Residential Mortgage Lending Update March 21, 2012

Residential Mortgage Lending Update March 21, 2012

Presenters • James A. SheriffGodfrey & Kahn, S.C.(414) 287-9390jsheriff@gklaw.com • Peter J. Wilder Godfrey & Kahn, S.C. (414) 287-9609pwilder@gklaw.com Godfrey & Kahn is a business law firm with five offices in Wisconsin and an office in Washington, D.C. The firm’s Financial Institutions Group includes eight attorneys whose practice focuses exclusively on financial service companies.

ResidentialMortgage Lending Update - Agenda • Mortgage Loan Originator Compensation Rules • TILA/RESPA Reforms and Combined Disclosures • Settlements Regarding Mortgage Foreclosure Practices • Mortgage Servicing Reforms • “Ability to Repay” and “Qualified Mortgages” (“QM”) • “Qualified Residential Mortgages” (“QRM”) and Risk Retention • Appraisal Reforms • Periodic Mortgage Statement • New CFPB Mortgage Compliance Intake

Mortgage Loan Originator Compensation Rules • 12 CFR 226.36(d) & (e) – (Regulation Z) • Effective 4/1/11 • Applies to any “consumer credit transaction secured by a dwelling” • Additional rule making expected this year

FRB’s LO Comp RuleThree Main Prohibitions • No comp may be paid to a LO based on loan term or condition (or other factor that serve as a proxy for loan term or condition), except amount of loan. • No comp may be paid to a LO by both the consumer and a party other than the consumer for same loan. • No improper “steering” by an LO (obtaining a loan that provides greater comp to LO unless loan is “in the consumer’s interest”) – safe harbor if LO presents consumer with loan options from significant number of creditors with which LO regularly does business (preferably 3), including: • Loan with lowest interest rate; • Loan with lowest interest rate but which does not allow for neg. am., prepayment fee, interest-only payments, balloon payment within first 7 years, demand feature or shared equity/shared appreciation feature; • Loan with lowest origination fees/discount points.

FRB’s LO Comp RuleExamples of Unacceptable Comp Under Prohibition #1 • Comp based on: • The loan interest rate • APR • LTV ratio • Existence of a prepayment penalty. • Comp based on a factor that is a “proxy” for a loan term or condition; e.g., consumer’s credit score or bank profitability.

FRB’s LO Comp RuleExamples of Acceptable Comp Under Prohibition #1 • LO’s overall loan volume • Long-term performance of LO’s loans • Hourly Rate or Salary or flat fee per loan (fixed in advance) • LO pull-through rate • Loans to existing v. new customers • Quality of LO’s files (accuracy and completeness) • LO’s fixed overhead costs • Comp based on amount of loan • Percentage of loan amount with fixed maximum and/or minimum amount per loan.

FRB’s LO Comp RuleIssues • Comp based on profitability/revenue • Different comp for different loan programs – FHA/VA or CRA or jumbo v. conventional; portfolio v. non-portfolio; in-house v. brokered, purchase v. refinance? • Borrower-pay mortgage broker comp/payment to LO? • Loans made through different channels (bank supplies leads v. Los get their own leads)? • Comp to managers who do/do not originate?

TILA/RESPA Reforms and Combined Disclosures • CFPB now has authority over TILA/RESPA. • Bureau will focus its rule making resources on Mortgage reforms in 2012. • e.g. underwriting standards and Combined GFE/TIL form. • 2 combined TIL/GRE prototypes have been tested with consumer and industry groups. (See slide 10.) • February 2012 – CFPB switched gears from combined disclosure to merging Regulation Z and Regulation X. • Industry wanted to know underlying “rules of the road” before using a new disclosure form.

TILA/RESPA Reforms and Combined Disclosures • CFPB now wants tighter cost estimates on GFE- End of 10% tolerance? • March 6, 2012 meeting of CFPB’s Small Business Review Panel: • ABA: Banks need minimum of 12-18 months to implement new regulations once issued; Community banks need adequate guidance materials. • Proposed rule expected by July 2012 (DFA deadline is 7/21/12).

Images of 2 Prototype Combined TIL/GFE Forms: (i) Butternut and (ii) Hemlock

Settlements Regarding Mortgage Foreclosure Practices • On February 9, 2012, a settlement in principle was announced between the Justice Department, 49 State Attorney Generals and five large mortgage servicers, related to mortgage servicing and foreclosure practices. • Settlement Agreement (yet to be approved by Court) will result in about $25 billion in sanctions and relief to borrowers. (Largest since the tobacco settlement in 1998.) • Agreement requires comprehensive reforms of mortgage loan servicing, discussed below. Servicing reforms likely to trickle down to all mortgage servicers, regardless of size.

Settlements Regarding Mortgage Foreclosure Practices - Continued • Settlement ends a year of intense negotiations between large banks, Attorney Generals and federal agencies. Settlement negotiations focused on robo-signing practices in foreclosures and alleged mortgage servicer misconduct. Summary of Key Settlement Terms: • Consumer Relief – Settlement requires 5 banks to allocate $17 billion in assistance to borrowers who have the intent and ability to stay in their homes while making reasonable repayments.

Settlements Regarding Mortgage Foreclosure Practices - Continued • At least $10 billion must be allocated to reduce principal balances of borrowers in default or at risk of default. • Banks also must provide $5 billion in other forms of homeowner assistance, such as facilitating short-sales where the loan amount exceeds the sale price. • Note legislation just introduced in Senate which would force lenders to speed up the short-sale process, by approving or denying any short-sale offers within 75 days, or face a $1,000 fine and attorneys fees. • Unemployed payment forbearance, to defer payments for persons “between jobs.”

Settlements Regarding Mortgage Foreclosure Practices - Continued • Refinance Program – Banks must offer $3 billion in refinance programs to borrowers who are underwater and cannot refinance, if they are current on loans. Banks must notify eligible borrowers. To qualify, current interest rate must exceed 5.25% and LTV must exceed 100%. • State Foreclosure Assistance – Banks must pay $1 billion to the states to address their “individual foreclosure challenges.” Some states (Wisconsin) have announced that this amount will be used to offset state budget deficits.

Settlements Regarding Mortgage Foreclosure Practices - Continued 4. Payments to Foreclosed Borrowers - $1.5 billion will be paid to certain borrowers who were foreclosed on after January 1, 2008. Servicers must notify persons of their right to file a claim. Eligible borrowers likely to get uniform payments of about $2,000. Borrowers will still be able to seek additional relief in court against servicers.

Mortgage Servicing Reforms • Key component of Settlement Agreement is comprehensive reform of mortgage servicing practices. • Prevents robo-signing of foreclosure documents and affidavits. • Requires banks to offer new loss mitigation alternatives before commencing foreclosure. • Imposes new time lines for servicers to respond to borrowers. • Prohibits “dual tracking” where foreclosure process is initiated while loss mitigation process still is ongoing. • Information in foreclosure affidavits must be personally reviewed.

Mortgage Servicing Reforms - Continued • The legal standing of a mortgage holder to foreclose must be fully disclosed and documented to borrower. • New pre-foreclosure notice must be sent by servicer giving borrower a summary of loss mit options, loan balance, account summary, description why lender is entitled to foreclose, identity of investor holding note, and statement that borrower is entitled to a copy of note. • Borrowers have a right to automatic appeal of any denials of loss mitigation requests.

Mortgage Servicing Reforms - Continued • Servicers must offer enhanced foreclosure protections for members of military. • Servicers required to expedite and facilitate short sales of distressed properties. • Restrictions imposed on default fees, late fees, third-party fees and force-placed insurance. • Note that DFA includes new “prompt service” requirements: • Credit payments on date received; • Payoff balance must be sent within seven business days of written request.

Mortgage Servicing Reforms - Continued • CFPB recently issued “Servicing Exam Procedures,” (available on CFPB’s website) and more servicing-related reforms will be implemented in 2012. • The Dodd-Frank Act gave CFPB authority to write consumer protection rules for all mortgage servicers. • CFPB intends to issue new comprehensive mortgage servicing rules. Expect these reforms to drive up the cost of servicing significantly.

Mortgage Servicing Reforms - Continued • The new Servicing Examination Manual offers insights into the areas that future compliance exams will focus on: • servicing transfers, loan transfers and escrow disclosures • payment processing and account maintenance • customer inquiries and complaints • force-placed insurance practices • reporting to credit bureaus • privacy and sharing of information • default servicing, collections and bankruptcies • loss mitigation • foreclosure processes

“Ability to Repay” and “Qualified Mortgages” (“QM”) • Dodd-Frank Act added a new “ability to repay” test when a lender is underwriting residential mortgage loans. Proposed Rule issued by banking agencies in May 2011. • A borrower can challenge, during the life of the loan, whether the lender satisfied this test, increasing significantly the potential liability for mortgage lenders. • Failure to satisfy this test if challenged by the borrower can result in reimbursement by the lender of all payments received.

“Ability to Repay” and “Qualified Mortgages” (“QM”) - Continued • DFA prohibits creditors from making a mortgage loan unless the creditor makes a: • reasonable and good faith determination • that consumer will have reasonable ability to repay loan • based on verified and documented evidence. • Proposal established minimum underwriting standards; imposed limits on prepayment penalties; and creates new record retention requirements.

“Ability to Repay” and “Qualified Mortgages” (“QM”) - Continued • All residential mortgage loans going forward will carry higher liability risks for lenders, and this risk will make mortgage loans more expensive. Scope of Coverage of QM Rule: • Closed-end consumer loan secured by a dwelling, regardless of lien position • Does not cover HELOCs Methods for Lenders to Comply: • Satisfy new Ability to Repay Standard; or • Originate a “Qualified Mortgage”

“Ability to Repay” and “Qualified Mortgages” (“QM”) - Continued General Ability To Repay Standard • No limits on loan terms or conditions, points, fees, etc. • But creditor must apply specific underwriting standards and payment calculations, and the proposed loan must meet all of these standards. Underwriting Factors • Income or assets • Employment status • Monthly payments on loan • Current debts • Monthly payments on all mortgage debts • DTI ratios • Credit History

“Ability to Repay” and “Qualified Mortgages” (“QM”) - Continued Originate “Qualified Mortgage” • Another method for a lender to comply with ability to repay rules. • Proposed rule on QM’s has been roundly criticized and it is likely there will be a new “QM” proposal released by the CFPB in the next several months. • Not worth reviewing all the aspects of original “QM” proposal because expectation is that it will be changed substantially.

“Ability to Repay” and “Qualified Mortgages” (“QM”) - Continued “Safe Harbor” or “Rebuttable Presumption”? • Unclear if the “QM” will be a true “safe harbor” for creditors that protects them against later legal challenge, or will QM only be a “rebuttable presumption” of compliance that can be challenged in court? • This is a key issue for the ABA and other banking trade groups, who want a “QM” to be an absolute safe harbor against subsequent legal challenges.

“Qualified Residential Mortgages” (“QRM’s”) and Risk Retention • “QRM’s” are yet another DFA creation; a “QRM” provides an exception to risk retention requirements built into DFA. • Last March, banking agencies jointly issued proposed QRM rule to implement DFA requirements that securitizers retain portion of the credit risk of securitized assets. • Many parties – both industry lobbyists as well as public interest and consumer groups - filed comments asking the banking agencies to re-write and re-issue the QRM rule.

“Qualified Residential Mortgages” (“QRM’s”) and Risk Retention - Continued • QRM proposal calls for a 20% downpayment requirement and a nearly spotless credit history. Most complaints have been about the downpayment aspect of rule. • Loans not meeting QRM requirements will be more expensive since lenders must offset the new DFA 5% risk retention requirements for non-QRM loans sold into secondary market (except for Fannie and Freddie!) • Fact that Fannie and Freddie are exempt from the risk retention requirements most likely will drive more volume to these GSE’s, and complicate future political efforts to restructure them.

“Qualified Residential Mortgages” (“QRM’s”) and Risk Retention - Continued • One immediate problem is that CFPB is issuing the new QM rule but the banking agencies are issuing the new QRM proposal. • The QM and QRM rules will reshape mortgage lending. Many lenders will only make QM loans due to the legal risk involved, and it will be difficult for many borrowers even to qualify for QRM’s as the rules are presently written. • Many current mortgage loan products either will be impossible to provide in future or will be undesirable due to the legal risks. • Some community banks may decide to stop providing mortgage loans due to risks and compliance costs.

Appraisal Reforms • New Regulation Z Valuation Independence Rules under DFA at 12 CFR 226.42. • Effective 4/1/11. • Superceded Home Valuation Code of Conduct. • Applies to consumer credit transactions secured by the consumer’s principal dwelling.

Valuation Independence RulesUse of Coercion • Prohibits: • Directly or indirectly causing or attempting to cause a valuation to be based on anything other than the independent judgment of the person performing the valuation. • Use of coercion, extortion, bribery, intimidation, compensation, or collusion to influence the person performing the valuation. • Material misrepresentations as to the value of the property by the person performing the valuation. • Falsifying or materially altering the valuation report. Note: It does not matter that the action was not intended to influence the valuation, or that the person refused the attempt – the mere conduct is a violation.

Valuation Independence RulesUse of Coercion • Examples of prohibited conduct: • Withholding or threatening to withhold payment because the valuation does not come in at a certain amount. • Implying that the willingness of the lender to retain the person for future engagements depends on the amount of the current valuation – “Come in at $X, or you’ll be dropped from our preferred vendor list.” • Conditioning payment for the valuation on the loan actually closing.

Valuation Independence RulesUse of Coercion • Examples of permissible activities: • Asking the preparer to consider additional and appropriate property information, including other comparable properties. • Asking the preparer to provide further detail, substantiation, or explanation for the valuation. • Asking the preparer to correct errors in the valuation. • Obtaining multiple valuations on the same property to obtain the most reliable valuation – a “Second Opinion.” • Withholding payment for breach of contract or substandard performance. Note: The key is that the request must be consistent with prudent banking practices and not an attempt to get the preparer to change the outcome of the valuation improperly.

Valuation Independence RulesConflicts of interests • Person who prepares valuations, or performs “valuation management functions” may not have a direct or indirect interest, financial or otherwise, in the property or the transaction. • Valuation management functions = • recruiting, selecting or retaining person to prepare valuation; • contracting with or employing person to prepare valuation; • managing or overseeing process of preparing valuations (e.g., receiving orders for and receiving valuations; submitting completed valuations to, and collecting fees from, creditors and underwriters; and compensating persons who prepare valuations); • reviewing verifying the work of person who prepares valuation.

Valuation Independence RulesConflicts of interests • For institutions > $250 million (past 2 years), there is a presumption of compliance if compensation of preparer not tied to valuation coming in at specific amount AND • Person performing the valuation or valuation management function not part of the loan production function. • No person in loan production function directly or indirectly involved in selecting, retaining, recommending, or influencing the selection of the person preparing the valuation or involved in the valuation management function.

Valuation Independence RulesConflicts of interests • For institutions < $250 million (past 2 years), there is a presumption of compliance if compensation of preparer not tied to valuation coming in at specific amount AND • Creditor requires that any of its employees, officers or directors who orders, performs, or reviews valuation not participate in decision to approve, decline or set terms of loan.

Valuation Independence RulesProhibition on Extension of Credit • Where creditor knows that a violation of the coercion or conflicts provisions has occurred, credit may not be extended unless creditor documents that it has acted with reason diligence to determine what the valuation does not materially misstate or misrepresent the value of the property. • A “material” misstatement is a misstatement that would affect credit decision.

Valuation Independence RulesPayment at “Customary and Reasonable” Rate • Creditor and its agents must compensate fee appraiser at “customary and reasonable” rate in the relevant geographic market. • Compliance presumed if: • Rate is reasonably related to recent rates paid for comparable services in relevant geographic market, taking into account type of property, scope of work, time required, appraiser’s qualifications, experience and professional record, and quality of work, and creditor does not engage in anticompetitive conduct. • Rate is based on (i) objective third-party information e.g., fee schedules, studies and surveys prepared by independent 3rd parties (gov’t, academia, research firms) which exclude fees paid to appraisals ordered by AMCs, or (ii) recent rates paid to a representative sample of providers in relevant geographic areas.

Valuation Independence RulesMandatory Reporting of Violations • Applies to all “covered persons” (creditors and other settlement service providers). • Applies when covered person reasonably believes appraiser has committed a “material” violation (one likely to significantly affect the property valuation) of Uniform Standards of Professional Appraisal Practice or ethical or professional requirements imposed by federal or state law. • Requires covered person to notify appropriate state appraiser certifying/licensing agency of suspected violation within reasonable period of time after determining reasonable basis exists to believe violation has occurred.

Periodic Mortgage Statement

Periodic Mortgage Statement - Continued • Dodd-Frank requires CFPB to come up with a monthly statement for servicers to provide borrowers with variable rate loans with information on principal, interest rate, estimated date of next rate reset, payments, late charges and any penalty fees. • Statement also must include contact information for local housing counselors for borrowers experiencing financial difficulties. • CFPB now testing various prototypes with consumers; final rule should be released before end of 2012. • Exemption for fixed rate mortgages.

New CFPB Mortgage Complaint Intake Process • On December 1, CFPB added mortgages to its complaint intake mechanism (previously, just credit cards.) CFPB received 2,300 on-line complaints about mortgage servicers in first month. Most common complaint has been that servicers repeatedly ask for the same documentation from borrowers. • CFPB’s goal is to have a single uniform set of servicing standards for all mortgage servicers. • After CFPB reviews complaint it sends it to servicer which has 15 days to respond. If CFPB doesn’t regulate servicer it will send complaint on to federal banking regulator.

QUESTIONS and ANSWERS 7582830_1

Residential Mortgage Lending Update March 21, 2012