July 2015 Legal Briefs

• TRID rule postponed
• The SCOTUS disparate impact ruling
• Small wave of flood changes, but watch the riptide

TRID rule postponed

By John S. Burnett

A technical glitch
The Consumer Financial Protection Bureau didn’t exactly “blink” when it announced on June 17 it would postpone the effective date of the Truth in Lending Act/Real Estate Settlement Procedures Act Integrated Disclosures (TRID) rule from August 1 to October 1. As it turns out, the Bureau’s formal proposal, issued on June 24, suggests October 3 as the new effective date, in order to provide a Saturday implementation date that, apparently, many mortgage lenders had been planning on. But the postponement wasn’t entirely designed to pacify those complaining that there just wasn’t enough time left before the due date.

The CFPB had been under pressure from members of Congress, lobbyists and lenders, to postpone the August 1 date, even though the rule was finalized in November 2013 and published on New Year’s Eve in 2013, with over 19 months to its effective date. Only a couple of weeks before the mid-June announcement, the Bureau had announced its intention “to be sensitive to the progress made by those entities that have been squarely focused on making good-faith efforts to come into compliance with the rule” by August 1, and that the agency had spoken with other regulators to clarify that approach. So why the change in direction signaled by the postponement of the August 1 date?

At least partly camouflaged among facile statements that the two-month postponement “may benefit both industry and consumers with a smoother transition to the new rules” and “would better accommodate the interests of the many consumers and providers whose families will be busy with the transition to the new school year at that time,” was the fact that the CFPB had slipped up and missed a deadline to file a required report to Congress about the rule under the Congressional Review Act (CRA). The CRA report was filed on June 16, and under the provisions of that Act, the TRID rule effective date would have to be no earlier than 60 days later, or August 15. In fact, that is the new, current effective date of the TRID Rule until the Bureau’s proposal is finalized.

A conspiracy theorist could argue that the Bureau deliberately missed the filing deadline for the CRA report to fabricate an excuse for the delay that many have clamored for. It’s much more likely that the TRID Rule has so many moving parts and the Bureau is attempting to respond to so many complex questions about implementation, that someone simply messed up and forgot to set a reminder for submitting the CRA report at least 60 days before August 1. The industry, by and large, is not complaining about the two-month reprieve.

August 15 or October 3?
The Bureau could have left matters unchanged and simply announced that the CRA had forced the two-week delay to August 15. But that short delay could have presented problems with software coded to manage the transition from current disclosure requirements for applications received before the effective date and the new TRID requirements for applications received on or after the effective date. To allow sufficient time for the software corrections, the Bureau needed to extend the two-week postponement somewhat, and apparently decided that changing two weeks to two months would also let some lenders and vendors who may have missed the effective date “catch up.”

One would think that lenders would be universally happy for the delay, but there are rumors that some feel they are ready for implementation and want no further delay beyond the current August 15 date. We don’t know yet how consumers will weigh in on the proposal to move the date back to October 3. So it would be a mistake to assume that the October 3 date is now cast in stone, although we think it’s likely to be finalized. We have to wait to see what the Bureau does in the final rule.
Short comment period

As you might imagine, the Bureau’s under pressure to finalize the matter of the new effective date as soon as it can. Consequently, it has set a short comment period ending July 7 for the proposal. We expect to see a final rule issued soon after the close of the comment period, but it will have to be published in the Federal Register no later than Friday, August 14.

The SCOTUS disparate impact ruling

By John S. Burnett
On June 25, the Supreme Court of the United States handed down its decision in the matter of Texas Department of Housing and Community Affairs, et al. v. Inclusive Communities Project, Inc., et al., affirming the judgment of the Court of the Appeals for the Fifth Circuit that disparate-impact claims are cognizable under the Fair Housing Act of 1968 (FHA). Several other cases presenting the same question had previously been scheduled for review by the Court, but had been settled before the Court could hear arguments.

Disparate-impact claims are not new. They have been brought successfully under other civil rights laws enacted since the mid-1960s. The Court cited two such laws in particular, Title VII of the Civil Rights Act of 1964 (Title VII) and the Age Discrimination in Employment Act of 1967 (ADEA), as precedents for its ruling. In both of those laws, and in the FHA, there is text that refers to the consequences of actions (the disparate impact) and not just to the mindset or intent of the actors (the parties whose actions are targeted by the laws). The Court also commented on Congress’ failure to address the matter of disparate impact when it amended the FHA, with the knowledge that nine circuit courts had ruled the FHA permitted disparate-impact claims, stating that Congress’ action (or lack thereof) essentially ratified the circuit courts’ rulings.

The SCOTUS ruling didn’t signal an intent that disparate-impact cases will or ought to be easily won, however. In the Syllabus (summary) of the opinion, we can read, “Disparate-impact liability must be limited so employers and other regulated entities are able to make the practical business choices and profit-related decisions that sustain the free-enterprise system. Before rejecting a business justification—or a governmental entity’s analogous public interest—a court must determine that a plaintiff has shown that there is ‘an available alternative . . . practice that has less disparate impact and serves the [entity’s] legitimate needs.’ ”

Later in the Syllabus, we find “A disparate-impact claim relying on a statistical disparity must fail if the plaintiff cannot point to a defendant’s policy or policies causing that disparity. A robust causality requirement is important in ensuring that defendants do not resort to the use of racial quotas. Courts must therefore examine with care whether a plaintiff has made out a prima facie showing of disparate impact, and prompt resolution of these cases is important. Policies, whether governmental or private, are not contrary to the disparate-impact requirement unless they are ‘artificial, arbitrary, and unnecessary barriers.’ Courts should avoid interpreting disparate-impact liability to be so expansive as to inject racial considerations into every housing decision. These limitations are also necessary to protect defendants against abusive disparate-impact claims.”

The Court also cites HUD’s 2013 Implementation of the Fair Housing Act’s Discriminatory Effects Standard, which set up a burden-shifting framework for handling disparate-impact claims. Under that regulation, a plaintiff has to first make a prima facie showing of disparate impact. In other words, the plaintiff has the burden of proving that a practice [of the defendant] caused or predictably will cause a discriminatory effect. Statistical discrepancies (see above) caused by factors other than the defendant’s policy don’t support a prima facie finding and will not result (by themselves) in liability for the defendant.

If the plaintiff succeeds in showing disparate impact, the burden shifts to the defendant to prove that the practice is necessary to achieve substantial, legitimate, nondiscriminatory [business] interests.

If that effort is successful, the burden then shifts back to the plaintiff, who must prove that the “substantial, legitimate, nondiscriminatory interests” of the defendant could be served by another practice with a less discriminatory effect.

What is a lender to do?
Although the Court didn’t endorse the HUD regulation as a roadmap for addressing disparate-impact claims, HUD’s regulation, which was not affected by the SCOTUS ruling, does provide guidance for those in the housing market as developers, government bodies or, importantly to our readers, lenders. Lenders should have policies and practices that are not only nondiscriminatory on their face, but can also be demonstrated to be necessary to achieve business goals that are substantial, legitimate and nondiscriminatory. “Necessary” should be understood to mean that the policy or practice is the optimal policy that achieves those goals with the least risk for disparate impact on protected classes.

For example (and solely for illustration), a lender might have a pricing policy that imposes a substantial application fee for residential mortgage loans and the fee is either greater for smaller loan amounts or, as a fixed amount, represents a greater percentage of the loan amount for smaller loans. Or a lender might not offer residential mortgage loans less than a stated amount. Either of those practices could be considered to have a disparate impact on applicants with lower incomes, and that could arguably translate to a disparate impact on a protected class. Such a lender should carefully analyze such policies or practices to make them as “bullet-proof” to a disparate-impact claim as possible by ensuring they are serving the lender’s “substantial, legitimate and nondiscriminatory” business goals with less discriminatory effect than any alternative policy or practice relating to residential mortgage loan pricing.

Small wave of Flood Changes, but Watch the Riptide

By Andy Zavoina
The final flood rules were published in June by the Office of the Comptroller of the Currency (OCC), Federal Reserve System (Fed), Federal Deposit Insurance Corporation (FDIC), Farm Credit Administration (FCA) and the National Credit Union Association (NCUA). Collectively, these are the Agencies. While this is a final rule, it is not the complete final rule. What is addressed in this new rule:

• exemption from flood insurance requirements for qualifying detached structures,
• escrow payments,
• flood insurance notice, and
• force-placed insurance.

The final rule does not address the private flood insurance provisions required in the Biggert-Waters Act. A separate rule will be published on that subject in the future.
Key dates mandated by this final rule are October 1, 2015 for the detached structures and force-placed insurance, and January 1, 2016 for the escrow rules.

Note the effective date of the escrow rules. Until that date your regulator will enforce the current rule that was effective with Biggert-Waters in July 2012. Although the TILA/RESPA Integrated Disclosure rules (TRID) are likely being shifted back to the October 2015 timeframe, giving you more time to prepare for the TRID changes, you will now have a few additional balls in the air to juggle because of the new flood rule.

Use your time wisely.
This article outlines the changes in the final flood rule to help you understand how to tweak your bank’s flood policy and procedures.

How did we get here?
In two years there were four key rulemaking milestones pertaining to flood rules.
1. October 2013 – Agencies issued a proposal for the Biggert-Waters Flood Insurance Reform Act of 2012. These rules would have required lenders to escrow flood insurance premiums and fees on residential improved real estate securing a loan unless certain conditions were met. The proposal also would implement the Biggert-Waters provisions allowing lenders and servicers to accept private flood insurance, provide guidance on refunds when multiple polices were on the same property, and update force-placed flood insurance rules.

2. March 2014 – the Homeowner Flood Insurance Affordability Act of 2014 (HFIAA) was signed by the President, amending parts of Biggert-Waters that had not been implemented.

3. October 2014 – Agencies issued a proposal to implement HFIAA. This proposal would have required lenders to escrow flood insurance premiums and fees on residential improved real estate securing a loan, consistent with HFIAA’s amendments to Biggert-Waters, and excluded certain detached structures from some flood requirements.

This proposal would have required institutions not subject to an escrow exception to offer borrowers the option to escrow on their loans. Institutions that no longer qualified for the small lender exception also would have had to comply with the general escrow requirements and the option to escrow.

4. June 2015 –this final rule was adopted. It implements provisions addressing escrow and the detached structures which were in the October 2014 Proposed Rule. (Your November 2014 Legal Briefs has more, refer to “Flood Insurance Proposed Rule.”)

In addition, this final rule incorporates the force-placed flood insurance provisions that were proposed in the October 2013 and were not affected by HFIAA.
Note that in this rulemaking, it says, “the Agencies encourage lenders to consult Biggert-Waters and HFIAA for further information about revisions to the flood insurance statutes that will not be implemented through the Agencies’ rulemakings.” As you prepare to make changes to your flood policies and procedures, you will need several resources to ensure compliance.

Biggert-Waters and HFIAA Amendments
It is Biggert-Waters that required the banking regulators to issue a rule requiring escrow of premiums and fees for flood insurance unless the small institution exception applies. The small institution exception applies to institutions with total assets of less than $1 billion as of December 31st of either of the two preceding calendar years and that, as of July 6, 2012, were not required by Federal or State law to escrow taxes or insurance, and did not have a policy to require these escrows. (Biggert-Waters did not reference the point in time the asset size test is applied. The Agencies clarified this in the final rule. They also clarified that the asset size is only of the institution itself and is not an aggregate based on multiple institutions under common ownership. As to “requiring” escrows, the Agencies have taken the position that an escrow established at the borrower’s request is not a “requirement” to have an escrow account.) Additional exceptions are described below.

HFIAA gave us the exclusion of certain detached structures from mandatory flood insurance that were effective when HIFAA was signed and some institutions were employing this exception, but the new rule provides some much-needed clarification.

New Rule – Specifics
What’s covered? The bank cannot Make, Increase, Renew or Extend (MIRE) a designated loan on a property in a Special Flood Hazard Area without having adequate flood insurance first. While not a change in the way the rule is applied, to reduce confusion over what must be insured, the rule specifies “coverage does not apply to land.”

Detached structure. There were questions about how to apply the new detached structure exemption. The new rule answers them. Remember having an application with a dwelling that was out of the flood zone, but the $300 shed was inside it? The common answer to that was, “flood insurance is required or raze the building.” Now you may not have to do that, plus we have some guidance to clear up the questions.
With respect to the detached structure exemption, the purpose of the loan is immaterial. The exemption applies to a “residential property,” whether the loan was made as a consumer loan or a commercial loan that happens to have a residence. If a structure is detached from a residential property, then the exemption can apply. But if it’s a commercial use building, the exemption does not. So what is a residential structure?

Borrowing from Reg Z, a structure that is part of a residential property refers to one used primarily for personal, family, or household purposes. Recognizing that you may have one property that is both a commercial property and a residence, the Agencies have determined that the exemption applies only when the primary purpose is residential. In the rulemaking process the Agencies agreed with commenters that this term can be used broadly. The Interagency Q&As address this at question 51 which deals with residential improved real estate and discusses multi-family buildings and mixed-use properties.

Now a clarification on what is “detached.” Some lenders questioned if a covered walkway between a house and a detached garage would mean it was not detached for this exemption. The rule is clear. It is detached if the structure stands alone – it is not joined by any structural connection to the residential structure.

Then there were questions as to the definition of “serve as a residence.” The IRS defines a residence as having a sleeping area, a bathroom and a kitchen. There was also discussion in the rulemaking process about value and square footage. In the end, the Agencies believe there is no bright line test for this and you, the lender, can rely on your own good faith determination. We recommend you outline your criteria in your procedures. Emphasis in the final rule is on “what is the structure’s intended use?” While the IRS test may provide clear guidance when a structure is serving as a residence, there are always exceptions, as a residence may not have a bathroom in it, but could have one available such as in a shared facility, but this is a good, general start. The Agencies do not want the actual use to be the determining factor as that could exclude homes under construction, vacant rental units, vacant garage apartments, and some other structures.

Is there an obligation on the part of the lender or servicer to monitor the ongoing use of the detached residential property to maintain this exemption? No, there is not. But a new triggering event (if you Make, Increase, Renew or Extend) will require that you review it. And consistent with treatment of existing loans subject to the Flood Disaster Protections Act (FDPA) if the lender or servicer does determine that a property is underinsured the borrower must be informed and provide adequate coverage or a policy may be force-placed.

Lastly, the bank may waive the flood insurance requirement on a structure detached from a residence, but it does not have to.

Escrow requirement. The October 2014 proposal and HFIAA require your bank (as a regulated institution), or a servicer acting on your behalf, to escrow all premiums and fees for flood insurance required for loans secured by residential improved real estate or a mobile home unless the loan or the lending institution qualifies for one of the statutory exceptions. In addition to the small lender exception, there are six others. These include:

(i) loans that are in a subordinate position to a senior lien secured by the same property for which flood insurance is being provided;
(ii) loans secured by residential improved real estate or a mobile home that is part of a condominium, cooperative, or other project development, provided certain conditions are met;
(iii) business purposesloans that are secured by residential improved real estate or a mobile home;
(iv) home equity lines of credit;
(v) nonperforming loans; and
(vi) loans with terms not longer than 12 months.

While the exceptions may seem clear to some lenders, others had questions and the new rules add clarification as to applicability.

For subordinate lien loans (i), the exception is only available for the property which already has flood insurance in place. If you use this exception, is there a requirement that you monitor the superior lien? The answer is “no” but as above, if you become aware that the superior lien is released or no longer applies or you have a triggering event under MIRE triggers, you would have to begin escrowing. For this reason your loan documents must require escrow in the event your loan is no longer excluded under an exception.

The “condo, coop” (# ii) exemption goes further, as the final rules incorporate a HFIAA escrow exception for loans that are secured by residential improved real estate or a mobile home that are part of a condominium, cooperative, or other project development and are covered by a flood insurance policy that:

(i) meets the mandatory flood insurance purchase requirement;
(ii) is provided by the condominium association, cooperative, homeowners association or other applicable group; and
(iii) the premium is paid by the condominium association, cooperative, homeowners association, or other applicable group as a common expense.

If the policy coverage is not sufficient in this exception, the borrower would be required to provide supplemental coverage unless the small lender exception also applied.

The Agencies clarified from the October 2014 proposal that these exceptions do apply to business, commercial and agricultural purpose loans (# iii).

Exception (# v) applies to nonperforming loans. These were proposed to be loans that were 90 days or more past due. Clarification was needed as different lenders accounted for these differently and loans may fluctuate on the days past due (being paid to a 60 day status, as an example, and then falling back into a 90 day status).

he final rule borrows from the FCA’s regulations on categorizing assets so that a nonperforming loan is “a loan that is 90 or more days past due and remains nonperforming until it is permanently modified or until the entire amount past due, including principal, accrued interest, and penalty interest incurred as the result of past due status, is collected or otherwise discharged in full.”

Short term loans (# vi) of 12 months or less is clear enough, but what about when a renewal of a construction loan is required? What happens then? The final rule provides that an extension or renewal of a loan that was 12 months or less retains its exception when the renewal or extension is also 12 months or less.

The Agencies do caution that if you avoid with these exceptions, then if at any time during the term of a designated loan you have a triggering event (MIRE) on or after January 1, 2016, and at that point you find that an exception does not apply, you must require the escrow of all flood insurance premiums and fees as soon as reasonably practicable. While commenters on the proposals wanted a definition for “reasonably practicable,” there is not one. The Agencies compared it to requirements banks already meet under Reg Z and Reg E where actions must meet a “reasonably practicable” standard and saw no problems.

When the institution itself transitions from exempt to nonexempt, the Agencies wanted to provide about six months to allow for the transition. They expect the lender to be aware of the asset size change coming in the first place and believe six months is sufficient. As an example, if your bank exceeds $1 billion in assets at the year ends of 2016 and 2017, triggering events (MIRE) after July 1, 2018 would no longer fall under the small bank exception. Further, if your bank decreased in size after losing its exemption technically the exemption would apply. But the Agencies believe that once the bank has systems in place, recognizing that growth could occur again and that borrowers would be confused over an on again, off again escrow requirement, the bank (or servicer) would continue the escrow procedures. Much thought would be needed for a bank to use the exemption based on the expectations the Agencies have.

Notices. There are minor changes to the notices required, in terms of content and timing requirements for disclosure.

The lender or servicer must mail or deliver a written notice informing a borrower that it is required to escrow all premiums and fees for required flood insurance on residential improved real estate. The October 2014 Proposed Rule was similar to the October 2013 proposal. The purpose of the notice is to ensure that borrowers are informed about the requirement to escrow premiums and fees for mandatory flood insurance. Since borrowers already receive a Notice of Special Flood Hazards the new text may be incorporated in that. There is one modification however, from the proposed rule.

As noted above, the lender or servicer must require the escrow of all flood insurance premiums and fees if at any time during the term of a loan an exception to the escrow requirement no longer applies. To alert borrowers to the potential need to escrow in those circumstances, lenders must provide the escrow notice in connection with any excepted loan that could lose its exception during the term of the loan. Consequently, borrowers of loans that may eventually become subject to the escrow requirement will be informed of that possibility.

HFIAA requires your bank, as a regulated institution, to offer and make available to a borrower the option to escrow flood insurance premiums and fees for certain loans outstanding as of January 1, 2016. (If your bank is not exempted as a small institution and a loan outstanding on that date has a subordinate lien, it is excepted from the escrow requirement and the bank need not send a notice.) Otherwise, the status of your loans as of January 1, 2016 will determine whether the requirement to offer and make available an option to escrow applies. Loans on which you already have these escrows will be exempt. Loans on which escrow requirements were waived are not excluded.

An institution that no longer qualifies for the small lender exception must provide the option to escrow for borrowers of loans outstanding on July 1 of the succeeding calendar year following the lender’s change in status. This is similar to the loss of an exemption described in the “Escrow requirement” section above. For example, a loan is made on March 1, 2016, by a small lender that no longer qualifies for the exception as of January 1, 2018, would be required to escrow flood insurance premiums and fees for triggered loans (MIRE) on or after July 1, 2018. Consequently, it would be required to offer the borrower on that loan the option to escrow.

The Agencies amended the proposed rule to require that the initial “option to escrow” notice should be provided by June 30, 2016. For banks that lose the small lender exception the notice be provided by September 30 of the succeeding calendar year following the change in status. This provides a nine month period to review the applicable loans in the bank’s portfolio.

Force placement. Biggert-Waters provided that a force-placed policy allows for the bank to collect premiums from the date the borrower’s policy lapsed, forward. Commenters discussed the meaning of when a policy ends and when grace periods may still apply. In the end, the Agencies say the date flood insurance coverage lapses is the expiration date provided by the policy.

If a force-placed policy has been issued and the borrower subsequently obtains their own policy for the bank, the bank must cancel its force-placed policy and refund to the borrower the costs charged during the overlap. This refund must be made within 30 days.