The Mini-Correspondent Channel: Pros and Cons

Several years ago, our firm, Lenders Compliance Group, provided unique guidance to the mortgage division of a bank.* The bank wished to build a special origination platform for its mortgage brokers. At that time, the prevailing regulations required disclosure of the Yield Spread Premium (YSP), and the bank wanted to give their Third Party Originators (TPOs) an opportunity to close in their own name, with their own funds, and, among other things, by-pass disclosure of the YSP. In building the platform for the bank, many features were needed to implement these relationships in accordance with federal and state law, as well as safety and soundness metrics. This all took place at a time when a 3% fee cap on broker revenue was not even a glimmer in the eyes of legislators or regulators, and Elizabeth Warren[i] had yet to promote the creation of the Consumer Financial Protection Bureau (CFPB).

As Shakespeare wrote in The Tempest, “What’s past is prologue.”

Since the early part of this year, many lenders are building a new origination channel. The proximate cause for the new channel is found in the Final Rule pertaining to the Ability-to-Repay guidelines and the requirements of a Qualified Mortgage (Rule).[ii]

The new channel is meant specifically for brokers who hope to by-pass a 3% cap on loan amounts above $100,000, the new CFPB requirement that substantially and principally affects broker TPOs.[iii] The loans covered by the Rule are first lien and junior lien mortgage loans that are closed-end mortgage loans secured by a dwelling, including home purchase, refinance and home equity loans. (Excluded loans are HELOCs; Timeshares; Reverses; Bridges with a term of 12 months or less and loans to purchase a new dwelling where the consumer plans to sell another dwelling within 12 months; Vacant Lot loans; Loan Modifications not subject to the "refinancing" provisions under TILA; and Business Loans.)[iv]

In particular, many brokers usually seek to charge fees between 2% and 3% per loan transaction; however, as of January 10, 2014,[v] 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). The result of the Final Rule and specifically the 3% cap is to create an incentive for many brokers to morph into a new kind of correspondent, termed the “Mini-Correspondent.” The new origination channel developed by some wholesale lenders is aptly called the “Mini-Correspondent Channel.”

One of us, Jonathan Foxx, has written extensively – both in magazine articles and newsletters – about the Ability-to-Repay guidelines (ATR), the Qualified Mortgage, and the Non-Qualified Mortgage (viz., which he has titled the “NQM”). For additional details and guidance, please read those publications.[vi]

In this article, we are going to explore two interrelated issues. First, we will discuss the 3% cap, its implementation and placement within the QM framework, and the way it affects the originations of the mortgage broker. To do that, we will provide the QM framework into which the 3% cap is situated. Secondly, we will discuss the structure of and certain requirements relating to a mini-correspondent TPO. Bear in mind that this new type of TPO is taking place in a dynamic regulatory environment and loan origination market; therefore, aspects of our observations may change, due to a regulatory response, or other material factors, that pertain to originating loans through this new channel. 

Two Classes of Qualified Mortgages

Essentially, the Rule creates two types of QMs, one of which provides a safe harbor from liability and another which does not provide a safe harbor, but does offer a rebuttable presumption of compliance with the Rule. Obviously, the former is preferred, though the latter is not without its merits.

The safe harbor is only available if the creditor complies with all aspects of the Rule, including, at minimum, all the ATR guidelines, and where the Annual Percentage Rate (APR) on a first lien loan must be within 1.5 percentage points of the “average prime offer rate” (APOR) as of the date the interest rate is set (viz., the APR on a junior lien must be within 3.5 percentage points of the APOR).[vii] If the APR threshold is exceeded, the creditor has a rebuttable presumption of compliance.

The distinction between the safe harbor and rebuttable presumption is very significant. With the safe harbor, a lender obtains a conclusive presumption of compliance and may refute a claim that it violated the Rule, such as not complying with the ATR guidelines. But if the lender obtains only a rebuttable presumption of compliance, a claim can be litigated on the basis of a creditor not making a “reasonable” and “good faith” determination of the borrower’s ability to repay, irrespective of a lender’s complying fully with various aspects of the Rule, such as the ATR guidelines.

The ATR test promulgated by the Rule consists of eight factors. Neither the safe harbor nor the rebuttable presumption is available to a lender solely because a loan is underwritten to the ATR test’s guidelines. The ATR factors require the lender to underwrite and verify (1) current or reasonably expected income or assets, other than the value of the dwelling, (2) current employment status (viz., if the creditor is relying on employment income), (3) monthly payment, (4) monthly payment on any “simultaneous loan” of which the creditor is (or should be) aware, (5) mortgage-related obligations, (6) current debt obligations (including alimony, palimony, and child support), (7) monthly Debt-to-Income (DTI) ratio or residual income, and (8) borrower credit history. It should be noted that the ATR test itself does not place limits on points and fees. 

Qualified Mortgage and the 3% Cap

As mentioned above, a QM with an APR that does not exceed the APOR thresholds receives a safe harbor from liability (i.e., compliance with the ATR guidelines). If the APOR thresholds are exceeded, this means that the loan is a higher-priced QM, and, as such, receives the rebuttable presumption of compliance. In effect, the two classes of QM constitute a prime and non-prime market, with the prime entitled to safe harbor and the non-prime entitled to a rebuttable presumption.[viii]

But there are several challenges that a lender must overcome in order to use the safe harbor defense, one of which is the 3% cap. The Rule excludes from the points and fees 3% cap any compensation paid, per transaction, by a mortgage broker to an employee of the mortgage broker and compensation paid by a creditor to its loan officers. Compensation paid by a creditor to a loan originator other than an employee of the creditor (i.e., paid to a broker by a creditor on a lender paid transaction) is included in the 3% cap along with other upfront charges paid by the consumer to the creditor or its affiliates.[ix] Furthermore, the 3% cap includes certain fees paid to affiliates, mortgage originator compensation paid directly or indirectly by the consumer, and amounts imposed by secondary market investors and passed through to borrowers to compensate for credit risk. When these "points and fees" are factored into the loan origination costs, many loans will exceed the 3% limit.[x] 

FHA: Updates Quality Control Requirements

On January 5, 2011, HUD-FHA issued Mortgagee Letter 2011-02, which clarifies quality control requirements relating to several important areas: (1) due to recent changes to the lender eligibility criteria for participation in FHA programs (i.e., "Helping Families Save Their Homes Act of 2009" (HFSH Act)); (2) "Continuation of FHA Reform: Strengthening Risk Management through Responsible FHA-approved Lenders" (Final Rule FR 5356-F-02); and, (3) Mortgagee Letter 2010-20.

Additionally, this Mortgagee Letter clarifies Quality Control requirements for servicing transfers and loan sales, reporting of fraud and material deficiencies, and the required timeframes for mortgagees to review rejected applications.

Especially if you are a Sponsoring Third Party Originator, we urge you to revise your Quality Plan immediately and implement the requirements contained in Mortgagee Letter 2011-02.

Effective: Immediately

SPONSORING THIRD PARTY ORIGINATORS

Beginning January 1, 2011, FHA will neither approve applications for approval as a loan correspondent, nor monitor lenders acting in such capacity for the purpose of the origination of loans submitted for FHA insurance. All lending entities performing in the capacity of a loan correspondent will thereafter be referred to as Sponsored Third Party Originators.

Consequently, all FHA-approved mortgagees will be responsible for performing quality control reviews of their Sponsored Third Party Originators.

The procedures used to review and monitor Sponsored Third Party Originators must be included in a mortgagee's FHA-approved Quality Control Plan.

Therefore, the Quality Control Plan must be reviewed and, where required, revised with respect to the review of loans originated and sold to the mortgagee by each of its Sponsored Third Party Originators.

• Mortgagees must determine the appropriate sample amount of each Sponsored Third Party Originator's loans to review based on volume, past experience, and other factors specified by the Department in Paragraph 7-6(C) of HUD Handbook 4060.1, REV-2.

• Sponsors must document the methodology used to review Sponsored Third Party Originators, the results of each review, and any corrective actions taken as a result of their review findings.

A report of the Quality Control review and follow-up that includes the review findings and actions taken, and the procedural information (such as the percentage of loans reviewed, basis for selecting loans, and who performed the review), must be retained by the mortgagee for a period of two years.

EARLY PAYMENT DEFAULTS

In addition to the loans selected for routine quality control reviews, mortgagees must review all loans that are originated or underwritten by their company and that are originated by their Sponsored Third Party Originators that go into default within the first six payments (referred to as early payment defaults). (Handbook 4060.1, REV-2 defines early payment defaults as loans that become 60 days past due within the first six payments.)

• Mortgagees must perform reviews of early payment defaults within 45 days from the end of the month the loan is reported as 60 days past due.
  

• The Early Payment Default review report and follow-up, including review findings and any actions taken, along with procedural information (as specified in HUD Handbook 4060.1 Rev.-2, Paragraph 7-6 (E)), must be retained by the mortgagee for a period of two years.

SALES AND TRANSFER OF LOANS

Mortgagees are responsible for determining whether the Mortgage Change Record was reported accurately to HUD via the FHA Connection on servicing transfers or sales of loans. Mortgagees' Quality Control Plans must contain a requirement to ensure the review of all Mortgage Change Records for accuracy, as follows:

For cases involving the transfer of legal rights to service FHA-insured loans:

• The transferee must report the change of legal rights to service to HUD The transferor should verify that the change of legal rights to service has been reported, and that all details contained in the report are accurate.

For cases involving the holder's sale of loans:

• The holder (seller) must report the sale of loans to HUD The buyer must confirm that the sale of loans has been reported, and that all details contained in the report are accurate.

REPORTING OF FRAUD OR MATERIAL DEFICIENCIES

If a mortgagee discovers potential fraud or other serious material deficiencies, it must be immediately reported to the HUD via the Neighborhood Watch Early Warning System (see: Handbook 4060.1 Rev.-2, Paragraph 7-3 (J)).

• Management is expected to review and respond accordingly to each instance of fraud or other serious material deficiency, indicating what steps if any have been taken to cure and/or resolve these violations.

• All corrective actions taken in response to instances of fraud or other serious material deficiencies should be reported to the Department via the Neighborhood Watch Early Warning System.
  

• Mortgagees must monitor all loans they originate, underwrite or service for potential fraud or serious material deficiencies throughout the lifecycle of the loans.

REJECTED APPLICATIONS

Rejected applications must be reviewed within 90 days from the end of the month in which the decision was made.

Visit Library for Issuance

Quality Control Requirements for Direct Endorsement Lenders
Mortgagee Letter 2011-02
January 5, 2011

LENDERS COMPLIANCE GROUP is the first full-service, mortgage risk management firm in the country, specializing exclusively in mortgage compliance and offering a full suite of hands-on and automated services in residential mortgage banking.

FHA: Quality Control for TPOs

By Jonathan Foxx

Jonathan Foxx, former Chief Compliance Officer of two publicly traded financial institutions, is the President and Managing Director of Lenders Compliance Group, the first full-service, mortgage risk management firm in the country.

Today, the Department of Housing and Urban Development (HUD) published a Comment Request, in a Notice entitled Quality Control Requirements for Direct Endorsement Lenders.

Mortgagee Letter 2010-20, issued on June 11, 2010, outlined some of the most important revisions that HUD-FHA has made to its single family loan origination program and contained the long-awaited guidance regarding the implementation of its Final Rule. That Final Rule adopted changes pertaining to the approval of lenders by the Federal Housing Administration (FHA). (Issuance)

In my article, entitled FHA Issues Guidance for Lender Approvals (July 2010, National Mortgage Professional Magazine), I discussed the many changes that would be required pursuant to Mortgagee Letter 2010-20. (Article)

Please visit our Archive for relevant posts.

As of January 1, 2011, mortgagees that were previously approved as Loan Correspondents will only be able to participate as Third Party Originators (TPOs) in FHA-insured mortgage transactions if the conditions outlined in 24 CFR 202.8 are met.

Per 24 CFR 202.8 (3), DE lenders which sponsor TPOs are responsible for the actions of third party originators or mortgagees in originating loans or mortgages, unless applicable law or regulation requires specific knowledge on the part of the party to be held responsible.

Consequently, DE lenders will be responsible for conducting quality control on TPO originations of FHA-insured mortgage loans, and ensuring that their QC plan is expanded to contain this oversight provision.

Comment Period Deadline: February 22, 2011
Contact Information in Federal Register.

Overview

On and after January 1, 2011, Loan Correspondents (i.e., Third-Party Originators, so-called "TPO"s) will only be permitted to continue participation in FHA programs by establishing a sponsorship relationship with an FHA-approved Direct Endorsement mortgagee.

HUD will hold the DE mortgagee responsible for compliance with FHA requirements in all aspects of an FHA loan transaction, whether performed by the DE mortgagee or by its sponsored TPO (unless applicable law or regulation governing the violations in question require specific knowledge on the part of the party to be held responsible).

Quality control is a core feature of HUD's verification and validation procedures. It is a regulatory compliance requirement that must be implemented in accordance with specified guidelines.

It is, therefore, critical that a DE mortgagee set forth and clearly delineate policies, procedures, approval guidelines, quality control requirements, and many other features of FHA and regulatory compliance, with respect to their sponsored TPOs.

All our clients that have TPO relationships now have their policies and procedures in place to support these new FHA relationship requirements.

ACTION: If your organization has TPO relationships, but has not drafted policies and procedures to comply with Mortgagee Letter 2010-20, we urge you to do so immediately.

Highlights

The Notice is soliciting comments from members of the public and affected agencies concerning the proposed collection of information to:

(1) Evaluate whether the proposed collection is necessary for the proper performance of the functions of the agency, including whether the information will have practical utility;

(2) Evaluate the accuracy of the agency's estimate of the burden of the proposed collection of information;

(3) Enhance the quality, utility, and clarity of the information to be collected; and

(4) Minimize the burden of the collection of information on those who are to respond, including the use of appropriate automated collection techniques or other forms of information technology (i.e., permitting electronic submission of responses).

Visit Library for Issuance

FHA: Quality Control Requirements for Direct Endorsement Lenders; Notice of Proposed Information Collection: Comment Request
Federal Register: 75/244
December 21, 2010

LENDERS COMPLIANCE GROUP is the first full-service, mortgage risk management firm in the country, specializing exclusively in mortgage compliance and offering a full suite of hands-on and automated services in residential mortgage banking.