REQUIRED READING: The second anniversary of the Dodd-Frank Act is coming up in a few months, and lenders and investors are still waiting for the other proverbial shoe to drop. It's hard to think of the current regulatory environment as a calm period, but the industry is in the eye of the storm: We are in a unique place where many regulations have been authorized or legislated, but the actual rules and details have not been announced.
Progress on the Dodd-Frank Act has been slow. According to the monthly progress report by law firm Davis Polk, as of the end of 2011, ‘a total of 200 Dodd-Frank rulemaking requirement deadlines have passed. Of these 200 passed deadlines, 149 (74.5 percent) have been missed [and] 51 (25.5 percent) have been met with finalized rules. [Twenty-five] of the 149 missed rules have not yet had proposals released.’
This means 2012 is shaping up to be a busy year for new regulations. Specifically, lenders are preparing now for changes to the Home Mortgage Disclosure Act (HMDA), Fannie Mae's Loan Quality Initiative (LQI), multistate exams and increased reporting requirements across the board.
What does this mean for the secondary market? The short answer is this: it increases the threat of buybacks. Buyback requests have many causes, but the most common is that the loan contains fraudulent information or the loan fails to comply with consumer-protection regulations.
While buybacks are often associated with loans that default within the first year, investors can also force buybacks of older loans if the note violates the representation-and-warranties clause. For most bankers today, the focus should be on ensuring that new loans meet all regulations and are attractive to investors.
One of the key themes in all the new regulations is an emphasis on better transparency. The mortgage world is transitioning into a process of instant compliance. Regulators are looking at more data for more loans, and investors are doing the same to better gauge the risk of mortgage-backed securities. Data is quickly analyzed by examiners in minutes, with outlier loans individually targeted for further review.
The Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act), which took effect in 2011, will continue to be important this year as an example of the type of data that is now being expected. Under the SAFE Act requirements, lenders holding a state license through the Nationwide Mortgage Licensing System are also required to submit a quarterly mortgage call report.
The report contains two major components: residential mortgage loan activity (RMLA) and financial condition. RMLA is due quarterly and includes application, closed loan, individual mortgage loan originator, line of credit and repurchasing information to be collected by states. The quarterly deadlines for RMLA to be submitted are Feb. 14, May 15, Aug. 14 and Nov. 14.
The financial-condition component requires the financial information at the company level to be presented annually within 90 days of a company's fiscal year end. A major concern is that regulators often are combining elements of multiple reports into new, broader reports, assuming the data all comes from a single system on the lender side. Since the most useful systems are often best-of-breed software, lenders should take steps to have software in place that will offer the ability to easily combine data from multiple systems and allow for scrubbing to ensure accuracy where conflicting data may exist.Â
Lenders will be required to report on every application and all activity completed by loan officers. This could require a great deal of labor and time to prepare. Investors are also interested in these reports, because they provide a quarterly look at a lender's activity and a snapshot of potential fraud or discrimination issues that might affect the loans purchased.
Since much of the data requested is already collected for HMDA reporting, lenders can use a similar process. However, it is essential that all the necessary data fields be completed, because missing information will require manual entry to ensure a complete report.
Since 2010, the Federal Financial Institutions Examination Council has been working to modify HMDA reporting. The main purpose of the reform is to add new data fields that would help regulators and consumer advocates better evaluate fair-lending efforts by lenders.
While the new data fields have yet to be officially announced, the Consumer Financial Protection Bureau is expected to add fields, such as applicant's credit score, credit score provider, appraised value, loan-to-value ratio, debt-to-income ratio, prepayment penalty months and total lender fees.
Lenders should also begin upgrading their geocoding and geomapping services. Beginning with the 2012 HMDA data collection – which will be reported in 2013 – lenders must also use the new 2010 census tracts. These tracts are dramatically different from the ones generated a decade ago. Out-of-date geocoding services could dramatically impact analyses of a lender's HMDA data.
Then there is the question of the government-sponsored enterprises (GSEs). Fannie Mae and Freddie Mac may eventually play a smaller role in the secondary market, but they are still the dominant source of investor funding for lenders.
Fannie Mae's LQI is designed to improve the quality of data collected and reported in all phases of the loan process. For lenders, the LQI outlines the data and underwriting standards needed to originate high-quality, lower-risk mortgage loans. The initiative also enables appraisers to produce electronic appraisal data files that are complete and consistent.
The voluntary implementation of the program's Uniform Loan Delivery Dataset has been delayed until April 23. All lenders will have to implement the standards by July 23.Â
Traditionally, lenders needed to submit to regulatory exams at the federal level for every state in which they operate. For those that serve multiple areas, this can mean a heavy exam load, with separate audits from each state board. The Conference of State Bank Supervisors (CSBS) and American Association of Residential Mortgage Regulators (AARMR) formed a committee in 2008 to transform the process of conducting state exams for lenders under the authority of multiple states.
Testing began in 2010, and a handful of initial exams were conducted in 2011. Most lenders can expect to see the new exam being applied in 2012. The Multi-State Mortgage Committee will be the overseer of the newly administered state-level exam process and has established a group of state examiners qualified to conduct a single exam covering the regulations of multiple states.
This first round of exams will be the most difficult, primarily because lenders are still working out the processes they need to comply with the new format. The first step lenders should take is education. The CSBS and AARMR websites have resources for understanding what the new examination process is and how it will be rolled out.
The next step is to select a method of creating the licensee examination file (LEF) and ensuring the file is ready for upload to regulators. LEF is the data format approved and accepted by the CSBS for use in a multistate exam.Â
Lenders should look for a compliance system that meets the RegulatorConnect standards. This certification is not required by the CSBS or AARMR, but the designation offers assurance to lenders that the compliance software will help them adapt to the new exam process. To date, eight companies have completed the certification, while two companies offer certified systems compliance with laws before the data touches the examiner's hands. Lenders should also ensure that the compliance system integrates smoothly with their loan origination software.
Secondary marketers should also strive to ensure there are no compliance surprises when the loan reaches the closing table and is ready for funding. The best compliance programs test loan files and applications at all stages of the workflow process – pre-funding, post-closing and during regular reporting. Superior compliance programs will be able to test for federal- and state-level regulations, in addition to ensuring compliance with both GSE and private-investor guidelines for the secondary market.
When selecting systems for the multistate exam, lenders should choose a compliance system that gives them the ability to test loans prior to export into LEF. These checks can be run on loans individually prior to closing or on a group of loan files in preparation for an exam. By proactively testing all of the loans, lenders will have a better idea of where potential trouble spots may be or if any errors are in the loan file.
The final step is to look for ways to consolidate the compliance process. The multistate exam will provide more thorough reviews of every loan, but by combining multiple exams into one review, lenders can also streamline their reporting process.
Lenders should integrate compliance checks on loans both pre- and post-closing. These checks will not only help at exam time, but also facilitate the sale of loans on the secondary market, because investors will be assured that the loans meet or exceed their standards.
Compliance software can ensure that the system is updated and compliant well in advance of new regulations, at the federal and state level. With another 200 deadlines still to come from Dodd-Frank, lenders will have their hands full keeping up with the changes. An automated system takes some of that burden off compliance staff.
In the end, lenders that proactively implement a compliance process that embraces automation will be more prepared when new regulations are enacted. While it is easy to get caught up in the next ‘compliance emergency,’ now is the time to tighten the data being collected and shore up testing processes. Anything less might result in a pool of unsellable loans or buybacks.
Leonard Ryan is president of Laguna Hills, Calif.-based QuestSoft. He can be reached at (800) 575-4632 or firstname.lastname@example.org.