Monthly Archives: June 2019

Have You Considered These Compliance Issues When Originating Non-QM Loans ?

A few years ago, only a handful of intrepid originators,  aggregators, investors, and issuers were actively participating in non-QM lending. The rest of the market watched from the sidelines, convinced non-QM lending brought significant potential liability, was hard to learn and easy to get wrong, or was not worth the effort when there was an abundance of refinance business to be done.

Several years of declining volume and intense margin compression on traditional loans, combined with a newly-receptive investor  community, are changing the market’s perception of non-QM lending.

Today, non-QM lending is widely viewed as one of the few growth areas left in the market and one that is attracting more lenders and issuers. Overall, this is good news for previously nderserved market segments: the 16 million self-employed consumers in the U.S., the millions of borrowers who have been repairing their credit since the mortgage crash, and even the aging cohort of baby boomers who are sitting on nearly $30 trillion in assets.

Last year, Nomura estimated non-QM lending volume could grow to more than $100 billion within 10 years. Other observers have since suggested the addressable market for non-QM products could be as high as $200 billon. Increasingly, non-QM securitizations are becoming a growing part of the private-label RMBS market. S&P expects non-QM securitizations to double in 2019 from $10 billion to $20 billion.

Recent changes in banking law have made it easier for mid-size and smaller banks to originate products that used to fall into the non-QM category. And, new investors and different approaches to due diligence are helping banks and originators get more omfortable with non-QM. But, despite the growing acceptance and interest in non-QM, there are challenges inherent in the product, particularly the increased risk of buybacks, due to underwriting defects and real compliance issues that remain.


Generally speaking, a first mortgage can be classified as non-QM for several reasons: a debtto-income (DTI) ratio above 43 percent; an interest only (IO) or balloon structure; rates and fees above three percent; or, the use of alternative documents in its underwriting. Adjacent products, such as expanded credit, asset depletion, and some fix-and-flip loans are usually included in the non-QM category. Non-QM loans, similar to their QM counterparts, must include a determination of the borrower’s ability to repay (ATR).

For the past five years, the “GSE patch” (QM safe harbor for loans eligible for purchase by Fannie Mae or Freddie Mac) has allowed lenders to avoid non-QM classifications on high DTI loans and, to  date, more than 54 percent of the GSEs’ purchases exceed the 43-percent threshold. The patch, however, is an option only while the GSEs remain in conservatorship and is set to expire in 2021, regardless of GSE conservatorship status.

In 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act changed the non-QM playing field for banks with assets below $10 billion. Now far more mortgages, regardless of compliance with Appendix Q of the ATR rule, DTI and credit characteristics, can be deemed QM loans, if the bank holds them in portfolio.

It’s still too early to determine whether this new option makes non-QM lending more attractive to banks, but it certainly gives community banks more permanent leeway in originating products that used to be portfolio staples before the mortgage market downturn and subsequent recession. Similarly, it should help them serve the mortgage needs of highnet worth, retired, and self-employed customers who had been disadvantaged by QM rules. A strong case can be made that broader relationships with these customers put banks in a better position to make credit decisions with alternative documents like checking accounts, credit cards, auto loans, etc.

Prudent bankers that want to take advantage of the new portfolio lending option will most likely want to originate products that could eventually be sold to non-QM issuers. This means staying abreast with the evolving private non-QM market category, its guidelines, and this market’s zero-tolerance approach to compliance.

Banks that are used to “portfolio-ing” loans or selling to the GSEs may be surprised by the rigors of the due diligence processes being used by non-QM issuers. Depending upon the asset types, it is very common for non-QM issuers to do due diligence on 100 percent of the loans in a securitization, not just a sample. At a recent industry conference, a ratings agency showed a sample due diligence exceptions report for a non-QM/ non-agency private-label deal. The sample pool of 2,581 loans had three open exceptions for property, 89 for credit, and 6,805 for compliance!

While many of these exceptions were eventually cleared, the process was most likely time consuming, expensive, and painful.


From a compliance standpoint, a non-QM loan is generally subject to the same regulations as a QM loan, including TRID, HOEPA, Fair Lending, and state and local regulations.

Lenders participating in the private secondary market since the TRID rule effective date will most likely have better discipline for preventing TRID errors than their counterparts participating only in the GSE and FHA markets.

Incentives to review and correct errors in the private secondary market are immediate. Loans with material TRID errors can be rejected from the securitization pool, leaving the lender holding a potentially unsalable loan. Or alternatively, the loan is accepted but only with a lender guarantee or a setaside to mitigate future devaluation from compliance losses. But, even then, only larger lenders with substantial capital and wherewithal in the marketplace are typically permitted by ratings agencies, issuers, or underwriters to use these options.

While the CFPB has promulgated TRID “clean up” rules, which have had the effect of reducing identified TRID errors, lenders entering the non-QM market must still have good controls in place and consistent compliance. TRID disclosure timing and disclosure error correction issues continue to persist, even for current, seasoned, private secondary market participants.

Additionally, there are QM (and non-QM) related ATR issues that have not yet been clarified by the CFPB and could impact loan program underwriting guidelines. Arguably, there are more issues in the QM space than in the non-QM market, given some of the vague income qualification requirements in Appendix Q and the liberal use of GSE underwriting guidelines by some lenders to meet perceived “gaps” in Appendix Q. As a practical matter, loans or loan programs intended to be QM, but with structural defects causing them to not be designated QM, may still comply with the ATR rule, without the safe harbor status.

For non-QM loans, complying with the ATR rule’s eight borrower repayment factors is the only concern. ATR rule compliance can be easier to prove as a de facto matter for older non-QM loan programs with large data sets, which establish low historical default rates, so long as the lender considers and documents the eight ATR factors.

However, the ATR rule also has gray areas when it comes to non-QM loans. For example, how should a lender consider repayment factor 7 (vii) for the “consumer’s monthly debt-to-income ratio or residual income” for an asset depletion loan where there is no income? The CFPB specifically contemplated certain non-dwelling asset-based loans when issuing the ATR rule but factor 7 (vii) is in direct conflict with Factor 1 (i). Factor 1 (i) of the rule provides that the creditor must consider “the consumer’s current or reasonably expected income or assets, other than the value of the dwelling, including any real property attached to the dwelling, that secures the loan.” If the loan is underwritten solely based on assets, there is less certainty for how to comply with factor 7 (vii).

If designed properly, asset depletion loans have strong repayment track records, especially for retirees with large asset holdings but minimal income derived from those assets or other sources of income; for instance, large quantities of treasury bond holdings without enough total yield to support DTI ratios. Borrowers plan to sell off assets on an “as needed” basis at irregular intervals to support monthly loan payments. Asset depletion loan programs often require that borrowers hold enough assets to support at least five years or more of monthly payments, depending on loan type and features. The proceeds from these types of sporadic asset sales often cannot be characterized as income. In some cases, the borrower’s monthly income could be $0 with $0 residual income. In others, the borrower has an insufficient amount of monthly fixed government program income to support loan payments. In either situation, however, the borrower clearly has the ability to repay as a de facto matter given the amount and liquidity of the assets.


The first generation of non-QM loans were, for the most part, super prime and fully documented. They tended to fall into the non-QM category due to their size, DTI ratio, or structure: balloons, lOs, etc. But, the products are now rapidly evolving as the industry gets more comfortable with alternative documentation (bank statement), expanded credit and rental loans. The issuers are also changing. No longer is non-QM the province of specialty aggregators, REITS and private equity players; now, insurance companies, asset managers, and major money center banks are bringing new private-label offerings, backed by non-QM assets, to market.

To help keep pace with new product options and the ever-changing underwriting guidelines, some originators, including non-depositories, banks and credit unions, are outsourcing non-QM underwriting to recognized and experienced third-party fulfillment providers for loans to be sold on the secondary market. This approach can provide comfort for the originator and the investor. Both parties are subject to TILA liability and buyback demands. By using these fulfillment providers, some lessexperienced or smaller originators may find it easier to obtain approval from investors and warehouse lenders for participation in non-QM programs.

Investors, including the GSEs, are also moving loan reviews and due diligence closer to the point of sale. In the non-QM space, several active investors are using third-party underwriting fulfillment service providers to conduct pre-loan sale underwriting reviews on the non-QM loans they buy. The process is used to identify and clear conditions.

Recently, larger correspondent and wholesale lenders have also begun to do bank statement income calculations for their correspondents and brokers. These initiatives, and others like them, are giving both originators and investors greater confidence to originate and purchase non-QM loans. These efforts also help to educe the number of scratchand- dent non-QM loans in the market.

Since the QM rule went live in 2014, the industry has been waiting for the non-QM market to fully develop. 2019 is shaping up to be the year it does.

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Anti-Money Laundering – The Red Flags You Need to Know

Suspicious activity reporting is the cornerstone of the Bank Secrecy Act (BSA), according to the Federal Financial Institutions Examination Council (FFIEC). And, the FFIEC also states that “(i)t is critical to the United States’ ability to utilize financial information to combat terrorism, terrorist financing, money laundering, and other financial crimes.” Before a Suspicious Activity Report (SAR) is filed, it’s critical to first understand the process of how suspicious activity is identified.

While financial institutions utilize various methods to identify unusual or suspicious activity, such as automated and/or manual transaction monitoring systems, law enforcement inquiries, or National Security Letters. Perhaps the best method is you, the employee. Do you know what red flags to watch for as you interact with customers during the loan process? Do you know your financial institution’s procedures for reporting the identification of unusual or suspicious activity?

Red Flags

Red flags can be considered as examples of potential suspicious activity. However, it’s important to note that just because you may identify a red flag, it doesn’t necessarily mean that criminal activity has occurred. What does mean is that further scrutiny may be necessary. Your responsibility is simply to report the suspicious activity according to your organization’s procedures. More than likely, the BSA compliance officer or a committee will determine if a SAR should be filed.

Based on the FFIEC BSA/AML Examination Manual, Appendix F, here are examples of red flags of which you need to be aware as you work with loan customers and/or process loan transactions.
Customers Who Provide Insufficient or Suspicious Information

A customer uses unusual or suspicious identification documents that cannot be readily verified. A customer provides an individual taxpayer identification number after having previously used a Social Security number. A customer uses different taxpayer identification numbers with variations of his or her name.

A business is reluctant, when establishing a new account, to provide complete information about the nature and purpose of its business, anticipated account activity, prior banking relationships, the names of its officers and directors, or information on its business location.

A customer’s home or business telephone is disconnected.

Lending Activity

Loans secured by pledged assets held by third parties unrelated to the borrower.
Loan secured by deposits or other readily marketable assets, such as securities, particularly when owned by apparently unrelated third parties.

Borrower defaults on a cash-secured loan or any loan that is secured by assets which are readily convertible into currency.
Loans are made for, or are paid on behalf of, a third party with no reasonable explanation.
To secure a loan, the customer purchases a certificate of deposit using an unknown source of funds, particularly when funds are provided via currency or multiple monetary instruments.

Loans that lack a legitimate business purpose, provide the bank with significant fees for assuming little or no risk, or tend to obscure the movement of funds (e.g., loans made to a borrower and immediately sold to an entity related to the borrower).


Employee exhibits a lavish lifestyle that cannot be supported by his or her salary. Employee fails to conform to recognized policies, procedures, and processes, particularly in private banking. Employee is reluctant to take a vacation. Employee overrides a hold placed on an account identified as suspicious so that transactions can occur in the account.

Other Unusual or Suspicious Customer Activity

Customer repeatedly uses a bank or branch location that is geographically distant from the customer’s home or office without sufficient business purpose. The stated occupation of the customer is not commensurate with the type or level of activity. A customer obtains a credit instrument or engages in commercial financial transactions involving the movement of funds to or from higher-risk locations when there appear to be no logical business reasons for dealing with those locations.

Reporting Identified Red Flags

Your responsibility is simply to report the suspicious activity. Do you know what to do? What is the process to notify the right person? Be sure to know your financial institution procedures. The key is report, not prove that an activity or person is suspicious. You may even see a red flag outside of what the FFIEC has documented in Appendix F. Or, you may have a ‘hunch’ that something’s not right. The key is to report!

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Around the Industry:

Happening Now

The OCC posted its Semiannual Risk Perspective for Spring 2019. Highlights include:

Credit quality is strong when measured by traditional performance metrics, but successive years of growth, incremental easing in underwriting, risk layering, and building credit concentrations result in accumulated risk in loan portfolios.

Operational risk is elevated as banks adapt to a changing and increasingly complex operating environment. Key drivers for operational risk include persistent cybersecurity threats as well as innovation in financial products and services, and increasing use of third parties to provide and support operations that are not effectively understood, implemented, and controlled.

Compliance risk related to Bank Secrecy Act/Anti-Money Laundering (BSA/AML) is high as banks remain challenged to effectively manage money laundering risks.

Interest rate risk and the related liquidity risk implications pose potential challenges to earnings given the uncertain rate environment, competitive pressures, changes in technology, and untested depositor behavior.


CFPB & Recent RESPA Violation Fines – Learn From Another’s Mistakes ?

The CFPB recently announced that it settled with a large mortgage servicer for the servicer’s alleged violations of the Consumer Financial Protection Act of 2010, RESPA, TILA, and their implementing regulations. Under the terms of the consent order, the servicer must, among other provisions, pay a civil money penalty of $200,000 and pay restitution to affected customers estimated to be at least $36,500.

Most of the loans the company serviced are owned by Fannie Mae and Freddie Mac, and approximately 21% of the serviced loans were 60 days or more unpaid. Further, the servicer offers loan modifications to eligible borrowers suffering economic hardships under proprietary programs offered by Fannie and Freddie and, until December 2016, the Department of Treasury’s Home Affordable Modification Program (HAMP).

The CFPB alleges that the servicer violated the above-mentioned statutes by:

Handling mortgage servicing transfers with incomplete or inaccurate; loss mitigation information, which resulted in failures to recognize transferred mortgage loans with pending loss mitigation applications, in-process loan modifications, and permanent loan modifications; escrow information, which resulted in untimely escrow disbursements; Inadequately overseeing service providers, which resulted in untimely escrow disbursements to pay borrowers’ property taxes and homeowners’ insurance premiums;

Failing to promptly enter interest rate adjustment loan data for adjustable rate mortgage (ARM) loans into its servicing system, which resulted in the issuance of monthly statements to consumers that sought to collect inaccurate principal and interest payments; and Maintaining an inadequate document management system that prevented the servicer’s personnel or consumers from readily obtaining accurate information about mortgage loans.

In addition to its civil money penalty and restitution payments, the servicer must also: (i) update “its oversight and compliance management systems to promptly identify and correct potential servicing errors and violations of Federal consumer financial laws;” (ii) within 120 days of May 29, 2019—the date on which the Consent Order was issued—establish and maintain a comprehensive data integrity program to ensure the accuracy, integrity, and completeness of the data for loans that it services; (iii) “implement an information technology plan appropriate to the nature, size, complexity, and scope of the servicer’s operations;” and (iv) within 120 days after the implementation of the data integrity program and the information technology plan, obtain an assessment and report from a qualified, independent, third-party professional acceptable to the Enforcement Director which evaluates said program and plan according to specified factors. Additionally, the servicer must not voluntarily transfer or acquire servicing for loans in loss mitigation or with a loss mitigation application pending, subject to a long list of exceptions.


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