Should US state nonbank mortgage servicers be subject to "safety and soundness" standards of the type imposed by federal law on insured depository institutions, even though the nonbanks do not solicit and hold customer funds in federally insured deposit accounts or pose a direct risk of a government bailout? Well, state mortgage banking regulators think so. On September 29, 2020, the Conference of State Bank Supervisors ("CSBS"), an organization made up of state regulators, released proposed prudential standards for state oversight of nonbank mortgage servicers (the "Proposal").1 CSBS pointed to a "changed nonbank mortgage market" as the driver of the proposed standards, emphasizing that nonbank mortgage servicers now service roughly 40% of the total single-family residential mortgage market. Comments from interested parties are due by December 31, 2020.

Background

CSBS correctly noted in its Proposal that there are no uniform or comprehensive prudential standards that apply to nonbank mortgage servicers. Yet, there are numerous requirements that apply to nonbank mortgage servicers, including the mortgage servicing rules promulgated by the Consumer Financial Protection Bureau ("CFPB")2 and licensing, consumer protection and other requirements of state regulators. The Federal Housing Finance Agency ("FHFA"), as the conservator of Fannie Mae and Freddie Mac, has instituted minimum capital, net worth and liquidity requirements, and Ginnie Mae also imposes financial strength requirements, but CSBS noted that these requirements do not apply across servicers' entire portfolios. For example, FHFA requirements apply only to the portions of servicers' portfolios that consist of Fannie Mae- and Freddie Mac-owned or -backed loans. The Proposal did not mention the fact that it is reported that third-party agency servicing presently comprises over 75% of the nonbank third-party servicing market. Nor did it highlight that the private investors on whose behalf nonbank mortgage services administer non-agency loans impose their own requirements as counterparties to their servicing agreements and are the ones most likely to bear the risk of loss on the serviced loans.

The idea of "prudential" standards generally is synonymous with "safety and soundness" standards.3 Section 39 of the Federal Deposit Insurance Act obligates the applicable federal banking agencies to prescribe for all insured depository institutions standards relating to, among others, internal controls, information systems, internal audit systems and other operational and managerial standards as the applicable agency deems to be appropriate.4 The widely cited meaning of an "unsafe or unsound practice" is:

Generally speaking, an "unsafe or unsound practice" embraces any action, or lack of action, which is contrary to generally accepted standards of prudent operation, the possible consequences of which, if continued, would be abnormal risk or loss or damage to an institution, its shareholders, or the agencies administering the insurance funds.5

Interestingly, the apparent purpose does not mention protecting bank customers, but, of course, safety and soundness standards, on one hand, and consumer protection requirements, on the other hand, are not mutually exclusive. Indeed, material, persistent violations of consumer protectionrelated laws and regulations could pose the very type of abnormal risk of loss that safety and soundness standards are designed to prevent. But managing legal risk is one small component of much more comprehensive safety and soundness standards that apply to insured depository institutions.

This is not the first effort to apply additional safety and soundness requirements to nonbank mortgage servicers. CSBS previously issued proposed prudential standards for nonbank mortgage servicers in 2015.6 In addition, the Housing Finance Reform and Taxpayer Protection Act of 2014, a bipartisan congressional effort to reform Fannie Mae and Freddie Mac that did not become law, would have required the creation of enhanced standards for servicers approved to service certain government-backed loans, including, among other things, standards related to the maintenance of adequate liquidity and reserves.7 The Homeowner Mortgage Servicing Fairness Act of 2018, a bill introduced by Congresswoman Maxine Waters that also did not become law, included some safety and soundness requirements for nonbank mortgage servicers modeled on similar requirements imposed on Fannie Mae and Freddie Mac.8 In addition, the Financial Stability Oversight Council ("FSOC") has encouraged state regulators to work to develop prudential and corporate governance standards for nonbank mortgage servicers9 and issued guidance describing the process FSOC would follow if it were to consider making a determination to subject a nonbank financial company to supervision by the Board of Governors of the Federal Reserve System and prudential standards.10

Description of the Proposal

CSBS' Proposal is designed to cover nonbank mortgage servicers and investors in mortgage servicing licensed by and operating in states, but it is not intended to apply to servicers solely owning and conducting reverse mortgage servicing and it would have limited application to entities that only perform subservicing for others. CSBS does not have any regulatory authority to require mortgage servicers to follow these standards. Instead, CSBS suggests that state regulators adopt these standards by enacting laws or regulations or through other formal issuances. In many cases, the standards are somewhat vague, simply stating that a standard will align with a certain previously issued bulletin, and if states were to adopt these requirements, they may need to further develop the standards. As vague as the proposed standards may be under the Proposal, they essentially are a crude "cut and paste" of federal banking requirements. While it hasn't done it in this case, CSBS has drafted model state laws in other areas.

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Footnotes

1. Conference of State Bank Supervisors, "Proposed Regulatory Prudential Standards for Nonbank Mortgage Servicers," Sept. 29, 2020, available at: https://www.csbs.org/system/files/2020-09/FinalProposedPrudentialStandardsForComment-2020_1.pdf.

2. See 12 C.F.R. § 1024.1 et seq. and 12 C.F.R. § 1026.1 et seq.

3. See our analysis of guidance issued by US federal banking regulators on sound practices for the largest US banking organizations here.

4. 12 U.S.C. § 1831p-1. For example, the OCC has issued various standards for safety and soundness in the form of 5 appendices to 12 C.F.R. pt. 30. https://www.law.cornell.edu/cfr/text/12/part-30

5. Financial Institutions Supervisory and Insurance Act of 1966: Hearings on S. 3158 and S. 3695 Before the House Comm. on Banking and Currency, 89th Cong., 2d Sess. 50 (1966); 112 Cong. Rec. 26,474 (1966) (memorandum submitted by John Horne, Chairman of the Federal Home Loan Bank Board).

6. CSBS explained that its most recent proposal relies heavily on the 2015 proposal.

7. Housing Finance Reform and Taxpayer Protection Act of 2014, S.1217, 113th Cong. (2014).

8. Homeowner Mortgage Servicing Fairness Act of 2018, H.R.6102, 115th Cong. (2018). See our prior analysis of this bill here.

9. Financial Stability Oversight Council, 2014 Annual Report, available at: https://www.treasury.gov/initiatives/fsoc/Documents/FSOC%202014%20Annual%20Report.pdf. See also Financial Stability Oversight Council, 2019 Annual Report, available at: https://home.treasury.gov/system/files/261/FSOC2019AnnualReport.pdf.

10. Financial Stability Oversight Council, "Authority to Require Supervision and Regulation of Certain Nonbank Financial," available at: https://home.treasury.gov/system/files/261/Interpretive-Guidance-on-Nonbank-Financial-Company-Determinations.pdf. See our prior analysis of this guidance here.

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