Managing Surety Bond Requirements

QUESTION

As a stateside licensed mortgage lender in many states, I am frustrated with the process of manually managing the surety bond and related requirements. Are there any plans in place to automate this process?

ANSWER

A number of state laws and regulations require financial service licensees to obtain a surety bond as a condition of licensure. State regulators and consumers can file claims against a surety bond to cover fines or penalties assessed or provide restitution to consumers due to the failure of a licensee to comply with licensing or regulatory requirements.

Additionally, the SAFE ACT imposes the requirement of net worth or surety bonds. This requirement stipulates that mortgage loan originators obtain their own surety bond or be covered by an aggregate surety bond under the sponsoring company’s blanket coverage surety bond. Approximately forty-eight states require this bond as a condition of originating residential home mortgages. State regulators provide statutes and regulations that spell out the specific requirements that must be met and maintained in order to become licensed and remain licensed.

At this time, NMLS has 177 license authorities on the system that require surety bonds as a condition of obtaining and keeping a license.

NMLS functionality is currently limited to the uploading of a surety bond document but does not provide any solutions for tracking bonds or requirements for maintaining bond information that is validated by insurance companies or surety bond providers. The manual tracking of these bonds is very time consuming and requires hands-on monitoring and reviewing by agency employees resulting in processing delays of renewals and approvals of new licenses.

In the coming two years, NMLS plans to provide functionality that will dramatically change how industry and regulators handle bond requirements.

State regulators have the following expectations for NMLS Electronic Surety Bond (NEBS) functionality:

• Regulators will be able to track surety bond compliance;
• The process for regulators to make a claim against a bond will be streamlined;
• The surety bond forms and processes will be simplified;
• Reliance on paper surety bonds will be dramatically reduced by using electronic bonds;
• The monitoring and enforcement of surety bonds thresholds will be accomplished by relying on information on the NMLS system such as the Mortgage Call Reports; and,
• Automation of the process will also include automating reports, notifications, deficiencies and other related issues.

At this year’s NMLS Annual Conference, representatives from the Conference of State Bank Supervisors, state banking agencies and the insurance industry discussed some of the steps being taken to accomplish the objective of automating the process. A working group has been established that includes industry representatives and eight states.

Basically, only insurance companies and surety bond providers that are entitled in NMLS will be able to provide bonds to their licensee clients. It is anticipated that some states will need to modify their statutes, regulations and rules prior to opting into the electronic bond system.

The entitled companies will designate the appropriate bond in line with bond limits that will be made part of the entity’s record. Going forward, the bond will be continuous and information from the Mortgage Call report will be used to determine the adequacy of the bond amount.

While there are still some issues that need to be worked out, the automation process is well underway and all involved can look forward to the day in the not too distant future when the process will be automated.

Alan Cicchetti

Director/Agency Relations

Lenders Compliance Group

Escrow Cushion Limitations

QUESTION

Under RESPA, lenders are allowed to charge a cushion for maintaining an escrow account up to two months. Are there state laws that would be more restrictive? For example, are there states that will not allow any cushion at all or allow only up to one month cushion?

ANSWER

During the course of the loan, Section 10 of RESPA prohibits a lender from charging excessive amounts for the escrow account. Each month the lender may require a borrower to pay into the escrow account no more than 1/12 of the total of all disbursements payable during the year, plus an amount necessary to pay for any shortage in the account. In addition, the lender may require a cushion, not to exceed an amount equal to 1/6 of the total disbursements for the year. (The lender must perform an escrow account analysis once during the year and notify borrowers of any shortage. Any excess of $50 or more must be returned to the borrower.)

However, state law may impose more restrictive limits on the amount of cushion a lender may establish and maintain. As of today’s date, the chart below shows those states with express escrow cushion requirements:

Brennan Holland

Director/Legal & Regulatory Compliance

Lenders Compliance Group

AML Program for Residential Mortgage Brokers

QUESTION

I am a mortgage broker, one-man shop. I have been told that I must have an anti-money laundering program in place and have a test of the program conducted by a third party. Given that my company consists only of me, this requirement seems very onerous and expensive. Must I have such a program in place and, if so, what does it consist of?

ANSWER

Yes, as a mortgage broker, you must have an Anti-Money Laundering Program in place, regardless of whether you are a company employing 100 loan originators or a ‘one-man shop’.

The Bank Secrecy Act of 1970 (BSA, or “Act”) requires financial institutions to assist U.S. government agencies in detecting and preventing money laundering. Among the activities to be performed by a financial institution is the reporting of suspicious activity that might signify money laundering. The Financial Crimes Enforcement Network (FinCEN) is responsible for implementing and enforcing compliance with the BSA.

On February 7, 2012, FinCEN extended the requirement for an Anti-Money Laundering Program to include residential mortgage loan originators (RMLOs) as it was thought that RMLOs could fill a regulatory gap open to exploitation by criminals. RMLOs, as the primary providers of mortgage financing, deal directly with consumers, and are in a unique position to identify and assess money laundering fraud. Under the Act, an RMLO includes a “person who accepts a residential mortgage loan application, or offers or negotiates terms of a residential mortgage loan”, such as a mortgage broker. [31 CFR § 1010.100(lll)(1)(iii)]  The requirement became effective August 13, 2012. 

An RMLO’s AML Program, at a minimum, should consist of the following four elements: (1) policies, procedures and internal controls; (2) designation of an AML Compliance Officer; (3) on-going training; and, (4) an independent test.  A brief overview of each of these elements is set forth below. [CFR: Title 31, Subtitle B, Chapter X, Section 1029.210 (a)-(d)]

First, you must develop and implement policies, procedures and internal controls designed to limit and control risks and achieve compliance with the BSA. The policies and procedures should be based upon a risk assessment of your company, identifying the level of risk posed by your customers. Such an assessment should take into account your products and services, your geographic lending locations, and customer markets served by your company. Additionally, the Program should include sound policies and processes to verify your customer’s identity and information. The Program should also contain methods for identifying suspicious activity, such as a red flags worksheet, and the procedures to be followed upon discovery of such activity.

Second, the company must appoint an AML Compliance Officer, which in the case of your one-man shop, would be you. This individual is responsible for managing AML compliance at the company. The AML Compliance Officer must monitor the compliance of all personnel with your AML Program, update the Program as necessary, and ensure that all affected personnel are trained on the various AML components.

Third, training on at least an annual basis is essential. Any company personnel who handles any aspects of a residential mortgage loan transaction must be kept informed about both the BSA and its regulations and your company’s specific policies, procedures and processes. It is essential that should an employee identify a red flag, the employee must know the procedures to be followed in order to bring the matter to a resolution. Thus, in a small shop, it is most likely that training should be required of all employees.

Fourth, your company’s AML Program should require annual independent testing to verify the effectiveness of the Program. This testing is generally in the form of an audit and can be performed by a third party or a Company employee. If it is performed by a company employee, it cannot be performed by the AML Compliance Officer or anyone reporting to the AML Compliance Officer. The frequency of testing is risk-based. Generally, regulators recommend that the testing be conducted no less than every 12 to 18 months and the scheduling of the audit be done commensurate with the company's size, complexity, and risk profile. The findings of the AML audit may indicate the frequency of testing. A risk assessment and testing should be conducted as loan products, services, or your business changes.

Joyce Wilkins Pollison

Director/Legal & Regulatory Compliance

Lenders Compliance Group

Quality Control: Defect Rate

Question

What is an acceptable defect rate target? Has the mortgage industry set a maximum defect rate target that lenders need to adhere to?

Answer

No, at this point there is no acceptable defect rate standard established by the mortgage industry.  However, Fannie Mae requires lenders to establish a methodology for identifying, categorizing, and measuring defects and trends against established defect rate targets in order to effectively evaluate and measure its loan quality standards.

Defects are defined as findings, errors or mistakes found within the loan documents of a loan file. Findings found within the compliance documents are not included in the defect rate calculations.

The Gross Defect Rate is calculated by dividing the number of loans with defects by the number of loans in the Quality Control sample for the period being audited.

The Net Defect Rate is calculated by dividing the number of loans with defects (gross defects), minus the defects that have been corrected or cured, by the number of loans in the Quality Control sample for the period being audited.

Target defect rates need to be established as reasonably low as possible and based upon the current defect rates. 

Lenders should review the current actual defect rates obtained from their Post Closing Quality Control Audits and then set their Gross and Net Targets accordingly, for the purposes of improving the quality standards. Once the defect rate targets are set, a lender should develop procedures or an action plan to reduce the defect rates to the new target levels. Defect rate targets must be reviewed at least annually and reset, if necessary.

Bruce Culp

Director/Quality Control & Loan Analytics

Lenders Compliance Group