Regulation in the mortgage industry, or for any financial product or service provider, is a double-edged sword. Obviously, rules are necessary to protect all parties — consumer, lender, investor, etc. — from predatory practices and just plain bad loan origination. But sometimes regulations, put in place for the best of reasons, overreach and hamstring the industry. And sometimes, what with different political regimes and their corresponding philosophies, it’s not always easy to tell what the “umpires” will consider fair balls from foul.
That’s the theme of a recent conversation between Mortgage Media’s Dave Stevens and Brian S. Levy, Of Counsel to Katten & Temple, LLP, who provides practical and creative regulatory, transactional and dispute resolution guidance to banks, mortgage lenders, and vendors to the industry.
Among the topics at the forefront: Rules regarding loan officer compensation; what the future holds in terms of repurchase claims; and the implications of the PHH case in terms of compliance with the Real Estate Settlement Procedure Act.
LOAN OFFICER COMPENSATION
The Mortgage Bankers Association (MBA), with nearly a dozen industry trade groups, asked the Consumer Financial Protection Bureau (CFPB) to change its Loan Originator Compensation Rule. The Rule was put in place to protect consumers from loan officers steering them to a higher-cost loan or higher interest rate in order to boost their compensation. However, the MBA noted, the Rule goes too far in its stipulations, resulting in various ills: an inability to hold loan officers financially accountable for loan errors; an inability to tailor compensation to different types of loans (some are more expensive to produce than others); and an inability to actually pass savings on to the consumer by originators voluntarily lowering their compensation.
Levy concurred that the LO rule “did really overreach in what it was trying to accomplish.”
“In terms of what they were trying to accomplish with it, (it) was largely a reaction to the subprime products that mortgage lenders were selling,” he said. “And they were able to make larger margins on those, and were offering larger commission rates to their sales staff to do that. And there was this feeling — and it may not have been wrong — that customers were being steered into the subprime products as a result of these commission rates. So, we ended up with the 2011 rule.”
But, Levy noted, the Rule’s stipulations overlap with other regulations, specifically rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act — rules regarding truth in lending disclosures, ability of borrowers to repay and protecting borrowers from excessive fees on Qualified Mortgages. “And so now we have these overlapping rules to accomplish multiple objectives. But the LO comp Rule’s objective seems to have been resolved either by the market or by the other rules. And so it’s now largely unnecessary in my view.”
As an aside, Levy pointed out that “steering” to a higher-comp product isn’t necessarily a bad thing when it’s not predatory or deceptive. “I’ll give you an example: A lot of companies paid higher commission rates for FHA loans. And it would be hard to argue that steering somebody into the government’s primary mortgage lending program for first-time home buyers would be a bad thing. I mean, just because it’s more profitable for the lender to originate that loan doesn’t necessarily mean it’s bad for the consumer.”
Regarding the Rule, Levy said it presents “some real challenges in being able to actually help the consumer,” and noted “it’s frankly a cultural shock to a sales-based industry, to be told that you can’t adjust your price at the point of sale.”
For instance, the loan officer can’t voluntarily lower their own commission to lower the price to the consumer under the Rule, he noted, though a company can elect to make a lower price available to the consumer for competitive purposes. “So what happens is, at some point the company says ‘Look, it’s not profitable at all; we’re going to lose money on this deal because we have to pay the loan officer the full commission’” even if the officer is willing to forgo it, Levy said. “It essentially acts as a price cap, if you will, because no company’s gonna just originate loans at a loss.” (That’s especially noteworthy considering the downward slope of net profitability in the industry, Stevens noted; in some cases, the firm’s just breaking even on the loan.)
Levy and Stevens also decried the inability of a firm to reduce commission as a disincentive to an employee’s defective behaviors, either by mistake or design. And that’s “a real head scratcher” in Levy’s words — in some circumstances that are outside the LO’s control, the compensation can be reduced (he gave the example of a title issue popping up that couldn’t be cleared by closing and requires an extended closing date and corresponding extension fee, which can be taken out of the LO’s compensation), while in areas that are within their control (say, misjudged time to get an appraisal or other foreseeable errors), you can’t touch it. “So, you just kind of go, ‘Well, wait a minute. the time when you want to do it [reduce their compensation] is when they make the error and they should have known better, but not when it was outside their control.’”
Chatter that Stevens and Levy hear from inside the CFPB offer little information on whether any specific action will be taken to change the Rule — Stevens has heard feedback that they view it as “sales competitive issues” and unworthy of a rule change, while Levy has heard about bureau staffers expressing sympathy for firms’ problems with the Rule. “But whether they’ll take specific action,” Levy said, “I don’t really know.”
This conversation, Stevens noted, is in the wake of major class action cases related to servicing issues resulting from the 2000s recession. What, he asked, is the outlook on repurchase demands?
“I’ve done a lot of work in defending repurchased claims; that has taught me quite a bit,” Levy said. “And with my in-house experience and understanding of the loan sale process, it’s got me a little nervous about the next wave. You know, at the end of the day, if we don’t have another real estate decline like we did previously, the losses just won’t be as great. But if we do, we’ll see a lot of these repurchase claims resurface.”
Still, it likely won’t be as bad as it could be, thanks to the GSEs moving forward on such things as representation and warranty relief and the Day One Certainty program, among other factors.
“Those things are terrific and in particular having a three-year sunset on a loan that qualifies, I think will take a lot of the heat off,” Levy said. “They also have a dispute resolution process that they’ve got in place now, which I think will also be beneficial to how these things are resolved in the future. So there’s still some holes in that and there’s some loans which could still come back, even though they’re past the three-year period. But I still think we’re vastly better than we were previously with the GSEs.”
That said he noted, in the private loan market, the contracts today are “much worse than they were before.” And any arguments that a firm could raise in a defense — statute of limitations, knowledge of the purchaser, etc. — “all of those things have been tightened up to the point where, if there’s pretty much anything technically wrong with the loan, that you might be getting it back under that contract. That, to me, is a real scary prospect, because it was never intended to be an industry where there was a zero tolerance for errors. And it sort of echoes the concerns that people have with False Claims Act claims under FHA.”
THE PHH CASE FALLOUT
The industry’s eyes have been trained in the past few years on the roller coaster ride involving PHH Corp., the CFPB and the Real Estate Settlement Procedures Act — a ride that involved a suit by the CFPB against PHH for making referrals in exchange for kickbacks, and changes in the CFPB’s approach to punitive action. The approach to RESPA interpretation was aggressive under former CFPB Director Richard Cordray, who in 2015 increased the fine levied against PHH by more than $100 million (an increase vacated by the U.S. Court of Appeals, a ruling that Cordray fought). The Bureau has been much less aggressive under Mike Mulvaney (a Trump appointee as acting CFPB director before his current job as Management and Budget director and White House chief of staff) and current Director Kathleen Kraninger. After losing the PHH case at the DC Circuit, under Mulvaney, the bureau dropped the case and dismissed administrative proceedings against the company.
Levy’s take: “PHH really is a very important case — not just for RESPA, but for regulatory action in general” — in effect rejecting “CFPB’s interpretation on whether you can provide services, or pay for services, from a referral source, or that’s provided by a referral source. In PHH’s case, it was a captive reinsurance company that they were referring mortgage insurance to. But it also applies to any kind of relationship that you might have with the referral source where you’re paying for services.” The CFPB under Cordray, Levy said, had “essentially tried to outlaw” Marketing Service Agreements but the DC Court of Appeals essentially said no — “nothing can prevent you from paying for services rendered.” In making that decision, he bureau’s policy on MSAs was essentially overturned by the DC Circuit — in an opinion authored by Brett Kavanaugh, now a US Supreme Court justice.
“What needs to be done to establish a compliant MSA,” he said. “…is that, you have to pay no more than the reasonable value for those services. You need to establish in some way what is the reasonable value for those services.” And, of course, “you cannot pay for referrals.”
The second, broader point, Levy noted, is that the whole idea of regulation-by-enforcement that was a hallmark of the Cordray era has been called into question, if not repudiated. He said the bureau’s approach under Cordray was that the industry should, in terms of its practices, be guided by the types of investigations and enforcement actions it saw the bureau taking.
“To issue these kinds of guidance-through-enforcement-action is really misguided, because sometimes the agencies get it wrong,” Levy said. “And it doesn’t have to go through the normal process of notice and comment that’s required for true guidance or regulatory information, or even what’s required for official guidance. Because it’s just a negotiation between a target and the regulatory authority.”
This doesn’t mean a lack of enforcement action as far as UDAAP (Unfair, Deceptive or Abusive Acts of Practice) is concerned is a good idea. It means, though, that if the bureau is seeing things in the marketplace that it sees as unfair, “they should tell us that” rather than make its statement through punitive action. Many in the industry would like more guidance as to just what constitutes an unfair practice under UDAAP. Granted, Levy noted, some unfair practices “stick out pretty well” — for instance, “I don’t think anybody needed to tell Wells Fargo that opening accounts for people that never authorized them was an unfair practice. It was really obvious. And I don’t think you need to tell anyone in advance that that’s something you shouldn’t do.”
The PHH case, however, doesn’t mean a free-for-all, even in a deregulatory environment. “Interpretations change over time,” Levy said, “and there’s also state regulators, and there’s also class action attorneys, that can enforce RESPA. PHH did not mean that it was open season.” There are, of course, still compliance obligations to make sure you don’t pay more than reasonable value for services and that the services are actual, necessary and distinct. But, he said, “The court gets to decide what is the proper interpretation of RESPA at the end of the day. Ultimately RESPA interpretation is a decision for the judiciary, if the judge thinks that the regulator has gotten it wrong.”