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Regulators in Washington State are in the process of developing "a new way" of overseeing mortgage companies that, if it proves successful, could become a universal system by which examiners look at the home loan business in their respective jurisdictions.

The system is being touted as a money and time saving tool for both regulators and lenders by Chuck Cross of Washington's Department of Financial Institutions, who described it as a method by which examiners can zero in more quickly on problem loans as well as a more efficient way for lenders to deal with routine exams.

Cross, who is acting director in the department's consumer services division as well as the division's chief enforcement officer, has dubbed the system "CAUSEWAY," which stands for Combined Analysis Using Software and Examinations to Winnow and Yield" for better regulatory compliance.

He admitted that the acronym is a mouthful that may not stand the test of time. But he said that if regulators, lenders and consumer advocates can come together under the CAUSEWAY mantel, it could become a national model.

"We're working on this in Washington State, but in no way do we want to keep it to ourselves." Cross said, "We want to export it nationally to see if it has any legs to it."

The regulator stressed at the American Association of Residential Mortgage Regulators' 15th annual convention in Washington late last month that the system is "not about more regulation" but rather a better method for complying with rules already on the books.

But he warned that the effort will succeed only if lender and consumer groups can agree on a universal set of instructions for examinations.

"It's a new way of sifting the wheat from the shaft and getting down to the real issues, but it only has a chance of working if the industry is full in on it and consumer advocates are full in on it," he said.

The geneses for the effort is what Cross, who was elected president of AARMR for the coming year, called "the fervor" over the meaning and suitability of the term "net tangible benefits."

Not only does the phrase "seem to scare the crap out of you guys," he said during a presentation to the AARMR's affiliate members, it also strikes fear in the heart of examiners who often have no idea exactly what they are looking for.

The "sample and review" type of examinations common in most jurisdictions are not a problem when the lender under scrutiny originates only a few hundred mortgages a year, the Washington regulator said.

But when the lender being reviewed has churned out thousands of loans since his last checkup, he added, examiners often end up "spinning their wheels and spending lots of time and money looking at non-issues."

As Cross sees it, examiners need a set of guidelines that will allow them "to get at the real issues more quickly."

At the center of CAUSEWAY will be a an "agreed upon" list of "red flags" that are indicative of abusive lending activities. There also would be a set of compensating factors, or mitigating circumstances that offset the danger signals and explain why the loans were made.

"The red flags would be markers of documentable events, not evidence," the new AARMR president said. "And the compensating factors would be plausible explanations for what appears on the surface to be predatory practices."

The red flags mentioned by Cross include the usual indicators of gouging such as high rates, high points and excessive fees. And the list of compensating factors might include low credit scores, the uniqueness of the property, significant cash back to the borrower, an attempt to rescue the borrower from foreclosure, or a change in the loan program, say from a 30-year adjustable to a 15-year fixed.

The regulator said the "challenge will be in getting everyone to agree on where in the loan continuum" the lender has stepped over the line between fair and fraud.

"If we can get together on when fraud actually occurs, that's when we can get this program moving," Cross said. "We don't have to define predatory as long as everyone agrees when the line is crossed over into predatory territory."

Initial reaction from the sparse audience was generally positive.

Robert Levy, legal counsel to the Mortgage Bankers Association of New Jersey and legislative and regulatory counsel to the MBA of Pennsylvania, said the intent was "laudable," but questioned what would happen if no red flags were discovered or if consumers were not actually hurt by violations that were technical in nature.

"In some cases," Levy, who also chairs AARMR's Advisory Council, pointed out, "reimbursement is ordered when consumers are not harmed. Sometimes, for example, a lack of disclosure has no bearing, yet it winds up being a windfall for consumers."

Cross agreed, saying that he believes "more consumers are harmed by preventing good companies from making good loans" than are hurt by predators.

But he also said the system he envisions could prevent that by rapidly pinpointing problem loans, and allowing examiners and lenders to concentrate on those cases alone.

As described during the hour-long session, examiners would ask lenders to submit electronic spread sheets of their entire loan portfolio several weeks before a scheduled on-site exam.

"We're already asking for much of this information anyway," Cross said. "We're just not looking at in a very efficient way."

The data would be entered into the CAUSEWAY software, a "decision making filter" that would instantly and simultaneously analyze good faith estimates, HUD-1 statements and loan documents and count "red flag hits."

If the system found an unfavorable number of potentially problem loans -- say 1,000 loans out of a 5,000-loan portfolio -- examiners would order a more comprehensive exam. But if only a small percentage of loans popped up -- say just 5 percent of the portfolio -- examiners "would give the lender a clean bill of health and walk away."

"There may not be enough potentially bad loans to go forward with a hearing or sanctions, so examiners would move on to the next company," Cross said. But if a more thorough exam was needed, regulators would be able to concentrate on suspect loans and not have to delve into an entire portfolio.

The AARMR president said examiners would study "no larger a sample (of loans) than they look at now, but they'd be able to look more closely at specific loans. You might end up looking at 100 files instead of 5,000, so it's a more efficient way of figuring out how many consumers are affected."

He also stressed that the "good players" who play by the book not only would breeze through the examination process "faster," but also be "protected from (false) allegations."

Samuel Morelli, president of Sunset Mortgage Co. in Chaddsford, Pa., indicated the idea has merit but warned that the "parameters must be good for everybody, not just Washington."

Cross agreed that the system "has to be universally acceptable. It can't single out one lender, and must be employed consistently."

"I can't promise that it will never be used in an arbitrary and capricious manner because all states are different," he said, "but that's the goal."

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