Mortgage Banking Update
In this issue:
- IP Economy – Intangible Assets as Collateral
- VA Issues Guidance on IRRRL Requirements
- VA Provides Interim Guidance on the Blue Water Navy Vietnam Veterans Act of 2019
- NMLS Ombudsman Holds Meeting at 2019 AARMR Annual Regulatory Conference
- CFPB Gives Boost to Use of Alternative Data and Machine Learning
- DOJ Files Amicus Brief With SCOTUS in FDCPA Statute of Limitations Case
- HUD Throws in the Towel on Down Payment Assistance Revisions
- HUD Publishes Proposed Revisions to Disparate Impact Rule
- Treatment of Models Under HUD’s Proposed Disparate Impact Rule: Our Thoughts
- Podcast: A Discussion of the CFPB’s Authority to Prohibit Abusive Acts or Practices
- CA Regulator Proposes Regulations to Implement New Law Requiring Consumer-Like Disclosures for Commercial Financing
- Did You Know?
- Looking Ahead
Intellectual property is an important, valuable, and often overlooked asset class that includes copyrights, trademarks, patents, trade secrets, and confidential information. Each category of intellectual property asset incentivizes innovation, spurs creativity, and boosts the economy by providing rights holders with an exclusive property right—an ability to invest in, build, and exploit a work, brand, or invention and exclude others from doing so for a period of time. When protected and enforced properly, the commercial value in IP can be great.
IP has always been a player in secured transactions, but because of its value, it could be the sole or primary source of collateral for lenders. And indeed, as we move from investing in physical assets to building on the cloud, the ability to navigate intangible asset-based lending is beneficial. Lenders can pool IP assets and issue a security backed by those assets. Before exploring a loan secured by IP, lenders should be aware of several issues:
In order evaluate whether an IP portfolio is valuable enough to secure a loan, lenders should obtain a detailed schedule on the types of IP alleged to be owned by the borrower. Work with an intellectual property attorney to independently audit a borrower’s IP portfolio to confirm, for example: owners of any claimed registered or unregistered rights, any outstanding and unresolved infringement claims, whether the IP rights are subject to an assignment or a license, and whether there are other security interests registered against assets in the portfolio.
Once you have a clear picture of the assets that comprise the IP portfolio, lenders should consider its commercial value—something not found on a company’s balance sheet. Undertaking an independent valuation of IP is the best way to determine how much lenders can lend against such assets, given that the highly specialized nature of IP requires expertise to understand and determine its value in the marketplace.
In the event that a borrower defaults, lenders should ensure that they will be able to dispose of the assets, and assess whether there is a potential market appetite. For instance, lenders should identity any potential investors or buyers to assess demand should the lender need to recover.
To protect veterans from loan churning, the Economic Growth, Regulatory Relief, and Consumer Protection Act (Growth Act) imposed additional requirements for Interest Rate Reduction Refinance Loans (IRRRLs) to be guaranteed by the U.S. Department of Veterans Affairs (VA), as previously reported. VA recently issued Circular 26-19-22 (which has three exhibits: Exhibit A, Exhibit B and Exhibit C) to consolidate and clarify guidance on the requirements, as well as to address the clarification of the loan seasoning requirement made by the Protecting Affordable Mortgages for Veterans Act of 2019.
VA emphasizes that the Circular addresses only IRRRLs and that lenders should not confuse VA guidance regarding cash-out refinance loans with the guidance provided in the Circular. VA also indicates that it has not updated its regulations for IRRRLs to reflect statutory changes and that “until VA publishes a final rule updating its IRRRL regulations, in instances where regulatory provisions unequivocally conflict with this Circular, this Circular constitutes VA’s interpretation of current policy.”
The Circular provides guidance regarding the fee recoupment, net tangible benefit, and loan seasoning requirements for IRRRLs. For IRRRLs originated on or after May 25, 2018 (the date VA initially issued guidance under the Growth Act) and before August 8, 2019 (the date of Circular 26-19-22) that do not meet the fee recoupment and loan seasoning requirements outlined in the Circular, lenders may take steps to cure the noncompliance without VA’s prior approval, provided that the cure does not result in any costs to the veteran. VA advises that lenders should keep detailed records of cure actions for VA examination in cases where VA conducts loan reviews or lender site inspections. The ability to cure regarding the fee recoupment and net tangible benefit requirements does not apply to loans for which applications are received on or after the date of the Circular. Additionally, due to the nature of the loan seasoning requirement, VA advises that remedial action is not available for that requirement.
Exhibit A to the Circular is a quick guide for compliance with the requirements in the Circular, and Exhibit B provides guidance on determining the fee recoupment period. VA advises in the Circular that lenders must twice present the veteran with a comparison of the existing loan and proposed refinance loan, and Exhibit C is a sample comparison disclosure.
The U.S. Department of Veterans Affairs recently issued Circular 26-19-23 to provide interim guidance on the provisions of the Blue Water Navy Vietnam Veterans Act of 2019 (Blue Water Act) that affect VA’s Loan Guaranty Service. The amendments made by the Blue Water Act will apply to loans that are closed on or after January 1, 2020.
The Blue Water Act increases the maximum VA guaranty amounts for purchase, construction, and cash-out refinance loans that exceed the Freddie Mac conforming loan limit. VA advises that for loans above $144,000, the maximum amount of the guaranty will be 25 percent of the loan amount, regardless of the Freddie Mac conforming loan limit. The Circular provides examples of how to calculate the maximum guaranty available for a loan in situations in which the veteran does and does not have the full entitlement available. (VA notes that for Interest Rate Reduction Refinance Loans, it will continue to guaranty 25 percent of the loan amount without regard to the veteran’s available entitlement or the Freddie Mac conforming loan limit.)
Based on changes made by the Blue Water Act, the Circular sets forth the funding fee rates that will apply for the most common types of VA loans for all veterans (i.e., regular military, Reserves and National Guard) for loans that are closed on or after January 1, 2020 and before January 1, 2022. Additionally, the Blue Water Act includes a waiver of the funding fee for members of the Armed Forces who are serving on active duty and provide, on or before the date of loan closing, a certificate or military orders indicating they were awarded the Purple Heart. VA advises that further guidance on what additional evidence may establish eligibility for the fee waiver will be issued in the future.
The Blue Water Act will permit VA fee panel appraisers to use third parties to obtain information. VA will issue guidance on this topic in the future. VA cautions that before it establishes policy on this topic, VA fee panel appraisers are not authorized to use third-party information.
An open meeting with the NMLS Ombudsman was held August 8, 2019 in San Diego in connection with the 2019 American Association of Residential Mortgage Regulators (AARMR) Annual Conference.
Among various topics addressed, one highlight included discussion of the anticipated pilot launch of the State Examination System (SES), which is a technology platform providing a new supervision tool in the NMLS to help facilitate information-sharing between state regulators conducting multi-state examinations. The stated goals of the SES are to provide a more consistent examination process between states and to standardize states’ request for information. The pilot program, which is set to begin on October 1, 2019 and run for three months, will be conducted with participants from several state agencies and companies. Upon conclusion of the program at the end of December, feedback will be collected from participants to determine whether the SES should proceed with a nationwide system.
Additionally, in response to concerns regarding certain limitations in the current version of the NMLS, the NMLS Ombudsman clarified that the redesigned NMLS 2.0 will be equipped with functionality to provide state regulators with varying levels of access to certain uploaded documents, depending on the type of document. With this feature, state-specific documents will be controlled to restrict access only to those states that require such documentation, instead of being available to all state regulators operating in the NMLS.
Other issues discussed during the meeting include CSBS’s interpretation of the temporary authority provision through its FAQs regarding the licensing of mortgage loan originators, and a new initiative by CSBS to streamline the licensing of branch office locations, among others.
A new CFPB blog post titled “An update on credit access and the Bureau’s first No-Action Letter” provides a boost to lenders using alternative data and machine learning in their underwriting models.
The Bureau issued its first (and so far only) no-action letter in September 2017 to Upstart Network Inc., stating that the CFPB had no present intention to take enforcement or supervisory action against the lender under the ECOA relating to the lender’s underwriting model, and especially its use of certain alternative data fields. The letter was conditioned on Upstart’s agreement to a model risk management and compliance plan that required it to analyze and address risks to consumers, and assess the real-world impact of alternative data and machine learning. In its blog post, the CFPB shares results provided by Upstart of simulations and analyses it conducted pursuant to that plan.
The results showed that Upstart’s model using alternative data and machine learning approved 27 percent more applications than a traditional lending model and yielded 16 percent lower average APRs. The expansion of credit access reflected in the results occurred “across all tested race, ethnicity, and sex segments” and “significantly expand[ed]” access in “many consumer segments,” such as “near prime” consumers, applicants under 25 years of age, and consumers with incomes under $50,000. The CFPB stated that “with regard to fair lending testing, which compared the tested model with the traditional model, the approval rate and APR analysis results provided for minority, female, and 62 and older applicants show no disparities that require further fair lending analysis under the compliance plan.”
In the blog post, the CFPB encourages lenders “to develop innovative means of increasing fair, equitable, and nondiscriminatory access to credit, particularly for credit invisibles and those whose credit history or lack thereof limits their credit access or increases their cost of credit, while maintaining a compliance management program that appropriately identifies and addresses risks of legal violations.”
The blog post concludes with the CFPB’s statement that it is “currently reviewing comments to its proposed No-Action Letter, Trial Disclosure, and Product Sandbox policies.” In September 2018, the Bureau proposed significant revisions to its “Policy to Encourage Trial Disclosure Programs,” which sets forth the Bureau’s standards and procedures for exempting individual companies on a case-by-case basis from applicable federal disclosure requirements to allow those companies to test trial disclosures. (Upstart’s no-action letter was issued under these procedures.) In December 2018, the CFPB issued proposed revisions to its 2016 final policy on issuing no-action letters, together with a proposal to create a new “product sandbox.”
The CFPB, in its July 2019 fair lending report, discussed supervisory reviews of alternative credit scoring models. It stated that in 2018, the Office of Fair Lending recommended supervisory reviews of third-party scoring models that would “focus on obtaining information about the models and compliance systems of third-party scoring companies for the purpose of assessing fair lending risks to consumers and whether the models are likely to increase access to credit. Observations from these reviews are expected to further the Bureau’s interest in identifying potential benefits and risks associated with the use of alternative data and modeling techniques.” The Bureau commented that while a significant focus of its interest is on how alternative data and modeling can expand credit access for credit invisibles, it is also interested in other potential direct or indirect benefits to consumers, “including enhanced creditworthiness predictions, more timely information about a consumer, lower costs, and operational improvements.”
The use of algorithmic models to assess credit risk or other objectives is specifically addressed by HUD in its soon to be released proposed revisions to its 2013 rule under which HUD or a private plaintiff can establish liability under the Fair Housing Act for discriminatory practices based on disparate impact even if there is no discriminatory intent. The proposed revisions include defenses that a defendant can use to establish that the plaintiff’s allegations do not support a prima facie case where the cause of a discriminatory effect is alleged to be a model used by the defendant such as a risk assessment algorithm.
Lawmakers are also focusing on the use of algorithms by consumer financial services providers. Earlier this year, the House Financial Services Committee established two task forces, one on financial technology and the other on artificial intelligence. Both task forces held their first meetings in June. Also in June, Democratic Senators Elizabeth Warren and Doug Jones sent a letter to the CFPB, Federal Reserve, OCC, and FDIC expressing concern that Fintech and traditional lenders using algorithms in their underwriting processes may be engaging in unlawful discrimination. The letter sought answers to a series of questions, including what the agencies are doing “to identify and combat lending discrimination by lenders who use algorithms for underwriting” and what analyses the agencies have conducted or plan to conduct regarding “the impact of Fintech companies or use of Fintech algorithms on minority borrowers, including differences in credit availability and pricing.”
Our weekly podcasts include an episode released in June titled, “Using artificial intelligence for consumer finance: a look at the opportunities and challenges.” In the episode, we discussed the opportunities and challenges created by the use of AI models in consumer financial services, including the benefits of explainable AI and its implications for the consumer financial services industry, especially for applications where understanding the model’s reasons for returning a score or decision are necessary. Click here to listen to the podcast.
The DOJ has filed an amicus brief in support of the defendant debt collector in Rotkiske v. Klemm, the case before the U.S. Supreme Court that hopefully will resolve a circuit court split over whether the FDCPA one-year statute of limitations (SOL) runs from the date of the alleged violation or starts upon a consumer’s discovery of the violation. The brief lists CFPB attorneys and DOJ attorneys (including the Solicitor General).
The FDCPA provides that “[a]n action to enforce any liability created by this subchapter may be brought in any appropriate United States District Court…within one year from the date on which the violation occurs.” In Rotkiske, the plaintiff alleged that the defendant violated the FDCPA by obtaining a default judgment against him based on service of a complaint at an address the defendant knew or should have known was incorrect.
An en banc U.S. Court of Appeals for the Third Circuit rejected the plaintiff’s argument that the FDCPA’s one-year SOL did not begin to run until he discovered the default judgment upon applying for a mortgage loan approximately five years after service of the complaint. Instead, based on the statutory text, the Third Circuit held that the SOL runs from the date of the violation. Unlike the Third Circuit, the Fourth and Ninth Circuits have held that the discovery rule does apply to the FDCPA’s one-year SOL.
The DOJ makes the following primary arguments in support of its position that the FDCPA SOL runs from the date of the alleged violation:
- The FDCPA’s plain text unambiguously makes the occurrence of an alleged violation the SOL’s starting point.
- SCOTUS has never adopted a general presumption that federal SOLs should be read to incorporate a discovery rule and even if such a presumption existed, it would be overcome by the FDCPA’s plain text.
- While equitable principles may sometimes warrant excusing a plaintiff’s failure to satisfy an SOL or preclude a defendant from asserting untimeliness as a defense, the plaintiff abandoned that argument on appeal and there is no basis to overturn the Third Circuit’s en banc decision based on equitable tolling. (The plaintiff had alleged that the defendant purposefully ensured that he could not properly be served and filed a false affidavit of service attesting that he had been properly served. The DOJ concedes that these allegations, if true, might warrant application of equitable tolling. It states that if SCOTUS were to conclude that consideration of equitable tolling is essential to proper analysis of the question presented, it should dismiss the writ of certiorari as improvidently granted.)
We have reported on the attempt by the U.S. Department of Housing and Urban Development (HUD) to impose new documentation requirements for down payment assistance provided by government entities to be used in connection with Federal Housing Administration (FHA) insured mortgage loans. For now, those efforts have come to an end.
Initially, HUD announced the requirements in Mortgagee Letter 2019-06. Significantly, the new requirements became effective for case numbers assigned on or after April 18, 2019, which was the date that the Mortgagee Letter was issued.
Next, in Mortgagee Letter 2019-07, HUD extended the effective date of the new requirements to case numbers assigned on or after July 23, 2019. HUD advised it extended the effective date to allow time for governmental entities to prepare the documentation described in Mortgagee Letter 2019-06. What HUD did not mention was that that CBC Mortgage Agency, which is an instrumentality of the Cedar Band of Paiutes Indian American tribe and operates the Chenoa Fund down payment assistance program, had filed a lawsuit in the U.S. District Court for Utah challenging HUD’s action.
Then, in July 2019 Judge David Neffer granted a preliminary injunction preventing HUD from implementing the requirements. Finally, in Mortgagee Letter 2019-10 HUD suspended the effective date of Mortgagee Letter 2019-06 until further notice. HUD also advised that mortgagees may continue to follow the guidance in HUD Handbook 4000.1 II.A.4.d.ii, which sets forth existing requirements regarding government-provided down payment assistance.
Now, HUD has thrown in the towel, at least temporarily, by announcing in Mortgagee Letter 2019-12 the rescission of all three Mortgagee Letters. HUD welcomes feedback from interested parties for a period of 30 days from the date of issuance of the Mortgagee Letter. Time will tell if HUD will make another attempt to impose the same type of requirements or seek to impose other requirements that it believes to be suitable alternatives.
HUD’s proposed revisions to its disparate impact rule were published in the Federal Register. Comments on the proposal are due on or before October 18, 2019.
Originally adopted in 2013, the rule sets forth the requirements for HUD or a private plaintiff to establish liability under the Fair Housing Act for discriminatory practices based on disparate impact even if there is no discriminatory intent. The proposed revisions include a new burden-shifting framework and other changes to reflect the 2015 U.S. Supreme Court ruling in Texas Department of Housing and Community Affairs v Inclusive Communities Project, Inc.
Under the proposal, a plaintiff would need to allege five elements to establish a prima facie case based on a claim that a policy or practice has a discriminatory effect, including that the challenged policy or practice is arbitrary, artificial, and unnecessary to achieve a valid interest or legitimate objective and that there is a robust causal link between the challenged policy or practice and a disparate impact on members of a protected class which shows the specific policy or practice is the direct cause of the discriminatory effect. As might be expected, HUD’s announcement that it was releasing the proposal was quickly followed by criticism of the proposal from consumer groups.
In its proposed disparate impact rule published in the Federal Register, HUD sets forth a framework for making (and defending against) claims of disparate impact under the Fair Housing Act. A new and unique aspect of the proposed rule–its treatment of mathematical models (like risk-scoring models used in the credit industry)–warrants a closer look.
In proposed section 100.500(c)(2), HUD provides three avenues of defense when a disparate impact claim is made based on the use of a “model … such as a risk assessment algorithm.” The proposed rule allows a defendant to prevail when it can establish any of three alternative defenses:
- If the defendant “[p]rovides the material factors which make up the inputs used in the challenged model and shows that these factors do not rely in any material part on factors which are substitutes or close proxies for protected classes under the Fair Housing Act and that the model is predictive of credit risk or other similar valid objective.”
- If the defendant “[s]hows that the challenged model is produced, maintained, or distributed by a recognized third party that determines industry standards, the inputs and methods within the model are not determined by the defendant, and the defendant is using the model as intended by the third party.”
- If the defendant “[s]hows that the model has been subjected to critical review and has been validated by an objective and unbiased neutral third party which has analyzed the challenged model and found that the model was empirically derived and is a demonstrably and statistically sound algorithm which accurately predicts risk or other valid objectives, and that none of the factors used in the algorithm rely in any material part on factors which are substitutes or close proxies for protected classes under the Fair Housing Act.”
Overall, the proposed rule appears to provide a relatively straightforward path for review of FHA disparate impact claims related to scoring models. For a model developed by the defendant itself (or for which it has information on attributes and performance), the first and third defenses would only require the defendant to show that it (or an objective and neutral third party) looked at the variables in the model, that none of them is a “substitute” or “close proxy” for a protected characteristic, and that the model as a whole “is predictive of credit risk or other similar valid objective.” Note that here, the assessment of predictiveness is on the model as a whole, not on any individual variable. This would seem to make fair lending testing much easier than a requirement that each attribute be shown to be predictive.
The second defense is interesting because it appears to be addressed to situations in which the defendant is using a model provided by a third party, and for which the defendant may not have access to information about attributes or performance. However, if the use of the model is an “industry standard,” the defendant is relieved from liability if it uses the model “as intended by the third party” that created it. It appears that the second defense could apply in a variety of situations, including when a mortgage lender uses the automated underwriting systems of Fannie Mae or Freddie Mac.
Although the thrust of these provisions seems to be a desire to provide a streamlined path for defendants to address disparate impact claims based on algorithmic models, the phrasing of the provisions still leaves some room for questions (and later interpretation). For example, the proposed rule does not define a “substitute” or “close proxy” for a protected characteristic, which invites divergent views on whether a particular model input is permissible or not. In addition, whether a model is provided by a “recognized third party that determines industry standards” seems to be somewhat ambiguous. Would it cover any scoring product offered by a large, national provider? Or is something more than that required to show that it is an “industry standard”?
We believe the treatment of models under the proposed HUD rule is a step in the right direction, but believe that the final rule would be made clearer by resolving these ambiguities. Regardless, the proposed rule would make it difficult for plaintiffs to advance disparate impact claims based on models, because it puts the focus where it should be: on whether the models directly discriminate on the basis of a protected characteristic, and whether they are predictive of credit risk or another business justification.
In this podcast, Alan Kaplinsky, who leads our Consumer Financial Services Group, interviews Todd Zywicki, a Professor of Law at George Mason University and leading consumer finance expert, on the CFPB’s authority to prohibit abusive conduct. After reviewing how the CFPB has used its authority, Todd shares his views on what abusive means, how it differs from unfair or deceptive, what products or services can involve abusiveness, how the CFPB can best provide clarity, and the CFPB’s likely next steps in the wake of its symposium (at which Todd was a panelist).
Click here to listen to the podcast.
The California Department of Business Oversight (DBO) has issued proposed regulations to implement SB 1235, the bill signed into law in September 2018 that requires consumer-like disclosures to be made for certain commercial financing products, including small business loans, merchant cash advances, and factoring. The law contains exemptions and carve-outs for, among other things, depository institutions, financings of more than $500,000, closed-end loans with a principal amount of less than $5,000, and transactions secured by real property.
Companies providing the types of financing covered by the law are not required to comply with the new disclosure requirements until the DBO’s final regulations become effective. Comments on the proposed regulations are due by September 9, 2019.
In addition to general formatting and content requirements, the proposal includes detailed provisions that address:
- Closed-end transaction formatting and content requirements
- Commercial open-end credit plan disclosure formatting
- Factoring disclosure formatting
- Sales-based financing disclosure formatting
- General asset-based lending transaction disclosure formatting
- Lease financing formatting and content requirements
- Signature requirements
- Rules for determining if the amount of commercial financing is equal to or less than $500,000
- Rules for disclosures for closed-end and open-end credit plans with payment options
- Rules for providing estimates
- Rules for calculating APR
- Components of finance charge
- Examples of asset-based lending and factoring transactions
The proposed regulations are accompanied by model disclosures for six types of financing: asset-based lending, closed-end transactions, general factoring, lease financing, sales-based financing, and open-end credit plan.
National Mortgage Policy Summit Set for November
AARMR and CSBS are hosting a National Mortgage Policy Summit for policymakers, regulators, and the industry on November 13, 2019 in Washington, D.C. The press release includes:
“The summit event will include keynote presentations and panels representing viewpoints on mortgage policy at the national level. Invited speakers include members of Congress, federal agency leadership, industry leaders, consumer advocates, state regulators and other policy stakeholders.
The U.S. housing market is experiencing an all-time high valued at $27.5 trillion, 15 % higher than the pre-crisis peak, marked by growing household equity, delayed purchaser entry, historically low interest rates and recovered housing values. However, the market has been constrained by supply and an increasing lack of affordability, impacting low to moderate income and minority home buyers and adding pressure to loosen underwriting standards. The mortgage loan market itself has held steady in the $10 to $11 trillion range for the last 12 years, indicating stability in this crucial sector of the US economy. But, since the end of the financial crisis the industry has seen a dramatic shift in market share of both mortgage originations and servicing from banks to nonbanks, coupled with increased borrower risk profiles and potential credit quality concerns in certain sectors.
Regulators, policy makers and other stakeholders are publicly and privately acknowledging and studying structural shifts in the industry. At the same time, Fannie Mae and Freddie Mac have been in conservatorship as federal policy makers and Congress remain focused on addressing the GSEs as part of larger reforms of the housing finance system.
State regulators have an important role and stake in these policy discussions. During the summit, CSBS and AARMR will share how state regulators approach risk management, enhanced prudential standards for nonbank servicers, the use of technology in compliance and supervision and the future of the secondary market.”
Find additional details on the summit here.
GLBA Safeguard Rule - FTC Proposed Amendments
RESPRO 2019 Fall Seminar | Charleston, S.C. | September 11-12, 2019
MBA’s Regulatory Compliance Conference 2019
Washington, D.C. | September 22-24, 2019
Speaker: Richard J. Andreano, Jr.
Speaker: Kim Phan
Speaker: Daniel JT McKenna
Speaker: Reid F. Herlihy
Speaker: Stacey L. Valerio
Speaker: John D. Socknat
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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.