Have your TPO contracts changed to account for Ability-to-Repay liability?
Thoughts on changes to contracts that may protect you when working with brokers / investors / correspondents.
What changes has your institution made to its contracts with third party originators (TPOs)--mortgage brokers, correspondent lenders, table-funded correspondent lenders (practically equivalent to brokers, but the "lender of record" under TILA)--to protect yourself from Dodd-Frank liability? Some institutions may not have made any changes, but with new regulations, new responsibilities, and new liability, it may be a good time to review them.
Some questions:
How have you adjusted your TPO contracts to accommodate for Ability-to-Repay liability?
Do your contracts distinguish between correspondent lenders and table-funded correspondent lenders? Or are you using the same standard contract?
We're not proposing that there's a one-size-fits-all contract ... after considering these issues, it's possible the only thing you change in your TPO contracts is the price. We do believe, however, that understanding the issues will allow you to negotiate the best deal for your institution.
ATR Liability by Business Model
The ATR rule makes the "creditor" responsible for determining in good faith that the borrower has a reasonable ability to repay the loan (ATR determination). This is ultimately an underwriting decision. For these purposes, the "creditor" is simply the institution with its name on the loan (the "lender of record"). Creditor = lender of record.
What does this all mean?
Broker
- Is not responsible for making the ATR determination...it does not underwrite loans or make the credit decision. But note: This may be modified by contract, the lender could contractually push some of this responsibility onto the broker. If you're a broker, make sure you understand what you're agreeing to.
Correspondent Lender
- Is responsible for making the ATR determination. As the lender of record, it underwrites and closes the loan in its own name.
Table-funded Correspondent Lender
- This is the "danger area." Practically speaking, table-funders are more like brokers than lenders- they may not have underwriters or a hefty compliance department. How could they determine that a borrower has the ability to repay the loan, then? Nonetheless, table- funded lenders are responsible for the ATR determination...the loan closes in their name, making them the "lender of record" (i.e., "creditor").
There's been a push towards this "emerging banker" model due in part to the QM rule... (#1) a lender's compensation doesn't count against the 3% points + fees cap, while a broker's comp. does, and (#2) a loan closed in another's name does not count towards the small creditor's 500-limit, while closing loans from a broker would
But our concern today lies with responsibility for making the ATR determination: does the investor realize the table- funded lender isn't equipped to do this? Does the contract reflect this? If the investor is trusting the table-funder to do it, and the table-funder (acting like it does, as a broker), is relying on the investor to do it - is anyone actually invested in doing it properly? Example: Small bank buys loans from a table-funded lender. The lender has no underwriters, just "closing" any loan that meets bank guidelines. The small bank's underwriters trust the table-funder's staff to make, in good-faith, the ability-to-repay decision. But is the lender actually doing that? Not in this example. If this loan goes non-QM and falls to foreclosure--defending the ATR claim is going to be problematic (read "expensive"). The lender will bear primary responsible as "creditor" under TILA, but expect a tough battle over any ambiguities in the contract. The lender is certainly going to argue that the bank makes the ATR determination, and that it is ridiculous to think otherwise because, after all, the lender doesn't even have an underwriting department. This sticky situation can be avoided by making changes to your TPO agreements today.
Changes to TPO Contracts
Here are some things you may want to re-negotiate or change with these TPO contracts (whether you are the TPO or the investor/lender):
1) Responsibility for ATR compliance
At the least, contracts should probably be updated to clearly assign responsibility for ATR compliance, e.g., "[Bank] is relying upon [Correspondent lender] to determine, in compliance with [ATR rule- 1026.43], that the borrower has a reasonable ability to repay the loan according to its terms, in addition to meeting any and all applicable [Bank] and investor guidelines."
Please let us be clear - an institution can "contract out" this responsibility for ATR compliance, but that institution remains ultimately responsible. Example: Table-funded lender is ultimately responsible for the ATR determination, but can rely on the determination by the investor's underwriters that the borrower has the ability to repay. ATR liability is expected to be expensive and scary ... that's why it's probably your best bet just to assign responsibility now (and negotiate prices accordingly) to avoid battling over this later.
2) Indemnification for Compliance/Underwriting Errors
You'll see many agreements where the TPO agrees to fully indemnify the investor/lender against any losses. TPOs may want to push back against this...perhaps agreeing to take responsibility unless the loss was within the lender/investor's control. Example: Table-funded lender or broker (relying on investor's underwriters) may agree to indemnify the investor except where the loss is due to an underwriting error (the investor's responsibility).
3) New look at vague language
This may be a good time to review the contracts for vague language - it may not mean the same today as yesterday. If a contract makes the TPO responsible for "the accurate preparation and submission of loan packages for each proposed loan ..."-- you'll want to make sure "loan packages" is defined. If not, you might just drop that language. Does loan package mean something that complies with ATR/QM? Whose decision is this?
4) New Section
The easiest approach may just be to add a new section that governs underwriting decisions. That might say, for example, that all underwriting decisions are made by the investor and that they take responsibility for underwriting errors.
Final Note: Vendor Management
If you're buying loans, you're in a position of bargaining power where you might successfully push all of this new ATR/QM liability back onto the TPO. But make sure you're not just jumping out of the frying pan and into the fire. Imagine what a regulator will think if a bank contracts out the ATR determination (intended to be made on a case-by-case basis) to a broker or table-funded lender with no underwriting staff. That just screams vendor management problem. And what are you doing to monitor their efforts to comply with regulations? Have you done an on-site visit or reviewed their policies/procedures? The contract is really just one small piece of the puzzle. That's why-instead of hoping to pull a fast one- the best approach is really to raise this with your TPOs and discuss how to handle this openly.
This is all not to recommend one specific course of action over another. Most likely, you should be aware of the new risks and incorporate that into your negotiations ... if you're assuming more or less liability, the price should be adjusted accordingly.
Other news/thoughts/triva:
We took my 10-year old brother-in-law to the movies this weekend. During a romantic scene, he turns to me and says, "I'm just going to close my eyes and think about race cars." With the increased regulatory red tape in the mortgage business today, how many are going to follow his lead and "Close your eyes and think about retirement?"
Hear about the CFPB's $500,000 action against a realty firm and title company from Alabama? The companies are affiliated (the title company's president is the realty firm's VP and general counsel - the same holding company owns both). This is yet another example of the CFPB's focus on RESPA Section 8 violations - in this case, they found the realty firm was improperly encouraging borrowers to use the title company's services (among other things, their disclosures just didn't cut it).
Join us on June 30, 2014 at Braintree Municipal Golf Course for the 15th annual Braintree Special Needs Golf Tournament. They are accepting hole sponsorship and other donations. Click on this link for more info. or just call our office at (781) 356-2772.
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- Albert Einstein
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