HMDA Highlights

HMDA Highlights

Last month I published an article on the changes coming in Regulation C,[1] the implementing regulation of the Home Mortgage Disclosure Act.[2] The article can be viewed here and downloaded here or here.

I would like to highlight a few of the salient features for you.

Essentially, HMDA serves three purposes: (1) it provides public and public officials with information to help determine whether financial institutions are serving the housing needs of the localities in which they are located and to assist public officials in their determination of where to distribute public sector investments to improve the private investment environment; (2) it requires the reporting of racial characteristics, gender, and income information on applicants; and (3) it identifies possible discriminatory lending patterns and enforcing anti-discrimination statutes. 

In 2010, the Dodd-Frank Act amended HMDA to expand the scope of information compiled, maintained and reported. In August 2014, the CFPB proposed amending Regulation C to implement the Dodd-Frank changes.

The CFPB chose not to adopt several data points specified in the Dodd-Frank Act and included a few on its own. Take the following summary listing of the changes made by the CFPB’s October 2015 Regulation C amendments (hereinafter, “Rule”) as a tool to be used along with my article and the CFPB’s own promulgated guides and issuances regarding the HMDA changes.

Institutional Coverage

Although it is not required by the Dodd-Frank Act, the CFPB nevertheless adopted uniform loan-volume thresholds for depository and non-depository institutions, which require an institution to report data if it originated in each of the two preceding calendar years at least 25 closed-end mortgage loans or at least 100 open-end lines of credit, assuming the institution meets the other criteria for coverage.

Institutions that meet only the closed-end threshold are not required to report open-end lending, and institutions that meet only the open-end threshold need not report closed-end lending.

The regulation retains the other coverage criteria for depository institutions, which require reporting by depository institutions that satisfy an asset-size threshold ($44 million in 2015), have a branch or home office in an MSA on the preceding December 31, originated at least one first-lien home purchase loan or refinancing secured by a one- to four-unit dwelling in the previous calendar year, and satisfy a “federally-related” test (i.e., the institution is federally insured or regulated or the loan previously mentioned was insured, guaranteed, or supplemented by a federal agency or intended for sale to FNMA or FHLMC).

For non-depository institutions, the above loan-volume threshold test replaces the current loan-volume or loan-amount test and Regulation C retains the criterion that the institution must have a branch or home office in an MSA on the preceding December 31.

Transactional Coverage

Also not required by the Dodd-Frank Act, the Rule adopts a dwelling-secured standard for reporting all loans or lines of credit for personal, family, or household purposes, whether the purpose of the loan is to finance the property serving as security or another property. Accordingly, the amendments discard the purpose test that previously required the reporting of home improvement loans, whether or not dwelling-secured. Among other things, this makes the reporting of dwelling-secured consumer open-end credit mandatory (no longer optional).

Most commercial-purpose transactions are subject to Regulation C reporting only if they are for the purpose of home purchase, home improvement, or refinancing (i.e., the Rule retains Regulation C’s traditional purpose test only for commercial-purpose transactions). The regulation does not apply to home improvement loans not secured by a dwelling, or agricultural-purpose loans/lines of credit. The regulation now uses the term “covered loans” as a shorthand term to refer to the universe of loans covered by HMDA.

·         The CFPB specifically noted that Regulation C does not require the reporting of loan modifications. There are two exceptions for which HMDA reporting is required because they represent new debt obligations in substance if not in form:[3] (1) assumptions, including successor-in-interest transactions (this differs from CFPB interpretations under TILA Regulation Z); and (2) New York consolidation, extension, and modification agreements (CEMAs) used in place of refinancings (this only refers to CEMAs made under § 255 of the New York Tax Law). The CFPB recognized that its determination that these New York CEMAs must be reported departs from past FRB guidance that they did not need to be reported. The CFPB noted that this Regulation C definition of the term “modification” differs from that of Regulation B, which defines it to include the granting of credit in any form, including the renewal of credit and the continuance of existing credit in some circumstances.

·         The amendments revise the definition of “dwelling.” Briefly put, the definition includes primary residences, second homes, investment properties (homes), multifamily properties, and manufactured home communities (whether or not any individual homes also secure the loan). The term excludes recreational vehicle parks, recreational vehicles, and pre-1976 mobile homes. The regulation retains the existing discretion for financial institutions to determine the primary use for multifamily properties (such as mixed-used properties with five or more individual dwelling units). Properties that provide long-term housing with related services such as a combined medical care component are reportable, while properties that provide medical care are not (consistent with the exclusion of hospitals).

Recess Appointment Gambit

By Jonathan Foxx

President & Managing Director

Some people just won’t take No for an answer!

The most recent fool’s errand is offered thanks to the irrepressible, litigious efforts of the State National Bank of Big Spring, Texas, and two advocacy groups, conservative think tank Competitive Enterprise Institute and the 60 Plus Association.

In State National Bank of Big Spring et al. v. Geithner et al. (U.S. District Court, DC, Case 1:12-cv-01032), the plaintiff seeks to disabuse the Consumer Financial Protection Bureau (“Bureau”) of its constitutionality.

Here is one of the lawsuits that started droning high and mighty soon after the Bureau received its enumerated authorities in the summer of 2011.

The bank sued in June 2012, arguing that the Bureau has an inordinate amount of power because (1) the Bureau’s director can't be removed at will, and (2) the agency's funding is routed around the congressional appropriations process.

A little over a year later, in August 2013, the case was booted, only to be resuscitated in July 2015 by the D.C. Circuit, since the appeals court found the bank has standing to challenge the Bureau’s constitutionality – based on the fact that the Bureau regulated the remittance market, which is the bank’s business. That said, there had been no enforcement action.

Lacking an enforcement action to protest, maybe the bank just wanted to get out in front of the problem before it started!

The bank went forward with a summary judgment challenge in November 2015.

In any event, about the 2012 suit’s allegation: the claim is that the law creating the Bureau, Title X of the Dodd-Frank Wall Street Reform and Consumer Protection Act, is unconstitutional. The bank claimed the president's inability to remove the Bureau’s director without good cause violates the separation of powers doctrine, a claim, the Bureau argues, that ignores Supreme Court precedent.

This gambit has been pushed hither and yon for some time. For instance, right from the start there has been a challenge to the recess appointment of Richard Cordray to be the Bureau's first director. President Barack Obama used a recess appointment to put Mr. Cordray in charge of the Bureau, albeit only after mostly Republican senators refused to vote on his nomination. Their opposition was based on the structure and congressional oversight of the Bureau, not really at all based on Mr. Cordray’s credentials.

But Conservatives have long held that the recess appointment violated the Constitution, engendering the recess appointment itself by keeping the Congress technically open by holding a series of pro forma sessions, gaveling in sessions for minutes or seconds, in order to meet the lowest bar for being open for business.

So, we’re back in court!

Now, the Bureau has asked a Washington, D.C., federal court for summary judgment. Filing last Friday, the Bureau asserts that the bank’s challenge to the Bureau's constitutionality can't get around long-standing precedent supporting legislators' authority to create independent agencies.

Here’s two of the pivotal quotes:

“SNB’s arguments that Title X violates constitutional separation-of-powers principles rest on policy arguments with no support in the constitutional text or judicial precedent.” 

“The challenged provisions of Title X – considered either individually or collectively – are consistent with Articles I and II of the Constitution, as they have been interpreted and applied by the Supreme Court.”

The Bureau argues that the Supreme Court had ruled in 1935, in Humphrey’s Executor v. United States, that Congress has the authority to create independent agencies with overseers appointed by the president who can only be removed for good cause.

Thus, asserts the Bureau, the authority is grounded in the establishment of the Federal Communications Commission, which was at issue in that case, or any of several other federal agencies, including the Securities and Exchange Commission, that are considered to have been created under the same authority.

Given precedent, the Bureau’s view is that, whether or not the Bureau is headed by a single, appointed director or several commissioners (or multiple directors or a phalanx of overseers), is entirely irrelevant and nugatory. In defending the single appointee, the Bureau’s brief states: “If anything, it should be easier for the president to hold accountable a single officer than several.” 

Furthermore, the Bureau stated that the foregoing argument didn't appear in the bank's complaint and that it can't raise the claim now in its own motion for summary judgment filed in early November. Indeed, it is argued that the bank was not harmed by the rules approved by Director Cordray, and, in cases where the bank claims it was harmed, invalidating them would not serve to correct the injuries alleged by the bank.

From a regulatory perspective, the Bureau is correct with respect to the validity of rules approved by the Bureau’s director. Even if the court were to consider the validity of rules approved by Director Cordray during his recess appointment, the D.C. Circuit has upheld such rules when later ratified by an agency.

I think you can see how this Hatfields and McCoys battle can get very complicated.

I expect this species of litigation to find its way into the dustbin of history.

Still, as Alexander Pope said, "Hope springs eternal in the human breast."

Revolving Door Regulators

Senator yesterday. Lobbyist today.

Representative yesterday. CEO today.

Cabinet level appointee yesterday. Bank Chairperson today.

Government Agency Director yesterday. Law firm senior partner today.

CFPB Regulator yesterday. Competitor today.

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IN THIS ARTICLE

The Inside-Outside Gambit

The Four Horsemen

A Business Model for Former Regulators

Partners in Business

Making a Market in Non-QM

Timeline

What did they know, and when did they know it?

Extinguishing the Fire

Library

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The Inside-Outside Gambit

There are many forms of corruption. Perhaps the most pernicious is where an elected or duly appointed representative of the citizenry leaves office to use the sloughed off position for financial gain in the private sector.

Let's set up a definition for such (mostly unregulated) behavior. I will give it a phrase: "inside-outside gambits."

What is an inside-outside gambit? It is the use of information obtained in the course of a former governmental position by an official for financial gain, directly or indirectly, soon or immediately after leaving government employment in that position. Such information includes contacts with decision-makers in the government; providing information about proprietary conversations leading up to the promulgating of laws, rules, and regulations; access to insiders and knowledge of their views; navigating the systemic and organizational structure; non-public facts regarding the governmental plans or condition that could provide a financial advantage. Note that I use the phrase "inside-outside," not "insider trading."

I am not talking about a situation where there is the illegal trading of a public company's stock or other securities (such as bonds or stock options) by individuals with access to non-public information about the subject company (such trading being illegal).

However, the effect of “inside-outside gambit” and “insider trading” is practically the same: these strategies lead to an unfair, usually economic, advantage.

A basic concept of law is that an injury must be sustained by a plaintiff. Broadly speaking, no injury, no case.

So who is harmed when an equity trader uses inside information for personal financial benefit? The public, of course. Certainly, that part of the public that invests in the stock market, relying on rules, regulations, and laws to be impartially applied, with equal access to all. And who is harmed when a former government official uses inside information for personal financial benefit almost immediately after being employed in the government position. Of course, the public. Certainly, that part of the public that relies on rules, regulations, and laws to be impartially applied, with equal access to all.

How about when regulators in the most powerful agency that regulates the origination of residential mortgage loans, the Consumer Financial Protection Bureau (CFPB), leave that agency and start a mortgage company soon after leaving the CFPB, to compete or partner with mortgage companies?

CFPB’s Mortgage Rules for Readiness

The just released 2013 CFPB Dodd-Frank Mortgage Rules Readiness Guide (Guide) from the Consumer Financial Protection Bureau (CFPB) provides, finally, a set of criteria and preparation procedures for residential mortgage lenders and originators. It is Version 1.0 and, like previously issued guides and manuals, the CFPB will update the Guide periodically, using the results from its field examinations to further enhance the audit methodologies.

Note that it is called a “Readiness Guide.” Such documents are not meant to be, and are not, conclusive. Such guides are expected to be sign posts leading the way, a means by which a company may learn of the priorities and exigencies of a regulator’s oversight functions. In other words, as the Guide itself declaims: “The Guide summarizes the mortgage rules finalized by the CFPB in January 2013, but it is not a substitute for the rules.”

To put a finer point on the use of the Guide, please always remember that only the rules and their official interpretations can provide complete and definitive information regarding their requirements.*

These rules can be found at http://www.consumerfinance.gov/regulatory-implementation/.

Each rule in the Guide also includes a hyperlink with additional information, which includes Small Entity Compliance Guides that may make the rule easier to digest. There are links to videos outlining the main elements of the rule. Furthermore, a convenient hyperlink compendium structure is embedded in the Guide, so that the rule headings are themselves hyperlinks directing the reader to the rule-specific CFPB website page.

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IN THIS ARTICLE

Sections of the Guide

Summary of the Rules

Questionnaire

Library

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SECTIONS OF THE GUIDE

The Guide consists of the following sections:

Part I: Summary of the Rules
Part II: Readiness Questionnaire
Part III: Frequently Asked Questions
Part IV: Tools

Part I (Summary of the Rules) contains an outline of the eight final rules issued in January 2013 concerning mortgage markets in the United States pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) Public Law 111-203, 124 Stat. 1376 (2010) (2013 Title XIV Final Rules).

The rules amend several existing regulations, including Regulation Z, X, and B. Throughout the year, CFPB expects to provide updates to the rules where necessary. Updates will be posted, along with summaries of the changes, on the regulatory implementation CFPB webpage.

The questionnaire in Part II (Readiness Questionnaire) is '”not intended” to encompass all details of a comprehensive compliance program. This should not be interpreted to mean that the questionnaire is a replacement for the examination procedures or regulations. It is intended to serve as a guide in preparing for implementation of the mortgage rules and in performing a self-assessment. Thus, the questionnaire should be used as a self-assessment in determining a company’s progress towards compliance with the new mortgage rules. The questionnaire contains twenty-nine self-assessment questions and numerous subsections. Do not confuse the questionnaire with a proxy examination tool: it will not be added to the Examination Manual. The CFPB views the questionnaire as a “voluntary guide” for preparation. I have no doubt that it will be used by management in their discussions with examiners. The extent of those discussions may be determined by the institution’s size, products offered, risk mitigation, risk profiles, and other factors, such as the overall strength of the compliance management system.

Elizabeth Warren's Interview

In July 2011, I published my interview of Elizabeth Warren, entitled Opening a Dialogue: Elizabeth Warren and the Mortgage Industry.*

I have been told that this interview is one of the last published interviews of Mrs. Warren prior to President Barack Obama's announcement of the nomination of former Ohio Attorney General Richard Cordray as the first director of the Consumer Financial Protection Bureau (CFPB) on July 18, 2011. Until that point, Mrs. Warren was acting in the capacity of the interim director of the CFPB.

READ WARREN INTERVIEW

In August 2011, Mrs. Warren began to receive substantial political support from many political organizations and private citizens, and on September 14, 2011 she announced her campaign as a candidate for Senator of Massachusetts.

Mrs. Warren is known to be a fierce consumer advocate and is considered by many to be the primary visionary behind the creation of the Consumer Financial Protection Bureau. The CFPB - these days known more and more colloquially as the "Bureau" -  was established by the Dodd–Frank Wall Street Reform and Consumer Protection Act and signed into law by President Obama in July 2010. For the first year after the bill's signing, Mrs. Warren worked tirelessly as the CFPB's Special Assistant to the President to “stand up” the Bureau.

But Warren's nomination for the Director's position was not put forward by Mr. Obama because of his conclusion that her nomination would be too politically contentious.

Notwithstanding the political environment, the CFPB received its enumerated authorities on July 21, 2011.

Due to the partisan resistance to virtually any nomination for Director - some members of Congress wanted to disempower the CFPB or defund it – Mr. Obama felt constrained to appoint former Ohio Attorney General Richard Cordray to be the Director of the CFPB in January 2012, through a "recess appointment", over the objections of Republican Senators.

Last week Mrs. Warren, the 63-year-old Harvard Law School professor, was elected the first female U. S. Senator of Massachusetts by the considerable lead of 54% to 46% over Scott Brown, who had been elected in 2010 to fill out the late Edward M. Kennedy’s term. Her acceptance speech included her promise that she would be "a fighter for the middle class".

Soon, Mrs. Warren will take her oath as the junior Senator of Massachusetts.

With this in mind, I thought it would be informative to consider Mrs. Warren's responses to the questions I posed in my interview, in the context of what the CFPB has accomplished to date and has pledged to accomplish in the future.

READ WARREN INTERVIEW

I have written extensively about the CFPB. If interested, please feel free to view or download these articles, newsletters, and recent papers.

For selected issuances involving the CFPB, visit our library.

Although it is in its infancy, perhaps we can begin to discern the broad outlines of the CFPB’s commitment to the vision of consumer advocacy set forth by Mrs. Warren.

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IN THIS ARTICLE

Organizations that Accepted Participation

Organizations that Declined Participation

Questions

In Her Own Words

Library

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Organizations that Accepted Participation

READ WARREN INTERVIEW

Nearly all major mortgage industry associations responded to my invitation to provide questions to me to ask Mrs. Warren. Many interview questions, though very important, were also very specific, and it was just not possible for Mrs. Warren to answer such questions of detailed specificity, prior to the CFPB being empowered to evaluate rulemaking and policy alternatives.

Nevertheless, I proffered a wide enough scope of questions that we were able to obtain firm and clear replies.

Organizations that Accepted Participation

Association of Residential Mortgage Compliance Professionals (ARMCP)
Jonathan Foxx, President

Community Mortgage Bankers Project (CMBP) Glen Corso, Managing Director

Impact Mortgage Management Advocacy & Advisory Group (IMMAAG)
Bill Kidwell, President

National Association of Independent Housing Professionals (NAIHP) Marc Savitt, President

National Association of Mortgage Brokers (NAMB)
Don Frommeyer, Them President Elect

National Association of Professional Mortgage Women (NAPMW)
Laurie Abshier, National President

National Association of Realtors (NAR)
Lucien Salvant, Managing Director

National Credit Reporting Association (NCRA) Terry Clemens, Executive Director

National Reverse Mortgage Lenders Association (NRMLA)
Daryl Hicks, Vice President, Communications

Real Estate Services Providers Council (RESPRO)
Sue Johnson, Executive Director

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Organizations that Declined Participation

American Bankers Association (ABA)
Peter Garuccio, Vice President, Public Relations

Mortgage Bankers Association (MBA) John Mechem, Sr. Director - Public Affairs Communications & Marketing

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CFPB's Five Year Strategic Plan

Recently, the Consumer Financial Protection Bureau (CFPB) published for comment on its website its draft Strategic Plan for 2013 - 2018 (Plan).

According to the CFPB, the plan includes the following four goals:

(1) Prevent financial harm to consumers while promoting good practices that benefit them.

(2) Empower consumers to live better financial lives.

(3) Inform the public, policymakers, and the CFPB’s own policymaking with data-driven analysis of consumer finance markets and consumer behavior.

(4) Advance the CFPB’s performance by maximizing resource productivity and enhancing impact. For each goal, the plan identifies outcomes to be achieved and how progress will be measured.

Submit comments to StrategyPlanComments@cfpb.gov before October 25, 2012.

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IN THIS ARTICLE

Goals, Strategies, and Metrics

Goal 1: Prevent Financial Harm to Consumers

Goal 2: Empower Consumers to Live Better Financial Lives

Goal 3: Inform The Public

Chart: Data Sources and Data Outputs

Goal 4: Maximizing Resources and Impact

Library

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Goals, Strategies, and Metrics

The Plan outlines these goals, strategies, and metrics:

- Strategic goals that outline what the CFPB aims to achieve.

- Desired outcomes in support of its goals.

- Strategies that state the actions the CFPB will take to accomplish our outcomes.

- Performance measures that CFPB will track against specific targets in order to assess its progress toward achieving its outcomes.

- Indicators that the CFPB will track and use to assess progress toward achieving our outcomes. (Unlike performance measures, indicators do not reflect targets.)

Goal 1

Prevent Financial Harm to Consumers while Promoting Good Practices

The CFPB stated that, prior to Congress enacting the Consumer Financial Protection Act (CFPA) as Title X of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Public Law 111-203, dated July 21, 2010), consumer financial protection had not been the primary focus of any one Federal agency, and no agency had effective tools to set the rules for and oversee the whole market.

Per the CFPB, the result was a system without sufficiently effective rules or consistent enforcement of the law. The CFPB believes that the consequences can be seen both in the 2008 financial crisis and in its aftermath.

The CFPB increased accountability in government by consolidating consumer financial protection authorities that had existed across seven different federal agencies into one, the Consumer Financial Protection Bureau. In addition to establishing the CFPB's enforcement powers, the CFPA gives the CFPB the authority to supervise and examine many financial institutions that were not previously subject to Federal oversight, such as nonbank mortgage companies, payday lenders, and private education lenders.

With the consolidation of existing and new federal authorities under one roof, the CFPB seeks to be properly focused and equipped to prevent financial harm to consumers while promoting practices that benefit consumers across financial institutions.

Goal 2

Empower Consumers to Live Better Financial Lives

This second goal of the CFPB is "to arm consumers with the knowledge, tools, and capabilities they need in order to make better informed financial decisions by engaging them in the right moments of their financial lives, in moments when the consumer is most receptive to seeking out and acting on assistance."

The CFPB plans to develop and maintain a variety of tools, programs, and initiatives that provide targeted, meaningful, and accessible assistance and information to consumers at the moment they need it.

To reify this goal, the CFPB has predicated two outcomes.

Outcome # 1:

The first outcome will collect, monitor, respond to, and share data associated with consumer complaints and inquiries about consumer financial products or services.

The CFPB has asserted that the consumer response function is central to its mission. The CFPB would provide direct assistance to consumers, in real-time, through its Consumer Response team. (See our October 4, 2012 article on Consumer Complaints and the Consumer Response team.) This team hears directly from consumers about the challenges they face in the marketplace and brings their concerns to the attention of the financial institutions that the CFPB regulates for investigation and resolution.

The Consumer Response team is tasked also to learn from the experiences of already operating complaint centers, for instance, by using the historical data from the FTC's Consumer Sentinel network, which is a collection of consumer complaint data from a variety of contributors, to inform its approach to handling complaints.

Performance metrics are applied by deriving data from complaint volume, the percentage of complaints routed through the dedicated company portal, and the complaint cycle time (i.e., intake cycle time, from receipt to company referral; company cycle time, from referral to company response; consumer cycle time, from company closure response to dispute; investigations cycle time, from investigations queue to closure).

Outcome # 2:

The second outcome helps consumers understand the costs, risks, and tradeoffs of financial decisions; build trusted relationships that are interactive and informative to help consumers take control of their financial choices to meet their own goals; and raise effectiveness of those who provide financial education services to increase financial literacy.

Loan Originator Compensation: Past is Prologue - Part I

In the economic sphere an act, a habit, an institution, a law
produces not only one effect, but a series of effects.
Of these effects, the first alone is immediate;
it appears simultaneously with its cause; it is seen.
The other effects emerge only subsequently; they are not seen;
we are fortunate if we foresee them.
What Is Seen and What Is Not Seen[i]
Frédéric Bastiat

Since April 6, 2011, mortgage loan originators (MLOs) have struggled to comply with the many requirements imposed on them by the MLO compensation provisions of the Truth in Lending Act (TILA),[ii] as amended by Title XIV of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). That date was the compliance effective date.[iii] Prior to that date, however, there were considerable and persistent efforts made to postpone its implementation. I tracked the burgeoning protests and litigation in a series of articles[iv] and newsletters.[v] Associations resisted these TILA revisions on behalf of their membership. The National Association of Mortgage Brokers (NAMB) and the National Association of Independent Housing Professionals (NAIHP) sued the Federal Reserve Board of Governors (FRB). Amicus briefs were filed. Many members of Congress, from both sides of the aisle, also protested aspects of the new MLO compensation requirements. All for naught!*

April 6, 2011 arrived. Resistance was futile!

The FRB had issued final rulemaking and official staff commentary with respect to the loan originator compensation rules and anti-steering provisions, but further guidance came to a virtual full stop on January 26, 2011, when the FRB issued its Compliance Guide for Small Entities on Loan Originator Compensation and Steering.[vi] After that, the FRB offered some conference calls, a webinar – which ostensibly cleared up some confusion, while causing other confusion – and provided occasional updates of the oral, rather than the written, official variety.

In the meantime, the Consumer Financial Protection Bureau (CFPB) received its “enumerated authorities” on July 21, 2011. From that date forward, the CFPB was in charge of promulgating and administering these compensation guidelines.

And on October 6, 2011 - exactly six months to the day when the rule became effective - the first examination guidelines for loan originator compensation were promulgated.[vii] In the State Nondepository Examiner Guidelines for Regulation Z - Loan Originator Compensation Rule, issued by the Multi-State Mortgage Committee (MMC),[viii] we were given a pretty good idea of the direction that federal and state regulators would be taking in their regulatory examinations for loan originator compensation.[ix]

For the most part, my firm’s clients were prepared for implementation of the compensation rule, but we spent hundreds of hours preparing them for it, consisting of many conferences and meetings, which included very comprehensive reviews of employment agreements, compensation plans, disclosures, policies and procedures, and many other details, both logistical and systemic.

Inevitably, I felt mortgage loan originators needed more information than was readily available. So, we consolidated our knowledgebase and offered the FAQs Outline - Loan Originator Compensation, a compendium of questions and answers about the MLO compensation requirements, first published on March 21, 2011 with 142 FAQs and 35 pages. About a year later, after 20 updates, the FAQs Outline was up to 450 FAQs and 147 pages![x]

In this article, the first in a two-part series, I will consider the recent CFPB proposal, issued on August 17, 2012, which contains certain proposed rules governing mortgage loan originations, especially relating to the MLO compensation guidelines in Regulation Z, the implementing regulation of TILA. Comments for this proposal are due by October 16, 2012.[xi]

In the second part of this series, I will explore these proposals in considerable depth, specifically their clarification of and expansion on existing regulations governing MLO compensation and qualifications.

The CFPB does plan to implement new laws, including a restriction on the payment of upfront discount points, origination points, and fees on most mortgage loan transactions. For this reason, I will conclude this article with a brief, generic outline of certain proposals. To some extent, these new proposals exemplify the hurly-burly, roller-coaster ride we’ve been jaunting about on, in the on-going, elusive quest to implement the MLO compensation rule.

Small Business Review Panel

There is only one difference between a bad economist and a good one:
the bad economist confines himself to the visible effect;
the good economist takes into account both the effect that can be seen
and those effects that must be foreseen.
What Is Seen and What Is Not Seen[xii]
Frédéric Bastiat

The CFPB is required to certify that a proposed rule will not have a significant, adverse, economic impact on a substantial number of small entities.[xiii] The Small Business Regulatory Enforcement Fairness Act (SBREFA) provides the basis for a review, inasmuch as, among other things, “small businesses bear a disproportionate share of regulatory costs and burdens.”[xiv] In order to comply with this requirement, the CFPB convened and chaired a Small Business Review Panel to consider the impact of the proposal and obtain feedback from representatives of the small entities that would be subject to the rule. When preparing the proposed rule and an initial regulatory flexibility analysis, the CFPB is expected to consider this panel’s findings.

The panel consisted of representatives from the CFPB, the Chief Counsel for Advocacy of the Small Business Administration (SBA), and the Administrator of the Office of Information and Regulatory Affairs within the Office of Management and Budget (OMB).[xv] On the panel were so-called small entity representatives (SERs), individuals who represent the business entities that would be subject to the CFPB’s proposal.[xvi] On July 11, 2012, the panel issued its report.[xvii]

Here are certain, salient topics that were reviewed by the panel:

• Payment of Discount Points
• Payment of Origination Points and Fees in Creditor-Paid Compensation
• Payment of Origination Points and Fees in Brokerage-Paid Compensation
• MLO Retirement Plans, Profit-Sharing, and Bonuses
• Pricing Concessions and Point Banks
• MLO Qualification and Training Requirements

Let us now consider the panel’s suggestions, concerns, resolutions, and recommendations.

Appraisals and APR for Higher-Risk Mortgages

On August 15, 2012, six federal financial regulatory agencies issued a proposed rule to establish new appraisal requirements for "higher-risk mortgage loans." The proposed rule has been issued by the Board of Governors of the Federal Reserve System, the Consumer Financial Protection Bureau (Bureau), the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the National Credit Union Administration, and the Office of the Comptroller of the Currency.

The proposed rule would implement amendments to the Truth in Lending Act (TILA) enacted by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank). Under the Dodd-Frank, mortgage loans are higher-risk if they are secured by a consumer's home and have interest rates above a certain threshold.

For higher-risk mortgage loans, the proposed rule would require creditors to use a licensed or certified appraiser who prepares a written report based on a physical inspection of the interior of the property. The proposed rule also would require creditors to disclose to applicants information about the purpose of the appraisal and provide consumers with a free copy of any appraisal report.

Creditors would have to obtain an additional appraisal at no cost to the consumer for a home-purchase higher-risk mortgage loan if the seller acquired the property for a lower price during the past six months. This requirement is meant to address fraudulent property flipping by seeking to ensure that the value of the property being used as collateral for the loan legitimately increased.

The aforementioned agencies are seeking comments from the public on all aspects of the proposal. The public will have 60 days, or until October 15, 2012, to review and comment on most of the proposal.

IN THIS ARTICLE

History

"Higher Risk" Mortgage Loans

Appraisal Requirements

Additional Written Appraisal

Calculating the Annual Percentage Rate

Replacing the Annual Percentage Rate

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History

On July 21, 2010, Dodd-Frank was signed into law. Section 1471 of Dodd-Frank establishes a new TILA section 129H, which sets forth appraisal requirements applicable to “higher-risk mortgages.”

Specifically, new TILA section 129H does not permit a creditor to extend credit in the form of a higher-risk mortgage loan to any consumer without first:

• Obtaining a written appraisal performed by a certified or licensed appraiser who conducts a physical property visit of the interior of the property.

• Obtaining an additional appraisal from a different certified or licensed appraiser if the purpose of the higher-risk mortgage loan is to finance the purchase or acquisition of a mortgaged property from a seller within 180 days of the purchase or acquisition of the

• Property by that seller at a price that was lower than the current sale price of the property. (The additional appraisal must include an analysis of the difference in sale prices, changes in market conditions, and any improvements made to the property between the date of the previous sale and the current sale.)

• Providing the applicant, at the time of the initial mortgage application, with a statement that any appraisal prepared for the mortgage is for the sole use of the creditor, and that the applicant may choose to have a separate appraisal conducted at the applicant’s expense.

• Providing the applicant with one copy of each appraisal conducted in accordance with TILA section 129H without charge, at least three (3) days prior to the transaction closing date.

"Higher Risk" Mortgage Loans

The new TILA section 129H(f) defines a “higher-risk mortgage” with reference to the annual percentage rate (APR) for the transaction. A higher-risk mortgage is a “residential mortgage loan” secured by a principal dwelling with an APR that exceeds the average prime offer rate (APOR) for a comparable transaction as of the date the interest rate is set, as follows:

• By 1.5 or more percentage points, for a first lien residential mortgage loan with an original principal obligation amount that does not exceed the amount for the maximum limitation on the original principal obligation of a mortgage in effect for a residence of the applicable size, as of the date of such interest rate set, pursuant to the sixth sentence of section 305(a)(2) of the Federal Home Loan Mortgage Corporation Act (12 U.S.C. 1454).
  

CFPB: Treatment of Privileged Information - Final Rule

The Consumer Financial Protection Bureau (the "CFPB" or "Bureau") issued its Final Rule ("Rule") on July 5, 2012, adopting its Proposed Rule, without modification, regarding the confidential treatment of information by adding a new section providing that the submission by any person of any information to the Bureau in the course of the Bureau's supervisory or regulatory processes does not waive or otherwise affect any privilege such person may claim with respect to such information under Federal or State law as to any other person or entity.*

Also, the CFPB has amended its regulations to provide that its provision of privileged information to another Federal or State agency does not waive any applicable privilege, whether the privilege belongs to the CFPB or any other person.

The Final Rule implements the Proposed Rule, without modification, regarding the confidential treatment of information. The effective date is August 6, 2012.

To put the Final Rule in context, you might want to read my April 2012 review of the CFPB’s Proposed Rule with respect to the treatment of privileged information. Entitled “The CFPB’s Treatment of Confidentiality and Privilege” (April 2012), my article outlined important considerations and also offers an Action Plan.

“CFPB’s Treatment of Confidentiality and Privilege”
 

Newsletter: HERE. (Abbreviated Version - March 2012)

Website Article: HERE. (Full Text - March 2012)

Article Download: HERE. (Publication - April 2012)

_____________________________________________

IN THIS ARTICLE

Proposed Rule

Certain Objections

Certain Clarifications

Summary

_____________________________________________

Proposed Rule

On March 15, 2012, the CFPB published a notice and request for comment regarding its proposal to add a new section to its rules relating to the confidential treatment of information that would provide that any person's submission of information to the CFPB in
the course of the CFPB's supervisory or regulatory processes will not waive any privilege such person may claim with respect to such information as to any other person or entity.

According to the CFPB, the proposed rule was intended to provide protections for the confidentiality of privileged information substantively identical to the statutory provisions that apply to the submission of privileged information to the prudential regulators, and State and foreign bank regulators.

In effect, the notice of proposed rulemaking reiterated the position set forth in CFPB Bulletin 12-01 ("Bulletin") that the submission of privileged information to the CFPB would not, under existing law, result in a waiver of any applicable privilege, and explained that the Bureau was exercising its rulemaking authority to codify this result in order to provide maximum assurances of confidentiality to the entities subject to its supervisory or regulatory authority.

The proposed rule was intended to govern any claim, in Federal or State court, that a person has waived any applicable privilege, including the privilege for attorney work product, by providing such information to the Bureau in the exercise of its supervisory or regulatory processes.

Certain Objections

I will provide a sketch of the objections raised by twenty trade associations (with one letter being submitted on behalf of five trade associations), eight individual financial institutions, and two individuals.

Objection

The Rule will have the effect of chilling attorney-client communications within supervised entities.

Note: According to the CFPB, the Rule encourages and strengthens communications between supervised entities and their attorneys by providing additional protections for the confidentiality of those communications. The Rule itself does not require the submission of privileged information, but instead merely provides protections for privileged information that is submitted to the CFPB, voluntarily or otherwise.

CFPB: Next Up, Reverse Mortgages!

In a June 28, 2012 Report to Congress, the Consumer Financial Protection Bureau (the CFPB or the Bureau) published its study of reverse mortgage transactions. This study was required by Section 1076 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).

The Report surmised that reverse mortgages are not being used as Congress originally intended, because, rather than provide income for borrowers during retirement, reverse mortgages are being provided to consumers at younger ages, thereby increasing the risk that these borrowers will go broke later in life. The study found that almost half of reverse mortgage borrowers in fiscal year 2011 were younger than 70 years of age.

Furthermore, the Report concluded that 70% of reverse mortgage borrowers withdrew all the available funds at once in lump-sum payments, which the CFPB claims can be squandered quickly, leaving borrowers with the potential to face foreclosure due to the reduced ability to pay property taxes. According to the study, nearly 10% of reverse mortgagors (as of February 2012) were at risk of foreclosure.

In its 231 page Report, the CFPB stated the following "emerging concerns":

1. Reverse mortgages are complex products and difficult for consumers to understand.

2. Reverse mortgage borrowers are using the loans in different ways than in the past, which increase risks to consumers.

3. Product features, market dynamics, and industry practices also create risks for consumers.

4. Counseling, while designed to help consumers understand the risks associated with reverse mortgages, needs improvement in order to be able to meet these challenges.

5. Some risks to consumers appear to have been adequately addressed by regulation, but remain a matter for supervision and enforcement, while other risks still require regulatory attention.

The study identified four major topics "where additional research would help determine if additional consumer education or regulatory action is needed."

Those topics are:

(a) Factors influencing consumer decisions;
(b) consumer use of reverse mortgage proceeds;
(c) the longer-term outcomes of reverse mortgages; and
(d) the differences in market dynamics and business practices among the broker, correspondent, and retail channels.

On July 2, 2012, the CFPB began the process of investigating the consumer use of reverse mortgages. This procedure begins with a Notice and Request for Information. In effect, that CFPB now seeks comment and information from the public on the aforementioned topics.

In this review of reverse mortgages, the CFPB will undertake, among other things, to identify any practice as unfair, deceptive, or abusive, and may provide for an integrated disclosure standard and model disclosures. Additionally, it will seek detailed information from the public on the factors that influence reverse mortgage consumers' decision-making, consumers' use of reverse mortgage loan proceeds, longer-term consumer outcomes of a decision to obtain a reverse mortgage, and differences in market dynamics and business practices among the broker, correspondent, and retail channels for reverse mortgages.

In this article, I will outline the scope of information that the CFPB is seeking from the public, including consumers, housing counselors, financial institutions, and others, regarding consumer use of reverse mortgages and consumer experiences during the reverse mortgage shopping process.*

Factors Influencing Consumer Decisions

The CFPB asks the following questions regarding the factors that influence consumer decisions:

1. What factors are most important to consumers in deciding whether to get a reverse mortgage?

2. What factors are most important to consumers in choosing among products? Among other things, comments could address the choice between fixed-rate, lump-sum reverse mortgages and adjustable-rate, line-of-credit or monthly disbursement reverse mortgages.

3. What factors are most important to consumers in choosing among potential lenders?

CFPB: Re-Opening "Ability-to-Repay"

On June 5, 2012, the Consumer Financial Protection Bureau (Bureau) announced that it is "reopening the comment period" for the proposed rule, issued on May 11, 2011 by the Federal Reserve Board (Board), addressing the new ability-to-repay requirements that generally will apply to consumer credit transactions secured by a dwelling and the definition of a "qualified mortgage."

The ability-to-repay requirements were set forth in the May 11, 2011 proposal to amend Regulation Z (the implementing regulation of the Truth in Lending Act (TILA) to implement amendments to TILA made by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).

Since then, pursuant to Dodd-Frank, the Board's rulemaking authority for TILA was transferred to the Bureau as of July 21, 2011. The original comment period to the proposed rule closed on July 22, 2011.

The Bureau is reopening the comment period until July 9, 2012 to seek comment specifically on certain new data and information submitted during or obtained after the close of the original comment period.

I have written extensively about the ability-to-repay. And I would urge you to read some of these articles to become familiar with these important requirements:*

Ability-to-Repay: Regulating or Underwriting? Part I
Ability-to-Repay: Regulating or Underwriting? Part II
Ability-to-Repay: The Basics and a Chart
Ability-to-Repay: The Chart
Ability-to-Repay: Additional Analysis
FRB: Proposes Rule - Ability-to-Repay

__________________________________

IN THIS ARTICLE

History

New Data

Questions and Comments

Litigation and Liability

Foreclosure

Litigants and Complaints

Outcomes from Litigation

Factors or Costs

__________________________________

History

Sections 1411, 1412, and 1414 of the Dodd-Frank created new TILA section 129C, which, among other things, established new ability-to-pay requirements. If a mortgage is a so-called "qualified mortgage," the compliance with the ability-to-repay rule would offer a presumption of compliance.

The word 'presumption' is a dispositive word in this proposal. Please keep the phrase "presumption of compliance" in mind as you read through this brief outline.

On May 11, 2011, the Board published for notice and comment a proposed ability-to-repay rule, amending Regulation Z to implement new TILA section 129C. The comment period for this initial proposal closed on July 22, 2011.

Then, on July 21, 2011 Dodd-Frank transferred the Board's rulemaking authority for TILA, among other consumer financial protection laws, to the Bureau. Accordingly, all comment letters on the proposed rule were also transferred to the Bureau. According to the Bureau, in response to the proposed rule approximately 1800 comment letters were received from numerous commenters, including members of Congress, lenders, consumer groups, trade associations, mortgage and real estate market participants, and individual consumers.

Even after the comment period closed, various interested parties, including industry and consumer group commenters, submitted to the Bureau oral and written ex parte presentations on the proposed rule.

Through various comment letters, ex parte communications, and the Bureau's own collection of data, the Bureau has received additional information and new data pertaining to the proposed rule.

The Bureau is now interested in providing opportunity for additional public comment on these materials. Thus, it is reopening the comment period until July 9, 2012, in order to request comments specifically on certain additional information or new data, but not other aspects of the proposed rule already submitted previously.

So, what are the new data?

New Data

The Bureau now seeks comment on mortgage loan data that the Bureau has received from the Federal Housing Finance Agency (FHFA). To date, the Bureau has received a sample drawn from the FHFA's Historical Loan Performance (HLP) data along with tabulations from the entire file.

The data include a one percent random sample of all mortgage loans in the HLP data from 1997 through 2011. Tabulations of the HLP data by the FHFA show the number of loans and performance of those loans by year and debt-to-income (DTI) range.

The HLP data consists of all mortgage loans purchased or guaranteed by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) (jointly, the GSEs), but does not include loans backing private-label mortgage-backed securities (MBS) bought by the GSEs.

The data contains loan-level information on characteristics and performance of all single-family mortgages purchased or guaranteed by the GSEs. FHFA updates the HLP data quarterly with information from each GSE.

Among other elements, the data includes product type; payment-to-income and debt-to-income (PTI/DTI) ratios at origination; initial loan-to-value (LTV) ratios based on the purchase price or appraised property value and the first-lien balance; and credit scores.

The Bureau proposes to use these data to tabulate volumes and performance of loans with varying characteristics and to perform other statistical analyses that may assist the Bureau in defining loans with characteristics that make it appropriate to presume that the lender complied with the ability-to-pay requirements or assist the Bureau in assessing the benefits and costs to consumers, including access to credit, and covered persons of, as well as the market share covered by, alternative definitions of a "qualified mortgage."

CFPB: Treatment of Privileged Information

On March 12, 2012, the Bureau of Consumer Financial Protection (CFPB) announced proposed amendments to the confidential treatment of information obtained from persons in connection with its exercise of authorities under federal consumer financial law.

The proposed amendments will add a new section to the rules which provide that the submission by any person of any information to the Bureau in the course of the Bureau's supervisory or regulatory processes will not waive or otherwise affect any privilege such person may claim with respect to such information under federal or state law as to any other person or entity.

Additionally, the CFPB is proposing to adopt a provision which provides that privileged information given by the CFPB to another federal or state agency does not waive any applicable privilege, whether the privilege belongs to the CFPB or any other person.

The Dodd-Frank Act (Dodd-Frank) did not explicitly address whether the submission of privileged information to the CFPB in the course of the its supervisory or regulatory processes will affect any privilege a supervised entity may claim with respect to such information, even though Congress did provide that "all the powers and duties" of the prudential regulators relating to their transferred consumer financial protection functions would be granted to the CFPB, and this grant of authority encompasses the ability to receive privileged information from supervised entities without effecting a waiver.

In this article, I will offer a brief understanding of this complex issue and provide an Action Plan.*

IN THIS ARTICLE

History
Bulletin 12-01
Proposed Rule
Confidentiality
Considerations
Action Plan

____________________________________________________

History

The CFPB first announced in October 2010 that it would be gathering information from banks and nonbanks in its efforts to examine and supervise financial service products.

Many financial institutions at the time expressed considerable concern that divulging privileged documents to the CFPB would be deemed a waiver by the courts, thereby permitting competitors and consumer groups to access the privileged documents.

The CFPB's first official release in 2012, Bulletin 12-01, addressed the treatment and scope of confidentiality protections accorded information collected from supervised institutions through the CFPB's supervisory process.

Then, as indicated above, on March 12, 2012, the CFPB proposed the new rule, the purpose of which, among other things, is to codify protections for privileged information submitted by financial institutions that are regulated by the CFPB.

Bulletin 12-01

The CFPB asserts that "Congress intended the Bureau's examination authority to be equivalent to that of the prudential regulators," with respect to the statutory provision that grants prudential regulators the authority to receive privileged information from their supervised entities without there being a waiver of privilege.

The CFPB reached this conclusion by claiming that in inheriting the prudential regulators' examination authority with respect to compliance with federal consumer financial laws for supervised institutions, it was concomitantly granted "all powers and duties" vested in the prudential regulators related to examination authority.

And one of the powers is the ability and authority to receive privileged information without affecting a waiver. However, it should be noted here that the statutes cited by the CFPB in support of its claim applies to federal banking agencies, not the CFPB. Thus, it seems that the CFPB is not entirely in a position to use, mutatis mutandis, the same statutory privilege protection provided for in Dodd-Frank.

Bulletin 12-01 (Bulletin) addressed two specific parts of the CFPB's policy on confidential information.

1) It states that institutions providing privileged information to the CFPB pursuant to a supervisory request will not waive any privilege that attaches to such information.

2) It indicates that the CFPB will treat information obtained through the supervisory process as confidential and privileged, and, importantly, it provides that the CFPB will only disclose such information to prudential and state regulators, when necessary and/or appropriate, and to law enforcement agencies, only where justified, as determined by the CFPB.

The Bulletin seeks to resolve an intrinsic issue regarding the CFPB's lack of a statutory examination privilege such as that provided to the federal banking agencies. Although the Bulletin provides possible legal support for why similar privilege applies to supervisory information provided to the CFPB, the outline itself does recognize the absence of the same statutory protection that the federal banking agencies had been compelled to pursue in the Financial Services Regulatory Relief Act of 2006 ("FSRRA"), specifically Section 607.

Riding the Horse Backwards

At a DC conference, dauntingly titled Mortgage Regulatory Forum, Barney Frank, the Congressman from Massachusetts whose name eponymously joins Dodd in the landmark Dodd-Frank Act, spoke about a "revolt" against the risk retention regulations embodied in the Qualified Residential Mortgage rules required by that Act.

We've heard about this risk retention requirement by its euphemistic cognate, rather barbarically described as to "keep skin in the game." I will be publishing a comprehensive article soon about the Act's provision regarding this "skin in the game" mandate. And I will see that you get a copy of the article. For the time being, though, maybe we should reflect a bit on Congressman Frank's worries.

But first, before speculating on Frank's musings about a revolution, let's begin with a story.

Snideley Whiplash and Dudley Do-Right

You might remember the cartoon character Dudley Do-Right of the "Dudley Do-Right of the Mounties" series, a part of the Rocky and Bullwinkle show. Dudley was forever saving Nell Fenwick, Mountie Inspector Fenwick's beautiful daughter, from the machinations of the evil Snideley Whiplash and Tuque, his equally nefarious sidekick. Whereas Dudley is garbed in the bold red uniform with shiny gold buttons of the Royal Canadian Mounted Police, Snidely wears black on black: suit, cape, stove pipe hat, boots - even a black, twisted, handlebar moustache.

Snidely was bent on doing naughty things to the hapless Nell, like tying her to a railroad track. And Snideley's arrogance was only exceeded by his sheer joy when conniving some evil exploit to be perpetrated on the innocent.

But Dudley would save Nell, usually just by dumb luck, free her from the railroad tracks, and boldly stand before her in a puffed-up, prideful "my hero" pose. And then Nell would thrillingly come running into Dudley's open arms, thanking him profusely for saving her!

Actually, no. Nell never did run into Dudley's arms. That just never happened. Not even once!

In fact, Nell would show her gratitude not to Dudley but to Dudley's horse, aptly named Horse, also dressed up like a Mountie. Dudley often rode Horse backwards, galloping boldly to the scenes of Snideley's pernicious schemes.

Even when Dudley had freed Nell from the chains holding her to the railroad tracks, she would hardly notice him. Instead, she gently stroked Horse's snout and elicited his big, charming, toothy smile. For the most part, Nell ignored Dudley, even when he saved her from Snideley's perilous plans.

Poor Dudley Do-Right! He really never did get the grateful recognition he thought he deserved. He never did win Nell's hand in romance. And yet Dudley never gave up on seeing himself as the bold hero responding with courageous alacrity to Nell's call of distress!

"Skin in the Game"

In a proposed rule issued by federal financial regulators, and pursuant to Dodd-Frank, there will soon be a requirement for sponsors of certain asset-backed securities to retain at least 5% of the credit risk of the assets underlying the securities. For "asset-backed securities" read mortgage securitizations. This is being referred to as "risk retention," or that "skin in the game" phrase I mentioned above.

According to those in favor of risk retention, the purpose of this rule is to coalesce underwriting guidelines into an incentivized alignment with securitizers and investors, through promoting a certain set of underwriting standards. The risk retention provision would exempt asset-backed securities that are collateralized exclusively by residential mortgages that are eligible as "qualified residential mortgages," now known, of course, as QRMs.

Many regulators have signed on to the QRM and risk retention provisions, since their view essentially is that "credit risk retention," the name given to the QRM concept, should be required because they believe it encourages prudent underwriting and securitization.

However, consider this: it is simply not known if 5% is even the appropriate amount of risk to be retained in order to align incentives! Indeed, there is scant statistical support for any such percentage whatsoever.

From a Distance

From a high altitude of consideration, the composite criteria of a QRM are the "plain vanilla" variety perfectly familiar to residential mortgage loan originators: 80% LTV; 20% down payment plus closing costs; 28% front-end ratio, and 36% back-end ratio.

Underwriting to the QRM guidelines means that securities backed by QRMs will not require securitizers to retain credit risk. Of course, there's far more to what constitutes a QRM and how it is structured. 

Recently, I spoke with a supervising prudential regulator, an old friend, and asked if QRM will crowd out the development of other products that could serve the consumer. His view was that the QRM criteria allow for innovation and, in any event, if they adversely affect a consumer's access to credit, then QRM standards may need to be changed. I must admit, I do not find that response very satisfying.

Markets are active, not passive. Much too often, though, regulatory requirements tend to be reactive, rather than responsive, mostly due to politicians catering to their constituencies and lobbyists. Since when did politicians and regulators so fully replace market action or override underwriting models that lenders undertake as part of making a market, pricing in risk, and developing loan products that respond to consumer needs?

"Revolt"

Congressman Frank seems to have concluded that the recent economic meltdown was largely caused by the housing bubble - presumably, that would be the housing bubble that he declared would never take place. So, "credit risk retention" is now being advanced as a policy that can help to avoid another housing bubble.

Here's the prevailing narrative: in 2008 and 2009, we went into the Great Recession, and now we're experiencing high unemployment and weak growth. Was the housing bubble the ultimate cause?

Most people seem to think so. They believe that the housing bubble burst in 2006 and led to a severe financial crisis in 2008, intensifying a recession that had begun in December 2007. And the Fed did what it could, through targeting inflation to prevent the crash, but could not stem the tide.

Here's another narrative, one actually supported by facts: the housing crash did not lead directly to a recession or high unemployment, although it seems to have been a proximate cause.

More than two-thirds of the decline in housing construction happened between January 2006 and April 2008. During that period, though, the unemployment rate rose only slightly, from 4.7% to just 4.9%. And statistics demonstrate that most of the workers who lost jobs in housing construction were subsequently reemployed in other fields. It wasn't until October 2009 that unemployment soared to 10.1%, with job losses spread out across almost all sectors of the economy.

Indeed, the financial crisis did have its roots in the housing bubble, and there were consequent systemic failures of financial institutions, yet for some odd reason this situation did not set off alarm bells at the Fed until much too late.

There is a world of difference between a proximate cause and the ultimate cause.

Bottom Line: monetary policy failed to predict the problem and the Fed did not respond soon enough.

Fallacy of the "Blame Game"

The assumptions of the first narrative have dominated politics and have led to the QRM remedy.

Thus it is that we have this statement from Mr. Frank:

"I am disappointed at this revolt against risk retention that was so clearly at the center of this."

"All the other problems we had ... they all centered on the system for selling to other people loans that shouldn't have been made in the first place."

"It's simply not possible with any conceivable number of regulators to monitor every loan. If the people making the loans do not have an incentive not to lend to people who can't repay, there is no way we will prevent those kinds of loans from being made." (My emphasis.)

That sweeping statement is certainly not supported by the facts. I have discussed this fallacy of the "blame game" in detail elsewhere, for instance in my three-part series on the Dodd-Frank legislation.

Yet the "revolt" is not just coming from lenders. Consumer advocacy groups want to ensure homeownership for qualified borrowers among low and middle income families, without having to be turned away due to a market that has been deincentivized from lending to them.

Nell and the Horse

Maybe there was a really good reason why Nell preferred to show her gratitude to the Horse, rather than to drape herself around Dudley Do-Right's neck in gleeful appreciation and unbounded thanks.

I wonder if you could suggest what Nell's reason might have been.

What do you think?

Please feel free to comment!

Jonathan Foxx is the President and Managing Director of Lenders Compliance Group.

Ability-to-Repay: The Basics and a Chart

Commentary By: Jonathan Foxx
President and Managing Director of Lenders Compliance Group

On May 11, 2011, the Federal Reserve Board (FRB) issued a proposed rule (Rule) to implement ability-to-repay requirements for closed-end residential loans.[i] The Rule implements Section 1411, Section 1412, and part of Section 1414 of the Dodd-Frank Wall Street Reform and Consumer Financial Protection Act of 2010 (Dodd-Frank).[ii] Comments on the Rule are to be received by no later than July 22, 2011.[iii] Having published the proposed Rule, the FRB retired from its involvement in this matter and handed over its rulemaking authority in the subject statute to the Consumer Financial Protection Bureau (CFPB) on July 21, 2011.[iv]

As a revision to Regulation Z (the implementing regulation of the Truth in Lending Act), the Rule requires creditors to determine a consumer’s ability to repay a mortgage before making the loan and would also establish minimum mortgage underwriting standards. The Rule applies to any consumer credit transaction secured by a dwelling, except an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan or ‘‘bridge’’ loan with a term of 12 months or less. [v] It appears that the Rule applies to purchase money and refinances, but not modifications of existing mortgages. There is a prohibition on prepayment penalties unless the mortgage is a prime, fixed rate, qualified mortgage - and unless the amount of the prepayment penalty is limited.

The Rule sets forth limits on prepayment penalties, the lengthening of the time creditors must retain records evidencing compliance with the ability-to-repay and prepayment penalty provisions, a prohibition to evading the Rule by structuring a closed-end extension of credit as an open-end plan, the delineation of new terms, procedures, and their resulting implications, and, very importantly, the means by which the Rule claims to offer tools to prevent likely default and mitigate risk for creditors and others who arrange, negotiate, or obtain an extension of mortgage credit for a consumer in return for compensation or other monetary gain.

Complying with the requirements of the ability-to-repay Rule is essential, because borrowers in a foreclosure proceeding will likely claim that the creditor failed to comply with the Rule as a defense by way of recoupment or set off, without regard to the normal statute of limitations under the Truth-in-Lending Act (TILA).[vi] A violation of the Rule subjects the creditor to the TILA civil monetary penalties, plus the same enhanced civil remedies that apply to violations of TILA’s high-cost loan rules,[vii] and TILA also would authorize state attorneys general to bring actions for violations of the Rule for a period of up to three years.[viii]

A loan that is a covered transaction must qualify, among other things, as a “qualified mortgage” if the creditor wishes to include a prepayment penalty in the loan.

The Rule provides a presumption of compliance with the ability-to-repay requirements if the mortgage loan is a ‘‘qualified mortgage,’’ which does not contain certain risky features and limits points and fees on the loan. Furthermore, one feature of a higher-risk mortgage loan (i.e., subject to enhanced appraisal requirements under Dodd-Frank § 1471) is the loan may not be a qualified mortgage.[ix]

There are four (4) options to the determination of compliance with the Rule. The Rule refers to these origination options as “methods” and equips each method with a description of (1) limits on the loan features or term, (2) limits on points and fees, (3) underwriting requirements, and (4) payment calculations.

Option # 1: General Ability-to-Repay Standard

A creditor can meet the general ability-to-repay standard or test by:

• Considering and verifying the following eight (8) underwriting factors:

1. Income or assets relied upon in making the ability-to-repay determination;

2. Current employment status;

3. The monthly payment on the mortgage;

4. The monthly payment on any simultaneous mortgage;

5. The monthly payment for mortgage-related obligations;

6. Current debt obligations;

7. The monthly debt-to-income ratio, or residual income; and

8. Credit history.

• Underwriting the payment for an adjustable-rate mortgage based on the fully indexed rate.

Comment: This is an option that will be carefully reviewed by plaintiff’s counsel in an action to challenge a creditor’s compliance with the Rule. Consequently, enforcing compliance with the Rule will require fully vetted, tested, and continually updated, written procedures to govern every aspect of the application and underwriting process. Without clear and unambiguous policies and internal enforcement of appropriate policies and procedures, the creditor is allowing exposure to such a challenge. This option contains rigorous underwriting criteria and requires unmitigated, fact-based evaluations. Option # 1- the ability-to-repay test - is somewhat unstable (due to the invariant rigors of procedural compliance) though a relatively favorable methodology for the creditor, even if the loan flow process leaves very little room for error.

Option # 2: Qualified Mortgage (QM)

A creditor can originate a “qualified mortgage,” which provides special protection from liability. Two alternative definitions of a “qualified mortgage” are being considered by the CFPB:

Alternative # 1: Provides a legal safe harbor and defines a “qualified mortgage” as a mortgage for which:

· The loan does not contain negative amortization, interest-only payments, or a balloon payment, or a loan term exceeding 30 years;

· The total points and fees do not exceed three (3%) percent of the total loan amount;

· The income or assets relied upon in making the ability-to-repay determination are considered and verified;[x] and,

· The underwriting of the mortgage (a) is based on the maximum interest rate that may apply in the first five years, (b) uses a payment scheduled that fully amortizes the loan over the loan term, and (c) takes into account any mortgage-related obligations.

Alternative # 2: Provides a rebuttable presumption of compliance and would define a “qualified mortgage” as including the criteria listed under Alternative # 1 (above) as well as additional underwriting requirements from the general ability-to-repay standard (see Option # 1). In any event, under Alternative # 2, the creditor would also have to consider and verify:

· The consumer’s employment status;

· The monthly payment for any simultaneous mortgage;

· The consumer’s current debt obligations;

· The monthly debt-to-income ratio or residual income; and

· The consumer’s credit history.

Comment: Two alternatives are given: in Alternative # 1, to obtain a legal safe harbor, the creditor must consider and verify the borrower’s current or reasonably expected income or assets to determine the borrower’s repayment ability; and, in Alternative # 2, to obtain a rebuttable presumption of compliance, the creditor must consider and verify the borrower’s current or reasonably expected income or assets (i.e., other than the value of the dwelling in question), the borrower’s current employment status (assuming the creditor relies on employment income), the borrower’s monthly payment on any simultaneous loan, the borrower’s current debt obligations, the borrower’s monthly DTI or residual income, and the borrower’s credit history. It should be noted that the second alternative is for the most part similar to the ability-to-repay test.