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   ARTICLE   |   From Scotsman Guide Residential Edition   |   March 2014

Getting Better All the Time

Several recent developments may bode well for affiliated business arrangements

Although it’s still in the process of being implemented through the regulations of the Consumer Financial Protection Bureau (CFPB), the Dodd-Frank Wall Street Reform and Consumer Protection Act has reshaped the business model and practices of the mortgage lending industry. Most of the attention has been focused on qualified mortgages (QMs), qualified residential mortgages, loan-officer compensation rules and the new integrated mortgage disclosures, the latter of which will go into effect in August 2015. With all of these issues drawing most of the headlines, little notice has been given to the fact that Dodd-Frank has indirectly put the viability of affiliated business arrangements (AfBAs) at risk.

Nevertheless, the CFPB is moving in the direction of minimizing this risk while it considers the arguments of interested parties on whether or not AfBAs should be in the disadvantaged position that they currently are under Dodd-Frank. Although congressional efforts to remedy this problem may extend well into 2014, the problem for AfBAs under Dodd-Frank became operational this past January.

AfBAs have long comprised an important facet of many mortgage banks and brokerages’ business, and accordingly, these arrangements’ continued viability is in many organizations’ best interests. What’s the recent history of AfBAs, and what lies ahead for them?

Looking back

There was a litigation development in federal court this past November that may signal a reversal to the trend of class-action challenges to the legitimacy of AfBAs. In reviewing the U.S. Department of Housing and Urban Development (HUD) 10-point policy statement on what it considers when determining if an AfBA is legitimate, the Court of Appeals for the Sixth Circuit determined that this policy was an impermissible regulatory action. This ruling was based on the fact that the Real Estate Settlement Procedures Act (RESPA) creates criminal liability, and in light of this, the policy statement cannot be valid, as it adds requirements beyond RESPA’s specified safe-harbor provisions for AfBAs.

It’s necessary to review some brief background on AfBAs to appreciate the meaning of these developments. First, it should be understood that AfBAs primarily exist in the context of a large real estate brokerage company or a major homebuilder. The AfBA usually consists of a mortgage bank or brokerage and a title insurance agency or homeowner’s insurance agency. AfBAs have been an essential source of income for large real estate brokerages because of the shrinking company dollar from real estate sales commissions.

Arguably, during the course of various state and federal regulatory skirmishes, there has been no credible evidence of any lesser quality of service or higher consumer costs arising from the use of AfBAs. This is particularly evident in regard to title-insurance premiums. There is, however, an issue of reverse competition that can apply to real estate agents and the help they provide in a consumer’s selection of additional services. Because many homebuyers engage in few and infrequent real estate purchases, they often rely on real estate agents to direct them to these service providers. Notwithstanding this issue and detractors’ claims of higher prices and lesser service, a large number of consumers have expressed satisfaction with using AfBAs and prefer the one-stop shopping experience that they provide.

Regarding Dodd-Frank, there was no focus during its adoption on whether or not AfBAs should be changed. Likewise, there was no focus on whether or not there were any consumer problems with the arrangements in terms of mortgage originations. In defining what was to be included in QM’s 3 percent cap on points and fees, however, Dodd-Frank utilized the concept from the high-cost loan provisions of the Truth in Lending Act (TILA), which adds in the fees and charges retained by lender affiliates for its annual percentage rate calculations.

Historically, this inclusion was not material because the tolerances of what defined a high-cost mortgage were fairly high. With QM, however, the inclusion of affiliate fees and charges — particularly a deal’s title-insurance premiums for the buyer and the seller — can cause the 3 percent points and fees limit to be exceeded for most loans as much as $250,000, although there are adjustments in Dodd-Frank for loans less than $100,000.

As a result of the inclusion of the affiliate fees for QM loans, mortgage banks and brokerages with affiliated title companies now must consider if their loan amounts will require them to close or otherwise divest their title agency, as the title-insurance premium is one of the main charges that may cause the deal’s fees to exceed 3 percent. The problem is even more severe for real estate brokerages that own a mortgage company and a title agency — and possibly an insurance agency, as well — because these organizations rely on that additional income as well as the efficiencies that arguably exist from AfBAs. The same issues exist for homebuilders that have AfBAs, although the sale of homes is typically more profitable than the business of a real estate brokerage.

Looking forward

There has been a concerted effort by numerous industry groups and associations to remedy this AfBA problem through proposed amendments to Dodd-Frank. More specifically, many industry participants hope to encourage Congress to amend the points and fees definition in QM to exclude title fees and costs from inclusion in the 3 percent cap. There is political opposition to this proposal, however, which is complicated by the fact that efforts to amend Dodd-Frank in any respect have been resisted on several fronts. Nonetheless, there are reasonable expectations that both houses of Congress may favorably act on the AfBA proposals this year, although this past January, the Senate refused to act on a proposal to suspend title fees from the 3 percent definition for a year, pending a review by the CFPB.

The CFPB’s recently expressed interest in learning more about this issue is key if the industry hopes to preserve AfBAs as they relate to mortgage originations. After repeatedly stating that it could not regulate around the specific provisions of Dodd-Frank regarding AfBA fees and QM loans, the CFPB appears to be willing to consider the merits of this issue. Related to this is a significant step that the CFPB took in late 2012, clarifying that only the fees retained by a mortgage company’s affiliated service provider are to be included in the 3 percent calculation for QM loans.

This is an interim and partial relief for those affected by the AfBA problem. Counting only the fees retained by an AfBA for QM purposes may enable more of them to participate in QM loans originated by their owners or affiliates. Thanks to this, the existence of these AfBAs and their current ownership relationships likely will continue, pending further Congressional action. In this regard, the CFPB also has asked for more data and information about AfBAs. Advocates of amending Dodd-Frank can only hope that the bureau will take a favorable — or at least neutral — stance when asked by Congress for its opinion.

Other developments

The other positive development for AfBAs is the previously mentioned decision by the Sixth Circuit of the Federal Court to set aside HUD’s policy statement on sham AfBAs. Although this decision is not binding in other parts of the country, it’s a clear indication that HUD’s policy statement and similar regulations or interpretations forthcoming by the CFPB should not be a valid basis for plaintiffs to challenge the validity of an AfBA.

From the court’s point of view, as long as a given AfBA was providing some settlement services and as long as the other AfBA statutory requirements were being followed, then it’s not proper to inquire further into the validity of the AfBA, as is done by the HUD policy statement. The court found that, since RESPA has criminal penalties, its AfBA requirements should be interpreted narrowly. In light of this, the court noted that the deference normally accorded to the regulator’s interpretation of a statute is not applicable, as such regulations can expand upon the scope and definition of the criminal conduct set forth in the statute itself.

This decision is a favorable development for those defending challenges to AfBAs, which are more likely to occur in a class-action context. Nevertheless, it’s doubtful that the CFPB will refrain from taking action against what it considers to be sham AfBAs that provide minimal services for which they are clearly overpaid. Additionally, the CFPB has authority beyond RESPA for unfair or deceptive practices, which it may use to address such business operations.

•  •  •

In brief, the ongoing actions of the CFPB on the 3 percent points and fees cap issue, as well as the federal court decision narrowing challenges to the viability of an AfBA, give some hope that AfBAs related to mortgage companies can remain a viable business methodology. The decision limiting regulatory expansion of the requirements for AfBA compliance, although not binding on federal district courts outside of the Sixth Circuit, is a welcome development that defenders of AfBAs can cite in resisting legal challenges.  


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