On July 9, 2014, the Consumer Financial Protection Bureau (“CFPB” or “Bureau”) issued Policy Guidance on the issue of Mortgage Brokers Transitioning to Mini-Correspondent Lenders (“Policy Guidance”), which highlights risks and considerations that should be taken into account by brokers who may be considering or venturing into the mini-correspondent channel.
The Mini-Correspondent Model
Mini-correspondents are mortgage lenders that close the loans in their own name but that operate with limited net worth. Mini-correspondents fund mortgage loans using warehouse lines of credit, which are sometimes supplied by the entities that will purchase the loans. Mini-correspondents vary in size and structure, but many have leaner operations and staffing than lenders in other channels. Under some—but not all—arrangements, the investor may underwrite, condition, and issue closing instructions as is done in the broker/wholesale model
Mini-correspondent lending is becoming more and more popular. Among other things, it is viewed as an alternative to mortgage brokering, which faces increasingly heavy regulation. For example, compensation paid to a broker by a mortgage lender requires disclosure to the consumer, while compensation paid to a lender by a secondary market purchaser does not. Likewise, fees paid to a broker by the lender count towards the 3 percent “points and fees” cap imposed under the Dodd Frank Act, whereas fees from the sale of loans in the secondary market do not. Bona fide secondary market transactions are also exempt from RESPA.
Critics argue that many mini-correspondents are essentially brokers in all but name, and may lack important lender protections, such as the financial wherewithal to repurchase a problematic loan or the infrastructure necessary to safeguard against fraud and abuse. Some also see the model as an opportunity to circumvent rules and regulations applicable to brokers.
Others point out that while capital requirements may be lower, warehouse lines of credit require a mini-correspondent to meet certain thresholds in terms of finances and creditworthiness. A warehouse line means increased financial reporting obligations and due diligence reviews conducted by the warehouse lender. And while state requirements vary, many states have higher net worth and bond requirements for correspondent lenders than brokers. Mini-correspondents also typically have oversight by warehouse lenders and investors to ensure compliance and that closed loans satisfy mainstream investor guidelines.
The CFPB Weighs In
The CFPB’s concern in issuing the Policy Guidance is the possibility that some mortgage brokers may be setting up arrangements with investors in which the broker claims to be a “mini-correspondent lender” when in fact it is still essentially acting as a broker.
The CFPB states that brokers who merely choose to describe themselves as “mini-correspondent lenders” are not automatically exempt from laws and regulations that apply to brokered transactions—and, in the Policy Guidance, the CFPB sets forth criteria regarding how it will evaluate transactions involving mini-correspondent lenders to understand their “true nature” and to identify what players must comply with broker laws, regardless of how they may self-identify. The Policy Guidance states that among the questions the CFPB will consider are:
- Does the mini-correspondent still act as a mortgage broker in some transactions? If so, what distinguishes those transactions from its “lender” transactions?
- How many “investors” purchase the mini-correspondent’s loans?
- Does the mini-correspondent fund loans using a “bona fide warehouse line of credit”?
- Is the line of credit provided by a third-party warehouse bank?
- How thorough was the process to obtain approval for the warehouse line of credit?
- Does the mini-correspondent have more than one warehouse line of credit?
- Is the warehouse lender one of the investors that purchases loans from the mini-correspondent (or an affiliate of the investor)?
- Is the correspondent required to sell the loans to the warehouse lender (or its affiliate)?
- What percentage of the mini-correspondent’s total monthly originated volume does it sell to the warehouse lender (or its affiliate)?
- Does the mini-correspondent’s warehouse line capacity bear a reasonable relationship, consistent with correspondent lenders generally, to its size (i.e., its assets or net worth)?
- What changes has the mini-correspondent made to staff, procedures, and infrastructure to support the transition from mortgage broker to mini-correspondent?
- What training or guidance has the mini-correspondent received to understand the additional compliance risk associated with residential mortgage lending?
- Which entity is performing the majority of the principal mortgage origination activities?
- Who underwrites the mortgage loan and otherwise makes the final loan decision?
- What percentage of the principal loan origination activities (e.g., application, processing, underwriting) is performed by the mini-correspondent (or its “independent agent”)?
- If the majority of the principal loan origination activities are being performed by the investor, is there a plan in place to transition these activities to the mini-correspondent? What conditions must be met to make this transition (e.g., number of loans, time)?
The CFPB says that no single question necessarily determines how it will exercise its authority, and that it will consider the “facts and circumstances” of the particular mortgage transaction at issue. Unfortunately, however, while the Bureau has identified a list of questions, it does not give weight to them or indicate how many of the questions a mini-correspondent lender must satisfy or how the answers will be balanced, nor does it provide any illustrative examples. Many in the industry will bemoan the similarity of this Policy Guidance to the “sham” joint venture guidelines issued in 1996 by the Department of Housing and Urban Development under its former RESPA authority to analyze the “affiliated business arrangement” exemption.
A mortgage broker that is considering transitioning to a mini-correspondent must perform its due diligence. In today’s regulatory environment, this means not only investigating issues such as state law requirements in the states in which it does business and the demands of the relevant warehouse lenders and investors, but also assessing the issues raised in the CFPB’s Policy Guidance. The principles reflected in the Policy Guidance, while non-binding, will guide the Bureau in exercising its supervisory and enforcement authority, and potentially could be used in adjudicating RESPA’s secondary market exemption as well.
It remains to be seen just how the Bureau will apply this new guidance and there are numerous open issues, but the questions posed do afford some generalizations. The Bureau clearly would be critical of an entity whose operations and infrastructure for “lender” transactions did not meaningfully differ from its former or current “brokered” transactions. It will be interested in the warehouse lines of credit and whether they appear to be the result of arms-length transactions and to have fair market terms and adequate capacity for the business. The CFPB will be more critical of operations that involve a “captive” warehouse line. Conversely, having more than one line of credit and selling closed loans to more than one investor, including selling a meaningful volume of loan to third party investors that are distinct from the warehouse lender, appear to be preferable. The CFPB will expect robust lender compliance. Perhaps most significantly, the CFPB appears to view the mini-correspondent model as appropriate only to the extent it is part of a demonstrable transition to become a full correspondent lender.