In the wake of downsizing by the Consumer Financial Protection Bureau, attention to supervision and enforcement of non-bank mortgage lenders has turned to the states.
In late April, Mark McArdle – a former top mortgage official of the CFPB - wrote a sobering
Effective mortgage regulation is important. IMBs are regulated by every state they do business in. Many states do a good job of mortgage market regulation, protecting borrowers from anti-consumer practices, in a balanced manner.
However, Mr. McArdle's piece highlighted what can happen when state supervision is not balanced. When the promise of a streamlined multi-state exam can morph into a free for all where many states see the exam process as an opportunity to levy their own fines for relatively minor infractions uncovered in the multi-state exam process.
We write to compliment - and to complement - Mr. McArdle's piece with our own vision of how mortgage supervision should work. We argue for a balance of consumer protection; transparent, practical, and effective rules; and streamlined compliance burdens. A statement of mortgage supervisory objectives, if you will.
The goal is compliance - not maximizing fines
Historically, supervision of banks has worked in a constructive way. The ultimate goal has been to achieve compliance with the rules. Banking regulators review a bank's compliance with rules, ensure that sound controls and procedures are in place, and require remediation of identified problems.
Bank regulators generally escalate their regulatory powers – moving to more serious penalties, such as litigation, enforcement actions, and fines – only when consumer harm is significant or when banks don't follow through on remediation of identified problems. A proper balancing that serves all parties.
Multi-state exams of non-bank mortgage lenders are conducted under a
Unfortunately, not all states seem committed to these goals. Some state regulators overseeing IMBs are bypassing the traditional supervision and escalation process, often in conjunction with the multi-state process – moving first to costly litigation and fines and enforcement. Even when the normal supervision and remediation process would have worked just as well in achieving compliance. This is harmful to consumers, as these costs inevitably get passed along to customers. It also creates a counterproductive adversarial relationship between regulator and the regulated entities.
Mr. McArdle's piece also points to a growing trend where some states seem to be following the same playbook as the CFPB in its early years – where the level of fines is viewed the measure of how well they are "protecting the consumer." It is not.
Base penalties on the extent of consumer harm
A second major principle of sound mortgage supervision is that penalties imposed by regulators for mortgage violations should be based on and proportional to the extent of consumer harm.
No financial product has more consumer rules than mortgage loans. RESPA, LO Comp, loan originator licensing, TRID, QM, HMDA, HOEPA, and many others. With so many rules – with ambiguous applications - not surprisingly, technical rules violations sometimes occur.
But when they do, the level of fines and enforcement action should be based on the extent of consumer harm. This principle should be intuitively obvious. In practice, it is sometimes ignored.
Too often we see examples where states are levying significant fines for violations of rules that have little or no impact on consumer protection.
The most common violations involve licensing violations. The most egregious example of this was the state of Connecticut putting 1st Alliance Lending out of business based on an allegation of licensing violations. Even though the multi-state consensus was that they were not violating the SAFE Act, and even though the same rules do not apply to banks, which have weaker licensing standards.
Regulation by enforcement is inappropriate
Regulation by enforcement occurs when a regulatory agency uses the enforcement process to change or impose new rules retroactively. A good example of this was the PHH case, where the CFPB sought a $109 million fine for alleged violations of RESPA – for behavior many years in the past and for "violations" that at the time where not obviously violations based on the rules at that time.
Another example took place when Pennsylvania adopted a licensing requirement for servicing. Many licensed lenders that sold loans they originated and then subserviced through authorized servicers reasonably did not interpret the statute as requiring licensing. Upon learning of the licensing requirements and filing an application for a servicing license, more than 40 of such lenders paid penalties, some into the six figure level.
Such regulation by enforcement is never fair or appropriate. This is particularly true for smaller mortgage lenders, that don't have the resource economies of scale to track (or hire lawyers or consultants to track) how regulators might be changing the rules or how they are enforced.
Streamline the 50-state mortgage regulatory maze
States should recognize that IMBs have control over which states they want to originate or service mortgages in. A state with a balanced regulatory approach, weeding out bad actors while not creating an unduly burdensome compliance regime, will fare better in attracting lenders. This is good for borrowers in that state. More competition means better prices and more responsive service.
Unfortunately, IMBs that operate in a large number of states face a compounding regulatory burden: a large number of federal mortgage rules – multiplied by different interpretations of these rules in different states - multiplied by exams in dozens of states. Plus individual state mortgage rules.
So, while we recognize the CFPB is reducing staff, it is critical that it continue to devote some of its remaining resources to provide guidance on how federal mortgage rules are interpreted. In turn, states should follow that guidance for what are federal mortgage rules.
In addition, state regulatory mortgage requirements should be reviewed periodically to determine whether they remain necessary. For example, with the adoption of TRID, a consumer is provided a Loan Estimate and a Closing Disclosure, with all information a consumer needs. Nevertheless, many states continue to require state disclosures which are duplicative and often confuse a consumer that is also receiving the federal disclosures. Similarly, licensees regularly filing reports through NMLS are still required by some states to file state-specific reports containing the same information.
Another area where states can attract more mortgage lenders is prompt reviews of license applications. It would be helpful if states, through the NMLS, could adopt uniform prescribed time periods for review of licensing applications, such as branching, name changes and changes of control. While change of control is typically reviewed in most states within 90 days, some states such as New York perform a more extensive review – similar in scope to a new license application. This can take a year or longer.
Responsibly embrace innovation
An emerging regulatory issue is artificial intelligence. AI offers significant promise to reduce the cost of manufacturing a loan, including streamlining and improving the accuracy of the underwriting process. Resulting cost reductions would benefit consumers, as lenders in this highly competitive market will pass savings on to consumers.
Therefore, states should exercise caution in adopting unnecessary restrictions on the use of AI.
In closing, a balanced, transparent, and coordinated regulatory approach for non-bank mortgage lender/servicers will benefit both consumers and the long-term health of the mortgage market.
