Mortgage Banking Update - November 15, 2012

Ballard Spahr LLP

CFPB Releases First "Supervisory Highlights" Report

The CFPB's release last week of its first "Supervisory Highlights" report reinforces previously voiced concerns that, instead of establishing industrywide standards through the rulemaking process, the CFPB plans to use its supervisory and enforcement authority to impose such standards.

The report discusses "the most critical" issues and problems detected by CFPB examiners during examinations conducted between July 2011 and September 30, 2012. According to the CFPB, the document is intended to "signal to all institutions the kinds of activities that should be carefully scrutinized for compliance with the law" and "will help providers of financial products and services better understand the CFPB's supervisory expectations so that they can take action to comply with Federal consumer financial laws." The CFPB states that it expects to periodically publish additional "Supervisory Highlights" and that "[t]hrough these supervisory reports, CFPB will provide financial institutions with clear guidance about the standards of conduct expected of them."

In discussing problems and issues it found at "financial institutions," the CFPB did not distinguish between banks and nonbanks over which it has supervisory authority, such as payday and private student loan lenders. The issues and problems described in the report include the following:

  • Comprehensive deficiencies in compliance management systems, such as failures to adopt and/or follow compliance policies and procedures. The CFPB notes that, in compliance exams, it "evaluates both the understanding and application of the financial institutions' compliance management programs by its managers and employees."
  • Failures to establish a comprehensive service provider management program or to effectively manage service providers to ensure compliance with federal consumer financial laws.
  • A lack of any formal fair lending compliance system or the implementation of systems that do not provide compliance oversight for all major lending products. The CFPB notes that in some cases where fair lending violations have been found, "financial institutions have been directed to expand their internal fair lending regression analysis, monitor compliance through special reports and certifications, or take other steps to address the potential existence of discrimination against applicants on a prohibited basis and to verify full compliance with ECOA."
  • In addition to the violations by the three card issuers that were the subject of the CFPB's public enforcement action, CARD Act violations by other issuers have resulted in non-public supervisory action by the CFPB. Those violations consisted of increases in credit limits on accounts issued to consumers under the age of 21, based on the ability to pay of a co-applicant age 21 or older without the co-applicant's written authorization, and failures to perform a rate review of an acquired portfolio within six months or to establish written policies for rate reevaluations.
  • FCRA violations consisting of failures to (1) communicate appropriate and accurate information to consumer reporting agencies, (2) indicate when a consumer had disputed account information, and (3) delete information upon completion of dispute investigations.
  • Significant TILA and RESPA violations by residential mortgage lenders, such as inadequate or improper completion of the Good Faith Estimate and HUD-1 Settlement Statement, and inaccurate TILA disclosures. The CFPB also identifies HMDA compliance as an area of concern, noting that its examiners found several financial institutions had significant error rates in their HMDA data.

The report is yet another example of the CFPB's continued focus on fair lending. In the Bureau's appeals procedure Bulletin that was released concurrently with the "Supervisory Highlights" report, fair lending was the only substantive area mentioned. Similarly, in the report, fair lending compliance programs were the only specific compliance programs mentioned by the CFPB in its discussion of the deficiencies it found in compliance management systems.

- Alan S. Kaplinsky

CFPB Issues Bulletin on Appeals Procedure

The Consumer Financial Protection Bureau released a Bulletin on October 31 outlining a procedure for supervised entities to appeal certain conclusions and findings made during the examination process. The appeal procedure is somewhat unclear, since the Bulletin is not specific about the personnel who will decide the appeal or the standard of review that they will use. Indeed, with regard to personnel, the Bulletin discusses various permutations of persons in various areas of the CFPB, suggesting that the lineup of decision-makers will be different for appeals of different types of issues. 

There are a couple of other notable points about the Bulletin. First, in the context of a petition to set aside or modify a civil investigative demand, the Director of the CFPB ultimately decides those petitions, while a lower-level official decides supervisory appeals as set forth in the Bulletin.

It seems anomalous that the scope of a discovery request would warrant review by the Director, but an examination finding that might require far-reaching changes in an entity's operations is handled at a lower level within the organization. Also, a petition to modify or set aside a CID will be made public unless good cause is shown (and two of them have already been made public), while the supervisory appeal process will be confidential, according to the Bulletin. 

The other notable aspect of the supervisory appeal process is its special emphasis on fair lending issues. Fair lending is mentioned three times in the Bulletin, while no other substantive area is mentioned. The Bulletin goes out of its way to state that a supervisory appeal will not delay or affect the CFPB's decision to bring an enforcement action or refer a case to the Department of Justice, and then later makes specific reference to the involvement of persons from the Bureau's Office of Fair Lending and Equal Opportunity.

Does all of this suggest that the CFPB is anticipating appeals from fair lending-related supervisory actions?  That is the message that these references seem to convey, and of course that message would be consistent with the separate tracking of fair lending supervisory actions in the Bureau's Five-Year Plan. Although we will have to wait and see what develops with regard to fair lending in the supervision context, one thing is certain: the constant emphasis on fair lending by the CFPB continues.

- Christopher J. Willis

Bank Regulators "Postpone" Effective Date of Basel III Capital Regime

Controversial risk-based capital rules proposed for financial institutions and their holding companies are unlikely to go into effect by their original target date of January 1, 2013. The rulemaking proceeding, inaugurated by the Office of the Comptroller of the Currency, the Federal Reserve Board, and the FDIC back in June 2012, was intended to implement the Basel III risk-based capital regime, as modified by the agencies to comply with the requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

These proposed rules received significant criticism and a large volume of comment letters. More than 150 comments were submitted. No less than 33 of the letters came from Capitol Hill. Some of these were from individual senators or congressmen; others were submitted by several senators or congressmen writing as a group.

The volume and disparity of views expressed in the comment letters, along with significant public criticism, have caused the agencies to reconsider the original implementation target date because they apparently concur with concerns, expressed by some commenters, that depository institutions and their holding companies might become subject to these complex capital rules without having had adequate time to digest them and make operational changes necessary for compliance. In a joint press release dated November 9, the agencies stated that they "do not expect" that any of the proposed rules would become effective on January 1.

The phrase in quotes is an interesting circumlocution. Notice that the release avoids the word "postpone" altogether. The phrase chosen, which probably entailed a fair amount of discussion and wordsmithing among the regulators, certainly leaves open the possibility that the capital rules, or some of them, might go into effect on January 1 after all.

Among the proposed capital rules are provisions designed to deter financial institutions from having risky mortgages in their portfolios. Such provisions could, however, create serious disincentives to any mortgage lending, especially at smaller banks. The increased emphasis on larger percentages of higher-quality (essentially common equity) Tier 1 capital and on holding back more capital for the nontraditional—but still largely performing—residential mortgage loans could easily cause smaller community banks to cut back on their originations.

The Basel III approach is predicated upon a more complex system of risk-weighting assets than that which prevailed under Basel I and Basel II. For banks with total assets of less than $250 million, federal regulators provided a so-called standardized approach. Under that approach, banks will have to hold back between 35 percent and 200 percent of any mortgage that is not guaranteed by the U.S. government, based on a variety of factors including the loan-to-value ratio. Under the prior regime, by contrast, the risk-weighting for one to four family residential mortgages was an invariant 50 percent.

To benefit from a lower risk-weighting (and thereby hold less capital), banks have to shoulder additional, non-Basel-related regulatory burdens, such as compliance with the Bureau of Consumer Financial Protection's qualified mortgage rule, under which a lender must ascertain the borrower's ability to repay the loan. Nevertheless, bank examiners have the discretion to determine that even loans that meet the criteria for lower capital retention are riskier than they should be if they do not conform with the soundest lending practices.

Many have criticized the proposed Basel III risk-based capital rules for being applied to smaller institutions when Basel III was targeted at large, globally significant financial institutions. Unlike those megabanks, their smaller brethren have more difficulty raising equity capital. That could presage a significant cutback in residential mortgage lending if they feel the regulatory costs become too expensive.

While the November 9 press release mentions no alternative target date, the agencies have indicated that they take seriously the internationally agreed-upon timing commitments regarding implementation of Basel III and plan to work diligently to complete the rulemaking process. This suggests that industry participants can expect a revised set of proposed rules in the near future. Given the imminent holiday season, however, it seems unlikely that any such proposals will be released until sometime during the first quarter of 2013.

- Keith R. Fisher

Indiana Transitions Collection Agency Licensing to NMLS

Starting November 1, 2012, the Nationwide Mortgage Licensing System and Registry (NMLS) will be used to manage Indiana's collection agency licensing. Only collection agencies required to renew their main office location by December 31, 2012, are required to transition through NMLS by that date. Collection agencies whose licenses expire on December 31, 2013, (along with their branches) will transition to the NMLS in 2013. Additionally, any new applications for an Indiana Collection Agency License must be submitted through NMLS after November 1, 2012.

NMLS Accommodates Those Affected by Hurricane Sandy

In the wake of Hurricane Sandy, the enrollment window for mortgage loan originator (MLO) testing has been extended for residents in a state that declared a State of Emergency. The enrollment window, which was due to expire between October 19 and November 9, 2012, will now be extended until December 10, 2012. The NMLS Ombudsman has also encouraged regulators in states affected by Hurricane Sandy to work with licensees and registrants in the event that the storm has interfered with the timely submission of their Third Quarter NMLS Mortgage Call Reports that were due November 14, 2012.

Maryland Removes Certain Licensing Exemptions

Recent Maryland legislation has removed the exemption for affiliates and subsidiaries of federally chartered institutions from Mortgage Lender License requirements. Effective January 1, 2013, such affiliates or subsidiaries that were previously exempt must be licensed as Mortgage Lenders to conduct Maryland mortgage lending business unless some other exemption applies. Maryland has additionally removed the de minimis exemption for a person who makes three or fewer mortgage loans, or for a broker who makes no more than one mortgage loan, per calendar year. Also effective January 1, 2013, such individuals must be licensed as Mortgage Lenders unless some other exemption applies.

- Matthew Saunig

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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