The evolution of affiliated business arrangementsJohn R. H. CotterRESPA, Controlled Business Amendment, compliance, service, profit, management
What mortgage brokers should know
Most mortgage company owners know that federal law allows mortgage
lenders, Realtors and builders to share in title company revenues
through ownership in entities called affiliated business
arrangements (ABAs). That has been true since 1983, when Congress
enacted an amendment to the original Real Estate Settlement
Procedures Act (RESPA), called the Controlled Business Amendment.
What many people don't know, however, is how much has changed since
the early days. Today, it is much harder and more dangerous to
start and maintain a profitable, claim-free and legally defensible
ABA. Any mortgage broker owning a title company or contemplating
starting one should examine carefully who is offering to help and
how it is set up and managed. There are arrangements existing today
that may not be managed well, operated in your financial interest
or sufficiently RESPA-compliant to defend against increased the U.S. Department of Housing and Urban
Development (HUD) investigations and the growing number of
class action lawsuits.
Having created and managed approximately 40 ABAs since 1992, I
have seen the damage a HUD investigation and class action lawsuit
can do to a title company. Neither one is a pleasant experience.
Fear and uncertainty infects employee morale, the paperwork and
legal bills drain your resources, and you lose business from some
clients. Beginning in 1992, ABAs started proliferating with offers
of joint-venture arrangements that were either patently illegal or
operated outside the spirit, if not the letter, of HUD's rules. At
the time, industry professionals complained that HUD lacked
enforcement, and class action lawsuits were rare. That changed
about five years ago HUD increased its enforcement staff and the
trial bar discovered lucrative opportunities in lawsuits attacking
companies that they deemed to be operating sham ABAs. Just in the
past five years alone, title companies have paid million of dollars
to settle such lawsuits.
These legal developments have changed the game. It is no longer
safe or responsible to participate in anything but 100 percent
RESPA-compliant ABAs. Unfortunately, the cost to operate a 100
percent RESPA-compliant ABA is greater than operating one that is
not compliant, especially with regard to smaller companies. This in
turn has raised the barrier to entry for smaller lenders. The
biggest challenge for most small- to medium-sized brokerages or
lenders is to generate enough ongoing business to afford the
expenses associated with knowledgeable management and competent
staff that can perform the many diversified functions required to
operate the business effectively and deliver high levels of
service. Title companies are complex, heavily regulated and demand
a strong attention to detail. Without strong management and trained
personnel, losses from processing mistakes and title claims mount
quickly.
Given the change in the regulatory environment, what are your
options in today's market? What are the key criteria you should
consider when choosing the safest and best business model for an
ABA? Which model meets your objectives best? There are four primary
types being offered today, and your appetite for risk and your size
dictate which option you should choose. Here, first, are the four
essential elements that today's ABA should contain:
1. Compliance
The most important requirement is compliance. Your ABA must be a
genuine title company, including employees paid on a W-2 and office
space. Employees should perform title work, processing and
closings. Avoid contracting work to other title companies to ensure
a compliant business. Your business should meet and exceed the ABA
law and all rules promulgated by HUD. Gone are the days when you
could risk operating 25 ABAs from one address and pay 25 paychecks
to a few shared employees.
2. Service
Service is more important than the promise of large profits.
Nothing ruins an ABA title company faster than poor service. Your
time will be consumed responding to complaints from disgruntled
loan associates. Before entering into an agreement, investigate in
depth how your provider intends to set up and manage the company.
Make sure you have employees that are dedicated to your company,
including at least one or two settlement agents/marketing types. If
you contract all the closings to another title company (possibly
owned by a joint-venture partner), you won't get the same dedicated
level of service. Plus, you will expose yourself to greater
liability under RESPA.
3. Profit
The best ABAs no longer include sharing profits with a
joint-venture title company partner. Better models exist, such as
those where you or a group of producing partners own the company
100 percent with the title insurance agency agreement being
established in your name, and the company is large enough to
operate in full compliance with HUD's rules. I call this model,
virtual partners. HUD has never liked joint ventures, and this
model has other advantages, which are cited below.
4. Management
Look for a model that does not require you to spend lots of time
running the day-to-day operation, but has excellent management.
There are only one or two companies around that provide
professional management and don't ask for ownership. Whether you
choose a management company or simply hire your own employee to
manage, make sure you meet once a month and review the company's
financial statements and operational health. That audit process
should be thorough and include these essential terms: every title
is reviewed by an expert, every HUD-1 is reviewed before closings,
all disbursements are handled by specialists only, recordings
tracked and confirmed, and reconciliations for both operating and
escrow accounts completed within a few days of the end of each
month. Also, make sure that you have all the proper licenses,
bonding and insurances for the company and all employees.
Here are the four primary types of ABAs. The one you choose will
depend on how much volume you can generate and your appetite for
risk under RESPA.
1. The joint venture
The joint venture is probably the most common form of ABA. In this
model, a title company approaches a mortgage lender or real estate
company and offers to set up a new title company, which each party
owns 50-50. The mortgage company is responsible for delivering
business. The title partner manages the operation. While there can
be variations to this model, generally the title company optimizes
its resources by housing the new joint venture in its offices,
charging the company a monthly lease for space and contracting
closings to settlement agents that work for the title-company
parent. This model is problematic if the ABA employees are
part-time or shared. HUD requires bona fide employees who must
perform a list of tasks, which HUD refers to as core title
functions. HUD doesn't like it when these employees also work for
one of the parent companies, or when employees are shared by many
ABAs and receive multiple paychecks. While this model allows small
companies to participate, it is dangerous and likely to be attacked
by class action attorneys who believe they can convince juries that
these types of ABA are sham arrangements, meant to funnel referral
fees back to the mortgage company.
2. The title-only model
This model is common with companies that have a low volume of
closings and do not want to assume high overhead expenses. It can
be a joint venture or an entity wholly owned by the mortgage
company. Either way, this model usually has one or two employees
who perform just the core title functions and contract the
processing, the closing, the post closing and some administrative
functions to one or more outside title companies, which have
brick-and-mortar office space. The owners save money and keep
financial risk low by only paying for processing and closing
services when a case closes. If the company is a joint venture, the
partners share the profits in some negotiated proportion. If wholly
owned, the mortgage broker/owner keeps all the profit. However, it
is difficult to negotiate a reasonable outsourcing fee with a
third-party title company if they are not also sharing in profits
from title insurance.
3. The wholly owned title company
Only larger companies can operate these models successfully because
they require a fairly large and steady volume of closings to pay
for the variety and type of employees required to run all aspects
of the company. In this model, everything is done under one roof or
one company umbrella. This can be the safest and most profitable
model, if you have 40 to 50 closings or more per month and people
who know what they are doing. The main advantages of this model are
the ability to hire a better quality of employee and the ability to
meet all the rules promulgated by HUD.
4. Virtual partners
This model takes all the advantages of the wholly owned title
company model and makes it available to smaller mortgage or real
estate companies by putting them together in partnerships.
Individually, the partners wouldn't have enough business to support
a genuinely RESPA-compliant title company. By combining the
partners into compatible groups, such as two real estate companies
and two mortgage brokers, you end up with a very viable title
operation that can return as much as $10,000 per month in net
profit to each partner.
In summary, if you can direct 40 or more closings per month to
an affiliated title company, the wholly owned version is your best
option. Retain a professional title company management firm and you
will optimize your chances for success. The best management firms
should be able to provide experience, employees, oversight and
emergency support that will prove invaluable. You may pay slightly
more than hiring your own manager, but you will get an entire
company of professionals supporting your effort and who are
accountable to you. If you can only direct 10 or 20 closings per
month to an affiliated title company, your best option in today's
environment is the virtual partner concept. The joint venture model
and the title only model may allow you to receive income, but they
are both more risky from a legal standpoint. In addition to greater
legal protection, the virtual partners concept creates
opportunities for your loan officers to meet and work together with
real estate agents who work for one or more of the other virtual
partners.
John R. H. Cotter is president of Greenbelt, Md.-based
Alliance Title Management LLC. He may be reached at (301) 802-6445
or e-mail
[email protected].
