Saturday, August 8, 2015

CFPB's Supervisory Highlights: Where Do Mortgage Lenders Fall Short in Compliance?

Recently the CFPB issued its 2015 Summer Supervisory Highlights to highlight the areas of compliance concerns revealed through its examination of supervised entities.

With respect to mortgage loan origination, the CFPB highlighted following compliance failures it noticed during its supervisory examination of mortgage lenders:

1.  Loan Originator Compensation Rule

In complying with the Truth-in-Lending Act and Regulation Z, mortgage lenders are required to establish and maintain written policies and procedures designed to ensure and monitor employees' compliance with TILA and Reg. Z.  The key component of the Loan Originator Compensation Rule under Reg Z is the prohibition against varying loan originator compensation based on loan terms.  Varying loan originator compensation based on loan terms may cause loan originators to steer consumer to costlier mortgage loans.

The CFPB noted that mortgage lenders written policies and procedures, if any, do not specifically instruct employees on how to comply with such policies and procedures.  In other words, the policies and procedures are defective, incomplete, incomprehensive, or impractical.

In my experience, I have seen lengthy written policies and procedures that either summarize or regurgitate laws or regulations.  Such policies and procedures do not meet lenders' needs because they have little practical value.  If written policies and procedures were purchased "off the shelf" without regard to the the lender's unique size and operational characteristics, they are hardly effective in accomplishing the ultimate goal of establishing and maintaining written policies and procedures -- to ensure and monitor compliance by each and every loan originator and officer of the entity.  Therefore, written policies and procedures must be tailor made, and they must address not only what the law is but also how to spot and avoid a violation.    

2.  Common RESPA Violations

A.  Untimely GFE

RESPA mandates that a lender must provide a good faith estimate of the fees and charges associated with a mortgage loan within three business days after the lender's receipt of a loan application.  Unfortunately, due to technical glitches or inadequate training of loan originators, many lenders fail to comply with this strict timeline consistently.

Lenders should be mindful that the same three-day requirement will apply to mortgage loan applications received by lenders on or after October 3, 2015, and they must deliver a Loan Estimate instead of the GFE in connection with covered loan transactions.

B.  Untimely Revised GFE

With respect to fees subject to the 0% or 10% tolerance, lenders may issue a change of circumstance disclosure and revised GFE within three business days of receiving the information constituting a change of circumstance.  This time restriction is critical to reset the applicable tolerance baseline.  Once the TRID Rule becomes effective, the same time restriction will apply to properly document a legitimate change of circumstance.

C.  Failure to Include All Fees on the GFE

The CFPB also noticed that lenders often fail to include all fees on a GFE.  This failure may cause an inaccurate estimate of fees to be paid by consumers at closing.

Under the TRID Rule, the disclosure of all fees and charges on the Loan Estimate is subject to the good faith standard.  Good faith requires a lender to accurately estimate and disclose loan-related fees and charges based on the best information available to the lender at the time of disclosure.  Good faith may require a lender to exercise due diligence to obtain information in order estimate certain fees and charges, including fees related to optional services, such as home warranty or inspection.

3.  Failure to Provide the Homeownership Counseling Disclosure

Effective since January 10, 2014, lenders are required to provide a list of homeownership counseling agencies within three business days of receiving a loan application for a RESPA-covered mortgage loan.  The disclosure must contain a list of at least 10 counseling agencies located nearest to the borrower's location (current residence zip code).  The list of counseling agencies must be accompanied by the following pieces of information related to each agency: name, phone number, street address, city, state, zip code, website URL, email address, services provided, and languages spoken.

These supervisory highlights offer lenders an opportunity to review  their own policies and procedures, and initial disclosures with respect to the above areas to determine whether they are in compliance with the applicable regulations.

Tuesday, August 4, 2015

Texas Home Equity Loans: How Not to Apply Equity Loan Proceeds?

It's not an exaggeration to state that originating a home equity loan in Texas can be perilous to any mortgage lender or financial institution.  The perils lie in the numerous restrictions, limitations, and requirements provided in the Texas Constitution and the Texas Administrative Code.

One of the restrictions relates to how to apply the proceeds from a Texas home equity loan.

Article 16, Section 50 (a)(6)(Q) of the Texas Constitution requires that a home equity loan is made on the condition that:

(i) the owner of the homestead is not required to apply the proceeds of the extension of credit to repay another debt except debt secured by the homestead or debt to another lender;

In addition, Section 50(a)(6)(g) requires the lender to provide each owner of the collateral property a disclosure at least 12 calendar days before closing a home equity loan.  The disclosure, commonly loan as the "12-Day Notice", must notify the recipient that the lender does
Texas Administrative Code (TAC), Title 7, Part 8, Article 153 was promulgated by the Texas Finance Commission to provide additional regulatory guidance regarding home equity lending in Texas. Section 153.18 provides:
An equity loan must be made on the condition that the owner of the homestead is not required to apply the proceeds of the extension of credit to repay another debt except debt secured by the homestead or debt to another lender.   (1) The lender may not require an owner to repay a debt owed to the lender, unless it is a debt secured by the homestead. The lender may require debt secured by the homestead or debt to another lender or creditor be paid out of the proceeds of an equity loan.  (2) An owner may apply for an equity loan for any purpose. An owner is not precluded from voluntarily using the proceeds of an equity loan to pay on a debt owed to the lender making the equity loan.
In other words, in originating a Texas home equity loan, the lender should not require the borrower to use the loan  proceeds to repay another debt owed to the lender unless the previous debt was secured by a lien against the homestead (e.g., purchase money lien, deed of trust lien, or a home equity lien). However, the lender may require the loan proceeds to be applied toward other debts owed to other creditors (e.g., tax lien, credit card debt, etc.)

According to the TAC, a borrower may voluntarily apply the loan proceeds from a home equity loan toward another debt owed to the same lender.  Lenders should, however, be cautious in doing so because it may have to prove to a court that the use of the loan proceeds was indeed voluntary in the event of a future default.  One can easily anticipate a defaulting borrower arguing otherwise when facing foreclosure. 

Sunday, August 2, 2015

Loan Originator Compensation - What to Avoid?

Prohibited Loan Originator Compensation Practices
-- Illegally Funded Employee Expense Accounts

            The CFPB’s Loan Originator Compensation Rule (“Rule”) prohibits compensation to loan originators based on the term of a loan transaction or terms of multiple transactions, but it permits compensation based on a fixed percentage of loan amount.  A compensation plan based on a fixed percentage (or basis points) of a certain loan amount may also be subject to a fixed floor or ceiling.  To attract talented loan originators or to increase production of existing originators, some mortgage lenders may attempt to introduce additional compensation mechanisms into their compensation scheme.  While some mechanisms designed to incentivize loan originators are legal, others, such as bonuses paid from individual employee expense accounts that are funded through loan-related profits resulting from origination charges or retained interest rebates, are illegal according to the CFPB.  Although the Rule does not expressly prohibit individual employee expense accounts, the CFPB has clearly shown that it believes some compensation or bonus mechanisms tied to individual employee expense accounts violate the Rule, and that they can create significant legal liability for mortgage lenders and their executives. 

1.         The CFPB’s Allegations  

In two recent enforcement actions against Franklin Loan Corporation (“Franklin”) and RPM Mortgage, Inc. (“RPM”), respectively, the CFPB targeted the lenders’ compensation plans, which allegedly contained the following features: (1) upfront commission based on a fixed percentage of the loan amount; and (2) additional compensation paid from individual employee expense accounts.  With respect to the employee expense accounts, the CFPB alleged that both Franklin and RPM: (1) established employee expense accounts for each loan originator; (2) deposited funds into the expense accounts only for closed loan with a profit; (3) the profit per loan is calculated by deducting the expenses from the revenue related to each loan; (4) the expenses related to each loan may include the loan originator’s upfront commission for the loan and/or other operating expenses allocated to the branch level; and (5) the revenue on each loan may include origination fees, net interest rebate, and other income tied to the interest rate.  The CFPB further alleged that Franklin paid quarterly bonuses to its loan originators that had positive balances in their individual employee expense accounts.  Regarding RPM, the CFPB claimed that RPM’s loan originators had open access to their individual expense accounts, and that they could use the funds to: (1) offset tolerance cures or other fee concessions to borrowers on future loans, and (2) provide periodic raises to themselves on future loans.          

2.         Civil Liability

            In the action against Franklin, the CFPB ordered Franklin to pay $730,000.00 in redress to borrowers for its alleged violation of the Rule.  Due to Franklin’s financial condition, the CFPB did not seek civil penalties against it. 

            With respect to RPM, the CFPB ordered RPM and its CEO to pay, jointly and severally, $18 million in civil damages; it also ordered RPM and its CEO to pay $1 million in civil penalties, respectively.
3.         Analysis

In both enforcement actions, the CFPB filed civil lawsuits against the defendants in federal courts in California.  The defendants in both cases chose to enter into a settlement agreement (Stipulated Final Judgment and Order) with the CFPB instead of trying the cases before the judge or a jury.  Therefore, concerned stakeholders in the mortgage industry will probably not know whether the CFPB’s allegations are facts or merely allegations.  While the results accomplished by the CFPB in these actions may demonstrate to the mortgage industry the enforcement power the CFPB wields, these cases lack the clarity and guidance that judicial decisions may otherwise provide.  Nonetheless, unless defendants in future enforcement actions are able to “fight” back, entering into settlement agreements and consent orders with the CFPB in enforcement actions will probably become the norm.   
            Assuming the CFPB’s allegations against Franklin and RPM were true, the “fatal” flaw in Franklin and RPM’s compensation plan was funding the employee expense accounts with revenue tied to the terms of loan transactions.  Terms under the Rule include fees, charges, interest rate, APR, collateral type, etc., related to covered mortgage loans.  By tying the employee expense accounts (e.g. source of additional compensation) to the revenue generated from each loan, Franklin and RPM’s compensation plans, arguably, incentivized loan originators to offer loan terms detrimental to consumers (higher rates and/or fees) in order to maximize the revenue on each loan so as to gain additional deposits into their expense accounts.  To be compliant, any compensation plan should not contain provisions that, directly or indirectly, purposefully or accidentally, link compensation to the terms of loan transactions.

            In zealously enforcing consumer finance protection laws, the CFPB has repeatedly demonstrated its willingness to hold mortgage company executives personally liable for civil penalties and damages.  Under the Consumer Financial Protection Act of 2010, a “related person” may be held jointly liable for a mortgage company’s violations, and the CFPB has actively relied on this legal tool to impose personal liability on executives for alleged violations that occurred on their watch.  Therefore, prudence dictates that mortgage company executives exercise due care and diligence in establishing and practicing a compliant lending culture that permeates all facets of a mortgage lender’s operations.    

4.         Conclusion

Creating a competitive and compliant loan origination compensation plan can be a challenging task.  On the one hand, the compensation plan must contain favorable terms to attract and maintain gifted loan originators in a highly competitive market place.  After all, the financial success of any mortgage lender largely depends on productive loan originators capable of originating high quality loans.  On the other hand, the Franklin and RPM enforcement actions serve as a stark reminder that a compensation plan incentivizing loan originators must comply with the Rule.  To accomplish these twin purposes in any compensation plan, mortgage lenders and their executives should carefully review their compensation plans for compliance with the Rule.  When necessary, they should engage legal counsel to see if their compensation plans contain any prohibited provisions.