In the first part of this series, we explored the Consumer Financial Protection Bureau's announcement regarding mini-correspondents and what it actually means for those operating under that title. When you get down to brass tacks, the CPPB announcement really talks about two things: (1) the relationship between the mini-c, the warehouse line provider and the investor and (2) the operational requirements of a true mini-c entity.
Be clear, however, the CFPB's guidance governs not only the mini-c's actions. Also covered are requirements for the warehouse lender and the investor. From the CFPB's perspective, the table-funded, captive mini-correspondent model was characterized by an improper relationship between two or more of the three entities listed above to avoid broker-required points and fees restrictions. What's interesting in the CFPB’s notice is that it clearly outlines how the mini-c exam procedure will be realized. This guidance should inform not only correspondent lenders small or large, but also their warehouse provider and their investor.
Let's take a tour of the policy guidance and the specific examination questions projected by the CFPB in their own analysis of the compliance of the mini-c business model.
Beyond the mortgage transaction at issue, does the mini-correspondent still act as a mortgage broker in some transactions, either brokering to the same wholesale lender that supplies the warehouse line of credit or otherwise?
Market-wide, most mortgage banking business models retain some component of brokering because they are either unwilling to accept the credit risk (i.e. delegated underwriting) or because their warehouse line may not permit that loan, typically with niche products.
So, what distinguishes the mini-c's broker and banker transactions? The clarifying answer will be centered on risk. For the sake of example, let's say you have a business relationship with one of the larger banks, and they are both your investor and your warehouse line. Further, 90% of your production is sold as a mortgage banker and 10% as a mortgage broker, and that 10% is comprised of niche products only your warehouse lender/correspondent investor bank will buy. That is a legitimate defense of your business model. However, if "nothing" and a shrug is what distinguishes your broker and banker transactions, you should revisit the policy guidance and take a gander at your business model.
How many 'investors' does the mini-correspondent have available to it to purchase loans?
Quite often a captive line is characterized by a "closed-loop" transaction, whereby the warehouse lender and the investor represent the same interests loan production. Yes, the mortgage "banker" is originating the loans, but it is not a true secondary market transaction if the loan is required to be priced, underwritten, closed, funded, and post-closed by the investor as a requirement of extension of credit by the warehouse lender. The loan is never truly in the control of the originator. The veil, such as exists in this scenario, is fairly transparent. Clearly this would be categorized as a table-funded, broker relationship.
Granted, there are other more permissive variations of this closed-loop model. For example, some warehouse lenders only required a certain percentage of all loans funded on their provided line be sold to their preferred investor, such as the correspondent investor division of their own bank. However, this is also disallowed by the CFPB policy guidance. In the subtext of the guidance, the CFPB telegraphs an important message the loan has to be executed with a true secondary market transaction where the mini-c has control over their choice of best execution takeout.
Is the mini-correspondent using a bona fide warehouse line of credit as the source to fund the loans that it originates? Is the warehouse line of credit provided by a third-party warehouse bank?
The CFPB clearly wants to ensure the warehouse line is an extension of credit not just a tacit production channel for the investor. There are many banks with well-established warehouse lending channels from Texas Capital Bank to Southwest Bank to Santander to Alliance Bank. These banks are in the warehouse lending business and extend credit to mortgage bankers as a stand-alone banking product. This very clearly establishes the line as bona fide.
The follow-up question: How thorough was the process for the mini correspondent to get approved for the warehouse line of credit? The due diligence, commitments and covenants of a bona fide warehouse line are directly related to the mortgage banker's credit and financial strength. At issue will be the warehouse line provider performing due diligence on the mortgage banker's loan production with only a small nod to credit and financials. If the warehouse line is provided by an entity extending credit for the purpose of buying loans rather than extending one, the CFPB will certainly question its legitimacy.
Next issue: Does the mini-correspondent have more than one warehouse line of credit? Until 2008 or so, it was uncommon, and perhaps unseemly, for a mortgage banker to have more than one warehouse line of credit. When liquidity dried up, the industry's perception shifted dramatically. Now, having only one warehouse line is seen as a significant enterprise risk factor. While it is not definitive proof your warehouse provider relationship is captive, it certainly raises doubts about your ability to effectively function as an emerging mortgage banker.
So we need to ask, Is the warehouse bank providing the line of credit to one of, or affiliated with any of, the mini-correspondent's investors that purchase loans from the mini-correspondent? The word "affiliated" was a deliberate choice on the CFPB’s part to close any semantic loopholes. This isn't a de facto indictment, but it definitely shows the CFPB has thought their analysis through.
If the warehouse line of credit is provided by an investor to whom the mini-correspondent will sell loans to, is the warehouse line a captive line (i.e., the mini-correspondent is required to sell the loans to the investor providing the warehouse line or affiliates of the investor)? Here the CFPB specifically calls out captive lines, and this exam question strikes at the heart of the issue the CFPB is trying to address. Mini-correspondents are customers. The word "customer" implies choice. Choice does not enter the equation in a captive arrangement, nor does best execution for pricing or service. If your warehouse provider gives you no choice or only limited choice about where you sell the loans originated on their line, then it becomes pretty clear in to which camp you fall.
What percentage of the mini-correspondent's total monthly originated volume is sold by the mini-correspondent to the entity providing the warehouse line of credit to the mini-correspondent, or to an investor related to the entity providing the warehouse line of credit? The answer to that question will most likely determine whether you are designated as a captive mini-c and, therefore, a broker.
Finally, in determining the bona fides of your warehouse line, the CFPB wants to know does the mini-correspondent's total warehouse line of credit capacity bear a reasonable relationship, consistent with correspondent lenders generally, to its size such as its assets or net worth? If, for example, you are a mini-correspondent with $50 million dollars in available credit but only $35,000 in net worth, that doesn't paint a picture of a mortgage banker on its way to standing on its own two feet. What it does suggest is that credit was "extended" to obtain production.
What changes has the mini-correspondent made to staff, procedures, and infrastructure to support the transition from mortgage broker to mini-correspondent?
So far, the questions the CFPB has put forth are questions the mini-c, their warehouse lender and their investor should be asking themselves about the nature of their relationship. What this question gets to is how the mini-c has distinguished itself from its previous broker activity operationally. Think about it this way if you transition from being a handyman to a full-fledged home builder, it will change the way you operate your business and what tasks you are going to be required to perform.
If you haven't made any substantive operational changes, whether to buy it, build it or outsource it, then have you really transitioned at all? As a mortgage banker, the consequence of poor operational work is very real and very expensive. The old adage, brokers ask for permission, bankers ask for forgiveness speaks to the heart of the issue. It also harkens to more specific mandate from the CFPB documented policies and procedures.
Of course, there are other items that the CFPB's announcement on mini-c's. For mini-c's outside of the table-funded, captive model, the message from the CFPB is, keep doing what you were doing. You're fine, but please make sure you are handling standard compliance requirements, like HMDA and the issuance of 1098s.
In writing this, it often sounded like that old Jeff Foxworthy routine "you might be a table-funded, captive mini-c if..." At the heart of the CFPB's examination is determining whether a captive mini-c model exists in the relationship between the relevant parties by form or function. However, there is not necessarily a malicious intent in this investigation to catch table-funders in the act. What the CFPB hopes to find is that, as a mini-c, you are a participant in an authentic secondary market transaction and, therefore, exempt from mortgage broker compensation rules. If you ask yourself the questions outlined above and come to the conclusion that you were, unknowingly, operating a captive mini-c model, there are strategies that can assist you in getting back on the true mini-c track, which we will cover in our final installment.
Ruth Lee is executive vice president of Titan Lenders Corp., Denver. Prior to joining Titan, she owned and operated her own mortgage company. She has extensive experience in both loan origination and operations and was a 2007 participant in the Mortgage Bankers Association’s Future Leaders Program. She can be reached at firstname.lastname@example.org; the company’s web site is www.titanlenderscorp.com.