The United States Court of Appeals for the Second Circuit held that the National Bank Act (“NBA”) limits the ability of states to regulate tax preparers that facilitate tax refund anticipation loans (“RALs”) for national banks. The decision in Pacific Capital Bank, N.A. v. Blumenthal is of particular interest to any federally regulated lender (national bank, federal savings association, or operating subsidiary of either) that relies on third party agents (including brokers) to source loans or other bank products.
At issue was a Connecticut statute that capped interest rates on RALs. National banks were exempt from the law by its terms (and federal law would have preempted it for national banks anyway), but the Connecticut Attorney General concluded in a legal opinion that a tax preparer or other party that facilitated an RAL with an interest rate in excess of the statutory cap violated the statute, even if the lender was a national bank.
The court held that federal law preempted the interest rate limitation for facilitators of RALs made by national banks, at least in connection with RALs made through the arrangement at issue in the case, finding that “the natural effect” of enforcing the interest rate limits against facilitators that assist national banks offering RALs “would . . . be either to prevent a facilitator from assisting such national banks with respect to RALs or to cause it to refuse such assistance unless the national banks agreed to forgo their NBA-permitted rates and limit themselves to the lower rates specified by” the Connecticut law. The court concluded that “[i]f a state statute subjects non-bank entities to punishment for acting as agents for national banks with respect to a particular NBA-authorized activity and thereby significantly interferes with national banks’ ability to carry on that activity, the state statute does not escape preemption on the theory that, on its face, it regulates only non-bank entities.”
The court’s reasoning could extend past the RAL context to other situations where states try to regulate parties that arrange loans for federally regulated lenders. For example, this decision calls into question whether recently enacted state laws that prohibit mortgage brokers from arranging loans that do not meet certain underwriting standards could be applied to brokers when they are arranging loans for federally regulated lenders.
HUD/VA/GSE Developments
Moratorium on Risk-Based Premiums for FHA-Insured Loans
In July 2008, HUD shifted its mortgage insurance premium structure to a risk-based structure based on a combination of borrower credit scores and loan-to-value ratios. In response to the FHA Modernization provisions of the Housing and Economic Recovery Act of 2008, however, HUD is now required to implement a one-year moratorium on its new risk-based premium structure. HUD recently released Mortgagee Letter 2008-22, which, effective October 1, 2008, rescinds the Department’s risk-based premium guidance and sets forth new requirements for up-front and annual mortgage insurance premiums for FHA-insured loans. The Mortgagee Letter also provides guidance with regard to the use of borrower credit scores to assess a borrower’s credit risk. For instance, FHA has determined that borrowers with decision credit scores below 500 and with loan-to-value ratios at or above 90 percent are not eligible for FHA-insured mortgage financing. Such a provision appears to be HUD’s attempt to salvage some parts of its now-rescinded risk-based premium insurance program. (LINK)
Borrower Downpayment Requirement Increases for FHA-Insured Loans
Until the recent enactment of the Housing and Economic Recovery Act of 2008, FHA guidelines required borrowers to make a 3% cash investment in the transaction, which could include a downpayment and borrower-paid closing costs. This requirement will change effective January 1, 2009, and HUD recently released Mortgagee Letter 2008-23 to provide guidance to mortgage lenders regarding these changes. Notably, for all new FHA case number assignments on or after January 1, 2009, the Mortgagee Letter advises that a borrower must make a 3.5% cash downpayment, and closing costs may not be used to meet the minimum amount. Moreover, given the 3.5% downpayment requirement, the appropriate loan-to-value ratio for all purchase-money mortgages will be 96.5%. Thus, to determine the maximum mortgage amount for which FHA borrowers are eligible, lenders will be required to apply the 96.5% figure to the lesser of either (i) the appraiser’s estimate of value; or (ii) the contract sales price for the property (minus any required adjustments, such as seller concessions above 6% of the sales price). (LINK)
Broker Advisors No Longer Permitted in HECM Transactions
The Housing and Economic Recovery Act of 2008 also enacted provisions affecting Home Equity Conversion Mortgages (“HECM”), which are FHA-insured reverse mortgage loans. One such provision requires that all parties that participate in the origination of HECM loans must be approved by HUD.
While this language itself does not appear to be groundbreaking, its effect is sure to change the way many HECM loans are currently originated - namely, with the assistance of non-approved advisors. In response to the Housing and Economic Recovery Act of 2008’s HECM requirements, HUD recently issued Mortgagee Letter 2008-24, which effectively outlaws the use of non-FHA-approved advisors in connection with HECM transactions. It does so by rescinding Mortgagee Letter 2008-14, which HUD issued in May 2008. Beginning with case number assignments made on or after October 1, 2008, only FHA-approved mortgagees may participate and be compensated for the origination of HECM loans. As a result, the use and compensation of “advisors” in connection with the origination of HECM loans may no longer be permissible. (LINK)
Freddie Mac Underscores Requirements Related to Quality Control Reviews
On September 4, 2008, Freddie Mac released an Industry Letter to its approved sellers and servicers as a reminder of Freddie Mac’s requirements related to post-funding quality control underwriting reviews. Notably, the Industry Letter highlighted many of the timing requirements imposed on seller/servicers. For instance, if a loan is selected for a post-funding quality control review, the seller/servicer must submit the requested loan file to Freddie Mac within 15 days of Freddie Mac’s request. If Freddie Mac discovers any underwriting deficiencies with the loan, the seller/servicer has 30 days from the date of Freddie Mac’s request to take remedial action. Similarly, if Freddie Mac requires repurchase of a loan following a post-funding quality control review, the seller/servicer must appeal the action or else remit the repurchase funds within 30 days from the date of Freddie Mac’s letter requiring repurchase. Freddie Mac emphasizes in the Industry Letter that these requirements are not new ones. Rather, given the unprecedented times in the mortgage market, Freddie Mac expects to increase its quality control efforts. (LINK)
State Developments
Illinois Imposes Default and Foreclosure Reporting Requirements on Servicers
Many state regulators, such as those in New York and North Carolina, have begun imposing reporting requirements on mortgage servicers so that they can get a handle on the severity of loan delinquencies, defaults, and foreclosures, and perhaps an early warning before those borrowers get into trouble. With little prior notice, Illinois regulators joined those states, announcing new biannual reporting obligations on loan servicers. In addition to asking for statistical information about modifications, the reporting form asks servicers to provide narrative descriptions of such things as the servicers’ proactive loss mitigation steps, “including calls and mailings to borrowers" and "participation at community outreach events.” The first of these reports is due this week.
Massachusetts Applies Community Investment Regulations to Mortgage Lenders and Brokers
Community-type reinvestment provisions are common fare for depository institutions, but that has not been true for non-depository lenders, such as mortgage lenders and brokers. That has now changed in Massachusetts, where community investment regulations applicable to mortgage lenders and mortgage brokers became effective on September 5, 2008. The regulations implement a new provision of that state’s licensing law, which was passed as part of the state’s response to the foreclosure crisis.
The statute and implementing regulations subject Massachusetts mortgage lenders and brokers to standards that are very similar to those set forth in the federal Community Reinvestment Act of 1977 (“CRA”). Mortgage lenders and mortgage brokers will be assessed on their record of meeting the mortgage credit needs of borrowers in Massachusetts, including low- and moderate-income neighborhoods and individuals. The assessment will be based upon a lending test and a service test — but not an investment test — that are similar to those applicable to banks. A licensee’s community investment rating will affect the procedures for it to obtain approvals of any applications, including license renewals, establishment or renewal of any branch, and mergers and acquisitions.
The consequences of a poor record under the new regulations for a mortgage lender may be far greater than a poor CRA record for a bank. A poor record could possibly result in non-renewal of a license, which would force a mortgage lender to cease lending operations in Massachusetts. (LINK)
While the federal government continues to struggle with the foreclosure crisis, states are adopting a variety of approaches to slow down foreclosures in their communities. New Jersey is the latest to join the ranks of more than ten other jurisdictions that have enacted such laws during 2008, but the New Jersey law takes a novel approach by extending the introductory rate of an adjustable rate mortgage for 3 years.
Effective September 15, 2008, AB 2780, the Save New Jersey Homes Act of 2008 applies to certain borrowers with adjustable rate mortgages who have received a foreclosure notice with respect to their principal residence and whose introductory rate or rate reset terms meet defined criteria. To be eligible for this three-year rate relief and the statutory suspension of foreclosure proceedings, the borrower must, among other things, certify that he or she does not have sufficient income to pay the monthly payments after the rate resets, and agree to repay all deferred interest at the time the mortgage is paid off. The Save New Jersey Homes Act of 2008 requires creditors to send written notices containing prescribed language and carries significant penalties for willful violations of its terms. (LINK)
State Foreclosure Prevention Working Group Issues Data Report #3
The State Foreclosure Prevention Working Group, a multi-state group made up of state attorneys general and state banking regulators, recently issued its third report on the performance of subprime mortgage servicing, calling the evidence “profoundly disappointing.”
Over the past year, the Working Group has been collecting data from servicers on a monthly basis. Their latest report finds:
- that the majority of seriously delinquent borrowers are not on track for any loss mitigation,
- the use of short sales is increasing while loan modifications are on the decline,
- 20% of loan modifications made in the past year are currently delinquent, and
- foreclosure rates remain high.
According to the Working Group, “[s]ervicers appear to have reached the ‘low hanging fruit’ of subprime loans facing interest rate resets, while not developing effective approaches to address the bulk of subprime loans which are in default before interest rate resets.” This has led to property value declines and additional losses on mortgage loan foreclosures, according to the report. Given the number of ARM loans facing reset over the next two years, the Working Group predicts another wave of preventable foreclosures.
With the exact terms of a federal bailout plan uncertain at the time of this writing, this report may fuel a more aggressive implementation of a foreclosure mitigation program at the federal level should a bailout plan be enacted. A copy of the report is available here.
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