Oh, California: A Guide to DRE and DFPI Licensing, Usury, Loan Sales, and Daily Compliance

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Confused by the mortgage lending regulatory lay of the land in California? Get in line.

California lending comes with a whole host of confusing regulations, licenses, and more. Unlike most of the country, California regulates mortgage lenders through its Department of Real Estate (DRE) AND the Department of Financial Protection and Innovation (DFPI). Beyond licensing and regulators, California regulates far more than almost any other state including complex usury laws, regulations on loan sales, table funding restrictions, complex late charge restrictions, limitations of interest charges, and a series of other potential landmines for mortgage lenders. In one succinct presentation, we provide you the tools necessary to understand how to make loans in California without accidentally shooting yourself in the foot in the process.

You will learn:

  • The difference between a DRE Broker’s license and DFPI’s CFL license.
  • What license may be necessary when you buy, sell, service, and broker loans.
  • Whether your debt fund and its affiliates all need to be licensed.
  • Whether you and your employees need to be additionally licensed.
  • California’s regulatory climate related to table funding and other secondary market transactions.
  • Construction loan limitations and complications.
  • Loan-level limitations such as usury, late charges, and prepayment restrictions.


Kevin Kim:

Well welcome everyone to today's webinar. My name is Kevin Kim partner here at Geraci, I manage the firm's corporate and securities division. So we do a lot of the actual CFL applications and DRE corporate applications for clients. We're also recognized experts when it comes to fund formation in the private lending space. Partner hosting the webinar today is also a partner here, Geraci, Nema Daghbandan. A lot of you know him, those of you who don't. Nema is the partner in charge of our operations and also is the brain, mastermind behind our wonderful doc platform, Lightning Docs. And him and I have both gained a lot of expertise in working with the DFPI and DRE and the respective licenses that come with that. And so we wanted to have this webinar today because it's an increasingly difficult process and complicated issue. So for those of you who want to find out more, we'll be answering questions throughout and stuff like that. So there's a little bit of housekeeping name was going to go over and then we'll get started.

Nema Daghbandan:

Perfect. And then on the housekeeping side, we'll go ahead and answer the questions that we are used to seeing on these webinars. So first this webinar is being recorded. A copy of the recording is available after the fact. All of the participants will receive an email with a link to access the recording, so feel free to distribute this after the fact. Anybody who may have missed it on your team there. Separately, a copy of these slides will be distributed in that email as well. So you will get a copy of the slides presentation today. And lastly, there is a little bar that all of you should have through Zoom which will let you ask questions. There's also a chat feature and a raise hand feature. We ask for purposes of the webinar that you solely use the q and a box. That's where we'll be diverting our attention to.

So please do not use the chat feature or the raise hand feature as we're generally not monitoring those areas. We're going to try a little something different today, which is that we're actually going to try to answer some questions in real time versus just wait till the very end. We have reserved time at the very end to answer questions, but again, feel free to ask questions in real time. We'll try to address them in real time today as we're hoping to answer any questions that you guys may have. Without further ado, we can go ahead and kick it off.

Kevin Kim:

Let's get started guys. So background, California as a state has some of the most complex licensing and lending regulations in the country to make a loan in general in the state of California, any kind of loan, the state of California wants you to be licensed. Now, as it pertains to real estate and our industry, there are two primary government agencies that regulate the licensing. Here in California, you've got your DFPI, Department of Financial Production and Innovation, formerly known as the Department of Business Oversight and the Department of Real Estate. And so these are two different divisions and when it comes to our clients making business purpose loans secured by residential real estate both licenses do apply. Both government agencies do govern depending on the licensing regime that you choose. And so under the Department of Real Estate, we have the real estate brokerage license.

And so a lot of you are very familiar with that. For those of you who are unfamiliar, brief explanation is a DRE Real Estate Broker's license is a license that an individual will obtain after having met a certain level of qualifications and education, which we'll get into in a second. And then also that license can be attached to a corporation but only a corporation. The DFPI regulates what we call this California Finance Lenders license, which is another type of license in California that authorizes you to make loans secured by residential real estate or commercial real estate or any type of actual loan. It's not a real estate specific license. The DFPI these applications typically are processed through an entity. They're very few individuals that possess a CFL license. It's really held by a corporation, LLC L P and so on and so forth.

It's a little bit less burdensome to obtain. We'll get into that later. But ultimately these are your choices in California, the DRE versus the CFL right. Now, there are a lot of differences and there are a lot of similarities when it comes to these licenses and we're going to go over those today. But big picture, I want everyone to understand that these are the two frameworks that we're operating under when it comes to making loans in general real estate loans, I'm sorry, real estate loans in California. And once again, these are for California only. The second we step outside of the state of California, we are not dealing these licenses. They don't really help you, right? They're really going to be used for making loans secured by California Real Estate. I was going to the differences really quick.

So I talked about the kind of thematic differences when it comes to actually obtaining the licenses. The DRE's meant for really an individual, you know, you go out there, you get your education, you usually start with a salesperson's license, but sometimes you can skip that. You have all that personal experience built up. You take the test and then you get the license as an individual. And then from that point you can attach that individual broker's license to a corporation. A CFL is meant for an entity usually, right? It's meant for a entity to have a license to make loans. This is a chart here that really covers all the various differences and all the various kind of requirements to maintain a license. The df, as you can see here, the CFL is a lot less involved. It really, it's meant primarily for a balance sheet lender.

It's designed for a company that wants to originate, fund, and hold loans. It has some limited capabilities to broker but very limited. And there are unique rules as it pertain under the CFL itself, there are unique rules associated with buying and selling loans secured by real estate as it pertains to who may buy and who may sell and who needs a license to do both. And we're going to cover that today. On top of all that, you have limitations associated with the lending, but on the real estate side, there's not much limitation when it comes to the CFL license, which is the reason why a lot of clients pursue that have a license as compared to the DRE. The DRE has very strict limitations as it pertains to what type of loans and the limitations associated with LTV and the amounts associated with construction loans and all that.

This is a very detailed kind of chart here, but what's important to notice here is the key differences between the two licenses. And this will, and we'll talk about this in more detail there today as it pertains to the ability to sell, broker, buy, service, and all that fun stuff. But I want you guys to pay close attention to a lot of differences you see here, these slides are going to be available to be downloaded later down the line, so I don't want to spend too much time with this, but it's important that you guys think about this when you are kind of getting set up in California or looking to expand in California because the DRE license, while it's very robust in its abilities and it's very it grants you a lot of power as beyond just finance, it has its own inherent limitations that the CFL can solve and vice versa. So it's important to weigh the balance and make sure you make the right choice or you engage and have both. So these are the differences between the two licenses

Nema Daghbandan:

And I know a lot of people on these webinars oftentimes are out of state. So I will go into a little bit of the details in terms of what is a California finance lender and what is a real estate broker. But high level if you're from out of state, you're probably a little bit confused because you are generally used to mortgages being covered under some sort of mortgage broker license. And California is unique in that sense. In California, our real estate brokers helped people buy and sell homes as well as obtain mortgages. And so it's normally broken apart. So normally in the mortgage world you have a department of finance which governs mortgage brokers, and then you have a department of real estate which governs the purchase and sale of real property and the leasing of real property in California, they've combined those roles into a single role cause the real estate broker, which can do all of those things.

So here in California a real estate broker's license is very powerful and can do many, many things but in fact it is a real estate broker's license rather than a mortgage broker's license that permits those sorts of activities. So we'll go ahead and start with the first concept here, which is what do we define a California finance lender as? So directly on this slide here you actually have the definition from the financial code here in California. Rather than read the actual content on here, kind of describe the concept of what's happening. Effectively, if you are making a loan right, secured or unsecured in the state of California, you're really considered a California finance lender. And so let me give a few exceptions to this rule that are relevant for purposes of the people that will be on this webinar. One, and the biggest one, is going to be any loan which is arranged by a licensed real estate broker secured by real property.

So you can do not need to be a California finance lender so long as that loan was arranged or brokered by a real estate broker in the state of California. There are minis exceptions as well. For business purpose loans there is a effectively absolute exception for one business purpose loan regardless of circumstances for a business purpose loan for one. And that's one made by an entity or an individual, doesn't matter, one lender in a 12 month period or there is a potential of five loan exception so long as the loans are made ancillary to the primary business of the party making loan. What that really just means is if you're in the business of making loans, you can't take advantage of that five loan exception, but it's designed for an employer who gives out a loan to an employee, these sorts of unique situations where it has really nothing to do with the primary of that, of the business of the lender.

So that's an exception. That was a question that Geoffrey had asked in the q and a box. So hopefully that clarifies the exceptions to this rule. But again, primary one that to think about for purposes of, and probably a point of confusion for a lot of our clients is that particularly for out of state lenders, out of state lenders are almost always familiar with the California finance lenders license. They are unfamiliar with our concept of a real estate broker's license. And so generally speaking, they always think the world of if you want to make a loan in California, the lender must be licensed. And that's not necessarily true. You can and oftentimes do have an unlicensed mortgage lender because the loan was brokered through a licensed real estate broker. And that's an exception to our mortgage lender licensing rules here in California.

So then let's get into the definition of what is a real estate broker. And this is often an area of consternation and surprise particularly because oftentimes the activity being conducted by a California finance lender actually broaches into the territory and the definitions of a real estate broker. And we cover a lot of concepts in what we consider a real estate broker in California. And remember high level, they're governed by two totally different regulatory bodies. The DFPI governs California Finance lenders and the Department of Real Estate governs real estate brokers. So you have two different regulatory agencies governing two different parties who could theoretically make loans. So let's do a little bit of a dive into some of the definitions you have here for what is considered a real estate broker in California. So these activities, right? Soliciting borrowers, soliciting lenders, negotiating, collecting payments for or servicing performing services.

Just a broad category of your performing services for any loan secured directly or indirectly by real estate. If you're doing any of those activities and it's related to a loan that's secured directly or indirectly by real estate, you are considered a real estate broker in California. The word indirectly for those of you who are wondering is, for example, if you're going to do a loan secured by a loan or a hypothecation or participation or some sort of underlying interest, which there is something that is attached to real estate, the underlying transaction is attached to real estate that is an indirect form of a real estate loan. So that's one series of definitions and what's surprising to most people is there's a whole other set of definitions and another code sections that all define what is a real estate broker in California. And here's some big ones too, which are heavy misconceptions which Kevin and I are constantly doing client intake calls on, which is the buy sale of loans.

When we've got, we're going to go into much greater detail, but high level, you are also considered a real estate broker in California, if you purchase eight or more loans and you resell those loans to the public, what is the public is not clearly defined. We'll go into that in greater detail as well. But effectively, if you're going to buy the loan and resell the loan, right, eight or more transactions per year and you are considered a real estate broker, if you sell eight or more loans to the public, unless those sales are arranged by a licensed real estate broker, you are considered a broker. If you are the lender, if make eight or more loans in the state of California, unless those loans are arranged by a licensed real estate broker, you are considered a broker. And remember, these rules generally don't care about whether you're a finance lender or not.

So you could be a finance lender and think that you can do all sorts of activities under that license, but in reality it's fairly limited in what you can do within the license. And so you oftentimes have challenges where you are a California finance lender who wants to perform some of these activities and find yourself in a world that you are now conducting activity which requires a real estate broker's license. And now you have a different department that can come regulate you and is in fact interested in your activity. And that's what a lot of this webinar will be focused on today.

So high level here our goal is to kind of give you an idea of the lay of the land and the most common activities that you'll see people conduct here. So we're going to break this down into how does the purchase of loans work, how does the sale of loans work? Servicing of loans on behalf of other parties and brokering loans because all of these could theoretically be done in some shape or form under a California Finance Center's license, oftentimes may be need to be facilitated through a real estate broker's license and will kind of give you a lay of the land of how to understand these activities and the interplay between your real estate brokers and your California finance lenders. So the first activity we're going to cover is the purchase of loans,

Kevin Kim:

Guys. So I want to cover this from both perspectives. And so the important thing to consider when you're dealing with activities as a lender in general or a loan originator in general in California is that like Nema said, there are two government agencies that may have to say, have something to say about the activity you are conducting. And the real question becomes is the proposed activity, does the proposed activity require a license? And does that manifest into licensable activity, right? Because of what a lot of people wonder is how many times can I do this before I'm required to have a license? In some circumstances you may actually require be required to have a license out the gate. So let's talk about buying loans. And there's a lot of unique issues in California when it comes to buying and selling real estate loan because there's an imbalance.

There's a strange imbalance when it comes to the statutory framework as it pertains to the sale of loans and the purchase of loans. So when it comes to buying loans, let's talk about the CFL really quick. So the CFL license is not going to be required to buy loans. You don't need to actually have a license out there under the CFL framework to actually acquire loans from third party originators. This is an interesting statutory issue because the code does not specifically define that activity as having to require a license. But unfortunately in the state of California there's another government regulator, there's the DRE and the DRE's code says that if you buy eight or more loans with the intent to resell them, and that's the key part with the intent to resell them eight or more a year within a year, you've got to have a license.

You've got to be a DRE licensed broker. So the question becomes how do we solve this issue and how does this practically play out? And so in the real world, this is a statutory kind of framework we're dealing with in the real world. Most people who are buying loans will either figure out that they can either buy the loans and hold 'em on balance sheet and they're going to be okay or they're going to pursue a license. And the reason why they're going to pursue a license is they're going to pursue a CFL license. You can buy loans from CFL to CFL without any major issues. It doesn't trade over A DRE. It's going to be easier that way. But the issue you run into there is now you have to apply for the license.

And that's actually not that hard. Comparatively speaking, a lot of people will choose to. A lot of aggregators, loan buyers and just general investors will choose to pursue a CFL license for convenience sake. And the reason why is because the license application process is relatively straightforward. You don't have to take a test, you don't have to, got to have pass background checks, but you don't have to have a lot of any experience. And so for commercial purpose, business purpose transactions, we don't necessarily need to go down that path. So the license, there's a little bit less red tape in getting the license, which is why folks will get them. Now one interesting component that actually changes this paradigm is construction loans. If you're buying construction loans. So if you're the person buying them, that does change the framework a little bit. NE's going to get to that later, but it is going to change the discussion when it comes to getting a license because of the draw process.

So we will get that in a second. Now let's talk about selling loans. Cause selling loans is a lot more complicated than buying loans. So selling loans is a very, very heavily regulated area under both licensing regimes. Okay, so let's talk about CFLs really quick. The DFPI A and in all their wisdom created a code section that says that A CFL licensee may sell loans to what they define as inDFPIonal investors. And this is just for selling loans. It's not about brokerage, it's not about originate, nothing else just selling loans. And when it comes to the sale of loans you can sell them as many as you want to people who are defined as institutional investors. And this is where a lot of clients get tripped up because oh yeah, we're an institutional investor, are a capital partner, is a Wall Street, a publicly traded company or what have you, right?

The reality of it is it actually, we don't actually find that this applies in most circumstances. In the instance of financial institutions such as banks and credit unions and insurance companies, it's typically not the actual bank that's actually doing the buying. It's some kind of uniquely created S P V that's doing the buying. And so that S P V doesn't qualify as the institutional investor. And the same thing goes for publicly traded companies. Typically, they're not going to have the actual opco going out there and buying the loans. And so that isn't the S P D that they create to do this isn't going to work. And this definition does acknowledge the fact that if they are registered under the 34 ACT or a subsidiary, they are thereof, it qualifies. The problem we run into is the org chart is so complex once you trail that daisy chain up the ladder, it really actually is not going to qualify because it's not usually isn't a wholly owned subsidiary.

That's kind of one of the key requirements. So what most people will end up kind of defaulting to under the definition of institutional investors actually, so who's got a CFL license? People who have companies that have CFL license are also defined following the definition of an institutional ambassador. So they can buy loans freely. Now what happens when we have an affiliate or a wholly owned sub, right? And so the DFPI has given us some clear answers on this issue, but the problem is it, it's in direct conflict with the position. So recently we were lucky enough to get an opinion from the DFPI that agreed with our argument, essentially based off case law that the language and the code when it comes to selling loans to institutional investors is permissive. However, the DFPI specifically advised us that they are, while they have no issue with it, they want to reserve any rights or claims the DRE may have.

And the DRE refuses to take an actual statement on this issue for very clear reasons. They don't want to make a clear answer on this because they have the ability to regulate this area too. Like Ima said, the sale of loans, the sale of eight or more loans within a given year to the public constitutes activity which requires a license to be a broker's license in California. So it's a very interesting kind of situation that you leave yourself in. And so in most scenarios, our clients in California who have the desire to sell loans on volume will typically have both licenses. Usually most of our clients are both. But if you find yourself with A CFL only, we have to navigate those issues. And lately the DFPI has asked us to make sure that we're conforming with DRE regulations.

They're, they're aware of this issue. They don't want us to violate DRE regulations. The interesting thing about this is that after all this, I guess you have a conflict of laws if you will. You got two different regulatory agencies that have a very minute or very complicated and also very, it's a kind of hidden in the code if you will. What this has produced is more creative transactions. And so lately the DRE really isn't going to care if you have other types of transactions that effectively end up the eco economic equivalent. Hence we have in the slide here why you'll see a lot of folks do unrecorded assignments, hypothe applications and participations because it ultimately ends up to being the same transaction, same economics, we'll pass through the economics, so on and so forth. But it doesn't constitute necessarily a full on sale of the loan which would trigger DRE activity.

Now we here at Jurassic are working very, very hard with the DRE to try to get a very clear answer on this. It's a little bit more difficult with the DRE as many of you have experience in the past as well. But we're continuing to push them to get a clear answer on the issue because they have not given us a clear answer as to what they define as the public. And that's basically mincing words with the DRE. But it's a very important issue and we're working hard to get that answer because it's not a defined term on the code and our industry deserves an answer. So that's kind of the framework we're in when it comes to selling a loan. So best practice wise, our recommendation is to make sure that you've definitely got the license when you're selling a loan. One or the other is going to be able to let you do it in most circumstances. But in a lot of scenarios, especially clients who are growing and have pretty significant volume or a u m, we would recommend that you have both, right? And that gives you a little bit more peace of mind in the long run. You're making sure you're navigating both and you're reporting to both and makes life easier for you. So that's the situation that we're in when it comes to selling loans.

Nema Daghbandan:

And one point of clarification as well, particularly because a lot of our California finance lender clients also make loans in other states as well. This eight or more limitation is strictly limited to the California loans. So if you are a common misconception that we deal with here internally is people say, I've got a California finance lender, can I make a loan in Nevada? Arizona doesn't insert state, right? The California Finance Lender's license permits you to make a loan in California. No other state cares that you are licensed in the state of California. It's irrelevant. You may not need to be licensed in another state. Each state governs their own licensing requirements related to making loans, brokering loans, servicing loans. So it's a 50 state analysis that we've done here for anyone who wants to get that information. But the fact that you are licensed in one state is irrelevant in all other states. So when we talk about the sale or purchase or when these rules apply, we are talking about loans in California. And it doesn't matter that you happen to be a California finance lender who happens to make loans in other states as well. This is strictly related to your California loans

Kevin Kim:

And Neman to the point on go further on that point, it's California real estate, right? That's right. California real estate. And I do want to one point of clarification as well on that when we're discussing the whole idea of the public and the issue of selling the institution, we didn't cover the affiliate issue. There is something that's going on lately, past two years, three years now, we've been forming a lot of REIT subsidiaries for fund managers out there. So if you've got a debt fund and you want to have a reit, the strategy is commonplace to have a subsidy, a wholly owned subsidiary underneath the fund and loans are transferred back and forth in California. We advise clients it just may be easier to avoid potential headache and this is really just for potential headache to get the subsidiary license. It's not absolutely necessary. The DFPI does not really care about the issue. Like I said, it's a very gray area right now with the DRE. So to avoid any potential arguments in audit for the DRE to have for you, it's just easier to get the license. And these license are relatively easy to obtain, just takes time. And so a lot of folks have been getting a license for subsidiary just to have ease of transaction.

Nema Daghbandan:

So the next activity here is servicing loans. So high level and the first point being made here is if you were self-service, right? You are the name lender in the transaction you may service the loan. There is no requirement in the state of California that you need to be licensed to service your own loans. Oddly enough, some states actually do require you to be licensed even to service your own loans, which is crazy. But nonetheless, the rule in a few jurisdictions. So let's start talking. So now we know threshold question is, are you servicing the loan on behalf of a third party? Right? So the California Finance Learner's license has very limited servicing capacity. The only time in which you can service a loan for a different party is if you sold the loan to an institutional investor. We talked about that in a few slides ago about what is an institutional institutional investor.

So you're a California finance lender, you've sold the loan to a bank, you've sold the loan to another CFL, you are permitted to continue to service that loan, right? Retain servicing rights for a loan sold to a, to an institutional investor. But outside of that very rare circumstance and that very isolated incidents, a California finance lender cannot service for anyone out there. If you sold California finance lender sold, sells it to Kevin or sells it to Kevin's debt fund or whatever, and they are not a California finance lender or not an institutional investor, the CFL does not permit you to retain those servicing rights. And the Department of Real Estate requires that you are a real estate broker with very, very strict rules on servicing, holding a trust account, all sorts of compliance requirements and the department. This is not an area you can play around with at all.

And the Department of Real Estate will be very, very aggressive if you are servicing loans without a license and without maintaining the formalities. Particularly on the trust account side. The state is hyperactive as it pertains to servicing activities. A real estate broker in California can service a loan for a California finance lender or an individual or whoever they want. They can act as a servicer for effectively any party in the state of California. When we went back a few slides ago, that was our definition of what is a real estate broker. One of the primary definitions is a party who services loans for another. And so one area that we oftentimes what I would say is the black letter of the law and oftentimes maybe a gray area of the law is it relates to the IS servicing on behalf of an affiliate. We touched upon it a little bit earlier.

You have, for example, you may originate in the name of your mortgage fund, but then sell it to your reit. You may originate loan and you may have five funds. You have fund one, fund two, fund three, fund four, fund five. But you always use fund one to originate cause that's where the California license is held. But you want to transfer the paper over to fund two, fund three, fund four, whatever. So it's these affiliates, right? Same principles, same operators. And the question is, can I service on behalf of the affiliate? The DFPI appears to generally not look down upon this activity, but remember the DFPI isn't the regulator here, right? It is effectively the Department of Real Estate that governs this activity, this. So the question then becomes is how aggressive is the Department of real Estate regarding the servicing for affiliated transactions?

We haven't seen the Department of Real Estate pop up on this issue yet. It's not to say they won't or they can't but it appears as though servicing on behalf of strict affiliates, meaning same ownership, same control is probably not going to cause a huge ruckus. But textually, when you look at the letter of the law, there is no exception even for affiliate entity transactions. So to Kevin's point, even if you have a reit, it probably makes sense to get both the REIT and the lender license just so you live within the black letter of the law. Particularly for those of you who have big institutional backers. If you're working with a Wall Street investment bank, you're going to get audited by the investment bank. They're going to be interested in terms of your practices. And so this is oftentimes the issue that they will pop into during an audit. So even if you don't have a regulatory audit, you're institutional investors likely will have an interest in your formalities related to whether you are appropriately licensed for the activity. So oftentimes you need a daisy chain of CFLs just for pure technical compliance purposes unless you want to get a department of real estate license and manage it that way.

So I've got two questions that came in on this once I'll clarify. I want to make sure the first question is, so if we have a fund and the fund services its own loans, is that okay? Right? Do I need to be licensed if I have a mortgage fund as the name lender and the fund services its own loans in the state of California, you do not need to be licensed. It's not an activity which requires a servicing license because servicing is an activity on behalf of another. So as long as the name lender is the servicer you are fine to go on that side of it. And I will dig into the next question towards the q and a on this one. So activity four,

Brokering loans also an area of confusion, particularly for those who obtain a California finance lender's license. So when you apply for a California Finance lender's license in California, you generally speaking apply for a broker and lender license. And the reason you do that is because it doesn't cost you anymore. It's part of the same application. It's basically a check the box. I want to be a broker as well. But the challenge is is that what loans you can broker is very, very, very, very, very limited. And so you can effectively broker loans to other CFLs. That's it. You can't broker loans to individuals. You can't broker loans to a Wall Street bank. It doesn't matter who the counterparty is. It's a tiny, tiny, tiny exception for brokering loans to other California finance lenders. This was often done in California many years ago when you would have a California finance lender, which was the management company of a mortgage fund.

And then you separately have the California mortgage fund as the mortgage lender. And so what happened in those transactions is that the management company, the operating company would broker loans to their mortgage fund. Both companies would be licensed and that way the company never needed a department of real estate license. So that was commonly what was done and a common form of brokering. But people are often confused and they have a false understanding that you can technically that they think they can broker loans and they'll say, well, it's broken brokering to Namur or some giant bank. And you're like, that doesn't matter. That's not what this exception is there for. So technically, if you are going to broker a loan to a third party at origination, you would need a licensed real estate broker. And the nice thing is when you were brokering alone as a real estate broker is you can broker loan to anyone.

You can broker to unlicensed Kevin Kim, you can broker to Kevin Kim's mortgage fund. I mean it doesn't really matter who you're brokering to in California, there's an exception for arranging a loan to any party under the department of real estate license. And this oftentimes comes up in the California finance lender concept is that oftentimes the California finance lender will say, well I'm, I'm the lender in the loan, right? I'm going to make the loan under my debt fund and it's a licensed California finance lender, but I've got the side card. I've got rich investor number two who's also an investor in my fund, but wants to direct interest in this loan. He wants to take down a portion of this. These sidecars are very problematic because now you have someone other than the CFL making the loan, there's technically more parties making the loan and those parties are unlicensed. You now need to inject a real estate broker into the transaction to now arrange the loan in California because you have these unlicensed lenders now as part of the transaction even though some of the parties of the loan are technically licensed.

Kevin Kim:

Alright guys, so we want to talk about getting the licenses because when it comes to the CFL license application, we get a ton of questions because while the itself, the qualifications are not that hard to comply with, the DRE requires all this years of experience salesperson first, then more experience, pass the exam as an individual, pass a background check as an individual, pass the exam and then attached to a corporation. That's the whole lifecycle. But CFLs are relatively simple. You pay the fee background checks and you wait. Basically you process the application. We do a lot of applications, we process about a hundred year and this stuff is not the most challenging to qualify for. But when we're dealing with companies with complicated organizational charts, they can tend to be a little complex because what we run into is primarily it boils down to the background check issue.

And also a lot of times with companies that are balance sheet or a fund or any kind of has an investment portfolio program that will also cause a little bit of confusion when it comes to who should have the license and the arrangement associated when it comes to agency law. So let's talk about org chart issues first. So one of the most common issues we run into for any client, regardless if you've got a fund or not, is we've got an individual okay? So let's break it down first. The CFL requires anyone that owns 10% or more of the applicant or any officer, director, manager, general partner or control person, direct or indirect to app apply to submit a background check to the DFPI. When you submit for the application, normally this isn't a problem, everyone's okay to give, do a life scan or fingerprint cards, but in the off situation we run into more commonly these days especially is that you've got some institutional investor or ultra high net worth investor or group somewhere in the organizational chart.

And it's a challenge to get a background check either because the individual himself does not want to do that because he's off as a passive investor and he is very high up in the chain and he doesn't want to do it. Or we have a big entity or a pension plan or something like that and it's physically impossible to get a fingerprint card from all the relevant people that would conform to the license application process. So these are considerations you have to make and this hyper application will require a very thoughtful and thorough application process. And we have to use the waiver process of the state, but not just, I mean it's not just you. Hey, hey, I need a waiver. The way you craft the arguments and the way you craft the organization heart and explain it to the DFPI is going to be operative and multiple times we had to get involved and restructuring things a little bit to make sure that it minimizes the likelihood of rejection and increases the likelihood of approval of the waiver process.

Now there's another question that comes up when it comes to debt funds. So the CFL license as opposed to the DRE license, the broker's license is designed for a company for a lender that's going to be funding loans off its own balance sheet. And that's key. The actual application requires that the code requires the funds which fund the loans must come from the applicant's balance sheet, which is why the DFPI requires a $25,000 net worth of the applicant. I want you to show them that you have enough money to fund these loans and it requires surety bond and all the other stuff. Well, the interesting component with this is that debt in debt in the debt fund world, debt funds themselves have no employees. They have no officers, they just have LPs or LLC members that are passive and own X percent of the company.

And that fund is managed by one or two entities is where the executives, officers, owners, directors, operators will sit. And the point of confusion with this is that how do we apply for this? Well, you apply on behalf of the fund typically, and the DFPI is well accustomed to this structure and you disclose the managerial relationship between the fund manager and the fund and you have to disclose the fund manager's, key executives and people that are required to submit a background check derivatively because the way the code is written, it says direct or indirect control. And so the DPI has had no problems with that. So when it comes to employees of a fund manager acting on behalf of a fund with a license, you're okay there. Now one additional link comes up, Nema brought this up earlier, is what happens if you've got a fund that's got a CFL license and a fund manager that has no license?

Okay, this is an interesting issue. If both entities had a license, they could independently fund loans and do all the activities a C licensee could do. But if the fund was the only party that was licensed, the fund manager, while authorized to act on behalf of the licensed, a licensed entity must be acting on behalf of the licensed entity and only the licensed entity. So from an agency perspective, it has to be wearing its fund manager hat at all times, no sidecars, no other transactions. It has to be done through the fund because you as a employee officer, director of the fund manager have been authorized to act on behalf of the licensed fund. And the DFPI acknowledges this, the second you have outside of that framework, you have now violated California lending laws. And so that is where the little RICO comes in.

So a lot of times companies that don't come to us with a DRE license, the normal framework is we've got to fund with A CFL and a manager with a D e, but they don't in California that is. But if they don't come with us with that framework and they're not going to want to get a DRE, especially from out state, pretty common issue, an easy solution may be to get two CFL licenses and it's okay. The application process to describe it is relatively straightforward. You have to gather all the information, get all the background check information, package it up. It should be written in a certain way to maximize efficiency and minimize deficiency notices and other I guess brain damage when it comes to the DFPI, the other government <inaudible>. But there's no additional qualifications as long as you conform with the minimum eligibility requirements and maintain them. So, and really going forward is only one app. The one thing you have to do is basically keep your report filed every year on March 15th. So it's a relatively easy license to get and relatively easy license to maintain, which is why a lot of folks would get multiple licenses.

Nema Daghbandan:

And on that note we've got an attendee who's been kind of asking questions about this issue, which is a fairly common one, which is we've have these weird situations where the manager is licensed for the fund is licensed. So one or the other is holding the license. So in this particular question from one of our attendees is assuming that the manager does have a license, but the fund is not. So in this circumstance, you could not name the fund as the lender in the loan transaction, right? Because the license, the person who must be the name lender in this circumstance is the manager. So we know with certainty at time of origination that the manager must be the named lender in the transaction. The question then becomes, what can I do with this? What can I do? For example, like an assignment at closing, a table funded type transaction where there's an assignment closing to the fund who is unlicensed?

Can I sell it after the fact of the fund? What can I do knowing that the manager must be the name lender? The easiest way to do this, if you wanted to be black letter law to CFLs, right? MA, get your fund license as a CFL broker, the loan from manager to the fund, no questions asked, do it all day, rinse and repeat, no problems. The next one goes into, well, what if I try to then fund the what if I use a co-term assignment, I do an assignment at closing from manager to the fund. You start entering more of the gray area one, you've got table funding issues. We'll dive into that in a second about table funding laws here. So who is the party funding into the closing escrow? Is that issue And separately too, is that the sale of a loan?

Is it to an institution? We've talked a lot about that issue is are these sales to institutions? Do you care? How great do you want to be in this situation? Right? What sort of regulatory oversight are you okay with? So the short answer is do IROs t you would get both the manager and the fund licensed but if it's something that was really causing you a lot of heartburn you know can definitely reach out to us and we can brainstorm. And it kind of goes into what we talk about in an earlier slide, which is there's alternative, there's participate, there's a lots of things you can try to do and the things that people do, particularly when they have complex org charts to try to stay compliant but have to come up with some creative financing vehicles to make this sense and still stay compliant without getting a separate CFL license.

So we alluded to this earlier and we'll kind of do a dive in it. One of the things that causes lots of issues and we get common, I would say it's one of the biggest misconceptions is the treatment of construction loans in California. And the reason why there is confusion on this is that we go back into that framework is you have a department of real estate that governs mortgage loans. You have a department of financial protection innovation governing real estate loans to totally different regulatory bodies, to totally different sets of statutes that both govern the same activity, mortgage loans. And so if you have a loan, which is a range so brokered by a licensed real estate broker, there are a series of rules which regulate construction loans. And when I use the term construction loans, what I mean by this is a loan in which there is going to be a holdback of construction funds.

It could be a fix and flip, it could be ground up, it doesn't matter. You're holding back money at closing and that's going to be dispersed after closing. So that is a construction loan in this context, if the loan is arranged by a licensed real estate broker, there are a series of very painful rules to follow, which causes lots and lots of heartburn. I've identified a few of 'em here. There are certain loan to value limitations. You must use a funds control, the loan has to be fully funded, you have to use an actual appraiser, you can't use A B P O or some other valuation. It's just a series of rules on this issue and they tend to be fairly painful. And there's another one is there's a loan cap loan can't exceed two and half million. So for new big in California, a big round of project two and a half million dollars isn't that much anymore.

So these cause tons of heartburn in situations and it primarily occurs when you have a real estate broker. Arranging to unlicensed lenders to high net worth individuals is more common than not when you run into these situations. And that's who it's designed to protect. Your average high net worth investor is a party who the Department of real Estate is trying to protect, saying these rules, make sure that the investor's money stays safe. We have a licensed third party funds control is going to manage the funds. We've got liquidity that we've figured out by fully funding the transaction, we're not going to make sure the loan to value stays appropriate. So your high net worth investors and overly exposed, all of it's with the framework of protecting individual high net worth investors. Because the California finance lender in its raw form in California, it's designed to be a balance sheet lender.

They don't care. They're like, look, if you want to make a dumb loan, make a dumb loan, make a hundred percent LTV loan, it's your money. Waste it, right? It's not protecting anyone here, it's your investment decision to make. So if the loan is made by a California finance lender, none of those rules apply because the regulatory body says, look, this person's capable of taking their own investment risk. And so none of those rules apply in the situation, but this is where people get tripped up and oftentimes becomes the issue. California finance lender makes the loan, we know we don't have a problem. There's no construction loan limitations, do whatever you want at origination, but you're then selling and it's not selling to some private high net worth individual. You're selling to Tour Act, Pierce Street, insert, whatever buyer you sell to, and they are not a California finance lender.

They are an unlicensed party. Your sale to them could run you into the definition of a real estate broker all of a sudden. So at origination you didn't have a real estate broker problem, but at time of sale you now just ran into a real estate broker problem, which because you've sold eight or more of these of lo, you've sold eight or more loans to non CFLs or to nons institutions. And what that now translates to is you now need to be licensed as Department of Real Estate broker to sell that eighth loan and the sale of that eighth loan is now fully governed by all of the Department of Real Estate's rules. So even though these are all activities that should have been done at origination, right? Using a funds control, fully funding loan, et cetera, that's a really origination focused activity. But because you've sold that eighth loan right now, now all that loan must conform to the real estate broker's standards.

So for example, you couldn't sell a loan greater than two and a half million dollars that shared these features. And so a lot of the times what we run into is dealing with organizational structure issues to deal with this, which is, hey, my business model entails the sale of loans. I know that that's part of my model to capital markets or to other parties. I might have multiple funds. Oftentimes there is a sale component to my strategy and you must must figure out how to solve this problem. There's lots of ways to solve this problem, but you have to think about if your strategy employs the sale of loans, you must understand what you, particularly if you're a construction lender, how you're going to be able to sell those loans without running into regulatory oversight.

And there's a few other questions in the box. I'm going to save most of these to the end here because I think that they're kind of general question or general questions versus the subject matter very specific to the slide. So just let you all know that I'm not ignoring you in that question box and I appreciate you asking questions in real time. Alright, so let's now dive into some of the daily loan level compliance issues that you're going to run into, whether it's through a Department of real estate or a C F O license loan. So most of the loan level limitations are actually under similar to how we had that construction loan dialogue that I just had in the last slide. Most of these regulations are not surprisingly under the Department of Real Estate Regulations, so they only really apply to loans arranged or brokered by licensed real estate brokers.

And so we'll just a sampling of what you'll find on here, but know that if you have a brokered loan, there are lots and lots of technical restrictions on those loans. So for example, one of 'em, the ones I sat on here, is that you have to have, assuming the property is a one to four family residential property, but that's your collateral. Doesn't matter whether it's for business purpose, consumer purpose, that's not what they're looking at. They're just saying, look, collateral is a one to four family because your collateral is one to four family. You have to have a minimum 10 day grace period and a maximum 10% late charge on that periodic payment, right? That's a specific regulation that just happens to be under the Department of Real Estate Regulations. Doesn't apply to California finance lenders. You could have a five day grace in the 15% late charge of Fair California finance lender.

There's just no statutory restriction. There are, there's case law and other restrictions that you'll find through our jurisprudence here, but you're not going to generally find it in the statutes related to California finance lenders. When you look at a California finance lenders regulations for commercial loans and business purpose loans, equal commercial loans for California finance lenders purposes, it's very skeleton on what they cover from a loan level regulation perspective. Whereas the Department of Real Estate governs a lot of activities on that side. So kind of high level one thing under the California finance under law we already talked about this, not a lot of restrictions. One of them that's worth noting is that if you are in the business of making business purpose owner occupied loans, right? So for example, a second taken out by an owner occupant to open up a restaurant or to go buy rental property or some other business purpose that is a business purpose loan that is owner occupied and you have prepayment penalty restrictions because, because that's applies to both department real estate brokers as well as California finance owners.

So that's kind of the one isolated instance that oftentimes comes to mind. But generally speaking, you don't have a lot of loan level limitations. However, in kind of common misconceptions that I find in here generally, so for example some parties like to charge balloon late charges. And what I mean by that is at maturity, let's say for example, give a 10% late charge on the periodic payments, some lenders will oftentimes come to us and say, oh, I want to charge a 10% balloon late charge on the entire principle balance, that same 10%, it's unenforceable. There's been a million cases on this issue. It's a losing issue every single time. You cannot charge a balloon late charge. That's a matter of contract. And the logic behind it is that the penalty far exceeds whatever the lender's loss is in the situation. So there are no balloon late charges on the entire principle balance.

You cannot table fund under either license. There's technical restrictions and it's very unique in the sense, I don't know of any other state that actually has this similar issue, but you cannot table fund alone. So table funding alone most often happens when you have a named lender in the loan transaction on the deed of trust. You have an assignment that is recorded at closing the party who you were assigning the loan to at closing is the party who actually funded into escrow, right? What California wants to see from a regulatory perspective is the party who is the named lender on the deed of trust is also the same party who sent the wire to escrow, right? That's what they're really looking for. To avoid the table funding issue here in the state of California, it's also an issue. We do a lot of workarounds or whatever you want to call 'em, but we do a lot of strategic guidance on how to deal with that, particularly when people have multiple mortgage funds or funding vehicles or whatever looks like.

But know that from a technical perspective, the Department of Real Estate and the Department of Financial Protection and Innovation both technically prohibit the table funding of a mortgage loan. And another thing to note in California, most people are unaware. We have crazy user laws here in California. And as a general rule, a loan is going to have a 10% a p R cap to it. In California, most people are unaware that we have the 10% a p r cap because most of the time these loans are exempt. And the reason why they're exempt is any loan which is made by a California finance lender is exempt from usy. Any loan which is arranged by a licensed real estate broker is exempt from usy, right? You have two blanket exemptions which apply for 99% of mortgage transactions in the state. And that's why we are generally not, that's generally why most people don't think about usy when they think of California.

So how do you get in trouble here? It's oftentimes when you have a one-off transaction. So for example, you're a mortgage fund, but you want to fund this in your own name. You've got a high net worth individual who wants to fund a loan, someone who wants to fund a loan they a preexisting borrower relationship. All of these instances in which basically is you inadvertently makely make a loan through an unlicensed entity not thinking about this issue. And while you may might be exempt from the licensing side, you could have made the loan without having a license because there's a one time exception to licensing. The problem you run into is the loan might be usurious because we have that 10% cap that now comes in and remember that's an p r. It's not, people are oftentimes like, oh, don't worry. I'm going to do a 7% loan. And then I'm like, well, how many points are you doing? They're like, well, it's three points. And I'm like, well, now you're already at the 10% and now you're processing fees, your dock fees, all these other things are probably going to start chipping into that a p R category categorization. And so oftentimes they exceed 10% a P r inadvertently. So just know that if you have an unlicensed lender in the transaction and it's not arranged by a broker, you oftentimes have a problem here.

All right. So now let's do a little bit into, in terms of the auditing as a California finance lender and auditing as a department of real estate broker. Kevin, why don't you kick us off with the CFL side in your experience?

Kevin Kim:

Yeah, so a lot of folks have been through this process. The DFPI is relatively straightforward and easy to work with. They do have a systematic approach to audit. So they've basically got a list and kind of go down the list and we'll send you an audit request examination request. If you're doing everything right, you're filing your reports on time, you're keeping your address up to date and all that kind of stuff, you're not going to really run into any hot water. But even if you were to ask technical violations, DFPI is relatively easy to work with, they'll usually ask you just to fix the problem, maybe just pay a small penalty for their time and be done with it. Notably though, there is something to be worrying about because a lot of folks forget this is that the DFPI is California Securities Regulator as well as a securities attorney and tell you, they will kind of look at your reports and your audit and they'll also be looking for securities violations.

And so it's the same enforcement team. The same enforcement team when it comes to mortgage is typically the same attorneys who we work with on the security side. And so they're going to know what needs to be fixed. They're not going to hit you hard on it, but they're probably going to ask you to go file a bunch of paperwork and pay the following fees and stuff like that. So the whole idea of selling loans and stuff like that is something that needs to be taken care of ahead of time. And so if you're thinking about doing any kind of transactions, that may even be, it may even smell like a security, come talk to me about it. It's really easy fix. But yeah, I mean generally speaking, DFPI is very good to deal with. Where they really get aggressive has to do with actually maintaining the eligibility of the license.

We've got a lot of clients forget to file their annual report on time. So the D D F P, I'll give you a grace period, but they're not very friendly with it. It's basically 10 days and after that you're pretty much going to lose your license if you file late. But they are forgiving when it comes to getting it reinstated if you happen to lose your license that way, it will require some kind of special groveling and begging with the right attorneys at the DFPI. But it is possible done it for a lot of clients over the past few years. But all other issues have come up where, hi, forget to maintain a balance sheet and they fall below, below $25,000 or their bond has gone defunct or they didn't accurately port their org chart or they moved and they didn't notify the D fpi.

These are all reasons why the DFPI can say, Hey, no, you just lost your license. And they've been really stickler for that kind of stuff. And so we really want everyone to be cognizant of those issues as well. The audits are actually not that bad. It's the actual technical compliance or the eligibility where they get really, really aggressive on and technically speaking, if you lose your license for violating these types of eligibility requirements, their automatic response is you can reapply, apply for reinstatement after a year. And that's when usually we get a call from a client because they're now freaking out. So best practice is definitely avoid all that and maintain all the eligibility, right? $25,000 net worth annual report every March 15th surety bond up to date. If you move offices, let 'em know ASAP or beforehand you change your org chart, notify them a asap, change your company name and all these things. It's like keeping up a corporation. If you do that, you're really going to stay out hot water when it comes to the CFL license.

Nema Daghbandan:

And conversely, with the Department of Real Estate they like to bring a missile launcher <laugh> every single time and aim without question. The Department of Real Estate's a very challenging auditor. Any person who has been through an audit with them can attest to that. I am unaware of anyone who has ever been audited with that without at least a site and fine meaning that some sort of fine was assessed. They are often incorrect in their positions. So you can point out statutory to support to state that the thing that I'm being cited for is incorrect. Here's the statutory support to demonstrate why I am correct. They would never admit that they are incorrect. And they simply say is, well, if you want, we can go to trial on this issue or you can pay us $300, not admit fault. And that also works here. And as you may imagine, many clients will choose the latter option.

So it is often known as a shakedown type agency to work with. For those reasons, more often than not for these sort of trivial or minor violations anything effectively outside of a trust account, it is usually going to result in some sort of fine and paying for the auditor's cost. But they are very accusatory in nature. They tend to be very aggressive from a regulatory standpoint. So oftentimes, if you're going to have to choose your choice of poison, we usually say is try to live within the California Finance lender land, even if that means getting multiple licenses or otherwise under the CFL because you don't really want to have a department of real estate license if you can avoid one because that regulator is just a much more challenging regulator to work with. And from our personal experience is often less informed on the commercial side of the CFL, they tend to have auditors who understand commercial loan transactions fairly well. So they tend to at least understand the world in which you operate because there are truly two separate licenses that you can obtain as a California finance lender, either a consumer license or a commercial license. So if you are only a commercial license operator, there is truly a different auditor that's going to come and examiner that deals with just commercial transactions. So you're not dealing with this interplay of consumer business purpose. They're not conflating basic issues. So they tend to have a more sophisticated examination process as well. So high level,

Kevin Kim:

They're also going to not going to hit you hard when the thumbs the shakedown either. So if you actually have a legal dispute, they'll hear you out on it and they'll debate it and they'll actually talk to you through it. We've had many good debates of the DFPI on legal issues and they see our side of it and they say, okay, you're right. We're actually not right on this issue.

Nema Daghbandan:

Right, right. And then quick upcoming events before we hit the q and a. We've got a few questions in the q and a box and feel free at this time as well for anybody who's been listening up to this point to ask any questions in that q and a box, we'll go ahead and answer any questions we find in there but want to give you guys an idea of a few upcoming events and webinars that are going to be occurring here. So the first one is going to be this Thursday with the main man, Anthony Geraci of Geraci fame. So this is one you do not want to miss. Be co-presenting this webinar with our good friends over at CU Business Group. So you business group represents about 500 credit unions. And so they are a very well-known and respected within the credit union world and we will be co-presenting on a enforcing commercial loan guarantee.

So effectively is you've got a foreclosure option, you've got a deficiency. Now you want to understand this is what sort of rights and recourse do I have against the guarantee, any sort of personal guarantee and the issue spotting side of the litigation related to personal guarantee. So should be a good one when we send out the wrap up email from this presentation, we will include links for all of these so you can go ahead and register for all of them next week. We have a co-presentation with our good friends over at wheland. Kevin's going to be speaking on that one with a few other industry movers and shakers as well. So should be a good discussion really about institutional capital and its approach into our industry. For those of you who are underwear there is a voracious appetite from what we would call Wall Street.

So either investment banks, actual banks but a huge appetite into the private lending space, particularly for term rental products. So 30 year rental products. There is an enormous appetite for loan originators to originate those loans and there is many, many buyers of that product. So really discussion of what it looks like on the capital market side. And Kevin will be presenting on behalf of Geraci on the May 25th webinar. And last upcoming event on here is our Captivate Conference. So those of you who have not been to one of our conferences we just had our live Innovate conference at the Balboa Bay Resort. It was fantastic really great to see people in person. Again, for those of you who haven't seen pre people again, go do it. It was really weird to be in a room full of people and it was a very odd experience, but I assure you it's well worth that.

There is nothing like the human connection at these events and it's just been wonderful to go to 'em. We're going to be having our flagship event, which is Captivate. It's going to be happening August 18th through 20th in Vegas. It's also paired up with Originate Connect. So there's another conference that oftentimes people will attend both our conference and Originate Connect. They are over a series of days there. So great event, it's at the Cosmo, which for those of you who do not know is the best hotel that exists in Las Vegas where they have very, very clean air and they spray perfume on you. So it's a great hotel, great event. And lastly, on that point we have early bird pricing still in effect it is through May 31st. So through the end of this month, after the end of this month, they will start triggering pricing increases.

Do not email me or Kevin afterwards. We have no discretion on these issues anymore. We have a marketing department, they run the show and they yell at us if we deviate from the rules or ask for special favors. So don't be that guy. Register now so that you are not getting the racked up unnecessary pricing. The event will absolutely be happening. We're very excited for it. And again, this is our flagship event. For those of you who have attended, you already know this. For those that who, this is where you will truly find a national audience. You'll have capital market providers, you'll have borrowers, brokers, high net worth investors. I mean it is truly the industry in a nutshell. And all the movers and shakers in our industry all kind of placed in one event. So that will be coming up live in Vegas. All right, so now without further ado and the link to Captivate, last thing will also be of course in that email.

So without further ado, let's address some of the questions we've got in the queue here. So the first question that I see, and I'll take this one, Kevin, is from Scott is it just best to hold a California finance lender's license and a corporate broker's license for the same company corporation and disclose both of those licenses? So oftentimes, as we've kind of talked about is your activity might be considered real estate broker activity. It might be considered a California Finance center activity. So if your business model kind of requires the use of both of these licenses, what's the best strategic play on this one? In my judgment, I generally want separate entities. I want a sep. In an ideal world, if I were to tell you to structure it from the outset, I would say is go get one corporation licensed under the Department of Real Estate.

Go get another entity licensed under the Department of Financial Protection Innovation because the issues you just identified, which is who are you marketing yourself as? Right? What does your website say? What do your business cards say? All these things. Because all of those things are actually regulated by both regulators. They'll say as we want to see your license number, we want to see how are you marketing on your website? All of those things, both of them will look at and may have a different opinion on in terms of whether you are compliant. So as a general rule, I'd rather you have separate formalities, you don't have to. We've worked with clients that technically have both and within the same company. But you've identified all of the day-to-day challenges you will now encounter which is that you have two different regulators with two different viewpoints on what it means to comply with advertising rules and with particularly on websites and your marketing campaigns, all that kind of stuff. So it just becomes a little bit more challenging to comply when one company possesses both licenses.

Next one I'll take as well, which is Sean asked a question, which is, if I'm a real estate broker, do I need to have an N M L S license number? Great question, huge misconception. So you do not need to have an N M L S license number as a California finance lender or as a real estate broker if your sole activity is making or brokering business purpose loans, right? Under the California Finance Lender's license, we talked about it earlier in the webinar, there is a separate application to just originate commercial purpose loans. And commercial purpose for these purposes mean business purpose in our world. So as long as you're solely originating business purpose loans, there is a separate license that's just a commercial only license. It's the only license you should obtain if you're only going to make to make business purpose loans. It's a paper application, entirely different application process on the CFL side, that's what you should do on the cfl.

If you are a real estate broker and you are only arranging business purpose loans, you should absolutely not get an LS license because similarly, you don't want, what you want to demonstrate, particularly from a regulatory auditing perspective, is that you are not a consumer lender and not subject to consumer regulations. And so it is important I think, in fact, to try to avoid getting an N M L S oftentimes because you don't want to be confused out in the marketplace. And oftentimes, I'll say this, now parlay, listen to your website and these sort things, make it very clear that you are in the business of business purpose loans. Make it very obvious so that if the CF P b for example, sends you a letter saying, Hey, look what we're taking a look at one of your loans, you can barely quickly come back and say, I don't make consumer loans. You govern consumer loans. We don't have a lot to talk about here, right? Because you are not regulating this sort of loan transaction. So to the degree we can be very black and white about our world and be a solely business purpose only lender, and that's the type of business you operate it. I prefer to try to market and treat everything as that in that extends to corporate formalities as well. Here.

Speaker 3:

There you go.

Nema Daghbandan:

Next question here and I don't want to go too into the details cause this is a common misconception other than to state that one question we get oftentimes is you'll hear the terminology of white label. White label means many, many different things in our industry right now but more often than not, it means you have a person who is marketing themselves as a direct lender. They're using some other capital provider who is licensed themselves to make the loan. If the person who is marketing is unlicensed in the state of California that's a prohibited transaction. They effectively have an unlicensed real estate broker masquerading around without a license and that that's the short of it. But beyond that, there's all sorts of other implications. There's table funding issues in California. There's lots of other legal issues. The short answer is if you are in a white label program or you are a white label lender yourself you likely need a law firm to help support the back office of what you are doing as it is very problematic for the reasons we talked about here in terms of dual licensing regimes, table funding issues, there's lots and lots of issues to navigate through.

So the short answer is if you are white labeling there is a high probability that you need an attorney to do this correctly.

Next question here is how are balloon late charges defined for compliance purposes? So there are periodic payments. Your monthly payments, you can charge a late charge under the Department of Real Estate under the California Finance Center's license. There's no limitations on that side. Or actually there are limitations of, it's a brokered loan secured by one of four family 10% late charge, 10% grace period. But assuming you're outside of that confine, there's no statutory limitation. However, if you charge a late charge on the entire principle balance at maturity, right? So let's say you have a million dollar loan and you have a 10% like charge you cannot apply that 10% late charge to the 1 million principle balance. It's unenforceable. It's never going to hold up in court. You're not going to win that battle, right? It's too great of a penalty based on to your borrower, based on the harms actually occurred. You didn't suddenly incur a hundred thousand dollars of harm because your borrower is one day past maturity, right? So that's why it's ineffective in the state of California. And really, I don't know of any other state that it would be effective it to make it. It's a basic contractual analysis and there has to be some reasonable relationship between the damages incurred and the harm that is actually suffered by a lender.

Next question here is so one of the things you've probably heard us kick around for a while, which is or you've probably heard us say it but may not have picked up on it. Weird California you can obtain a California finance lender's license as an LLC or corporation, doesn't matter. You're a limited partnership. Whatever your corporate form doesn't as an individual, doesn't matter. All these things are licensable. As a California finance lender, oddly enough in California there is what we call a corporate broker's license, which means that the actual corporation itself possesses its own license. You have to affiliate a license broker to the corporation, but you can have the corporation license and for liability reasons, oftentimes that would make sense. However, for whatever reason, the state of California only licenses corporations. They will not license limited liability companies. They will not license your lp. These won't. And so there's been many, many times laws that have attempted to pass to try to fix what appears to be an oversight doesn't pass. So as far as I'm aware, there is no change in that law. We still only license corporations for real estate broker purposes. Who knows?

All right next question here is if I market to holders of seller financed real estate notes and buy seven or fewer of them for my own portfolio in a given year do I need to be licensed? So this goes back into the question of can I, do I need to be licensed to buy loans? No, you can buy as many loans. You can buy closed loans in the state of California. You do not need to be licensed to buy closed loans in the state of California. But if you sell those loans, right, it's the resale that is causing the heartburn. From a licensing perspective, you could buy seven loans. You could sell seven loans. That would not be problematic if you bought eight loans and you sold that eighth loan in a 12 month period. You are a licensed real estate broker in the state of California. So that would be when you would get the heartburn in our state related to the purchase and resell of the loans.

Another question on here is can you table fund outside of the state of California? We've actually done a 50 state research on this exact question amongst many other things. So we've done 50 state research on late charges, prepaid penalties, user insert licensing of every kind. I don't recall the answer off the top of my head. I believe California is one of a handful of states that actually cares about table funding but I just don't candidly know the answer off the top of my head of whether there's any other state that actually requires or prohibits the practice of table funding alone. Arizona. Arizona. There you go. Hate it. They hate it in Arizona. Yep.

Oh, and then there's the next question. My favorite one to answer is how do we get a copy of the state by state licensing requirement matrix? You mentioned, as you can imagine, we only spent about 10,000 hours producing this thing. So we don't actually offer it for free. We sell it as a research package and sell it to our clients. Two, you were interested in obtaining our research memoranda or obtaining information on that side. Feel free to reach out to myself and I'm happy to follow up with you in regards to putting together a proposal for you. Next question here is, as a CFL, can you sell loans to tour acts and such, right? Or is that now a B R thing? So this goes back into the slide we had earlier, which was the sale of loans to institutional investors, other CFLs, publicly traded companies, banks.

You can sell an unlimited number of those loans as long as you're selling to those counterparties and not need to be licensed as a real estate broker in California. Technically speaking, if you are selling to non CFLs, right, or these non-institutional. So I don't know the corporate formalities of every single loan buyer, but I know that lots of loan buyers don't have a California finance unders license or otherwise not considered institutional investors. So if you are selling to these counterparties, the Department of Financial Protection has come out and said, look, we don't govern that. We're not governing you in this situation because you are falling under the definition of a department of real estate broker. So that's their position, which is we're not going to do anything about it under our side of the fence, but the Department of Real Estate can come in after the fact and say, look, no, you needed to be licensed to sell these loans.

We have yet to see any department of real estate activity on this particular point, probably because they have no idea. As you can imagine, there's millions of transactions occurring. I suspect the Department of Real Estate does not know that you are actually selling loans these counterparties. Maybe they care, maybe they don't, I don't know. But at least as it pertains to the DFPI, they're making you affirm that you comply with all law, all regulatory requirements. So I think you should probably look into whether your buyer is A CFL and that would make sense to obviously prefer to sell to other CFOs than you know are following the letter of the law. But from a practical perspective many of our clients are selling to insert name buyer who are oftentimes not CFLs. And we have yet to see any sort of regulatory backlash related to that issue.

Would an individual or entity entity collecting on third party debt secured against real property now be required to hold a broker's license? For example, a foreclosing trustee. So if you are servicing a loan and by servicing a loan, meaning collecting payments on behalf of another, you are considered a real estate broker with a very, very limited exception we talked about earlier about A CFL selling a loan to another CFL and retaining servicing rights. So the short answer is yes, you'd have to be, have a real estate broker's license. The example you gave is a foreclosing trustee. Well, foreclosing trustee is not servicing a loan and the foreclosing on a real property, they're not a loan servicer. They're performing the administrative function of foreclosing on a property. So you know, do not need to be licensed in California to foreclose on a loan, for example.

And then we also have separate definitions for debt collectors. So if you sold a debt to someone and they're just trying to enforce the debt, probably a debt collector in California. But the short answer is if you're servicing or otherwise trying to collect the payment from the borrower, you're going to need to be licensed in California. That's what I have to take. Nema, you look like you've lost a few pounds and I look great. Well, thank you Jim Lockey, I appreciate your vote of confidence. My ego, as Kevin knows, is not big enough here yet at Geraci. But I will also give a shout out to my partner Melissa Marella on this point. I've recently joined her, Jim they are the buffs strongest people I've ever met in my life and it's fantastic, but thank you in covid, tried to stay healthy. I can't wait to see all of you all out there as well at that point.

Next question on here is if the fund doesn't have a license and the loan was brokered by a California department of real estate broker, can the fund be the lender? And the answer is yes, an unlicensed lender, it doesn't matter what it's a fund or not, it could be you and an individual, it could be a mortgage fund. It doesn't matter who the lender is. A licensed real estate broker can arrange loans to an unlicensed lender. This is known as a wholesale lender exception. And it's many, many other states have this kind of concept encapsulated. California is not unique in this. There are California and other states oftentimes in which they have this broker, they oftentimes permit the broker to arrange a loan to an unlicensed lender. So the short answer to your question is yes, in California the fund does not need to be licensed so long as the broker arranging the loan is licensed right?

Next question on here is, if you are a department of real estate broker arranging a fix and flip loan in California and you sell the loan to an institution prior to making any of the rehab draws, do you still need to set up a third-party funds control? Great question. And this is where people get into issues, is that oftentimes there might be an exception available to at origination when you are selling the loan that was pursuant to the Department of Real Estate license. Let's say for example, I have a million dollar loan, I've got a hundred thousand dollars construction holdback, I'm now selling that loan, right? And let's say I didn't, let me give you a different example. I'm a California finance lender and I made that transaction. We know that there's no regulation governing the origination of that loan, right? You didn't need to use a third party funds control to manage that a hundred thousand dollars because you've sold the loan to a non CFL at this time, that sale must comply with the Department of Real Estate.

So now what you now need to do is, even though you didn't set up one in origination, you now need to contact a funds control and the buyer needs to advance the a hundred thousand dollars into a funds control account to now comply with the Department of Real Estate Regulations. And that's the challenge that you run into on the construction side. And what gives people a lot of heartburn is that when you are selling loans to non-institutionally and there's a construction holdback component what we are finding is lots of the institutional buyers who we've consulted with on this exact issue because that's because they're asking the same question too. They're saying, Hey, I know that there's some construction problem in California. I don't understand what it is. More often than not, we're just telling our institutional buyers saying, look, go get licenses CFL because it's just, and then you can sell these loans back and forth between each other. It's just a much better way to transact.

Do licensing requirements come up when a person buys a loans or shares an origin fees? I don't know if fully understand the question, but let me, I think address the point being address here in California and many other states, people like to pay unlicensed parties referral fees, points, whatever you want to call it in states in which you are required to be licensed to broker a loan such as California, there are usually very, very strict limitations on the payment of these fees. So even though you don't have a federal RESPA issue so the payment of referral fees is generally permissible. There's no federal restriction on the payment of referral fees. There is a huge issue with the payment of referral fees to unlicensed parties in states which require licensing. So both the Department of Real Estate and the California Finance lenders under the DFPI both have huge regulatory restrictions as it pertain, as it pertains to payment to unlicensed parties.

There is very, very limited exceptions. So for example, just passing along a referral with no file communication, but then you kind of run into these pragmatic issues. So if you guys remember that one of the first slides I had on here, which is what are the definitions of a real estate broker? One of the definitions is a party who solicits borrowers or lenders for loan secured by real estate. So did the referring party here did they solicit the borrower? Right? Did they solicit you as the lender? I mean, were there any solicitation? Chances are that party is an unlicensed party who is required to have a license to do the activity they are doing. So that oftentimes is what causes the issue. So if you're paying referral fees in general, you should understand the state licensing regime and the state you are operating in because that is governed and controlled under most states regulations. Alright? Can a self-directed 401k a trust become a CFL? Kevin? I have no idea.

Kevin Kim:

Yes, trust can be a CFL 401k, not so much because 401ks are accounts held by an individual. The trust can, but we don't recommend it. You run in the trusts are so diverse in their strategies that who the owners are becomes kind of a question mark. And as you can imagine, the Madea PIs people aren't the brightest folks in the world. So we recommend you stick with an entity and have the shareholders or the members be the trust. And that's totally fine. So

Nema Daghbandan:

All right, next question here is if a construction hold holdback loan was originated by a department of real estate broker and the beneficiary is a high net worth individual who is calculating interest on the entire loan amount, I e a Dutch based interest loan, what broker lender exposure is there? If there was no third party funds control set up? We've actually dealt with this in a litigation context. There's a ton. I mean, it's a statutory violation. The statute is there to protect the borrower and the investor. So the borrower could very likely sue claiming a statutory violation and then claim it. You'd have demonstrate that this thing caused damages. The Department of Real Estate. I've dealt with this personally in audits. They've absolutely spot this issue. So if you have a DRE audit and they see one of these files, they will identify it in the file. They don't tend to be super aggressive on it, but they will identify it and it will be brought up. And if it's a huge practice, I suspect that they will have a bigger issue with it. So I would not do this type of activity under a real estate broker's license without complying with it. And I'm not trying to be cute about the response. This really is a problem both from a litigation standpoint as well as a regulatory standpoint.

If the fund is the lender and it has its own bank account, all borrowers payments go to the fund, bank account, people doing collections, deposits, et cetera, are employees of the manager who is considered the service servicer. Oh, the fund manager. So Kevin, why don't you hit on this one? Cause I know you deal with a lot of these kind of self servicing related issues on funds manager.

Kevin Kim:

So when you're dealing with that fact pattern that the CFO F application you submit will state that the fund managers acting on behalf of the fund because the fund has no employees or other agents, officers, directors, whatever the fund is the empty when it comes to personnel, the fund managers acting in on it's behalf of its sole agent and the employees and executives thereof will be acting on behalf of the fund derivatively. And so the DFPI understands that framework. So you're not really doing servicing on behalf of the fund as a third party servicer. You're acting on behalf of the fund because an entity cannot act without it's individuals acting for it. So in reality, what's happening here is that the people inside of the fund manager are acting on behalf of the fund. And that has to be very clear cut though, right? So it really depends on what hat you're wearing is you've got multiple business lines within your operating company or your fund manager. You're probably going to have to be very careful there. So we strongly advise if you've got a fund and you've got a CFL license in there, making sure your org charts set up properly and all your designations set up properly are going to be important. So

Nema Daghbandan:

Great. And one last question because we're running a good amount over here and want to be prudent with your time and ours. So the last one here is if I am a department of real estate broker and I also have a California Finance Nurse's license, am I obligated to comply with all the Department of Real Estate requirements? Right? Goes back to that dual licensing regime issue. So the short answer is, and this is where we'll throw another wrench in there, is the Department of Real Estate treats a loan made by California Finance, or sorry, made by Department of Real Estate Broker. So when you are the lender and you're a real estate broker, there are different rules than when you are brokering a loan. A good example is the construction scenario that we've been talking about a lot here. The rules that pertain to construction loan limitations are when the loan is arranged by a licensed real estate broker.

When the real estate broker makes the loan, when they're the name lender and that's the role that they're playing in the transaction, those construction loan limitations go away. And the reason why they go away is it's investor protection. They're saying it's look, it's your own risk. Take your own risk. And so the short answer is if the California finance lender is the name lender and you have to be very clear about this, it's why we talked about a few questions ago about should I have two separate companies? What's the best strategy? It goes back on the question is that you, if you're both, you can go down one road or the other. You could say, look, I'm making this loan through my California Finance owner's license. I'm using the license number throughout my application material. So my lois is issued from and it's got a D B O or DFPI license number on it.

My loan documents have my D F P A license on my swear, I'm clearly articulating to the borrower I am using, I'm a California finance lender and I'm using my license here to make this loan. You have to be very clear about the road you are taking and you, and similarly cause you have to represent that when you're getting audited because if you're, let's say the Department of Real Estate, you can come in and say, show me all your loan files. You have to demonstrate to them, why is this loan not something you can regulate to partner real estate? Because you have to demonstrate is I intentionally have chosen that this loan, the entire pathway through was going to be a California finance lender loan. My marketing material, my business cards, all these things have been my CFL license number. That's what I use to originate my website.

All of these sorts of things. And that's why you have to be very careful when you possess dual licenses about how do you market to the outside world. What is your L O I state, what are your loan doc statement? Are all of these little kind of borrower facing activities? Who are you representing yourself as a DRE broker or as a California finance lender? If you are solely using the Department of Real Estate license to facilitate additional activities, for example, to service loans, to sell loans. If you're doing it to facilitate your California Finance Center transactions, I would generally not use my DRE license as much as possible. In terms of my marketing activities. I'm very intentional about using my CFL and only using the Department of Real Estate and using those license numbers as necessary to facilitate those secondary transactions, not as a primary borrower facing features on websites, business cards, those things for example.

Because I do not want the Department of Real Estate snooping around in my, effectively my CFL license transactions. But that is very much the onus on you and your daily operations, oddly enough. All right, and that is all for today's webinar. Like I said, we will have the presentation available to you available to everyone after this as well as a copy of the slides. My email, Kevin's email will be on the record on this slide as well. You'll see both of our emails. So feel free to reach out to any of us directly. Hopefully found value in today's webinar. We are always very, very honored that you guys sit here through this and hope all of you have a great rest of the week. Take care everybody.

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