Insights

Last summer, just as the federal government began to grapple with the fallout of the subprime mortgage crisis, President Bush signed into law the Housing and Economic Recovery Act of 2008 (“HERA”). HERA includes the Secure and Fair Enforcement for Mortgage Licensing Act of 2008, more commonly known as the SAFE Act. The SAFE Act attempts to fix one of the problems that consumer advocates and regulators point to as a chief contributor to the subprime mortgage crisis – the lack of uniformity of standards for the licensing of mortgage loan originators. To this end, the SAFE Act aims “to increase uniformity, reduce regulatory burden, enhance consumer protection, and reduce fraud” by requiring states to establish a Nationwide Mortgage Licensing System and Registry for the residential mortgage industry that accomplishes the following objectives:

1. Provides uniform license applications and reporting requirements for state-licensed loan originators.

2. Provides a comprehensive licensing and supervisory database.

3. Aggregates and improves the flow of information to and between regulators.

4. Provides increased accountability and tracking of loan originators.

5. Streamlines the licensing process and reduces the regulatory burden.

6. Enhances consumer protections and supports anti-fraud measures.

7. Provides consumers with easily accessible information, offered at no charge, utilizing electronic media, including the Internet, regarding the employment history of, and publicly adjudicated disciplinary and enforcement actions against, loan originators.

8. Establishes a means by which residential mortgage loan originators would, to the greatest extent possible, be required to act in the best interests of the consumer.

9. Facilitates responsible behavior in the subprime mortgage marketplace and provides comprehensive training and examination requirements related to subprime mortgage lending.

10. Facilitates the collection and disbursement of consumer complaints on behalf of State and Federal mortgage regulators.

Essentially, the SAFE Act requires all states to enact legislation to establish licensing standards for loan originators and to license qualified loan originators through the web-based Nationwide Mortgage Licensing System and Registry (“NMLS”), launched in January 2008 by the State Regulatory Registry, LLC (“SRR”), a subsidiary of the Conference of State Bank Supervisors (“CSBS”). States whose legislatures meet annually must enact such legislation by July 31, 2009, while states whose legislatures meet biennially must act by July 31, 2010. As of March 31, 2009, six states had enacted SAFE Act legislation and all but 12 states and the District of Columbia had pending legislation. According to SRR, 24 states and Puerto Rico presently participate in the NMLS, which currently manages approximately 90,000 loan originators.

Although the SAFE Act accomplishes part of its purposes, including the long-advocated consumer protection position that licensing requirements for the mortgage industry should reach all the way down to individual loan originators, it does not succeed in other areas, mainly due to the creation of a dual system of loan originator standards.

The SAFE Act defines “loan originator” to include an individual who takes a residential mortgage loan application and offers or negotiates terms of a residential mortgage loan for compensation or gain. However, the SAFE Act segregates loan originators into two categories: state-licensed loan originators and registered loan originators. What’s the difference? Turns out, a great deal.

A registered loan originator means an individual that otherwise meets the definition of a loan originator, but who is employed by any of the following: (i) a depository institution; (ii) a subsidiary that is owned and controlled by a depository institution and regulated by a federal banking agency; or
(iii) an institution regulated by the Farm Credit Administration. The SAFE Act references the definition of depository institution under the Federal Deposit Insurance Act, which includes state and federal banks, and adds “any credit union.” A state-licensed loan originator is basically any loan originator, who is not a registered loan originator.

The SAFE Act sets certain minimum standards for the licensing and registration of state-licensed loan originators and registered loan originators. However, “registered loan originators” – that is, generally, the people who take the mortgage application at a bank or other depository institution – only have to submit to a background check that requires them to: (i) provide fingerprints for submission to the FBI and any governmental agency or entity authorized to receive such information for a state and national criminal history background check; and, (ii) provide their personal history and experience in some form, including authorization for the NMLS to obtain information related to any administrative, civil or criminal findings by any governmental jurisdiction.

In contrast, the SAFE Act mandates different requirements for state-licensed, non-bank loan originators. The SAFE Act requires states to establish “minimum” standards in enacting their state legislation, which includes far more extensive requirements for initial licensing as well as for maintaining a license. Those minimum standards include a background check that is similar to the one registered loan originators must undergo, but also include the following:

• Authorization to obtain an independent credit report from a consumer reporting agency; and information related to any administrative, civil or criminal findings by any governmental jurisdiction;
• Character and Financial Responsibility Requirements that include having: (i) never had a loan originator license revoked; (ii) never been convicted of, or pled guilty or nolo contendere to, a felony in a domestic, foreign, or military court during the 7-year period preceding the date of the application for licensing and registration; or at any time preceding such date of application, if such felony involved an act of fraud, dishonesty, or a breach of trust, or money laundering; (iii) demonstrated financial responsibility, character, and general fitness such as to command the confidence of the community and to warrant a determination that the loan originator will operate honestly, fairly, and efficiently; (iv) met either a net worth or surety bond requirement, or paid into a state fund, as applicable;
• Educational Requirements that consist of at least 20 hours of approved education, including at least 3 hours of federal law and regulations; 3 hours of ethics on, among other things, fraud, consumer protection, and fair lending issues; and 2 hours of training related to lending standards for the nontraditional mortgage product marketplace;
• Testing that requires a passing score of no less than 75% on a qualified written test developed by the NMLS, which measures the applicant’s knowledge and comprehension in appropriate subject areas, including ethics; federal law and regulation pertaining to mortgage origination; state law and regulation pertaining to mortgage origination; federal and state law and regulation, including instruction on fraud, consumer protection, the nontraditional mortgage marketplace, and fair lending issues; and,
• Continuing Education Requirements of at least 8 hours of annual approved continuing education, including at least 3 hours of federal law and regulations; 2 hours of ethics on, among other things, fraud, consumer protection, and fair lending issues; and 2 hours of training related to lending standards for the nontraditional mortgage product marketplace.

In addition to wide disparities between what the SAFE Act requires of state-licensed loan originators and registered, depository institution loan originators, the United States Department of Housing and Urban Development (“HUD”) approved a model state law intended to assist the states in passing legislation that complies with the SAFE Act’s minimum requirements, but which arguably enlarges the population of individuals engaged in the business of state-licensed loan origination. Under the model state law, for the purpose of state-licensed loan originators only, a “mortgage loan originator” means an individual who takes a residential mortgage loan application or offers or negotiates terms of a residential mortgage loan for compensation or gain.

Because HUD approved the language for the model state law in the disjunctive, some states (and frankly the CSBS) have taken the position that the bifurcation of the two definitional prongs permits the states to require the licensing of loss mitigation personnel in addition to an individual who receives an application for a new mortgage loan, which is the traditionally understood meaning of “loan originator.” However, that expanded definition would not apply to loss mitigation personnel employed by depository institutions. Other than possibly raising revenues for the state licensing authority, the position to extend the licensing requirements to loss mitigation personnel does not appear to advance the purposes of the SAFE Act or to address the immediate concerns that lead to its enactment, including curbing the sale of subprime and non-traditional mortgage products.

Further, the extension of the licensing requirement to loss mitigation personnel would likely cause the unintended consequence of slowing down the pace of loan modification assistance in the midst of the current economic and housing crisis. In fact, CSBS and the American Association of Residential Mortgage Regulators (“AARMR”), who co-drafted the model state act, have acknowledged that tension, stating in a letter to HUD that “[t]he consumer protection gains achieved through licensing or registering loan originators specializing in foreclosure mitigation efforts would be offset in this time of crisis by the potential loss of capacity of servicers to conduct loan workouts.” Because of this conflict, CSBS and AARMR asked HUD to delay the effective date for the licensing of loss mitigation personnel until July 31, 2011, presumably to allow loss mitigation personnel to focus on their jobs in the current crisis. However, that request appears driven, in part, by some states’ attempts to exempt loss mitigation personnel from their licensing requirements.

Although we do not yet know whether HUD will grant such an extension or whether it will find a state’s exemption of loss mitigation personnel as non-compliant with the SAFE Act’s minimum requirements, it is clear that the SAFE Act has saddled non-depository institutions with far greater operation costs and expenses than depository institutions, including the initial and annual state licensing fees, educational and testing costs, and the possible inclusion of loss mitigation personnel in each of the foregoing. Additionally, because the SAFE Act will mainly affect smaller business entities, it is likely that these extra costs will ultimately result in higher costs to consumers, which may be one of the unintended consequences of legislation designed to protect consumers. Finally, it is possible that those higher costs will drive consumers to potentially lower priced products offered through depository institutions, where theoretically consumers are less protected due to the fact that those loan originators have not been subject to the rigorous scrutiny applicable to state-licensed loan originators. Indeed, depository institutions might become safe-havens for loan originators that, for one reason or another, cannot pass such scrutiny at the state level.

Dana Frederick Clarke is a partner in the California office of Hudson Cook, LLP. Basis Points readers can reach Dana at 310-349-8433 or by email at dclarke@hudco.com.