United States: Mid-South Regulatory Compliance Group Quarterly Report Vol. 16, No. 2


By Cliff Harrison

We are pleased to introduce to you the latest addition to our banking team. Doug Weissenger joined Butler Snow in March. Doug comes to us from a boutique banking law firm in Austin, TX where he focused on mergers and acquisitions, corporate and securities law, and regulatory compliance. He is a native Mississippian, grew up in the Delta and comes from a banking family. At the moment, Doug is temporarily located in our Austin, TX office, but he and his family will be moving to Memphis later this summer. Doug will be at the May quarterly meetings in Jackson and Memphis. We've told him what a special group you all are, and he is looking forward to the chance to get to know and work with you all. We're excited to have him on board. Welcome, Doug!


By Doug Weissinger

As you know, under the National Flood Insurance Program (NFIP), financial institutions are prohibited from making loans secured by improved real property located in special flood hazard areas unless the property has adequate flood insurance coverage. Federal regulators recently issued a joint final rule to implement provisions of the Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert-Waters), which was enacted in part to stimulate the private flood insurance market by requiring lenders to accept private flood insurance that provides adequate flood coverage under the NFIP. The final rule takes effect July 1, 2019, so from that day forward, financial institutions must accept private flood insurance policies that satisfy certain criteria on loans secured by property located in flood zones.

Mandatory Acceptance. To qualify as a valid private flood insurance policy, the policy must meet the statutory definition of "private flood insurance". The final rule defines "private flood insurance" as a policy that:

  1. is issued by an insurance company that is licensed, admitted, or otherwise approved to engage in the business of insurance in the State or jurisdiction in which the property to be insured is located, by the insurance a regulator of that State or jurisdiction or, in the case of a policy of difference in conditions, multiple peril, all risk, or other blanket coverage insuring nonresidential commercial property, is recognized, or not disapproved, as a surplus lines insurer by the State Insurance regulator of the State or jurisdiction where the property to be insured is located;
  2. provides flood insurance coverage that is at least as broad as the coverage provided under a standard flood insurance policy (SFIP) issued under the NFIP, including when considering deductibles, exclusions, and conditions offered by the insurer;
  3. includes a requirement for the insurer to give written notice 45 days before cancellation or non-renewal of flood insurance coverage to the insured and the regulated lending institution, or a servicer acting on the institution's behalf;
  4. includes information about the availability of flood insurance coverage under the NFIP;
  5. includes a mortgage interest clause similar to the clause contained in an SFIP;
  6. includes a provision requiring an insured to file suit not later than one year after the date of a written denial for all or part of a claim under a policy; and
  7. contains cancellation provisions that are as restrictive as the provisions contained in an SFIP.

Since Biggert-Waters was enacted, a major concern for financial institutions has been how to determine if a private flood policy's coverage is "at least as broad as" SFIP coverage. The final rule attempts to solve this issue by providing that a private policy is "at least as broad as" the coverage provided under an SFIP if the policy, at a minimum:

  1. defines the term ''flood'' to include the events defined as a ''flood'' in an SFIP;
  2. contains the coverage specified in an SFIP;
  3. contains deductibles no higher than SFIP deductibles for policy amounts up to NFIP maximums;
  4. only excludes losses that are excluded in an SFIP, except those that apply to coverage that is beyond what is provided by an SFIP; and
  5. does not contain conditions that narrow the coverage provided in an SFIP.

Discretionary Acceptance. The final rule also outlines the process by which financial institutions may accept, at their discretion, private flood policies that fail to meet the statutory definition of "private flood insurance". Financial institutions may accept a private flood insurance policy that does not meet the definition of "private flood insurance" as long as the policy:

  1. provides the minimum amount of coverage required by statute, which is at least equal to the lesser of the outstanding principal balance of the designated loan or the maximum limit of coverage available for the property;
  2. is issued by an insurer that is licensed, admitted, or otherwise approved to engage in the business of insurance by the insurance regulator of the State or jurisdiction in which the property to be insured is located;
  3. covers both the mortgagor(s) and the mortgagee(s) as loss payees, except in the case of a policy that is provided by a condominium association, cooperative, homeowners association, or other applicable group and for which the premium is paid by the condominium association, cooperative, homeowners association, or other applicable group as a common expense; and
  4. provides sufficient protection of the designated loan, consistent with general safety and soundness principles, and the financial institution documents its conclusion regarding sufficiency of the protection of the loan in writing.

To aid financial institutions determine whether a private policy that fails to meet the statutory definition provides "sufficient protection", federal regulators provided the following factors that financial institutions may consider:

  1. whether the flood insurance policy's deductibles are reasonable based on the borrower's financial condition;
  2. whether the insurer provides adequate notice of cancellation to the mortgagor and mortgagee to ensure timely force placement of flood insurance, if necessary;
  3. whether the terms and conditions of the flood insurance policy with respect to payment per occurrence or per loss and aggregate limits are adequate to protect the regulated lending institution's interest in the collateral;
  4. whether the flood insurance policy complies with applicable State insurance laws; and
  5. whether the private insurance company has the financial solvency, strength, and ability to satisfy claims.

In addition, financial institutions may accept nontraditional flood coverage provided by a mutual aid society, which is defined as an organization (1) whose members share a common religious, charitable, educational, or fraternal bond, (2) that covers losses caused by damage to members' property pursuant to an agreement, including damage caused by flooding, in accordance with this common bond, and (3) that has a demonstrated history of fulfilling the terms of agreements to cover losses to members' property caused by flooding. Examples of mutual aid societies include Amish Aid. Financial institutions may accept a plan issued by a mutual aid society if (1) the applicable federal regulator has determined that the plan qualifies as flood insurance for purposes of Biggert Waters, (2) the plan provides coverage in the amount required by the flood insurance purchase requirement, (3) the plan provides specified coverage for the mortgagor and mortgagee as loss payees, and (4) the financial institution documents in writing its determination that the plan provides sufficient protection of the applicable loan, consistent with general safety and soundness principles.

Safe Harbor. To help financial institutions determine if a private insurance policy is acceptable, the final rule contains a safe harbor. A financial institutions may accept a private policy, without further review, if the policy contains the following statement: "This policy meets the definition of private flood insurance contained in 42 U.S.C. 4012a(b)(7) and the corresponding regulation." The statement can be included within the text of the policy or as an endorsement to the policy. However, the final rule does not require insurance companies to include the statement in a private policy, and financial institutions cannot reject a private policy simply because the statement is not provided. Also, it remains to be seen whether insurance companies will revise their policies to reflect the terms required to be equivalent to a standard policy.

Financial institutions that display a pattern of incorrectly rejecting private policies could be subject to civil money penalties. Accordingly, we recommend that you update your policies and procedures before the July 1, 2019 deadline. At a minimum, your policies and procedures should incorporate the regulators' recommended factors to determine if a private policy provides "sufficient protection" for a loan and provide for thorough documentation in the application of these factors. We also encourage you to contact insurance companies in your community to determine if they plan to update the terms of their flood policies to meet the statutory definition of flood insurance or include the safe harbor statement.


By Patsy Parkin

The federal banking agencies recently published updated interagency examination procedures for RESPA. Also, just last week, a "little bird" gave us a "heads up" that examiners are being trained nationwide on RESPA, in particular on RESPA Section 8, and that examiners will begin enhanced reviews for compliance sometime in 2020. Your steering committee's crystal ball was working well as the committee asked that we include this topic in the quarterly meeting, so this appears to be very good timing!

One of the stated purposes of the 1974 Real Estate Settlement Procedures Act was the elimination of kickbacks or referral fees that tend to increase unnecessarily the costs of mortgage settlement services. Section 8(a) of RESPA broadly prohibits payment or acceptance of any fee, kickback, or thing of value pursuant to any agreement or understanding, oral or otherwise, that business related to a settlement service will be referred to any person. RESPA Section 8(b) similarly prohibits fee splitting and states that no person may pay or accept any portion of any fee for a settlement service other than for service performed.

The prohibition against kickbacks and unearned fees means, in brief:

  • No fees may be paid or received by anyone for referral of business that is part of a settlement service, and that includes origination of a mortgage loan. A referral is a non-compensable service.
  • No split of fees or charges for settlement services may be given or received, except for settlement services actually performed.

A "thing of value" is broadly defined and covers a wide range of items including: money, things, discounts, salaries commissions, fees, duplicate payments of a charge, stock, dividends, distributions of partnership profits, franchise royalties, credits representing monies that may be paid at a future date, the opportunity to participate in a money-making program, retained or increased earnings, increased equity in a parent or subsidiary entity, special bank deposits or accounts, special or unusual banking terms, services or all types at special or free rates, sales or rentals at special prices or rates, lease or rental payments based in whole or in part on the amount of business referred, trips and payment of another person's expenses, or reduction in credit against an existing obligation. A "referral" may be oral or written and covers pretty much anything that is directed to a person that may influence the selection of a settlement service provider.

There are exceptions. Section 8(c) of RESPA, states specifically that "[n]othing in this section shall be construed as prohibiting" payments to attorneys or title companies for services actually rendered, payments by a lender to its agent (e.g., employee) for services performed, payments between real estate agents and real estate brokers under cooperative brokerage agreements, and payments under affiliated business arrangements (provided required disclosures are given, the use of the affiliated business is not required, and the only thing of value received, other than payment for actual settlement services provided, is a return on the ownership interest in the affiliated business). There is an additional exception that helps protect against overly broad interpretations of Section 8(a). RESPA Section 8(c) states that nothing in Section 8 prohibits "the payment to any person of ... bona fide ... compensation for goods or facilities actually furnished or for services actually performed." Long standing HUD statements of policy, which predate Dodd-Frank's transfer of authority over RESPA to the CFPB, indicate that bona fide payment means payment of reasonable market value – the payment bears a reasonable relationship to the market value of the services performed or the goods or facilities provided.

Section 8 issues come up in a variety of ways for banks and mortgage lenders. For example, a mortgage loan originator might want to lease an office or rent a desk in a real estate agent's office. Or, a loan originator might want to advertise alongside a real estate agent or participate in a marketing event with a real estate agent and share or pay the advertising and marketing expenses. In arrangements where services are being provided by or for someone that might also be a referral source, the regulators generally look at the big picture. Since a referral is non-compensable and since only bona fide fees may be paid for settlement services actually provided or performed, any payment, including any payment to a third party for the expense of another person, that exceeds the market value of the services actually provided will be presumed to be payment for referrals.

As an example, assume a real estate agent sponsors an open house for other agents. Your bank has been asked to pay for the refreshments, even though the bank does not plan to attend or even advertise its services. Would this be a violation? The answer is yes! By paying for the cost of the refreshments and absorbing the expense the real estate agent would otherwise have to pay, the bank has given the real estate agent a "thing of value" which likely would be consideration for the referral of business since there appears to be no other business purpose for the payment. Both the bank and the real estate agent may be liable for a RESPA violation since both paying and receiving a referral fee is prohibited. On the other hand, if the bank were to attend the open house and make a presentation or otherwise market its services, the payment may be lawful under RESPA since the bank is paying the, presumably reasonable, costs of marketing its own services.

Another area which presents substantial risk to mortgage lenders for Section 8 violations is marketing services agreements. Marketing services agreements often involve providers of settlement services in a mortgage loan transaction, such as a lender, real estate agent or broker, or a title company and may also include third parties, such as membership organizations. These marketing services agreements are generally framed as payments for advertising or promotional services, but in some cases may be disguised compensation for referrals. MSAs were the subject of CFPB Compliance Bulletin 2015-05. Essentially, the Bureau said it pretty much viewed all MSAs with suspicion saying many are designed to avoid the prohibition on payment of referral fees.

Section 8 violations have been the subject of numerous CFPB enforcement actions, and these actions illustrate how issues may arise. For example, some of the earliest enforcement actions by the Bureau were against MGIC and other private mortgage insurance companies over captive reinsurance arrangements where the mortgage lender, or an affiliate of the lender, re-insured a portion of the PMI company's liability and received a portion of the PMI premium. One of those lenders was PHH Corp. which subsequently appealed the Bureau's findings and challenged the constitutionality of the CFPB. While the Bureau's organization was found to be constitutional, the federal appeals court hearing the case overturned the Bureau's interpretation of RESPA and found that captive mortgage reinsurance arrangements did not violate RESPA as long as the captive reinsurer charged no more than the reasonable market value of the reinsurance, even if referrals were also involved.

Another example involved a homebuilder who formed a mortgage company jointly owned by the homebuilder and a bank. The homebuilder referred his customers to the mortgage company which, ostensibly, was the originator of the mortgage loans. According to the Bureau, however, the mortgage company was a sham entity, the bank did all the work, and kickbacks were passed through to the homebuilder in the form of profit distributions and payments under a "service agreement." Similar enforcement actions have been brought involving title agencies structured as joint venture type arrangements between title insurance companies and lenders or between closing attorneys and realtors where the joint venture title agency ostensibly issues the title policy and collects some part of the premium, but the Bureau found the agency was a sham and the substantive work of issuing the title policy was performed elsewhere. The profit distributions and payments to the so-called "owners" were found to be disguised kickbacks.

Other examples include payment of inflated lease payments by a mortgage company to a bank for renting office space within the bank; payment of title insurance commissions to individuals who were found not to be bona fide employees of the title insurance agency; payment by a mortgage lender of fees to a veteran's organization for lead generation and licensing services under a marketing services agreement whereby the lender was named as the "exclusive lender" of the veteran's organization; and payment by a title insurance agency of the cost of providing marketing leads and marketing letters for bank loan officers.

At the quarterly meeting we will cover prohibitions under RESPA, exceptions to prohibitions, and walk through examples of what a bank can and cannot do re: federally related mortgage loans. We want you to be ready for 2020!

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