State action highlights LO licensing risks for direct mortgage lenders

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A common hope many advocates of direct mortgage lending have is that automated or remote strategies will allow them to produce loans more efficiently, using fewer highly paid loan officers.

But a preference for human intervention limits lenders' ability to do this, and a recent state regulatory action suggests there's potential to use nonbank LO licensing rules to further restrict those productivity gains.

Connecticut, in response to a whistleblower complaint, is alleging that direct lender 1st Alliance engaged in an egregious use of support staff to handle licensable activity rather than using licensed LOs.

1st Alliance CEO John DiIorio says the company tried to comply, but finds Connecticut's interpretation a threat to efficiencies the company depended on and inconsistent with the way other states view licensing requirements. The company recently ceased funding but is hoping to recapitalize.

The two sides disagree on most points, but one of the few things they both concur on is that their dispute may not end with the administrative hearing on the matter that starts Tuesday.

In the meantime, the disagreement highlights potential risks lenders may overlook — that state interpretations of LO licensing rules could lead to staff changes with financial implications.

It's a concern in line with the pros and cons of licensing seen in several industries, where studies show that the regulatory scrutiny that provides consumer protection, and higher wages for licensed individuals, also reduces access to work and raises costs.

And it's a risk that could loom largest for small nondepository players, handing an advantage to larger banks.

Open to interpretation

Drawing up an exact definition of licensable activity for use in staffing direct lenders can be tough because state interpretations vary and often occur in the context of private supervisory matters.

While federal law makes it clear that taking an application, and offering and negotiating the terms of a loan for compensation or gain, are licensable, there can be state-level differences in what that means.

An appendix to the Secure and Fair Enforcement of Mortgage Licensing Act does recognize lenders will use unlicensed support staff to handle some tasks, and some examples of what tasks are given.

But even those examples are subject to interpretation.

For example, taking an application is defined as "receiving information provided in connection with a request for a loan to be used to determine whether the consumer qualifies for a loan."

That remains true even if the employee "is not engaged in approval of the loan, including determining whether the consumer qualifies for the loan," among other things.

On the other hand, the appendix suggests that receiving and passing on information to a loan officer, without reviewing it, can be done without licensing.

Taking an application does not include activities like "receiving a loan application through the mail and forwarding it, without review, to loan approval personnel."

And one of the exemptions from the definition of offering and negotiating the terms of a loan is "collecting information about a consumer in order to provide the consumer with information on loan products for which the consumer generally may qualify."

The prequal question

This latter example may be among the reasons why some lenders allow unlicensed employees to collect information for prequalifications, but not preapprovals.

"A prequalification letter is basically marketing material. It does not even require a full 1003. So based on very limited information, the lender is saying, 'you may qualify,'" said Tyler Moore, compliance counsel at origination technology provider SimpleNexus. "A preapproval letter, on the other hand, is an underwritten decision. It has been vetted and indicates a conditional commitment to lend. For obvious reasons, preapproval letters must issue from a licensed LO."

Connecticut alleges the way 1st Alliance compensated some of its unlicensed employees, allowed them to gather information, and allowed them to mark potential borrowers as prequalified prior to sending that information to an LO crossed the line into licensable activity.

The company defended its practices by comparing its unlicensed employees' work to an online mortgage platform's collection of information used to help LOs generate prequalification letters.

A parallel in the digital world

Some online lenders looking at the question of where they need licensed LOs involved in the origination process have looked to the TILA/RESPA integrated disclosure rule known as TRID.

1st Alliance, which runs a call center, did the same in responding to Connecticut.

Although it's a separate rule from the SAFE Act that governs nonbank LO licensing, TRID does define when an application is taken for disclosure purposes based the collection of six pieces of information.

"With the new technologies, what you have happen is folks go down the path of looking to the six loan criteria that make that application a real application," said Samir Agrawal, a vice president at consultancy Wolters Kluwer.

Because 1st Alliance's unlicensed employees "do not obtain the six pieces of information" they "do not have the information customary and necessary to extend an offer," DiIorio said in his response.

Whether this means today's digital mortgage platforms could be subject to the same kind of scrutiny remains to be seen.

Connecticut alleges other factors like compensation make 1st Alliance's situation unique, and the current level of technology was not contemplated at the time LO licensing rules were drawn up.

"I think a lot of the state regulations are written from the perspective that there's going to be a human being that's a licensed person originating a loan. So those regulations have not caught up with where I think the industry is quickly evolving to," said Dan Cutaia, an industry consultant and former lending executive.

Some regulators make allowances for technological advancements, but generally it's unlikely that automation will give lenders a pass when it comes to LO licensing requirements.

Early advocates of direct lending had hoped they might be able to originate without human intervention at all. But precedent from past call-center licensing actions suggest that loan officers generally have to be involved at some point in remote originations.

"The question was whether individuals in call centers in areas like India, Costa Rica or Detroit had to be licensed to originate loans," said Larry Platt, an industry attorney and partner at law firm Mayer Brown. "The answer usually was yes."

But getting a more specific sense of where to draw the line when it comes to what activity needs to be handled by a human because it's licensable could be trickier.

Technologies like a chatbot that represents a human and answers questions about a loan, for example, could be challenging to categorize, Platt said.

The upshot

Such licensing questions highlight risks for nonbanks reliant on staffing efficiencies like digital and direct lending that could be particularly taxing in the current market.

If lenders were operating with a surfeit of origination professionals relative to demand, it might be less of a concern.

But the recent refi boom has strained the availability of both LOs and support staff.

While nonbank licensing has raised salaries for LOs, and gets cited as an edge when it comes to expertise by nondepositories, it becomes a challenge when it comes to recruiting and cost management.

"If you're going to force companies to hire more LOs that will be especially hard on the small lenders," said Tyler House, manager of advisory services at consulting and accounting firm Richey May. And banks and larger players may benefit as a result from having less competition.

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State regulators Workforce management Licenses and charters Digital mortgages Consumer direct Nonbank Artificial intelligence Mortgage technology 1st Alliance Lending Connecticut