be worth a look. Despite the fact that this regional bank is close to the $50 billion threshold that defines so-called “systematically important financial institutions” (SIFIs) and the additional regulatory burdens of tighter capital requirements and annual stress tests that come with that designation, NYCB has a conservative portfolio, quality long-term management, and a healthy dividend.

Other regional banks such as United Community Banks (NASDAQ: UCBI) and Valley National Bank (NYSE: VLY) that have less revenue and similar portfolios could also provide investors with relief from the lingering uncertainties in the banking sector at large.

United Community Banks, Inc. is the holding company for United Community Bank. The firm provides retail banking services to individuals and business banking aimed at small to mid-size outfits. Moreover, the bank’s stock price has climbed by more than 25% in the past year.

UCB also has an impressive record of earnings per share, a rise in net income, and strong profit margins. One caveat, however, is that some analysts maintain that UCB’s return on equity has been disappointing.

Valley National Bank provides an array of commercial, retail, trust, and investment services. But its strength lies as a depositary banking unit. Its deposit products include savings accounts, NOW accounts, money market accounts and certificates of deposit. Thus far, shares are up a bit more than 5% this year.

At the end of the day, these regional players offer investors a means to stay in the banking sector while mitigating the risks of the deepening Libor probe and the soon-to-surface fraud investigations in the mortgage lending sector.

And these ongoing scandals will be more than just another black eye for the too big to fail outfits. Civil and criminal cases are likely to be brought and many banking executives will be joining the ranks of the unemployed, if not the convicted. The bottom line: scandals create uncertainty, and uncertainty is always an impediment to good investment decisions.

kcolona has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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