Alston & Bird Consumer Finance Blog

#CFPB

Second Circuit Deepens Circuit Split over CFPB Funding Structure

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A&B ABstract:

On March 23, 2023, the Second Circuit held the Consumer Financial Protection Bureau’s (CFPB) funding structure is constitutional.  This decision comes on the heels of the Supreme Court granting certiorari to review the Fifth Circuit’s ruling in Community Financial that reached the opposite conclusion.

The Second Circuit’s Ruling

The Second Circuit case, styled Consumer Financial Protection Bureau v. Law Offices of Crystal Moroney, looks at a challenge to a civil investigative demand (CID) for documents made to a law firm that principally advises and services clients seeking to collect debts.  On appeal, the law firm argued the CID could not be enforced because, for among other reasons, the funding structure of the CFPB violated the Appropriations Clause of Article I of the Constitution.

Rejecting this argument, the Second Circuit held that the Appropriations Clause provides “simply that no money can be paid out of the Treasury unless it has been appropriated by an act of Congress.”  That is, if a payment of money from the Treasury is “authorized by statute,” then it does not run afoul of the Appropriations Clause.  And “[t]here can be no dispute that the CFPB’s funding structure was authorized by the CFPBA – a statute passed by Congress and signed into law by the President.”

In reaching this conclusion, the Second Circuit declined to follow the Fifth Circuit’s rationale in Community Financial.  There, the Fifth Circuit reasoned that the CFPB’s funding structure violated the separation of powers embodied in the Appropriations Clause because it was “doubly” insulated from Congressional control.  Specifically, the Fifth Circuit posited that Congress had first ceded control directly over the CFPB’s budget by insulating it from review during the annual appropriations process and second conceded control indirectly by providing that the CFPB’s funding be drawn from a source that was itself outside the appropriations process.

In response to this, the Second Circuit explained that, in its view, the design of the Constitution in the Appropriations Clause was to ensure that the purpose, limit, and fund of every expenditure be ascertained by a previous law.  Thus, as long as the CFPB’s budget had an articulated purpose (as set forth in the CFPA), came from an articulated fund (the earnings of the Federal Reserve System), and had articulable limits (a 12% cap set by Congress in the CFPA), then it was constitutional.  In short, Congress specified the purpose, limit, and fund of its appropriation for the CFPB’s budget in the CFPA, which was all that the Constitution required.

Takeaway

Whether the CFPB’s funding structure is constitutional poses a possibly existential threat to the CFPB’s operations.  The Second Circuit’s decision deepens the split on the issue, which the Supreme Court has already begun undertaking to resolve.  Stay tuned for further updates on how the Supreme Court resolves this split.

CFPB Issues Special Edition of Supervisory Highlights Focusing on Junk Fees

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A&B ABstract:

In the 29nd edition of its Supervisory Highlights, the Consumer Financial Protection Bureau (“CFPB”) focused on the impact of so-called “junk” fees in the mortgage servicing, auto servicing, and student loan servicing industries, among others.

CFPB Issues New Edition of Supervisory Highlights:

On March 8, the CFPB published a special edition of its Supervisory Highlights, addressing supervisory observations with respect to the imposition of junk fees in the mortgage servicing and auto servicing markets – as well as for deposits, payday and small-dollar lending, and student loan servicing.  The observations cover examinations of participants in these industries that the CFPB conducted between July 1, 2022 and February 1, 2023.

Auto Servicing

With respect to auto servicing, the CFPB noted three principal categories of findings the Bureau claims constitute acts or practices prohibited by the Consumer Financial Protection Act (“CFPA”).

First, examiners asserted that auto servicers engaged in unfair acts or practices by assessing late fees: (a) that exceeded the maximum amount stated in consumers’ contracts; or (b) after consumers’ vehicles had been repossessed and the full balances were due.  With respect to the latter, the acceleration of the contract balance upon repossession extinguished not only the customers’ contractual obligation to make further periodic payments, but also the servicers’ contractual right to charge late fees on such periodic payments. The report notes that in response to the findings, the servicers ceased their assessment practices, and provided refunds to affected consumers.

Second, examiners alleged that auto servicers engaged in unfair acts or practices by charging estimated repossession fees that were significantly higher than the average repossession cost.  Although servicers returned excess amounts to consumers after being invoiced for the actual costs, the CFPB found that the assessment of the materially higher estimated fees caused or was likely to cause concrete monetary harm – and, thus, “substantial injury” as identified in unfair, deceptive, and abusive acts and practices (“UDAAP”) supervisory guidance – to consumers.  Further, consumers could have suffered injury in the form of loss of their vehicles to the extent that they did not want – or could not afford – to pay the higher estimated repossession fees if they sought to reinstate or redeem the vehicle.  Examiners found that such injuries: (a) were not reasonably avoidable by consumers, who could not control the servicers’ fee practices; and (b) were not outweighed by a countervailing benefit to consumers or competition.  The report notes that in response to the findings, the servicers ceased the practice of charging estimated repossession fees that were significantly higher than average actual costs, and also provided refunds to consumers affected by the practice.

Third, examiners claimed that auto servicers engaged in unfair and abusive acts or practices by assessing payment processing fees that exceeded the servicers’ actual costs for processing payments.  CFPB examiners noted that servicers offered consumers two free methods of payment: (a) pre-authorized recurring ACH debits; and (b) mailed checks.  Only consumers with bank accounts can utilize those methods; all those without a bank account, or who chose to use a different payment method, incurred a processing fee.  The CFPB reported that as a result of “pay-to-pay” fees, servicers received millions of dollars in incentive payments totaling approximately half of the total amount of payment processing fees collected by the third party payment processors.

Mortgage Servicing

In examining mortgage servicers, CFPB examiners noted five principal categories of findings that related to the assessment of junk fees, which were alleged to constitute UDAAPs and/or violate Regulation Z.

First, CFPB examiners found that servicers assessed borrowers late fees in excess of the amounts permitted by loan agreements, often by neglecting to input the maximum fee permitted by agreement into their operating systems.   The examiners found that by instead charging the maximum late fees permitted under state laws, servicers engaged in unfair acts or practices.  Further, servicers violated Regulation Z by issuing periodic statements that reflected the charging of fees in excess of those permitted by borrowers’ loan agreements. In response to these findings, servicers took corrective action including: (a) waiving or refunding late fees that were in excess of those permitted under borrowers’ loan agreements; and (b) corrected borrower’s periodic statements to reflect correct late fee amounts.

Second, CFPB examiners found that servicers engaged in unfair acts and practices by repeatedly charged consumers for unnecessary property inspections (such as repeat property preservation visits to known bad addresses). In response to the finding, servicers revised their policies to preclude multiple charges to a known bad address, and waived or refunded the fees that had been assessed to borrowers.

Third, CFPB examiners noted two sets of findings related to private mortgage insurance (“PMI”).  When a loan is originated with lender-paid PMI, PMI premiums should not be billed directly to consumers.  In certain cases, the CFPB found that servicers engaged in deceptive acts or practices by mispresenting to consumers – including on periodic statements and escrow disclosures – that they owed PMI premiums, when in fact the borrowers’ loans had lender-paid PMI.  These misrepresentations led to borrowers’ overpayments reflecting the PMI premiums; in response to the findings, servicers refunded any such overpayments. Similarly, CFPB examiners found that servicers violated the Homeowners Protection Act by failing to terminate PMI on the date that the principal balance of a current loan was scheduled to read a 78 percent LTV ratio, and continuing to accept borrowers’ payments for PMI after that date.  In response to these findings, servicers both issued refunds of excess PMI payments and implemented compliance controls to enhance their PMI handling.

Fourth, CFPB examiners found that servicers engaged in unfair acts or practices by failing to waive charges (including late fees and penalties) accrued outside of forbearance periods for federally backed mortgages subject to the protections of the CARES Act.  The CARES Act generally prohibits the accrual of fees, penalties, or additional interest beyond scheduled monthly payment amounts during a forbearance period; however, the law does not address fees and charges accrued during periods when loans are not in forbearance.  Under certain circumstances, HUD required servicers of FHA-insured mortgages to waive fees and penalties accrued outside of forbearance periods for borrowers exiting forbearances and  entering permanent loss mitigation options.  CFPB examiners found that servicers sometimes failed to complete the required fee waivers, constituting an unfair act or practice under the CFA.

Finally, CFPB examiners found that servicers engaged in deceptive acts and practices by sending consumers in their last month of forbearance periodic statements that incorrectly listed a $0 late fee for the next month’s payment, when a full late fee would be charged if such payment were late.  In response to the finding, servicers updated their periodic statements and either waived or refunded late fees incurred in the referenced payments.

Deposits

The CFPB determined that two overdraft-related practices constitute unfair acts or practices: (i) authorizing transactions when a deposit’s balance was positive but settled negative (APSN fees); and (ii) assessing multiple non-sufficient funds (NSF) fees when merchants present a payment against a customer’s account multiple times despite the lack of sufficient funds in the account.  The CFPB has criticized both fees before in Consumer Financial Protection Circular 2022-06, Unanticipated Overdraft Fee Assessment Practices.

According to the report, tens of millions of dollars in related customer injury are attributable to APSN fee practices, and redress is already underway to more than 170,000 customers.  Many financial institutions have abandoned the practice, but the CFPB noted that even some such institutions had not ceased the practice and were accordingly issued matters requiring attention to correct the problems.  As for NSF fees, the CFPB found millions of dollars of consumer harm to tens of thousands of customers.  It also determined that “virtually all” institutions interacting with the CFPB on the issue have abandoned the practice.

Student Loan Servicing

Turning to student loan servicing, the CFPB found that servicers engaged in unfair acts or practices prohibited by the CFPA where: (a) customer service representative errors delayed consumers from making valid payments on their accounts, and (b) those delays led to consumers owing additional late fees and interest associated with the delinquency.  Contrary to servicers’ state policies against the acceptance of credit cards, customer service representatives accepted and processed credit card payments from consumers over the phone.  The servicers initially processed the credit card payments, but then reversed those payments when the error in payment method was identified.

Payday and Small Dollar Lending

The CFPB determined that lenders, in connection with payday, installment, title, and line-of-credit loans, engaged in a number of unfair acts or practices.  The first conclusion they made was that lenders simultaneously or near-simultaneously re-presented split payments from customers’ accounts without obtaining proper authorization, resulting in multiple overdraft fees, indirect follow-on fees, unauthorized loss of funds, and inability to prioritize payment decisions. The second such conclusion concerned charges to borrowers to retrieve personal property from repossessed vehicles, servicer charges, and withholding subject personal property and vehicles until fees were paid.  The third such determination related to stopping vehicle repossessions before title loan payments were due as previously agreed, and then withholding the vehicles until consumers paid repossession-related fees and refinanced their debts.

Takeaways

The CFPB’s focus on “junk” fees is not new – it follows on an announcement last January that the agency would be focused on the fairness of fees that various industries impose on consumers.  (We have previously discussed how the CFPB’s actions could impact mortgage servicing fee structures.)  Similarly, the Federal Trade Commission has previously considered the issue of “junk fees” in connection with auto finance transactions.

By focusing specifically on the issue in a special edition of the Supervisory Highlights, the CFPB is drawing special attention to the issue of these fees in the servicing context.  Mortgage, auto, and student loan servicers might use this as an opportunity to review their current practices and see how they stack up against the CFPB’s findings.

The COVID-19 National Emergency is Ending: Are mortgage servicers ready?

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A&B Abstract:

On January 30, 2023, President Biden informed Congress that the COVID-19 National Emergency (the “COVID Emergency”) will be extended beyond March 1, 2023, but that he anticipates terminating the national emergency on May 11, 2023. The White House Briefing Room reiterated the President’s position on February 10, 2023. Given the significant updates mortgage servicers made to their compliance management systems (“CMS”) to ensure compliance with the myriad of COVID-19-related laws, regulations and guidance issued in response to the pandemic, servicers should begin evaluating their CMS now to determine whether updates are necessary to minimize the risk of non-compliance and consumer harm as the COVID Emergency comes to an end. Set forth below, we discuss some of the key areas on which servicers should focus as they develop a plan for winding down COVID-19 protections.

Background

The COVID-19 pandemic created unprecedented operational challenges for mortgage servicers – challenges servicers sought to overcome through significant actions that were taken at the outset of the pandemic and over the last three years to implement the myriad of federal and state laws, regulations, and guidance that were enacted or promulgated in response to the pandemic.

Indeed, in response to the pandemic, the US Congress passed the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, Sections 4021 and 4022 of which provided certain borrowers impacted by the pandemic with certain credit reporting and mortgage-related protections.

Section 4021 of the CARES Act amended the Fair Credit Reporting Act by adding a new section providing special instructions for reporting consumer credit information to credit reporting agencies when a creditor or other furnisher offers an “accommodation” to a consumer affected by the pandemic during the “covered period,” which ends 120 days after the COVID Emergency terminates.

Section 4022 of the CARES Act granted forbearance rights and protection against foreclosure to certain borrowers with a “federally backed mortgage loan.” Specifically, during the “covered period,” a borrower with a federally backed mortgage loan who is experiencing a financial hardship that is due, directly or indirectly, to the COVID Emergency may request forbearance on their loan, regardless of delinquency status, by submitting a request to their servicer during and affirming that they are experiencing a financial hardship during the COVID Emergency. When the CARES Act was enacted, there was uncertainty in the industry as to how to define the “covered period” as the term was undefined. However, because the borrower must attest to a financial hardship during the COVID Emergency, the industry came to understand the “covered period” to be synonymous with the COVID Emergency, such that borrower requests received outside the COVID Emergency need not be granted.

Additionally, under Section 4022, a servicer of a federally backed mortgage loan were prohibited from initiating any judicial or nonjudicial foreclosure process, moving for a foreclosure judgment or order of sale, or executing a foreclosure-related eviction or foreclosure sale (except with respect to vacant and abandoned properties) through May 16, 2020.

In response to the CARES Act, mortgage servicers were inundated with directives issued by the US Department of Housing and Urban Development (“HUD”), the US Department of Veterans Affairs (“VA”), the US Department of Agriculture (“USDA”), the Consumer Financial Protection Bureau (“CFPB”), as well as the guidelines published by Fannie Mae and Freddie Mac (collectively, the “Agencies”), as the Agencies (other than the CFPB) were tasked with implementing the protections afforded by the CARES Act.  As result of these directives, servicers were required to quickly implement changes to their servicing operations, while ensuring accurate communication of such changes to its customers. For example, HUD alone issued over 20 mortgagee letters since the outset of the pandemic that were directly related to the operations of HUD-approved servicers.

In addition to the Agencies, several states either passed legislation, promulgated regulations or issued directives that mortgage servicers were required to implement. Servicers were also required to respond to the CFPB’s Prioritized Assessments, inquiries from Congress, and requests from the Agencies. Accordingly, servicers devoted substantial legal, compliance, and training resources to ensure compliance with applicable laws and requirements.

In implementing the foregoing laws and regulations, servicers made significant updates to their CMS and the various components that support an effective CMS, including, among others, policies, procedures, training, scripting, correspondence, system updates, and vendor management. Similarly, now that the COVID Emergency appears to be nearing an end, servicers should reevaluate what updates are necessary to effectively wind-down COVID-19 protections while minimizing regulatory risk and consumer harm.

Below we discuss several issues servicers should be particularly mindful of in developing a plan for winding down COVID-19 protections.

Key Areas of Focus for Servicers

Agency/GSE Guidelines: The myriad of Agency guidance issued in response to the pandemic included new and evolving requirements regarding the offering of COVID-19 Forbearance Plans, COVID-19-specific loss mitigation options, and other COVID-19-related borrower protections. For example, HUD, VA, and USDA have largely tied a borrower’s ability to request an initial COVID-19 Forbearance to the expiration of the COVID Emergency. HUD has indicated that a borrower may only request an additional forbearance extension of up to six months if the initial forbearance will be exhausted and expires during the COVID Emergency. On the other hand, Fannie Mae and Freddie Mac have previously informally indicated that servicers should continue to process borrower requests for COVID-19 Forbearances until the GSEs announce otherwise. Moreover, there is the possibility that all or some of the Agencies will expand post-forbearance COVID-19 protections to a broader class of borrowers given the apparent success of the streamlined options. On January 30, 2023, HUD issued a mortgagee letter (which was corrected and reissued on February 13th) extending its COVID-19 Recovery Loss Mitigation Options to include additional eligible borrowers, increase its COVID-19 Recovery Partial Claims, and add incentive payments to servicers. Notably, the mortgagee letter does not appear to update HUD’s existing guidance on the availability of COVID-19 Forbearance Plans, and it temporarily suspends several of HUD’s non-COVID-19 loss mitigation options, such as all FHA-HAMP options. In preparing for the end of the COVID Emergency, servicers should ensure that they identify and carefully review applicable Agency guidelines to determine what, if any, updates to existing processes are necessary.

Policies, Procedures, and Training: Whether a servicer created a specific COVID-19/CARES Act policy and/or updated its existing policies to reflect applicable COVID-19 protections, servicers must now review and update those policies to ensure they do not inaccurately reflect requirements no longer in effect as a result of the termination of the COVID Emergency. As a reminder, Regulation X requires servicers to maintain policies and procedures that are reasonably designed to achieve the objectives in 12 C.F.R. § 1024.38. Commentary to Regulation X clarifies that “procedures” refers to the actual practices followed by the servicer. Thus, servicers should ensure that its procedures reflect its policies. It is also important that updated and accurate training and job aids are provided to servicing employees, particularly to consumer service representatives, to ensure clear, accurate, and up to date information is communicated to consumers. It’s also a good time to ensure that policies, procedures, and training reflect the expiration of certain CFPB COVID-19-related measures. For example, the enhanced live contact requirements for borrowers experiencing COVID-19 related hardships were in effect from August 31, 2021 through October 1, 2022.

Scripts, Letters and Agreements: The CFPB called for mortgage servicers to take proactive steps to assist borrowers impacted by COVID-19 including prioritizing clear communications and proactive outreach to borrowers. In response, servicers updated communications through emails, texts, letters, loss mitigation agreements, buck slips, periodic statements, and other standard communications alerting borrowers of requirements for accepting and processing requests for forbearance, approving forbearance requests, providing credit reporting accommodations, and providing information on post-forbearance loss mitigation options and foreclosure. One of the standards the CFPB uses in assessing whether an unfair, deceptive, or abusive act or practice (“UDAAP”) occurred is whether a representation, omission, act or practice is deceptive, meaning that it misleads or is likely to mislead the consumer, the consumer’s interpretation of the representation is reasonable under the circumstances, and the misleading representation, omission, act or practice is material. Thus, it is important for servicers to review their communication library to make sure outdated CARES Act and other COVID-19-related information is not included in borrower communications.

System Updates: Throughout the last three years servicers were required to implement substantial system enhancements to ensure compliance with the myriad of requirements that arose in response to the pandemic. These enhancements included, among others, stop codes to ensure compliance with applicable foreclosure moratoria; changes to loss mitigation decisioning systems to reflect new and revised loss mitigation waterfalls; updates to borrower-facing websites and interactive voice response (“IVR”) systems to provide borrowers with information on available COVID-19 protections and to facilitate a borrower’s ability to self-serve when requesting a COVID-19 Forbearance; enhancing credit reporting systems to ensure accurate credit reporting for borrowers who are provided an accommodation under the CARES Act; and implementing system updates to ensure compliance with applicable fee restrictions. Given the significant time, effort, and resources required to implement the foregoing enhancements, servicers should begin evaluating their systems now to determine what changes are necessary to reflect that some or all of these protections will no longer be in effect.

State Law: In response to the COVID-19 pandemic, several states (including but not limited to California, the District of Columbia, Maryland, Massachusetts, New York, and Oregon) enacted their own protections, most of which have since expired. Now is the time for servicers to ensure that their CMS is updated to reflect that these laws are no longer in effect.

Instructions to Service Providers: Many servicers rely on third-party service providers to provide certain support functions. During the pandemic, reliance on such service providers was even more critical as servicers worked to implement the above-referenced requirements. Such service providers include, among others, print/mail vendors, foreclosure counsel, and third-party customer support representatives. In preparing for the end of the COVID Emergency, servicers should ensure accurate and consistent instructions are provided to, and appropriate oversight is exercised over, service providers to ensure compliance with applicable law and to minimize UDAAP risk.

Takeaway

The implementation of federal and state COVID-19 protections required that servicers devote substantial time, effort, and resources to ensure consumers could avail themselves of available protections and to minimize the risk of harm. Unfortunately, when the pandemic first began, servicers did not have the luxury of time when implementing these measures. However, given that the end of the COVID Emergency is not until May 11th, servicers should utilize this time to think through what impact the termination of the emergency will have on their current processes and controls, and begin making necessary updates.

CFPB Issues Advisory Opinion Warning Against Kickbacks for Mortgage Rate Shopping Platforms

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A&B ABstract:

Last week, the Consumer Financial Protection Bureau (CFPB) issued an advisory opinion to address the applicability of the Real Estate Settlement Procedures Act (RESPA)’s Section 8 – the anti-kickback provision – to operators of certain digital technology platforms that enable consumers to comparison shop for mortgages and other real estate settlement services. These platforms include those that generate potential leads for the platform participants through consumers’ interactions with the platform, referred to by the CFPB as Digital Mortgage Comparison-Shopping Platforms.

The Advisory Opinion

The Advisory Opinion is an interpretive rule issued under the CFPB’s authority to interpret RESPA and Regulation X, including under section 1022(b)(1) of the Consumer Financial Protection Act of 2010, which authorizes guidance as may be necessary or appropriate to enable the CFPB to administer and carry out the purposes and objectives of federal consumer financial laws.

The Advisory Opinion provides that an operator of a Digital Mortgage Comparison-Shopping Platform violates RESPA section 8 if the platform provides enhanced placement or otherwise steers consumers to platform participants based on compensation the platform operator receives from those participants rather than based on neutral criteria.

More specifically, the Advisory Opinion states that an operator of a Digital Mortgage Comparison-Shopping Platform receives a prohibited referral fee in violation of RESPA section 8 when: (1) the Digital Mortgage Comparison-Shopping Platform non-neutrally uses or presents information about one or more settlement service providers participating on the platform; (2) such non-neutral use or presentation of information has the effect of steering the consumer to use, or otherwise affirmatively influences the selection of, those settlement service providers, thus constituting referral activity; and (3) the operator receives a payment or other thing of value that is, at least in part, for that referral activity. In other words, where the platform’s operator presents lenders based on extracted referral payments rather than the shopper’s personal data or preferences or other objective criteria, the platform has violated section 8 of RESPA. The CFPB provides two (2) examples of prohibited conduct:

  • Platform operator presents a lender as the best option because that lender pays the highest referral fee. However, the shopper is led to believe the lender was selected based on their shared personal data or preferences.
  • Platform receives payments from lenders to rotate them as the top presented option regardless of whether the highlighted lender is the best fit for the shopper.

Furthermore, if an operator of a Digital Mortgage Comparison-Shopping Platform receives a higher fee for including one settlement service provider compared to what it receives for including other settlement service providers participating on the same platform, the CFPB views this as evidence of an illegal referral fee arrangement (absent other facts indicating that the payment is not for enhanced placement or other form of steering). Ultimately, where a platform’s formula is designed to steer shoppers to use providers in which the operator has a financial stake, the platform has violated section 8 of RESPA.

Takeaway

The CFPB is concerned that Digital Mortgage Comparison-Shopping Platforms, particularly popular during a time of increasing mortgage interest rates, may attempt to take advantage of consumers rather than provide them with a neutral and fair presentation of the providers that may best meet their mortgage or other settlement needs. Any entity involved, even tangentially, in the mortgage settlement process, should ensure that services are offered based on neutral criteria rather than the compensation received from a third-party provider.

Moving to Address Appraisal Bias, Agencies and the Appraisal Foundation Issue Updates

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A&B ABstract:

 A year and a half after President Biden’s announcement of the Interagency Task Force on Property Appraisal and Valuation Equity (“PAVE”), the past weeks have seen a flurry of activity from federal agencies and the Appraisal Foundation to address issues of bias in residential property appraisal.  What should lenders, servicers, and appraisers know?

Background:

In June 2021, President Biden announced the formation of the PAVE Task Force, comprising 13 federal agencies, including the White House Domestic Policy Council.  He tasked the group with identifying and evaluating “the causes, extent, and consequences of appraisal bias and to establish a transformative set of recommendations to root out racial and ethnic bias in home valuations.”

In March 2022, the member agencies of the PAVE Task Force published an action plan, announcing a series of concrete commitments to address appraisal bias in five broad categories:

  • strengthening guardrails against discrimination in all stages of residential valuation;
  • enhancing fair housing and fair lending enforcement, and driving accountability in the appraisal industry;
  • building a diverse, well-trained, and accessible appraiser workforce;
  • empowering consumers to take action against bias; and
  • giving researchers and enforcement agencies better data to study and monitor valuation bias.

While the Task Force’s activity is ongoing, federal agencies in the past few weeks have announced a series of steps that are in line with the PAVE goal of addressing real property appraisal bias.

FHA: Draft Mortgagee Letter on Reconsiderations of Value and Appraisal Review

On January 3, 2023, the Federal Housing Administration (“FHA”) published for public comment a draft mortgagee letter, Borrower Request for Review of Appraisal Results, that would permit a second appraisal to be ordered if a Direct Endorsement underwriter determines that an original appraisal contains a material deficiency.  The letter would expressly identify as a material deficiency – one that would directly impact value and marketability of the underlying property – either indications of unlawful bias in the appraisal or of a violation of applicable federal, state, or local fair housing and non-discrimination laws.

Further, the draft mortgagee letter would require the underwriter in a transaction involving an FHA-insured loan to “review the appraisal and determine that it is complete, accurate, and provides a credible analysis of the marketability and value of the Property.”  Among other criteria, this would require the underwriter to make a determination of whether the appraisal is materially deficient – that is, whether the appraisal contains indications of unlawful bias or of a violation of applicable fair housing and non-discrimination laws.  Providing a “credible analysis” exceeds the scope of a quality control review.  If included in a finalized mortgagee letter, it would require lenders to determine whether underwriters must be state-licensed or -certified appraisers.

The draft mortgagee letter also sets forth standards for the submission and consideration of a borrower’s request for a review of appraisal results, including the submission of a reconsideration of value request to the appraiser.

VA: Enhanced Oversight Procedures to Combat Appraisal Bias

On January 18, the Department of Veterans Affairs (“VA”) issued Circular 26-23-05, detailing the enhanced oversight procedures that the VA has adopted “to identify discriminatory bias in home loan appraisals and act against participants who illegally discriminate based on race, color, national origin, religion, sex (including gender identity and sexual orientation), age, familial status, or disability.”

In the Circular, the VA indicated that it will review all appraisal reports submitted in connection with VA-guaranteed home loans to identify any potential discriminatory bias.  The VA will: (a) conduct an escalated review of any suspected incidents of bias; and (b) remove from its panel of approved appraisers any individual who is confirmed to have provided a biased appraisal as the result of such a review.

The VA also reminded panel appraisers that in submitting a Fannie Mae Form 1004 (Uniform Residential Appraisal Report), they certify that they have not based the opinion communicated in an appraisal report on discriminatory factors (e.g., the race) of either the property applicants or the residents of the area in which the property is located.

Appraisal Foundation: Proposed Revision of Appraisal Standards

In mid-December, the Appraisal Standards Board (“ASB”) of the Appraisal Foundation released its fourth exposure draft of proposed changes to the Uniform Standards of Professional Appraisal Practice (“USPAP”), the operational standards that govern real property appraisal practice.

In response to comments received in response to the last draft, the ASB proposes to add to the USPAP Ethics Rule a section expressly discussing non-discrimination.  The proposed section would prohibit appraisers from engaging in both unethical discrimination and illegal discrimination, and would provide guidance as to the type of conduct constituting each form.

Unethical Discrimination:

First, the ASB proposes to include an express statement that an appraiser must not engage in unethical discrimination.  First, that prohibition would preclude an appraiser from developing and/or reporting an opinion or value that is based, in whole or in part, on the actual or perceived protected characteristics of any person.

Second, the rule would prohibit an appraiser from performing an assignment with bias with respect to the actual or perceived protected characteristics of any person – meaning that the appraiser may not engage in any discriminatory conduct (regardless of whether it arises in the course of developing and/or reporting an opinion of value). For purposes of this prohibition, the rule would utilize the USPAP definition of bias: “a preference or inclination that precludes an appraiser’s impartiality, independence, or objectivity in an assignment.”

The rule would make a limited exception for activity that qualifies with “limited permissive language,” permitting an appraiser to use or rely upon a protected characteristic in an assignment only where:

  • laws and regulations expressly permit or otherwise allow the consideration of a protected characteristic;
  • use of or reliance on that characteristic is essential to the assignment and necessary for credible assignment results; and
  • consideration of the characteristic is not based upon bias, prejudice, or stereotype.

The exposure draft provides as an example of activity that might qualify for the exception the completion of an appraisal review in order to determine whether the initial appraisal was discriminatory.

The ASB proposal makes clear that because “an appraiser’s ethical duties are broader than the law’s prohibitions,” an appraiser may commit unethical discrimination without violating any applicable law; however, an act that “constitutes illegal discrimination … will also constitute unethical discrimination.”

Illegal Discrimination:

Complementing the prohibitions discussed above, the ASB proposes to include an express statement that an appraiser must not engage in illegal discrimination – conduct that violates the minimum standards of anti-discrimination set forth in the Fair Housing Act (“FHA”), the Equal Credit Opportunity Act (“ECOA”), and Section 1981 of the Civil Rights Act of 1866 (“Section 1981”).  The rule would impose on appraisers a duty to understand and comply with such laws as they apply to the appraiser and the appraiser’s assignments, including the concepts of disparate treatment and disparate impact.  Further, the rule would prohibit an appraiser from using or relying on a non-protected characteristic as a pretext to conceal the use of or reliance upon protected characteristics when performing an assignment.

Further Guidance:

 The exposure draft indicates that the ASB would follow the adoption of the new non-discrimination section of the ethics rule with detailed guidance on the scope of these prohibitions, including:

  • Background on federal, state, and local anti-discrimination laws;
  • Guidance on the application of FHA, ECOA, and Section 1981 to appraisals of residential real property;
  • Explanation of the disparate treatment and disparate impact theories of discrimination, including examples relating to appraisal practice;
  • Guidance on neighborhood discrimination in real property appraisals; and
  • Clarification on acceptable uses of protected characteristics, in connection with the “limited permissive language” exception for the prohibition against unethical discrimination.

OMB: AVM Rule on Regulatory Agenda

 Automated valuation models  (“AVMs”) are considered a useful tool to help mitigate appraisal discrimination.  On January 4, the Office of Management and Budget (“OMB”) released its Fall 2022 Regulatory Agenda.  Among other topics, OMB indicated that an interagency proposed rule addressing quality control standards for AVMs is expected in March 2023. The Dodd-Frank Act’s amendments to the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”) require the federal banking regulatory agencies to undertake this rulemaking.

 ASC: Hearing on Appraisal Bias

 On January 24, the Appraisal Subcommittee (“ASC”) of the Federal Financial Institutions Examination Council held a hearing on appraisal bias.  Of note, Consumer Financial Protection Bureau Director Rohit Chopra ended the hearing by articulating the objective that the “lodestar” of appraisals is an appraisal that neither too high nor too low, but rather is accurate.    Director Chopra then questioned the regulatory structure governing appraisals, calling it “byzantine.”  His remarks focused on the funding mechanism between the Appraisal Institute and the Appraisal Foundation, implying that there may be a conflict of interest.

To understand Director Chopra’s comment requires knowledge of the current regulatory framework, which Title XI of FIRREA established in 1989.   It includes three principal parties: the ASC, the Appraisal Foundation, and the Appraisal Institute:

  • The ASC is a federal agency with oversight responsibility of the state appraisal regulatory structure for real property appraisers as well as to monitor activities of the Appraisal Foundation.
  • The Appraisal Foundation is a private non-profit educational organization. Through the ASB and the Appraiser Qualifications Board (“AQB”), the Appraisal Foundation sets the ethical and performance standards of appraisers in the USPAP.  The AQB establishes the minimum education, experience, and examination requirements for real property appraisers, which are then enforced by state regulatory agencies.  The Appraisal Foundation is funded through sales of publications and services, as well as by its sponsoring organizations.
  • The Appraisal Institute is a private professional organization of appraisal professionals, and is one of the sponsoring organizations of the Appraisal Foundation.

Takeaway

 Viewed through the lens of the overall PAVE Task Force efforts, actions by the FHA and the VA show early and concrete action to address residential appraisal bias.  Because they implicate government insurance and guarantee programs, the focus is particularly important for lenders and appraisers to take heed of – such that documentation submitted to the agencies is accurate.

Appraisers should also take note of the updated USPAP exposure draft as it moves toward final adoption, so that they are aware of their responsibilities with respect to avoiding bias in appraisal reports. Finally, with regulators scrutinizing the appraisal framework – as seen in the OMB and ASC announcements – more significant changes are expected.