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Note: This article is excerpted from remarks of Andrea Lee Negroni (BuckleySandler LLP) and the author, at the 60th Annual Convention of the MBA of Florida on June 20, 2013. This is not legal advice to any person and is provided as a courtesy to the MBA of Florida and its members.
Introduction
The regulatory compliance challenges facing financial institutions have never been higher. In 2012, the American Bankers Association said the regulatory burden for community banks had created a tipping point beyond which many banks cannot survive. Industry commenters say:
- "There is literally not enough time in the day to read and interpret all of the newly issued regulations while keeping up with our daily compliance responsibilities."
- "I spend more time on compliance than I do with clients ... No matter how hard you work or how smart and frugal you are, the regulations and reporting requirements are simply becoming too burdensome to operate a small business."
Among the topics Florida mortgage bankers must focus on now are the Qualified Mortgage Rule; mortgage banking law amendments; new court decisions; and a host of emerging issues, including the forthcoming regulation of social media and the pricing and placement of force-placed insurance. I'll review these in turn.
- The Qualified Mortgage (QM) Rule
The Qualified Mortgage Rule goes into effect in January 2014. Its safe harbors can minimize enforcement and litigation risk, incentivizing lenders to offer these loans. The QM Rule, which applies to closed-end loans secured by a home, requires lenders to make reasonable and good-faith determinations that a borrower has the ability to repay the loan. Borrowers cannot be qualified based on temporarily low payments during interest-only periods or the front end of a short ARM.
Generally speaking, the Rule can be satisfied in two ways (exceptions are not addressed here). The first is by adhering to qualifying standards, also called the "Ability to Repay" option. The second is to originate a "Qualified Mortgage." Of the two, the Ability to Repay option is more flexible. The Ability to Repay option requires the lender to consider several underwriting factors and verify underwriting information. These factors are: income or assets; borrower's employment status; the monthly loan payment (PITI); the monthly payment on simultaneous loans; the borrower's other debt; and his credit history. Although these factors must be considered, underwriting standards are neither mandated nor fixed. For example, there is no maximum debt to income ratio for the Ability to Repay option, nor is there a minimum credit score. Underwriting departments retain the discretion to determine whether a borrower is an acceptable credit risk.
Lenders must verify underwriting information with written records provided by someone other than the borrower or the lender. These records include tax returns, W-2s, and bank statements, for example. (Third party verification of employment can be done by phone.) The lender may consider assets in lieu of income if that is reasonable. Only the income necessary to support a determination of repayment ability must be verified. If, for example, a borrower earns a base salary plus optional bonuses, and the lender reasonably determines that the base salary is sufficient to repay the loan, the bonuses need not be verified. The monthly payment for qualifying borrowers is the total of the principal, interest, taxes, and insurance, plus the principal and interest on any simultaneous 2nd trust loan, plus any required homeowners association or condo fees. Principal and interest payments must be calculated at the fully-indexed and fully-amortized rate. For ARMs, the payment must be calculated using the index that applies when the loan adjusts, plus the maximum margin applicable at any time during the loan. The Ability to Repay option doesn't restrict product features, limit points and fees, or prohibit ARMs or interest-only loans. It permits flexibility in underwriting leading to reasonable, good faith determinations of the borrower's ability to repay.
The Qualified Mortgage is the alternative to the Ability to Repay option. A QM loan can be considered a higher-priced loan, or not. In the interest of space, I address only those that are not. For a Qualified Mortgage that is not "higher-priced," a lender is presumed to have met the Ability to Repay standard regardless of whether the lender made a reasonable or good faith determination of the borrower's repayment ability. In essence, this is a safe harbor for QM loans. A Qualified Mortgage has limited product features, must meet one of two underwriting tests, and may not include excessive points and fees. Qualified Mortgages may not exceed 30 year terms and must have regular periodic payments that are substantially equal, except for ARM interest rate adjustments. They cannot have interest-only options, negative amortization, balloon payments, or deferred principal payments.
The QM underwriting test requires either meeting the standards of Fannie, Freddie or a government agency (FHA or VA), or compliance with specific detailed underwriting guidelines. The underwriting requirements run 20 pages, but the main point is that the borrower's income must be verified, all debts must be included and the total "back-end" debt to income ratio cannot exceed 43%. Points and fees are limited: for loans over $100,000, the cap is 3 points. Certain prepayment penalties count against the point and fee cap.
This is a very rudimentary summary of the QM Rule and you should review the detailed requirements in time to comply in January.
2. Florida Mortgage Lending: Legal Developments
Florida recently adopted several mortgage-related laws and participated in the state/federal $25 billion foreclosure/servicing settlement. Florida Attorney General Pam Bondi said financially troubled borrowers in the state will get $3.1 billion for loss mitigation, $309 million will go to homeowners with underwater mortgages and loan rates over 5.25% to enable them to refinance, and $171 million will go to borrowers who lost homes in foreclosure. Florida also expects to get $334 million to fund housing and foreclosure-prevention programs.
The settlement requires servicing process modifications by the largest mortgage servicers of privately held loans (Ally/GMAC, Bank of America, Citi, JPMorgan Chase and Wells Fargo); these changes are expected to eventually cover other servicers too. The changes mandate: a single point of contact for homeowners; adequate staffing levels and staff training; higher standards for executing foreclosure documents to prevent robo-signing; reduction of excessive default-related fees; monitoring of lawyers and third parties involved in the foreclosure process; procedures to ensure accuracy of accounts and default fees; procedures to prevent neglect of bank-owned properties; restrictions on inappropriate force-placed insurance; review of modification applications to ensure they are handled expeditiously and fairly; and no dual tracking of foreclosures while modification is under review.
While these changes are being implemented, regulators continue to address loan modification complaints. The CFPB's database puts Florida in fifth place nationally on mortgage complaints per capita. In Florida, mortgage modification problems were the #1 source of consumer complaints to the Office of Financial Regulation in 2012. The OFR has responded with cease-and-desist orders and has levied fines against loan modification providers. Concurrently, the Florida legislature enacted laws regulating the mortgage modification business.
Florida law requires an individual or company that provides loan modification services to obtain a license from the OFR. This requirement enhances the 2008 Foreclosure Rescue Fraud Prevention Act, F.S. �501.1377, which prohibits up-front fees for loan modification services related to foreclosures. The foreclosure rescue fraud law restricts sale/rent-back contracts if the repurchase price is unconscionable. Unconscionability is presumed if the repurchase price exceeds 17% per annum of the amount paid by the purchaser to acquire the property.
The housing downturn resulted in a tsunami of Florida court decisions on foreclosures and related issues. Homeowners facing foreclosure, and their lawyers, can be creative. New legal defenses, such as the robo-signing defense, have been successful in Florida. Less familiar recent decisions deal with the standard for setting aside a foreclosure for inadequacy of sale price.
In CitiMortgage v. Synuria, 86 So.3d 1237 (Fla. App. 4 Dist., 2012), a trial court denied Citi's motion to vacate a foreclosure sale. Citi did not have an agent at the sale because it had substituted lawyers; it claimed "excusable neglect." Foreclosure of a $41,000 mortgage resulted in a sale for $800. The lender succeeded in setting aside the sale based on gross inadequacy of the sales price. The purpose of the law, said the court, is to "encourage good faith offers for foreclosed properties, [but] not to protect outrageous windfalls to buyers who make de minimis bids." But HSBC Bank v. Nixon, 2012 WL 6600927, came out differently. HSBC sought to vacate a sale in which its $787,473 judgment was lost to a buyer who paid $1,600 for the property. HSBC's attorney moved to withdraw and sought a continuance of sale date to allow the bank to get another lawyer. Unfortunately, the withdrawing lawyer didn't publish notice of the sale or set a hearing on his motion to withdraw. The court said HSBC never provided evidence to demonstrate a mistake that would entitle it to relief.
These seemingly contrary conclusions make it worthwhile to review the Florida Supreme Court's rule about inadequacy of price as a ground for setting aside a judicial sale, as set forth in Arlt v. Buchanan (190 So.2d 575, 1966):
The general rule is ... that standing alone mere inadequacy of price is not a ground for setting aside a judicial sale. But where the inadequacy is gross and is shown to result from any mistake, accident, surprise, fraud, misconduct or irregularity upon the part of either the purchaser or other person connected with the sale, with resulting injustice to the complaining party, equity will act to prevent the wrong result.
In Vargas v. Deutsche Bank, 104 So.3d 1156 (Fla. App. 3 Dist, 2012), the borrower challenged the foreclosure. Vargas borrowed $232,000 from First NLC Financial Services; the note was assigned to Deutsche Bank. After default, a foreclosure date was set and postponed. The servicer offered a written modification with an expiration date. Vargas didn't sign it; instead he asked the court to order a modification more to his liking. His request was denied and he filed bankruptcy, which automatically postponed the foreclosure. Eventually, Vargas asked the court to enforce the original (unsigned) modification offer. The Florida statute of frauds requires a debtor's action on a credit agreement to be supported by a written agreement. The Vargas decision holds that a promise to modify a mortgage is a credit agreement subject to the Florida statute of frauds. Therefore, an unsigned agreement can't be used to prevent foreclosure.
Homestead exemption claims come up frequently in Florida courts. In Grisolia v. Pfeffer, 77 So.3d 732 (Fla. App. 11/23/2011), a Florida appeals court considered the factors relevant to determination of homestead status. The decision holds that a person's failure to claim a homestead tax exemption is not evidence that the property is not his homestead. The homestead tax exemption, an exemption from taxes, is construed strictly against the homeowner, whereas the homestead exemption from forced sale is liberally construed in favor of the homeowner. Eligibility for the exemption from forced sale depends on the intent of the homesteader, and not on immigration or citizenship status. Florida law doesn't require the property owner who claims homestead to live in the property -- it is sufficient if his family lives in the property.
- Emerging Issues
Compliance in a changing regulatory world requires lenders to look down the road ahead as well as back into the rear view mirror. High on the emerging issues list are efforts to regulate social media use by financial institutions. The government is concerned about the risks created by social media, ranging from hacking and the posting of false information to data breaches and inadvertent disclosures of personal financial information. Legal regulation in this area is inevitable, especially for legal-centric transactions, such as mortgages.
In January 2013, the Federal Financial Institutions Examination Council (FFIEC) proposed guidance for financial institutions (FIs) using social media. The non-binding guidance says FIs should identify, measure, monitor and control the risk of social media use and ensure it is consistent with laws and regulations governing their business activities. Issues unresolved by the guidance, include, for example: How can loan officers tweet a Fair Housing logo or provide extensive disclosures in 140 characters? Will fair housing laws prevent credit advertising on blogs catering specifically to women, young people, or protected classes? Will anti-discrimination concerns (or effects-test considerations) lead to requirements for social media marketing in multiple languages? How can individuals' postings be monitored to ensure a lender's reputational risk is minimized? Consistent with Constitutional freedom of expression principles, can a lender prevent customers from posting financial data on social media feedback sites? Where will responsibility fall when hacking into these sites results in the inadvertent disclosure of confidential financial information? These and other questions are the tip of a potentially huge legal and regulatory iceberg for financial institutions.
Force-placed insurance is another area of emerging risk for the Florida mortgage industry. Consumer advocates claim borrowers suffer when lenders force-place hazard insurance. They also argue that lenders earn undisclosed commissions on the sale of the insurance, driving up the price. Groups such as the Consumer Federation of America and Center for Economic Justice are lobbying the Florida Insurance Commission to stop force-placed insurance "overcharges." In short, consumer advocates object to the way the product is offered and priced. Some government agencies may be inclined to agree.
In late March, the Federal Housing Finance Agency announced it would no longer allow insurers to pay commissions to lenders or servicers on GSE-owned loans. Almost simultaneously, New York's Department of Financial Services made a $14 million settlement with Assurant, barring it from paying commissions to banks, paying lenders sign-up bonuses, or offering low-priced flood insurance monitoring to attract business. The order also prohibits lenders from force-placing insurance through affiliated companies, and prohibits insurers from reinsuring a force-placed insurance risk with affiliated companies. Challenges to lender-placed insurance are cropping up in lawsuits across South Florida. In May 2013, a settlement for more than $19 million resolved homeowners' complaints that their force-placed insurance premiums unfairly hid commissions to the lender. Skirmishes in the battle over force-placed insurance are likely to continue and the industry may operate very differently in a year or two than it does today.
Conclusion
I end where I began. In the home loan industry, regulatory compliance grows more complex and more expensive with the passage of time. In troubled economic environments, practices that were previously thought benign generate scrutiny from consumers and regulators, along with demands for reform. As challenging as it is to implement procedures responsive to the increasing regulatory burden, a compliance-centric business approach is the best way to serve and satisfy customers, with the least legal risk.
About the Author:
Steven vonBerg is a 2013 graduate of the American University Washington College of Law where he was an Articles Editor on the American University Business Law Review. Previously, he worked as a mortgage originator. He interned at the U.S. Securities and Exchange Commission, an antitrust litigation firm, and a boutique hedge fund advisory firm. Mr. vonBerg has a special interest in emerging technology and its impact on the law. He can be reached at [email protected].
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