MLO COMPENSATION, REGULATION Z, AND DODD-FRANK ACT Vermont Mortgage Bankers Association & Mortgage Bankers/Brokers Association of NH Mortgage Compliance Conference Thursday, March 3, 2011 Sean P. Mahoney K&L Gates LLP State Street Financial Center One Lincoln Street Boston, MA 02111 (617) 261-3100 Sean.Mahoney@KLGates.com Copyright 2010 by K&L Gates LLP. All rights reserved.
Overview Federal Reserve Final Regulation on compensation of mortgage loan originators Dodd-Frank Act will impact mortgage bankers and loan originators Creates new consumer financial services regulator Imposes new requirements on mortgage origination Imposes new securitization rules and exemptions to skin in the game requirements 1
Federal Reserve MLO Compensation Regulations 2
Fed Regulations Limit Forms of Compensation Applies to all loans for which an application is received after April 1, 2011 Prohibits a loan originator from receiving, and any person from paying to the loan originator, compensation in an amount that is based on any of the loan s terms or conditions (other than the loan amount) Mandates single source compensation Prohibits steering 3
Loan Originators Defined as a person (including an individual or entity, an employee or employer) who, for compensation or other monetary gain, or in expectation of compensation or other monetary gain, arranges, negotiates, or otherwise obtains an applicable extension of consumer credit for another person 4
Loan Originators Includes mortgage brokers, employees of mortgage brokers, employees of banks and other lenders, and named lenders in table-funded transactions 5
The Basic Concept The clear intent of the Federal Reserve is to remove any incentive of an originator to make one loan versus another From compensation perspective, originator should be ambivalent as to type of loan or rate customer pays Disrupts mortgage banking market as originators lose flexibility to reduce their own compensation to provide discount to borrowers 6
Prohibited Originator Compensation Any compensation based upon terms and conditions of loans interest rate annual percentage rate loan-to-value ratio existence of a prepayment penalty 7
Permissible Originator Compensation Compensation based on Loan amount (fixed percentage with or without floors and caps) Overall loan volume Long-term performance of the originator s loans Actual number of hours worked New customer/existing customer Fixed fee per loan, set in advance Percentage of applications that result in consummated transactions Quality of the loan files submitted to the creditor Legitimate business expenses 8
Single Source Compensation A loan originator s compensation may come directly from the consumer or another person but not both if any loan originator receives compensation directly from a consumer, such loan originator may not receive compensation from any other person in connection with the transaction no person who knows or has reason to know of the consumer-paid compensation to the loan originator may pay any compensation to a loan originator in connection with the transaction 9
Single Source Compensation Yield Spread Premiums Are allowed, but any YSP in excess of fixed broker compensation must be used to offset borrower closing costs YSP cannot be used to vary compensation paid to broker YSP can be present if points are paid, but the two are netted in Box 2 of the GFE (can only have credit or charge; not both) 10
Single Source Compensation If borrower pays broker s fee Broker and borrower are free to set compensation Broker s compensation may be paid out of loan proceeds But not out of discount points paid by borrower And not out of increased rate paid by borrower 11
Anti-Steering A loan originator may not direct or steer a consumer to consummate a transaction based on the fact that the originator will receive greater compensation from the creditor in that transaction than in other transactions the originator offered or could have offered to the consumer, unless the consummated transaction is in the consumer s interest In other words, broker may not elect to place loans of a certain type only with a certain lender based upon compensation paid by the lender 12
Consumer s Interest Standard Most relevant to mortgage brokers or table-funded transactions Compensation for loan originator from employer cannot vary by loan type Mortgage brokers have ability to place loan with different lenders Does not require loan originator to direct consumers to loans that pay lowest compensation, but loan with lowest compensation is deemed to satisfy the test 13
Consumer s Interest Standard Safe Harbor In general, if the originator obtains loan options from a significant number of the creditors with which it does business and for each type of transaction in which the consumer expressed an interest, presents the consumer with loan options Then any of the following among the options presented are in the consumer s interest the loan with the lowest interest rate the loan with the lowest interest rate without exotic features the loan with the lowest total dollar amount for origination points or fees and discount points 14
Bureau of Consumer and Financial Protection (CFPB) 15
Overview Title X of the Dodd-Frank Act (the Consumer Financial Protection Act of 2010) creates a new federal regulator, the Bureau of Consumer and Financial Protection (CFPB) Primary justification - existing federal regulators did not adequately protect consumers Interested in safety and soundness of banks Little federal examination and supervision of mortgage bankers 16
CFPB Organization An independent bureau within the Fed, considered an executive agency Run by a Director nominated by the President and confirmed by the Senate Main office in D.C. branch offices permitted Directed to coordinate with other federal agencies and state regulators 17
Bureau of Consumer and Financial Protection CFPB begins operations on the designated transfer date Various requirements and reforms are also keyed off of this date Designated transfer date is July 21, 2011 18
CFPB Authority Charged with regulating the offering and providing of consumer financial products and services under the federal consumer financial protection laws Rulemaking Authority CFPB is authorized to implement the federal consumer protection laws through regulations, orders and guidance Has near exclusive authority to implement federal consumer protection laws 19
CFPB Supervisory Authority CFPB has authority to regulate, examine, and take enforcement action with respect to any person that engages in the offering or providing of a financial product or service to a consumer (subject to exemptions) Primary examination and enforcement authority with respect to compliance by mortgage-related businesses, and certain larger participants in financial services such as banks and credit unions with more than $10 billion in assets 20
Residential Mortgage Loan Reforms in the Dodd-Frank Act 21
Mortgage loan originator A mortgage originator is defined as any person (an individual or an organization) that, for or in the expectation of direct or indirect compensation or gain: Takes a residential mortgage loan application; Assists a consumer in obtaining or applying to obtain a residential mortgage loan; or Offers or negotiates terms of a residential mortgage loan Not a creditor that funds loan with its own resources and later resells the loan 22
Mortgage Originator Qualifications Mortgage originators must: Be qualified and licensed or registered in accordance with applicable law, including the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 ( SAFE Act ) Include a unique mortgage originator identifier on all loan documents FRB regulations to require depository institutions to establish compliance procedures with respect to this section and SAFE Act registration procedures 23
Prohibition on Steering Incentives Mortgage originator may not receive compensation that varies based on the terms of the loan, other than the principal amount Mortgage originator may not receive an origination fee or charge from any person other than the consumer, other than Bona fide third party charges Compensation from a third party if The originator does not receive compensation from the consumer and The consumer does not make an upfront payment of discount points, origination fees or other fees other than bona fide third party charges not retained by the originator, creditor or an affiliate As permitted by FRB 24
Prohibition on Steering Incentives FRB regulations to prohibit: Steering to a loan that consumer lacks a reasonable ability to repay or has predatory characteristics or effects Steering from a qualified mortgage for which the consumer is qualified to a non-qualified mortgage Abusive or unfair lending practices based on race, ethnicity, gender or age Mischaracterizing credit history, available loans or appraised value Discouraging a consumer from seeking a better loan elsewhere 25
Prohibition on Steering Incentives Rules of Construction: Prohibits a yield spread premium or similar compensation that would permit total originator compensation to vary based on loan terms, other than the amount of principal Does not limit creditor s compensation from resale of loan Does not restrict consumer s ability to capitalize permitted origination fees or costs Does not prohibit incentive payments to an originator based on the number of loans originated within a specified period of time 26
Liability The civil liability provisions of TILA (including new duty of care and steering prohibitions) apply to mortgage originators Maximum liability is The greater of Actual damages or An amount equal to 3 times the total amount of direct and indirect compensation or gain accruing to the mortgage originator in connection with the relevant loan Plus costs and attorneys fees 27
Regulations FRB is to issue regulations to prohibit abusive, unfair, deceptive or predatory practices, to ensure that responsible, affordable credit remains available, and to effectuate, facilitate compliance with or prevent circumvention of the purposes of TILA Regulations will apply to all residential mortgage loans FRB has authority to establish full or partial exemptions from disclosure requirements for any class of residential mortgage loans 28
Ability to Repay No creditor may make a residential mortgage loan without determining that the consumer has a reasonable ability to repay the loan If the creditor knows or has reason to know that 1 or more loans secured by the same dwelling will be made to the same consumer, the creditor must determine that the consumer has a reasonable ability to repay all loans on the same dwelling 29
Qualified Mortgage Safe Harbor A rebuttable presumption not an absolute safe harbor Creditor may presume that a loan meets ability to repay requirements if it is a qualified mortgage 30
Qualified Mortgage Safe Harbor A qualified mortgage is a residential mortgage that: If fixed rate, is underwritten on the basis of a fully amortizing loan If adjustable rate, is underwritten based on the maximum rate permitted during the first 5 years No negative amortization or balloon payments No deferred repayment of principal Verified income and financial resources Complies with FRB regulations on debt-to-income ratios or residual income Points and fees do not exceed 3% Term does not exceed 30 years 31
Additional Loan Standards and Requirements Prepayment Penalties Allowed only for qualified mortgages Allowed for 3 years only (max. of 3%, 2%, 1% of outstanding balance) Must offer loan without a prepayment penalty Single Premium Credit Insurance Prohibition Applies to residential mortgage loans and home equity lines secured by principal dwellings Creditors cannot finance single premium credit insurance products except on a monthly basis 32
Additional Loan Standards and Requirements Arbitration Arbitration clauses prohibited in connection with residential mortgage loans and home equity lines secured by principal dwellings Negative Amortization Prohibited unless creditor makes certain requisite disclosures Counseling required for first-time borrowers Does not apply to reverse mortgages 33
Civil Liability and Defenses Increases civil liability exposure under TILA Statute of limitations for certain TILA violations is increased from 1 to 3 years Borrower may sue for recoupment after the initiation of foreclosure for violation of anti-steering prohibitions or ability to repay requirement Adds new legal defense to civil liability and rescission liability where obligor has been convicted of obtaining a residential mortgage by actual fraud 34
High-Cost Mortgage Criteria (Rates) First mortgage APR at consummation exceeds the average prime offer rate for a comparable transaction by more than 6.5% (8.5% if the dwelling is personal property and the transaction is for less than $50,000) Subordinate Mortgage APR at consummation exceeds the average prime offer rate for a comparable transaction by more than 8.5% 35
High-Cost Mortgage Criteria (Points and Fees) Total points and fees (excluding bona fide third party charges) exceed For a transaction of $20,000 or more, 5% of the total transaction amount For a transaction of less than $20,000, the lesser of 5% of the total transaction amount or $1,000 FRB may adjust dollar amount Loan documents permit prepayment fees more than 36 months after closing, or total prepayment fees exceed 2% of the amount prepaid 36
Super Appraisals for Higher Risk Mortgages Creditor is obligated to obtain A second, independent appraisal From a different licensed and certified appraiser Before making a higher risk mortgage loan Where the purpose of the loan is to finance the acquisition of property that had been acquired by the seller within the previous 180 days at a price lower than the current sale price This is to identify instances of apparent flipping 37
Higher-Risk Mortgage Definition Not a qualified mortgage If a first mortgage, the APR exceeds the average prime offer rate for a comparable transaction, as of the date the interest rate is set By 1.5% or more for loans within the Freddie Mac conforming loan limit (i.e., conforming loans) By 2.5% or more for loans in excess of Freddie Mac conforming loan limit (i.e., jumbo loans) If a subordinate mortgage, APR exceeds the average prime offer rate for a comparable transaction by 3.5% or more as of the date the interest rate is set 38
Appraisal Independence Requirements Acts or practices which violate appraisal independence are unlawful Compensation or coercion of appraiser by interested party Mischaracterization of appraised value Seeking to influence appraiser (including withholding or threatening to withhold payment) Regulations to determine other unlawful acts 39
Broker Price Opinions Defined an estimate prepared by a real estate broker, agent or sales person detailing the probable selling price of property May not be used as the primary basis for determining the value of the security property for a loan to finance the purchase of a consumer s principal dwelling 40
Copies of Appraisals and Valuations Creditor must provide a copy of all written appraisals and valuations to applicant for first mortgage on dwelling Valuation any estimate of value of a dwelling developed in connection with credit decision Obligation exists regardless of whether the loan is granted or denied, the application is complete or the application is withdrawn To be furnished no later than 3 days before closing Must be provided at no additional cost Creditor must notify applicant of right to receive copies in writing 41
Securitization Rules That Push Market to Plain Vanilla 42
Securitizers Required to Retain Risk Rulemaking required to mandate securitizers (not originators) retain at least a 5% interest in assets securitized Securitizer defined as an issuer of an asset-backed security a person who organizes and initiates an asset backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuer Retained risk generally may not be hedged 43
Allocation of Risk Retention Regulations are to provide for allocation of risk between securitizers and originators that deliver into securitizations based on particular categories of assets determined with reference to the credit risk of the assets the characteristics of securitization transactions involving those assets potential impact of a risk retention requirement on the availability of credit to consumers and businesses 44
Qualified Residential Mortgages Exemption from risk retention requirements for securitizations consisting solely of qualified residential mortgages Essentially these are plain vanilla mortgages, but the precise definition will be determined by regulation can be no broader than definition of qualified mortgages under TILA must also take into loan features or underwriting practices shown to be associated with high or low risk of borrower default 45
Qualified Residential Mortgages Given exemption, originate-to-distribute will survive with respect to qualified residential mortgages Given that many mortgage lenders do not have wherewithal to retain risk, market may be overwhelmingly tilted to qualified residential mortgages Ultimately, these reforms may result in less innovation with respect to mortgage products 46
Government Backed Mortgage Loans Also exempt from risk retention provisions This makes sense as the originator or investor will have little risk associated with a loan guaranteed by the government These loans include Farm Credit Administration Federal Housing Administration Does not include Fannie Mae and Freddie Mac securitizations 47
Asset Class Regulations Regulations will establish asset classes and specifically govern securitizations of each of those asset classes incorporate underwriting guidelines established by the bank regulators that specify the terms, conditions, and characteristics of a loan within the asset class that indicate a low credit risk with respect to the loan asset classes include residential and commercial mortgages, commercial loans, auto loans, and any other asset classes deemed appropriate by regulators 48