Some lenders get
so big that they think there is a need to set up remote processing, otherwise
known as back-office processing, or, to put it bluntly, a downsizing ploy the
purpose of which is to fire internal staff and hire external staff at a lower cost.
I see this happening particularly when margins get compressed and lenders look
for ways to cut.
It amazes me
still how loyalty is expected by employees but less so by employers. I’ve been
told it is a “profit over people issue.” But not really. After all, a competent
internal employee can offer the consumer a hands-on experience that is usually
not possible to achieve by remote back-office personnel. Catching a few extra
mazumah may lead to increasing the bottom line, but it can also cause a chain
reaction of decreasing morale, not only in operations but also in the entire
loan flow process from point of sale to securitization. In my view, people are
not replaceable widgets to be booted out for a few extra kernels of moolah.
There are even
back-offices that are remote – in the sense of very, very, very remote, as in
off-shore, as in way off-shore in India and elsewhere in the wide world. These
entities may have offices in the United States that give the look and feel of a
presence in this country, but the real work is done thousands of miles away.
Their USA offices are more like fronts for assuaging regulatory concerns. I am
not suggesting that they are doing anything illegal per se. But, realistically, how does a lender exercise due
diligence for consumers’ non-public personal information and all the aspects of
privacy, when that lender never actually visits the remote location in some far-off
country to verify that such protection even exists? Just because a system is
digital does not mean it can’t be compromised.
Going further,
some lenders set up an affiliated back-office processing unit. But there is
much more involved than a simple ‘plug and play’ add-on. To set it up correctly
the financial institution should be carefully ensuring that various regulatory
factors are reviewed. Careful analysis must be done, which I call an undertaking,
so that we have considered all the ramifications. The review should be
documented, in the event that a regulator wishes to examine the relationship.
I will discuss
just one of multiple factors to take into consideration in the context of affiliated
back-office processing.
The factor I will
discuss is called “required use.”
Here’s an
important question: Is the lender required to
disclose the affiliated back-office relationship as an affiliated business
arrangement?
For the sake of
our discussion, by affiliated business arrangement I refer to “an arrangement
in which (A) a person who is in a position to refer business incident to or a
part of a real estate settlement service involving a federally related mortgage
loan, or an associate of such person, has either an affiliate relationship with
or a direct or beneficial ownership interest of more than 1 percent in a
provider of settlement services; and (B) either of such persons directly or
indirectly refers such business to that provider or affirmatively influences
the selection of that provider.”[i]
By required
use, I mean a situation in which a person “must use a particular provider of a
settlement service in order to have access to some distinct service or
property, and the person will pay for the settlement service of the particular
provider or will pay a charge attributable, in whole or in part, to the
settlement service.”[ii]
Offering
a package - or combination of settlement services - or the offering of
discounts or rebates to consumers for the purchase of multiple settlement
services does not constitute a required use. But any package or discount must
be optional to the purchaser. Also, the discount must be a true discount below
the prices that are otherwise generally available, and must not be made up by
higher costs elsewhere in the settlement process.[iii]
Let’s dive deeper to see where required use may come into
play in determining whether the Affiliated Business Arrangement (“AfBA”) disclosure
requirements apply. A person making a referral may not require the use of the
affiliated business provider, except a lender may require “a buyer,
borrower or seller to pay for the services of an attorney, credit reporting
agency, or real estate appraiser chosen by the lender to represent the lender's
interest in a real estate transaction, or except if such person is an attorney
or law firm for arranging for issuance of a title insurance policy for a
client, directly as agent or through a separate corporate title insurance
agency that may be operated as an adjunct to the law practice of the attorney
or law firm, as part of representation of that client in a real estate
transaction.” [iv]
But “required use” has a broader meaning than might be
expected.
Here's a fuller version of the explanation, cursorily rendered
above, per Regulation X:
Required use means a situation in
which a person must use a particular provider of a settlement service in order
to have access to some distinct service or property, and the person will pay
for the settlement service of the particular provider or will pay a charge
attributable, in whole or in part, to the settlement service. However, the
offering of a package (or combination of settlement services) or the offering
of discounts or rebates to consumers for the purchase of multiple settlement
services does not constitute a required use. Any package or discount must be
optional to the purchaser. The discount must be a true discount below the
prices that are otherwise generally available, and must not be made up by higher
costs elsewhere in the settlement process.[v]
Over the years, HUD’s initial rulings[vi]
have provided examples of required use of affiliated businesses, such as:
- A savings and loan association will not accept mortgagee’s title insurance from any source other than a wholly owned title insurance company. (The AfBA exception would not protect this arrangement.)
- A builder refuses to pay closing costs or discount points for homebuyers if the purchasers do not use the builder’s title and mortgage lending entities, whereas the builder pays closing costs or discount points for homebuyers who do use those entities. (The AfBA exception also would not protect this arrangement.)
- A home builder requires purchasers who finance the purchase of their homes to originate their loans using a broker with whom the home builder has entered into a loan origination and servicing agreement. (The AfBA exception would not cover this arrangement.)
- A real estate company restricts homebuyers from using title or closing agencies and mortgage lenders, other than companies owned by or affiliated with the real estate company. (The AfBA exception would not apply.)
- A lender requires borrowers to use an affiliated mortgagee for closing services.[vii] (HUD pointed out that the lender could not require the use of the affiliated mortgagee to fall within the AfBA exception.)
- A loan originator may not require the use of its affiliate for obtaining a tax service or flood certificate. (The AfBA exception would not protect this arrangement.)
- A builder/developer requires buyers to use a wholly owned subsidiary mortgage lender. If a buyer objects to using the lender, the lender insists on acting as a broker to locate another lender for the buyer and earning a broker fee. (The AfBA exception would not be available unless the builder/developer does not require the use of its subsidiary lender.)
- A law firm owns an abstract company that issues title insurance policies as an agent for a title insurance company. At the time of application, a lender discloses to the borrower that the law firm will represent the lender and that the borrower must obtain title insurance from a title insurance company selected by the law firm (presumably the abstract company owned by the law firm). (The AfBA exception is available to the law firm and its affiliated abstract company.)
An interesting issue with AfBA implications arises when the
lender hires an affiliated entity to perform back-office processing, such as
loan credit underwriting or processing.[viii]
So, to repeat the posed question, is the lender required to
disclose the affiliated back-office processing relationship as an affiliated
business arrangement?
The answer is that the lender does not allow the borrower to select the
underwriter or processor; however, if this is a required use, then the situation
would fall outside the AfBA exception.
Back in 1995 a report was published that illuminates this
issue succinctly. The Conference Report of the 1992 Housing and Community
Development Act, which included the 1992 AfBA revisions to RESPA, suggested the
answer in the following statement by Senator Donald Riegle:
“[The new language] is not intended
to prohibit lenders from contracting out all or a portion of their loan
origination services, including processing and underwriting services. … The
section is also not intended to require a lender to disclose to a borrower that
the lender is using a third party to perform such back office type loan
origination services provided that these third parties are not involved in the
referral or marketing of the lender’s services to the public. Similarly,
payments by a lender to such a third party contractor are not subject to
disclosure by this amendment. It is within a lender’s discretion to determine
how to manage its origination services."[ix]
The conclusion seems to be that lenders may hire affiliated
back-office service providers and AfBA disclosures are not required.
Alternative arguments – assuming the AfBA exception is a “safe harbor” rather
than the only acceptable way of setting up an AfBA – are provided by Section
8’s specific allowance of payments to contractors performing processing
services[x]
and the standard Section 8 allowance of reasonable payments for services
actually rendered.
In 2005, a federal district court in Florida held that
Section 8(b) clearly does not intend for lenders to be liable for employing
their servicing arms to service loans. The court granted a lender’s motion to
dismiss an action alleging that the lender imposed a $500 escrow waiver fee at
loan closing in violation of Section 8(b).[xi]
The complaint alleged that the escrow waiver fee violated Section 8(b) because services in connection with the fee
were provided not by the lender, Bank of America, but by a separate legal
entity, Bank of America Mortgage Corp., even though the fee was accepted by
the lender. According to the court:
Said the court:
“It is not a plausible
interpretation of § 8(b) that Bank of America, N.A. should be liable for
utilizing Bank of America Mortgage Corporation to service loans because the
relationship between the two entities is not one in which business is
“referred” from one entity to the next. As far as the Plaintiffs are concerned,
Bank of America N.A. and Bank of America Mortgage Corporation are the same
entity. Indeed, the mortgage documents attached to Plaintiffs’ Complaint reveal
that the Plaintiffs were to make monthly payments to “Bank of America Mortgage,
P.O. Box 17404, Baltimore, MD 21297-1404.” … Thus even [if] the Complaint
facially alleges that Bank of America, N.A. is a separate legal entity from
Bank of America Mortgage Corporation, the documents attached thereto reveal
that the companies were interchangeable for purposes of their transaction with
the Plaintiffs.”
An undertaking such as the foregoing review is
important to conduct before using an affiliated back-office entity. Without
such a review, it could be really quite detrimental to launch such a relationship. Maybe
the back-office relationship is unaffiliated, in which case it is critical to review in
detail all the aspect of the relationship through a careful consideration of the
applicable regulatory frameworks.
Whatever the result of a review, treat the
undertaking with care towards documentation, implementation, monitoring, and
testing.
[i] 12 USC § 2602 (7)
[ii] 1024.2(b)
[iii] Idem
[iv] 1024.15(b)2
[v] Regulation X, 12 CFR 1024.2(b); 12 USC 2602. In November 2008,
HUD revised this definition, but later, in May 2009, it withdrew the revision,
leaving the previous definition, as quoted here, in place. According to the
Federal Register notice, “HUD remains committed to the RESPA reform goals of
the November 17, 2008, final rule and concerned about some of the practices
reported by commenters, and will initiate a new rulemaking process on required
use.” [74 Fed. Reg. 22,822 (May 15, 2009)] HUD concluded that its revised
definition did not strike the right balance between HUD’s goals of enhancing
consumer protection consistent with the statutory scheme of RESPA and providing
needed guidance to industry participants. By leaving in place the prior
definition of “required use,” HUD obviously thought the prior definition could
be used to address some deceptive referral arrangements, even though it does
not achieve the enhanced consumer protections HUD sought with respect to
mortgage loans involving affiliated business arrangements. Now, under the CFPB,
new rulemaking would allow further refining of regulations on practices
prohibited under other RESPA provisions.
[vi] These rulings over the years were withdrawn, revised or clarified,
but can be traced all the way back to 1987.
[vii] The term “closing services” in this context refers to handling
the actual closing, not merely the back-office activities leading up to the
closing.
[viii] Regulation X, 12 CFR 1024.14(g)(1)(iii) expressly permits a
payment “[b]y a lender to its duly appointed agent or contractor for services
actually performed in the origination, processing, or funding of a loan.”
[ix] 138 Cong. Rec. S17910 (Oct. 8, 1992)
[x] Regulation X, 12 CFR 1024.14(g)(1)(iii)
[xi] Wydler v. Bank of America, 2005 U.S. Dist. (SD Fla. 2005)
