You know you're working with trusted advisors, but how do you convince your investor?
September, 2006 - If there is one thing everyone knows about the predatory lending landscape it's that being found on the wrong side of the line carries with it significant negative consequences. Now, where that line is exactly varies by jurisdiction and is often subject to debate. Ultimately, the final decision could rest with a court of law, but if it goes that far, the lender – and its secondary market investors – have already lost.
In certain cases, unknowingly violating an anti-predatory lending ordinance can involve regulator-imposed fines or loss of licenses. If the plaintiff's bar believes there was willful misconduct, the lender could end up in court, which brings with it legal costs and the potential for a costly settlement or court-awarded damages. The company could end up facing the horror of horrors, the class action lawsuit, which could lead to potential liabilities so high that the company could be crushed. The lender's executive team could even end up going to jail.
But even in the most minor predatory lending offense, there is a risk that is far more dangerous than many might think. Negative publicity could leave a lasting mark on a company and its ability to compete in the marketplace. Consumer activists have characterized predatory lending as the lowest form of commerce, where companies cheat the disabled or elderly out of their life savings. That image has been firmly established in the minds of consumers. Any lender that ignores that fact treads a dangerous path.
Even if word of an accidentally non-compliant deal doesn't leak out to the public, the lender is still saddled with a loan it cannot sell. Those mistakes can be expensive.
Investors know that the problems with a predatory loan don't always end with the party that made the loan. Those problems can visit the investors as well. Assignee liability was a horrifying concept when it was first encountered. Today, investors require that their sources have compliance solutions in place.
A complicated proposition
For instance, a lender making a loan in Chicago would have to ensure compliance with a Chicago city ordinance and a Cook County ordinance, as well as perform an Illinois high-cost loan analysis and an Illinois interest rate analysis. Then, of course, there are the federal laws to consider. Not only must the lender know what all of these ordinances require and what the test thresholds are at the time the loan is made, but it must also track them as they change.
Even when the lender knows what the law says, there is the question of how it may be interpreted. In many cases, the laws have been written in such a way that reasonable people can come up with different conclusions. It can be a challenge to determine whether it is the management or the compliance department that determines how the company will interpret the law. There is risk here.
The matter would be simplified if the rules in the various jurisdictions were designed to work together, but they are not. Consequently, it has become very challenging to make a simple loan.
Fortunately for lenders, a number of very good compliance solutions exist. But having chosen a solution, lenders are still faced with convincing their secondary market investors that the compliance partner they have selected can perform the job effectively.
Selling what you've been sold
Following are the top benefits that compliance services are marketing to lenders today. Being able to verbalize why you chose one solution over another in each of these areas will help you assure your investors that you've made the right choice.
Benefit 1: Ability to implement. Nearly all of the compliance solutions on the market today involve technology to a great degree. Most involve some form of integration with a lender's existing mortgage loan origination system. One of the first things a compliance solution provider must sell the prospect is its ability to get the systems connected.
What was it about the provider that you chose that convinced you the company could get the implementation done? How did the company prove that it had the technical wherewithal to get its system to share data with your LOS seamlessly and error-free?
This is not an easy sell for some compliance firms that have evolved out of existing law firms. On the other hand, compliance solutions that came out of existing document preparation firms may have a leg up as those firms were in the technology development business from the beginning.
Firms that have been in the technology business for a while also have the advantage of being able to produce systems that are easier to use and require less training. However, unless the lender is an expert in the technology offered by the compliance provider, it's not generally a good idea to attempt to sell it to the investor. Technology, in general, is a tough thing to sell as most people do not understand it well and have been conditioned to expect problems to crop up, especially with new systems.
Benefit 2: Ability to be flexible. Because the anti-predatory lending legislation that is springing up around the country is subject to interpretation, lenders want to choose how they will comply with the law instead of letting a compliance advisor dictate to them. Often this involves a process wherein the lender's internal compliance team compares detailed notes with the outside advisor.
It is useful to gain access to the memos the outside compliance attorneys used to instruct the company's programmers. This will give the lender and its investors a good idea of the thinking behind the decisions the company has made in each jurisdiction. But when the lender disagrees with the outside advisor, the investor will want to know that the compliance provider can accommodate the lender without compromising the protection it is designed to offer.
A good example of this is whether to include a yield spread premium paid by the lender to the broker in the calculation of broker compensation. In some jurisdictions it clearly must be included. In others, it need not be. But in some it is not clear and is subject to interpretation. A provider's technology must be flexible enough to meet the lender's interpretation in these cases.
Benefit 3: Ability to be monitored. Every time a law changes somewhere compliance providers must make changes in their systems. Some lenders like to know when this happens and what it means to them. While a big part of the reason to outsource this function is that lenders don't have time to deal with it, most still want to know what is being done on their behalf.
In some respects, it's similar to how an attorney treats litigation that is outsourced. When a law department hires an outside firm to handle a piece of litigation, they cannot simply forget about the case. Someone needs to monitor that lawyer with respect to that particular piece of litigation. In the same way, lenders must pay attention to what their compliance advisors are doing.
If a lender can present an investor with periodic communications from its compliance advisor — whether that be newsletters, frequent e-mail updates or information gleaned from a website — that will go along way toward convincing the investor that the lender made a good decision.
Benefit 4: Experience in the field. Everyone wants to be served by people who are experts in their field and who have direct experience solving the problems their customers are facing. This is particularly important when it comes to regulatory compliance in the mortgage lending industry.
A compliance department is more than a group of attorneys that monitors lawmaking bodies, or it should be. Do the legal professionals working in the company have direct experience working for wholesale lenders? Have they faced similar problems when it comes to selling loans into the secondary market? What firms have they worked for in the past and what clients does the company serve today?
Even though predatory lending compliance has only been around a half dozen years or so as a vital service, companies with much less experience than that may find it harder to sell their services to lenders. It should come as no surprise that less experience would be harder to sell to an investor as well.
How has the company grown over time? How much money has it reinvested in its operation, in its legal team and in the resources it uses to make decisions? How easy is it to get these attorneys on the phone? Do they answer questions and solve problems for their customers while they are on the line? The answers to these questions will tell how dedicated the provider is to the service is has chosen to provide.
It's easier to sell a compliance company with a good track record who can provide a lot of references from both small and larger companies. Ultimately, a company's track record will tell a lender how successful they are at heading off non-compliance and keeping their lender customers out of trouble. For both lenders and investors, that's the bottom line.
Being able to show an investor why the lender chose its particular compliance solution over all others in terms of the offered benefits above will go a long way toward making that investor feel better about the relationship. It may even open the doors for doing more business together in the future.
Bill Lambropoulos is general counsel and director of compliance for DocMagic (Document Systems, Inc.), Carson, Calif., where he has served since 1998. DocMagic document preparation software and web-based systems offer a complete compliance solution for residential mortgage lenders.