Monday, July 14, 2014

The Strange Case of the Shrinking Mini-Correspondent: A Primer on Forensics

 Jonathan Foxx
President & Managing Director

There is nothing more deceptive than an obvious fact.
The Bascombe Valley Mystery
Sir Arthur Conan Doyle

The predictable sometimes is predicted and sometimes it is not. Our biases tend to lead the way in determining a course of action based on perceived predictability. We find ways to convince ourselves that the obvious is not obvious and the necessary is really not essential. It is said that facts are stubborn things, but they are more like heat-seeking missiles if they bear ill-tidings. So, in finding the means toward a “workaround” or any method of circumventing or overcoming a problem, real or imagined, our hearty species indulges in an endless variety of obfuscations, bafflements, blinding bewilderments, miasmic confusion, discombobulating fogs of frenzy, perplexities of interests and foolish entanglements. All for the sake of avoiding ineluctable facts!

A characteristic feature of a predictable event is that it often becomes inevitable. When that happens, no manner of pleadings or remonstrations will undo the already done! It is not as if we did not know that the predictable could become the inevitable. Our biases simply refused to admit that our present plans will oneday meet their future denouement. And so it is that the strange case of the shrinking mini-correspondent took its course, gradually and inexorably, through the annals of mortgage banking to its current resting place on July 11, 2014, with the bloviatingly long title “Policy Guidance on Supervisory and Enforcement Considerations Relevant to Mortgage Brokers Transitioning to Mini-Correspondent Lenders.” Published by the Consumer Financial Protection Bureau (“CFPB” or “Bureau”), the issuance is on its way to all supervised institutions as a Policy Guidance (“Guidance”) relating to the Bureau’s exercise of its authority to supervise and enforce compliance with RESPA and Regulation X and TILA and Regulation Z in certain transactions involving “mini-correspondent lenders”.[i]

The billowing wave of the mini-correspondent began as a trickle, intensified as lenders established “mini-correspondent channels,” and gushed into a modest torrent, its demand rising in prominence on January 10, 2014. For it was on this date that the proximate cause for the new mini-correspondent channel was given its impetus, due to the Final Rule pertaining to the Ability-to-Repay guidelines and the requirements of the Qualified Mortgage rule (“Rule”). Many brokers usually seek to charge fees between 2% and 3% per loan transaction; however, under the foregoing requirements, any excess above 3% in total points and fees virtually guarantees that such loans, originated by brokers, will not be eligible for treatment as a Qualified Mortgage (QM). A consequence of the Final Rule and specifically the 3% cap was to create an incentive for many brokers to morph into a new kind of loan originator, termed the “Mini-Correspondent.”

In September 2013, in anticipation of the Rule’s compliance effective date coming just months away, my colleague, Michael Barone,[ii] and I published a White Paper and article in which we discussed the challenges facing the mini-correspondent channel. The White Paper was entitled “The Mini-Correspondent Channel: Pros and Cons.”[iii] In the article’s penultimate section, titled "Mini-Correspondents and the CFPB," the following observation was made:

“Before concluding please consider these final points.

Has anyone given consideration as to what the CFPB might take as a position when a tremendous amount of mortgage brokers transform themselves into mini-correspondents with the primary purpose of avoiding QM’s 3% points and fees cap? We surely have, and so have many others. The CFPB has not commented on this issue, but you bet they will at some point down the road. 

It is possible that the CFPB will take no issue with mortgage brokers becoming mini-correspondents! After all, this has been done for years, and when done correctly, it has been a valuable intermediary step for a brokerage firm that wishes to transition from broker to lender. 

But would it shock anyone if the CFPB took issue with the mini-correspondent channel and tried to eliminate it to the extent it is used to avoid the 3% points and fees cap? This would not be difficult. The CFPB could modify the exception to loan originators of the entity that makes the credit decision or take any number of other actions to prevent the mini-correspondent channel from growing solely for the benefit of avoiding the 3% cap. For now, we have to wait and see what their position on mini-correspondents will be.”[iv]

We were not soothsayers or prophets. The facts, such as they were, the experience working with applicable mortgage acts and practices, and the regulatory compliance concerns of our clients, gave us a unique purview.

Are we now finding that the mini-correspondent wave is running its course, shrinking in momentum, and undulating to its demise? Let us explore the requirements and implications of the Guidance.[v] Perhaps we will find a way to solve the mystery at the heart of the mini-correspondent surge and derive some insight about its potential fate.

Eliminate all other factors, and the one which remains must be the truth.
The Sign of Four
Sir Arthur Conan Doyle

Due to the Bureau becoming aware of the transitioning of mortgage brokers from their traditional roles to mini-correspondent lender roles, the CFPB has become concerned that some mortgage brokers may be shifting to the mini-correspondent model in the belief that, by identifying themselves as “mini-correspondent lenders,” they automatically alter the application of important consumer protections that apply to transactions involving mortgage brokers. The specific protections that the Bureau cites include provisions in RESPA and its implementing Regulation X,[vi] and TILA and its implementing Regulation Z.[vii] RESPA and TILA were amended by Title XIV of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act).[viii] On the compliance effective date of January 10, 2014, the Final Rule (issued in January 2013) required that Regulations X and Z apply certain requirements and prohibitions to compensation paid to a mortgage broker. 

An outline of applicable provisions, as they concern mortgage brokers and compensation, consist of the following four factors:

1.     Disclosure of mortgage broker compensation. 
Regulation X requires that the lender’s compensation to the mortgage broker be disclosed on the Good-Faith Estimate and HUD-1 Settlement Statement.[ix] However, payments received by the lender from an investor as compensation for a bona fide transfer of the loan in the secondary market need not be disclosed.[x]

2.     Inclusion of mortgage broker compensation in “points and fees.” 
Under Regulation Z, compensation paid to a mortgage broker by a consumer or creditor is included in points and fees for purposes of the points-and-fees cap for “qualified mortgages” and for the points-and-fees test for determining whether a mortgage is a “high-cost mortgage” under the Home Ownership and Equity Protection Act (HOEPA).[xi]   But, the interest paid to a creditor is excluded in points and fees. Excluded also are any points and fees compensation a creditor receives from a third party that purchases the loan.[xii]

3.     Restrictions on mortgage broker compensation.
TILA and Regulation Z[xiii] prohibit certain compensation arrangements between creditors and loan originators, including mortgage brokers.[xiv]