Common Pitfalls in Mortgage Accounting Compliance

Ensuring compliance with mortgage accounting principles and best practices is a critical responsibility for financial institutions of all sizes, including both depositories and independent mortgage bankers. Missteps can lead to financial penalties, reputational damage, and operational inefficiencies. Navigating these challenges requires a clear understanding of compliance issues, particularly those tied to U.S. Generally Accepted Accounting Principles (GAAP), as well as agency, state, and other regulations.

This post highlights common pitfalls in the accounting for mortgage lending activities and provides actionable tips to help your organization stay on track.

1. Compliance with State and Agency Regulations

State-level regulations governing mortgage lending activities vary widely, and noncompliance often results from neglecting these localized requirements. For example, certain states impose specific licensing rules, disclosure requirements, or escrow fund handling policies. For example, California requires that escrow funds be held in separate non-interest-bearing cash accounts and that they are reconciled daily to borrower escrow liabilities reported on the financial statements.

Agency requirements for Ginnie Mae and the U.S. Department of Housing and Urban Development (HUD) can also be complex and overlooked, particularly for smaller IMBs. Companies often miss key updates from these agencies or misinterpret the guidance. Requirements impacting the accounting for mortgage lending activities, such as those listed below, should be fully understood and regularly monitored for compliance.

• Risk-Based Capital Ratio (RBCR) Requirements
• Net worth and liquidity requirements and an understanding of unacceptable assets
• Net operating losses triggering notification of a material event and timely reporting
• Ginnie Mae Fidelity and Errors & Omissions Insurance Requirements
• HUD Cybersecurity Incident Reporting

Key Tip: Designate a team member or engage legal counsel to continuously monitor agency and state-specific regulations. Implement regular training for your accounting and compliance staff to ensure they understand the nuances of these rules and how they relate to your business. Integrate these compliance checks into your monthly close checklist.

2. Navigating Financial Reports Required for Compliance

The types of financial reports required to maintain compliance with various states, agencies, and counterparties are often misunderstood. Choosing the appropriate level of third-party assurance depends on the needs of the business, regulatory requirements, and the interests of the stakeholders. Financial statement and other compliance-related audits provide the highest level of assurance, followed by reviews, which provide limited assurance. Financial statement compilations and preparations offer no assurance but serve different purposes depending on the complexity and requirements of financial reporting. Understanding these differences helps businesses make informed decisions about their financial reporting needs.

Key Tip: Be sure to understand the type of financial statement reports required by the various states for appropriate licensing and what types of reports your counterparties will require. If you engage a Certified Public Accountant (CPA) or consulting firm to outsource your accounting, they will be responsible for financial statement preparation and can potentially provide a compilation if agreed upon in advance; however, a review or audit requires an independent third party and must be performed by a separate, licensed CPA firm.

3. Understanding and Oversight of Servicing Activity

Failure to appropriately classify income and costs associated with loan servicing activities, whether servicing in-house or outsourcing to a sub-servicer, is another common pitfall. Misclassification can distort financial statements, result in earnings volatility, and compromise compliance with U.S. GAAP. Make sure your organization records the various servicing transactions correctly based on a thorough understanding of the types of transactions and your subservicing remittance advice. Knowing which advances are reimbursable or non-reimbursable is key to properly classifying these transactions in your financial statements. Servicing advances are also subject to Current Expected Credit Losses (CECL) requirements, meaning companies must have a methodology for determining future expected losses on existing advances.

From a compliance perspective, another key consideration is ensuring the appropriate milestones are met to support the reimbursement of advances through the claims process.

Key Tip: If you work with a subservicer to service your loans, maintaining effective oversight is essential to comply with regulations. Proper oversight includes an annual review and testing of the servicer's processes and procedures. The responsibility to service properly and oversee a subservicer falls on you as the master servicer.

4. Misclassification of Loan Balances

Appropriately understanding and classifying mortgage loans held for sale (LHFS), aged LHFS, loans held for investment (LHFI) and real estate owned (REO) is another common pitfall, particularly when loans move from one classification to another.

• LHFS are those intended to be sold in the short term on the secondary market and are typically reported at fair value with changes in the fair value reported in gain on sale of mortgage loans held for sale in the statement of operations.
• Aged LHFS refer to loans initially classified as held for sale, but which have remained unsold past a reasonable period; they are still typically valued at fair value, though extended holding periods may necessitate further scrutiny to ensure proper valuation and to determine whether an impairment is required.
• LHFI are loans the lender intends to hold until maturity or payoff, valued at either fair value or amortized cost.
• REO represents properties acquired through foreclosure or other processes, classified as non-financial assets, and valued at the lower of the property's carrying amount or fair value less any costs to sell.

Each loan classification serves a distinct purpose under U.S. GAAP, with its valuation methodology ensuring transparency and alignment with financial reporting standards.

Key Tip: Once the fair value option is elected in LHFS, it is irrevocable, meaning you cannot return to lower of cost or market. If a loan is transferred from LHFS to LHFI and it was originally valued utilizing the fair value option in LHFS, it must remain at fair value in LHFI.

5. Mismanagement of Appraisal Fees

A frequent area of confusion involves accounting for appraisal fees collected from borrowers and paid to appraisers, as well as any related management fees. Institutions often struggle with properly recognizing these fees, which can lead to noncompliance with accounting standards. Additionally, certain states may require companies to hold these fees collected from borrowers in trust.

Key Tip: Ensure that appraisal fees collected from borrowers and paid to third-party appraisers are treated as pass-through transactions. They should not be reported as revenue on your financial statements unless your institution retains a portion as a management fee. In cases where management fees are applicable, establish clear policies to allocate revenue and expenses appropriately.

Conclusion

Mortgage accounting compliance may seem daunting, but by focusing on proactive measures and adhering to U.S. GAAP, state, and agency regulations, your institution can avoid costly pitfalls. As a CEO, CFO, or president, your leadership in fostering a culture of compliance and equipping your team with the right tools and training will ensure sustained operational excellence in this complex and highly regulated industry.

If you have questions about the mortgage accounting pitfalls or need additional support, contact Richey May’s experts today at info@richeymay.com or visit our website.

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