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Seeking common ground.

SEEKING COMMON GROUND

OVER THE PAST FIVE YEARS, STATE regulation of the mortgage banking industry has increased dramatically. Each year, more state legislature consider passing laws and regulations governing the licensing and examination of mortgage firms. As of year-end 1990, licensing laws had been adopted in some 38 states (and the District of Columbia and Puerto Rico), and bills to create licensing statutes had been introduced in several others. These laws also incorporate examination requirements in conjuction with licensing.

Many mortgage banking firms that are subject to licensing requirements operate in more than one state. As a result, these organizations are also subject to examinations by agencies in each of the states where they operate. Certain companies face the possibility of numerous separate examinations, all based on different fiscal years, all asking for different information. Since most state agencies bill for these examinations through actual expenses incurred, the potential time and expense to mortgage banking firms, as well as regulators, is enormous. In fact, many firms have already paid several thousands of dollars for one state's examination.

At a November 1988 organizational meeting of a new association of state mortgage regulators called the American Association of Residential Mortgage Regulators (AARMR), Virginia's Commissioner of Financial Institutions Sidney A. Bailey, stated that one of the association's primary objectives, if not its most important objective, must be to tackle and resolve the problem of examining multistate mortgage banking firms. As state regulation of mortgage banking has evolved over the last few years, both the industry and its state regulators have pledged to tackle this and other issues. Under the direction of John D. Seymour, Illinois commissioner of Savings and Residential Finance and founding president of AARMR, the association has begun work in three key areas of regulatory supervision and administration.

First, AARMR is attempting to developed consistent and compatible state legislation for the regulation and supervision of the residential mortgage industry. AARMR's Matrix of Minimum Licensing Law Standards Task Force was designed to begin a dialogue and review the process of current state statutory and regulatory standards governing mortgage lenders, servicers and brokers. The goal of the task force is to define minimum licensure standards for these entities. The task force is drawing upon the criteria that individual states have presently established for licensure, as well as the regulations implementing these state law standards. Though the task force is interested in categorizing common approaches to licensing, it is committed to the final goal of recommending a core of minimum standards that all states should consider when implementing new legislation or revising existing law.

On a second front, AARMR's Formalizing Regulatory Inter-Relationships and Clearinghouse Task Force was created to pursue efforts to provide information-sharing criteria among the state regulatory bodies, federal government regulators and those involved in regulation at Freddie Mac, Fannie Mae and GNMA. Discussions have been held concerning establishing minimum examiner and department standards and to make provisions for reciprocal enforcement activities.

This task force has also discussed existing communication problems and the need for improved formal communication among the various authorities. The discussions covered general and confidential information sharing, enforcement activities, application actions, ownership changes and criminal referrals. The legal and financial aspects of information sharing have been studied, as have the extent to which information should be available either on a public or supervisory level. Generally, the task force believes that the individual states have more supervisory control over entities because of specific licensing laws and regulations and, therefore, might be able to move more quickly (than their federal counterparts) against bad players in the industry.

In terms of priorities, the task force is preparing an outline of appropriate items to be included in a national directory of information, such as listings of all states involved in licensing, contacts, federal counterparts, licensees, authorities, formal administrative actions and so forth. The Task Force also is developing short- and long-form model agreements for inter-agency exchanges of supervisory/confidential information and is studying national problem shop procedures and the mechanics of establishing supervisory personnel and examiner standards.

Third, another task force was established to develop an examination report, standards, schedules, formats and procedures that could be used on a common basis by various states to monitor and supervise the activities of mortgage lenders, brokers and/or servicers operating in multiple states. The Core Examination Task Force, composed of chief state mortgage examiners, in consultation with representatives from the accounting profession and other interested parties, has offered to the mortgage industry for comment its draft of the "national" or "core" examination. After some further modification, it is anticipated that the core examination will be ready for use on a trial basis by the fall of 1991.

Generally, the comments received to date on the core examination have been mixed, both in favor of and in opposition to the examination. Although most state regulators view the core examination as a potentially useful tool in the ongoing supervision of multistate mortgage firms, many in the industry view the core examination as "redundant and expensive." In fact, some mortgage firms observed that the industry is over-regulated and over-examined at present and that the need for such an examination "has not been adequately demonstrated."

Whether or not the industry is over-regulated and/or over-examined will continue to be debated at length for some time. However, the underlying dilemma is that laws are now in place that require state agencies to routinely examine the affairs of their mortgage licensees. Accordingly, licensed entities operating in multiple states will be examined on a regular basis by different state agencies (all at different intervals) and likely at a substantial expense to the mortgage firm. The core examination is expected to reduce this duplication of effort and, in turn, reduce the costs of examination and regulation to the licensed firm, as well as to its supervising agency. The core examination should not be viewed as another examination, but rather as one consistent, comprehensive, coordinated and cost-effective examination.

Briefly, the core examination includes four basic components: 1) the core report composed of various questions requesting information such as the number of branch offices, ownership and so forth; 2) additional schedules as required by each individual state in which the mortgage licensee operates; 3) the Uniform Single Audit for mortgage bankers; and 4) the firm's external audit as conducted by a certified external public accountant. It is envisioned that the core examination will be used by different state regulatory agencies involved in the supervision of multistate mortgage banking and/or servicing firms. An examination manual is also being written to aid in the preparation of the core examination.

As those in the industry know only too well, many multistate mortgage firms have been subjected to numerous examinations and/or investigations by different state authorities. The time and expense of conducting and undergoing such an examination/investigation have reached unprecedented levels. For this reason, AARMR's core examination has, to date, drawn much attention and is expected to have a significant and immediate impact upon both regulators and the industry. For such an effort to be successful though, there must be identifiable similarities in laws and examination procedures, as well as a willingness among regulators to accept such a standardized product. The following paragraphs will focus on the reason why such an examination is warranted and feasible.

Recent published literature has identified similarities and differences in state legislation. Generally, commonalities exist in licensing requirements, exemptions to licensing, bonding and maximum capital requirements, and denial and revocation of licenses. Differences occur in the degree of licensing, bonding, capital and so forth and in the pattern of laws and opinions regarding prohibited practices. Inherently, because mortgage laws have been developed at the state (as opposed to the federal) level, a patchwork of conflicting legal requirements has developed, and the pattern is likely to continue.

However, the development of state laws licensing and regulating mortgage bankers and brokers is not coincidental. (For a more detailed study of these developments, see "Traps for the Unwary, Recent Legal Developments in Mortgage Banking," Mortgage Banking, October 1987, page 169, by Andrea Lee Negroni.) Similarly, the development of individual state examination reports and procedures is not coincidental. State legislatures, as well as state regulatory departments, have consulted, cooperated and used various statutes, procedures and processes of neighboring states. Thus, many laws and examination procedures have marked and noticeable similarities. In fact, Virginia's Mortgage Lender and Broker Act was patterned after those statutes passed in Connecticut and New York. In addition, Virginia's examination report and procedures were devised only after reviewing other states' reports and procedures, particularly those in Florida and New York. Illinois' examination procedures were developed after consultation with New York mortgage banking officials. Thus, it can be safely argued that each state's examination report and procedures have noticeable similarities, as do each state's laws.

Even with noticeable similarities in state law and examination practices, operating a mortgage banking, brokering or servicing business on a national scale is increasingly difficult. Operating such a business at this level requires knowledge of many requirements, both state and federal. Some multistate operations are challenged with obtaining as many as 12 (or more) different state licenses to engage in business, and are faced with the possibility of 12 (or more) separate examinations. To complicate matters further, the financial services industry as a whole has changed and will continue to change rapidly. Unfortunately, some believe the state regulatory environment for mortgage banking has not kept pace with developments in the industry. William F. Mack, a California attorney, submits that for California loans, state regulation has caused strains on the system that have in turn caused serious problems for interstate mortgage banking. (An assessment of the California situation is provided in "Regulatory Roadblock, California's Licensing Dilemma," Mortgage Banking, December 1988, page 45.)

Although it can be argued that development of any legislation at the individual state level (as opposed to the federal level) will inherently produce non-uniformity in laws and regulation, the review of mortgage banking literature as well as personal experience indicates otherwise.

To determine individual regulator's perceptions towards a uniform residential mortgage examination, a survey of 35 state regulators was conducted in early 1990. One of the primary purposes of the survey was to first ascertain the identity and number of regulators who must contend with out-of-state travel in order to conduct required mortgage examinations. Of the 26 regulators responding to the survey, 10, or 38 percent, indicated some out-of-state travel is now required for examinations. The number of required out-of-state examinations per state varied from 3 to 200 with the average being 59.6 per state. The costs of conducting these examinations also varied from a high of $15,686 to a low of $130, with the average ranging from $1,305 to $4,380. It should be noted that one eastern state indicated that most of its out-of-state examinations had been limited to neighboring states only, which has understandably kept its regulatory costs low.

With respect to the recovery of costs associated with an out-of-state examination, of the ten states indicating out-of-state travel was necessary, five disclosed that they charge the license holder for the actual travel expenses incurred during the examination. The actual expenses generally include prorated examiner salaries and benefits, travel, lodging, meals and so forth. The remaining five states varied in their methods for recovering costs. For example, in one state, the department pays all examination costs. In another, the license holder is billed $400 per examiner, plus out-of-pocket expenses. In yet another, the licensee is charged $100 per examiner day. In still another, the license holder is liable for $27 per examiner hour, plus expenses.

The survey also asked each regulator to identify what he or she considered the most important part of the state's laws and examination report and the minimum that each would require in a uniform, consolidated examination report. Each regulator was asked to check one of four categories: * financial analysis, * management analysis, * regulatory compliance, * other (specify).

Of the 26 respondents, 17, or 65 percent, indicated that examination for compliance with laws and regulations was the most important. Four respondents also checked either management analysis or financial analysis as important aspects. Only one respondent checked other and listed truth-in-lending, Federal Regulation Z, as an important part of that state's law and examination report.

Although it was hoped that the survey would get similar and definitive responses, the respondents gave a wide variety of answers when asked to identify strong and weak points in their laws and examination reports. In retrospect, this variety is to be expected, since each state's laws and examination report are still unique. A number of states indicated that the examination for compliance with respective state laws was the strongest point of their examination. Other responses included examination for escrow (trust) funds, licensing and punitive powers, the comprehensive examination report, response rate to complaints, charging of unlimited examination fees, consumer protection and prohibited practices.

The relative weaknesses of laws and examinations as identified by individual regulators included the failure to distinguish (define) between mortgage brokers and bankers, no mandate for examination, the ease of obtaining a license, limited enforcement provisions, failure to regulate servicing, failure to include compliance with federal laws, low capital requirements, small bond requirements and the lack of internal consistency on the individual-examiner level.

Finally, each regulator was asked to submit what he or she would require in a uniform, consolidated mortgage examination. The predominant response was that regulatory compliance with both state and federal laws must be monitored and checked, particularly in the areas of escrow accounts and truth-in-lending disclosures. Several regulators indicated that some form of analysis of the licensed entity's financial condition must be performed. (Note: this analysis is not generally performed since mortgage banking firms are not depository institutions and depositor funds are not at risk.) Other respondents were more specific and indicated that biographical information on the firm's principals, identification of the license holder's funding sources and some inquiry into consumer complaints would be helpful.

Perhaps the most important response to the survey was whether each regulator would be willing to accept a uniform, consolidated examination inclusive of other state's requirements. In the absence of a positive response to this fundamental question, any or all of the other findings or conclusions drawn from the survey would have been irrelevant. Sixteen of the 26 respondents. or 61 percent, indicated that they would be willing to accept such an examination. Only one respondent indicated "no," and two responded as "uncertain." The remaining respondents left this question blank, which perhaps was an indication that each was hesitant (or also uncertain) to commit. A blank response could be interpreted as a "maybe," pending further evidence with respect to the final outcome or product. Nevertheless, the overall response to this question was positive and shows that the acceptance of a core or national examination among state regulators may be regarded as likely. In fact, of the ten states indicating a need for out-of-state travel, nine also indicated an acceptance of the core examination.

During the past five or so years, other surveys have been conducted concerning the status of mortgage regulation in the United States. These other surveys provide some insights into the evolution and development of state mortgage regulation. One such survey was conducted by the Tennessee Department of Financial Institutions in 1987.

This survey yielded some interesting results about licensing and examination of first and subordinate mortgage entities, the cooperation among regulators and regulator comments on the nature of mortgage regulation. The findings of this survey suggested that cooperation among various state regulators was necessary and mandatory (particularly with respect to multistate operators) in order to properly monitor and supervise the industry.

This survey disclosed that 31 states had some form of regulation requiring the licensing of either first or subordinate mortgage entities as of year-end 1987. Of these 31 states, all performed an examination or investigation of licensed businesses. Interestingly, 16 of the 31 respondents, or 52 percent, indicated that they had not or had rarely received cooperation from other state regulators in handling complaints on out-of-state entities, particularly mortgage servicers.

Other general comments expressed a need for a more organized framework nationwide for the regulation of mortgage companies. Further, it was observed that in 1987 (long before the idea of AARMR evolved) there was not enough communication between states. This was possibly due to the lack of awareness of the agencies responsible for mortgage supervision. This lack of cooperation and awareness was one of the primary reasons AARMR was organized in 1989.

In retrospect, this lack of cooperation and awareness may have been due to the fact that many agencies are prohibited by law from sharing or divulging examination and supervisory information (which is confidential in nature) with one another. Several states including California, Kentucky and Michigan have taken the lead in this area and have incorporated into law a directive allowing for the option of sharing confidential information with other state agencies. For a uniform national examination to succeed, all involved state must adopt some type of law or agreement along these lines. Through its Regulatory, Inter-Relationships and Clearinghouse Task Force, AARMR is attempting to formally and legally remove these barriers prohibiting the sharing of information among states.

Turning for a moment to the industry side, in 1989, the Illinois Mortgage Bankers Association conducted a survey of its 385 members in order to identify issues and problems that the industry felt warranted regulatory attention, particularly those issues and problems relating to the scope, quality, cost and purpose of out-of-state mortgage examinations. The Illinois Office of Savings and Residential Finance, which was one of the first to conduct out-of-state examinations, used staff examiners to examine mortgage companies based in Illinois and contracted certified public accountants to examine companies headquartered out-of-state. Companies were billed for actual expenses of the examination.

The survey found that the average cost of an examination was from $3,259 to $7,860. Further, the survey found that 50 percent of the respondents indicated the examination process had, or may have had, an adverse effect on their willingness to conduct mortgage business in Illinois. Perhaps more important, 90 percent of the respondents (who also do business in states outside Illinois) indicated that the cost of the examination and related costs rendered Illinois more expensive to do business in than other states. However, as state regulation has progressed, other states have begun examining out-of-state mortgage businesses and are also charging substantial examination fees.

In summary, mortgage regulation at the state level has increased dramatically during the past five years. Many multistate mortgage banking firms have found it difficult to operate in multiple states, with each state having different laws and examination requirements. Similarly, many state regulators have found it difficult to supervise and examine these multistate firms. The cost of supervision and examination of multistate firms has been unacceptable for both the industry and government.

The American Association of Residential Mortgage Regulators was created to address and help resolve many of the issues described in this article that confront both regulators and the industry. Through its three ongoing task forces, AARMR is pursuing solutions to leading issues of concern, including multistate examinations, consistent and compatible legislation, and sharing of information. Each of AARMR's task forces meets on a quarterly basis in Washington, D.C., and its meeting are open to interested parties.

E. J. Face, Jr. is consumer finance and mortgage supervisor for the State Corporation Commission, Bureau of Financial Affairs, for the Commonwealth of Virginia.
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Title Annotation:state regulation of mortgage banking
Author:Face, E.J., Jr.
Publication:Mortgage Banking
Date:Mar 1, 1991
Words:3260
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