What You Don’t Know about Your Mortgage Partners Can Hurt You and Your Members
In a classic case of closing the doors after the horses have fled and arsonists have set fire to the barn, we have all discovered that lax oversight opens the door to unsafe and abusive lending practices, with far-reaching consequences for borrowers, lenders, the financial markets, and, it seems, the broader economy. If the subprime fiasco has done nothing else, it has proven once again what most of us already knew: Bad actors thrive in a loosely monitored environment. The likely response is also predictable - expressions of shock and outrage followed by a torrent of new policies, new laws and new regulations designed to ensure that this outrageous behavior, which we've seen before in different forms but similar circumstances, will never occur again.
Credit unions will maintain that the subprime mess has little to do with them because they didn’t make these loans to begin with, and they will be right, but only partly right. It’s true that most credit unions didn’t originate the questionable no - documentation, no-interest, “neutron” loans (they destroy borrowers and investors but leave the properties standing) that have rattled the markets and awakened the regulators. But all financial institutions, including credit unions that never touched sub-prime loans, will be affected by the economic aftershocks and the regulatory fallout to come.
Brace yourselves. Underwriting standards will be more restrictive, consumer protection requirements will be more expansive, disclosures will be more extensive, and all lenders will have to know a lot more about the third parties that originate and/or sell mortgage loans on their behalf. You’re not going to be able to buy loans from, or fund loans through, any Tom, Dick, or Harry who wants to “help” you provide mortgages to your members. You’re going to have to assess the credentials and competencies of those Toms, Dicks, and Harries first.
Need to Know
These due diligence expectations, which will almost certainly be codified in regulations or laws, haven’t gotten much attention, but they may be among the most significant of the changes the subprime mess will bring. Far more than in the past, what credit unions don’t know about the third parties with which they do business will have the potential to hurt them financially and professionally.
When it becomes clear that the mortgage broker who misappropriated borrower funds, or the mortgage company that failed to fund closed loans has no assets, the borrowers and regulators will start looking for deeper pockets to sue. And the credit unions doing business with these failed or fly-by-night entities are going to be on that hit list.
You’re going to have to find ways to tell the good guys from the bad guys, and there are plenty of both - good guys and bad guys - in this business. All mortgage brokers and all mortgage companies are not created equal. They are not equally capable, equally ethical, equally professional, or equally well-capitalized. How do you distinguish among them? The licensing requirements are a good place to start. You only need assets of $25,000 to set up shop as a mortgage broker in Massachusetts and $100,000 to operate as a mortgage company. But it takes a minimum net worth of $250,000 and usually $500,000 to win approval as a Fannie Mae or Freddie Mac seller-servicer.
Financial strength is no guarantee that a company is competent or will behave ethically, to be sure. You can find many examples to illustrate that sad fact. But a company with $500,000 in assets has more at risk and so is less likely to play “fast Eddie” with borrowers’ funds than a mortgage broker whose assets consist of a dozen maxed-out credit cards and a second-hand desk.
Because of the standards Fannie and Freddie set and the due diligence they perform, seller-servicer status is a reasonable threshold requirement for your partners, and not only because of the capital requirements they must meet. Fannie and Freddie also consider the reputation and experience of their seller-servicers and require them to have appropriate insurance as well.
Are They Covered?
Insurance is particularly important, not only as a financial buffer if something goes wrong, but as a means of evaluating the companies soliciting your business. Insurers will want the entities and individuals they insure to have in place policies and procedures that are likely to keep them out of trouble - policies and procedures that will protect you and your members as well.
You want mortgage brokers and mortgage companies to have three types of insurance coverage:
- Mortgagee Errors and Omissions, covering errors resulting from specified problems in the servicing of loans, for example, failing to pay the borrower’s real estate taxes, improperly recording documents, or failing to release funds as required at closing.
- Fidelity coverage, insuring against losses caused by dishonest employees or third-party contractors.
- Professional Services Liability coverage offering protection for errors and omissions in the marketing, origination, underwriting, and closing process – areas that aren’t typically covered by the standard Errors and Omissions policy. This comprehensive coverage targets, among other problems, violations of federal laws (such as the Real Estate Settlement Practices Act, the Truth-in-Lending Act, the Equal Credit Opportunity Act, and the Fair Housing Act); errors in calculating ARM adjustments; and errors in processing loan assumptions and handling loan defaults.
If an insurer is willing to provide these coverages to a mortgage broker or a mortgage company, that tells you something about those entities. The reverse is also true; if mortgage brokers or mortgage companies can’t obtain insurance or aren’t willing to pay for it, that tells you something about them too. One of the things it tells you is, you probably don’t want to do business with them.
It’s not just your financial health that you risk by doing business with financially unstable, unreliable, or unethical partners; it is your reputation and your relationship with your members. You’ve told your members they can rely on you, and they do. The member who ends up with an inappropriate or unaffordable loan won’t blame the mortgage broker who recommended it or the mortgage company that packaged and sold it; that member will blame you.
The subprime crisis occurred in part because a lot of mortgage brokers and no small number of mortgage companies were motivated solely by a desire to make as much money as possible on every loan they originated. That’s not why credit unions are in business. You’re not out to gouge your members, you’re out to do the right thing by them, and you want to be damned sure that any third party touching your mortgage business and touching your members shares your goals. You want to be sure these entities understand what makes credit unions different and you want to know they appreciate and value those differences as much as you do. You want your partners to have both the “right stuff” (adequate capital, adequate insurance, and high ethical standards) and the right attitude about credit unions and their members. If they do, you can be reasonably confident that the partners standing with you today will still be standing by you and standing by your members tomorrow. And if they don’t - you know as well as I do how this sentence ends. |
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