Cenlar Consent Order is a wake-up name for non-banks

Last week the world of mortgage services got an unpleasant surprise. Cenlar FSB, the nation's largest sub-servicer of residential mortgages, has been confronted by the Office of the Comptroller of the Currency with a consent warrant for allegedly "unsafe and unhealthy" banking practices.

"The order requires the bank to take comprehensive corrective action to address identified deficiencies and implement internal controls and risk management practices that are appropriate to the bank's risk profile and the size of its mortgage management operations," the OCC notes.

Cenlar's subservicing book has grown rapidly in recent years, including the raising of loans owned by Citigroup's CitiMortgage unit. Cenlar was rated positively as a servicer by the major rating agencies. S&P rated Cenlar as “strong” in February of this year. Fitch Ratings rated Cenlar “RPS2” in 2020. Fitch said the rating "reflects Cenlar's continued investment in its service operations, experienced management team and employees, sophisticated growth strategy, effective corporate risk management controls, and the financial strength and support of parent company Cenlar Capital Corporation."

The OCC regulation suggests that the bank's internal systems and controls have significant weaknesses. Remember, OCC has found no consumer harm and has not fined Cenlar. By accepting the results of the OCC without a fight, however, Cenlar recognized a long list of operational deficiencies that must be addressed before the thrift holding company can take on new services.

The Cenlar case is unusual for several reasons. First, Cenlar is a tiny bank that started out as Centennial Savings over a century ago. In the second quarter of 2021, Thrift had only $ 1.1 billion in total assets, about $ 300 million primarily noninterest income, and $ 8.2 million in net income. The bank has no diversified banking or deposit base, has virtually no fiduciary deposits or mortgage servicing rights, and instead focuses entirely on mortgage underservation.

Cenlar FSB is actually a very small bank that is now regulated as a large bank by the OCC, the most prescriptive and problematic federal bank regulator. Why? Because Cenlar is under-managing three million loans with an unpaid principal balance of over $ 750 billion as of June 30, 2020. Cenlar FSB looks more than a commercial bank like many large non-bank service providers.

The OCC Consent Order limits "excessive growth" and prioritizes remedial action by requiring that the bank not receive regulatory objections from the OCC before adding new child customers and declaring or paying dividends to shareholders while the order is in effect. However, in order to understand the actions of the OCC, we need a little bit of context.

The federal banking supervisory authorities have long made it clear to the regulated institutions that they are averse to reputational risks. Regulators are also not keen on monoline business models that focus on residential mortgage loans, again because of reputational risk. Given that consumers are a major source of reputational risk in the world of servicing 1-4 family mortgage loans, the OCC and other regulators have consistently raised the bar for consumer finance institutions to avoid such risks.

Another data point comes from the recent troubles at Wells Fargo & Co., which have been in regulatory purgatory for years due to a breakdown in internal systems and controls in several areas of the bank. Wells has been subject to government sanctions for nearly a decade to correct deficiencies in its harm reduction activities. But the board of directors and senior management of the giant bank have so far made no progress in addressing these areas.

As a result, the OCC just fined Wells $ 250 million based on the bank's "unsafe or unsound" practices related to flaws in its home loan mitigation program and violations of the 2018 Compliance Consent Order. The bank has been asked to fix issues but has not and is now facing additional fines and penalties.

“Wells Fargo failed to meet the requirements of the 2018 OCC lawsuit against the bank. That is unacceptable, ”said the acting currency auditor Michael J. Hsu. "In addition to the $ 250 million civil fine we are going to impose on Wells Fargo, today's policy will limit the bank's future operations until the existing mortgage servicing issues are adequately addressed."

Hsu continued, "The OCC will continue to use all the tools at our disposal, including business restrictions, to ensure that the national banks address issues in a timely manner, treat customers fairly, and operate safely and soundly." Wells Fargo or we will force you to downsize and eventually liquidate the bank.

Likewise, the bank has reportedly been told by Cenlar to make improvements in many areas of its systems and controls. Cenlar made progress and added several senior executives to its management team. These changes did not take place in time, at least as measured by the OCC, so that Cenlar is now confronted with a draconian consent order that restricts the bank's legal capacity and restricts capital measures. Ironically, the OCC action damaged Cenlar's reputation and also poses a potential threat to non-banking service providers.

The OCC's Consent Order for Cenlar contains a list of issues that many banks and mortgage service providers have seen in the past. However, this is the strictest order that OCC has imposed on a bank in a decade. Even if the order did not include a fine or a determination of consumer harm, the Consumer Finance Protection Bureau and government agencies may decide to impose similar standards on independent mortgage lenders.

The OCC action against Cenlar FSB can be seen as a preventative measure to avoid future mistakes, consumer damage and fines once credit losses return to normal. The lesson from the Wells and Cenlar FSB cases is clear: fix operational issues identified by regulators or feel ashamed of yourself by an enforcement action and the public reputational damage it entails.

Many executives in the mortgage finance industry take comfort in the fact that they are not custodians. But that's a mistake. Here, too, Cenlar looks much more like an IMB like the sub-service giant Dovenmuehle or the private service provider Lakeview than Wells Fargo, JPMorgan, Flagstar Bancorp, a large sub-servicer who is also one of the largest warehouse lenders in the industry.

The OCC's focus on operational risk at Cenlar, even before consumer harm has occurred, should be a wake-up call for all IMBs with significant maintenance or sub-service books.

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