Yield Spread Premiums Not Governed by TILA

In its September 20, 2010 Opinion, the Third Circuit Court of Appeals affirmed the trial court’s holding that yield spread premiums do not form Truth-in-Lending Act, 15U.S.C. §1601, et seq. (“TILA”) “finance charges” nor inclusion in the annual percentage rate (“APR”) calculation. Abbott v. Washington Mutual. Finance, Inc., 2008 WL 756069 (E.D. Pa. 2008).

By way of background, Barbara Abbott borrowed $130,000 from loan originator Loan City, Inc. (“Loan City”) in a loan brokered by Priority Mortgage Group (“Loan”), the HUD 1 for which notes that Loan City paid Priority a $1596.60 “yield spread premium”, i.e., monies lenders pay mortgage brokers outside of the distribution of loan proceeds for originating a loan at an interest rate higher than the lender’s minimum.

Ms. Abbott filed a Complaint demanding TILA rescission for failing to disclose or include the $1,596.40 yield spread premium as a “finance charge” or as part of Truth in Lending Disclosure Statement’s APR.

Following a bench trial, the trial court entered judgment for the lender ruling that because the lender - - and not Ms. Abbott - - paid the $1,596.40 Yield Spread Premium, TILA disclosure was not required. 2008 WL 756069, *2.

Ms. Abbott appealed arguing that the Yield Spread Premium required disclosure beyond being set forth on HUD 1 and inclusion in finance charge calculation.

Yield Spread Premium Requires No Separate Disclosure Nor Finance Charge Inclusion

TILA, as implemented by Regulation Z, 12 C.F.R. §§ 226.1 et seq., requires creditors making loans secured by borrowers’ principal dwelling to provide "material disclosures" including “annual percentage rate”, “finance charge”, and “amount financed”. In re Community Bank of Northern Virginia, 418 F.3d 277, 304-305 (3d Cir. 2005); 12 C.F.R. §226.23. Both TILA and Regulation Z expressly excludes “bona fide”, “reasonable” and “real-estate related fees from the finance charge’s computation. Davis v. Deutsche Bank Nat. Trust Co., 2007 WL 3342398, at *4-5 (E.D. Pa. 2007) citing 15 U.S.C. §1605 (e) and 12 C.F.R. §226.4( c)(7)(1).

“Yield spread premiums” are defined as a bonus paid to a broker when it originates a loan at an interest rate higher than the minimum interest rate approved by the lender for a particular loan. Escher v. Decision One Mortg. Co., LLC, 2009 WL 3127753, *4 (E.D.Pa. 2009). As long as it is disclosed on the HUD-1, and because it is already included in the disclosed interest rate, TILA and its implementing regulations do not require lenders to disclose yield spread premiums as part of a loan's finance charge or explain its impact on the interest rate. Id., *4. District Courts have uniformly held that a yield spread premium need not be separately disclosed or included as a pre-paid finance charge because it is already included in the interest rate and should not be double counted. Id., *4-*5.

Charge Was a Yield Spread Premium and Disclosed on the HUD 1

Yield spread premiums are monies lenders pay mortgage brokers outside of the distribution of loan proceeds calculated by multiplying the loan’s principal amount by the “above par value”, i.e., the percentage amount above par for which the loan’s originator can sell the loan. The “yield spread” - - or amount above par that Loan City was able to sell the Loan - - was 1.228%. The 1.228% yield spread multiplied by the Loan’s $130,000 principal equals the $1,596.40 yield spread premium that Loan City paid to Priority.

Although on January 28, 2003, Ms. Abbott “locked in” at the 6% interest rate, on that day Loan City was offering rates between 5.625% and 6.375% and between January and February 2003 interest rates between 5% and 6.75%. Thus, because Ms. Abbott was eligible for a rate of interest as low as 5% (“Approved Minimum”), 6% was not her Approved Minimum.

Because Priority originated this Loan at an interest rate higher than Loan City’s minimum rate, i.e., Ms. Abbott’s 5% Approved Minimum, Loan City paid it a $1596.60 yield spread premium outside of the loan’s proceeds.

Mortgage Reform and Anti-Predatory Lending Act

Although the Third Circuit adopted in whole the trial court’s analysis, the recently enacted Mortgage Reform and Anti-Predatory Lending Act prohibits yield spread premiums payment for referral of a loan to a lender at a higher than par interest rate.

However, the Act but does not bar pre-enactment yield spread premiums or payments passed on to third parties for bona fide charges not retained by lender or broker or impact compensation that secondary market purchasers pay for closed loans.

Mortgage Reform and Anti-Predatory Lending Act

The Federal Reserve recently issued a final rulemaking regarding Title XIV of the Dodd-Frank Act ("Act") prescribing new residential mortgage loan standards, creating stringent consumer protections, and greatly increasing loan originators’ underwriting burdens.

Beyond creating incentives for lenders to only offer prime quality "vanilla" loan products, the Act and its regulations will reduce credit availability to the non-prime lending sector.

Increased Underwriting Requirements

The Act amends the Truth-in-Lending Act’s ("TILA") "mortgage originator” definition to any person, who for direct or indirect compensation, takes a residential mortgage loan application, assists a consumer in obtaining or applying to obtain a residential mortgage loan or offers or negotiates terms of a residential loan.

Excluded from the definition are persons performing "purely administrative or clerical tasks" or solely real estate brokerage activities if properly licensed, and persons making 3 or fewer fully amortized purchase money loans in any 12 month period where borrower has a reasonable ability to repay loan.

Section XIV’s core is a TILA amendment mandating that consumers be offered loans reasonably reflecting their ability to repay, that are understandable and not unfair, deceptive or abusive, and requiring originators be appropriately licensed and adhere to Secured and Fair Enforcement for Mortgage Licensing Act of 2008 requirements.

“Steering” Prohibition

The Act prohibits mortgage lenders and brokers from giving or receiving compensation that varies with loan terms (other than principal amount) and payment of yield spread premiums for referral of a loan to a lender at a higher than par interest rate but does not bar payment to lenders ultimately passed on third parties for bona fide charges not retained by lender or broker or impact compensation that secondary market purchasers pay for closed loans.

The Act directs the newly created Bureau of Consumer Financial Protection ("Bureau") to prescribe regulations prohibiting mortgage originators from steering consumers to a residential mortgage loan that they lack a reasonable ability to repay, has predatory characteristics or effects (i.e., equity stripping, excessive fees or abusive terms), is a non-qualified mortgage when consumer was eligible for a qualified mortgage, or have abusive or unfair lending impact promoting disparities among consumers of equal credit worthiness of different race, ethnicity, gender or assets.

Further, the Act prohibits mortgage originators from mischaracterizing consumer credit history or residential mortgage loans available to consumer, mischaracterizing appraised value of property securing credit extension, and discouraging consumer from seeking a loan secured by their principal dwelling from another originator if unable to suggest, offer or recommend to consumer a loan that is not more expensive than a loan for which the consumer qualifies.

“Duty of Care” and “Steering” Violations Liability

Mortgage originators violating duty of care and steering provisions are subject to TILA liability up to the greater of actual damages or 3 times the total of compensation earned by mortgage, plus litigation costs including reasonable attorney's fees.

The Act increases TILA violations statutory civil liability from current $100 – $1,000 for individual actions to $200 – $2,000 and class actions from current $500,000 to $1,000,000.

Further, the statute of limitations for bringing steering and ability to pay provisions claims is expanded from 1 to 3 years.

Additionally, borrowers may assert a defense to foreclosures brought by creditor or assignees if creditor violated anti-steering and ability to repay provisions.

Regulation Promulgation

The Act authorizes the Bureau to promulgate regulations prohibiting:
○abusive, unfair, deceptive, predatory acts or practices necessary or proper to ensure that responsible, affordable mortgage credit remains available; and
○creditors from making residential loans unless they make a reasonable and good faith determination based on verified information that, at the time loan is consummated, consumer has a reasonable ability to repay loan, according to its terms, all applicable taxes and insurance (including mortgage guarantee insurance), and assessments.

In determining “ability to repay a residential mortgage loan”, creditor must consider credit history, current income, expected income consumer is reasonably assured of receiving, current obligations, debt-to-income ratio or residual income consumer will have after paying non-mortgage debt and other mortgage-related obligations, employment status, and other financial resources other than consumer's equity in property securing loan’s repayment.

Safe Harbor and Rebuttable Presumption

Creditors and their assignees are subject to a rebuttable presumption of “repayment ability” compliance if originated loan is a “qualified mortgage” defined as any residential mortgage loan with no negative amortization or balloon payments, verified and documented income and financial resources, loan’s underwriting process is based on a payment schedule fully amortizing loan over loan’s term (or, if adjustable rate loan, underwriting process based on maximum rate permitted for first 5 years) taking into account taxes and insurance, complies with all Federal Reserve debt-to-income ratios pronouncements, total points and fees do not exceed 3 percent of total loan amount and term not exceeding 30 years.

HOEPA Expansion

The Act expands the primary federal anti-predatory lending law Home Ownership and Equity Protection Act’s ("HOEPA") scope currently applying to loan refinances with points and fees exceeding 8% of the "total loan amount" or $592.

The Act increases HOEPA coverage to purchase money loans and home equity lines of credits and creates a new APR test based on an undefined "average prime offer rate" instead of currently used yield on a Treasury Security of comparable maturity to the loan term. Under this new test, first lien loans either not secured by personal property or in amounts of $50,000 or greater will be subject to HOEPA if APR at consummation exceeds average prime offer rate by 6.5 percentage points and for subordinate lien loans if APR at consummation exceeds average prime offer rate by 8.5 percentage points.

The Act creates a new HOEPA threshold triggered if total points and fees, other than bona fide third party charges exceed in a transaction of $20,000 or more, 5 percent of "total transaction amount" or, if less than $20,000, lesser of 8% of the "total transaction amount" or $1,000.

The Act provides that a creditor or assignee, when acting in good faith, may correct a HOEPA violation if:
○within 30 days of loan’s closing and prior to institution of any action, it notifies consumer, makes "restitution" and adjustments either rendering loan compliant with HOEPA or no longer subject to statute; or
○within 60 days of creditor's discovery or receipt of notification of an unintentional violation or bona fide error, it notifies consumer and makes "restitution" and adjustments either rendering loan compliant with HOEPA or no longer subject to statute.

Restoring American Financial Stability Act

On May 20, 2010, the Senate passed the Restoring American Financial Stability Act, (“Act”),
viewable, with amendments, at http://thomas.loc.gov/cgi-bin/bdquery/z?d111:s.03217:.

A comprehensive financial regulatory reform bill, the Act consolidates existing consumer protection authorities into a new Consumer Financial Protection Bureau, establishes a council to monitor and address systemic risk, and implements a resolution authority to prevent firms from being considered “too big to fail”.


Consumer Financial Protection Bureau

The Act establishes the Consumer Financial Protection Bureau, an independent entity housed within the Federal Reserve.

The Act authorizes the Bureau to write consumer protection rules for banks and nonbank financial firms offering consumer financial services or products, and examine and enforce regulations for banks and credit unions with greater than $10 billion in assets, all mortgage-related businesses (i.e., lenders, servicers, and mortgage brokers), and large non-bank financial companies (i.e., payday lenders, debt collectors, and consumer reporting agencies).

Interestingly, the Act prohibits the Bureau from defining “insurance” as a financial product or service and excludes from its authority insurance, accountants and tax preparers, attorneys, persons regulated by a state insurance regulator, merchants, retailers, other sellers of non-financial services, real estate brokerage activities, manufactured home retailers and modular home retailers.

Instead, the Act creates Office of National Insurance within the Treasury Department to monitor the insurance industry, coordinate international prudential insurance issues, and conduct a study and report to Congress on modernizing insurance regulation.


Financial Stability Oversight Council

The Act also creates the Financial Stability Oversight Council to identify, monitor, and address systemic risk and make recommendations to the Federal Reserve for heightened capital, leverage, liquidity, and risk management standards.

The Act mandates minimum leverage and risk-based capital requirements for insured depository institutions, depository institution holding companies, and for nonbank financial firms identified by the Council.


Creation and Enforcement of Consumer Rights

The Act amends the Truth In Lending Act by requiring lenders to determine a borrower’s “reasonable ability to repay” before making a mortgage and prohibits loan originator compensation that varies with loan terms other than the principal amount thereby prohibiting yield spread premiums.

The Act also requires that credit bureaus provide consumers with numerical credit scores contained in a credit report used to deny credit and allows state attorneys general to sue national banks for failure to comply with state laws or for violating Bureau issued regulations.


Financial Institution Oversight

The Act merges the Office of Thrift Supervision into the Office of the Comptroller of the Currency and the Federal Reserve will retain supervision of bank holding companies and state-chartered banks and become supervisor of savings and loan holding companies.

The Act will also require large, complex companies to periodically submit “funeral plans” for their rapid and orderly shutdown/wind-down in the event of economic failure and redefines how the Federal Deposit Insurance Company calculates the deposit insurance premiums it charges by basing premiums on the risks posed by those institutions.

The Act does not address Fannie Mae and Freddie Mac’s future and must be reconciled with H. R. 4173, the House-passed financial regulatory reform bill.

PA Supreme Court Not Making In-House Counsel’s Life Easier

The Pennsylvania Supreme Court’s recent Nationwide Mut. Ins. Co. v. Fleming --- A.2d ----, 2010 WL 336171 (Pa. 2010) decision provides little guidance on the attorney-client privilege’s applicability to in-house counsel communications to his client involving more than legal advice.

Instead, the evenly split Supreme Court left standing the Superior Court’s controversial Nationwide Mutual Insurance Company v. Fleming decision denying attorney-client privilege protection to in-house counsel’s confidential communication to the corporate client containing legal advice regarding litigation.

At issue was Nationwide’s in-house attorney’s memorandum to its officers regarding the defection of Nationwide’s agents, providing the strategy behind Nationwide’s lawsuits against former agents and their new agencies, and opining as to the litigation’s likely outcome.

Although not invoking the work product doctrine, Nationwide asserted that the document was protected from disclosure by the attorney-client privilege.

Defendants argued that because two other attorney-client communications contained the same “agent defection” subject matter Nationwide had waived privilege, i.e., a director’s memorandum to Nationwide officers, employees, and attorneys outlining its response to the agents’ defections which was not labeled privileged and/or confidential; and a “Privileged and Confidential” labeled memorandum from an in-house attorney to officers, managers, and attorneys outlining counsel’s understanding regarding departing agents and the need to obtain information to assess legal options.

The trial court found that Nationwide had waived its privilege by improperly using the attorney-client privilege as both a sword and a shield through disclosing favorable “agent defection” communications while withholding an unfavorable one as privileged.

In its appeal, Nationwide argued that because the other documents were unprivileged routine business communications not revealing any protected communications to its counsel, their disclosure could not waive the attorney-client privilege as to the subject document.

The Superior Court affirmed holding that the subject document was never privileged. Instead, it
interpreted the attorney-client privilege statute as only protecting confidential communications made by a client to counsel in connection with the provision of legal services and would only protect the subject document to the extent the communications “contain and would thus reveal confidential communications from the client.”

The Superior Court found that the subject document reveal[ed] no confidential facts communicated by to counsel,” and, as a result, was not protected by the attorney-client privilege.

Because the four-member Supreme Court of Pennsylvania panel considering the appeal was equally divided, the Superior Court’s decision was affirmed.

In his opinion supporting affirmance, Justice Eakin concluded that the matter turned on waiver, finding that Nationwide “waived attorney-client privilege with respect to the subject of agent defections upon disclosing in the follow up documents, and cannot claim the privilege applies to the subject document containing the same subject matter, as well as potentially damaging admissions.”

Justice Saylor’s opinion supporting reversal concludes that all the Justices agreed that the subject document “reveals confidential client communications” and “exemplifies the substantial difficulty with a narrow approach to the attorney-client privilege rigidly centered on the identification of specific client communications, in that attorney advice and client input are often inextricably intermixed.”

Because of this unavoidable intertwining, Justice Saylor expressed a preference for protecting all confidential attorney-client communications providing legal advice instead of only client-to-attorney communications.

The lesson appears to be pare down every communication for which attorney client protection will be sought to exclusively those providing legal advice and analysis.

Further, the Nationwide Mut. Ins. Co. v. Fleming opinion suggests that to preserve the privilege, in house counsel must somehow prevent its “privilege seeking communication’s” subject matter from ever being disseminated by it or the client.

Appraisers and Appraisals: Dodging Civil and Criminal Landmines

While not the only culprit, fishy appraisers have caused a tidal wave of predatory lending, mortgage foreclosure and real estate litigation, and, more recently, blistering criminal prosecutions.

Understanding appraisals’ parameters, methodology and time value, appraisers’ licensure and standards, and what is meant by “intended use” is critical to consumer finance litigation.

Real Estate Appraisals and Appraisers

An “appraisal” is an opinion of value of a parcel of land and any structures and improvements.

Although the “actual value” cannot be ascertained until the lot is sold, appraisals should be independent, impartial and objective opinions of market value based upon facts and circumstances known to the appraiser at the time.

Some appraisers specialize in residential or commercial properties, some value both, while others offer comprehensive business valuations including valuing personalty and intellectual property.

Standards for Appraisals

Appraisal practice is governed by the Uniform Standards of Professional Appraisal Practice, (“USPAP”), and any appraisal done in connection with any federally related transaction must be in accordance with USPAP.

USPAP is overseen by The Appraisal Foundation, a private nonprofit organization establishing appraisal licensure‘s minimum qualifications, which, in turn, is overseen by the Congressionally created Appraisal Subcommittee.

Although requiring appraisers to arrive at an opinion of value using a methodology consistent with these standards, industry practice and the appraisal assignment, USPAP does not dictate exactly how an appraisal must be performed.

Methodology for Appraising

Appraisals commence with information gathering - - including a site visit and taking photographs - - to ascertain recent sales of other comparable market properties, any income and expenses the property is generating, and cost of repairing any damage.

Next, appraisers determine an opinion of value using “sales comparison approach” (analyzing past comparable sales in the market), “income approach” (analyzing value based upon income the property produces), or “cost approach” (analyzing cost of rebuilding premises).

The task’s scope, intended user’s identity and nature of intended use factor into which approaches is used. For example, the sales comparison approach is heavily used in valuing single-family residential real estate, while the income approach is employed to value rental properties or businesses.

Time Value of Appraisals

Just as a picture only depicts its subject at a moment in time, an appraisal’s opinion of value may become stale immediately after its effective date.

For example, because both the market and property’s condition may rapidly change, a cluster of area foreclosures, extensive wind and water damage, or skyrocketing labor and/or building materials costs may quickly moot an otherwise valid opinion of value.

Similarly, hidden or latent defects unknown to the appraiser which are not visible upon inspection may also diminish the appraisal’s validity.

What is Meant By Intended Use

Because USPAP requires that each appraisal is performed with a specific, stated use in mind, an appraiser may utilize, ignore or weigh differently any of the approaches to value depending on the intended use.

For example, valuing a building for insurance purposes versus an outright sale may lead to applying different methodologies, which may produce differing opinions of value.

USPAP also requires that an appraisal identify its intended users. For example, in a traditional residential real estate financing setting, an appraisal is commissioned by the lender, who is the intended user for purposes of ensuring that if a mortgage default occurs the loan is sufficiently collateralized.

Joint Defense Privilege: Strength Lies in Numbers

The recent In re Condemnation by City of Philadelphia, 981 A.2d 391 (Pa.Cmwlth.2009) opinion demonstrates what a powerful tool the Joint Defense Privilege is for limiting legal costs and resolving multi defendant disputes quickly, cheaply and efficiently.

The "joint defense" - - or "common interest" - - privilege extends the attorney-client privilege to information-sharing and developing joint litigation strategies between and among counsel for co-defendants.

As the In re Condemnation Court noted:

[T]he joint defense doctrine is highly desirable because it allows for greater efficiency in the handling of litigation. Frequently, co-defendants with essentially the same interests must retain separate counsel to avoid potential conflicts over contingent or subsidiary issues in the case. To avoid duplication of efforts, such defendants should be able to pool their resources on matters of common interest. This can be done most effectively if both counsel can attend and participate in interviews with each other's clients.

981 A.2d at 397.

To fall within the privilege’s protection defendants must “share a common legal, as opposed to a mere commercial or business, interest in the matter” and demonstrate that the: (1) communications were made in the course of a joint defense effort; (2) statements were designed to further that effort; and (3) privilege has not been waived. In re Condemnation, 981 A.2d at 397, n4.

Unfortunately, because of a lack of case law, including the absence of any Pennsylvania Supreme Court authority, issues surrounding the Joint Defense Privilege’s scope and availability remain unresolved.

To best invoke this tool, and cut needless legal expense incurred by duplicative communications and resolution of secondary issues amongst and between defendants, the following must be done. First, ascertain if a true common legal interest exists among or between the parties with whom the communications are to be shared. Second, execute a written joint defense agreement confirming that the participating defendants understand and agree as to the joint legal interests and to what communication the privilege extends.

Through pooling resources, joint interviewing of clients and witnesses, and unification of defense efforts, the Joint Defense Privilege streamlines and focuses litigation and profoundly reduces the costs incurred in defense.

Res Judicata Bars TILA Recovery

In the recent Stuart v. Decision One Mortg. Co., LLC, 975 A.2d 1151 (Pa.Super. 2009) opinion, Pennsylvania's Superior Court barred defaulting mortgage foreclosure defendants from asserting Truth In Lending Act, 15 U.S.C.A. §1601 et seq. (“TILA”) rescission claims in a subsequent proceeding under res judicata.

Specifically, after allowing a default judgment to be entered against them in a mortgage foreclosure in which they failed to assert any counterclaims or defenses, the Stuart v. Decision One Mortg. Co., LLC plaintiffs asserted TILA rescission and money damages claims against their mortgage lender in a separate proceeding.

In affirming the trial court’s “judgment on the pleadings” grant, the Superior Court ruled that “rescission relates to the very transaction that formed the basis of the foreclosure action to which a default judgment was entered”, “res judicata applies not only to claims that were made but also to claims that could have been made” and that “a successful TILA claim would . . . undermine the {mortgage foreclosure} default judgment”. 975 A.2d at 1152-1153.

Further, Pennsylvania’s Superior Court adopted the R.G. Financial Corp. v. Pedro Vergara-Nunez, 446 F.3d 178 (1st Cir. 2006) ruling in holding that because the Stuart v. Decision One Mortg. Co., LLC plaintiffs “had the opportunity to raise rescission as a defense to the foreclosure and failed to do so” they “cannot sit out one cause of action and then force the opposing party into another action over an issue that both could and should have been raised in the first place”. 975 A.2d at 1154.

The Stuart v. Decision One Mortg. Co., LLC opinion’s impact for mortgage lenders will be enormous.

Default judgments in mortgage foreclosures will hereafter eviscerate TILA rescission claims throughout the Commonwealth of Pennsylvania.