Mortgage Banking Update by the Mortgage Banking Group

Developer May Not Extinguish Contractor’s Liens by Foreclosing on Its Own Mortgage, Florida Court Holds

A Florida appellate court recently rejected a real estate developer’s creative effort to shed its property of contractor’s liens. The court applied the venerable principal of mortgage law that a borrower may not extinguish intervening junior liens on its property by purchasing the senior mortgage on the property and then foreclosing on the mortgage.

In this case, both the developer and the entity that purchased the developer’s mortgage and attempted to foreclose were allegedly controlled by the same individual. A contractor that had junior liens on the property opposed the foreclosure, but the trial court rejected the contractor’s arguments and entered summary judgment in favor of the foreclosing entity.

The Florida Court of Appeal reversed. Citing prior Florida case law and the Restatement (Third) of Property (Mortgages) Section 6.4 (comment e), the appellate court explained that “[t]he law does not permit a person to borrow money from a bank, give the bank a mortgage, incur additional liens and junior mortgages on the property, purchase the mortgage back from the bank, and then foreclose on the mortgage for the primary purpose of eliminating the additional liens and junior mortgages.”

The court further held that the person cannot avoid this result simply by having a different but related entity act as the foreclosing entity. Specifically, the court explained that investors cannot “grant mortgages,” contract with a contractor “for the improvement of the property mortgaged,” and “then use a network of companies to purchase and foreclose the mortgage for the primary purpose of extinguishing the construction liens that increased the value of the property.” Otherwise, the court reasoned, a party would “receive a windfall in the form of the value of [a] Contractor’s labor, equipment, and materials that went into” the investors’ property.

After a detailed review of the record, the appellate court concluded that there was sufficient evidence for a jury to find that the same individual controlled both the developer and the foreclosing entity, and for the jury to find that the foreclosing entity was created for the primary purpose of thwarting the contractor’s ability to collect on its construction liens.

-Joel E. Tasca and Zaven A. Sargsian

HOA Lien Extinguishes First Deed of Trust in Foreclosure, Nevada Supreme Court Holds

On the heels of a recentD.C. Court of Appeals ruling, the Nevada Supreme Court issued an opinion last month holding that a homeowners association (HOA) lien is a true super-priority lien that, if foreclosed upon, extinguishes a first deed of trust. This ruling will affect how residential lenders underwrite and structure their loans going forward, and it will affect the long-term servicing of residential loans.

As noted in ourMarch 19, 2013, e-alert, HOAs were foreclosing on liens for assessments, and third parties were buying homes at the resulting foreclosure sales. Although it was generally accepted that the HOA’s foreclosure extinguished the homeowner’s title and interest in the home, the question of whether such foreclosure also extinguished a first deed of trust was up in the air.

InSFR Investments Pool 1, LLC. v. U.S. Bank, N.A.,the Nevada Supreme Court noted that the Nevada HOA lien statute is based on the Uniform Common Interest Ownership Act of 1982, and that the court could look to the drafters’ comments and the laws of other states to explain the Act. The court ultimately reasoned that a portion of an HOA lien was superior to a first deed of trust, and it rejected the first deed holder’s arguments that the HOA statute only provided a payment priority.

To support its analysis, the court found that notice of an HOA foreclosure sale must be given to junior lienholders, and to senior lienholders who ask for notice. The court reasoned that a junior lienholder can simply pay off an HOA lien or establish an escrow account to pay HOA dues. These two actions, if not provided for by the lender, result in an inequity of the lender’s own doing when the lender loses its first deed of trust.

In addition, the court rejected the first deed holder’s other arguments, including:

• That any super-priority HOA lien must be judicially foreclosed upon, as opposed to non-judicially foreclosed upon
• That non-judicial foreclosure of an HOA lien violates due process
• That a lender-savings clause in the HOA’s conditions, covenants, and restrictions—which explicitly subordinates an HOA lien to that of a first deed of trust—is ineffective, given that the statute does not allow the HOA lien scheme to be varied

Although the opinion holds that a non-judicial foreclosure by an HOA generally extinguishes a first mortgage interest, it leaves several other issues unanswered. For example, it does not address whether an HOA foreclosure is invalid if a first deed holder attempts to pay off the underlying lien, but the HOA refuses either to provide the amount of the lien or to allow the lender to tender payment. This is a common occurrence in Nevada, with some HOAs arguing that they are either prohibited or not obligated to provide the amount of the lien. The opinion also declines to address whether an HOA foreclosure is invalid if the sale is not properly noticed by the HOA.

Finally, another unanswered question is whether an HOA foreclosure is void as commercially unreasonable if the sale price is unreasonably low. Houses sold as HOA foreclosures typically sell for a tiny fraction of the market value of the property—usually $5,000 to $10,000. If such a sale can extinguish a first deed of trust, the lender is left with an enormous unsecured debt and the homeowner is left with an enormous deficiency judgment to the lender.

- Abran Vigil and Matthew D. Lamb

CFPB Issues First Enforcement Action for Servicing Rules Violations

The Consumer Financial Protection Bureau recently announced aconsent order with Flagstar Bank, F.S.B., alleging unfair acts and practices under the Consumer Financial Protection Act (CFPA) and violations of the CFPB’s Mortgage Servicing Rules. The penalties include $27.5 million in damages for harmed borrowers, a $10 million civil money penalty, a temporary restriction on the Bank’s ability to acquire additional default loan servicing rights, and a required compliance review and plan implementation.

Pre-Servicing Rules Violations

While this constitutes the first CFPB enforcement action for violations of the Bureau’s Mortgage Servicing Rules, the majority of the activity subject to the consent order occurred before January 10, 2014, when the rules took effect. The Bureau concluded that such activities constitute unfair acts and practices under the CFPA. A summary of those findings is provided below. The Bank did not admit any of the findings.

Failure To Timely Evaluate Loss Mitigation Applications

The CFPB found that from 2011 until 2013, the Bank failed to review loss mitigation applications in a reasonable amount of time. The order focused on the Bank’s inability to process its volume of loss mitigation applications due to insufficient staffing, lack of written policies, no quality assurance function, and inadequate servicing systems.

Interestingly, among the alleged unfair acts and practices, the consent order states that the Bank failed to meet “industry guidelines” for the timely evaluation of loss mitigation applications. The order alleges that the evaluation routinely took more than 90 days, while government-sponsored enterprise (GSE) guidelines require a review within 30 days. Accordingly, while the 30-day loss mitigation evaluation requirement under the rules was not yet effective, the Bureau took the position that a failure to meet the 30-day evaluation requirement imposed by the GSE constitutes an unfair, deceptive or abusive acts or practices (UDAAP) violation.

Failure To Inform Borrowers of Required Missing Documentation

The consent order alleges that from 2012 to 2013, the Bank failed to adequately inform borrowers of outstanding information required to complete a loss mitigation application. According to the CFPB, the Bank failed to send out missing documentation request letters, or delayed sending them, giving the borrower insufficient time to respond.

Improper Denial of Loan Modifications

The Bureau found that the Bank improperly calculated borrower income in loss mitigation evaluations, which resulted in incorrect modification denials. Regarding this alleged violation, the CFPB states that the Bank lacked a “systemized, controlled process for calculating borrower income.” The consent order cites findings from internal audit reviews, third-party audits, and GSE reviews.

Prolonging Trial Periods for Loan Modifications

The order states that the Bank improperly kept borrowers in trial loan modification periods, instead of permanently modifying the loans in accordance with investor guidelines. As an example, the order states that GSE guidelines entitle a borrower to a permanent modification after 120 days of trial payments. The Bank, however, allegedly kept borrowers in trial plans for 120 to 150 days from the first trial payment in some cases. According to the order, the prolonged trial plans resulted in an increased loan amount under the permanent modification, as well as unnecessary delinquency reporting to the credit bureaus.

Violations of the Mortgage Servicing Rules

Regarding activities that occurred after January 10, 2014, the CFPB alleges violations of the Mortgage Servicing Rules, namely the loss mitigation requirements under 12 C.F.R. § 1024.41. These alleged activities are generally continuations of the alleged unfair acts and practices discussed above.

Loss Mitigation Acknowledgement Letters

The order alleges a failure to provide a compliant loss mitigation acknowledgement letter within five business days of receiving an application, in accordance with 12 C.F.R. § 1024.41(b). The frequency of these alleged violations after January 10 is not made clear in the consent order.

Evaluation of Complete Loss Mitigation Applications

Regarding the Bank’s evaluation of loss mitigation applications after January 10, the order alleges violations of the 30-day evaluation requirement under 12 C.F.R. § 1024.41(c). Notably, the consent order alleges only one occurrence of an evaluation taking 90 days, and two occurrences of an evaluation taking 60 days. The order further alleges an insufficient explanation of denial reasons in the Bank’s evaluation letters. According to the CFPB, the Bank often used a blanket statement that the application did not meet investor guidelines, instead of specifying the criteria.

Failure To Notify Borrowers of Appeal Rights

The consent order alleges that the Bank incorrectly informed borrowers of their loan modification appeal rights in violation of 12 C.F.R. § 1024.41(c), (h). The order cites language in the denial notices that states that the borrower may be entitled to loss mitigation appeal rights only in certain states. Notably, in a subsequent section of the consent order, the CFPB also characterizes this activity as a deceptive act or practice in violation of the CFPA.

Failure To Maintain Reasonable Policies and Procedures

In alleging violations of the requirement to maintain certain reasonable loss mitigation policies and procedures, under 12 C.F.R. § 1024.38, the CFPB focuses on the Bank’s practical failure to issue compliant acknowledgement letters and evaluation notices. Regarding the actual content of the Bank’s policies and procedures, the order includes a brief statement that vague and contradictory guidance appeared in some places regarding the acknowledgement letter requirement.

Prohibition of Acquiring Additional Default Servicing Rights

The order prohibits the Bank from acquiring servicing rights for any third-party originated loan that is in default. For the purpose of this restriction, a loan is in “default” if it meets any of the following three criteria: the loan is at least 60 days delinquent; the borrower has applied for loss mitigation and the process is still pending; or the borrower is in active bankruptcy. In the event a loan goes into default after acquisition by the Bank, servicing activities must be transferred to a service provider within 10 days. To clear these restrictions, the Bank must implement a compliance plan detailed in the order.

Additional Provisions

The order includes a section imposing certain immediate requirements for the Bank to provide loss mitigation assistance to borrowers currently delinquent or in foreclosure. The Bank also must undergo an independent compliance management system review covering default loan servicing and implement the resulting compliance plan.

Analysis

It is not surprising that the CFPB’s first enforcement action under the Mortgage Servicing Rules pertains to alleged loss mitigation violations. Among the rules that took effect on January 10,2014, a failure to meet the loss mitigation requirements has the greatest potential for borrower harm. Surprisingly, the Bureau effectively enforced certain of these requirements, for violations occurring prior to the effective date, using its UDAAP enforcement authority.

It is also interesting to note the CFPB’s imposition of a provision restricting the bank’s ability to acquire additional servicing rights for default loan portfolios. Over the past six months, a variety of regulators have increasingly attempted to restrict or otherwise scrutinize servicing transfers before the transfer occurs. The Federal Housing Finance Agency has published heightened guidelines for approval of servicing transfers by the GSEs, and its Inspector General advocated even greater scrutiny for transfers to nonbank servicers. The CFPB’s recent bulletin also provides a framework for pre-transfer evaluation of a servicing transfer plan. This restriction on the bank’s acquisition of default loan servicing rights seems to be part of a growing regulatory trend for the industry.

The enforcement action should be a wake-up call to the industry that the CFPB is going to strictly enforce the Mortgage Servicing Rules and that servicers should confirm that they are in full compliance.

- John D. Socknat, Richard J. Andreano, Jr., and Reid F. Herlihy

CFPB Provides Guidance on the New Loan Estimate

On October 1, 2014, the CFPB staff and Federal Reserve Board co-hosted awebinar that addressed questions about the final TILA-RESPA Integrated Disclosures Rule that will be effective for applications received by creditors or mortgage brokers on or after August 1, 2015. The webinar focused on the Loan Estimate and addressed specific questions regarding the content of the Loan Estimate form that relate to corresponding provisions of the Closing Disclosure. Many of the issues covered were in response to questions received by the CFPB from mortgage industry stakeholders and technology vendors who need additional information to facilitate the development of compliance and quality control procedures and software.

The webinar is the third in a planned series to address the new rule. In the initial webinar, the CFPB staff provided a basic overview of the final rule and new disclosures. In the second webinar, the CFPB staff focused on core operation issues such as the receipt of an application, assumptions, fee tolerances, record retention, and timing for the initial and revised Loan Estimates.

According to the CFPB staff, this webinar and the ones that will follow will be in the format of a spoken Q&A. Although the CFPB staff does not plan to issue written Q&A, the staff believes this approach will help facilitate clear guidance on the new rules in an accessible way. As we have stated before, industry members would prefer formal written guidance. Among other concerns, the CFPB approach presents challenges to the ability of hearing-impaired individuals to benefit from the guidance.

During the webinar, the CFPB staff provided a high-level overview of the rule and answered more than 30 technical questions. Below is a summary of select questions of interest addressed by the CFPB staff. The topics covered include brokered transactions, origination charges, calculating cash to close, and the adjustable payment and adjustable interest rate tables.

Q:Does the creditor have to disclose an itemization of the amount financed with the Loan Estimate?

No. A creditor would not disclose an itemization of the amount financed with the Loan Estimate and Closing Disclosure. The CFPB also advised that some disclosures are required to be made only on the Closing Disclosure and not the Loan Estimate. These include some of the Fed Box disclosures, such as the amount financed and the finance charge. These disclosures are required to be on the Closing Disclosure in accordance with sections 1026.38(o)(2) and (o)(3), but are not required to be included on the Loan Estimate. However, note that even for the Closing Disclosure, the amount financed is not itemized. Section 1026.38(o)(3) requires that only the amount financed itself (which is calculated in accordance with section 1026.18(b)) be disclosed.

Q: When the sale price of the property is not yet known, does the creditor disclose a label other than “sale price” for the sale price on the Loan Estimate?

No. The label should state the sale price, and the label does not change when the creditor uses an estimated sales price as described in commentary section 1026.37(a)(7)-1. For transactions without a seller, such as a refinance, because there is no sale, the estimated value of the property is disclosed in place of the sales price, and labeled “property value” with “property” abbreviated as “prop.”

Q: If a broker is issuing a Loan Estimate but does not know the creditor, may the broker put its name on the form in place of the creditor’s?

No. Section 1026.37(a)(3) requires the name and address of the creditor, and a broker would not place its name and address where the name of the creditor is unknown. Commentary section 1026.37(a)(3)-2 addresses situations where the mortgage broker is making the disclosure and the creditor has not yet been determined. The comment provides that the broker must make a good faith estimate to disclose the name of the creditor, but when the name of the creditor is not known at the time the Loan Estimate is required to be delivered or placed in the mail, the mortgage broker may leave the creditor’s name blank. This does not allow the mortgage broker to substitute its name for the creditor’s name.

Q: Section 1026.37(a)(12) indicates that the creditor must disclose a unique loan ID number. If the creditor is unknown:

(A) Is the broker required to generate and disclose a unique ID number?

No. A broker would not be required to generate and disclose its own unique loan ID in a Loan Estimate, and assuming the creditor’s unique ID is not available to the broker, the disclosure may be left blank. The loan ID number must be a unique identifier that should be determined by the creditor. However, the rule does not prohibit creditors from outsourcing this function, and creditors could allow brokers to assign and generate unique IDs on their behalf. Creditors could also provide the unique loan ID to brokers in advance of the disclosures for them to include it on the Loan Estimate.

(B) Is the creditor required to disclose its own unique loan ID once there is a creditor for the loan?

Yes. The creditor is required to include a unique loan ID on any subsequent disclosures it provides, such as revised Loan Estimates or the Closing Disclosure. The creditor is ultimately responsible for the disclosures, and that includes providing its own unique loan ID.

Q: If a creditor charges an origination fee that is a percentage of the loan amount, but it is not a “point paid to the creditor to reduce the interest rate,” may the creditor identify it as a point in some way to preserve its tax deductibility for the consumer?

No. Section 1026.37(f)(1)(i) provides that only points paid to the creditor to reduce the interest rate may be labeled as points. The Loan Estimate form is meant to provide accurate disclosures to consumers, not to document eligibility for tax benefits or other purposes.

Q: Can the alternative cash to close table be used for multiple loan transactions without a seller?

Yes. The alternative table can be used where there are multiple loan transactions without a seller. To the extent there are multiple transactions, each loan covered by the rule will have a separate Loan Estimate and Closing Disclosure. At consummation, each Closing Disclosure will indicate the cash due to or from the consumer for each loan. In the rare scenario, involving a cash out refinance and a subordinate lien consummating at the same time, the settlement agent can total the cash due to and the cash due from the consumer across all of the loans to determine the final amount that is payable to or due from the consumer. This is a change from the existing use of the HUD-1-A form.

Q: Are the adjustable payments and adjustable interest tables disclosed for a fixed rate loan?

The adjustable payments table (APT) is used only when there are adjustable payment features. If there are no such features in the legal obligation the APT table is not disclosed. Accordingly, the APT table will only be disclosed if the fixed rate loan has adjustable payment features. The adjustable interest rate (AIR) table is only disclosed when interest rates can change, which would be contrary to the definition of a fixed rate loan. Therefore, the AIR table should never be disclosed with a fixed rate loan.

Q: Does the creditor need to disclose on the Loan Estimate that it will transfer servicing if the transfer is not immediate, but will happen at some later point in time during the life of the loan?

Yes. The creditor must disclose on the Loan Estimate that it will transfer servicing if the creditor’s intent at the time the Loan Estimate is issued is to transfer servicing at some point during the life of the loan. Section 1026.37(m)(6) requires disclosure of a statement of when the creditor intends to service the loan or transfer the loan to another servicer. This means that a creditor is required to disclose whether it intends to service the loan directly or transfer servicing to another servicer at any time after consummation. A creditor complies with the rule if the disclosure reflects the creditor’s intent at the time the Loan Estimate is issued.

Q: Does the creditor need to disclose on the Loan Estimate that it will transfer servicing if the transfer is to the creditor’s subsidiary or affiliate?

Yes. The creditor must disclose that it will transfer servicing, even if the transfer will be to a subsidiary or affiliate, if that is the creditor’s intent at the time the Loan Estimate is issued. As with the previous question, Section 1026.37(m)(6) requires a creditor to disclose a statement of whether the creditor intends to service the loan directly or transfer servicing to another servicer. A creditor’s subsidiary or affiliate is another servicer for the purposes of this requirement if it is a person responsible for receiving scheduled periodic payments from a borrower.

- Marc D. Patterson

CFPB Updates Reverse Mortgage Guide

The CFPB has announced that it has updated its reverse mortgage guide to reflect recent product changes. The changes concern the amount of money a borrower can draw in the first year and the ability of a non-borrowing spouse to continue to live in the home after the spouse who signed the loan passes away.

- Barbara S. Mishkin

CFPB Settles RESPA Charges for Marketing Services Agreements Allegedly Tied To Referrals

The CFPB has announced that it has entered into a consent order with a Michigan title insurance agency to settle charges that the agency violated the Real Estate Settlement Procedures Act (RESPA) by paying fees to various companies under marketing services agreements (MSAs) that were based on the referrals the agency received or expected to receive from such companies. The consent order provides that the agency does not admit or deny any of the CFPB’s findings of fact or conclusions of law except to admit the facts necessary to establish the CFPB’s jurisdiction.

The consent order finds that the agency entered into the MSAs with the understanding that the counterparties (who include real estate brokers, according to the CFPB’s press release) would refer mortgage closings and title insurance business to the agency. The order also finds that the agency:

• Did not determine or document how it determined a fair market value for the services it allegedly received under the MSAs
• Set the fees to be paid under the MSAs in part by considering how many referrals it had received from the counterparties and the revenue generated by the referrals and “in some cases” by considering what competing title companies would pay the same counterparties for such services
• Did not diligently monitor its counterparties to ensure it received the services for which it contracted
• Received significantly more referrals from counterparties when they had MSAs with the agency than when they did not

According to the consent order, the differences are “statistically significant and are not explained by seasonal or year-to-year fluctuations.”

The consent order requires the agency to pay a civil money penalty of $200,000. It also requires the agency to terminate any existing MSAs with companies in a position to refer real estate settlement service business to the agency and prohibits the agency from entering into new MSAs with any such companies. (An agreement under which the agency is to pay a person who does not provide settlement services to place advertisements to the public is not deemed an MSA unless such person endorses the agency as part of the advertisement.)

In addition, the consent order requires the agency to document “all exchanges of things of value worth more than $5.00” with companies in a position to refer settlement service business to it, including a description of all things of value exchanged and the reasons for the exchange. Such documentation must be maintained for five years after the exchange. The requirement to document such things of value is a new element for a CFPB RESPA consent order, and may signal an approach that the CFPB will seek to take in future RESPA Section 8 enforcement matters.

This consent order is the latest in a series of CFPB consent orders dealing with RESPA’s referral fee prohibition.

- Richard J. Andreano, Jr.

Oregon To Adopt Uniform State Test for MLOs

The Oregon Division of Finance and Corporate Securities is the latest mortgage banking regulator to adopt the National SAFE Mortgage Loan Originator (MLO) Test with a Uniform State Test (UST) effective January 1, 2015. It is the46th state agency that will no longer require a second state-specific test component to be taken by MLOs seeking licensure with its state agency. The National SAFE MLO Test with a UST first became available on April 1, 2013.

- Marc D. Patterson

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This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.