There is a trend we’ve seen manifesting itself in the field of mortgage banking that smacks of financial institutions “renting their charters” to independent mortgage bankers. This is a practice that has been specifically condemned by the national banking regulators, most recently with respect to “payday lending.” The same objections are applicable to mortgage lending and other activities where the preemption granted to banks and other types of financial institutions, whether by state or federal law, attracts a third party lender to “hitch his wagon” to a bank or thrift, yet, in many important respects, to remain an independent business.
Here is a typical scenario: a state-chartered “thrift and loan” located in a state with a less-than-restrictive state banking regulator recruit independent mortgage originators throughout the country by having them sign an agreement in which they will originate mortgage loans as a “licensee” or “agent” of the lender, in states other than where they have a license to do business. The loans are originated in the name of the lender, which, like “bank” as defined by state law, is exempt from state licensing under the laws of at least 37 states. The broker is given a web page provided by the bank and solicits borrowers throughout the 37 states. In states where it is not licensed as a mortgage broker, it must rely upon the argument that it is performing only loan “processing” services for the bank and is not acting as a “broker” in the state of the borrower’s residence. The bank retains and pays the third party fees shown on the borrower’s settlement statement, and retains a fee for its “funding” services. The remaining fees earned on the loan are paid by the bank to the broker.
There are a host of issues raised by this arrangement, not the least of which are the treatment of the various fees under RESPA. Are any of the fees paid for “referrals,” which may be illegal payments under RESPA (and, believe it or not, some of the agreements actually refer to the payment of “referral fees”), or are they only for actual services rendered? If the latter, are the fees “reasonable,” and do they otherwise comply with HUD standards for payment of fees to brokers, including their treatment on the HUD-1? Are “volume bonuses” paid by loan purchasers to the bank and then split with the broker proper fees paid in connection with a bona fide secondary market transaction? If the broker is not an employee (which many of the agreements we have reviewed clearly provide), then how are FHA loans made (in light of HUD’s prohibition on the use of other than employees of the lender)?
The fact that a state-chartered bank may not be required to be licensed as a mortgage lender or broker in a given state does not mean that other aspects of the preemption of state apply to the loan process or the other activities of the broker or the bank. For example, some states specifically restrict certain loan terms, such as loan fees and prepayment penalties. A federal savings bank, for example, would be exempt from such state laws by virtue of specific regulatory preemption regulations. A state-chartered “bank” would not have the benefit of similar federal law preemption principles. The broker and the bank would be responsible for knowing the specific restrictions of state law regarding the terms of the loans and other matters that are not preempted (disclosures, advertising, etc.).
Of even greater concern to banking, regulators is the fact that the banks involved are touting this arrangement as a way for independent mortgage brokers to remain independent, yet use the bank’s preemption from state licensing laws to permit the broker to originate loans in states other than those in which it is licensed to do so as a mortgage broker or lender. Certainly, a federal savings bank regulated by the OTS or a national bank regulated by the OCC could expect scrutiny of such arrangements, to ensure that the bank or thrift actually exercised effective control over the operations of brokers who are originating loans in the bank’s or thrift’s name, through web sites that identify the bank as the lender. “Renting a charter” to a third party for the purpose of avoiding state laws that protect consumers is a “hot potato” at the current time. The FDIC’s apparent laxity with respect to “pay-day” lenders, and the fight over the OCC’s recently promulgated regulations on federal preemption of state law applicable to national banks, and on predatory lending practices, have brought the entire issue to the forefront.
Apparently, the state-chartered banks involved in this practice are counting on the continued lack of objection by the FDIC, and the continued sympathy of state banking regulators who are eager to increase the number of state-chartered institutions that they regulate. In my opinion, this is a risky course. The preemption from state licensing requirements for “banks” depends on the law of each state involved. Currently, at least 13 states do not preempt state-chartered banks from state licensing. The other 37 states each will permit such preemption to exist only so long as the issue does not appear on the radar screen of other state-chartered banks, consumer advocacy groups or other interested parties with local political clout to force a change in state law or a change in the attitude of the FDIC.
There are ways to structure relationships between mortgage brokers and federally-chartered financial institutions that will allow mortgage originators to enjoy the benefits of preemption of state law licensing requirements in all 50 states, not merely 37, and without running afoul of the concerns of the federal banking regulators that the institution is “renting its charter.” Such arrangements should also provide broader and more stable preemption of state law restrictions on loan activities of mortgage originators than is provided by many of the arrangements we have reviewed.