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January 27,2010
Phil Angelides
Via FcdEx
The Honorable Lisa Madigan
Attorney General
State of Illinois
100 West Randolph Street
Chicago, IL 6060 I
C/w;rmnll
Re:
Han. Bill Thomas
Financial Crisis Inquiry Commission Hearing on
January 14,2010
ViC(' Chnirmnll
Dear Attorney General Madigan:
Brooksley Born
Commissioller
Byron S. Georgiou
Commissioner
Senator Bob Graham
Commissioner
Keith Ilennessey
COli/missioner
On January 20, 20 I0, Chairman Angelides and Vice Chairman Thomas sent you a
letter thanking you for testifying at the January 14, 2010 hearing and informing
you that the staff of the FCIe might be contacting you to follow up on certain
areas of your testimony and to submit written questions and requests for
information related to your testimony. During the hearing, some of the
Commissioners asked you to answer certain questions in writing. Please answer
the questions listed below and provide any additional information requested by
February 26, 2010.
1. Please provide rate sheets and other documentation to support your
testimony that brokers were incentivized to push consumers into higherpriced, riskier loans.
Douglas Holtz+Eakin
Commissioner
Heather H. Murren, CFA
Commissioner
John W. Thompson
Commissioner
2. Please provide any data that you have on the pervasiveness of mortgage
fraud from 2000 to present. Please provide any data or studies that would
assist the Commission in assessing the dimension of fraud in subprime
lending.
3. Please provide any data regarding the amount of prime loans and payoption-arms that were securitized by Wall Street firms from 2000 to the
present.
Peter J. Wallison
Commissioller
Thomas Greene
ExcelltiVt'Direcfor
4. Please provide information/statistics, if available, that would give the
Commission further insight into the universe of current foreclosures and
assist in classifying the borrowers into four categories: 1) victims (people
who were defrauded into taking out a loan that they never should have
taken; 2) borrowers who knew they were taking a risk; 3) speculators or
gamblers; and 4) fraudulent borrowers.
1717 Pennsylvania Avenue, NW, Suite 800 • Washington, DC 20006-4614
202.292.2799 • 202.632.1604 Fax
'"
The Honorable Lisa Madigan
January 27, 2010
Page 2
5. Please provide data to support your testimony that national banks funded 21 of the 25
largest subprime issuers and that national banks, federal thrifts and their subsidiaries
were responsible for almost 32 percent of subprime loans, 41 percent of the Alt - A
loans, and 51 percent of the pay-option and interest-only ARMS in 2006 (see Hearing
I Transcript, page 160). Please provide that data for any additional years from 2000
to present, if available.
6. Please provide data on the number of cases that you referred to federal regulators
when the state was preempted from taking action. What action did the federal agency
pursue in those cases?
The Commissioners and staff of the FCIC sincerely appreciate your continued cooperation with
this investigation. If you have any questions or concerns, please do not hesitate to contact Chris
Seefer at (202) 292-2799, or cseefer@fcic.gov.
Sincerely,
~~
Thomas Greene
Executive Director
cc:
Phil Angelides, Chairman, Financial Crisis Inquiry Commission
Bill Thomas, Vice Chairman, Financial Crisis Inquiry Commission
OFFICE OF THE ATTORNEY GENERAL
STATE OF ILLINOIS
Lisa Madigan
ATTORNEY GENERAL
Apri127,2010
By Electronic Mail and First Class Mail
Financial Crisis Inquiry Commission
1717 Pennsylvania Avenue, NW
Suite 800
Washington, DC 20006-4614
Re: Financial Crisis Inquiry Commission Hearing on January 14,2010
Dear Commissioners:
Pursuant to your January 27, 2010 letter, the Office of the Illinois Attorney General has
prepared responses to the six questions that you posed after Attorney General Madigan's
January 14, 2010 oral and written testimony before the Financial Crisis Inquiry
Commission.
1.
Please provide rate sheets and other documentation to support your testimony that
brokers were incentivized to push consumers into higher-priced, riskier loans.
Rate sheets obtained by our Office show that lenders incentivized brokers to push
borrowers into higher-priced, riskier loans, even though the brokers are hired by and
purportedly work on behalf of the borrowers - not the lenders. Borrowers can
compensate brokers in two ways: lump sum fees paid directly by borrowers at the
origination of a loan and/or yield spread premiums. The lump sum fee that a broker will
charge is disclosed to a borrower prior to closing. The borrower must either bring money
to the closing to pay this fee or increase the loan she is obtaining so that it will cover the
fee. A yield spread premium, on the other hand, is paid indirectly by the borrower.
Typically, the YSP is based on a broker selling a borrower a loan with a higher interest
rate than the "par rate" for which the borrower qualified. The YSP is calculated as a
percentage of the borrower's loan amount and is paid directly by the lender to the broker
and is sometimes referred to as the loan's "rebate" or "price." Lenders provide brokers
with rate sheets that show the pricing available for each loan product, as well as the
amount the YSP will vary depending on the borrower's credit and property
characteristics.
500 South Second Street, Springfield, Illinois 62706 • (217) 782-1090 • TTY: (877) 844-5461 • Fax: (217) 782-7046
100 West Randolph Street, Chicago, Illinois 60601 • (312) 814-3000 • lTY: (800) 964-3013 • Fax: (312) 814-3806
1001 East Main, Carbondale, Illinois 62901 • (618) 529-6400 • lTY: (877) 675-9339 • Fax: (618) 529-6416
~.
In theory, YSPs offer borrowers the ability to finance closing costs and fees and to avoid
bringing money to the loan closing or increasing the loan amount to cover these costs and
fees. But, borrowers are typically not told either the interest rate of the loan for which
they were actually qualified or the amount of the YSP the lender is paying to the broker.
Borrowers are also not given access to lenders' rate sheets. Therefore, the borrower is
completely unable to evaluate whether it makes more financial sense to compensate the
broker through lump sum fees or YSPs. Moreover, our Office has seen that many
borrowers ultimately paid brokers both lump sum fees and YSPs - an illogical
proposition if the point ofYSPs is to cover the borrower's closing costs. Even worse, we
have seen cases in which borrowers paid additional monies at closing to "buy down" the
interest rate of their loan, while the broker also increased the interest rate of the loan to
earn YSPs. This appears to be only a subterfuge that hides the broker's compensation
, from the borrower. While the broker is putting the borrower in a loan with a higher
interest rate to earn a YSP, the broker is also charging the borrower "points" to bring the
rate back down to where it was originally. As discussed below, by manipulating the YSP
a broker would earn for selling different loan products, lenders incentivized brokers to
sell loans that were unnecessarily costly, risky and inappropriate for their clients'
circumstances. It is critical to remember that, although brokers certainly maximized their
compensation through YSPs, it was lenders that created this incentive structure.
Yield Spread Premiums Incentivized Higher Priced, Risky Loans
There can be no question that yield spread premiums incentivized brokers to sell
borrowers costlier loans. The higher the interest rate on a loan, the more compensation
the broker earned from the lender. This is illustrated in the December 15, 2006 rate sheet
attached as Exhibit A. The chart titled "30 Year Fixed Conforming" provides the interest
rates available for a fixed interest rate loan amortized over a 30-year period that conforms
with Fannie Mae and Freddie Mac's purchase guidelines. The left side of the chart lists
the available interest rates and the top of the chart lists the periods for which a borrower
can "lock" the interest rate. The numbers in the middle of the chart show the YSPs
available for selling loans with certain interest rates and lock periods. Ifthe number is
positive, the broker would have to pay that amount in order to obtain that particular loan
for a borrower - a cost that is always passed along to the borrower. If the number is
negative, that is the amount the broker will receive from the lender.
As the chart shows, the par rate for a 30-year fixed interest rate conforming loan with a
30-day interest rate lock was 6%. But, if the broker placed the borrower in a loan with a
6.375% interest rate, the lender would pay the broker a yield spread premium of 1% of
the loan amount. If the broker placed the borrower in a loan with a 7% interest rate, the
lender would pay the broker a yield spread premium of2.25% of the loan amount. If the
broker could get the borrower to accept a loan with a 7.75% interest rate, the broker
would receive 3.25% ofthe loan balance as a YSP. Lenders clearly incentivize brokers
to sell loans with as high an interest rate as possible, in order to earn the largest
commission, regardless of whether the borrower qualified for a lower rate.
2
Our investigations have shown that brokers could earn handsome sums for putting
borrowers in worse loans than that for which they qualified. For example, one Illinois
broker received YSPs from Countrywide ranging from $4185 to $11,310 per loan in the
month of March 2006. During that one month, the broker received a total of at least
$100,000 from Countrywide in the form of yield spread premiums.
Even though most lenders capped the YSP that they would pay to a broker, brokers were
still incentivized to put borrowers in loans with the highest YSPs - even if the YSP was
over what the brokers would ultimately be paid. As an illustration, HSBC capped the
maximum YSP a broker could earn on 30-year fixed interest rate mortgages that were
eligible for purchase by Fannie Mae at 3%. See Exhibit B (HSBC refers to YSPs as the
loan's "price"). Nonetheless, HSBC's rate sheet lists YSPs as high as 3.659% for a 30year loan with a 6.875% fixed interest rate and a 30-day interest rate lock and 3.219% for
the same loan with a 6.75% fixed interest rate. The broker still has an incentive to put the
borrower in the higher interest rate loan with a higher YSP, even though the YSP paid to
the broker is capped at 3%. Specifically, ifthere were any adjustments made to the YSP
due to borrower credit or property characteristics, it would be more beneficial for the
broker to have the highest possible start value on the YSP. If the borrower wanted to get
cash out during a refinance and the loan would be over 80% of the value ofthe property,
for example, HSBC would deduct .75% from the YSP. The available YSP would now be
2.909% for the higher interest rate loan or 2.469% for the lower interest rate loan. In
short, even with YSP caps, lenders still incentivized brokers to sell loans with higher
interest rates. Thus, a YSP cap does not really provide protection for borrowers.
Loan Balance-Based Compensation Incentivized Brokers to Push Larger Loans
Lenders incentivized brokers to encourage borrowers to take out loans that were larger
than what the borrower necessarily needed. First, because YSPs are calculated as a
percentage ofthe borrower's loan balance, brokers obviously earned proportionally more
as the loan amount increased. Second, some loan products would pay more if they were
coupled with factors that increased their riskiness. This is illustrated by Indymac's home
equity line of credit (HELOC) and closed-end seconds pricing. Indymac would pay
brokers more if they convinced borrowers to draw down lines of credit - thereby
decreasing the borrowers' home equity. The maximum YSP a broker could earn ifthe
borrower drew less than 24.99% of the line of credit was 0.5%, but the broker could earn
a 2% YSP if the borrower drew at least 75% of the line of credit. See Exhibit C.
Brokers Earned More by Selling Loans with Prepayment Penalties
The attached rate sheets show that lenders put a premium on selling loans with
prepayment penalties that predictably trapped borrowers in high cost adjustable interest
rate loans. As the attached Indymac rate sheet from December 20, 2006 shows, a broker
could earn more for selling a loan with the longest possible prepayment penalty. For a
three year adjustable rate mortgage with a starting interest rate of 6.50%, the lender
would pay a YSP of 0.625% if the loan did not have a prepayment penalty. See Exhibit
D. But, the lender would pay twice as much, a YSP of 1.25%, if the loan had a three year
3
L..-_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _____
~
~~_
prepayment penalty. Diminishing the duration of the prepayment penalty from three
years to one or two years would decrease the broker's compensation by 0.375% or
0.250%. Id. In addition, the presence of a prepayment frequently impacted the
maximum YSP available. Ifthe Indymac loan described above had a three year
prepayment penalty, the maximum YSP was 2.5%. Id. Any shorter p'repayment penalty
decreased the maximum YSP to 2.0%. !d.
Although prepayment penalties are touted by lenders as a bargaining tool for consumers,
analysis has revealed that subprime borrowers generally received no appreciable benefit
in exchange for accepting a loan with a prepayment penalty.! Even ifborrowers realized
that they could qualify for a loan with more favorable terms, they were locked into a
higher cost loan by the prepayment penalty imposed by the brokers and lenders. In
addition to harming borrowers, this also inhibited healthy market competition. Lenders
did not have to worry about competing with each other on interest rates, if they were able
to trap borrowers in bad loans. Even more troubling, research shows that the existence of
a prepayment penalty on a loan increases the borrower's risk of default or foreclosure. 2
And, at least one broker has informed our Office that, although he was paid more for a
loan with a prepayment penalty, there was no appreciable benefit to a prime consumer for
taking a loan with a prepayment penalty. Apparently, the only point of this risky feature
was to generate additional profit for lenders and brokers because investors would pay
more for loans with prepayment penalties.
Riskier Adjustable Rate Mortgages Paid More than Fixed Rate Loans
While mortgages with interest rates that adjust are riskier for borrowers, brokers were
sometimes incentivized to place borrowers in loans with adjustable interest rates, as
opposed to fixed interest rate loans. An Indymac ratesheet for December 20,2006 shows
that brokers could earn 0.576% for placing a borrower in a three year adjustable rate
mortgage with a 5.75% start rate. See Exhibit G. The broker would not earn a YSP for
placing the borrower in a fixed rate loan at that interest rate; rather the broker would have
to charge the borrower 0.195% for that rate. Likewise, the broker could earn 0.777% for
placing the borrower in an adjustable interest rate loan with a start rate of 5.875%, but
would earn less than half that amount, only 0.332%, for a loan with a fixed interest rate of
5.875%.
The March 6, 2010 rate sheet for CitiMortgage shows the same incentives to place
borrowers in adjustable rate mortgages, as opposed to fixed rate mortgages. A broker
would earn a 0.003% YSP for selling a conforming 30-year mortgage with a fixed
interest rate of 5.875% and a 30-day interest rate lock. See Exhibit H. At the same
interest rate, the available YSP was higher for one year adjustable rate mortgages
I Keith Ernst, Center for Responsible Lending, Borrowers Gain No Interest Rate Benefits from Prepayment
Penalties on Subprime Mortgages (Jan. 2005), http://www.responsiblelending.org/mortgagelending/research-analysis/rr005-PPP Interest Rate-O lO5.pdf (attached as Exhibit E).
2 Munpyung 0, University of California at Santa Barbara, The Effect of Prepayment Penalties on Subprime
Borrowers' Decisions to Default: A Perfect Storm (Nov. 16,2009),
http://www.econ. ucsb.edu/jobmarket/O, %20Munpyung%20-%20Research%20Paper .pdf (attached as
Exhibit F).
4
(l.080% to l.196%), three year adjustable rate mortgages (0.527% to 0.572%), five year
adjustable rate mortgages (0.468% to 0.596%), seven year adjustable rate mortgages
(0.046% to 0.375%), and even for ten year adjustable rate mortgages with a Treasury
index (0.239%). See Exhibit I. In short, CitiMortgage's YSPs incentivized brokers to
sell almost anything except a 30-year fixed interest rate conforming mortgage.
Toxic Pay Option ARMs Paid More Than Fixed Rate Loans
Lenders structured the YSP for option ARMs in a manner that virtually guaranteed that
brokers who were more concerned with getting the highest YSP possible than getting
their borrowers the best loan would steer borrowers into these risky products. Plainly
put, it was easier to obtain higher commissions for option ARMs as opposed to other
traditional mortgage products. Ordinarily a broker would need to increase the interest
rate over a borrower's par rate on a loan in order to receive a higher YSP. If a borrower
did comparison shopping, she could realize that the broker was offering a loan with a
higher interest rate than available from other brokers or lenders. But, the factors that
increased a broker's compensation with option ARMs are completely opaque.
An option ARM has a teaser interest rate, typically for the first month of the mortgage,
and an adjustable interest rate based on the loan's index and margin thereafter. Although
the actual interest rate on the loan adjusts upward after the first month, the borrower is
permitted to continue making payments based on the teaser interest rate for a certain
period of time. During that time, the difference between the interest due each month and
the interest covered by the borrower's payment is added to the loan's balance. The fraud
associated with pay option adjustable rate mortgages is well documented and summarized
in our response to Question 2. Suffice it to say, these loans were appropriate for few, if
any, owner-occupied residential mortgage borrowers.
The YSP for an option ARM is based on the amount of the margin that is used to
calculate the loan's interest rate after the first month and the existence of a prepayment
penalty. The rate sheet for December 15, 2006 attached as Exhibit J shows how this
calculation worked. The available margin for the loan ranged from 2.4% to 3.45% and
the product could be offered with up to a three-year prepayment penalty. As shown on
the rate sheet, the broker could earn up to 4.05% of the loan amount by selling an option
ARM with a 3.45% margin and a three-year prepayment penalty. The start rate for the
loan was still 1%, however, and at least one lender advised its employees to "sell the
payment." Selling the payment in the case of this toxic product would serve only to
obfuscate the true nature of the loan. Borrowers were very unlikely to notice what the
margin for the subsequent interest rate on the mortgage was or realize that they were able
to negotiate this term. The fully indexed interest rate on the loan on December 15,2006
was actually 8.333% (4.883%, the amount of the index on that day, plus 3.45%, the
amount of the margin).
Brokers were incentivized to sell this toxic product because if would have been
impossible to obtain the same YSP on any other loan product. The highest YSPs
available for prime loans from this lender were 3.375% for a 30-year fixed interest rate
5
loan and 1.75% for a 7-year adjustable rate mortgage. See Exhibit A. Both of these loan
products were considerably less risky for borrowers than an option ARM because they
had lower fully-indexed interest rates (7.875% and 7.25%, respectively). Moreover,
neither of these loan products trapped borrowers with prepayment penalties.
Nonetheless, brokers were incentivized by lenders' YSPs to put borrowers in the riskiest,
most toxic product available.
Other lenders presented brokers with these same perverse incentives. For example, on
December 20, 2006, Indymac's highest YSP for an option ARM was 4.00%. See Exhibit
K. This loan had a very high 8.283% fully indexed interest rate and a three year
prepayment penalty. Fixed interest rate and adjustable interest rate loans at 7.375% were
available - and these loans had no prepayment penalties. See Exhibit G. But, the highest
available YSPs were 3.791 % for the fixed interest rate loan and 3.139% for the adjustable
interest rate loan.
Volume-Based Compensation Drove the Use of Reduced Documentation Underwriting,
Without Countervailing Incentives to Sell Full Documentation Loans
Since brokers could earn YSPs on each loan that they sold, they were incentivized to sell
as many loans as possible. Ifborrowers could be qualified for a loan with reduceddocumentation underwriting, brokers and underwriters would be able to submit and
process loan applications much more quickly. During our Office's investigation of
Countrywide Home Loans, for example, we found that it took as little as 30 minutes to
underwrite some reduced-documentation loans, and some loans closed the same day the
application was taken from the borrower. Using risky reduced-documentation
underwriting was therefore a way that brokers and underwriters could maximize the
incentives created by lenders.
While some lenders attempted to mitigate the impact of this risky incentive by decreasing
the amount of compensation brokers and underwriters would earn on reduceddocumentation loans, lenders did not always do so. For example, Indymac offered the
same broker YSP on option ARMs regardless of documentation level. See Exhibit K.
The broker could sell a "NINA" loan, which prohibited disclosure of employment,
income and assets on the loan application, and receive the same compensation as selling a
full-documentation loan. The difference was that the margin on the reduceddocumentation loan would increase slightly and, even more importantly, there would be
no debt-to-income calculation to verify that the loan was affordable for the borrower.
This allowed the brokers to sell loans they might not otherwise have been able to sell.
Another lender treated loans in which borrowers' income was not verified just the same
as full-documentation loans, as long as the totalloan-to-value ratio was under 80%. See
Exhibit G.
2.
Please provide any data that you have on the pervasiveness of mortgage fraud
from 2000 to present. Please provide any data or studies that would assist the
Commission in assessing the dimension of fraud in subprime lending.
6
The FBI defines mortgage fraud as "the intentional misstatement, misrepresentation, or
omission by an applicant or other interested parties, relied on by a lender or underwriter
to provide funding for, to purchase, or to insure a mortgage loan.',3 While our Office
certainly agrees that this conduct equates to mortgage fraud, we believe that this
definition of what constitutes mortgage fraud is too narrow. Our Office believes that the
sale af unaffardable ar structurally unfair mortgage praducts to. barrawers is also.
martgage fraud. This is one of the primary theories in the lawsuit we filed against
Countrywide Home Loans in June 2008. The means for committing this type of
mortgage fraud varied, but the main methods included the severe erosion of underwriting
standards and allowing the layering of risky features on one loan, combined with
incentives to sell risky or unaffordable loans without sufficient checks on abuses. An
example of this type of mortgage fraud can be found in our lawsuit against Countrywide.
There we describe just one Countrywide borrower, a 64-year-old widow on a fixed
income who was refinanced by Countrywide into a mortgage with a three-year fixed
"teaser" interest rate and interest-only period, after which the loan became adjustable.
The borrower was unable to afford the payments on this mortgage even befare the end of
the fixed-rate and interest-only period (i.e. before year three).
A quote from a letter from Countrywide to the Office of Thrift Supervision, set out in our
Office's lawsuit against the company, provides a sense of how prevalent the practice of
selling unaffordable loans to subprime borrowers had become by 2006. In reference to
the fourth quarter of that year Countrywide writes, " ... we know that almost 60% of the
borrowers who obtained subprime hybrid ARMs [from Countrywide] would not have
qualified at the fully indexed rate" (emphasis added).4 Testimony by Martin Eakes, CEO
for the Center for Responsible Lending and Center for Community Self-Help (CRL),
provides additional examples of lenders who utilized underwriting standards that would
qualify borrowers for ARMs at less than fully-indexed rates. s These examples
demonstrate how pervasive this type of poor underwriting was in the industry, and, thus,
how prevalent this type of mortgage fraud on borrowers was.
This fraud was most prevalent in the subprime market, but was also present in the prime
and Alt-A markets. As an illustration, pay option ARM loans were considered a "prime"
product, but one in which we saw an enormous amount of fraudulent conduct. A section
of our Countrywide complaint details the unfair and deceptive nature of the company's
pay option ARM loan product. 6 The core features of an option ARM - multiple payment
options, negative amortization and automatic recasting of loan terms - make the product
much riskier than traditional mortgages. But lenders proceeded to layer the product with
Dep't ofHous. and Urban Dev., Report to Congress on the Root Causes of the Foreclosure Crisis 39 (Jan.
2010) ("HUD Report") (citing Federal Bureau ofInvestigation).
4 People of the State of Illinois v. Countrywide Financial Corporation et al at ~4, No. 08 CH 22994 (Circuit
Court of Cook County, Illinois June 25, 2008) ("Countrywide Compl.") (attached as Exhibit M).
5 Preserving the American Dream: PredatOlY Lending Practices and Home Foreclosures: Hearing Before
S. Comm. on Banking. Housing and Urban Affairs, 110th Congo 14 (Feb. 7,2007) (written statement of
Martin Eakes, Chief Executive Officer, Center for Responsible Lending and Center for Community SelfHelp) (identifying Option One Mortgage Corp, Fremont Investment & Loan, and New Century as lenders
who underwrote ARMs at less than fully-indexed rates) (attached as Exhibit N).
6 Countrywide Compl. at ~~ 123-208 (Ex. M).
3
7
features that made it exceptionally risky, placing borrowers at risk of losing equity in
their homes or even their homes. These features include: illusory teaser interest rates,
prepayment penalties, high loan-to-value ratios and/or reduced documentation
underwriting guidelines. As one former Countrywide loan originator explained,
Countrywide's "option ARMs were built to fail.,,7 Despite the structural unfairness of the
loan, we described how Countrywide marketed the product indiscriminately to all
borrowers, pushed its employees and brokers who sold Countrywide loans to sell the
product inappropriately and failed to provide disclosures to ameliorate borrowers'
confusion about the mortgage they were obtaining. s Between January 1,2005 and July
31, 2007, Countrywide originated thousands pay option ARM loans in Illinois alone.
Moreover, Countrywide's incentive structure, loose underwriting guidelines and
complete lack of oversight enabled and facilitated its broker business partners to commit
fraud in the sale of both pay option ARMs and other loan products. 9 For example, we
sued a broker who specialized in selling pay option ARMs for predatory lending practices
that would not have been possible absent Countrywide's own malfeasance. 10 This
broker, who had five felony convictions, was a Countrywide business partner from April
8,2004 through December 26,2007. As detailed in the complaint we filed against the
broker, borrowers who purchased pay option ARMs were subjected to predictable harms
such as sales techniques that including telling consumers the amount of only one payment
- the minimum payment - and not that the initial low interest rate was merely a one
month teaser rate or that negative amortization would occur if the consumers paid only
the minimum payment. In addition, there was rampant fraud on borrowers' loan
applications without the consumers' knowledge, and which Countrywide then completely
failed to detect and even enabled due to reduced documentation underwriting.
Countrywide incentivized the broker's misconduct with yield spread premiums. During
one month, the broker received at least $100,000 from Countrywide in the form of yield
spread premiums. Countrywide, through this one Illinois broker, sold numerous
consumers loans that were in all likelihood predatory, inappropriate and ultimately
unaffordable. This constitutes fraud.
We also refer you to a report by the CRL on the lender Indymac, a traditionally Alt-A
lender (as opposed to subprime).ll The Indymac report describes much of the same
conduct we describe in our Countrywide complaint, including the massive use of stated
income loans and poor underwriting that resulted in borrowers receiving unaffordable
loans. The report notes that the description ofIndymac's loans and origination practices
are from lawsuits filed against the company and interviews of former employees
Id. aql136.
SId. at'I~158-171.
9 Jd. at '1'1172-193.
101d. aql'1194-208; The People of the State of Illinois v. One Source Mortgage, Inc. et ai, No. 07 CH 34450
(Circuit Court of Cook County, Illinois Nov. 26, 2007) (attached as Exhibit 0).
\I Mike Hudson, Center for Responsible Lending, Indymac: What Went Wrong? How an "Alt-A" Leader
Fueled its Growth with Unsound and Abusive Mortgage Lending (June 30, 2008)
http://www.responsiblelending.org/mortgage-Iending/research-analysis/indvmac-what-went-wrong.html
.
(attached as Exhibit P).
7
8
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conducted by CRL and that Indymac denies much of the conduct. This report
exemplifies just how difficult it is to quantify fraud in the mortgage market.
While it is difficult to quantify the amount of this type of fraud that occurred in the past
decade, we point you to the HUD Report's summation of the literature available on the
causes of the current foreclosure crisis: " ... [I]t seems clear from the literature that the
sharp rise in mortgage delinquencies and foreclosures is fundamentally the result of rapid
growth in loans with a high risk of default-due both to the terms of these loans and to
loosening underwriting controls and standards.,,12 We believe that placing borrowers in
loans they cannot afford equates to mortgage fraud.
In addition to the fraud described above is the more traditionally-defined form of
mortgage fraud, i.e., intentional misstatements or misrepresentations made by a borrower
or broker/lender. The recent HUD Report on the Root Causes of the Foreclosure Crisis
attempts to provide some estimate of the amount of this type of fraud in the mortgage
market. We refer you to that report for its findings. The HUD Report noted a steep
increase in the number of FBI Suspicious Activity Reports between 2003 (6,939) and
2007 (46,717).13 The HUD Report also cites an analysis by BasePoint Analytics, a
private firm specializing in detecting mortgage fraud, as estimating that 9 percent of loan
delinquencies are associated with some form of fraud. 14 In our opinion, these figures
likely underestimate the amount of mortgage fraud in the marketplace in the last decade.
The HUD Report acknowledges several reasons why these reports of fraud may be
underestimated. First, not all lending institutions make Suspicious Activity Reports.
Second, and more importantly, mortgage fraud can be very difficult to identify,
particularly when the adverse consequences of an overly expensive or unsustainable loan,
which might otherwise trigger a review for fraud, are masked by the borrower's decision
to refinance into another loan or to sell their home to get out from under a fraudulent
mortgage. This was often the case during the heyday of the subprime market: housing
prices were rising, and many, ifnot most, borrowers were able to get out of a fraudulent
mortgage either by refinancing into another mortgage or by selling their home for enough
to extinguish the fraudulent mortgage. It was only when borrowers' equity was so tapped
that they could no longer refinance, and a slowing housing market had eliminated the
option of selling for many struggling borrowers, that the massive delinquencies and
foreclosures we have recently seen began to appear. Thus, we believe these figures are a
very conservative estimate in the amount of mortgage fraud that was occurring prior to
the collapse of the subprime market.
It is also important to note that, as found in the HUD Report, the FBI has estimated that
about 80 percent of what they consider to be mortgage fraud is fraud "for profit,"
meaning it is fraud committed by a mortgage broker/lender in order to make money on
the loan (as opposed to fraud committed by a borrower in order to obtain financing for a
home).15 The HUD Report also notes that BasePoint Analytics "has concluded that most
121d. at 29.
13 ld. at 39.
14 d.
1
15 d.
1
9
fraud is driven by mortgage brokers in their efforts to earn profits by originating loans.,,16
This estimate comports with what we have seen in our work in this area. We mainly
witness borrowers who have been the unknowing victims of mortgage broker/lender
fraud. We have seen very little in the way of fraud committed by borrowers on their own
in order to obtain financing for a home.
The HUD Report cites studies byBasePoint Analytics, the Mortgage Asset Research
Institute, and Fitch Ratings Agency demonstrating that the majority of mortgage fraud
involves the misrepresentation of income, employment, or occupancy of the home on
loan applications. Our experience supports these analyses. We believe that the rise of
no- and low-documentation loans allowed this type of fraud to become pervasive in the
mortgage market. The HUD Report pointed out that the growth of these types of loans
"appears to be highly related to the growth in fraud.,,17
As you may be aware, stated income loans earned the nickname "liar loans" in the
industry because they were routinely used to qualify borrowers for loans based upon
inflated incomes. In our review of mortgage complaints and in our investigation of
Countrywide, we discovered that the use of stated income loans was systemically used to
inflate borrowers' incomes, with most borrowers unaware that their income was being
inflated. ls A Mortgage Asset Research Institute review of 100 stated income loans
compared the income on the loan documents with the borrowers' tax documents and
found that almost 60% of the income amounts were inflated by more than 50% and that
90% of the loans had inflated income of at least 5%.19
For a sense of the pervasiveness of the use of these loan products in the years leading up
to the mortgage market meltdown, we would point you to our statement in the lawsuit our
Office filed against Countrywide that from 2005 through the first half of 2007, a majority
of all Countrywide's loans were stated income 10ans. 2o Countrywide sold stated income
loans to "subprime" borrowers and to wage earners-i.e., those borrowers who could
have documented their income with W_2S.21 A 2006 report by Fitch states that loans with
less than full documentation standards make up more than half of the subprime market. 22
In our opinion, the massive sale of these products demonstrates how extensive this type
of fraud was in the market leading up to its collapse.
Id. at 40-41.
ld. at 40.
18 See Countrywide Compl. at ~~95-96 (Ex. M).
19 Mortgage Asset Research Institute, Inc., Eighth Periodic Mortgage Fraud Case Report to Mortgage
Bankers Association 12 (Apr. 2006), http://www.mari-inc.com/pdfs/mbaIMBASthCaseRpt.pdf.
20 Countrywide Compl. at ~SI (Ex. M).
21 ld. at 'I~S4-S5.
22 Preserving the American Dream: Predatory Lending Practices and Home Foreclosures: Hearing Before
S. Comm. on Banking, Housing and Urban Affairs, 110th Congo 14 (Feb. 7, 2007) (written statement of
Martin Eakes, Chief Executive Officer, Center for Responsible Lending and Center for Community SelfHelp) (citing Structured Finance: u.s. RMBS Criteriafor Sl/bprime Interest-Only ARMs, Fitch Ratings
Credit Policy, Oct. 4, 2006) (attached as Ex. N).
16
17
10
3.
Please provide any data regarding the amount of prime loans and pay-option-arms
that were securitized by Wall Street firms from 2000 to the present.
Aside from data available from the Securities and Exchange Commission, our Office's
investigation of Countrywide Financial Corporation and its subsidiaries and affiliates
provided insight into the securitization of residential mortgages. Exhibit B is a list of all
Countrywide securities offerings from 2005 to 2007. As the document shows,
Countrywide had over 170 securities offerings in 2005, over 160 offerings in 2006, and
more than 70 offerings in 2007. Although option ARM loans may be included in other
offerings, option-ARM-specific offerings are identified by "OA" in the deal name. By
our review, over 20 of these offerings included option ARM loans.
4.
Please provide information/statistics, if available, that would give the
Commission further insight into the universe of current foreclosures and assist in
classifying borrowers into four categories: 1) victims (people who were defrauded
into taking out a loan that they never should have taken; 2) borrowers who knew
they were taking a risk; 3) speculators or gamblers; and 4) fraudulent borrowers.
In terms of information and/or statistics regarding mortgage fraud, we refer you to the
HUD Report to Congress on the Root Causes of the Foreclosure Crisis generally.
Specifically, HUD's Report noted that the FBI has estimated that about 80 percent of
what it considers mortgage fraud is fraud "for profit," meaning it is fraud committed by a
mortgage broker/lender in order to make money on the loan (as opposed to fraud
committed by a borrower in order to obtain financing for a home). BasePoint Analytics
also concluded that most fraud was committed by mortgage brokers in an effort to earn
profits by originating loans. To support this conclusion, BasePoint Analytics relied on
the high correlation between the incidence of fraud and above-average interest rates and
fees on loans as well as the fact that about ten percent of brokers accounted for all cases
of fraud it uncovered in a database of three million loans. These estimates and
conclusions comport with what we have seen in our review of mortgage complaints and
investigations of lenders and mortgage brokers. Thus, we believe a greater number of
foreclosures involved borrowers who were victims of fraud (category 1), as opposed to
borrowers who knew they were taking a risk or were themselves engaged in fraud
(categories 2 and 4).
5.
Please provide data to support your testimony that national banks funded 21 of the
25 largest subprime issuers and that national banks, federal thrifts and their
subsidiaries were responsible for almost 32 percent of subprime loans, 41 percent
of the Alt-A loans, and 51 percent of the pay-option and interest-only ARMS in
2006 (see Hearing 1 Transcript, page 160). Please provide that data for any
additional years from 2000 to present, if available.
As noted in Attorney General Madigan's written testimony, the Center for Public
Integrity found that national banks/thrifts funded 21 of the 25 largest subprime issuers.23
First Public Hearing of the FCIC: Hearing Before the Financial Crisis Inquiry Commission, lllth Congo
10 n.14 (Jan. 14, 2010) (written testimony of Lisa Madigan, Attorney General, State of Illinois) (citing the
23
11
The statistics regarding the percentage of loan originations in 2006 are found in a study
conducted by the National Consumer Law Center. For residential mortgage loans
originated in 2006, the study found that banks were responsible for 31.5% of the
subprime loans, 40.1 % of the Alt-A loans, and 51 % of the pay option arm and interest24
only loans.
Data regarding other years is available from the Federal Reserve and Inside Mortgage
Finance, among other sources. In its annual analysis of Rome Mortgage Disclosure Act
data, the Federal Reserve found that depository institutions (combined with their
subsidiaries and other affiliates) originated about half of subprime and Alt-A mortgages
made in 2004 and 2005,54% in 2006, and 79% in 2007. 25 Inside Mortgage Finance
("IMF"), a company that provides news and statistics for the residential mortgage
business, has collected data on the top 50 lenders for 2008 to 2009, the top 40 lenders for
2005 to 2007, the top 30 lenders for 1994 to 2004, and the top 25 lenders for 1991 to
,1993.
Our Office understands that certain regulators cite other statistics in support of the
proposition that state-regulated lenders were largely responsible for the origination of
subprime and Alt-A mortgage loans. These other statistics do not take into account
whether the state-regulated lenders were affiliates of or funded by a national bank or
thrift. The core underlying premise is that national banks and thrifts bear no
responsibility for their affiliates, subsidiaries or the companies that they financially
support. Federal regulators' aggressive stance on preemption issues, however, created an
environment in which states had to exercise caution even when dealing with non-bank
affiliates and subsidiaries of national banks and thrifts.
My Office is currently facing this exact issue in our litigation against Countrywide
Financial Corporation ("CFC"), a holding company, Countrywide Rome Loans, a statelicensed lending subsidiary ofCFC, and the companies' founder, Angelo Mozilo. In
addition to its state-licensed entities, CFC also had a subsidiary that was a national bank
regulated by the OCC that became a thrift regulated by the OTS in March 2007. Our
lawsuit was not against the bank/thrift, but rather sought to hold the holding company,
state-licensed entity and Mozilo accountable for their predatory lending practices. In
response, Countrywide and Mozilo relied heavily on Watters v. Wachovia Bank, N.A.,
550 U.S. 1 (2007), and argued that
... Plaintiffs attempt to avoid preemption by failing to name Countrywide.
Bank, N.A. the OCC regulated entity or Countrywide Bank, F.S.B., the
OTS regulated entity is unavailing. The scope of federal preemption of
banking activities is not limited by formal corporate structure nor limited
Center for Public Integrity, Who's Behind the Financial Meltdown? (May 6, 2009),
http://www.publicintegrity.org/investigations/economic meItdown/).
24 See National Consumer Law Center, Preemption and Regulatory Reform: Restore the States' Traditional
Role as 'First Responder' 11-13 and tbls. 1-3 (Sept. 2009) (attached as Exhibit R).
25 See Robert B. Avery et aI, "The 2007 HMDA Data," Federal Reserve Bulletin AI24-25 and tbl. 11 (Dec.
2008) (attached as Exhibit S).
12
to the entity specifically regulated by the OCC or OTS, but looks instead
to the activity at issue ...
.. .The fact that Plaintiff has failed to name the entity that conducted much
of Countrywide's mortgage lending business and funded substantial
portions of that business during the time covered by the Complaint is
immaterial to the preemption analysis.
Although our Office firmly believes that state-licensed entities are subject to state
regulation, there is no escaping the fact that the federal regulators' actions leave the door
open for arguments on even that simple proposition. It is disingenuous at best for federal
regulators to now disclaim all responsibility for the dysfunctional regulatory environment
they created.
Finally, even taking the numbers presented by one of the federal regulators at face value,
it is inescapable that a significant portion of the subprime and Alt-A lending between
2005 and 2007 was done by federally-regulated institutions. Specifically, federallyregulated institutions directly originated 42.9% of all subprime and Alt-A loans during
26
this period. Of the loans originated during this time period, 26.9% ofthe loans
originated by OTS-regulated entities experienced a foreclosure start and 22.0% of the
loans originated by OCC-regulated entities experienced a foreclosure start. 27 These
numbers do not support a conclusion that a failure of state regulation was the leading
cause of the foreclosure crisis.
6.
Please provide data on the number of cases that you referred to federal regulators
when the state was preempted from taking action. What action did the federal
agency pursue in those cases?
Generally, our practice has not been to refer "cases" to federal regulators because, in our
experience, they have not provided any assistance to our consumers. First, it is important
to note that, although the OCC and OTS attempted to greatly expand their preemptive
authority over state laws during the past decade, whether or not a particular investigation
or "case" is, in fact, preempted has often been a matter of debate. As is apparent from the
recent Supreme Court ruling in Cuomo v. Clearing House Assn., L.L.C, 129 S.Ct. 2710
(2009), even where federal regulators believed states were preempted, that did not mean
we actually were preempted from taking action. Thus, simply because a financial
institution, or even a federal regulator, claimed states were preempted did not mean we
necessarily agreed with that position or felt we could not take action to protect our
consumers where necessary. What it did mean to us, however, was that any such action
we would undertake would require an added layer of work for our Office because we
would not only be attempting to investigate a claim of wrongdoing, but we would also
Subprime Lending and Securitization and Government-Sponsored Enterprises: Hearing Before the
Financial Crisis Inquiry Commission, III th Congo Appendix B: Activities of National Banks Related to
Subprime Lending at 4 (Apr. 8, 2010) (written testimony of John C. Dugan, Comptroller, Office of the
Comptroller of Currency).
27 Id. at 9.
26
13
have to fight with the financial institution, and likely the federal regulator, about whether
we could investigate the allegation. This had the effect of stymieing claims we might
otherwise have pursued, had they been alleged against a state-regulated entity, because
we did not have the resources to fight the extra fight on preemption.
Second, our experience with federal financial regulators has historically been that they
are very antagonistic towards the states and are not very interested in protecting our
consumers from abuses. The Cuomo case is a very good example ofthe reasons why
Illinois and other states have not trusted federal regulators to investigate allegations of
consumer abuses. In Cuomo, the New York Attorney General had concerns over HMDA
data showing racial disparities in the lending practices of some lenders that were
federally regulated. When the New York Attorney General sent letters to those lenders
requesting additional data to investigate these concerns, he was sued not only by the
lenders, but by the OCC itself. Instead of working with the New York Attorney General
to investigate his concerns, the OCC spent its resources fighting whether the investigation
was proper and attempting to stop New York's investigation. Unfortunately, the OCC's
attitude towards state law enforcement efforts is nothing new.
History of the State Attorneys General's Relationship with the OCC
During the early 2000s, our Office, along with the Minnesota Attorney General and
several others, was investigating marketing companies and federal financial institutions
involved in preacquired account marketing, business relationships in which third-party
vendors paid national banks for use of the bank's name and access to bank customers'
accounts in order to market club memberships offering certain products and services to
bank credit card holders. Because the financial institutions were regulated by the OCC,
the Minnesota Attorney General's Office organized a meeting of several other state
attorneys general offices and the OCC in May 2001. The state attorney general group
went to the meeting to describe the problems they were seeing in this area to the OCC,
and hoped that the OCC, once they understood the issue, would help the states in their
efforts to stop the consumer abuses they were seeing.
The assistant attorneys general at the meeting explained the preacquired account
marketing problem and other consumer protection concerns, and requested for help in
addressing these matters. The OCC's response was to lecture the assistant attorneys
general about the preeminent position of the OCC and national banks. The states were
told that the OCC would welcome receiving information they possessed, but that it would
be in the sole authority of the OCC to decide whether and how to proceed. The OCC
rejected the idea of a joint investigation and enforcement action. The assistant attorneys
general were warned that the OCC might oppose any state attorney general actions
against national banks under state consumer fraud statutes on the grounds that the OCC
had the exclusive authority to bring such actions.
An example of this OCC opposition is Minnesota v. Fleet Mortgage Corporation, 181
F.Supp.2d 995 (D. Minn. 2001). In 2001, the Minnesota Attorney General sued Fleet
Mortgage Corporation, a non-bank subsidiary of a national bank, for violations of the
14
......._----------------------------------------
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------ -
------
Telemarketing Sales Rule ("TSR"), 16 C.F.R. §§310.1-310.7. Minnesota alleged that
Fleet's participation in preacquired account marketing resulted in unauthorized charges to
Fleet's customers' mortgage accounts. The OCC petitioned the court and was allowed to
file an amicus brief in support of Fleet's motion to dismiss. The OCC argued that neither
Minnesota nor the Federal Trade Commission had authority to enforce the TSR against
Fleet because national banks are exempt from the TSR, and this exemption extended to
non-bank subsidiaries of national banks such as Fleet.
In August 2001, we received a Memorandum from the OCC setting out its procedures for
processing referrals it received from state attorneys general and other state officials. A
copy of this Memorandum and cover letter is attached as Exhibit T. The Memorandum
set out the OCC's internal procedures for handling referrals from state officials.
Nowhere in this Memorandum is there any provision to discuss with the state official
what action should or should not be taken. The states strongly disagreed with the OCC's
position that the states had no enforcement authority over national banks concerning
consumer fraud matters. This memorandum was not an agreement or understanding.
Rather, it was the OCC's position and stated policy concerning how states were to
communicate with the OCC regarding national banks.
After meeting with the OCC concerning the preacquired account marketing problem, and
the OCC's refusal to work with or help the states in any way on this issue, the states
continued their investigation of this practice by two national banks. The OCC
continually advised these banks not to cooperate or settle with the states. Nonetheless, in
2002 our Office and 27 other states were able to reach an agreement with Citibank and
Bank One and entered into voluntary compliance agreements with them, over the OCC's
objections. As evidence of the ongoing dispute between the states and the OCC, the
compliance agreement contains the following provision:
The States acknowledge that it is the position of the Bank and the OCC
that only the OCC may exercise visitorial powers over the Bank. The
Bank and the OCC believe that these exclusive visitorial powers include,
but are not limited to, the regulation, examination and supervision of Bank
and Bank activities as well as the enforcement of applicable federal and
state consumer protection laws, rules and regulations. Accordingly, the
Bank expressly reserves the right to claim and/or argue that the power to
supervise or enforce this Assurance and/or to examine for compliance with
this Assurance resides solely with the OCc. The Bank acknowledges that
it is the position of the States that the States may enforce applicable
federal and state consumer protection laws, rules and regulations against
the Bank. Accordingly, the States expressly reserve the right to seek to
enforce this Assurance and/or to seek to examine for compliance with this
Assurance, and the Bank expressly reserves its right to respond by
asserting the visitorial powers argument and/or defense described above.
Following the settlements with Citibank and Bank One the OCC issued an advisory letter
in November 2002. One of the stated purposes of this letter was to advise its regulated
15
entities "to consult with the DCC if state officials contact them concerning the potential
application of a state law, or if these officials seek information concerning a national
bank's operations.,,28 In addition to advising DCC-regulated entities to let the DCC know
if they were contacted by a state official, the advisory letter also stated:
State officials are urged to contact the DCC if they have any information
to indicate that a national bank may be violating federal or an applicable
state law or if they seek information concerning a national bank's
operations. The acc will review any such information and, if
appropriate, take supervisory action, which may include an enforcement
action, if it concludes that a national bank has violated an applicable
law. 29
Thus, by early in the last decade, the DCC had made it clear to the states and to the
entities the DCC regulates that the DCC was going to run interference on any issues the
states may have with national banks. The DCC was not proposing a cooperative venture
with state attorneys general to combat consumer abuses. Instead, the DCC was going to
decide, in its sole discretion, whether action needed to be taken concerning any particular
consumer protection issue.
.
This attitude applied equally, ifnot even more forcefully, to state attempts to reign in
predatory lending. The DCC stymied states' attempts to investigate predatory lending
and proactively aided national lenders fighting to avoid compliance with state antipredatory lending laws. For example, in 2002, the DCC stopped Washington's
investigation into National City Mortgage's mortgage practices. 3o And, in 2003, the
DCC issued a ruling exempting national banks from Georgia's anti-predatory lending law
upon request by First Franklin and National City Bank (First Franklin's subsidiary).3l
The DCC has even attacked the usefulness of state anti-predatory lending laws
generally. 32
A recent study of the impact of state anti-predatory lending laws shows the impact of
preemption. 33 The study shows that the default rates for national lending institutions
became worse after the lenders were exempted from state anti-predatory lending laws.
The study also shows that these national lenders' mortgages also contained more risky
features after the lenders were exempted from state anti-predatory lending laws. 34 This
28 Questions Concerning Applicability and Enforcement of State Laws: Contacts from State Officials, OCC
Advisory Letter (AL 2002-9) at 1 (Nov. 25, 2002) (attached as Exhibit U).
29/d. at p. 4 (emphasis added).
30 A description of the OCC's action is in a Seattle Post-Intelligencer investigative report (Eric Nalder,
Mortgage System Crumbled While Regulators Jousted, Oct. 11,2008), attached as Exhibit V.
31 Preemption Determination and Order, Office of the Comptroller of the Currency, 68 Fed. Reg. 46,264
(Aug. 5, 2003).
32 See Economic Issues in PredatOlY Lending (Office of the Comptroller of the Currency Working Paper,
July 30, 2003) (attached as Exhibit W).
33 Center for Community Capital, The Preemption Effect: The Impacts of Federal Preemption of State AntiPredatory Lending Laws on the Foreclosure Crisis (Mar. 29, 2010),
http://www.ccc. unc.eduldocuments/preemption.effect.revised.3 .29.1 O.pdf (attached as Exhibit X).
34 Id. at 16-21.
16
demonstrates that while the OCC was attacking state attempts to reign in predatory and
abusive lending, it was doing nothing to fill the void it was creating.
In 2003, the OCC proposed broad preemption rules, which the state attorneys general
vehemently opposed. The attorneys general for all 50 states, the District of Columbia and
the US Virgin Islands sent joint comments, attached as Exhibit Y, spelling out their
opposition to the OCC's preemption rules. The comments spell out the states' opposition
to the OCC's aggressive preemption of state laws and its interference with state consumer
protection enforcement generally. The comments also specifically voice the state
attorneys general's concern that the OCC's preemption rules would undermine state
efforts to combat predatory lending. 35
Despite the state attorneys general's opposition, the OCC adopted its proposed
preemption rules in 2004. Following these rules, the OCC continued to aggressively
interfere with state enforcement efforts to protect consumers. For example, as described
above, the OCC sued the New York Attorney General to stop an investigation into
potential discriminatory lending by national banks in 2005.
We are aware that in late 2006 the OCC and the Conference of State Bank Supervisors
agreed upon a form Memorandum of Understanding to be entered into between state
banking regulators and the OCC in order to better share consumer complaint information.
However, to our knowledge, state attorneys general were not parties to these agreements.
More importantly, these agreements did not appear to alter, in any meaningful way, the
OCC's attitude and conduct towards the states or towards consumer protection. 36
The oee continued its antagonistic attitude towards the states even after the subprime
market collapsed and the current foreclosure crisis began. In the fall 0[2007, a group of
state attorneys general and state banking regulators formed a working group to begin
discussions with the largest servicers of subprime mortgages in hopes of getting in front
of the oncoming tsunami of foreclosures and helping push forward more reasonable loan
modifications. The working group made requests to the top 20 largest servicers of
subprime mortgages for data on the performance of the loans they serviced and the types
of modifications and other workout solutions being offered. In response, the OCC
35 See Conunents on Docket No. 03-16, 12 CFR Parts 7 and 14, National Association of Attorneys General
(Oct. 6,2003) at. 9-12 (attached as Exhibit Y).
36 See Ryan Chittum, Angelides. The Audit. and Unfair Lending, Columbia Journalism Review (Apr. 16,
2010) (quoting John Ryan ofCSBS as "strongly disagree[ing]" with John Hawke's testimony to the
Conunission that the OCC received "zero" referrals of evidence of national banks involved in predatory
lending and stating: "That statement doesn't reflect what we [state banking regulators] experienced [ .. ]
There were tons of consumer complaints referred to the OCC by the states. I was regularly hearing from
state regulators that sending complaints to the OCC was equivalent to a black hole .... The agreement they
sent the states was not meant to be cooperative. It required the states to say 'we surrender, we have no
authority.' Their focus was not on cracking down on lending practices but rather facilitating the subprime
business model of the biggest banks. The actions of the OCC weren't meant to create a cooperative
atmosphere.") (attached as Exhibit Z).
17
advised national banks not to provide this data to the state working group.37 The letter
sent from Chase to the state working group illustrates the impact of the acc's advice:
With respect to your request that we complete and submit monthly the
detailed servicer call report you provided, I'm sure you appreciate that
Chase is a national bank, chartered under authority of federal law, and is
supervised and regulated exclusively by an agency of the federal
government - the Office of the Comptroller of the Currency (aCC). The
call report requests information about the bank, its loans and its servicing
practices subject to this federal oversight, and as such, this kind of detailed
information would ordinarily be available only to the acc. We have
consulted with the acc and they have advised us that it would be
inconsistent with the acc's exclusive oversight and examination of a
national bank for information of the kind required to complete the call
report to be provided to officials other than the ace. As a result, Chase
must respectfully decline your request for the call report and supplements
which would contain detailed information about loan performance, loss
mitigation efforts, and foreclosures. The OCC has advised us that you
should feel free to discuss with the OCc. 38
The state working group never received data from any of the national banks to whom it
made requests, except Bank of America, which has provided data for Countrywide
mortgages. Thus, even in the aftermath of the lending abuses, the OCC has interrupted
efforts by the states to aid our citizens and has refused to allow national banks to work
with us in this endeavor.
Examples of State Referrals to the
acc and the OCC's Inaction
As described above, the OCC did very little in response to the preacquired account
marketing issue raised and handled by the State Attorneys General. The OCC issued an
"advisory letter on unfair or deceptive acts or practices" in 2002. 39 However, to our
knowledge, the OCC has never taken a formal action, beyond the advisory letter, in
response to the state attorneys general's concerns.
This inaction extended to other matters. For example, we received a complaint from a
consumer about a federal lending institution's practice of universal default. This is
holding someone in default on their credit card when that person is in default, delinquent,
or behind on other debt obligatioris. We believed this practice was a consumer abuse that
warranted investigation. This was shortly after the meeting with the OCC on preacquired
account marketing described above and we decided that, instead of attempting to remedy
the abuse, we would refer the matter to the acc for it to handle. The issue our Office
See Dec. 19,2007 Letter from Chase Home Finance (attached as Exhibit AA); see also Dec. 13,2007
Letter from Wells Fargo Home Mortgage (attached as Exhibit BB).
38 Jd. (emphasis added).
39 Guidance on Unfair or Deceptive Acts or Practices, OCC Advisory Letter (Mar. 22, 2002),
http;//www.occ.treas.gov/ftp/advisory/2002- ~.txt.
37
18
sent to the OCC was whether the universal default provision was a deceptive or unfair
practice under Section 5 of the FTC Act, which the OCC claims to enforce. After
reviewing our information, the DCC informed us that it had determined this was not an
abusive practice and that it would not be taking any action.
In 2004 our Office forwarded complaints we had received concerning a national bank's
involvement with an unlicensed third-party company allegedly providing computer
certification training to students to the OCe. The bank made student loans for the
program, paying the total loan proceeds directly to the company, which ended up
declaring bankruptcy and failed to provide the promised training to many students. The
OCC again declined to take any action, instead informing our Office that it did not
believe any of the bank's conduct was a violation of federal or Illinois law. We did not
agree with the OCC's interpretation of our state consumer protection laws. The OCC
sent letters to our consumers advising them that they were not able to conclude that the
bank had violated any law, that the DCC could not help in the matter, and that the
consumers may wish to consult with an attorney.
Not surprisingly, the OCC's attitude threatened even informal mediation efforts. Our
4o
Office sends out voluntary mediation letters when we receive a consumer complaint.
Following the OCC's November 2002 advisory, we began receiving letters like the one
attached as Exhibit CC from National City. In the letter, National City cited the DCC's
advisory letter and requested that we send any future inquiries to the OCe. Due to the
DCC's actions, and the type of responses we received to our informal mediation attempts
with national banks,we instituted a new policy to forward complaints we received
concerning national banks to the OCC's Texas office. Despite the OCC's advisory letter,
most national banks do cooperate at least somewhat with our Office in our informal
mediation, although at least one bank does not. Nearly all of the complaints we forward
to the OCC involve credit card issues. We have received thousands of such complaints.
Sometimes we refer these complaints to the DCC after we have attempted to resolve the
matter through our informal mediation process but are unsuccessful in achieving any
relief for our consumer. Other times we copy the DCC before we begin mediation. We
are not aware of what actions, if any, the OCC has taken in response to the consumer
complaints we have forwarded to them.
We know that other state attorneys general have their own examples of referrals made to
the OCC, with no action taken by the OCC in response. And, according to John Ryan of
the Conference of State Bank Supervisors, state banking regulators had similar
experiences, describing sending consumer complaints to the OCC as equivalent to a
"black hole.,,41 One example of press reports on this issue, citing a litany of situations in
which the OCC took the side of its banks over that of consumers, is attached as Exhibit z.
As a "first-responder" for consumer issues in the State of Illinois, our Office receives tens of thousands
of consumer complaints each year. In order to assist consumers and businesses in attempting to find a
resolution to these complaints, we have an informal mediation process whereby we attempt to get both
sides to come to an agreement on how to resolve the problem.
41 Ryan Chittum, Angelides, The Audit, and Unfair Lending, Columbia Journalism Review (Apr. 16,2010)
(attached as Exhibit Z).
40
19
The article gives a sense of how the OCC was viewed by those trying to protect consumer
interests. We shared the same concerns.
We hope this gives context for why we have not referred more matters to federal
regulators. Unfortunately, our past experience is that these regulators are often almost as
antagonistic as the targets of our investigations. We have not found the federal regulators
to be very protective of consumers, but rather, have found them to be highly protective of
the institutions they regulate.
Unfortunately, it was during the last decade's very tumultuous and antagonistic period
with federal banking regulators that the bulk of the subprime lending abuses were
occurring. As we outlined in General Madigan's initial written testimony, the state
attorneys general spent countless resources on investigating, attacking and beating back
predatory lending. However, we did not view the federal banking regulators as partners
in this endeavor. Instead, we viewed the federal regulators as being both opposed to us
and unwilling to take aggressive action to stop abuses by their regulated entities.
Please do not hesitate to contact me if you have any further questions about the
information provided in this letter or Attorney General Madigan's January 14,2010 oral
and written testimony.
Very truly yours,
!t!::!'1trjJt[
Chief, Consumer Protection Division
Office of the Illinois Attorney General
20
""""
.........
_Codo:
AMERICAN BROKERS CONDUT
ABC WEST .IRVlNE WHOlESALE RATeSHEET
wmy,ABCONDtla COM
Be PRIME EXPRESS FIXE
UIS
O.ODD
0.125
.. 200
.....,
e.31S
0.=
07(10
• SIS
7,ODD
7.'25
7.200
7.375
7.500
7.11Z!
7.750
1.375
I ....,
0175
tODD
0750
0""
0250
III 125)
10.500)
10"'51
(1.125)
(1500)
(1.825)
~1IlO)
~250)
(2.825)
(2."")
(2,825)
o.>1S
o.ODD
1Il>25)
('''00)
(I_
(1.375)
(1.500)
(1.875)
(2.125)
(2500)
(2500)
~500)
iW1~'!~~~iiti~~
:~.'!.e!.·v~u.a ~VI~~ ~,!f1e1Y_
';:;-:':'rif iii:ioitliti~c Md-'--'-;
i-~;'~~ii"';i'\iic:p~'~~~~;~.
EXHIBIT
:f:
I
HSBCm
Broker - Fannie Mae Programs
CALIFORNIA
I
~.I'"
.
"SOC Website: hne:Jl'WrbIoen.us.trsbc.eom
~E
:.:
10"1>0 IV E'S'T
0",..107' Until
~tDeoo.,.P.c.
~ ... - . 0" amem ....... onlyi.nd ... cub)ocl'ochonge
oob'"
r....
.,..
Loeb EIpirwlbn Da1n
lOo.,Upfnlnl F_
O.I~
lSDI,.
1au
0.' 2ft
0 ......
0 ......
OU""
:lOCo,.
0 .....
lOCo,.
D."""
0.750"1'
~
Up Imnt F. .
!:~:=!::
YDI2OO7
....,...7
51712007
Fannie Mo_ Conforming FInd Tenn UBOR Arms
I
DU.d IIIW HS8C ~IIQIICarporalal (USA,
---...
.youwbnladiKoRl-' ~ ~ ~~"'''''''''''*
MftdfOO' opHM I9qUMIlo .bJlmd attuttornenOlIO hItIc.~. br lu III On-3:X)"797
Ofbr ........ .,,-OOO-:l7307O:ll1ltJbOn''SpecitrIR.teMp,....'''',...I.)ol ...... ~II~bJput'~OIemU.dIhaes&Jg''VwM)VVr~'''-.rN
w. wta ...... JOU Crvm our lit wINn ~ dap. Our Idol,. to do 10 mar tie
I
\III""'"
~
L:J
rrJiO
EXHIBIT
iB
Indymac Bank
HELOCICloBed End Socpnds • Whplgi;alo
etredtww:
~V2M:IIS 1:51 lIN
.....T3t41qtOISlC1~lB
....~cbZII.CIMn
H,l1T9L04"'*':'~·UCPWPBT
I
IHome Equity line of Credit Base Margins (HELOC)
...
,
limE_
PII. Prbt Bald en 00
c."", a..1V
I
0.2..
(0'"
0250
1001·IIf'ftC.a.TV
80 0' • .,., Q.lV
DO.01 • 13 a.rv
06 D1 ., DI* Ct. TV""
Hace 10/10
FULt.DOC
n«>-",
...
~71'
"oao
0.250
(0'"
0 ...
0000
0."50
1000
(lU'O
D ...
0000
-.l1'.'"
D.n!
0""
"""0
0815
0'"
0875
STATED INCOME
Par Prim Baed on 60 __ Ba1 Elm
7...
0.000
0000
0_
0.500
'000
~~a.TV
I
JD.01·8O'M.Q..lV
80 0' • eo.. a. TV
80.01 • 85" a.TV
85.01 .1~
HELOC taW
a:",.-
nOona
7~7t.
0.000
0000
0.000
OOOD
....
OOOD
",.
D....
0 ...
1160
.....
"""
Mor1Pn FIocw'
3000
rio
.......
,.....
...
1.500
• 000
:5.160
nIa
M
.. M51
6ZM>'
1,750
»50
M
""""
...
3500
M
nIa
nIa
0 ~ . ~ ftoor· '00 OOD
Add
to . .rutn
0.000
0.500
D.rbO
1.000
.... Pnnnkim Based an InItlai Or.. P.n:entage
nlill Dmr 0.2"'" DtI Unt Amoum
1OD.~O
(0.2$0)
(O.:n&,
0.200
0.250
0.500
"S1o=n"""'•=.,....!:":;,.;:~~~":::""';;.P:;::':..~Ootd~~.....
;·m;:.:_::,on~;:::..H'!:~'~::.,.---I---;~=:"::O-_-{I~~::::::::: ~::=
100,1$0
1'".D00
"Jdll Drwf 'I-'~ at Un_ Amount
.. 8.1::.
PrtmII R.. •
FloCI)' tnctaxecl Rate •
12M3'
0.500
1 000
a50
PmhIum (Z:'
0.000 Pan Rebut.
'.000 PWeI Rebute
t ,000
........... 1'nIpany
......"
0 ...
1750
~n
ion
..."
_........
......,
0. ...
HELOC""", Adjuame....
1M'
Or. ~, < 125.000
Lie AmC..m S1SO.QDI).U48.880
Lin. ~ ".S2S0,DDO
0000
0"6
0 ...
2.815
3250
OSOD
0815
O~
......"
102.000
Addition. Hl!LOC Proarwn Guldellnn
H.LOCHI ...' .....
Conamn lDtItt tnsIrv tae: SO Doc Pnlip f8a: SO
• '111Gns nowlWlllablD1,n .. wrs
• ~m J*'1"I"ICI'ItI lItO
oII'tf or 1100. ~ I, g-aowr
• Pla\n.m rndlt CDi'd eG::es.lncudld ~ .Utl blBnll d'Mn:*s
Standalone'. funding IDe: "2:a
• CuoIIV usIrcI hI..... Or/y ..""""
• FOSIFmWlW\1evallablo" All Dec~"'" fa" cndtIlRXlIfn .700...,... no
.~~(~t:.%a.1V:~1nInaoo'tErllcNi)
Ann.IaIIae .. $1$. wotwd the ftRI
""knSI
Eady T~ Fft: 1500 If doeod 'tIItIhh ItI1 3 J08", or
D~byl1ldOl8W
rc-
• RcfcrtD Lcrdng GuIlD b ClSchcNI fftIVI"II" ~ Indra~
.No~celCLdatI~UPIO
- . . novatM>
4iD1m
8~CL1V behhdellP~OptbIARMlwllhmutrtun
ICI to 125%
I
Closed End Seconds Base
I
74 ..
7000
7....
1000
caoo..Cl.1V
80.01·"'" a.TV
8O.01.B5"'a.TV
15..01·'00% a.TV
30115 F\led
15t15Rntd
o V, PPp)
FULL DOC
no-n•.
Rates(CI;~J
7OD-11.
",.
....
7:!I75
n""
7.'"
.'75
...",,.....
&6I).6JI
."""
g!loM
7875
... .... ....
....
7...
n...n.
7 ...
• 000
,
BntEttcrt
eo.01.~
Q.TV
u,.
GO.O'·II5'" Q.lV
lOY' PPp)
...
,
I
I
:.oI1SFtntt
....
7t~J1.
68.....
&6I).6JI
"M51
'025
7875
Ill'"
1000
10825
."'"
I
NO RATIO
80 o'·e~ a.lV
n.01·1C1O% a.TV
1~r1.
....
8025
.....
_.
.......
"'2!.
I ,.. .....
0 ....
(0.250)
Am. 2nd cSSO.ooo
All ,.1 Ion PDY CO.... ARM Hoa Am • CCmcumtnl OW)
I
-c&OtIICllVc-ao%
0.750
1.000
Sl""
.....
e 815
AddtDR . .
0.000
R ..... (2i'
0.000_ .......
O.5aJPoirlRabill.
1.000 PaIn!. Rllba10
2.000 Pol .... Rebato
0 ....
~ AmounI c 12O,DDO
Laon AnDItII •• 1100,000 FlCO.-c5BO
0.250
0.500
,.....
1.000
2.$00 PoIrt Rabal.
2&3V,PPP
, Y,HARDPPP
(0.1")
C.S50.aoo
J V, HARD PPP
CO.250
150,001 • SlB,saB
410 ond CLTV .~
I
11M3.
10",,",
1''''
..~
12M3'
1315
to.ooo
1t500
•. 000
1.12&
10.250
11.825
12.500
. .00
1375
t'1:I'5
'77'50
'0 '1"5
" 750
N/A tor 12atd1!ono1. RGIw 10 BOr.lO ra'IIiJ",GOt tor priGng an ccnc:urant 'lrWlSoca1an.
f20.7U
B31§
as,.
BO,O'·~a.TV
CO v, PPp)
10,315
11 'is
,,.00
to 75(\
a....
1.1'6
10 ':1'5
" 1115
HJA tgr"enclata'Mtl. R"',to 80120 ra,.IhOllt lor~ErI ~ hroaaicnl
a >50
-uSCMCl.1V
t~5flard
6ao.o:J.
8.875
10i50
N/A tot ~.ndaIones. Rafar 10 80120 nnall'loe"l for ptdog en cmcuntnI trunsDCtlErl'
STATED INCOME
P'lWPricllBaedcn.S
"M51
01:10
ee..
SUlCI COO.
Q.500)
Q.ooo)
..l' .• ""j
ssoa,coo
NDPrepoy
C......I
CI.ooo)
ID .....)
2 V, HARD PPP
I
~
Addldonal Cloud End 8eccnd Prognm Guldelnn
Vr HARD PPP
Cloud I!nd Second H
FG5IFcnmnlOvallablo
oc»tbW cxtustmcn1
I
-C01aJmtn1tebt.~toe:
en.. BO% a.1V; CEnCIImzm trwIsactcnl on""
• ThIll potted l1I1es do not DnN'1t 1h8I1hII1~ will peN Of'l1 tDdcrDI CI'
IlIItD pndotary brrdng tnta. ThII
Driy bII d ...nnnod on the dato
1M'" II d .. od wltI all tho opplCDbto toes o~ COIU.
'*'
ND U"'~ c:afo..dIIdu, up ID
.5"'tLlV batind
PDyCplanARMI(Cmcuran1'
1
------.....-...--_._..
......----_...
-----_.---....--.-...
.----...-..-.-....... ......----..
. _•• __ ... _Dl ...
--
......
~..
SO DD1I Pntpr.: SO
l", All 000 rrafllhs'" atdiS ..:era. _700 wI1h nD
.
~&.
___
I-..... ......... ....,.-....--
~
.... __., •• ...-_____
ot.....-.... , •• _ .............
EXHIBIT
L
I
Indymac Bank
An-A Products· Whole .. 1e Conforming
loan Amount. c= S 417.000
En.CUwe:
www~'bDCm
'"Zf20J068'6VaN
I
o-UITS Ho~ Ocsl.: '.a&I-56o-M1TS
..... 116 LDdI
51'1 UBOAARII
'''US''''''''''I
&Me..,.
.....
1m
1.500
1.375
1.250
1.125
1.000
&815
8150
U25
8.500
8.315
6.250
8.125
.000
5 a'5
"".Cop
1.1.........
I
lOB!
~Y'Pn&Yf
,.y,Pnp.,
(71:1'5)
p8'~)
""-
(2000)
(1.875)
(I '50)
(' SOD)
(l:\n)
P"~)
(71&0)
(2.B2~)
(2""')
(73 7 5)
(2 '25)
(2DDB)
(' JSO)
(
)
(1.200)
(..,25)
'(0815)
(0.025)
(0"'1
(0 '>5)
D'"
(7,.,0)
('>~)
P'7~
(. 87~)
('~
(' '15)
(. ODD)
(0.'00)
(D.IIZi)
(0."'5)
(0.250)
0.000
(' ,.,~)
("25!')
('~)
(O.7op)
(0620)
ft''''
~!~
0","
'.11"""'.
(331 5)
p'",)
"DOD)
("50)
(75DO)
(2.250)
17 ODD)
....
(1.25)
""'50)
(0875)
i....i
I
'.Yc:wttnPra»r
0315
"YarKMIPruor
D.'"
0371
0.250
I
I
I
I
(>100)
""5)
" \75)
(7000)
(11SO)
(. 825)
(')J"
('~H)
(O075}
(0.625)
(0375)
(0 '25)
o':l~
DSOO
0"'.
PR1CE
0375
0.250
('''5}
(>""')
(>250)
('."5}
(287.)'
('''5}
(U'5}
P''')
("'75)
(1.1... 6)
('250)
(0."0)
(0 "51
0000
0315
.".
..",...., ""("00)
(>600)
(3200)
(3 ODD)
(2750\
(20"')
P"S}
('750)
('.500)
(, '?S)
(0750)
(0500)
(''''''')
("00)
(2500)
(>250)
(2""")
(. ''''I
(' SOD)
('
(0175)
(0100)
(0250)
0000
0 ....
1125
,")
....
D'"
1125
•,DD
lo)."ur
0.375
DocT
". no
11.mo
II
StII.d InCXJm.
I
65 .....
-'20
... ....
.......
.,.....
.......
""20
7'g.FOO
~
I
.,........
......
111'-700
HINA
I
..&4211
.........
"".
I
"'n"
710.700
Nocac
F~I
Doc
I
AD
.ARMPIID~
LTV
Co.()p(HVC...,)
Low Riu Cancb
I
I
40 diYeln
I
MlGrtI.uUon (RATE)
~~~
..........,
i_ _ _ ...-_ .....
Tl".
I
...... 00.001
i
1332.000 • 127'-001
12J5.DOO .1'so.001
1'50.000· "00.001
"00.000.178.00"
115,000- S50.001 J
;,.... 000
_...
,-,---,~
n",
(0.'00)
(0.025)
(DIOO)
CO.3J5}
(0.200)
CO'"}
O.25D
, '79
• fT5
...
, ...,
NIA
NJA
80.0'-45
(0.250)
1$.0\-00
(0.125)
0.000
0.125
o.OOD
O.'~
0.125
o ISO
D"'D
(n.12')
n.ooo
D.DOD
0.1;"
D~'"
0.375
0.000
0.)15
• 0.375
n.125
0500
0250
0''''
0.500
037!'i
DODO
D....
o.an
.......
....
0.31:1
0,500
0."
0.250
0"5
0.000
0''''
0.250
D.1l5
DODO
0.825
n.:\75
0.750
D.SIIO
0.120
0.50
D.3J5
0.500
06..
o.aJ5
o ISO
0015
0.750
0.1171\
'.000
0.311
, ODD
1.125
0.:1115
1250
t.375
, 500
"26
1,250
....
.....
....
031S
, 375
0100
"5O
'."
'>DO
0'"
• 625
15.01"0
70.01-71
0000
DODD
0'"
.000
0 ...
0750
DODD
DODD
0'25
0000
DO.O'~I
'10.01-76
7Un-4lO
o>so
0750
D.ODD
0""'
0.125
0 ....
0,12S
80.0''''
0200
0.000
....
.'00
1S.01-90
0.315
D.""
0.625
0.250
0.0lI0
0.500
D'5O
• UOO
UD,.",
10.0'-15
70.n_
o.sn
0.31$
0.250
0.31.
0.37&
0 ...
1.000
0.125
D.'"
o SIlO
0.~50
"A
0.'25
015
D'Z:;
0250
0250
02"
0.250
".250
0000
0.\25
o '2S
D.DOD
'.250
7375
0000
MOO
15.01-10
O~J'5
NlA
'.7~
15.01-00
NI.
D.DOD
...
'.875
10.01"'"
HlA
0,000
0.250
NlA
'.DUO
1750
"A
"A
"A
0'25
"'50
',375
NI.
NlA
0250
oDOD
0.750
'.000
1.12S
, 2r.D
, 375
...
,' ..
O>SO
NI.
0'"
oSOD
'
,DOD
0000
0000
0'75
0000
U.125
0:160
....
n.:\7~
0175
'.000
NI.
NlA
'000
DOOD
OODD
D50D
0'50
1.120
'.250
, 375
0750
1500
...25
NlA
NlA
NI.
76.01~O
0.125
0200
0375
" ..
NlA
NI•
, "D
• ,.D
, 07.
" ..
10.0,41
(0. 125)
0,751)
0.750
0'"
0.250
0.750
0.115
1.1)1')0
'.125
0.500
'200
1.375
0.750
0.125
0.625
, 3J5'
0"5
0 ..00
0.125
O.DDO
0,25
;0.0'4.
oGOO
D37!1
0.020
0,375
"
• DOD
'17,
110.0''''5
1!1.01..go
........ ~-
0.171
0,:115
0.)15
O.SlO
0]15
. 0,5UD
,.~O
, 250
0250
0,7:iO
0'"
'.100
0.250
NlA
NlA
./A
HIA
037'
0.250
O.~O
0.825
,
MalImUfnR.tt.e..
",3"" HIt", PPP
I
(2.000)
I_Q-d....
HE NM NY.o.tcA PA.SO VA,WA..WI WY
S400~I331.DDll
1.rJO
(0.250)
N.lA, MI NS He NO OK SC TN WV
AZ. CA. DC. HI., ct. MA. NH.HV. RI,lIT. vr
L.... _
(. 025)
('.2S0)
(0.8'15)
(11625)
• .DOO
0"00
75.0, . .
I
A~
(')50)
(0 .•'5)
(0"')
(0."0)
0.200
DO,.
(0500)
(0 '25)
OSOD
, 250
NI.
,
At<. CO, CT, DE, Fl.!. GA,tA" 10, tCS, KY, MD, ME ...... MO, MT,IIlI
Al.
PDOD)
(0 7 50)
O.DDD
D.DDD
0'"
0250
o 11S·
I
TX
('B~)
(0'50)
(0.375)
(D ...)
DOOD
(O.~)
0.000
DDOD
0.000
0.000
DODO
Booond Horne
""',
(l,7ft)
,tm..,ts
LlY
Tler'
(111S)
(' 8'15)
('000)
(1 ..,"S)
70.0toll
3 ..........
Other PRICE Ad
(' 500)
(7.750)
(2615)
(0.125)
O.ODD
O.ODD
0.125
0.000
0.000
0.000
0.000
DlI»SO
,cnIgn ....... ,E.&cIpStll.clt'lalrnl)
-,
(O.175}
(0500)
0"5
081.
'ODD
{' :J751
(> "0)
(> ....)
(>.'25)
(> '2')
('000)
(2.''''')
(,> ...)
(22S0)
1'.'50)
(O.250)
,......
~
(1 ')5}
,.",..,
(2.87&)
G5.0,-70
Hlgn_'Condg
I
f"15,
(0150)
(0500)
0.126
081'
(>000)
(2 '25)
('ODD)
('.175)
(' .,50)
(' 500)
(~311)
('....,
..nft.,.,
(2.875)
(2''')
(2.500)
(2.250)
(2'75)
('.T5)
(' '1SO)
(0.'25)
D.ODD
D.ODD
0.000
(n",,)
D.DOD
D.ODD
D.ODD
O.DOD
10250)
o ODD
0.000
•.1100
D.DOD
(D.25D)
0.000
0.000
0.'2&
D ...
10150)
DODD
DOD
0'"
0.3715
NI.
P _ ... T,.".PAlC . . . .
I
(>250)
(2'7:1)
C'IJ5}
(1.750)
C' 3711)
,.BE
"Y,',..,
065
(0.250)
Ltv Ad nnentto R,t.
I
I
"''')
(HOO)
NlA
.......
I
,,~
NlA
._1,
........
1\1 00\II, Doc TVPOf
..
(UOO)
(>IX>O)
(2.8'5}
P"5}
(2.500)
(2""')
'(7 .• ")
(117')
1'875)
(2'00)
(2500)
..... ....
lnl. . .tOrdy RATE Adjustment. _ARMs
Credh kore
DODD
-'00
DODD
DorG
OSN20
'·700
DODD
• ODD
6SQ.I21)
0.000
I
I
DocT
""- ,.,' .....,
o
117V-16O
I
16 Y• ., Fla'"
"BE
.-
,",""'Ad
.,.......
.....
.......
.,.....
!
SO V••,rIud
'082
D.25D
»-720
7,80700
......0
I
JOV. .,Plud .
lOB!
LlY
I
F.a Doc
).",..,.,
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EXHIBIT
.'- .-
- ._.
I
0
-
Borrowers Gain No Interest Rate
Benefits from Prepayment
Penalties on Subprime Mortgages
;\ rL·'L·.i rc It rLj'l1ft
Cl'l1tcr rllr RC~I'()I1~ihk
I,)'
rilL"
LL'nciing
January 2005
~(!"T!R
~
~
fOR
RESPONSIBLE
LENDING
www.responsiblelending. 0 rg
EXHIBIT
b
I
L-.
L-
---I!!=---
Research Report: No Interest Rate Benefits from Subprime Prepayment Penalties
Introduction I
I
I
Homeownership not 6nlY supplies families with shelter, it also provides a means of savings,
allowing borrowers td build wealth and economic security. Home equity accounts for 76 percent
I
of the median net WOItt h of American households.! For those in the subprime market, however,
prepayment penalties on home loans can cancel out the positive wealth-building effects of
I borrowers with subprime loans qualifY for a more affordable loan during
homeownership. When
I
a prepayment penalty,s effective period, they face a choice between depleting savings or staying
locked in a higher-cost loan. Understanding the impact of prepayment penalties in subprime
home loans on wealt~-building is critical, because up to 80 percent of subprime mortgage loans
include prepayment p~malties, in contrast to only two percent of mortgages in the prime market. 2
representati~es
Industry
have long argued that borrowers with subprime loans are compensated
for the negative effec~s of prepayment penalties by receiving a lower interest rate than otherwise
would be available. to test this claim, the Center for Responsible Lending (CRL) investigated
whether prepayment penalties convey benefits to borrowers commensurate with their costs. The
evidence presented here shows that, in fact, borrowers with subprime loans fail to receive lower
interest rates and, in ~ome cases, actually pay a higher rate than similarly situated borrowers
with subprime loans ~ithout prepayment penalties. Because a prepayment penalty makes it
more difficult for oth~r lenders to refinance a borrower into a better-priced loan, the fact that
borrowers receive no interest savings makes prepayment penalties unfair and anti competitive.
Key Findings
To assess how prepayment penalties affect interest rates in the subprime market, researchers
from the Center for Responsible Lending (CRL) examined loan-level data from approximately
half a million subprirlte loans. 3 Using multivariate regression models, CRL researchers analyzed
fixed-rate, 30-year lo~ns originated during a three-year period. We believe the research
presented here is the bost complete to date examining this aspect of prepayment penalties:
•
In refinance lians, prepayment penalties produced no statistically significant difference
in the interestl paid by borrowers with subprime loans. In other words, borrowers with
prepayment penalties paid similar interest rates to similarly situated borrowers who did
not have pencilties.
•
For purchase Iloans, borrowers who had subprime loans with prepayment penalties paid
higher intere~t rates than similarly situated borrowers who had subprime loans without
prepayment p:enalties. For example, in 2002, borrowers with a 30-year, fixed-rate
subprime purchase mortgage paid an interest rate that was 40 basis points (0.40%)
higher ifthei~ loan included a prepayment penalty than if it did not. As shown in the
chart on pagelS, these trends were consistent over the three-year period.
•
For an estimJted 380,000 borrowers that received subprime purchase loans in 2003, the
lifetime cost bfthis higher interest rate is up to $881 million.
I
© 2005 Center for Responsible Lending
www.responsiblelending.org
Research Report: No Interest Rate Benefits from Subprime Prepayment Penalties
I
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I
Background
I
I
inte~est
Given the higher
rates attached to subprime loans compared with prime loans, many
prepayments are triggered when borrowers have established a stronger credit history.
Prepayment is therefdre a positive step for these borrowers, signaling the ability to qualify for a
loan with more favorJble
terms. In the subprime market,
however, prepayment penalties may
I
I
alter this dynamic and harm borrowers in several ways:
I
1. Draining equity. Many homeowners with subprime loans have worked hard for years to
accumulate equity in their homes. A prepayment penalty, routinely amounting to
thousands of dollars, directly drains home equity when a borrower refinances.
I
I
2. Creating a high-cost trap. Sometimes borrowers simply cannot afford the cost ofthe
prepayment penalty.
In such cases, they may be forced to continue paying a higher
I
interest rate when they could otherwise refinance and qualify for a more affordable loan.
I
' .
3. Providing an i:ncentive for kickbacks. When brokers deliver loans at a higher interest rate
than the lende'r requires, the lender typically pays the broker a kickback, known as a
"yield spread ~remium." Because lenders want to recoup the cost of the kickback even if
the borrower pays off early, they are more willing to pay yield spread premiums on loans
with prepayment penalties. For this reason, prepayment penalties facilitate brokers
charging highbr interest rates for borrowers who could otherwise qualify for lower rates.
Prepayment penaltiesl have become increasingly common in the subprime market in recent years,
at a level far out of p~oportion to the prime mortgage market. The wide disparity between the two
markets raises substantial doubts as to whether consumer choice explains the prevalence of
prepayment penaltiesl in the subprime market, especially given these borrowers' incentive to
build a good credit history and refinance as soon as feasible.
I
sig~ificant
Prepayment rates are la
issue for investors in both the prime and subprime markets, yet
the two sectors manage prepayments in different ways. Those who originate, invest in, and
purchase loans base their decisions on anticipated cash flows. Mortgage prepayments disrupt the
expected stream of ir~come and make it more challenging to project revenues over time. In the
competitive prime m~rket, where refinances are commonplace and prepayment penalties are rare,
the market adjusts thJ pricing on loans and securities to account for prepayments. In the
subprime market, lenders choose to manage early payoffs by using prepayment penalties to lock
borrowers into loans br ensure additional revenues (through the cash received from the penalty
itself) if borrowers d6 refinance.
I
In the prime mortgagl market, prepayment risk is allocated among all borrowers, lenders and
investors, and borroJers who can qualify for more affordable loans can do so without paying a
penalty. In the subpri1me market, lenders and investors are able to minimize their own
I
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I
© 2005 Center for Responsible Lending
www.responsiblelending.org
2
Research Report: No Interest Rate Benefits from Subprime Prepayment Penalties
I
prepayment risk at thJ expense of a large subset of borrowers who receive the burden of
penalties without any offsetting interest rate benefit.
Current Regulation of Prepayment Penalties
Numerous states havJ passed laws and issued regulations that prohibit or restrict the use of
prepayment penalties lin the mortgage market. Currently, laws banning prepayment penalties are
effective in at least nine states, including states that allow for limited exceptions. 4 Other states
have imposed speci.fi9 limits, including limits on (1) the amount of fees associated with the
penalties; (2) permissible loan types; or (3) additional lender disclosure requirements.
A recent regulatory dLision
by the Office of Thrift Supervision has ensiJred that such state laws
I
are in effect for state-,based mortgage lenders, such as finance companies. Freddie Mac and
Fannie Mae both have announced that they will not invest in subprime home loans with
prepayment penaltiesithat remain in effect for more than three years. These restrictions have had
no discernible effect on
, the availability of subprime mortgages or the rapid growth of the
subprime market. In QOOO, the subprime mortgage market was $138 billion. Only three years
later, the market had Inore than doubled, reaching $332 billion. 5 Today, one in every five
mortgages is a subprilne loan. 6
I
© 2005 Center for Responsible Lending
www.responsiblelending.org
3
Research Report: No Interest Rate Benefits from Subprime Prepayment Penalties
Data and M+hOdO!Ogy
mortga~e
To measure the effecl of prepayment penalties on subprime
interest rates, CRL
researchers used mul~ivariate regression models to estimate separate results for each year 20002002 and for fixed-rate loan products (30-year purcha~e mortgages and 30-year refinances). The
study relied on a rele~ant subset from the Loan Performance Asset-Backed Securities Database
(ABS Database) of sJcuritized
subprime loans. 7 The database contains an array of variables at
I
the loan level, including
many variables not
I
available in other national mortgage databases such
Characteristics of Subprime, 30-Year,
as FICO scores, loanfto-value ratios, debt-toFixed Rate Mortgages in ABS Database
income ratios, and th~ length of prepayment
Number of loans
1,190,500
I
penalty terms.
A potential confoundling factor is that borrowers
may choose a particular loan-to-value ratio (LTV)
to achieve a desired ihterest rate. To better isolate
the association betwden interest rates and
prepayment penaltied, it was necessary to use a
specific statistical tedhnique (least squares
instrumental variabldsI estimation) to better
estimate the effect o~ variables correlated with
LTV. This method increases
confidence that the
I
results accurately reflect relationships between
prepayment penaltie~ and loan pricing, rather than
the effects of LTV. I
Origination period
2000-2002
Refinances
65%
Single-family residences
74%
Mean loan amount
$171,956
Loans with prepayment penalties
40%
Variables·
• Geography
• Loan-level underwriting factors. (e.g., credit
score, LTV)
• Individual loan characteristics (e.g., loan amount,
adjustable vs. fixed, level of documentation)
• Residence type
• For a complete list of variables, see Appendix 1.
© 2005 Center for Responsible Lending
www.responsiblelending.org
4
Research Report: No Interest Rate Benefits from Subprime Prepayment Penalties
Findings
Interest Rate Efflcts of Prepayment Penalties
fixed-rat~
For 30-year,
subprime purchase loans, the prepayment penalty coefficient is positive
and statistically significant in all models, indicating that the presence of a prepayment penalty is
. d Wit
. h an Increase
. I
•
associate
In
---------- ______________________ _
interest rates. For 30ryear, fixedrate. subprime refinances,
the
I
presence of a prepayment penalty
had no consistent, mdaningful
•
•
I
Impact
on Interest rates.
,
I
.
The Effect of Prepayment Penalties on Subprime
Mortgage Interest Rates
Interest Rate Changes Associated with Penalties (in
rounded basis points)
I
For complete results on both types
of loans, see Appendix 2.
I
I...
Loan Type
2000
2001
2002
30-yr. FRM
-9*
+2
o
refinances
ImtJa II y counter-intUitive
Th ese .,.
I
+39*
+40*
30-yr. FRM
+51*
results contrast with the other
purchases
variables analyzed, ~hich
consistently produce the expected
·Statistically significant at a 99.9% confidence level (p< 0.001 level),
results. For example! FICO
scores and interest rates have a strong negative relationship: a 100-point increase in a FICO score
decreases the interestlrate by 90 - 120 basis points, all other things equal. Similarly, LTVs and
debt-to-income ratios were positively associated with interest rates on loans, meaning that higher
LTVs and debt-to-indome ratios increased rates borrowers received.
I
The Costs of Hidher Interest Rates Associated with Prepayment Penalties
Higher interest rates lssociated with prepayment penalties on subprime purchase loans impose
significant additionali cost on families over time. Assuming a 30-year subprime purchase loan of
$120,000 with a fixed interest rate of 8.4 percent (versus the 8 percent rate the borrower likely
would have received lwithout a prepayment penalty), borrowers would pay more than $2,000 in
additional interest over a five-year period iftheir loan included a prepayment penalty. Ifheld to
maturity, borrowers ~ould pay more than $12,000.
~fthe
The cost imPlicatioJ become even more compelling when considered in the context
entire
estimate that borrowers who took out subprime purchase loans with
subprime market.
prepayment penaltie~ in 2003 will pay up to $881 million in extra interest alone over the life of
their loans, without e~en considering the cost of the prepayment penalty fee.
wb
I
This estimate is deri~ed from an analysis of a subset of the ABS Database,8 which shows that
60,000 borrowers would pay $139 million in extra interest over the life of their loans. 9
I
© 2005 Center for Responsible Lending
www.responsiblelending.org
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5
Research Report: No Interest Rate Benefits from Subprime Prepayment Penalties
Extending that result to the larger ABS Database and then to the subprime market as a whole,
and adjusting for actJal market volume,1O we arrive at the estimate of up to $881 million in extra
interest for borrower~ with subprime purchase loans.
This extra cost is implsed on borrowers who must, in addition, pay a substantial fee if they
refinance during the ~enalty term. While this analysis does not project the total prepayment
penalty fees borrowets with sub prime loans will incur as a result of early loan payoffs, we note
that 2003 borrowers' rotal exposure to potential subprime prepayment penalties is $7.0 billion."
Even for subprime refinance mortgages, which showed neither an interest benefit nor a cost
associated with subpr:ime prepayment penalties, CRL's findings stand in sharp contrast to claims
touting the benefits of such penalties. For example, Countrywide Financial Corporation is
among the lenders w~o imply that prepayment penalties help keep interest rates relatively low
for subprime borrowers, and that eliminating penalties will contribute to "significantly higher
interest rates and morithly payments for borrowers who can least afford them.,,'2 However, our
analysis shows that bbrrowersin the subprime market fail to realize the purported interest rate
benefits ofprepaymeht penalties while relinquishing valuable savings from their home equity.
© 2005 Center for Responsible Lending
www.responsiblelending.org
6
Research Report: No Interest Rate Benefits from Subprime Prepayment Penalties
Conclusion
ahd Comments
I
I
f~r
While lenders may dilcount interest rates to brokers
loans with prepayment penalties, this
research suggests tha~ borrowers in the subprime market do not receive these benefits. In fact,
prior research has identified a "principal-agent" issue that finds brokers seizing on similar
3
benefits for themselv~s
at the expense of borrowers. I With respect to prepayment penalties, the
I
expense is also shared by other lenders that will find it more difficult, if not impossible, to
compete to offer a ratb low enough to entice a rational borrower with a prepayment penalty to
refinance. In this Iig~t, prepayment penalties operate to reduce competition in the mortgage
I
market.
One interesting aspec1t of our findings is the marked difference in the results for subprime
purchase and refinande loans. Prepayment penalties are associated with a significant increase in
interest rates on subp}ime
purchase loans, but have no meaningful impact on subprime
I
refinances. One poss,ible explanation for this difference lies in the typical financial positions of
borrowers in the purc,hase and refinance markets. Borrowers who seek purchase loans in the
subprime market likely have the minimum amount of assets needed to get a loan. 14 Faced with
the reality that the bo~rower has little or no excess equity, brokers and others involved in the
transaction have a strbng motive to seek alternative ways to get paid, including yield-spread
premiums based, at IJast indirectly, on prepayment penalties. For refinancing borrowers, the
motivation 'to seek suph forms of compensation may be weaker, since the borrower typically has
accumulated equity that can be used as a resource to pay up-front fees. Still, findings show that
in a subprime refinanbe
transaction, borrowers are receiving no benefit from the prepayment
I
penalty in the form of reduced interest.
I
CRL's findings stronkly suggest that prepayment penalties in
subprime loans are not serving borrowers' best interests. The data
here indicate that the !purported tradeoff between prepayment
penalties and interestl rates in subprime loans is essentially
.
nonexistent as borro'rers receive the burdens of penalties without
compensating benefits.
Once the penalty is in place, the
I
borrower's ability to Ibuild wealth is significantly hampered since
the borrower either continues to pay excess interest or gives up
accumulated home equity to get a better loan.
I
Finally, we believe t~e issue of prepayment penalties should be
viewed in light of lorlgstanding policies designed to support and
facilitate affordable rhortgage credit. Homeownership provides
one of the most acceJsible
ways that lower-income, working
I
families can achieve sustainable economic security. By burdening
such families with prbpayment penalties, the subprime mortgage
market perpetuates a!practice that is directly counter to these
important national p~iorities.
About the Center for
Responsible Lending
The Center for Responsible
Lending is a nonprofit,
nonpartisan research and
policy organization dedicated
to protecting home ownership
and family wealth by working
to eliminate abusive financial
practices. CRL is affiliated
with Self-Help, one of the
nation's largest community
development financial
institutions.
For additional information,
please visit our website at
www.responsiblelending.org.
I
I
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I
i
© 2005 Center for Responsible Lending
www.responsiblelending.org
7
I
Research Report:
NO! Interest Rate Benefits from Subprime Prepayment Penalties
Notes
I
Shawna Orzechowski and feter Sepielli, ''Net Worth and Asset Ownership of Households: 1998 and 2000," U.S. Department of
Commerce, Economics and Statistics Administration - U.S. Census Bureau (P70-88), May 2003, p. 15.
2 See Standard & Poor's, "N)MS Analysis: Valuing Prepayment Penalty Fee Income," at http://www.standardandpoors.com
(January 3, 2001); see also Standard & Poor's, "Legal Criteria Reaffirmed for the Securitization of Prepayment Penalties," at
httpllwww.standardandpoor~.com (May 29, 2002); "Prepayment penalties prove their merit for subprime and 'A' market
lenders," http://www.standatdandpoors.com (January 3, 2001); see also "Freddie offers a new A-, prepay-penalty program,"
Mortgage Marketplace, at I r2 (May 24, 1999); see also Joshua Brockman, "Fannie revamps prepayment-penalty bonds,"
American Banker at 16 (JuiX 20, 1999).
3 The regression analyses in :this report were performed by Christopher A. Richardson. The conclusions presented are those of the
Center for Responsible Lending and should not be attributed to Mr. Richardson. Our data source was the Loan Performance
Asset-Backed Securities dathbase (ABS database). For more information on this data set, see John Farris and Christopher A.
Richardson, "The Geography of Subprime Mortgage Prepayment Penalty Patterns" in Housing Policy Debate (Fannie Mae
Foundation), vol. 15, issue 3; (2004).
4 For example, in North and ISouth Carolina, the ban on prepayment penalties is limited to loan amounts less than $150,000.
5 Mortgage Statistical Annuql, March 2004.
6 Inside Mortgage Finance's Inside B&C Lending, November 15,2004 (vol. 9, issue 23), p. 3.
7 See note 3.
I
H Fixed-rate, 30-year subprime loans originated in 2003 and recorded in the database.
9 We assume an average lo~ life of 3.6 years based on subprime prepayment curves from Standard & Poor's and Fitch Ratings.
III To extend the analysis to the full ABS Database, we assume that the remaining purchase loans not studied exhibit the same
increase in interest rates. Ncixt, to extend the results to the full market, we multiply this figure by the proportion of total
estimated 2003 subprime volume (as listed in the Mortgage Statistical Annual) divided by the total volume of loans in the ABS
i
Database.
II This figure is calculated as the product of the following three conservative estimates: $332 billion total subprime market
volume in 2003, 70 percent bfsubprime loans with prepayment penalties, three percent average maximum prepayment penalty
fee. In 2001, CRL estimated that borrowers of sub prime home loans cumulatively paid $2.3 billion in penalties each year. See
Eric Stein, "Quantifying the iEconomic Cost of Predatory Lending," Coalition for Responsible Lending (200 I) at
http://www.rcsponsiblclending.org).
12 See, e.g., testimony of Sandy Samuels on behalf of Countrywide Financial Corporation and the Housing Policy Council of the
Financial Services Roundta~le before the Subcommittees on Financial Insititutions and Housing - U.S. House of Representatives,
1
March 30, 2004.
I
13 See, e.g., Howell E. Jackson & Jeremy Berry, "Kickbacks or Compensation: The Case of Yield Spread Premiums" (January
2002) at http://www.law.hari-ard.edu/facliitylhjackson/pdfs/janliarv draft.pdf. See also William C. Apgar and Allen J. Fishbein,
"The Changing Industrial Organization of Housing Finance and the Changing Role of Community-Based Organizations," (May
2004) at www.jchs.harvard.Jdll/pliblicationslfinancelbabclbabc/ 04-9.pdf, p.9.
.
.
14 In fact, among loans examined for this study, borrowers with refinances had almost twice as much equity available as the
purchase loan borrowers.
I
I
© 2005 Center for Responsible Lending
www.responsiblelending.org
8
APPENDIKI
I
Definition of Variables
I
I Description
Variable Name
I
I
Prepayment Pen~/ty
PP~
I Loans with prepayment penalty
I
Borrower's Creditworthiness
I
FICG
D"T:I
Borrowers' credit score at origination
Borrowers' debt to income ratio
I
Borrower's ShareI of Equity
LT\I'
I Origination loan to value ratio
Jumbo MortgagJs
I
Jumbo
I
Minority
Loans with amounts larger than the Fannie Mae/Freddie Mac
conforming loan limit, which is $300,700, $275,000, and $252,700 for
2002, 2001 and 2000, respectively.
I
Concen~ration
Minojo
Percentage of residents in each zip code who are, not single-race
Caucasian. Latinos and multiracial individuals are classified as minority
even if one of the races they self-identify as is Caucasian. Zip code
information is from LP database. Minority percentage is from the
Summary File 2 (SF2) database of the 2000 Census.
Loan DocumentJtion
Level
I
Low-d09 Low loan documentation level
NO-d0 9 No loan documentation
[
Mortgage PropertY Type
Condo
Coop
2-4 uni,t
T~
puq
MI7
Condo
Coop
2-4 unit residence
Townhouse
Planned unit development
Manufactured housing
Origination seaslnal
Effects
I
Feb-Dec!:
I
I
I
I February to December dummies
I
APPENDIf2
Full results for th~ ordinary least squares (OLS) and instrumental variables (IV)
regressions are presented on the following pages. For reasons detailed in the
methodology sections, the reported results in the paper rely on the output from the IV
regressions.
In each case, the ~eported coefficients represent the estimated change in interest rate for a
one-unit change in each variable. In the case of variables with a continuous distribution,
such as FICO scotes, results should be understood to mean changes in interest rate
holding other vari~bles constant. In the case of dummy variables (variables that describe
discreet categoriet such as whether or not a loan has a prepayment penalty), the
coefficient repres6nts the estimated change in interest rate when the dummy variable
changes from an dmitted reference category to the indicated status holding other variables
constant.
I
sinc~
For example,
the IV coefficient for 30-year fixed rate purchase loan borrowers with
prepayment penalties in 2002 (PPP in the third column ofthe first table of Appendix
2) is 0.403, we cah say that the model estimates that these borrowers' interest rates were
0.403 percentage points higher than those of borrowers without prepayment penalties. In
other words, the change in status here associated with the dummy variable is from a loan
without a prepayn\ent penalty to a loan with a prepayment penalty.
t
For each coefficierlt, it is also interesting to observe the associated confidence level,
revealed by the t-~tatistic. A t-statistic with an absolute value of3.3 indicates that the
estimated coeffici~nt differs from zero by a statistically significant amount at a 99.9
percent confidenc~ level. Similar measurements of2.6 and 2.0 indicate that the
measurement is di!fferent from zero by a statistically significant amount at a 99 and 95
percent confidence level, respectively.
t
Finally, readers wishing to understand the extent to which variables in the models explain
the variation in interest rate on home loans in the dataset should review the line at the
bottom of each re~ression set that lists the associated adjusted R-squared measurement.
For example, look;ing again at the first IV regression column in the first table, the
adjusted R-square~ measurement of 0.536 indicates that the model explained 53.6% of all
variation in intere~t rates. This suggests that while the model could benefit from the
inclusion of other ~nknown variables that may also explain differing interest rates, it
nonetheless explaiins a majority of the variation in interest rates.
Appendix 2 (cont.)
30-Year Fixed Rate Purchases
I
I
2002
2001
I
OLS
OLS
IV
1
2000
IV
IV
OLS
Coeff.
t-stat I
Coeff.
t-stat
Coeff.
t-stat
Coeff.
t-stat
Coeff.
t-stat
Coeff.
t-stat
13.45
146.2
12.288
105.7
15.292
105.4
13.532
75.1
14.713
104.6
13.263
77.4
PPP
0.411
59.5
0.403
57.2
0.474
48.5
0.507
49.4
0.374
34.5
0.386
34.6
FICO*
-0.009
-174.0
-0.009
-168.4
-0.01
-144.0
-0.011
-134.8
-0.009
-119.3
-0.009
-108.4
LTV*
0.02
72.1
0.035
37.0
0.018
46.7
0.042
29.3
0.01
23.6
0.032
21.7
DTI*
0.002
6.8
0.002
9.9
0.004
11.4
0.005
16.0
0.006
18.7
0.007
20.2
Jumbo
-0102
-115
-0047
Min%*
0.302
20.6
Const.
-49
-0225
-197
-0.145
-11 5
-0.188
-15.0
-0.121
-89
0.24
15.6
0.447
23.2
0.361
17.6
0.36
17.7
0.291
13.6
0.21
31.1
i
I
0.294
34.7
0.219
22.1
0.364
27.7
0.128
12.1
0.247
18.7
0.665
52.21
0.735
53.9
0.675
33.6
0.803
36.5
0.706
26.6
0.825
29.1
Condo
0.05
4.5
0.0526
4.6
0.069
4.5
0.077
4.9
0.07
4.2
0.088
5.1
Coop
0.518
8.2
0.625
9.7
0.332
5.5
0.512
8.1
0.515
8.3
0.691
10.6
2-4 unit
0.124
9.6
0.119
9.0
0.161
8.8
0.159
8.4
0.044
2.4
0.032
1.7
TH
0.046
1.2
0.029
0.8
0.032
0.7
0.014
0.3
0.047
1.2
0.062
1.6
PUD
-0.151
-17.5
-0.14
-15.8
-0.156
-13.1
-0.136
-11.1
-0.142
-10.1
-0.111
-7.6
MH
0.378
12.3
0.429
13.6
0.425
12.3
0.487
13.6
0.355
10.4
0.427
12.1
Feb
-0.105
-6.1
-0.109
-6.2
-0.22
-9.8
-0.218
-9.5
0.033
1.5
0.012
0.5
Mar
-0.214
-13.0
-0.223
-13.3
-0.339
-16.1
-0.333
-15.3
0.081
3.7
0.062
2.7
Low
No
1
I
Apr
-0.198
-12.5
-0.21
-13.0
-0.431
-20.5
-0.425
-19.6
0.102
4.5
0.062
2.7
May
-0.34
-21.9
-0.346
-21.9
-0.425
-20.9
-0.421
-20.0
0.251
11.7
0.207
9.2
Jun
-0.49
-31.9
-0.507
-32.3
-0.408
-20.2
-0.411
-19.7
0.264
12.7
0.218
10.1
-0.635
-41.5
-0.658
-42.0
-0.48
-24.0
-0.495
-23.9
0.219
10.3
0.17
7.6
Aug
-0.786
-51.4
-0.805
-51.5
-0.576
-29.7
-0.583
-29.1
0.181
8.5
0.133
6.0
Sep
-0.922
-59.7
-0.945
-59.8
-0.714
-35.0
-0.72
-34.2
0.133
6.1
0.076
3.4
Oct
-1.012
-65.9
-1.03
-65.6
-0.926
-46.7
-0.944
-46.1
0.061
2.8
0.002
0.1
Jul'
Nov
-1.046
-65.9
-1.064
-65.5
-1.08
-53.7
-1.102
-52.9
0.048
2.2
-0.003
-0.1
Dec
-1.099
-70.6
-1.113
-70.0
-0.871
-42.7
-0.904
-42.8
-0.116
-5.3
-0.175
-7.6
# obs.
77,491
Adj. R2
.556
I
77,491
60,806
60,806
50,636
50,636
0.536
.556
.536
.537
0.522
Appendix 12 (cont.)
30-Year Fixed RJte Refinances
I
2002
I
2001
OLS
IV
Coeff.
I-sIal
Const.
15.621
PPP
I
2000
OLS
IV
OLS
IV
Coeff.
I-sIal
Coeff.
I-sIal
Coeff.
I-sIal
Coeff.
I-sIal
Coeff.
I-sIal
170.2
14.424
141.3
18.302
124.7
16.96
103.4
17.516
123.0
14.84
73.4
0.033
4.8
-0.001
-0.1
0.023
2.7
0.015
1.6
-0.043
-3.6
-0.092
-6.8
FICO'
-0.011
-260.4
-0.012
-254.3
-0.013
-237.4
-0.014
-229.6
-0.012
-147.6
-0.012
-132.6
LTV"
0.009
50.2
0.027
45.4
0.005
18.8
0.023
25.0
-0.004
-12.3
0.037
18.6
on'
0
2.5 I
-0.001
-2.9
0.002
7.0
0.001
5.3
-0.002
-5.7
-0.003
-9.3
Jumbo
-0.231
-28.31
-0.223
-26.4
-0.302
-28.7
-0.289
-26.7
-0.335
-19.2
-0.369
-19.1
Min%'
0.321
27.1
I
0.268
21.7
0.474
33.4
0.443
30.2
0.489
27.7
0.431
21.9
Low
0.139
0.22
33.0
0.174
21.5
0.273
28.5
0.139
11.6
0.371
21.6
No
0.271
23.41
15.4
0.355
19.3
0.535
20.0
0.64
22.9
0.482
10.4
0.768
14.5
Condo
0.084
5.9
0.064
4.4
0.111
5.3
0.104
4.8
0.115
3.5
0.065
1.8
Coop
0.964
10.0
1.064
10.7
0.628
6.4
0.813
8.1
0.815
6.2
1.256
8.5
2-4 unil
0.042
3.3
0.072
5.5
0.109
5.8
0.151
7.8
0.006
0.3
0.065
2.5
TH
0.085
2.2
0.069
1.7
0.144
3.7
0.136
3.4
0.355
9.5
0.31
7.5
PUD
-0.142
-13.6
-0.158
-14.8
-0.118
-8.2
-0.129
-8.7
-0.136
-5.4
-0.178
-6.4
MH
0.477
23.7
0.516
24.8
0.443
19.2
0.481
20.3
0.307
11.7
0.363
12.5
Feb
0.083
5.7
0.075
5.0
-0.321
-17.8
-0.315
-17.0
0.034
1.6
0.046
2.0
Mar
0.044
3.1
0.039
2.7
-0.496
-29.1
-0.493
-28.1
0.133
6.5
0.139
6.1
Apr
0.019
1.4
0.013
1.0
-0.62
-36.3
-0.612
-34.8
0.219
10.0
0.225
9.3
May
-0.019
-1.4
-0.029
-2.0
-0.675
-40.2
-0.662
-38.4
0.27
12.5
0.267
11.2
Jun
-0.128
-9.2
-0.145
-10.1
-0.649
-38.0
-0.638
-36.3
0.371
17.1
0.365
15.3
Jul
-0.249
-18.4
-0.279
-20.0
-0.655
-39.1
-0.645
-37.4
0.384
17.4
0.38
15.5
Aug
-0.441
-33.8
-0.471
-35.0
-0.737
-44.3
-0.737
-43.1
0.337
15.8
0.318
13.4
Sep
-0.527.
-41.7
-0.559
-42.8
-0.832
-46.7
-0.834
-45.6
0.358
16.3
0.343
14.1
Ocl
-0.663
-52.6
-0.692
-53.2
-1.081
-64.1
-1.088
-62.8
0.237
11.3
0.218
9.4
Nov
-0.744
-59.6
-0.771
-59.8
-1.225
-70.9
-1.224
-69.0
0.185
8.8
0.159
6.8
Dec
-0.838
-68.2
-0.854
-67.4
-1.194
-69.2
-1.187
-67.0
0.116
5.5
0.088
3.8
#obs.
141,661
141,661
103,229
103,229
66,538
66,538
Adj. R2
.559
.544
.611
.598
.480
.432
i
The Effebt of Prepayment Penalties on Subprime
I
Borrowers' Decisions to Default:
I
A Perfect Storm
Munpyung 0*
University of California at Santa Barbara
munpyung @econ.ucsb.edu
[Job market paper]
November 16, 2009
Abstract
We present a continuous time option pricing model for mortgage valuation to examine the effdcts of a prepayment penalty on the default and the prepayment decision
of subprime bbrrowers. We show that the options embedded in the mortgage contract
have significaJlt positive values to the mortgage borrower. In particular, the value of the
prepayment option to the subprime mortgage borrower is significant. The prepayment
penalty prevaI'ent in subprime mortgage contracts has two effects on the subprime borrower's mortgkge termination decision: First, the prepayment penalty makes prepayment
or refinancingl difficult. Second, the prepayment penalty increases the likelihood of default by subprime borrowers because it reduces the option values of mortgage contracts.
Because of th1ese two effects, the default decision of the subprime borrower becomes
I
more susceptible
to house price depreciation. Consequently, there was a sharp increase
I
of default in the subprime mortgage market with a drastic house price depreciation in
2006.
JEL classification: 001,021,053
Keywords: Subprim~ mortgages, prepayment penalty, default, option values
I
'
I
"The author wishdI to thank Steve LeRoy, Doug Steigerwald, Cheng-Zhong Qin, and Peter Rupert for their
helpful comments and, advice. The paper has also benefitted from comments received at the UCSB Macrofinance Seminar.
I
I
EXHIBIT
I F
Contents
1
Introduction
2
Mortgage valoation
3
I
5
I
3
Model with orily default option
14
4
Model with bJth options
22
5
Default
6
Model with pJepayment penalty
decisi~n and option values
I
28
36
I
7
Conclusion
I
I
41
I
List of Figures
I
1
2
3
4
5
P(x), M(lr), E(x), and x* with only default option
P(x), M(k), E(x), and Xu with both options . . .
Mortgagb value and equity without option . . . .
Value of :options . . . . . . . . . . . . . . . . . . . . . .
Mortgage value with and without the prepayment penalty
21
27
30
35
40
List of Tables
1
2
3
4
5
6
compaJtive statics analysis of x*, LTV, Yield, and RR
X*, LTV,I Yield, and RR for various value of c and (J .
The change in the default point for different c and (J. . . . . . . .
The valub of options and the mortgages for different c and (J at Xo . . . . .
k;, the upper bound of the prepayment penalty for different values of c and (J
Default points, prepayment points, and option values with the prepayment .
penaltiesl . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..
18
20
26
34
37
38
1 Introdu1tion
We are in the middle of an economy-wide financial crisis with the subprime mortgage market
at the epicenter of lhe crisis. The first sign of trouble was a sudden increase of default in the
subprime mortgagl market with a drastic house price depreciation in 2006. What caused this
I
sudden increase inl default rates in the subprime mortgage market after many years of high
I
prepayment rates?1 This paper is an attempt to answer this question. This is of interest to
academics, policy makers, and the general public.
We present a continuous time version of an option pricing model for mortgage valuation
to examine the effLts of a prepayment penalty on the default and the prepayment decision
of subprime borroLers. Our study shows that a sudden increase of default in the subprime
I
market is caused by the prepayment penalty, that is prevalent in subprime mortgage contracts,
I
along with house price depreciation. These two together have generated a perfect storm in
subprime mortgagb market.
This paper demonstrates that the prepayment penalty has two effects on the subprime
borrower's
mortga~e termination decisions. The prepayment penalty makes prepayment or
I
refinancing prohibitively costly. Equity extraction from house price appreciation is the key
to the subprime mbrtgage design. And this equity extraction from house price appreciation
I
is only possible thtough the prepayment. With a high prepayment penalty, this prepayment
option is not availJble to the subprime mortgage borrowers.
The options embedded in mortgage contracts add economic value to the mortgage borrower since these bptions provide partial protection from the volatility of house prices. In
particular, the valJe of the prepayment option to the subprime mortgage borrower is signif-
3
icant. The prepayment penalty increases the likelihood of default by subprime borrowers
because the penaltt reduces the option values of mortgage contract. By these two effects of
the prepayment pehalty, the subprime borrowers become more vulnerable to default caused
by the house price depreciation. This inability to refinance mortgage loans and the high default point, induced by the prepayment penalty translated into a high rate of mortgage defaults
I
and foreclosures. (Consequently, borrower default began to increase as house price started to
depreciate in 20061
I
I
'
I
I
The paper is organized as follows. In section 2, we consider mortgages as financial assets
I
that generate dividends in the form of the housing services. We characterize a mortgage as
I
a fixed income derivative with two options- default and prepayment. We formulate a general
I
mortgage
valuatio~
model as a stochastic control problem in continuous time and reformu-
late the problem aJI an optimal stopping problem reducing it to a free-boundary problem. We
then derive the Ha6iltonian-Jacobi-Bellman equation for the stochastic control problem. In
section 3, we conJider the simplest case where the mortgage contract only has the default
I
option. We derive hn explicit functional form for optimal default and other important expres-
I
sions related to m6rtgages such as loan to value (LTV) ratio, yield and recovery rate (RR).
I
We also show hoJ optimal default is affected by the parameters. In section 4, we consider
I
the case when the borrowers also have a prepayment option, as this is essential to the analysis
of the subprime Jortgages. In section 5, we investigate the option values embedded in the
mortgage contract to show how these option values affect the default decision of mortgage
borrowers. It turns out that the default and prepayment decisions are both closely related to
I
the value of optiobs. Because one of the distinctive characteristics of subprime mortgages
is the prevalence Jf prepayment penalties, we include the prepayment penalty in section 6.
We analyze how iJs inclusion affects the default decision of subprime borrowers. Section 7
concludes.
I
I
i
I
i
I
I
I
4
I
2 Mortgag~ valuation
I
The most promineJt contractual feature of mortgage loans, compared to other loan contracts,
are the length of mlturity and the possibility of early termination, through either prepayment
or default. A mortlage lender does not just lend money but also gives the borrower the right
and the option to
d~fault or to prepay. Thus the borrower can decide whether to continue the
I
mortgage contract by paying the periodic payment or to terminate the contract by exercising
the given options. This possibility of early termination of the mortgage contract becomes a
serious risk to the I,ender. Quantifying and managing these risks is essential for the mortgage
lender. In this SeeriOn. we present a mortgage valuation model that captures these unique
features of the mOigage contract.
The financial abset,
the house generates housing services, x, as dividends. Housing serI
I
vices can be interpreted as the difference between rental income and other expenses owning
house. We assume1that the housing service follows a geometric Brownian motion with drift.
dx
= ax dt + ax dz,
(1)
I
where a is the grlwth rat~ of housing services, a is the volatility parameter of the housing
services, and dz is the increment of the standard Wiener process. We capture the uncertain future stochastc economic environment or the underlying source of uncertainty by this
stochastic process.
The price of housing equals the expected present value of future housing services.
5
P(x(t)) = lEt
.
[(OO
h~
e-p(r-t)
x(-r) d-r] =
~,
(2)
p-a
where lEt denotes the expectation based on the information as of time t, and p denotes an ex1
.
ogenous discount rlate. We set x(O), the value of housing services at the mortgage origination
date, equal to 1.
We consider the mortgage as a derivative asset whose value is derived from the value of
I
the underlying asset, the house. The price of a house is determined by the housing services
I
.
from equation (2).1 Thus the value of mortgage M(x(t)) is also determined by the housing
services.
Given the hou~ing price in equation (2), the house owner minimizes her mortgage liability by
choosin~ an optimal time to exercise termination options.
maximize her
This is equivalent to
eqUi~y since her equity on housing is the difference between housing price and
I
the mortgage liability. I
E(x(t)) = P(x(t)) - M(x(t))
(3)
We formulate the home owner's problem as a stochastic control problem in continuous
time and reformullte the problem as an optimal stopping problem and reduce the problem
I
to a free-boundal problem. In general, optimal stopping problems are two-dimensional in
the sense that theYI consist of finding the unknown value function and the unknown optimal
boundaries (or unMnown expiration date T) simultaneously; the value function can be seen as
unknlo~n stopping boundaries. We find the solution in reverse order: First, we
find the free-boun~aries of the differential equation. Second, we find the optimal stopping
a function of
level of the state triable, that is, we determine the optimal default point and the optimal
I
I Home
equity is tHe current market value of a house minus the outstanding mortgage balance.
6
prepayment point. IFinally, we solve the initial continuous time stochastic control problem.
We assume that the termination of contract occurs solely for financial considerations. We
denote two threshLds as x** and x*: the default point x**, is the level of housing services
II
where the house owner optimally exercises the default option; prepayment point x* , is the
level of housing sJvices where the house owner optimally exercises the prepayment option. 2
Thus these optionJ are at the money at x** and at x* respectively.
I
I
I
We define the 0ptimal stopping time of default as
T(x**) = inf { t 2:: 0, x(t) :S x** }
and the optimal st0pping time of prepayment as
I
I
T(x*)
= inf { t 2:: 0, x(t) 2:: x*
}
The random time variables T(x**) and T(x*) denote the first passage times that the housing
services x hits thel down-barrier x .. and up-barrier x', respectively. Let's define a random
variable T = T(x~*) 1\ T(x*) as the first time the process x(t) reaches default point x** or
I
prepayment point ~*. Thus T is the optimal stopping time of the mortgage contract, i.e., the
I.
. I termInatIon
. . tIme 0 f mortgage contract.
optIma
I
The home own1er's decision problem is to choose the level of x where she optimally exercises the options ahd terminates the mortgage contract. She has to decide whether the future
expected gain froJ maintaining the mortgage contract will outweigh the loss due to terminatI
is a down bah-ier and x· is a up barrier for this stochastic process. The two barriers are so called
absorbing barriers, sidce the process x is killed as soon as it hits one of the barriers. Therefore, the mortgage is
'k"ock-oul Iyt'" dour b..moe oplio".
2X ••
I
7
ing mortgage contract. Therefore her optimization is with respect to the choice of threshold
I
val ues x*. and x*'1 The home owner is confronted with the following optimization problem.
The principle of optimality implies that E satisfies the Bellman equation.
i
I
E(x
Jx~~~'
{
Ex
+ lEx
[fa
pr
(x(
[e- PT I x(T)
I
i
e-
+ Ex [ e-
pT
c)
= xu] E(x**)
I x(T) ~ x' J E(x')
dx = ax dt + ax dz
sJject to
r) - dr 1
= x** 1
Pr [x(T)
Pr I x(T)
~ x' )
(4)
}
and x(O) = 1,
I
.
where x is a state rariable for this stochastic control problem and E(x) denote the expected
discounted equity ifrom following an optimal policy given the initial state x(O) = 1. Thus,
the equity functioq E(x) is the value function. The first term in equation (4) is the expected
present value of eJuity for the periods before the home owner terminates mortgage contract.
The second term il the expected present value of equity when the home owner defaults. The
last term is the
ex~ectedPresent value of equity when the home owner prepays. E(x) is the
I
sum of three tennl'
I
The default point x** and prepayment point x· are the optimal stopping levels of x. These
I
thresholds or cutoff points Xu and x* separate the whole range of x into three regions: region
I
below xu, region between
Xu
and x*, and the region above x*. The region between x** and
I
.
x* is called inactioh or continuation region where the continuation of payment is optimal and
no option is exercLed. Other two regions, the region below
Xu
and the region above x* are
. I stoppmg
. 9rI th e mortgage termmatIOn
' " regIOn. I n t he regIOn
. bl
.. the
e ow xu, exerclsmg
optIma
3
The advantage
6f this
dynamic programming over the other methods is that it is possible to use this
<loch".;, b.1 ",",l1y tho ,o',,;on i, , nonllno", PDE,
,ppro"h whon Iho ool"",n"
I
I
I
=
8
default option is optimal and in the region above x' exercising prepayment option is optimal
I
for the house owner.
For the continuation region where the home owner doesn't exercise options, i.e., for the
open interval (x** ,Ix*), or for the time periods [0, T), we can make the probability of reaching either threshold arbitrarily small by setting dt sufficiently small.
Thus from equation (4), we have
E(x(tn = lEx
[l~o e- PT (xCr) -
c) d'C]
for x E (x**, x*) .
(5)
Notice that there is no maximization operator on the right hand side since no action is taken,
i.e., no option is exercised in the interval (x** ,x*). In this inaction region, the homeowner
just pays a periodJ payment c and receives the housing services x without exercising any
I
mortgage option.
It follows from 1(5) and from the principle of optimality that
E{x) = (x - c) dt
where
+ e- pdt lEx [E(x') 1
x' is the next period housing services so x'
VxE (Xu ,x*)
(6)
= x + dx. We dropped time t from the
I
equation since this equation is independent from time. The equation holds for all t as far as x
is in (x** ,x*). Thlrefore the value function E(x) is common to all t E [0, T). The current
.
I
state x(t) matters, out the calender date t by itself has no effect.
I
I
The first term on the right-hand side is the immediate net housing service from holding
I
the mortgage contract. The second term constitutes the continuation value of the mortgage
i
.
9
I
I
I
1
I
I
i
holding. The important point here is that the home owner maximizes her equity considering
I
.
not just the immediate payout, net housing service (x - c) dt, but also the future value of eqI
uity lEx [E (x') ] . Therefore, the homeowner's mortgage termination decision depends on the
net housing servicls and on the future expected value of equity.
I
-
I
By expanding the right hand side of (6) we have
E(x) = (x-c)dt
I
+ (l-pdt+O(dt))
lEx [E(x)+dE(x)J,
I
I
where O(dt) is th6 sum of higher-order terms in dt. We omit O(dt) and rearrange terms in
the equation to
ha~e following stochastic differential equation
I
pE(x) dt = (x-c) dt+lE[dE(x)J.
(7)
The left hand side If equation (7) measures the nonnal return that the home owner would reI
.
quire for holding tJ1e house. The right hand side of the equation measures the expected total
return from
of capital
hOldin~ the house, that is, the sum of net housing services and the expected rate
apprecia~ion. This is also the opportunity cost of exercising an option today. Thus,
this equality is thJ return equilibrium condition 4 . These two must be equal, otherwise the
I
mortgage would b~ improperly valued. The equality becomes a no-arbitrary or equilibrium
I
I
condition, expressing the homeowner's willingness to hold the house. s
If we rearrange equation (7), we have
I
pE(x) dt +cdt = x dt +1E[dE(x) J.
41t is also called as1set equilibrium condition
5The equity functi6n E(x) satisfies the stochastic differential equation hy the martingale property.
II
I
I
10
(8)
The left hand side of equation is the marginal cost of holding the mortgage contract and the
right hand side of the equation is the marginal benefit of holding mortgage contract. Thus,
the equation show,s that the marginal cost and the marginal benefit of holding a mortgage
contract should belsame at the optimum.
I
Again we reaJange equation (7), we have
E(x) = ~ [(x-c)
+ ch lE[dE(x)]]
.
The first term of the right hand side of equation is an immediate payout or net dividends from
the house and the second term is its expected rate of capital gain. Therefore the home equity is essentially
te
amount of ownership that has been built up t;>y the holder of mortgage
through the periodic payments and the house price appreciation.
By using Ito's lemma, we can rewrite the the second term of right-hand side in equation
(8) as
IE [dE (x)]
= ax E' (x) dt +! cr 2x2 E" (x) dt.
(9)
I
The expected valu'e of the change of future equity or capital appreciation depends not just
on the trend of hoting services, a, but also the volatility of housing services, cr, that is the
I
. vaIue
I '10 mortgages.
source 0 f optIOn
Substituting this equation (9) into equation (8) leads to the ordinary differential equation 6
(10)
6This equation is k nonconstant (variable) coefficients, nonhomogeneous, second order linear differential
equation. Also this ty~e of differential equation is called a Cauchy-Euler equation.
11
This is the Hamilton-Jacobi-Bellman equation for the above stochastic continuous time dynamic programmihg problem (4). It is the necessary and sufficient condition for the optimum.? The optimll value function E satisfies the equation (10) in the continuation region,
the interval (x** ,
~*
).
.
This second oraer ordinary differential equation has the solution.
E(x)
= elx m] + e2x m2 + p~a -
where
ml, m2
=
~
,
(11 )
y'
-( a-! CT 2 )'I' (a- ~ CT 2 )2+2CT 2p
2
CT 2
are the two roots of the characteristic equation of the differential equation (10).
To complete the solution of this equation we have to specify two free boundaries, E(x**)
I
and E(x*) of the above equation. These two free boundaries, x** and x* are determined by
requiring that E aJd E' be continuous at Xu and x*. These conditions, called value matching
and smooth pastink, reproduce the solution obtained by maximizing equation (4). In a freeboundary probleml, the solution of the differential equation and the domain over which the
differential eqUatiJn must be solved, need to be determined simultaneously.
From the equations (2), (3) and (11), we can derive the explicit mortgage value function
as the difference blrween house price and equity:
M(x)
= P(x) -
E(x)
= -elx m] -
e2x m2 + ~,
(12)
7 This is the stoch~stic analog to a continuous-time Bellman equation. The difference is that the variance
term makes the HJB e~uation a second order ordinary difference equation. while the Bellman equation is first
order.
12
Thus the housei price, the equity, and the economic value of the mortgage are all functions
of the housing service x.
I
13
3
Model with only default option
For this section we Lume that the home owner does not have the prepayment option. When
there is no prepayJent option, the homeowner can terminate the mortgage contract only by
defaulting. Thus thl homeowner has a binary decision problem at every instant. She maximizes her equity 01er the binary choice: terminate the mortgage contract by exercising the
. default option or mrtain the mortgage contract by continuing to pay the periodic payment c.
The equity funcbon E(x) satisfies the Bellman equation
I
i
E(xr =
~Ea: { E(x*)
, (x - c) dt
+ e- pdt IE [E(x') Ixl} ,
(13)
I
I
I
I subject to
dx = ax dt + ox dz
and x(O) = 1,
I
where A = {
exerci~e default option,
sible actions and
pay periodic payment} is the set of home owner's pos-
xl denotes default point when we have only default option. We distinguish
x* with xu, the dJault point when we have both options. Accordingly, we denote the ter-
mination payoff as E(x*) when there is only default option. The first term in the bracket is
the equity when the home owner exercises ,the default option or the termination payoff. The
second term is the lqUity when she does not exercise the option or the payoff when she post-
.. tiiie optIon.
.
pones exerclsmg
Since E(x) is iAcreasing in x, the optimal policy of the home owner is
a* = { exercise default option
pay periodic payment
14
(14)
if x> x* .
The threshold x* separates the whole range of x into two regions: the region below x* and
the region above x*. Therefore x* ::; x(O)
= 1 ::; x*.
For x lower than x*, stopping payment is
optimal and for x higher than x*, continuing payment is optimal. That is, the region below x*
I
is the optimal stopping region and the region above x* is the continuation region.
The solution of equation (13) can be written as
I
E(x) = E(x*)·
~. [0, x.](x) + { (x - c) dt +
.
e-
pdl
IE [E(x') I x J } .:[ (x"oo)(x) ,
(I5)
I
where :[A(X) is an Jndicator function. The first term, E(x*).:[ [0 x ](x)
I
tion region, (x*, 00):. Thus
' •
=0
in the continua-
I
I
~(x) = (x- c) dt
+ e- pdl IE
[E(x') I x J
for (x*, 00) .
(16)
i.
.
' 0 f th'IS equatIon
. .IS
. th
e prevIous
sectIOn,
th
e soIutlOn
A s s h own In
I
We have three unKnowns in this case: two constants of integration, . eJ and
e2
from the
equation, and a f+ boundary, i.e., the unknown default point X,. To detennine these three
unknowns, we need three conditions that E(x) must satisfy.
We have the first condition from the fact the equity can not grow to infinity. Thus the
coefficient
e2
in tJe differential equation should be zero. Otherwise, E(x) is not defined at
I
the large value of x.
Thus when the default option is not exercised, i.e., for x E (x*, 00), or for t E [0, T), the
15
solution of the stochastic Bellman equation (13) is
I
E(x) = ex ml
.
where
m)
+ _x
_ _
p-a
£.
(17)
p
is the negative root associated with the differential equation (10).
To determine tfue remaining two unknowns, the constant of integration e and a free boundary x*, we need tJo more boundary conditions.
The first boundary condition is the value matching condition:
E(. x* ) -- ex*ml
+ p-a
x
- Iic --
0.
(18)
t
This condition implies that the home owner defaults when the housing price equals the mort-
gage value, P{x)
M{x). That is, she defaults when the value of equity on the mortgage
becomes zero, E(.XJ)
to those of the
= O. This condition matches the value of the unknown function E(x) = 0
kn~wn termination payoff function E(x*).
But the boundary x* itself is an
unknown.
The second boundary condition is the smooth pasting condition:
(19)
This boundary condition implies that the value of E(x) and E(x*) should meet tangentially
at the boundary
xl' The value matching and smooth-pasting conditions determine the free
I
I
I
I
I
16
boundary x* that separates the continuation region from the stopping region.
With these boundary conditions (18) and (19), we can get the analytical expression of
I
.
the constant of integration e and the default point x*. That is, we determine the unknown
I
functional form of E (x) and the unknown default point x* from equations (18) and (19) simultaneously.
(20)
I
x*
= (~) [m~;-=-Ia)]
.
(21)
Using equatioL (20) and (21) we draw the house price P(x), the mortgage value M(x),
the equity functioJ E(x), and the default point x.. for specific parameter values in figure (I).
We also derive the analytical expression of the loan to value ratio (LTV), recovery ratio
(RR), and yield as
~unctions of the parameters, a, cr, p, and c. All these variables x*, LTV,
RR, and yield are lndogenouslY determined.
LTV
RR=
= ~Ni = (l + ~ )(p - a) ,
~(i? = [(~) (~)] (l+~)-l
Yield =
M(J)
=c'
where 1=
(l+~)-I
_1_
p-a
xl *
ml _
,
(22)
,
(f.) x-*
p
m1
.
The following table summarizes the comparative statics analysis results and shows how
the endogenous variables, x*, LTV, Yield, and RR are affected by changes in the exogenous
I
parameters c, cr,
'.
a, and p8.
------------4'-----------8These results are
under the conditions, ex > 0, p > 0 and p > ex
til
17
I
.
Table I: Comparative statics analysis of x*, LTV, Yield, and RR
Do x*
Do LTV
Do Yield
Do RR
Doc
(+)
(+ )
(+ )
Do(j
(- )
(- )
(- )
(- )
(+ )
(+ )
(- )
(- )
(?)
(+ )
(+ )
(+ )
(+ )
Doa
Dop
The signs (+) and (-) in the table show the signs of the partial derivatives of endogenous variables withI respect to the parameters. For example, the ( +) sign in first row and first
column in the
tabl~ shows the positive sign of partial derivative, ~ and it can be interpreted
as higher periodic payment c induces higher default point x*. Similarly, the (-) sign in the
table denotes the negative sign of the partial derivatives.
If we substitute equation (9) to (8), we have
~ E(x) dt + cdt = x dt + ax E' (x) dt +! (j2x 2 E" (x) dt .
,
v
,
(23)
lE [dE(x) 1
We can interpret the results of the comparative statics analysis with the equation above.
I
If c increases, the left hand side of equation (23) becomes larger than the right hand side of
the equation, x* sJoUld be higher to equalize the marginal cost and the marginal benefit of
holding mortgageJ implying
.~ > O.
Similarly, if the discount factor p increases, the left
hand side becomeJ greater than the right hand side,so the house owner defaults at higher x*
or defaults more qlicklY implying
~ > O. If a increases, the expected future equity value
that is a part of thl economic value of equity E(x) increases, so the house owner holds the
mortgage longer, i.e., ~ < O. Thus if the house owner predicts future house price appreciation, she defaults at a lower x*, that is, she holds the mortgage longer. Because future
I
expected equity value is higher when (j is large, ~ < O. If the house owner expects volatile
18
future house price movement, she holds mortgage longer. 9 Basically the exogenous parameters c,
(J',
a, and
.
~ affect not just immediate payoff (x - c) dt but also the expected future
I
value of eqUIty lE [dr; (x) ].
Initial mortgagerates in the subprime market are significantly higher than prime mortgage
rates. While this is true for interest rates on fixed-rate mortgages (FRMs), it is also true, contrary to popular beli1f, on teaser rates of hybrid adjustable rate mortgages (ARMs)(Bhardwajy
and Sengupta 200SJ.I For numerical calculation we use c = 1.75 as periodic payment of subI
prime mortgages and c = 1.25 as periodic payment of prime mortgages. Since ~ > 0,
subprime mortgagelbOrrOwer defaults faster than prime mortgage borrower.
I
I
From the equations (21) and (22), we can calculate numerical values of x*, LTV, Yield,
I
and RR for various values of c and
0.07. Given values for parameters,
(J'.
For these calibrations, we assume that a = 0.03, P =
a, (J', p, and c, we can get the numerical values of the
default point x*, LiV' Yield, and RR explicitly. We report this calibration results in table (2).
We are able to confirm the results from our comparative statics analysis with this numerical
exercise.
9In the continuatio~ region. (x., 00), E(x), E'(x), and E"(x) are all positive.
II
!
I
I
19
Ta@le
2: X*, LTV, Yield, and
RR for various value of c and
I
.
I
I
X*
LTV(%)
Yield(%)
RR(%)
= 0.10
c
1.00
1.25
1.50
1.75
2.00
0.500
0.625
0.750
0.875
1.000
57.09
71.10
84.28
95.09
100.00
7.01
7.03
7.12
7.36
8.00
87.59
87.91
88.99
92.02
100.00
X*
LTV(%)
Yield(%)
RR(%)
= 0.15
c
1.00
1.25
1.50
1.75
2.00
0.443
0.554
0.665
0.776
0.887
56.38
69.37
81.04
90.69
97.40
7.10
7.21
7.40
7.72
8.21
78.65
79.91
82.07
85.56
·91.05
x*
LTV(%)
Yield(%)
RR(%)
= 0.20
c
1.00
1.25
1.50
1.75
2.00
0.389
0.487
0.584
0.681
0.779
54.72
66.55
77.06
85.97
92.95
7.31
7.51
7.79
8.14
8.61
71.15
73.13
75.78
79.25
83.76
I
I
(j
I
I
I
I
I
(j
(j
I
20
----
FiJure 1: P(x), M(x), E(x), and x* with only default option
P(x)
.~
If)
Q)
Cl
nI
?0
M(x)
I~
~
U')
~
:x·
0.5
0.6
0.7
0.8
0.9
1.1
x
o
~
E(x)
o
1-----------~~~--------------~-----1
U')
I
0.5
0.6
0.7
0.8
x
21
0.9
1.0
1.1
4
Model with both options
Mortgage contracts are based on the borrower's ability to repay the mortgage loan. In the
prime mortgage clse this ability is based on well documented, proven future income. Thus,
the prime mortgaJe lending is based on borrowers future income. However, the subprime
mortgage design iJ based on the fact that the dominant form of wealth of low-income household is potentially their home equity since the subprime borrowers have a lower income than
the prime borrowers and their ability to repay the mortgage loan is not proven, sometimes
I
not documented ptoperlY. Thus, the subprime mortgages are closely linked to appreciation
of the underlying hsset, the house. No other consumer loan has the contractual feature that
I
I
the borrowers ability to repay is so sensitively linked to appreciation of the underlying asset.
I
The equity extraction from the house price appreciation is the key to the subprime mortgage
I
.
contract design. 1o lAnd this equity extraction from house price appreciation is only possible
through the
borro~er's
prepayment option.
I
Thus, the prepayment option is the integral part
of the subprime mbrtgage design.
If borrowers pFepay the current mortgage contract and move to a lower interest mortgage
contract, they can !pay a smaller periodic payment. This is the prepayment incentive to both
prime and subpriJe mortgage borrowers. Subprime mortgage borrowers have another incen. to prepay mortgage:
I
by th'
.
borrower
tlve
elr cre d"It Improvement, they can step up to pnme
status. Even if thte is no change in interest rate as we assumed here, subprime borrower
I
has an incentive ti prepay. Therefore including prepayment option in our model is crucial to
examine the behalor of subprime borrowers.
In the previoul section we assume that borrowers do not have the prepayment option.
______________~!---J-----------
.
IOWhile equity extr~ction is common in the prime mortgage market, it is even more prevalent in the subprime
mortgage market. Chbmsisengphet and Pennington-Cross (2006) show that a higher proportion of subprime
refinancing involve eq~ity extraction, compared to prime refinancing.
I
22
I
Thus they have only two choices; being current on payment or default and terminate the
mortgage contract. I Therefore if they do not default on the contract, their payment is a perpetuity. This is a
~ery unrealistic assumption,
especially for subprime mortgages. In this
section, the borroJers have three choices on their mortgage contract: pay the periodic payment, default or prlpay. We show how the default point x** is affected by the inclusion of the
prepayment option in the model.
When the opti0ns
are not exercised, i.e., for the continuation region
I
I
solution of the Bellman equation (4) is
X
E (x**,x*), the
I
When we have a prepayment option in the model, both constants of integration e I and e2
are not zero. Thuslwe have four unknowns, the constants of integration of the equation
e"
e2, the default poinf Xu and the prepayment point x*. To determine these four unknowns, we
need four boundarl conditions: the value matching conditions and smooth pasting conditions
at x** and at x* respectively.
.
I
I
The value matching condition at the default point x** is
(24)
23
and the smooth pasting condition at the default point Xu is
E'(x u
)
= O.
(25)
These are the samb conditions for the default point x* in equations (18) and (19).
I
I
The value matlhing condition at the prepayment point x* is
I
I
I
I
M(I)+E(x*)+k p =P(x*).
(26)
I
I
The left hand side of equation is the total cost of exercising prepayment option at x* that
is the sum of M(li), the mortgage value at the origination date and E(x'), the equity at the
prepayment point ~nd kp, the required prepayment penalty. The right hand side of equation
I
(26) is the benefitifrom exercising prepayment option at x*, the housing price P(x*). Thus
the home owner eScercises the prepayment option only when the benefit from exercising it
I
exceeds the total erst of prepayment, that is, when the option is in the money. I I
The smooth pjsting condition at the prepayment point x* is
E'(x*) = p~a
.
(27)
·1 con d'"
. con d
" "lor optima
. I exercise
. 0 f the optIOns
.
Th e smooth pastmg
IlIon IS a necessary
ItlOn
since the default pLnt and prepayment point are free boundaries. It requires M(x) to be tan-
I
gent to x/(p - a) at xu. And also that the slope of E(x) at x* should be equal to the slope of
P(x). Figure (2) sLws that the house price P(x), the mortgage value M(x), the equity func-·
tion E(x), default bOint x**, prepayment point x* and these boundary conditions graphically.
i
wi!1 p~epay only when the value of their mortgages exceed their origination value M{ 1) by at
least k p, I.e., M{x ) =1 M{ I) + kp
.
.
II Borr.owers
L - ._ _ _ _ _ _ _ _ _ _ _
I
I
I
I
I
24
From above folr boundary conditions, we have following system of equations;
(28)
This is a system of four nonlinear equations with four unknowns, el, e2, X**, and x*. The
unknown functionll form of E(x) and the two unknown free boundaries are determined siI
multaneously by these system of equations. Since the system of equation (28) can not be
solved analyticall), we solve this system of equations numerically by the Newton-Raphson
method. 12 We set
b= 0.07 and ex = 0.03 for these numerical calculation. Before we consider
I
the effect of prepayment penalty, we examine the effect of the inclusion of prepayment option
in the model. ThUJ. at this point we set kp = O.
Now we can see the effects of inclusion of prepayment option to the model. The numerical
calculations are
re~orted in table (3) .
. The default pdint, x**, in the model with the prepayment option, is lower than the default point, x*, in
~he model without the prepayment option.
Thus, the house owner holds
the mo;tgage longlr when we include the prepayment option in the model. The difference,
I
(x* - x**), widens las the periodic payment c increases, since the prepayment option is more
valuable to the suoprime mortgages borrower. For example, when c
=
1.75 and
(J
= 0.2, the
percentage changJ in the default point is as high as 11.31 %. The subprime borrowers have
a bigger incentive Ifor prepayment since they are paying a higher periodic payment c. After
prepaying the moJgage, the subprime borrower can step up to a prime mortgage contract by
I
12The error tolerande
for the approximation is 10- 8 . The number of maximum iteration is 105 .
I
I
I
I
I
I
25
Table 3: The change in the default point for different c and
I
c
I
1. 25
(5
I
x*
0.05 0.687
0.10 0.625
0.15 0.554
0.20 0.487
I
x**
0.687
0.620
0.540
0.466
(5
I % change I
0.00
0.80
2.53
4.31
1. 50
0.05
0.10
0.15
0.20
0.824
0.750
0.665
0.584
0.823
0.726
0.627
0.541
0.12
3.20
5.71
7.36
1. 75
0.05
0.10
0.15
0.20
0.962
0.875
0.776
0.681
0.917
0.803
0.696
0.604
4.68
8.23
10.31
11.31
the improvement (i)f her credit rating. The prepayment option is more valuable to the subprime borrowers.IThe higher
(5
(5,
the larger the difference, (x* - x**). When c
= 1.75 and
I
= 0.05, the pereentage change in default point is 4.68% but it is 11.68% when c = 1.75
.
I
and
(5
= 0.20. In the model with only default option, the borrower never prepays since they
do not have that Jption. However, in the model with a prepayment option, the borrower
prepays whenever x ?: 1. In the next section, we investigate why and how the inclusion of
the prepayment
o~tion
in the mortgage contract affects the default decision of the mortgage
borrowers.
26
Figure 2: P(x), M(x), E(x), and x** with both options
I
.
I
sub62.r 2009-11-0714:46
I
o
M
10
N
(/)
Q)
OJ
III
OJ
t·
0
~
~I
10
x
(/)
Q)
o
<=
'::;
0w
o
x
27
5 Default drciSion and option values
In the previous
sec~ions,
we show that the default point x** is greatly affected by the in-
I
clusion of termination options. In this section we investigate how the options embedded in
the mortgage contrLts influence the borrower's mortgage default decision by calculating the
economic values of the options embedded in the mortgage contract explicitly.
We define MO as the mortgage value without termination options, and M{x), the mortgage
II
value with terminat,on options. If there is no termination option in the mortgage contract, the
I
mortgage is a perpetuity. That is, the mortgage is just a fixed income security to the lender.
I
Since the borrower! pays a periodic payment c forever, MO is
~ .. Notice that
this mortgage
value is independedt to the level of housing services x and house price.
I
I
As we showed ih the previous section, the mortgage value with termination options M{x)
is a function of the housing services x. The difference between the mortgage value without
termination option MO and the mortgage value with termination option M{x) is the option
I
value OV{x) embedded in the mortgage contract defined as
I
OV{x) = MO -M{x)
(29)
Since the option has a positive value to the borrower, the mortgage liability M{x) decreases
by the inclusion of lhe options. Rearranging the terms of (29) leads to
I
M{x) = MO - OV{x) .
(30)
When there is onlYla default option, the total option value, OV{x), is just DOV{x), the value
28
of the default option. We denote the mortgage value with the default option, Md (x), as
(31 )
When there are both options, the total option value, OV (x), is the sum of the default option
I
value, DOV(x), and the prepayment option value, POV(x). We denote the mortgage value
I
with both options, MP(x), as
I
I
MP(x)
= MO -
(DOV(x) +POV(X)I) .
(32)
The borrower dJs not want to have a mortgage liability bigger than the market value of
I
house, which would imply negative home equity. That is, a home owner defaults her mortgage contract wheh her home equity becomes zero. Since the home equity is the difference
between the housell price and the mortgage liability, a home owner makes her default decision
by comparing the price of her house and the value of the mortgage. Thus, given the house
price, the home oJner's default decision depends on the mortgage value.
As in equation (30), the mortgage value is the difference between the mortgage value
I
without terminatidn options MO and the option values embedded in the mortgage contract.
Since the mortgagl value without termination options, MO, is given by the specified periodic
I
payment c, the mortgage value depends on the option value OV(x). Thus given c, the periodic
I
payment, the borrdwers default decision is determined by the option values.
To get the nUierical option values, we derive the three different equity functions from
the above three different types of mortgage values.
29
The equity without termination options can be written as
(33)
Figure 3: Mortgage value and equity without option
Fri Sep 2513:28:182009
II>
'"
'"
0
'"
P(x)
II>
N
Q)
Ol
ro
.g>
0
N
0
::<
."0..1i
';!.
0
~
II>
0
II>
~
0
·5
Jf
4---------------__~----~------
II>
I
o
I
II>
I
o
N
I
0.0
0.2
0.4
0.6
0.8
X
1.0
1.2
sub58.r 2009-09-2513:28
Figure (3) shows the mortgage value without options ~ and the equity without options
£o(x). We denote
ko as the level of housing service where the equity without termination
option is zero, i.e., I£o(xo) = O. At xO, the house price, P(x), equals MO, the mortgage value
I
I
30
without terminatio1n options. Thus xO =
x
< xO.
The optioh value depends on
(J,
.
(p~a) c. Notice that EO(x) can be negative if
the volatility of housing service and the housing
price as well as a lnd p. However xO depends on the parameters a and p but not on
. IS
. unre I ate d to thie option.
.
It
(J
since
.
The equity witl'l termination options is the sum of EO(x) and the option values embedded
in mortgage contrJct. From equations (12) and (30), we have
I
I
I
E(x) = EO(x)
+ OV(x)
.
(34)
We denote EP(x) as the equity when borrowers have both the default option and the prepayment option:
(35)
Ed (x) is the equity when borrowers have only the default option.
(36)
The first two plots in figure (4) shows the different mortgage functions MO, M d , and MP,
as well as the threl different equity functions EO, Ed, and EP. The distinction of the above
I
three different equity functions EO, Ed, and EP is critical to measure the values of the default and prepaymJnt options. We can express the option values in terms of equity functions,
EO(x), Ed(x), and EP(x). We derive the explicit expressions for the option values from the
equations (33) - (36).
The value of tHe default option is the difference between the two equity functions Ed (x)
I
31
(37)
= ey/'l' .
The value of the prepayment option is the difference between the two equity functions EP(x)
and Ed(x):
POV(x) = EP(x) -Ed(x)
(38)
The value of both options is the sum of two values.
OV(x) = POV(x) + DOV(x)
(39)
All these option values are functions of
(J
as well as ex and p. Figure (4) shows the
values of these optons. The value of the default option is the vertical distance between the
two equity functiohs Ed (x) and EO(x) (between MO and Md (x)) and the value of prepayment
option is the vertJal distance between the two equity functions E P(x) and Ed (x) (between
Md (x) and MP(x))I. Figure (4) shows the following:
I. As the hOUSilng services, x, increases, the default option value decreases exponentially,
since the prdbability of using the default option decreases as x increases.
I
2. As the housing services, x, increases, the prepayment option value increases since the
If .
. mcreases.
.
pro b ab 1'l'Ity a usmg th e prepayment option
3. As the houst services, x, increases, the total option value decreases. Since the fall of
the default obtion value offsets the increase of the prepayment option value.
I
32
Given parameter values, we can calculate numerical option values from equation (37)(39). Table (4) Shots the calculated values of both options and the mortgage values for di fferent value of c and
(j
at xo. The numbers in the parentheses in the default column and the
prepayment columJ show the option values as a percentage of the total option value. We list
the mortgage valueJ at
I
xo in the last column of the table. In this table, we can see that mort-
gage values are affdcted by changes in the option value. In turn, these changes in mortgage
I
'
value affect the default decision of the borrower. The values of both options increase as
(j
I
increases since the ~ption is a partial protection against the fluctuation of x and p. Thus, the
I
I
higher (j, the largerlthe option values, the smaller mortgage liability, and the lower x**. Thus,
E(T(x**)), the expected optimal stopping time is larger when
rower holds the moJtgage longer on average when
I
if the volatility
(j
(j
is higher. That is, the bor-
is bigger. For example, when c
= 1.75,
irlcreases from 0.05 to 0.2, OV(x), the option value increases from 1.404
to 6.503. The optibn value with
with
(j
(j
(j
= 0.2 is about four times larger than the option value
= 0.05. AccbrdinglY, the mortgage liability of the borrower decreases from 23.596 to
18.497. Thus the bJrrower defaults at x** = 0.604 instead at x** = 0.917. That is, E(T(x**)),
the expected optimJl stopping(default) time is larger. This shows a cascade effect, the default
decision depends
o~ the mortgage value, the mortgage value depends on the option values,
and the option valut depends on the volatility of the housing services. Thus, the default decision depends eXcltivelY on the volatility of housing services and the housing price through
the option values vik the mortgage values.
This table also shows that the inclusion of the prepayment option in mortgage contract
I
'
gives additional value to the mortgage contract. As a result the home owner will choose
to exercise the defJult option at' a lower x, i.e.,
(j
= 0.1, the option value is
Xu
<
X •.
For example, when c = 1.75 and
1.227 and the borrower defaults at x*
= 0.875
when there is no
prepayment option. However, the prepayment option adds 1.984 to the total option value and
33
Table 4: Tihe value of options and the mortgages for different e and
I
c
(J
1.25
0.05
0.10
0.15
0.20
1.50
1.75
I
MP(xU)
x*
x**
0.7 14
0.687
0.625
0.554
0.487
0.687
0.620
0.540
0.466
default (%)
0.255 (100.0)
0.877 (89.9)
1.662 (81.4)
2.506 (79.0)
0.824
0.750
0.665
0.584
0.823
0.726
0.627
0.541
0.306 (90.6)
1.052 (65.5)
1.994 (64.2)
3.007 (66.4)
0.032 (9.4)
0.555 (34.5)
1.110 (35.8)
1.523 (33.6)
0.339
1.607
3.104
4.530
21.090
19.822
18.324
16.899
0.962
0.875
0.776
0.681
0.917
0.803
0.696
0.604
0.358 (25.5)
1.227 (38.2)
2.327 (47.2)
3.508 (53.9)
1.046 (74.5)
1.984 (61.8)
2.603 (52.8)
2.995 (46.1)
1.404
3.211
4.930
6.503
23.596
21.789
20.070
18.497
0.8~7
I
I
0.05
0.10
0.15
0.20
at xo
XO
I
0.05
0.10
0.15
0.20
option values
prepayment(% )
~ 0 (0.00)
0.099 (10.1)
0.381 (18.6)
0.667 (21.0)
(J
I
o
I.°r
both
0.255
0.976
2.043
3.173
17.602
16.880
15.814
14.685
the borrower defaLs at the lower x .. = 0.803. The existence of the prepayment option af-
I
.
fects the value of mortgages even if interest rates are taken to be nonstochastic and constant,
as is the case here.
As we have mentioned, the equity extraction is very important for subprime borrowers
and that equity
ext~action is possible only through prepayment. Thus, this prepayment option
v.alue is prominen! in the subprime mortgage case. Table 4 shows this fact clearly. When
e = 1.25 and
(J
= 0.1 the prepayment option value is only 0.099 that is 10.1 % of the total op-
tion value. But Wh1en e = 1.75 and
(J
= 0.1, the prepayment option value is 1.984, or 61.8%
of the total option ivalue. Thus in the subprime mortgage case, the prepayment option adds a
. significant value to the mortgage.
34
Figure 4: Value of options
subS7.r 2009-10-02 11 :44
ex:>
N
CD
N
"
N
(/)
Q)
Cl
'"
N
N
Cl
1:
0
:=
0
N
ex:>
~
;!
:0.626 :0.665
'0.857
:x··
:x
0.6'
:x·
. 0.7
0.9
0.8
1;0
ex:>
1.1
EP(x)
"
Ed(x)
CD
EO(x)
"
(/)
Q)
N
:;:
'5
0-
W
0
N
I
"
I
CD
I
0.6:
: 0.7
0.8
0.9
1:0
1.1
;!
N
0
~
(/)
Q)
:J
(ij
ex:>
>
c:
0
E.
CD
0
"
- --
N
"-
0
~
0.6
-- - - -
OV
POV
DOV
-:-
0.7
0.8
0.9
x
35
1.0
1.1
6
Model wi,th prepayment penalty
Subprime borrowJ are protected from large losses from decreases in property values because of
th~ default option and the low level of their equity.
I
With the default option, they
.
have a limited liability instead of a unlimited liability for the loan. This means that when a
I
bad event occurs, like a drastic housing price depreciation, they can exercise the default op-
pu~oses. But lenders, on the other hand, are subjected to big default losses
if house values dro~. When house prices rise, borrowers can prepay and extract the accution for hedging
I
mulated equity
fro~
I
the appreciation. They can use the prepayment option for speculation
I
purposes as usual 1ption exercising practice. As shown in the previous section, the prepayment option gives
a: substantial economic value to the subprime mortgage borrower.
But due
to the prepayment bption, lenders are unlikely to benefit from any gains if the house prices
rise. For the lender the prepayment option given to the borrower becomes an another source
of risk, prepayment risk, associated with the early unscheduled return of principal. Therefore, lenders are liJelY to lose money whether house prices increase or decrease, as lenders
I
are subject to two risks: default risk and prepayment risk.
Because of default risk, lenders require very large periodic payments for subprime mortgage borrowers. In order to mitigate the prepayment risk, subprime lenders typically include
prepayment penalti1es or fees as part of the mortgage contract. One of the distinctive characteristics of subprirrie mortgages, relative to the prime mortgages, is the size and prevalence
of the prepayment Jenalties. 13 These penalties are seldom imposed in the conventional mortgage market. FroJ an economic standpoint, prepayment penalties can be thought as a premium added to mohgages to compensate the lender for the supposedly high prepayment risk
I
generated by the subprime loan. The lender uses prepayment penalties to prevent prepayment
I
13S ee . e.g .• Farris and Richardson (2004). Fannie Mae estimates that 80 percent of subprime mortgages have
prepayment penalties. ~hile only two percent of prime mortgages have prepayment penalties (see Zigas. Parry.
and Weech (2002». I
I
I
I
36
and to offset lossd from prepayment. Thus subprime mortgages typically have significantly
higher periodic
case they are
pa~ments and higher prepayment penalties than prime mortgages, in which
typic~llY zero.
If there is no J?repayment penalty or fee, a house owner could make a profit out of the
mortgage contract by prepaying the mortgage whenever x is higher than 1. In this section,
we include a
posit~ve
prepayment penalty, kp > 0, to avoid this unrealistic prediction of the
model. Thus, the shbprime mortgage lenders impose positive penalties on prepayments.
I
However, thJ is a maximum prepayment penally
I
k; that the lender can impose to the
borrowers. The boh-ower prepays only when the total cost of prepayment, M (1)
than the benefit frdm prepayment, M(x*).14 Thus, M(I)
of M(x*) is
~, the hpper limit for kp is
+ kp
+ kp, is less
-:; M(x*). Since the maximum
(40)
If k; > ~ - M( 1), the borrower would never prepay (x* = 00). The table (5) shows the upper
limit values of kp f1r different values of c and
(J.
I
I
Table 5:
k;, the' iupper bound of the prepayment penalty for different values of c and
I c
11.25
11.50
11.75
I
(J
= 0.05 I (J = 0.10
0.000
0.006
0.358
0.083
0.358
1.227
I
(J
= 0.15
0.518
1.169
2.327
I
(J
= 0.20
(J
I
1.221
2.163
3.508
To examine the effect of the prepayment penalty on the borrowers mortgage termination
decisions, we solvi the system of equations (29) numerically and report the optimal default
14 M( I) = M(x(O)) i~ the origination value of the mortgage, i.e., the initial mortgage value at t
I
book value of the mortgage.
I
I
I
I
I
37
= O.
It is the
points xu, the optimal prepayment points x*, and the option values for the different periodic
payment c and the brepayment penalty kp in table (6). The bold numbers in the second column of the table sh1ws the the upper bound of kp for different values of c. Figure (5) shows
that the mortgage
f~nctions M(x), with and without the prepayment penalty, when c = 1.75
and cr = 0.15. As Jhown in the table and the figure, the prepayment penalty affects both on
prepayment deciSior and also on
defaultdecisi~n.
.
I
Table 6: Default po~nts, prepayment points, and option values with the prepayment penalties
,
I
I
c
1.25
I
Kp
,
0.'000
Oh50
0.1500
O~518
0.000
0.'250
I
0.1500
Oh50
1.75
l.boo
Ih50
1.1500
1.[750
2.'000
2h50
2.!327
I
xU
0.714
0.714
0.714
0.714
1.000
1.000
1.000
1.000
l.000
l.000
l.000
1.000
1.000
1.000
1.000
I
I
x*
0.554
0.554
0.554
0.554
0.776
0.776
0.776
0.776
0.776
0.776
0.776
0.776
0.776
0.776
0.776
I
x**
x*
0.540
0.552
0.554
0.554
0.696
0.730
0.742
0.752
0.759
0.764
0.769
0.772
0.774
0.776
l.000
1.157
l.250
l.343
1.445
1.565
1.719
1.939
2.322
3.599
0~776
00
1.000
l.475
3.514
00
I
DOV
1.662
1.662
1.662
1.662
2.327
2.327
2.327
2.327
2.327
2.327
2.327
2.327
2.327
2.327
2.327
I POV I ov I
0.381
0.052
0.001
0.000
2.603
l.344
0.930
0.656
0.456
0.304
0.188
0.100
0.039
0.004
0.000
2.043
l.714
l.663
l.662
4.930
3.671
3.257
2.983
2.782
2.630
2.514
2.427
2.366
2.331
2.327
First, we considlr the effect of the prepayment penalty kp on the borrower's prepayment
decision. When
the~e is a positive penalty, the borrowers do not prepay right away at x* = I,
i.e., the prepaymenJ point is higher than 1, i.e., x*
> 1.
Also the table shows that the bigger
the penalty kp is, thk higher x* is. For example, when c = 1.75, without prepayment penalty
(k p
= 0), the borro)er prepays her loan at x =
the higher x, i.e., at! x
=
1.25 and at x
1. But with kp
= 2.322 with kp = 2.
= 0.5, the borrower prepays at
The borrowers hold mortgages
longer and prepay al the higher x since the high prepayment penalty implies the high price of
38
the prepayment. Tnerefore, the prepayment penalties are effective deterrents of prepayment.
Imposing the prepatment penalty on the subprime mortgage makes refinancing difficult. The
table also shows thJt the value of prepayment option is reduced by the increase of the prepay-
I
ment penalty. Particularly for the subprime mortgage, the reduction of prepayment option
I
I
value by the prepayment penalty is drastic. For example, if the lender impose the penalty
I
kp
=
1 when c
=
IrS,
the prepayment option value decreases by 2.147, which is more than
two years worth ofl the housing services. If the lender imposes the maximum prepayment
penalty
k;, the prepayment option value disappears completely and the total option value
is just the default obtion value. The prepayment is not an available option anymore for the
borrower since it iJ prohibitively costly. The borrower is trapped in the mortgage contract
I
with a high periodib payment. Thus, the mortgage contract with
ment penalty is
a~ extremely high prepay-
th~ same as the mortgage contract without the prepayment option.
the prepayment dols not happen, i.e., x*
=
00.
Thus,
Refinancing is not possible for the subprime
borrowers.
The prepayment penalty affects not only the prepayment decision but also the default decision. Table (6) shbws the effect of the prepayment penalty, kp on the default point, xu: The
higher kp is, the hiJher Xu is. This is because the value of the mortgage depends on not only
I
the value of defauli option but also on the value of the prepayment option. When the preI
payment penalty is Ibig, the value of prepayment is small, and so is the mortgage value. The
prepayment penalt)l takes the value of prepayment option away from the mortgage borrowers. This reduction iOf the option value induced by the penalty affects the default decision of
the subprime borrowers. Thus, borrowers default more quickly or at the higher default point
when the prepaymelt penalty is large. That is, the expected optimal default time, E (T (xu) )
becomes smaller. Fbr instance, when c is 1.75, where kp is 0.5, the option value is 3.257 and
I
when kp is 2, the 0ton value is 2.366. Accordingly, for kp
I
I
I
39
~ 0.5 and 2, the default points are
Figure 5: Mortgage value with and without the prepayment penalty
..
o
PIx)
M(x) with c=1.7S, k,=l
o
N
,,
,,,
M(x) with c=1.7S, k,=O
,
M(x) with c=1.2S, k,=O
,
,,
,,,
,
,
:
,
,
:
I
0
1
0.540
0.696 0.759
0.6
1.445
0.8
1.0
1.2
1.4
I
I
0.742 and 0.774 re!pectiveI Y. Figure (5) shows that the loans with prepayment penalties are
significantly more likely to default than those without prepayment penalties. When c = 1.25
I
without the penaltyl which we consider being as the prime mortgage, the default point is as
low as 0,540 and fdr the subprime mortgage, c = 1.75 with the penalty kp = I, x** is 0.759.
The difference is as large as 0.219. 15 As kp increases, Xu converges to the x*. Thus, at k;, the
default point in the model with prepayment option is same as the default point in the model
without the prepayment option, i.e., x** = x*.
For the financially distressed subprime borrower, defaulting is an optimal choice when
the prepayment peJalty, the cost of prepayment, is high relative to the cost of default. In
this sense, the defahlt option is a substitute to the prepayment option. When house prices
I
rise, subprime borrbwers can accumulate home equity from the price appreciation. Thus,
I
t5Roberto G, Querci~,I Michael A, Stegman, and Walter R. Davis (2007) showed that, controlling for other
risk factors, the odds ofl foreclosure for loans with prepayment penalties were about 20 percent higher than for
loans without prepaym9nt penalties,
. .
I
40
..
-------------------,-----------------------------------------------------------------------,
a financially distreJsed borrower could avoid default by prepaying the loan even if there is
I
a prepayment penalty. Hence there was a sustained high prepayment rates of the subprime
mortgages in the
fi~st part of this decade.
16
However, the prepayment option is no longer
available when priJes depreciate since the optimal prepayment point x* with 'a positive preI
payment penalty is lalways above 1. Prepaying at 1 or below 1 is not an optimal prepayment
decision as shown in table (6) and figure (5). Thus, the subprime borrowers can be trapped
in the mortgage coJtract with high periodic payment. Also the default point of the subprime
borrower is higher !With a positive prepayment penalty. This high default point makes the
I
'
subprime borrower (muCh more vulnerable to the price depreciation. Therefore, this inability
to refinance the mottgage loans and the high default point induced by the prepayment penalty
I
translated into the high rate of mortgage defaults and foreclosures. Consequently, borrower
I
default began to indrease as house price started to depreciate in 2006.
7
Conclusion
We characterize tJ mortgage as a fixed income security with two options, the default option
and the prepaymenJ option. By transforming this characterization of mortgages into the optiI
mal stopping time framework, we are able to examine the effects of prepayment penalties on
I
the termination decision of subprime borrowers.
We identify two effects of the prepayment penalty on subprime borrowers' mortgage termination decisions. One is that a high prepayment penalty deters the prepayment. As shown
in the model, the prepayment penalty makes the optimal prepayment point higher. In other
I
.
words, it makes refinancing more difficult. The prepayment penalty affects not only the preI
16The prepayment rate of the fixed rate mortgages up to five years after the origination dates are 50%, 55%,
60%, 68%, 70% in yeJrs 1998, 1999, 2000, 200 I, 2002, 2003 respectively. The prepayment rate of the adjustable mortgage rateslare much higher than these numbers.
I
I
I
I
I
I
41
payment decision btlt also the default decision of subprime borrowers. The options embedded
in the mortgage coJtracts add economic values to the mortgage contracts since these options
provide a partial prbtection from the volatility of the house prices. In particular, the value
of the prepayment dption to the subprime mortgage borrower is significant. The prepayment
penalty increases t t likelihood of default by subprime borrowers because the penalty re-
I
duces the option values of the mortgage contracts.
By these two effects of prepayment penalty on mortgage termination decision, the default
I
decision of the
bo~ower
becomes more susceptible to the house price depreciation. When
I
house price depredates, the subprime borrowers are trapped in the mortgage contract with
high periodic paymJnts. Thus, financially distressed borrowers have only one option: default.
With an enough hote price fall, even if subprime borrowers are not financially distressed,
defaulting becomes an optimal decision.
The existence of the prepayment penalty in subprime mortgage contract amplifies the
I
effect of housing price decline on mortgage default. This is the one of the reason why there
I
was a sharp increase of the default and foreclose rates in the subprime mortgage market after
I
2006.
42
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I
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under Optimal Prepayment," Review of Financial Studies, 1996,
9 (3), 817-44'i
Lin, X. Sheldon, 'IDouble barrier hitting time distributions with applications to exotic options," Insurance: Mathematics and Economics, 1998,23 (1), 45 - 58.
I
McDonald,
Rober~
.
and Daniel Siegel, "The Value of Waiting to Invest," The Quarterly
I
Journal of Ec6nomics,
1986,101 (4),707-728.
I
Merton, Robert
c.t "Theory of Rational Option Pricing," Bell Journal of Economics, Spring
I
1973,4 (1),141-183.
I
I
- _ , "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of
Finance, 1974[29,449-470.
I
I
Peskir, Goran and IAlbert Shiryaev, Optimal Stopping and Free-Boundary Problems (Lectures in Mathe,matics. ETH Zurich), Birkhauser Basel, September 2006.
I
Quercia, Roberto G., Michael A. Stegman, and Walter R. Davis, "The Impact of PredaI
tory Loan
Ten~s on Subprime Foreclosures: The Special Case of Prepayment Penalties
and Balloon plyments," Housing Policy Debate, 2007,18,311-346.
Sodal, Sigbjorn, ,,) simplified exposition of smooth pasting," Economics Letters, February
1998, 58 (2), 2117-223.
45
,-'
-
Indymac Bank
Agency Conforming Products - Wholesale
*** No Adjustment for FastForward***
Effective:
1212012006
e-MITS Help Desk:
311 LIBOR ARM 511 LlBOR ARM
5/2/5 caps
2/216 Caps I
2.25 Margin
I
lit:
(2.58~!
I
(2.l17)
(2281)
(2241)
(2.097)
(1.954)
(1.831)
(1.706)
(1.529)
(1.352)
(1.164)
(0.975)
t
JO
IKate
7.375
7.2SU
7.125
7.000
6.875
6.7SU
6.625
6.500
6.375
6.2SU
6.125
6.000
5.875
5.7SU
6:59AM
2.25 Margin
;so lit:
(3.~~~!
(2.915)
(2.740)
(2.565)
(2.407)
(2.247)
(2.053)
(1.857)
(1.593)
(1.328)
(1.047)
(0.763)
(0.429)
(0.094)
. (O.83~l
(0.371
Ixed
e-MITS Only. Lock Hours: 7:00AM· 8:00PM PST
7/1 UBORARM 10/1 LlBOR ARM
51215 Caps
512J5 Caps
2.25 Margin
2.25 Margin
JOUR;
3D lit:
(2.92~!
(2.73l)
(2.55l)
(2.l74)
(2.222)
(2.071)
(1.920)
(1.765)
(1.554)
(1.341)
(1.115)
(0.887)
l?·7~l
0.578
www.lndymacb2b.com
.'
1.a88·56e-MITS
:~:~:
(2.086)
(1.850)
(1.612)
(1.317)
(1.021)
(0.687)
(0.350)
0.080
0.510 .'
Prtc& AdJuslmen
I
I
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, "",. ,,,. -.'"
0.500
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(3.5&4)
(l.356)
(l.O98)
(l.071)
(2.827)
(2.550)
(2.230)
(1.881)
(1.565)
(1.197)
(0.789)
(0.332)
0.195
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(2.793)
(2.554)
(2.285)
I
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va
(2.2m
(2.020)
(1.729)
(1.395)
(0.924)
(0.593)
(0.211)
0.212
0.799
1.508
0.000
Condo· California
0.000
0.2SU
0.7SU
0.000
Primary Residence Purchase. 1 unll. LTV >90'1'0
Primary Resldenca Purdlase. 2 unll. LTV >90'1'0
Non..owner Fees· Purchasel No Ca!lh Ruti
LTV 01075'1'0
LTV >75'1'0 saO'll>
LTV >80'1'0 S90'll>
30 Year FRM
ARM Ad ustments
1001UBOR Max rice 101.SU All other ARM"s 102.00
Prtce AdJu.lmen
MaXImum Price • 10J.00
Fp!dFgrwprd IAdditfgnpl GuldelinO BctddGttg"p May Appl>d
30 Year FRM
!~.91~!
(l.692)
(l.455)
(l.202)
(l.4n)
(l.242)
(2.974)
(2.681)
(2.427)
(2.146)
(1.829)
(1.479)
(1.111)
(0.756)
(2.712)
(2.480)
(2284)
d us m n s
15 Year FRM
).4 Units
0.7SU
0.250
0.000
O.2SU
0.250
0.500
0.750
LTV >80% S90%
1.500
2.000
2.500
7512015
60115/5 or 90/515
0.000
0.2SU
0.250
LTV>75%~%
Cash Out Rofi. Non:OwD!r Oscupl,d 1..2 UnUIi
LTVO-70%
LTV >70% $15%
'
LTV>75~80%
LTV >80'1'0
a
0
-
0
0.500
0.7SU
1.500
2.000
2.500
3.250
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Occu lad
LTV $10%
•
cu 10
0
1.500
2.000
2.500
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1.500
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0.125
1.000
FICO 679-620
FICO < 620
t
FICO 679-e20
FICO <620
0.250
I
0.2SU
0.250
1.000
ARM Guidelines
Residence on
Stated Doc: I-UnIUP"
0
LTV> 75% with subordinate nnanclng
LTV > 90'1'0
I.SUO
C/Purposo
010. 2nd. Pun:hlRT
010. 2nd. PurchIRT
L
ARMIFRM Stat. Adjustments
~~~~r~I~-;~AL=.~AR~.M5~.~N~D~.~TX~.~WV~~~________________- i ~OIO.Pu~T
roer 2
IN. LA. MI. NC. OH. OK. SC. TN
N/OIO. PurchlRT
nFICO
620
660
680
1-~~::;:::r..:3:...........;:AK==•..:D:;E:;.';;GFA.:.,:IA;";':,:I;;D;.:'KS,::;::'.:.;t<Y';;';,:M~N;.~M~T.:,;'N:.;:E;;:.,:.N;:,:M,;;.•.:,P..
A.:,:S;;D:....._-t All Cash out
nor 4
CO. CT. FL.IL. ME. MD. MO. NH. NJ. NY. OR. RI. VA
All Cash out
WA. WI. W'(
rvp Doc ype
I
~___~~r~5~~~AZ=.~CA.~~DC~.Hil~.M~A.~NV~.U~T~.~VT~~~'-~~'-~~i).4 ~
Dan S a
<$SU.OOO
$50.001- $100.000
$100001· 150000
$150.001· $175.000
>.$175001
0.375
0.375
0.500
0.500)
or
.87
lOr
.000
1.125
1. 50
0.500
0.2SU
o.J75
0.375)
0.625
0.125
0.250
0.375
0.750
0.000
0.125
O.2SU)
0.875
0.125
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LTV $15%
720
..-;.;;;.;;..;;.;------------R::'a~te~lo=ck~P::'rI-:'ca.;;v~A~d:i-u..:.~tm;...-n~t.-.....r.--....;.;~----I
P.
BOI' Efforta
150a
450 a
60 Days
Refer to .... MITS
for Rat. Lock
Ad ustmonts
I
Wholesale Lending
I
Eye tD Eye Service
Only 'rDm ClliMortgage
l
cffimortgage
EHectlva Oate and TIme: Tue Mar 06
I
DB.3D.00 CST 2007
Spotlight
Broker Northern CA
'Registr.Uon Phone: (Bn) 381-3827
Registration Fa.: (B66) 311~
FLOAT ONlY BEl'M:EN 8:00AM and
8:30 AM CST
Web
s~:
h11PS:tlbrpkm ghmpdgagn com
Explore These Changes to Our Expanded Lending Rate Sheet
II
- Pricing for LTV is now down to 65%
- Adjustor Changes for: High-Rise Condo, 2 - 4 Family, Second Home & Non-Owner Occupied
Look for mo~e exciting changes to
I Vail
ClUJ
ou~ Expanded Lending product guidelines in the coming days.
WIIb Site •• bUps/lbm!!! '"i!l!O!1!!app Blm Dr can'aoI YD"r Aacaunl ex"".,..,. ,.... dd ...... d.,.....
.
FIXEO RAlE PROOUCTS
ConfoJflllng P,ogl,lIns
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30 Year FRr.l ~ 10
~
0.750
88'S
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8.375
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5.750
5875
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5.375
(2.398)
('1178)
(1885)
(1.4113)
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2.094
(2293)
(7.077)
(1719)
(1,393)
(1.158)
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8.750
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5.875
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EXHIBIT
,
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TO~""""""''''''''''''~'''''' __ IN~'''''' __ '''''''''''""",o.-. L __ _
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~~~...:='=::~;~~n=.=:::.~:&-\IItJ
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I0 ..... " ' . . . . . . . . . . . . . . . . . _
.
i
H
Broker Northem CA
Wholesale Lending
"Registration Phone: (8n) 381-3827
Regislnlllon Fax: (866) 311-6608
effi mortgage
Eye to Eye Service
Only from CitIMc"t~laQe',
FlOATONI.Y BE'lWfEN 8:110 AM ond
8:30 AM CST
WJb Situ: MIR§'/lbrpkor aU,mogi'98 woo
ALL PURCHASES IS Sl1LL .25l1o. REFER TO OUR NORlliERN CAUFORNJA WEEKLY UPOATE FOR LOCK DELIVERY
6 r.10fl1fl TlNsu,V
1 YeiJr Treasury
1 VeJf LIBOR
~.1.1'gln.
r,1JIgm. 2.750 Caps: 21216InCle1.: 5.050
1.131IJIO' 2.;!SO CilPS: 212,16 tm1(!A: 5.330
2.750 Caps: 1'115 In<'CA: 4.950
~
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8.875
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8.525
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6115
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0.141
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(2.382)
(2.073)
(1 81 8)
("'98)
(1.299)
(1.0m
(0775)
(0.375)
(0.011)
0.288
8.7SO
8.825
8.500
8315
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8.125
80D0
5.875
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5.525
(2.832)
(2.436)
(2.12')
(1393)
(10117)
(D US)
(0.280)
0157
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(2.364)
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('.337)
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0.1117
o S38
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(1735)
8250
B125
8000
5.B75
5.750
5.815
5.500
5376
5.250
51:>5
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(0.7<8)
(0.559)
(0357)
(015))
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(0.527)
(0330)
(0.130)
0307
0.536
0777
0319
0542
0170
D._
....
llt:I2IIrt
8.2SO
6125
8000
5875
5.7SO
5.825
5.5011
5.375
5.250
5.125
(1.256)
(
)
(0.817)
(0505)
(0.2<8)
(0.027)
0.269
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(2.33D)
(2036)
(17m
(. 475)
(1.281)
(1.053)
(07'8)
(0.342)
0.014
0.318
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( •.V70)
(1.717)
(1470)
(1231)
( •.009)
(0707)
(0.309)
0.043
0.342
6.750
B625
8500
6375
8.250
8.125
B.OOO
5.675
5.7SO
5.825
(2.104)
(1810)
(1.IiSO)
(1214)
(1.022)
(0.793)
(0.488)
(0.082)
0.266
D._
4,750
4.625
llt:I2IIrt
0 ...
. 0'18
0.578
0.641
1.112
13B5
1.595
un
2.040
2.270
7.000
6.875
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8.825
8.500
6.375
6.250
6175
8.000
5.875
§lY2Dx
~
('no)
(2645)
(2.323)
(2.25')
(2011)
(1947)
(. B73) . (1583)
(1258)
(1.3'2)
(0.968)
(1.0'7)
(0671) .
(0664)
(0.200)
(0.181)
07,g
0'18
o GO?
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tI!lIa.BIIl§
675D
8.&26
8500
B.375
82SO
8125
BOOO
5.875
5750
5825
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(1059)
(0.819)
(0640)
(0470)
(028')
(0 OS2)
0.1:18
8.250
0.125
6.000
5.875
5750
6.625
5.500
0]S5
0.S64
0820
0388
0589
0870
5750
5175
~
D.754
0773
0807
0906
1.171
1.442
o.m
0897
1.187
1.1.711
1.836
2.218
2.291
2.826
171'
1.923
2200
2.366
2.598
~
om
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0014
1.164
1.480
1737
1.951
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(2.041)
(1.955)
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1.018
1.328
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(1.488)
(1.188)
(0,970)
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(0.046)
0.319
0.B19
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('555)
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(1.854)
(1.467)
(1.138)
(11837)
(0480)
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0430
0816
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(1.599)
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6375
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(0.969)
(0.189)
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(0388)
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0054
0300
0578
0179
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(0.926)
(0.7.')
(0556)
(03511)
(0.155)
0071
0311
0533
0780
~
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(0931)
(0.709)
(0.402)
(0161)
0053
0.344
o.no
1.D8'
1.364
tI!i!I..BD llt:I2IIrt
~
HrIIa.BaIa
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(1641)
(1.387)
(109')
(0.902)
(0.678)
(11.316)
0.021
0.373
0673
7.375
7.250
7.125
7.000
6.875
6.7SO
8.625
8.500
6.375
8750
(2368)
(1.996)
(1877)
(129')
(1.003)
(0708)
(0338)
0.117
0577
0908
6.875
6750
8.625
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8375
8.250
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5.75D
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(1647)
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('.560)
(. 5B5)
('.351)
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l!!im!!!I
J!IWllIZ
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D4iD1J1l8
07J1l1/OB
10101108
311 ARM
04101/10
07101110
10101110
un
2.405
2.640
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(3521)
(2.873)
(2.571)
(2.677)
(2.317)
(2.030)
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(1715)
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(3.'29)
(2.165)
(2.489)
(2.600)
(2.245)
(1.983)
(1.668)
(1.364)
('.163)
IimAJlIIIg
1.375
7.250
7.125
7.000
8.875
8.750
8625
5.500
5375
B150
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(4264)
(3.381)
(3."5)
(3.189)
(2698)
(23'6)
(1.970)
(1561)
(1773)
iII!:.Qn
(04&4)
(4.'86)
(3.300)
(2.958)
(3.067)
(262')
(2''')
(1.904)
(. 498)
(1187)
I/lUBaIa llt:I2IIrt
5.000
5.875
5.7SO
5625
5.500
5.375
5.250
5.125
5.000
4.875
0.232
0.57'
0.93'
',1.5
1.231
IIIOS
1.l1li7
2.510
2.na
3.131
~
0.54B
D._
1.258
1175
1.568
1941
2.342
2.9DD
3.113
3.522
..
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............. ...,.E.... '-~HmI.E. . '
•
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(2230)
(1.993)
(1.743)
(1.518)
(1.573)
(1.334)
(1.121)
(0.644)
(0.510)
(0.301)
~
(2.'54)
(1.922)
(1.878)
(1.458)
(1518)
(1204)
(1.077)
(O.8D4)
(0.476)
(0.271)
~
(3.624)
(3.351)
(2.734)
(2.433)
(2.513)
(2.213)
(1.927)
(1.627)
(1.351)
(1 '45)
~
(3.527)
(3.259)
(2.648)
(2.352)
(2.'S7)
(2.142)
(1.881)
(1.587)
(1.298)
(1095)
~
(4 "1)
(•. 106)
(3.246)
(2.899)
(3.056)
(2.58$)
(2203)
('.658)
(1"0)
(1"3)
~
(. 310)
('.012)
(3.158)
(2.B14)
(2.075)
(2.510)
(2133)
(1.794)
(1390)
(1.069)
FHAIVA 311 ARI.1
nJIO,n: 2 000 C.ps: 1/115 Index: 5 050
QlaIi/IIZ
...
0826
r.1'119111: 2 250 CiJPs: 5/2/5 Ind~ ... : 5.330
IiIWIIX
EmdIIs1
d~
0574
~
(1.095)
(0.866)
(0.691)
(O.S06)
(0310)
(0.107)
0.118
o ]SO
0579
0826
Fw.1A 1011110 LIBOR
Purchasod by
. . . . , . _ _ .~ . . . f . . . . . _ _ _ _ _
~
(1.142)
(0.908)
(o.nS)
(0.538)
(0331)
(0.12B)
0102
O.:I4B
r.1afu1n: 2.250 C;Jps: 5/~/5 Indejll' 5.330
~
(2443)
(2.068)
(1.742)
(1.350)
(1.D57)
(0757)
(0.380)
0.078
0094
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(2479)
(2.109)
(1.788)
(1.400)
('.D81)
(0.788)
(0."4)
0.039
0'65
0648
... yCll,l_,.__ .. "' •..,.•.
I
(1.B32)
(1.8$1)
(un)
(1.692)
(1.813)
(1.533)
(1 .•53)
(13n)
FW..1A 711 110 USOR
~
(2.000)
(17D8)
(1 ... 7)
(1.147)
(0.952)
(O.m)
(0.417)
(0.013)
0.344
0849
»Dn
tI!i!I..BD .t.:i:.Iliu
TD........a.tcIft ...................... 'jIDW . . . . . . . . . . . ~ . . . . . . _'II'lIINfII. . . . ~Dn:IU"
(32090441131) .. 10110
~
FNr.1A 5/1 110 llBOR
1.1.'9on: 2.250 Caps: 5l21S'nde., 5.330
~
(1.190)
(0878)
(01018)
(0.437)
(0.190)
0._
0.325
0.707
1.073
1.381
;)IWiIJ.
(1.207)
(0l1li7)
(0.775)
(0.068)
(0215)
(0.001)
0.290
0.667
1.028
1.332
GOV4:1 nlllent ARr.l Change Oates
:m:!lu
~
(2.181)
(2.090)
(2.000)
(1,910)
(1.820)
(1.73IJ)
(1.640)
(. S48)
(1.388)
(1.290)
r.1Jrgln: 2.251) C.lps: 2/216 Inau: 5,330
~
(1.118)
(0.881)
(0.685)
(0.5011)
(D JOB)
(0.103)
D.'"
O._
M;ugrn. 2.750 C.,ps: 11115Indcx: 5.050
5760
5815
5500
5.375
5.250
5115
5.000
4.875
HrIIa.BaIa
(1.757)
(1.661)
(1.605)
(1.530)
(1.455)
(138')
(1.306)
(1109)
(1.033)
. (0.957)
1011 LI60R
r\1;"9'" 2 250 Caps: 5/2/5 lode,,: 5 330
FHA' Yc;:u A Rr.1
~
(. 464)
(1.364)
(1.181)
(1.100)
(1.019)
lHI:Qax
711 LIBOR
r.l;llgln: 2.250 Caps: 512/5 Index: 5.330
1011 T'l'asul),
llt:I2IIrt
~
~
fl.la'o,n: 2 750 Caps: 512/5 Inde,,: 5.050
~
('.765)
(1.704)
(1.823)
(1.543)
FtJr.1A 311 110 LI60R
~
(1.287)
(IOS8)
(0837)
(0530)
(0.288)
(0.078)
0.218
0.5113
0.958
1.281
~
(1.311)
(. IOJ)
(OB76)
(0.565)
(0.317)
(0.1199)
0.197
O.sao
0.950
1.258
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(1.334)
(. 174)
(0.903)
(0.596)
(0.342)
(0.129)
0.182
0.54D
0.905
1.209
7/1 Tle'l~uly
rll.HQln. 2.750 COJps: 5/2/5 Inllcx: 5.050
IimAJlIIIg
8.760
8.525
8.5DD
8375
8.2SO
8.125
8.000
5.875
6.7SO
5.825
~
(1.666)
;m,Qra
(1,975)
(1.888)
(1.aDZ)
(1.717)
(1.831)
(1548)
(UIi2)
(1.2501)
(1.168)
(1.080)
511l160R
I.l.'gln. 2.250 C.ps: 51215 Indox: 5.330
Malyin- 2.750 Caps: 5/215 IndeJl: 5.050
8.2SO
8.125
6000
5.875
5.7SO
5.825
5.500
5.375
·5.2SO
5.125
(2.115)
(2.D23)
(1932)
(1.642)
(1.751)
(1661)
(1.571)
(1.3511)
(1.266)
(1.17')
Margm: 2.250 Caps: Zl216lndex: 5.330
5" Tfe.lsury
tI!I!U!AIJ llt:I2IIrt
llt:I2IIrt
311l160R
MJlgon. 2.750 Caps: 2/216 Index: 5.050
~
~
7.000
6.875
6750
8.625
8.500
B375
6.2SO
8'25
8.000
5.B75
In.gf===.-=:-..::~~ t::~:= .=.~':..~'::!QMa_
A mem
§:i2JIx
D.5Ba
0.930
1.287
150'
1.587
1.9113
2.352
2.905
3.113
3.518
~
D.607
0.953
1.315
1.518
1.601
1.988
2.382
2.939
3.153
3.5GD
EIOCINe T"IJI'ID:
AMERICAN BROKER' COHOUn
_Codo
ABC MSl-1RVINB WHOLEaALB RA1ESKEET
r.ywv,ABCDHpU".c9M
ABC POWER A Rr.1S (30
1.000
'.000
'.000
1000
1.000
•. 000
1.000
'.000
• 000
1000
1.000
1.000
1.000
1000
1.000
'.000
1.000
1.000
.000
1.000 .
12 III) MTA
oy, Am) Full Doc ~nd Slated. Possible Neg Am MTA ARMs
Loons \11th _ _ lor Noptho _
.........
tuoe .... PI' and Qua", ...... Hghor 01 .... so.rt RIIhI 01)
Primary & Second Home.
4.25"" For lTV c= 80"lIl
•. 95'4forLTV>9O'W.>
lPUI
PM! "Q P....ry & Second_ 4.7_
4._
lnw5tmDnt PYvpor1in
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EXHIBIT
j~
.Indymac Bank
-.......--
12 MAT Pay Option A.~M "Wh~kls~'e·.
E_
'zr.DOee:5iAM
.... RS ~ 0.0: '-8II~"ns
StzrtRn
• 000
'.000
•1.1100
000
.urrSl»Hours: 1:0Q0W.,.'OUPIIIPST
Ib",,,,
'!H).
2 500
Z.IOO
7150
2.876
0000
(05OO)
2_
0.000
{OJ~l
('.IIOO)
2._
2.600
2.700
'.000
'.000
'.000
1000
'.000
'.000
'.000
'.000
1.000
• DOD
1.000
1.000
1.000
1.000
'.000
• coo
9.115"
'V.,Hiad
9.115,.
9._
9.&5%
9._
9._
(0.500)
(0.750)
('.Il00)
41,260)
(1.12ti)
, V,. Hard
tV. . Hard
1 Yew Hitnt
Cl.5OO)
(;1.000)
CU15)
(1875)
'V_Hard
'Vrn.Hard
, v•• Hard
~'25)
'VICI"Hlrd
0'25
2.700
2_
2.900
3.000
3.100
( •• 250)
{I.'25)
(1315)
('.625)
2V. . HaJd
2 V. . Hard
2V. . Henf
>JOO
C'5OO)
('.750)
(2.Il00)
2Voar Hard
2Yoar "-"'
2 Veil' H..,
(;1750)
('.975)
(2.'25)
(2.626)
2 Y•• H..,
0.000
( •. 000)
C'.5OO)
0.'25
lV. . HanI
~250)
(0875)
~OOO)
(2.25/))
(2.500)
(2.7501
CJ.IIOO)
a=
3.400
~~.
~y_ttard
CI.B75)
(2.'25)
(2.375)
(2.625)
(2.B75)
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~:'75)
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US'll.
9.9S'11.
9._
IU/5""
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9._
9._
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·'' ' IXII
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~~.CKIO"
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11,85"
9._
9_
9._
US,.
9.96"
)VnrHllrd
3 V•• Hard
3 V", Hard
... "DOI)oI. . .,oxr
.:::=
9.&5%
11.&5%
9.&5%
)v . . Hard
cun)
, 11M! A::l..'\J!nror.'l
oc.....
9._
, Y.,. Hard
OCOO
~~".(M1~
LNA"'--"
9.&5"
9._
g-
H_
~250)
2.•00
Z.500
2.600
2.700
2_
Z.900
3.000
3.200
'.000
None
2700
z..oo
'.000
I.DOD
'.000
'.000
1.000
'.DOD
1.000
1.000
I.DOD
-.
ut.c. " .
.....
0.125
(0.'25)
(Oo315)
(0645)
(0.B15,
(G.:r.IO)
2.900
3.000
3.'00
3_
3.'"
....
f!5·Q)
0.125
(0315)
(0"')
(O.B15)
--"'_ _..,-_ . -----......-.---.
.......... -,..
....-_.........
_1., .... 1.---................
... '--...... .
-.--.........
..
~--
--.-~
....
EXHIBIT
•
I
0.625
0.250
CO.I25)
CO.25O)
CO iDO)
CO 750)
CO 875)
0.750
O!lOO
0250
0125
CO· 125)
CO.375)
CO 500)
IUXXI)
11.125)
NlA
NlA
N'A
NtA
HlA
NlA
HlA
HI"
NIl
NIl
0.500
0..500
NIl
0.Z50
NIl
0.090
0.125
0.500
EXHIBIT
L
.
:
.
Atty. No. 99000
. ....... ~ ...
IN THE CIRCUIT COURT OF COOK COUNTY, STATE OF ILLINOIS
COUNTY·DEPA~.r2CHANCERY DIVISION
2~8JUN2S AH
.
~'P.SUIT COUR
(
10·•. 18
THE PEOPLE OF THE STATE Offln'/JJi~l~UofsOOIC
ILLINOIS,
~Y("IV,
. ooiWTII~Cl[R~
Plaintiff,
(
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v.
(
(
(
COUNTR YWIDE FI~ANCIAL
(
CORPORATION, a Delaware
corporation; COUNTRYWIDE
HOME
(
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LOANS, INC., a New York
(
(
corporation also dlb/~ Full SpectDlm
Lending; FULL SPE<CTRUM
(
LENDING, a Califorhia corporation
(
formerly doing busin~ss in Illinois;
(
COUNTRYWIDE HpME LOANS
(
SERVICING, LP, a Texas
partnership;
(
I
and ANGELO R. . M<DZILO,
(
I
individually and in his capacity as
(
Chief Executive OfrJcer
of
Defendant
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I
COUNTR YWIDE FINANCIAL
(
(
CORPORA nON;
(
Defe) dants.
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_-w....,-
OSCH22994
1
COMPLAINT FOR INJUNCTIVE AND OTHER RELIEF
I
NOW COMES the Plaintiff, THE PEOPLE OF THE STATE OF ILLINOIS, by LISA
MADIGAN, AttoJey General of the State of Illinois, and complains of Defendants
I
COUNTRYWIDE FINANCIAL CORPORATION, a Delaware corporation, COUNTRYWIDE
HOME LOANS,
11c., a New York corporation also doing business as Full Spectrum Lending,
FULL SPECTRUM LENDING, a California corporation formerly doing business in Illinois,
COUNTRYWIDE HOME LOANS SERVICING LP, a Texas partnership, and ANGELO R.
EXHIBIT
jM
MOZILO, individuality and in his capacity as Chief Executive Officer of Defendant
I
COUNTRYWIDE FINANCIAL CORPORATION.
Countrywide, in pursuit of market share, engaged in unfair and deceptive practices
including the looseniflgof underwriting standards, structuring unfair loan products with risky
features, engaging in Lisleading marketing and sales techniques, and incentivizing employees
and brokers to sell mLe and more loans with risky features. Countrywide's business practices
resulted in unaffordJle mortgage loans and increased delinquencies and foreclosures for Illinois
homeowners.
countrywide'ls explosive growth was paralleled by the demand for loans with nontraditional risky features on the secondary market. Through the securitization process,
Countrywide shi fted ithe risk of the fai Iure of these non-traditional loans to investors. Moreover,
securitization allowea Countrywide to gain much needed capital to fuel the origination process
and reach its goal of!capturing more and more market share. As the risky Countrywide loans
began to fail, it was forced to repurchase or replace the failing loans in the investor pools. This
created further pressLe to increase the volume of loan origination.
To facilitate lhe increase in loan origination volume, Countrywide relaxed its
underwriting stan1ds and sold unaffordable and unnecessarily expensive loans. Reduced
documentation underwriting guidelines were heavily used to qualify many borrowers for
unaffordable loans. Countrywide created so-called "affordability" loan products, such as
adjustable rate mortgages and interest-only loan products, that only required qualifying
borrowers at less
th~ the full interest rate for the loan products. Countrywide pushed products
that containing layJs of unduly risky features, such as pay option ARMs and mortgage loans for
,
100% of the value
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borrowers' homes. Unfair and deceptive advertising, marketing and sales
2
practices were utilized to push mortgages, while hiding the real costs and risks to borrowers.
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These practices included enticing borrowers with low teaser rates, low monthly payments and
;'no closing cost" 10Js that failed to make clear and conspicuous disclosures of the products'
risks. Finally, countLwide engaged in unfair and deceptive acts and practices while servicing
I
borrowers' loans, such as requiring borrowers to make initial payments without regard to
whether a loan repayient plan or loan modification was even possible.
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1.
.
JURISDICTION AND VENUE
This 'action is jbrOUght for and on behalf of THE PEOPLE OF THE STATE OF
ILLINOIS, by LISA MADIGAN, Attorney General ofthe State of Illinois, pursuant to the
provisions of the coJsumer Fraud and Deceptive Business Practices Act, 815 ILCS 505/1 e/
seq., the Illinois FairLss in Lending Act, 815 ILCS 12011 el seq., and her common law authority
as Attorney a'eneral
2.
Venue for
Jo represent the People of the State of Illinois.
thil action properly lies in Cook County, Illinois, pursuant to Section 2-10 I of
I
the Illinois Code ofOivil Procedure, 735 ILCS 5/2-101, in that the Defendants are doing
business in Cook cJnty, Illinois.
..
PARTIES
3.
Plaintiff, THE PEOPLE OF THE STATE OF ILLINOIS, by LISA MADIGAN, Attorney
General of the State rl f Illinois, is charged, inter alia, with the enforcement of the Consumer
Fraud and Deceptive Business Practices Act, 815 ILCS 50511 e/ seq. and the Illinois Fairness in
Lending Act, 815 ILCS 120/1 et seq.
4.
I
Defendant AiGELO R. MOZILO
. a co-founder of Defendant COUNTRYWIDE
IS
FINANCIAL CORPORATION, which was fonned as Countrywide Credit Industries in 1969.
3
5.
Defendant M<DZILO participates in, manages, controls, and has knowledge of the day-to-
day activities of Defehdant COUNTRYWIDE FINANCIAL CORPORATION. He has been the
Chairman of Defendalt COUNTRYWIDE FINANCIAL CORPORATION'S Board since March
1999 and Chief Exe+i ve Officer of the company since February 1998. Defendant MOZI LO
was also President 0The company from March ~OO~ through December 2003 and has served in
other executive caparies since the company's formation.
6.
Defendant MOZILO has stated that he has "devoted [his] life to building from the ground
up a mortgage banki1g company focused on providing homeownership opportunities to all
Americans" for the lrt four decades.
7.
Although Defendant MOZILO resides in California, his companies conduct business in
Illinois and, on at lealt two occasions, he has engaged in purposeful activity to further the
interests of DefendaJt COUNTRYWIDE FINANCIAL CORPORATION (and its subsidiaries)
I
.
while in the State ofIIIinois.
8.
Specifically,
~Uri~g an April 27, 2006 earnings conference call, Defendant MOZILO
I
reported that he had just finished a tour of the offices of the subsidiary that handles the
securitization of motgage loans originated by Defendant COUNTRYWIDE FINANCIAL
CORPORA TION. As he reported, one ofthose offices was in Chicago.
9.
I
In addition, during October \998, Defendant MOZILO appeared at the Mortgage
Banker's AssociatiJ of
Defendant
Ameri~a's annual convention in Chicago. At this appearance,
MOZIL~ discussed the turbulence in the mortgage business. and stated that only· big
.firms with adequate resources to maintain access to bank lenders and the capital markets would
survive. He predicted that Defendant COUNTRYWIDE FINANCIAL CORPORATION would
be a beneficiary of tt market turbulence.
4
+-___________.______.__ ..
1--_ _ _ _ _ _ _ _ _ _ _
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10.
Defendant C,UNTR YWIDE FINANCIAL CORPORATION is a thrift holding
company. It has numerous subsidiaries that originate, purchase, securitize, sell and service
residential and comrnlrcial "loans; provide loanclosing services such as credit reports, appraisals
..1 cond uct fiIxed'mcome seCUrItIes
. . un d erwntmg
. . an d tra d'mg actIvItIes;
...
an d f1 00 d d etermmatlOns;
provide property, life and casualty insurance; and manage a captive mortgage reinsurance
company."
II.
Since Decemrr 23, 1980, Defendant COUNTRYWIDE HOME LOANS, INC., a
wholly-owned subsidiary of Defendant COUNTRYWIDE FINANCIAL CORPORATION, has
been
~ registered foJgn corporation in the State of Illinois. Defendant COUNTRYWIDE
HOME LOAN"S, INJ. is a licensed Illinois mortgage bank, holding mortgage banker license
MB.0000I39, which is issued by the Illinois Department of Financial and Professional
Regulations, Division of Banking. Since 2004, Defendant COUNTRYWIDE HOME LOANS,
INC. has also done blsiness in Illinois as Full Spectrum Lending.
12.
Defendant FJLL SPECTRUM LENDING, INC., was a registered foreign corporation in
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the State of Illinois from October 3, 1996 through April 25, 2005. FULL SPECTRUM
LEND~NG, INC. wal a licensed Illinois mortgage bank, hol~ing mortgage banker license
MB.00049IO, which was issued by the Illinois Department of Professional Regulations, Division
of Banking. Defendant FULL SPECTRUM LENDING, INC. became a division of Defendant
"
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COUNTRYWIDE HOME LOANS, INC. in 2004. In April 2005, FULL SPECTRUM
LENDING, INC.
wi~hdrew as a registered foreign corporation and began operating in Illinois as
I
Full Spectrum Lending, a division of COUNTRYWIDE HOME LOANS, INC.
.
13.
1
In its annual reports from 1999 to 2006, Defendant COUNTRYWIDE FINANCIAL"
CORPORA TION elphasized that mortgage banking, which has historically been conducted
5
through Defendant COUNTRYWIDE HOME LOANS, INC. for prime loan originations and
Defendant FULL
SPE~TRUM LENDING, INC. for subprime loan originations, was its core
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business. Defendant aOUNTRYWIDE FINANCIAL CORPORATION has stated that the
company is engaged plimarilY in residential mortgage lending and that Defendant
COUNTRYWIDE HJME LOANS, INC: is its primary subsidiary.
14.
I.
.
During the entire time period from 1999 to 2006, there was a significant identity in the
corporate governance and managing directors of Defendant COUNTRYWIDE FINANCIAL
CORPORATION and Defendant COUNTRYWIDE HOME LOANS, INC. For example,
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COUNTRYWIDE HOME LOANS, INC. and he was also the Chief Operating Officer for
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between 1999 and 2005, Stanford Kurland was the Chief Executive Officer for Defendant
Defendant COUNTR/YWIDE FINANCIAL CORPORATION. In 2006, David Sambol became
Chainnan of the BOjd and Chief Executive Officer for Defendant COUNTRYWIDE HOME
LOANS, INC. and President and Chief Operating Officer of Defendant COUNTRYWIDE
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FINANCIAL CORPORATION.
15.
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There was also overlap between the management of Defendant FULL SPECTRUM
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LENDING, INC., when it was a separate company, and Defendant COUNTRYWIDE
FINANCIAL CORP6RATION. Specifically, Gregory Lumsden has been the President and
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Chief Executive Officer for Defendant FULL SPECTRUM LENDING, INC. from 2001, when it
was a separate comJany, to the present day, when it is a division of Defendant
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COUNTRYWIDE HOME LOANS, INC. He has been and is currently a managing director for
Defendant
16.
COUNT~YWIDE FINANCIAL CORPORATION.
Defendant 10UNTRYWIDE FINANCIAL CORPORATION issues consolidated annual
reports and SEC filings with Defendant COUNTRYWIDE HOME LOANS, INC. Additionally,
6
Defendant COUNTRYWIDE FINANCIAL CORPORATION files a consolidated federal
income tax return and a combined state income tax return in California wjth Defendant
COUNTRYWIDE HOME LOANS, INC. and Defendant FULL SPECTRUM LENDING, INC.
Defendant COUNTR{WIDE FINANCIAL CORPORATION also issued consolidated earnings
statements and balanJ sheets for itself, Defendant COUNTRYWIDE HOME LOANS, INC. and
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Defendant FULL SPECTRUM LENDING, INC.
17.
Defendant CdUNTRYWIDE FINANCIAL CORPORATION controls the policies and
operations and profitsl from the activities of Defendant COUNTRYWIDE HOME LOANS, INC.
and Defendant FULL SPECTRUM LENDING, INC. Defendant COUNTRYWIDE
FINANCIAL CORPORATION arranged and profited from the securitization and/or sale of loans
originated and servic1d by Defendant COUNTRYWIDE HOME LOANS, £NC. and Defendant
FULL SPECTRUM JENDING,
18.
n~c.·
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Because they Lted cooperatively in carrying out the conduct alleged in this Complaint,
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Defendants ANGEL<D R. MOZILO, COUNTRYWIDE FINANCIAL CORPORATION,
COUNTRYWIDE HbME LOANS, INC. and FULL SPECTRUM LENDING, INC. are
collectively referred
Jo as "Countrywide," unless otherwise specified, and each is responsible for
the unlawful conduct alleged herein.
19.
Defendant C<DUNTRYWIDE HOME LOANS SERVIC£NG, LP is a licensed mortgage
bank, holding mortgJge banker license MB.0006041, which was issued by the Illinois
Department of FinanLal and Professional Regulation, Division of Banking. Defendant
COUNTR YWiDE HiOME LOANS SERVICING, LP is a Texas limited partnership directly
owned by two wholly-owned subsidiaries of Defendant COUNTRYWIDE HOME LOANS,
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INC. Defendant COUNTRYWIDE HOME LOANS SERVICING, LP services loans originated
7
by Defendant COUN,R YWIDE HOME LOANS, INC., the Federal National Mortgage
Association (Fannie rae), the Federal Home Loan Mortgage Corporation (Freddie Mac), the
Government National Mortgage Association (Ginnie Mae), the United States Department of
.
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Housing and Urban Oevelopment, and the United States Veterans Administration.
20.
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Any allegation about any acts of Defendants COUNTRYWIDE HOME LOANS, INC.,
COUNTRYW'IDE
F~ANCIAL CORPORATION, FuLL SPECTRUM LENDING, INC. or
COUNTRYWIDE HbME LOANS SERVICING, LP, means that the entities did the acts alleged
through their officersl directors, employees, agents and/or representatives while they were acting
within the actual or Jstensible scope of their authority.
COMMERCE
21.,
Section I(t) ythe Consumer Fraud arid Deceptive Business Practices Act, 815 ILCS,
50511 (t), defines "traCie" and "commerce" as follows:
'com~erce'
The tJrms 'trade' and
mean the advertising, offering for sale,
sale, dr distribution of any services and any property, tangible or
intangible, real, personal, or mixed, and any other article, commodity, or
thing pf value wherever situated, and sh/illl include any trade or comme'rce
directly or indirectly affecting ~he people of this State.
22.
Defendants Je and were, at all relevant times hereto, engaged in trade and commerce in
the State of Illinois, i'n that they offered mortgage lending services to the general public of the
State of Illinois.
23.
The Attorney General's Office has received over 200 complaints related to Countrywide
since 2005.
8
COUNTRYWIDE'S BUSINESS PRACTICES RESULTED IN UNAFFORDABLE
MORTGAGE LOANS AND INCREASED FORECLOSURES IN ILLINOIS
Countrywide's DomiJation of the Mortgage Industry
24.
Both countrytde Financial Corporation ("CFC") and Countrywide Home Loans, Inc.
are based in Calabas1' California. CFC was formed by David Loeb and Angelo Mozilo as
Countrywide Credit Industries in 1969. The company went public shortly thereafter. Loeb
retired in 2000. The lompany restructured in 2001 and assumed its current name in 2002.
25.
Through its nlmerous subsidiaries, CFC is involved in virtually every segment of the
residential mortgage i!ndustry. The company sells, purchases, securitizes and services residential
and commercialloanJ provides loan closing services such as credit reports, appraisals and flood
determinations; condtcts fixed income securities underwriting and trading activities; provides
property, life and casualty insurance; and manages a captive mortgage reinsurance company.
26.
CFC's
prima~ subsidiary, Countrywide Home Loans, Inc., offers loans to consumers'
'through three produJon charmels. The first channel is comprised of Countrywide'S prime
consumer-direct (retJl) lending locations, referred to as the Consumer Markets Division, and
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non prime consumer-direct (retail) lending locations, referred to as Full Spectrum Lending. The
second channel is whblesale lending through a network of mortgage loan brokers and other
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financial intermediaries. The third channel is correspondent lending through which Countrywide
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provides lines of credit to financial institutions such as independent mortgage companies,
commercial banks, sLings and loans and credit unions, purchases the mortgages made pursuant
to the lines of credit, and then arranges for the securitization of these loans.
27.
Today,
Coun~rywide
is America's largest mortgage lender. In the first quarter of2008,
the company OriginJed $73 billion dollars nationally in mortgage loans. Countrywide has also
been a significant
ori~inator of subprime mortgages. By the first quarter of2007, Countrywide
9
~-----------f-'-----------------.-
..,-..---.---------
had become the largest originator of subprime loans, with a total subprime loan volume of
roughly $ 7,881,000,doo.
28.
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'
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Countrywide is also the nation's largest loan servicer. The 'company administers $1.5
trilli~n in loans made/bY both it and other institutions. Countrywide's servicing operation
generated $1.4 billioJ in revenue in the first quarter of 2008.
29.
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Countrywide has a significant presence in Illinois. At the peak of its presence in Illinois,
Countrywide operate1 approximately 100 retail branch offices and its mortgage loan products
were offered by numLous mortgage brokers licensed to do business in Illinois. Countrywide
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also purchased loans rhrOUgh a network of some 2,100 correspondent lenders.
30.
Countrywide jwas the largest lender in Illinois in 2004,2005, and 2006. During these
years, Countrywide sold approximately 94,000 loans to Illinois consumers.
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31.
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In addition, Countrywide is ,the largest lender in the Chicago area . .In 2006, for example,
Countrywide made Ler 21,000 loans to consumers in the seven county Chicago area.
The Exolosive GroJh of a Market for Loans with Non-Traditional Riskv Features
)2.
countrywid+ growth paralleled and was fueled by the rise of private-label securitization
in the mortgage industry.
33.
,
securitizatiJ of mortgage loans is a relatively recent phenomenon. Historically,
mortgages were
l?n~l-term, fixed rate, amortizing products sold by depository institutions. From
the post-World War II era to 1973, savings and loan institutions held the majority of all
mortgages.
34.
The privatization of the Federal National Mortgage Association (Fannie Mae) in 1968
and the creation
oft~e Federal Home Loan Mortgage Corporation (Freddie Mac) in 1970 laid the
groundwork for secLitization of mortgages and the secondary market's role in the mortgage
10
industry. Fannie Mae and Freddie Mac, also known as government-sponsored entities C"GSEs"),
began purchasing loans from financial institutions. These financial institutions were required to
make limited represJtations and warranties regarding the quality of the loans. Any remaining
I
risk passed on to the rSES. .
35.
After purchas , the GSEs bundled the mortgages into pools in order to sell the income
stream to investors.
L,
asset-backed or mortgage-backed security is ultimately created from
such a pool of loans. The entire process is generally referred to as securitization. As used by the
GSEs, the primary pUrPose of securitization was to create liquidity for funding more reSidential
mortgage loans.
36.
There are limirs on the types of loans that Fannie Mae and Freddie Mac purchase. The
loans they purchase are subject to certain standards regarding loan amount and credit risk, which
generaily must be delonstrated through written documents showing the borrower's credit score,
income, assets and liJbilities and the value of the home securing the loan. Loans that meet the
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underwriting standards are referred to in the mortgage industry as "conforming loans." Like
other mortgage lendJs, Countrywide marketed and sold conforming loans to borrowers and then
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sold these loans to the GSEs.
37.
Until the earlJ 1990s, "non-conforming loaps," or loans that did not meet the GSEs;
underwriting standarls, were rare and expensive. Borrowers who were considered subprime
(due to credit profileJ riskier than the minimum required for conforming loans) or were unable to
document income aJ assets, or who wanted loan amounts in excess of the GSEs' underwriting
guidelines had few
38.
In the early
o~tions. This situation would soon change.
.
1'~90S, banking regulators adopted new rules at a time when banks were
under considerable fihancial stress from the 1991 recession. For the first time, the new rules
11
measured bank healtll through the use of a capital to asset ratio. Unable to raise new capital to
increase the ratio, bals found it easier to reduce assets instead, and securitization proved
particularly useful
39.
f01 that task.
Once banks
ht
These assets included mortgage loans.
an incentive to divest assets, and with securitization enabling them to
pass at least part of tile risk ofa loan's failure to investors, financial institutions became less
. k·1
i·
I· oans. SecuntizatlOn
. . . was no I
·Just a too I to create
· ns
wary 0 f rna k109
ler non-con formmg
onger
liquidity in the confJming mortgage industry. Instead, mortgage originators could employ it as
a way of shedding mlch of the credit risk associated with non-conforming loans that they
originated.
40.
Wall Street became aware of the potential cash flow from the securities backed by non-
conforming mortgagj loans. Investors were attracted to these securities because they assumed
that
n~n-confOrming lortgage-baCked securities would share the same stable performance of the
conforming mortgagLbaCked securities issued by the GSEs. The favorable investment grade
ratings .given to the SfCUrities by the various ratings agencies - which allowed institutional
investors such as state pension funds to buy the products - seemed to corroborate this
assumption.
41.
In addition, tHe yields on the non-conforming loan securities were attractive. While
subprime loans - a tybe of non-conforming loan - carry greater risks, they also produce higher·
I
returns. For a time, the large returns on subprime mortgage-backed securities outpaced (and
concealed) high failJe rates of loans in securitization pools.
42.
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Investors paid a premium for certain types of loans and certain loan features, such as
loans with high interJst rates (i.e., subprime loans) or loans with prepayment penalties. Indeed,
investors' growing aJpetite for mortgage-backed securities fueled a surge in the origination of
12
subprime mortgage leRding. Between 1994 and 2005, subprime mortgage lending grew from
$35 billion to $625 bililion. By the first quarter of2007, subprime mortgage-backed securities
were being sold at a r1te of $100 billion per quarter. The explosive growth in subprime
mortgage lending als1 marked a shifting away from traditional underwriting standards.
43.
Lenders, such as Countrywide, were aware of the types of loans and loan features for
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which investors would pay a premium. Investor demand and secondary market valuation,
therefore, became the/primary concern when determining what types of loans to market and sell
and at what price, rattr than the consumers' ability to repay the loans. Countrywide sought to
place greater number! of borrowers into loans laden with these premium-enhancing features.
44.
Countrywide had already established a small presence in the subprime lending field in the
late 1990s, when it
fJ~ed its retail subprime lending unit, Full Spectrum Lending. Following
David Loeb's" retireJent in 2000, Countrywide became more aggressive in growing its business
in an effort to be the" hation' s largest mortgage lender. Countrywide expanded the range of non-
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conforming loan products that "it offered to consumers and began to concentrate more on
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subprime lending and exotic mortgage products. For example, in 2002, Countrywide originated
roughly $9 billion in subprime loans. In 2005, that number shot up to over $44 billion.
45.
Countrywide also changed its corporate strategy to focus on increasing loan volume,
which would in tum generate more loan origination fees for the company. Instead of focusing on
fixed rate loans to crLitworthY borrowers, the company began to emphasize reduced
documentation 10aJ and adjustable rate products. Forexample, in 2003, only 18% of the loans
originated by countlwide had adjustable interest rates. In 2004, however, that number had
grown to 49%.
13
46.
By 2005, Countrywide's growth in both revenue and number of loans originated was
fueled by the compJy's origination ofa menu of risky loan products, such as reduced
documentation loans, option ARMs, and loans for 100% ofa home's value.
Record Numbers of Roreclosures Nationally and in Illinois
47.
F~r many yeJs, rising home prices concealed the consequences of Countrywide's
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increased drive to sell loans regardless of the borrower's credit risk and ability to repay the loan.
Borrowers were
OftJ lured into expensive home loans with the promise that they could
refinance if the loan tcame unaffordable. As long as housing prices continued to rise and credit
remained available, lany borrowers followed this strategy. Predictably, with the collapse of the
mortgage market and concomitant drop in housing prices, the days when borrowers could
refinance out of an unaffordable mortgage ended, and, as has been widely documented, defaults
.I·de·are rap 1'dl'
.
y rlsmg.
an d fiorec Iosures natlonWl
48.
.
In the third qlarter of 2007,24% of all outstanding subprime loans and 30% of subprime
ARMs were either dJlinqUent or in foreclosure. The Center for Responsible Lending has
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.
projected that 2.2 mTion homeowners nationwide will lose their homes as a result offailed
subprime home loans originated from 1998 through 2006. This number could very well grow
larger, as the projecti1bn was made before subprime def.ult rates skyrocketed in 2007.
49.
In the Chicago area, the foreclosure crisis resulting from subprime loan origination will
likely linger longer tlan in other parts ofthe country. In 2006, the Chicago metropolitan area
I
had more "high-COSt'r (i.e., subprime) mortgages than any other metropolitan area in the country,
according to a Chicago Reporter study. This marked the third year in a row that the Chicago
metro area claimed t t nation's top spot for high-cost mortgages. Countrywide led
high-cost loans in cJiCagO - in 2006 it was the leader in high-cost lending.
14
th~ way with
50.
Ultimately, although homeownership for subprime borrowers increased during recent
years, it appears that there will be a net loss in homeownership nationwide. With the number of
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completed subprime foreclosures from 1998 to 2006 exceeding the number of home buyers who
used a subprime loan to enter the marketplace, the Center for Responsible Lending estimates that
subprime mortgage lending has resulted in a net loss in homeownership of 900,000 homes
. nationwide. AccordiL to federal government figures, in 2007homeownership suffered the
biggest one-year droJ on record.
.
51.
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The failure of subprime loans explains only part of the homeownership crisis. Risky loan
origination practices ILed in the prime mortgage market. such as volatile loan· products like
option ARMs and lax underwriting standards, also contributed to the current situation.
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Nationally, roughly 143,000 homes were in some stage of the foreclosure process in April 2008.
This is up 65% from April 2007. The nationwide delinquency rate on mortgage payments grew
to 6.35% in the first quarter of 2008, the highest since 1979.
52.
Illinois'.
homl foreclosure rates have ranked among the highest in the nation for more
than a year. Illinois Lperienced .a 46% increase in the number of unique properties in foreclosure
from 2006 to 2007 - 64,310 properties in 2007 as compared with 44,047 the year before.
Lenders filed 9,670 foreclosures in May of this year alone, placing the state eighth in the number
I
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of new foreclosures filed. This represents a 41.71% increase from May 2007.
53.
The external bosts of the mortgage
cOlIa~se, in tenns of declining property values and
shrinking tax bases, ire estimated to run over $200 billion nationally, with urban centers hit
hardest. In Illinois, Jhe loss is projected to be $15 billion, with $13 billion in Chicago.
15
Countrywide's Role in the Foreclosure Crisis Nationally and in Illinois
54.
The delinqUeJy rate on the mortgage loans of America's biggest mortgage lender and
servi,cer, countryWide! was 9.27% by the end of March 2008. The compC!ny originated $7
billion nationally in mbrtgage loans in one quarter of2008. The March 20089.27% delinquency
rate was an increase fLm 5.02% at the end of2006 and 3.68% in March 2006.
55.
The inCidenc+ f "seriously delinquent" loans - loans thar are 90 days or more past due or
in foreclosure - is alsi increasing. Countrywide's latest financial filing says that 4.81 % of the
loans it services werelseriOUSIY delinquent as of the end of March 2008. This serious
delinquency rate was up almost four times from 1. 70% at the same time in 2007.
56.
In terms of actal foreclosures, the percentage of Countrywide loans in foreclosure at the
end of March 2008, 1.28%, had almost doubled from 0.69% at the end of March 2007.
57.
countryWide'r subprime loans have failed even more frequently. By the end of the first
quarter of 2008, 35.88% of the subprime loans serviced by Countrywide were delinquent, up
I
from 19.62% in the first quarter of2007. Slightly over 21% of all Countrywide subprime loclns
serviced by the comJany were seriously delinquent by the end of March 2008, up from 7.82% in
March 2007.
58.
The number
r
Countrywide foreclosure filings in Illinois is troubling. From 2006 to
2007, all foreciosurel-,comPlaint filings in Cook Country increased by46%. For this same period,
however, countryWi/Cle Home Loans, Inc.'s foreclosure complaint filings increased by 117%.
From January 2004 through June 2008, Countrywide Home Loans, Inc. has foreclosed upon at
least 2,534 Cook cJunty homeovmers. Note that this number does not include foreclosures filed
by Full Spectrum LLding or any other Countrywide entity.
16
Securitization Sleight of Hand Masked Countrywide's Systemic Loan Origination Issues
59.
Countrywide's delinquency and foreclosure numbers show that there were systemic
problems with the company's loan origination standards. These loosened loan origination
II'
. . . practIces.
.
stan dards came .mto J? ace due to C'ountrywl'd e ' s secuntlzatlOn
60.
Countrywide's quest for domination in the mortgage lending industry is well-.
documented. During a May 24, 2005 investor conference, Defendant and Countrywide CEO
Angelo Mozilo stated: "I am going to -little question - it's a question of dominance, you have
heard this before we
t
we have [no] intention to structure the company to be at second place or
third place." This sentiment was echoed by then-Countrywide President and Chief Operating
Officer Stanley KurlAnd. who stated: "In the past, we talked about origination market share
reaching 30% by 20ds and, as we've noted, this was intended to be a stretch goal as it is part of
our culture, part of
oL
nature to set aggressive targets." Ultimately, this
q~est
for market
. domination created a self-perpetuating cycle in which Countrywide raced against time to
originate loans of decreasing quality to cover up the failure of its p~ior loan originations.
61.
This cycle belan with Countrywide'S attempt to gain market share. The company had to
acquire capital to
Countrywide both
fun~ loans and find borrowers to buy the loans. To find borrowers,
ex~anded its menu of nonconforming mortgage products and loosened the
I
standards for selling its products to reach untapped consumers. To gain capital, Countrywide
relied on securitizing the loans that it made from its menu of nonconforming mortgage products
and loosened loan origination standards.
62.
Securitization allowed Countrywide to generate capital using one of two methods. In one
method, Countrywide sold the loans it made to third parties who then aggregated the loans into
pools and sold the inLme streams from the pooled loans to investors. In this
17
~rrangement, a
party other than a Countrywide-controlled entity had an opportunity to evaluate the quality of the
loans being aggregatJ .. This party was
I'
.
abl~ to enforce any representations and warranties that
Countrywide made wlilen selling the mortgage loans.
63.
In the other mthod, Countrywide eliminated the third-party intennediaries and
I
. completed the securitization process by. itself. Countrywide Financial Corporation created
numerous subsidiarie for this exact purpose. These subsidiaries purchased loans from
Countrywide entities, pooled them, and issued securities that were later sold through a brokerage
house. Securitization done through affiliated entities reduced any potential for delay in the
process.
64.
This second method allowed Countrywide to control the entire origination and
securitization proceJ In other words, Countrywide sold the loans itself, purchased and
.
I
aggregated the loans itself, and issued the securities itself.' The same corporate executive could
even sign off on secJitization contracts as both the originator of the underlying mortgage loans
I
.
and the purchaser of the same loans.
65.
Countrywide Ihad strong incentives to securitize its loans quickly. In order for an asset-
backed security to mlet the Securities and Exchange Commission's requirements, it may not
have non-performinJ loans and delinquent loans may not constitute 50% or more of the pool on
the date the pool is rI'adied for sale?
66.
The securitiz tion process was beneficial for Countrywide because it both generated
I
capital and allowed <r::ountrywide to shed "credit risk" from the possible failure of the underlying
I
.
I
I In this self-dealing method, it is unclear how the required representations and warranties regarding the quality of
the underlying loans w041d be enforced. Moreover, the Bank for International Settlements issued a 1992 report
noting that "[t]here is at 'east a potential conflict of interest if a bank originates, sells, services and underwrites the
same issue of securities.'i BlS is an international organization established in 1930 which fosters international
monetary and financial c1ooperation and serves as a bank for central banks.
.
2 Under this analysis, pay-option ARMs would have been among the most desirable products to satisfy this element .
since, with their very low teaser rate and option to make less than full interest payments for a certain period, they are
.
unlikely to experience eJrly payment defaults.
18
mortgage loans. credr risk is the potential for financial loss resulting from the failure of a
borrower to pay on a mortgage loan. As CFC noted in its annual regulatory filing for 2003, it
manage.d "mortgage Jedit risk principally by securitizing substantially all mortgage loans that
we produce, and by oilY retaining high credit quality mortgages in our loan portfolio." In
.comments to federal jegulators. Countrywide advised that any guidance on nontraditional
mortgage products "contain explicit acknowledgement that the risk profile of a lender who
.
I
effectively transfers the economic risks of a loan to the secondary market is lower than that of a
portfolio lender" (emfhaSiS added).
67.
.
By selling loans onto the secondary market, Countrywide created loan pooling
agreements through "lhiCh it sought to limit its responsibility for the performance of the loans.
For instance. count1wide is required to repurchase the loan from investors under these
agreements only in tge event of documentation errors, underwriting errors, fraud, or early
payment defaults (i.el, the borrower defaults within one or two months after the loan sale).
68.
Although cJntryWide attempted to shed the risk of originating loans of lower quality, it
retained some credit tisk due to the representations and warranties that it is required to make
when selling mortgaJe loans to either third parties or itself for securitization. As a result,
.
investors still have slme level of recourse against the company for defective loans.
I
69.
.
This recours, generally takes one of two forms. In some cases, these agreements
required Countrywide to indemnify the investors for the defective loans. In other cases,
however, countryWit could simply swap in new loans for the defective loans through the
"removal of accountl provisions" included in some of its securitization agreements. Swapping
loans was preferable to lenders because it does not them to actually give investors cash.
19
70.
Under this apprach, a lender, like Countrywide, needed to generate more loans if it both
wanted to continue securitizing and needed to replace the defaulting loans removed from the
securitized pools. In a6dition, the lender, who is not able to transfer the defaulted loans it takes
back from the pools
J
anyone else, will want to hold more good loans on its balance sheet to
offset the increasing nlmbers of bad loans it is holding. The lender must originate more loans to
hold on its books - in 11he hope that a sufficient number of the new loans wi II not de faul t - to
offset the bad loans. <.Countrywide admitted that it did as much in its December 31, 2005 10-K
filing, in which the coimpany disclosed that "[tJhe impact in the increase of the allowance for
[delinquent option] loan losses will be partially mitigated by the addition of new loans to our
portfolio. "
71.
As CountrywiC:ie well knew or should have known, the loans that underpinned
Countrywide's securillizations were unstable. In fact, the loans began to fail at a precipitous rate.
As the company observed in 2007, the volume of claims for breaches of its representations and
lo the deterioration in credit performance of its loans.
warranties grew due
Thus, Countrywide
J
had to accelerate origination to satisfy increased investor claims at precisely the time when it was
already increasing 01igination to simply obtain capital to maintain its market position.
Defendants' Unfair and Deceptive Underwriting Standards, Loan Products, Sales Techniques
and Servicing Practices
72.
I
Countrywide'S need to accelerate loan originations compelled the company to develop a
business model that, beginning in at least 2003 or 2004 and lasting into 2007, reflected the
company's indifference to whether homeowners could afford its loans. As part of this model,
I
Countrywide: (a) originated mortgage loans to borrowers who did not have the ability to repay
the loan; (b) OriginJed mortgage loans with
~ultiple layers of risk that exposed borrowers to an
unnecessarily high JiSk of foreclosure or loss of home equity; (c) originated unnecessarily more
20
' - - - - - - - - - - - - + - - - - - - - - - - - - - - - - - - - - - - - - - - - - _ .. _-_ ....... .
expensive mortgage loans to unknowing borrowers; and (d) engaged in unfair and/or deceptive
-
I
marketing and advertising acts or practices.
73.
Also,
.'
.
country~ide implemented a compensation structure that incentivized broker and
employee misconduc without exercising sufficient oversight to ensure that misconduct did not
occur due to:
a. Implementing a compensation structure that incentivized employees to maximize
loan Jles without proper oversight, resulting in the sale of unaffordable and/or
unneJssarilY expensive loans;
b. Failinl to adequately supervise and/or implement proper underwriting guidelines
to see whether brokers used and sold reduced documentation loans to avoid
revealing borrowers' true income and assets;
c. RewJding brokers for selling loans with certain risky loan features such as
prepa}ment penalties without ensuring that borrowers received a benefit from the
I
risky features; and
d. StrucLring the compensation for option ARMs in such a way that brokers were
inceJvized to sell this riskier loan product - to the exclusion of other products -
in ord1lr to obtain the maximum yield spread premium possible.
74.
Countrywide's servicing division, Countrywide Home Loans Servicing, LP, unfairly and
deceptively required borrowers to make additional payments just to consider whether they would
qualify for a loan repayment or modification plan - regardless of the potential feasibility or
affordability of such a plan.
75.
Former employees commented on Countrywide's increasing disregard for a borrower's
ability to repay a mokgage loan. For example, a former Full Spectrum Lending Division
21
employee stated that the division (which was Countrywide's subprime lending arm) had
underwriting gUideliJs that would approve virtually any loan. Likewise, an underwriter in
Countrywide's wholelale Lending Division said that her supervisor would approve most of the
I
.
loans that she herself did not feel comfortable approving.
76.
'
.
Even though fLmer employees noted that Countrywide had loose underwriting
standards, the companl also had a system to grant exceptions to those standards. A Countrywide
wholesale account eJcutive said that in the beginning of 2006, Country;ide became very
aggressive in grantinJ exceptions to their underwriting criteria - further diluting borrower
protections.
77.
This employee also explained that she was pushed to sell more "Expanded Criteria"
loans. Another
more to
whol~sale account executive remarked that Countrywide paid its employees
s~1l "ExpandL Criteria" loans.' Expanded Criteria loans included loans with reduced
documentation underLriting, higher loan-to-value ratios and other risky loan features.
78.
.
Countrywide Itself observed in its first quarter 2008 10-Q the consequences of this
expansion into risky broducts and practices. It disclosed that, since 2007, it had "observed a
marked decline in crLit performance (as adjusted for age) for recent vintages, especially those
loans with
high~r risJ characteristics, including reduced documentation, high loan to value ratios
.
I
or low credit scores. "/
79.
.
As described, Countrywide's expansion into riskier products and practices became
I
.
apparent in a numbelil of ways.
.
Countrywide Sold Unaffordable and More Expensive Loans to Borrowers Due to its Lax
underwritin1
80.
Stand~dS
. ' .
..
For the reasons descnbed above, CountryWIde relaxed ItS underwrltmg standards
I
recent years. These elaxed
~nderwriting standards allowed the mass selling of reduced
22
.
In
documentation loans and the failure to ensure borrowers had sufficient capacity to repay the
mortgages countryWibe sold them.
A.
Countrywide Ihappropriatelv Sold Reduced Documentation Loans
81.
Countrywide' relaxation of tradi tional underwriting standards is evident in its increased
.
1
reliance on reduced d0cumentation loans. From 2005 through the first .half of2007, a majority
of the Countrywide Jortgages sold in Illinois were reduced documentation loans, often called
.
I
"stated-income" or "liar's loans." Countrywide underwrote these loans with less documentation
and, consequently, IJs verification, of borrowers' income and assets than traditional mortgages.
82.
The four type! of reduced documentation loans sold by Countrywide from at least 2004
through the first half of 2007 are described. as follows:
I
a. The "Stated Income Verified Assets" loan, often referred to as a "SIVA," required
the diLlosure of employment, income and assets on the loan application.
EmPldyment and assets were verified, but income was not verified by
.
countlwide. A debt-to-income ratio was calculated based on the stated income
and it !tyPicallY had to meet certain requirements. This product was the most
commonly sold reduced documentation loan. In addition to the SIVA product,
coun~wide sold a product known as the "Fast 'n' Easy" that had similar
underLiting criteria. Borrowers whose credit score exceeded a certain threshold
could qualify for the Fast 'n' Easy as opposed to the SIVA product.
b. The "No Ratio" loan, often called a "NIVA," required the disclosure of
emp+ment and assets on the loan application, both of which were verified.
However; Income could not be dIsclosed on the loan applIcatIon, and
23
CountIJYwide did not calculate debt-to-income ratios in qualifying borrowers for
I
.
these loans ..
I
.
c. A "Stated Income Stated Assets" loan, or "SISA," required that employment be
discIJed and verified, but neither income nor assets were verified by
I .
Countrywide.
.
d. A "N1lncome No Assets No Employment" loan, also called a "No Doc" or
"NINl' loan, prohibited disclosure of employment, income and assets on the
loan application. No debt-to-income rat~o was calculated to qualify the borrower.
83.
The various Jpes of reduced documentation loans sold by Countrywide are collectively
referred to in this coLplaint as "reduced documentation'" or "stated income" loans.
84.
Countrywide II old reduced documentation loans to prime borrowers and some types of
reduced documentati n loans to subprime borrowers. Over time, Countrywide actually lowered
the minimum credit Jcore for which it would approve a reduced documentation loan to include a
broader set of borroJers. Countrywide also lessened underwriting standards for reduced
documentation loans sold to subprime borrowers, increasing the numbers of subprime borrowers
who were eligible to receive these loans. In fact, during recent years, a significant percentage of
I
.
the subprime loans iountryWide sold to Illinois borrowers were reduced documentation loans.
85.
Because a majority of the loans sold in Illinois in recent years were reduced
documentation loansl Countrywide employees and brokers clearly sold reduced documentation
loans to borrowers Jgardless of the borrowers' ability of the borrower to document income and
assets. In fact, counlryWide sold some of its reduced documentation loans to salaried borrowers
who received W-2's rrom their employment. Countrywide had no rules restricting the sale of
reduced documentation loans to borrowers who had difficulty documenting their income.
24
·-
-. '. - - - - - - - - 1 - - - -
.---.-------------~-------------__,
Rather, they could be sold to borrowers regardless of the ease or difficulty of documenting their
income, employment
86.
L
assets.
Countrywide Jad very
fe~ safeguards on the use and underwriting of reduced
documentation loans. The only check on fraudulent income was a reasonableness standard
allegedly used by Countrywide. Early on, Countrywide employees merely used their judgment
in deciding whether
JI
not a stated income loan seemed reasonable. In or around 2005 or 2006,
.
Countrywide reqUire, its employees to use salary. com - a website that provides a salary range
for a given job title or profession in a certain zip code - to determine whether the income stated
on the loan apPlicatiJn appeared reasonable. However, if the stated income fell outside of the
range provided by sJary.com, Countrywide underwriters could still approve the loan.
87.
In addition to a lack of controls on these risky underwriting guidelines, Countrywide
pushed their sales employees, both retail and wholesale, and their underwriters to sell and close
large volumes of 10aL without due regard for the risk to borrowers as quickly as possible.
Countrywide fired el Ployees for low production when they failed to originate and close
I
'
sufficient numbers ot" loans.
88.
To encouragel the fast origination of loans, Countrywide compensated its sales
employees, at least iJ part, on the volume of loans sold. The more loans its employees sold, the
more money countdwide paid them. Countrywide sales employees were paid on a tiered bonus
system that compenslted them
mor~
for each tier of sales volume they reached during the month.
Once an employee sLd enough loans to put him in the next tier for that month, he would earn
more on each loan hi had sold during that month. A substantial portion of the salary of
Countrywide sales eLployees, both retail and wholesale, was based on sales volume. In fact,
wholesale account Jecutives-countryWide employees who dealt with
25
brokers~were paid only
on commission, they had no base salary. Countrywide employees, therefore, had incentives to
sell as many loans as possible - regardless of credit risk.
89.
countryWide'ls underwriters were also compensated based on the number of loans they
underwrote. They w re paid a base salary, but a large percentage of their total salary was a
I
bonus payment based on the number of loans underwritten. In addition, the goal for underwriters
who reviewed brokJ files was to approve and process purchase files in 24 hours and refinance
files in 48-72 hours. One underwriter stated that, for a period of time, she was required to
underwrite 25 loan files a day during the week and 25-35 loan application files over the
weekend. Thus, coJntryWide underwriters also had a large incentive to underwrite as many
loans as possible as JUiCklY as
90.
po~sible, and Countrywide pushed them to do so.
In addition to these compensation incentives for its own employees, Countrywide enticed
its mortgage brokers to sell reduced documentation loans with advertisements proclaiming
Expanded Criteria: More ways to say yes! Qualify more of your borrowers with
Expanded Criteria programs from Countrywide®, America's Wholesale Lender®.
Countrywideloffers some of the most flexible documentation guidelines in the
industry. OUf extensive Expanded Criteria programs provide you with solutions
that help yourclose more loans. You'll see that when it comes to lower
documentation loans; no one delivers like Countrywide.
I
91.
Countrywide also enticed brokers with advertisements that said "Designed to deliver Low
Doc and No Doc solutions to meet the needs of virtually every type of borrower," "NO
I
INCOME NO ASSEITS DOC OPTIONS," "Reduced Doc - Simplified and ~nhanced!," and
"Low down payment, low documentation solutions."
92.
The lack of 1les and oversight on stated income loans. and the push for employees to sell
more loans and to c10se loans quickly, facilitated rampant fraud in the sales of reduced
documentation loansl Countrywide sales empfoyees and brokers used reduced documentation
loans as a way to qJlify borrowers for loans they could not afford. One fonner Countrywide
26
employee has
estima~ed
that approximately 90% of all reduced documentation loans sold out of
the branch where he lorked in Chicago had inflated incomes.
93.
As noted in a fhiCagO Tribune article, the Mortgage Asset Research Institute reviewed
100 stated income loans, comparing the income on the loan documents with the borrowers' tax
documents. The reviJw found that almost 60% of the income amounts were inflated by more
,
I
than 50%, and that 90% of the loans had inflated income of at least 5%.
94.
Countrywide lales employees sometimes received income documentation (e.g. W-2's or
tax returns) and deteiined that the borrower could not qualifY for the loan based on their real
income. The emPloyle would then submit the loan as a stated income'loan, inflating the
borrower's income t1 qualify him for the loan .. Countrywide "stretch[edl the income" on
reduced documentation loans as far as possible.
95.
In the review bf one Illinois mortgage broker's sales of Countrywide loans, the vast
majority of the loans had inflated income, almost all without the borrowers' knowledge.
96.
Many Countrywide borrowers were not aware they were receiving a reduced
,
documentation Joan, bd did not realize they were being sold a loan they could not afford and
were not qualified to receive.
97.
In addition to a lack of rules concerning what borrowers were appropriate for reduced
documentation loans, Countrywide failed to have sufficient controls concerning what loan
programs could be S11d as reduced documentation loans. Many of the riskier exotic and
"affordability" products offered by Countrywide were sold with reduced documentation. For
I
'
example, Countrywide's option ARM and interest-only products could be sold with reduced
documentation undetiting. Countrywide also sold loans with very high loan-to-value ratio,
with reduced documentation underwriting.
27
98.
Countrywide pushed these products in advertisements to its mortgage brokers like:
"Check Out countrytde's Expanded Criteria 80/20 Loans with Reduced Documentation!";
"Low down paymentllow documentation solutions. QualitY more. borrowers with high LTV s and
low doc options frol Countrywide®, America's Wholesale Lender®;" "Stated Income Program
Enhancements. Up to 100% LTV;" and "The PayOption ARM from Countrywide®, America's
Wholesale Lender® lffers your qualified borrowers reduced paperwork with the Stated
Income/Stated Asset! (SISA) documentation option."·
99.
..
Not surprisingly, reduced documentation loans have higher delinquency rales than full
documentation loans) further suggesting the prevalence of fraud in these loans.
100.
Countrywide laCknOwledged the existence of higher default rates for reduced
documentation loans in its 10-Q filing for the first quarter of 2008:
We attribute the
overall increase in delinquencies in our servicing portfolio from
I
March, 31, 2007 to March 31, 2008, to increased production of loans in recent
years with hi~her loan-to-value ratios and reduced documentation requirements,
combined wi~h a weakening housing market and significant tightening of
available credit and to portfolio seasoning.
101.
Even if incoJe was not inflated, Countrywide charged many borrowers more for reduced
documentation loansl Countrywide employees used reduced documentation loans because they
were faster, easier to sell, and to underwrite. It took as little as 30 minutes to undervrrite some
reduced documentatirn loans, and some loans closed the same day the application was taken
from the borrower. This scheme enabled Countrywide employees to sell more loans and make
more money. So, sore borrowers who could easily have documented their income were sold
more expensive reduced documentation loans by Countrywide employees and brokers.
28
.
102.
In short, countrwide's sal~ of reduced documentation loans put many Illinois borrowers
into unnecessarily riskier and more costly loans and, for many borrowers, loans that they could
not afford.
B.
Countrywide Inappropriately Qualified Borrowers For Adjustable Rate and Interest-Only
Mortgages Bas6d on Less than a Fully-Indexed Rate or Less Than Fully-Amortizing
Payments
I
103.
.
In addition to increased sales of reduced documentation loans, in recent years
Country~ide also incrlased its sale of "affordability" products. These loans allowed borrowers
to obtain a loan with Ibw initial payments that would not continue for the life of the loan.
I
.. I .
to repay the Ioan Its entirety.
.
I
104. One affordability product Countrywide sold was an interest-only loan. An interest-only
Countrywide qualified borrowers at this initial low payment knowing that they would not be able
In
loan allows borrowerl to make payments covering only the interest on their loan during the first
years of the loan, usulllY the first 3, 5, 7 or 10 years. After this initial period, borrowers must
make fully.-amortizink payments to payoff their principal balance plus interest over the
I
I
lower than the later fully-amortizing payments.
remaining life of the loan. The interest-only payments at the beginning of the loan are much
105.
According tol.an article by the New York Times published on November II, 2007,
Countrywide was thl second leading originator of interest-only loans from 2006 through the
I
.
second quarter of 2007.
106.
Countrywide sold interest-only loans to prime and subprime borrowers as stated income
loans. In 2005 and 2006, Countrywide's interest-only loan was sold to a borrower with a credit
score as low as 560 J and as a stated income loan to a borrower with a credit score aslow as 620.
29
107.
In 2007, Countrywide qualified non-prime borrowers to receive interest-only loans for up
to $1 million with a
linimu~ credit score of 600 and up to $850,000 with a minimum cr~dit
score of 580. IntereJonlY loans in lesser amounts were also available to non-prime borrowers
as stated income loJs. One Countrywide ad to brokers touts "Interest-Only loans from
Countrywide®, AmJica's Wholesale Lender® offer low monthly payments for the
I
.
.
initi~lloan
period, possibly helping your non-prime customers qualify for a bigger loan amount."
108.
During at le+ part of the time from 2003 through 2007, Countrywide qualified its
borrowers at less thar fully-amortized payments on its interest-only products. According to
comments Countrywide provided to federal regulators concerning the proposed Interagency
I
.
.
Guidance on Nontraditional Mortgage Products, Countrywide stated that "[i]nterest-only loans
are designed to be
J
affordability product, allowing borrowers to qualify at the 'minimum' or
lower non-amortizink interest only payment for a fixed and extended term. We [Countrywide]
believe that it is appLpriate to qualify borrowers based on the interest only payment."
109.
Countrywide advertised these loose underwriting standards to its brokers in ads like
"Maximize your borrower's cash flow with Interest-Only loans. Qualify based on the InterestOnly payment."
110.
The practice 10f qualifying borrowers at low interest-only payments, which, under the
terms of the mortgar' can only be paid during a certain period of the loan and then a higher,
fully amortizing payment will be required, places borrowers into loans that they ultimately may
not be able to affordl. Such a practice implicitly relies on borrowers either changing their
financial circumstanlces or being able to sell their home or refinance their loan.
30
Ill.
Moreover, th se interest-only loans could be given using the loose standards of a Stated
.
.
.
I
Income; No Ratio; srted Income, Stated Asset; and a No Income, No Assets or Employment
(No Doc) loan, creating even more risk that the borrower would not be able to afford the loan.
112.
Countrywide advertised its "flexible qualifying criteria" even to brokers selling this
product to subprime borrowers. In'one ad to brokers titled "Interest Only Now Available for
I
.
,
Non-Prime Stated Wage Earners," Countrywide told its brokers that their "Interest Only loan
I
options give Stated rage Earners more flexible qualifying criteria." Countrywide went on to
entice brokers to "le1rn more about how our Non-Prime Interest Only loan programs can help
you increase your business and qualify more borrowers for their dream home ... ". This
interest~only
product could be sold as a stated income loan to a borrower with a credit score as
low as 620.
113.
The interest-only loan advertised above could also be a hybrid ARM. Borrowers who
i
took out this loan as hybrid adjustable rate mortgage ("ARM") received a loan that (I) allowed
them to pay only the [interest portion of their full payment for the first years of the loan, and (2)
came with a discouJed interest rate that would likely increase after the first few years. Such
borrowers were set
u~ for a payment shock once the discounted fixed rate term and interest-only
portion of their loan tas over.
114.
Countrywide lsed these products to entice unsuspecting borrowers with low monthly
payments and to qUal!ify more borrowers for loans - often loans that they might not be able to
afford long-term.
115.
Another afforaability product sold by Countrywide was the hybrid ARM.' These loans
typically have a ,WO+.,hree- year fixed rale followed by 28 or 27 years of a variable rale, and
are often referred to as a 2128 and 3/27. These loans usually came with low, discounted interest
31
L-_ _ _ _ _ _ _ _ _ _.....L_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _------'-______..
rates during the short fixed-rate period. After the fixed-rate period ended, the rate would
adjust-b~t could onl~ adjust up, not down-every six months to a year, based on an index plus
a margin.
116.
countrywi~e sold these loans to prime and subprime borrowers.
Countrywide Lso qualified its borrowers at less than fully-indexed rates on its 2/28's and
I
3/27's, meaning that Countrywide qualified the borrowers based on low rates that would adjust
upward in two or thrl years without regard to whether the borrowers could afford the higher
I
.
rates. This scheme ,orced borrowers into unaffordable payments once the fixed rate period of
their loans terminated because they were not qualified at these higher payments.
117.
One Illinois donsumer's experience provides an example of Countrywide's business
practice of placing bdrrowers in unaffordable hybrid ARM loans. Countrywide was the servicer
Wid~W'S mortgage loan. This widow lived on a fixed income. At the time
Countrywide purchaded the servicing rights for her loan, the widow had a 30-year fixed-rat~
for a 64 year-old
mortgage with a monlhlY payment of approximately $300. In January 2005, Countrywide
refinanced this 64 yet-old borrower into a 3/27 interest-only loan with a fixed rate for only the
.
I
.
first three years of the loan. The consumer's monthly payment more than doubled to
approximately $800
l
month. Even before this consumer's loan reset, however, she was unable
. to afford her mortgaje payment - showing that Countrywide refinanced her into an unaffordable
adjustable rate mortglge.
118.
Countrywide acknowledged in a May 7, 2007 letter to the Office of Thrift Supervision
commenting on a pryosed federal Statement on Subprime Mortgage Lending that: "Specifically
looking at originations in the fourth quarter of2006, we know that almost 60% of the borrowers
who obtained sUbPriLe hybrid ARMs [from Countrywide] would not have qualified at the fully
indexed rate." counJryWide also acknowledged that "almost 25% of the borrowers would not
32
have qualified for any/ other [Countrywide] product." Even removing the added risk layers of
reduced documentation and high loan-to-value ratios, Countrywide knew that a majority of the
borrowers who receivld' their hybrid ARMs, at least during this period, were likely unable to
afford the loans unleJ they refinanced by the time the introductory fixed period expired.
I
119.
"
,
'Countrywide did not inform its borrowers who were qualified at less than a fully-indexed
rate or less than a
full~-amortizing payment, that they were not qualified at the higher payments
after the loans reseLl
120.
Countrywide. ade loans to borrowers that they ultimately would not be able to afford,
relying on the premisl that borrowers would be able to continue to refinance out of their
unaffordable loans inL
~ew loans - and without making clear to borrowers the costs and risks of
such loans.
Countrywide Pursued Market Share With Products That Layered Borrowers' Loans with
Unnecessary Additional Risk
121.
Even as it wJ relaxing its underwriting standards to increase loan origination,
Countrywide also SOight to increase its market share by offering new products packed with
features that compouted risk to the borrower. These included option ARM mortgage products
and loans for all or elise to all of a homeowner's equity in a home.
122.
The New York Times aptly described Countrywide's increasing origination of exotic
products during the P1lriod from 2005 into 2007 with a quote from a forme; Countrywide
executive that: "To tHe extent that more than 5 percent of the market was originating a particular
product" any new aItJrnative mortgage product, then Countrywide would originate it."
33
A.
Countrywidel's Combined its PayOption ARM with Unnecessary Layers of Risk.
Confusing Disclosures. Inappropriate Sales Incentives and
Improper Marketing.
i,
Inadequate Oversight
, ,
123.
countryWiderS marketing and selling of option ARM mortgage loans exemplifies the
I
'
company's increasing reliance on unfair and deceptive loan products and sales techniques to
increase its market
124.
s~are.
From their iJception, option ARMs were intended to be "a niche product aimed at'
sophi'sticated and wJII-heeled borrowers who wanted flexibility." Starting in 2003, however,
option ARM OriginJion grew beyond this narrow market, particularly at Countrywide.
125.
Option A'JS, frequently referred to as "exotic" mortgage products, have three core
features that sharply contrast with traditional mortgage loan products.
126.
First, for a certain period of time, borrowers have four options as to which payment to
I
make each month. These payment options are (I) a minimum payment that covers none ofthe
principal and only pL of the interest normally due each month; (2) an interest-only payment; (3)
a payment that is aJortized to pay off the loan in 30 years; and (4) a payment that is amortized to
~
payoff the loan in 1 years.
127.
'
Second, an obtion ARM may result in negative amortization - meaning that the amount
owed increases over time. The amount of accrued interest that is not paid each month is added
onto the borrower's Iloan balance. Therefore, the balance of the borrower's loan will actually
increase by the amount of the unpaid interest if the borrower makes only minimum payments.
128.
Traditional1~. failure to pay the amount ofaccrued interest on a loan each month results
in, default and, ultimately, foreclosure. This outcome is a negative event for both the borrower
and the lender.
Wit~ option ARMs, however, Countrywide was able to neutralize this negative
34
event - at least for itstf. Countrywide simply added this uncollected interest to the borrower's
loan as additional principal and calculated the interest on this new, higher amount of principal.
129.
There was, h+ever, a cap to the amount of unpaid interest growing from negative
amortization that could be added to the principal of the loan. Once the loan balance hit a certain
I
.
ceiling - typically 115% of the loan's value - the minimum and interest-only payment options
were removed and tht borrower had to make fully-amortizing principal and interest payments.
This "recasting" of tie loan is the third core feature of a option ARM.
) 30.
The fully-amortizing payments that borrowers must make after recast are far more than
the minimum paymel that the borrowers had been previously
I
maki~g. Taking one consumer's
.
loan as an example, the monthly minimum payment was $75), but the fully amortizing payment
was $1834. The paytent shock experienced by option ARM borrowers when the interest rate on
their adjustable rate mortgage fluctuated was small compared to the payment shock from a loan
.
. 1
. . payment. A
'·
.
. fior
recastmg to reqUire t/lle full y-amortlzmg
ssummg
stead y mterest
rates, recastmg
.
I.
consumers who consjstently make the minimum required payment will occur approximately
three to four years a1er origination of the loan.
131.
Countrywide jqUiCklYbecame a leader in this profitable and growing part of the mortgage
market. Option ARMs increased from approximately 3% of the company's loan production
during the quarter enred June 30, 2004, to approximately 21 % of its production during the
quarter ended June 30, 2005.
132.
.
The reason fL Countrywide's increasing origination of option ARMs is clear: profit. An
I
investigation by the New York Times revealed that option ARMs "were especially lucrative.
Internal company. doLments from March [2007] show that Countrywide made gross profit
35
margins of more than 4 percent on such loans, compared with 2 percent margins earned on loans
backed by the Federal Housing Administration."
133.
.
At the same tile that Countrywide touted the profitability of these loans, it also
acknowledged that thly were riskier for borrowers. The company said in its June 30, 2005 10-Q
filing, "[w]hen the mLthlY payments for pay-option loans eventually increase, borrowers may
. I
..
.
be less likely to pay the increased amounts and, therefore, more likely to default on the loan, than
a borrower using a Jrmal amortizing loan." Angelo Mozilo even acknowledged that "it isn't
clear how succeSSfUl/borrowers ultimately wiH be in paying off their option ARMs."
134.
As discussed /below, it is now clear that many borrowers will not only fail to pay off their
option ARMs, but will lose equity in their homes and perhaps the ownership of their homes
altogether. The full teadth of the problem has yet to emerge, but the numbers show that
borrowers are losing ground. During the nine months ended September 30, 2007, 76% of
borrowers elected to make less than full interest payments - much less than a payment that
would cover any am Dunt of the outstanding loan principal. This represents a 10% increase over
the number of borrolers making less than full interest payments during the same period in 2006.
135.
While attentitn is now focused on the meltdown in the subprime mortgage industry,
option ARMs - whiJh are classified as "prime" loan products - are ticking time bombs contained
in lenders' prime IJn portfolios and in· securitized· loan pools. According to Moody's
Economy.com, monJhlY payments on roughly $229 billion of option ARMs will recast to include
market-rate interest
lnd principal from 2009 to 2011.
36
-+-_ _ _._ ..._... __ ...... .
L--_ _ _ _ _ _ _ _ _ _
.
1
136.
CountliVwide Inappropriately Coupled its Volatile PayOption ARM Loan Product
with Teaser Interest Rates, Prepayment Penalties, High LTVs and Reduced
. Docun!tentation Underwriting
The core featJes of an option ARM - multiple payment options, negative amortization
and automatic
re~astiig of loan terms - make the product much riskier than traditional
.
mortgages. But CoultryWide typically did not sell its option ARM (typically called a PayOption
ARM) with just theJ three features. Instead, it proceeded to layer the product with features that
made it exceptionaU1 risky, placing borrowers at risk of losing equHy in their homes or even
their homes. These features include: illusory teaser interest rates, prepayment penalties, high
loan-to-value ratios jndlor reduced documentation underwriting guidelines. As one former .
I
Countrywide loan originator explained, Countrywide'S "options ARMs were built to fail."
137.
Countrywide frequently combined its PayOption ARMs with illusory "teaser" interest
rates. These "teaser'i interest rates could be as low as I %, but were illusory in that they were
generally only valid for the first month or first three months of the loan.
138.
After the illJOry teaser interest rate expired, the interest
.
rat~ on the loan would adjust to
a true interest rate tht typically had a cap of9.95%. After the initial interest rate adjustment, the
interest rate on the IJan would continue to adjust each month.
Therefore~ the borrower would
only have the benefiJ of the interest rate for one to three months of the 30 to 40 years of the life
of the loan.
139.
An interest rre that was only in effect for one month conferred no real benefit to a
borro~er.
.
Thus, thej marketing emphasis on the teaser interest rate of Countrywide's PayOption
ARM was inherently misleading.
140.
Interviews 1th fonner Countrywide employees and brokers and an examination of
Countrywide'S adve)1isements confirmed that the teaser interest rate was used to mislead
37
' - - - - - - - - - - - - - + - - - - - - - - - - - - - - - - - - - - - - - _ ... -
... -_ ....
borrowers and Obfuscle the true interest rate of the loan. A former Countrywide Account
Executive, who was assigned to work with brokers in selling Countrywide products, was
.
I
.
encouraged to tell her brokers to sell the loan based on the low monthly payment. A former
I
.
employee who worked at Countrywide's prime retail locations confirmed that loan originators
sold the product by
hi~hlighting the low payment on the option ARM, although it was based on
'11
.
I
an I usory teaser .lnterst rate..
141.
..
.
CountrywIde's advertIsements hIghlighted the teaser Interest rate. For example, a
television advertisemLt promoting the product emphasized "[a]nd 1 percent, you can't beat that.
So pick up the phone, call Countrywide, or just visit your local branch today." Despite legal
disclaimers, this emphasis on the teaser interest rate shows the company's intent to use the teaser
to market the prOduct)
142.
Countrywide Lso generally coupled its option ARM loans with a three year prepayment
penalty. In order for
1consumer to refinance an option ARM during the first three years of the
loan, the consumer wLld be required to pay the equivalent of six
I
months~ interest on the loan.
Consequently, even if borrowers became aware of the risky features of their mortgage, they were
effectively trapped in a loan with a payment that could adjust upward and become unaffordable.
143.
Although prepayment penalties are touted by lenders as a bargaining tool for consumers,
analysis has revealed that subprime borrowers generally received no appreciable benefit in
exchange for accepting a loan with a prepayment penalty. At least one broker indicated that,
although he was paid more for a loan with a prepayment penalty, there was no appreciable
benefit to a prime cOl:}sumer for taking a loan with a prepayment penalty. Therefore, the only
point ofthis risky fJture was to generate additional profit for Countrywide because investors
would pay more for Ibans ,with prepayment penalties.
38
.
144.
Another risk Yi feature that Countrywide layered onto its PayOption ARM allowed a
1
I'
borrower to mortgag 90-95% of a home's value with a PayOption ARM first mortgage for the
.
bulk of the amount and a second mortgage for the remainder.
145.
According to a UBS survey conducted on behalf of The Wall Street Journal:
Countrywide also allowed borrowers to put down as little as 5% of a home's price and
offered "pigghack mortgages," which allow borrowers to finance more than 80% of a
home's valuelwithout paying for private mortgage insurance. By 2006, nearly 29% of the
option ARMs' originated by Countrywide and packaged into mortgage securities had a
combined lot-to-value of 90% or more, up from just 15% in 2004, accord.in g to UBS.
146.
Although higher loan-to-value ratios are inherently riskier than lower loan-to-value
ratios, that risk is colpounded when' the underlying mortgage product is an option ARM. If a
borrower has an oPtit ARM mortgage with a high loan-to-value ratio
o~ during a time when the
housing market deprLiates (or .both), the borrower could easily end up owing more on a home
than it was worth bJause of the possibility of negative amortization on this product.
147.
Finally, the vtt majority of the PayOption ARMs sold by Countrywide were
.
I
.
underwritten with reduced documentation requirements. Prudent underwriting is how borrowers
are protected from thl risk that they will be given a mortgage that they will not be able to repay.
In the case of a paydption ARM; Countrywide purportedly mitigated the risk that borrowers
would not be
~ble to ~epay their risky loans by requiring that its underwriters qualify borrowers
.
at the full principal Jd interest payment for the option ARM. This process became a
meaningless protectit, however, when Countrywide failed to require full documentation for· its
underwriting.
148.
When COUntTwide designed its mortgage products, it also determined what underwriting
documentation requi ements it would attach to the product. As discussed above, these
39
requirements could
lary from full documentation to no documentation at all. Countrywide
apparently decided tnat its underwriting for an option ARM did not require full documentation.
149.
This decision led to underwriting guidelines that allowed a borrower to mortgage 95% or
more of the value of a home with a PayOption ARM underwritten with stated income and stated
assets.
150.
countryWidels decision to allow reduced documentation underwriting resulted in the vast
majority of its PayO ' tion ARMs being sold with less than full documentation. Of the option
ARMs Countrywide sold in 2007,82% were reduced documentation mortgages in which the
borrower did not funy document income or assets.
151.
.
One former JountryWide manager noted that the loans were an easy sell because they
could use stated
inc~me - presumably to ensure that the borrower's income (at least what was
stated as the borrower's income) was sufficient to qualify for the mortgage.
·152.
As discussed/above, low or no documentation loans are likely to contain material
misrepresentations
a~dlor fraud that will result in increased default r~tes. Risk of default is
compounded when al lessened underwriting standard is coupled with "nontraditional" mortgages
such as option ARMl. Regulators and analysts have counseled against this type of risk layering.
inco~e
Banking regJlators say that' lenders are increasingly relying on unverified
to
qualify borrofers for so-called nontraditional mortgage loans. Those products - such as
pay-option adjustable-rate mortgages and interest-only loans - allow borrowers to defer
payment of ~rincipal and sometimes interest. Many analysts see such a combination of
nontraditional products and nontraditional underwriting processes as presenting another
layer of risk to those who could be hurt by defaults, including consumers, shareholders in
mortgage len~ers and investors in securities backed by mortgage loans.
153.
Combining a PayOption ARM with any of the risk-layering features described above
results in a product that is significantly increases a borrower's risk of loosing home equity or
ending up in forecJo lure.
40
154.
Delinquency reports support this conclusion. Statistics show that consumers are
I
becoming increasingly delinquent on option,ARMs. Countrywide securitized roughly three
quarters of its option ARMs, but held the loans most likely to be high performing in its portfolio.
Of the option ARMs that Countrywide held in its bank portfolio, 9.4% of the option ARMs were
at least 90 days past aue in April 2008, up from 5.7% at the end of December 2007 and 1% a
I '
.
year earlier. As this input likely includes many option ARMs that have not recast, these
delinquencies are
pa~fiCUlarlY alarming as they show consumers are not even able to make the
minimum payment
these loans. In other words, borrowers somehow received option ARMs
0
when they were unaOjle to make even the minimum payments, much less the fully-amortizing
payment.
ISS.
These numbe s show that option ARMs are failing at a troubling rate, but that has not led
I
Countrywide to stop layering the product with risky features. In fact, an analysis of only those
option ARMs that clntrywide held in its own portfolios (i.e., the least risky option ARMs)
sho~s a steady decreLe in loan quality. For example, the loan-to-value ratio for the product
I
.
increased from 73% in 2004 to 76% in 2007. The average credit score, a general indicator of
creditworthiness. drotPed from 730 in December 2004 to 716 in September 2007. Even though
external indicators should have provided Countrywide with ample notice that it needed to tighten
option ARM undeJiting criteria, the company continued to relax its standards in selling
increasingly risky lJns.
156.
.
'
Former counJryWide employees and brokers who sold Countrywide products have stated
that option ARMs aJ risky products.
IS 7.
.
Some of coJtryWide' s own former employees found the product unsound for anyone.
Brokers who sold the product opined that it should never be paired with either a prepayment
41
penalty or reduced documentation underwriting due to the dramatic increase in risk to the
borrowers. Another Jroker referred to the product as a "ticking time bomb" and another former
Countrywide emPloyl referred to it as "dangerous."
2.
158.
.
.
countlwide Improperly Mass Marketed Its PayOption ARMs and Failed to
providb Borrowers with Adequate Disclosures About the Product's Risks
Despite the stLctural unfairness of·the PayOption ARM described above, Countrywide
marketed the product indiscriminately to all borrowers, pushed its employees and brokers who
sold Countrywide loans to sell the product inappropriately and failed to provide disclosures to
I·
.
.
ameliorate borrowers/' confusion about the mortgage they were obtaining.
1~9.
With all of itS risky features. the pay~Ption ARM should have been marketed. cautiously
j
- If at all. That was Jot, however, CountryWIde's approach. For example, CountryWIde sent
direct mailers to conLmers whose loans it serviced to market the product. In one such mailer,
I
.
Countrywide advised the consumer that he had an "excellent payment record" and might now
qual iIY for "our best I, A' level mortgage interest rates - such as our PayOption ARM."
160.
Likewise, Countrywide sent direct mailers to consumers advising them to call
Countrywide for a 01e year anniversary loan check-up. The direct mailer also touted
Countrywide's option ARM product.
161.
countrywidelprovided its brokers with sample advertisements that they could use to
entice borrowers to Jet option ARMs. One of these advertisement exemplars asks borrowers
"[w]ho doesn't need more options?" The implication of the ad is that an option ARM is
appropriate for anyone who would simply like "more options."
162.
The disclos.!es that Countrywide gave borrowers provided little help in explaining their
actual mortgages
bi~use they were the epitome of "infonnation overload." For example,. in
2007, one disclosure entitled the "Home Loan Application Disclosure Handbook" (Handbook)
42
L - - - - - - - - - - - : - - - - ' - - f - - - - - - - -_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ .... _ .. _
was 123 pages long ard had 63 pages concerning all of the available Countrywide lo~n products,
not just the products in which borrowers were interested.
163.
Regardless 01whether borrowers applied for loans through a broker or a retail division,
Countrywide sent bOfwers various disclosures, such as this handbook, prior to closing loans.
Often aCknOWledgmTtforms accompanied the disclosures. For some borrowers, Countrywide
required consumers to sign acknowledgement forms prior to processing the loan application. At
this point, what typesjOf loans they could even afford. Without th'is information, it was difficult
for borrowers to asse s the various mortgage products and their options. For other borrowers,
Countrywide reqUirJ borrowers to sign acknowledgment forms at closings, along with many
other closing documelts.
164.
For borroweJ wanting to learn about PayOption ARMs, in the Handbook, there were
I
"
eight pages about different PayOption ARMs buried in the middle of other disclosures. Each of
I "
"
"
these" had confusing titles such as "PayOption Adjustable Rate Mortgage Loan Program
I
Disclosure Monthly Treasury Average ("MTA") Index-Payment Caps All States Except New
York."
165.
Not only did
rS
Handbook bury explanations of Countrywide PayOption ARMs and use
confusing titles to describe them, it also failed to adequately warn borrowers about the possible
pitfalls of negative 10rtization with option ARMs, like depreciation of home values. The
Handbook defined negative amortization as ... "the interest shortage in a [consumer's] payment
is automatically addet to the loan balance and then interest may be charged on that amount}.
[The consumer] might therefore owe the lender more later in the loan ... " It then stated,
I.
"H owever, an Increase
.
. what you"
In the va Iue 0 f your h""
orne may rna ke up fior th'
e Increase In
43
"
owe." Yet, it never tated that if the market failed or the value of the homes depreciated,
consumers would 01e more than the value of their homes.
166.
By overloading borrowers with irrelevant information and using confusing language,
Countrywide's disc+ures hid the very infonnation that they were supposed to disclose to
consumers-the relTant details about their actual mortgages.
J 67.
'.
Notably, a number of former Countrywide employees remarked that they did not feel
I'
.
comfortable selling the products because they either did not understand the product themselves
or did not feel comrJjble explaining it to someone else..
J68.
.
Although COl:lntrywide may have created training materials for the product, at least one
former employee did not recall receiving any training on it at all - although she was authorized
to sell option ARMs. Brokers authorized to sell Countrywide products similarly recalled that the
company failed to prDvide any training materials on option ARMs.
169.
.
With their riJ and complexity, option ARMs should have been sold with discretion and
I
only with proper disclosures of risks. Countrywide knew from its own empirical evidence that
its mass-marketing JthiS product would place many homeowners into unsustainable loans.
170. . When consuJers made only the minimum payment, Countrywide carried the negative
amortization that reJlted on its books as uncollected "income." In 2004, the accumulated
negative amortization "income" was only $29 thousand. For the year ending 2007, however,
accumulated negative amortization from pay option ARMs that Countrywide was holding on its
books had grown to $1.215 billion. The negative amortization had steadily - and markedly _
increased from $29 thpusand to slightly over a billion dollars by rising to $74.7 million in 2005
and $654 million at ylar end 2006,.
.
44
171.
Despite all of these warning signs and the widespread acknowledgement among analysts
and even its own foJer employees that this product is unsuitable for most
borro~ers,
Countrywide is still Jromoting its option ARM products on its website to this day.
1,
172.
counthwide Incentivized and Facilitated Improper Sales Techniques without
Providing Adequate Guidelines for Selling its PayOption ARMs
I
Countrywide further increased the risks associated with this product by incentivizing
mortgage brokers to Jell PayOption ARMs over more traditional mortgage products. The
company then failed
i~ provide the brokers with sufficient parameters for selling the produc~
facilitated deceptive Jales tactics and did not exercise sufficient oversight over brokers' conduct.
173.
As Angelo MtZilO stated during an April 26, 2005 investor conference call, the product
I
was "a good product for both us, the lender, and for the mortgage broker." Countrywide left
consumers out of thij analysis.
174.
As an initial latter, Countrywide provided financial incentives for brokers and its
employees to inapprJpriatelY sell its PayOption ARMs.
175.
Brokers are clmpensated in two ways. First, borrowers may·compensate brokers directly
I
through loan origination, underwriting, processing and other fees. The second way that brokers
are compensated, hotever, is through "yield spread premiums" ("YSPs").
176:
A yield sprea, premium is the cash rebate paid to a mortgage broker by a lender.
Typically, the YSP iSI based on a broker selling a borrower a loan with an interest rate above the
wholesale par rate. The par rate is the actual interest rate a borrower qualifies for with a given
lender. For example, a mortgage broker could earn a YSP for selling a borrower a loan with an
interest rate of 6.25%/ when the borrower's par rate i,s 6%. This fee is paid by the lender directly
to the broker as a "re ,ate." Although the consumer is not charged the fee directly, the consumer
45
- . - - - ... - ._....... _ - - - - - - - - - - - - - - - - - - - ,
pays the fee indirectl;y by paying a higher interest rate. The YSP is typically a percentage of the
.
I
loan amount, therefore, the larger the loan, the larger the fee that the broker earns.
177.
Countrywide structured the YSP for option ARMs in a manner that virtually guaranteed
. that brokers who weT more concerned with getting the highest YSP possible than getting their
borrowers the best loan possible would steer borrowers into these risky loans. Plainly put, it was
easier to obtain highL commissions for option ARMs as 'opposed to o'ther traditional
Countrywide
178.
mortga~e products.
.
.
Ordinarily a ,roker would need to increase the interest rate over a borrower's par rate on
a loan in order to receive a higher YSP. A borrower would notice, of course, that a broker was
offering a loan with
Jhigher interest rate.
.
179.· With option lRMs, the YSP was based on three factors which helped obscure the true
cost of the loan: the tount of the teaser interest rate, the
amo~nt of the margin that was used to
calculate the prodUCT interest rate, and the existence of a prepayment penalty.
180.
First, the teaser rate was so low, borrowers would not notice a material difference
I
between 1%, for exaTPle, and 1.25%.
181.
Second, as fal as the margin, borrowers were unlikely to notice what the margin was and
realize that they were able to negotiate this term. Once the one-month teaser rate has expired,
the Pay Option ARM's interest rate is calculated each month by adding a margin-e.g. 40/0-0n
top of on an
in~ex (slh as the monthly United States Treasury average yield). The margin
remains the same thrlghout the life of the loan, while the index changes monthly. The higher
the margin, the highJ the borrower's interest rate would be from month to month after the oneI
.
.
.
month teaser rate expired. Both the standard used for the index and the margin amount could be
negotiated by the boJower. But because brokers sold the low monthly payment and the teaser
46
interest rate, the fact tnat there were other features that could be adjusted - to the borrower's
detriment - often wenJ unnoticed and was buried in the midst of the voluminous disclosures that
,
I
borrowers received. ihUS, borrowers would not typically notice if their broker increased their
loan's margin to the maximum sold by Countrywide (around 4%) in order to increase his YSP.
182.
Finally, brokel often added a three-year prepayment penalty to the loan. As discussed
above, borrowers
fre.q~entIY
did not receive any benefit for accepting a loan with a prepayment
penalty - if they were jeven aware the loan had a prepayment penalty.
183.
By slightly increasing an already low "teaser" rate, increasing the margin, and adding a
three-year prepaymenJ penalty, brokers could maximize the YSP Countrywide paid them.
184.
Notably, becJse PayOption ARMs were considered "prime" loan products, borrowers
I
'
who qualified for the loan would also ,have qualified for fixed rate and adjustable rate mortgages
with favorably low iJerest rates. The true interest rate on a PayOption ARM was typically
.
higher than the rates 1n either of these products .. In other words, borrowers paid a premium for a
product that most of tlitem did not understand and that did not provide them with any benefits in
return for this premiuL.
185.
'
Therefore, CobntryWide provided brokers
~ith a financial incentive to sell option ARMs
with a high margin an6 the worst prepayment penalty possible. Although the possible fraud that
this financial incentiJ would motivate should have been clear, Countrywide then failed to
institute appropriate clecks on its sale or to adequately oversee its brokers.
186.
A mortgage bLker's primary contact within Countrywide was its assigned Account
Executive, a countrylde employee. Account Executives gave brokers selling tips on option
ARMs to emphasize t~e meaningless one-month teaser rate. One former Countrywide Account
47
Executive was encourged to tell herbrokers to sell the,loan based on the low monthly payment,
since rising property values would offset negative amortization.
187.
Countrywide tso gave its Account Executives materials, like flyers, which they could .
use to promote certait loan products to brokers or that they could give brokers to use to promote
Countrywide products to borrowers. Almost all of the flyers that Account Executives gave to
brokers highlighted ttt reduced documentation could be used to qualify borrowers for the
I
product and also emphasized the illusory teaser interest rate for the product.
188.
Not surprisinJlY, after receiving materials emphasizing the illusory teaser interest rate,
brokers used the rate
189.
One broker,
~o obfuscate the true cost and interest rates of an option ARM.
fL
example, placed a full-page advertisement in the Chicago-Sun Times for
a closed-end line of Jedit of $235,000.00 for a monthly payment amount of $656.05. The
advertisement does o1t disclose that the interest rate upon which the payment is based is only
applicable for the
190.
firsf month of the mortgage loan.
Another example is a direct mailing that a broker used to advertise an option ARM
product. The broker Llicited consumers through a direct mailing for a closed-end line of credit
of $681,182.00 for a LonthlY payment amount of $1 ,898.54. Again, the direct mailing does not
~isclose, in .readilY UIlderstandable terms, that the interest rate upon which the payment is based
IS
only apphcable for the first month of the mortgage loan.
191.
Countrywide Iso failed to create any checks on who received a Countrywide option
ARM. Due to the coLplexity of the product and the likelihood of severe negative consequences
.
I
.
to the borrower - such as loss of home equity, this product was not appropriate for most
I
borrowers. As descrifed above, the option ARM was initially designed for sophisticated·
borrowers - people who were investing in or building homes or properties for resale.
48
Countrywide took tHis niche product and mass marketed it to the general public, often through
I·h . . .
mortgage bro kers, WIt out mstltutmg any parameters fi·
or Its saIe.
192.
Based Qn the materials that Acco.unt Executives gave brQkers regarding the pro.duct, it
wo.uld seem that the pro.duct was apprQpriate fo.r any bQrro.wer who. wanted "o.ptiQns," regardless
I
o.ftheir actual financial circumstances. This lack Qfrules enabled Co.untrywide's brokers to.
misuse the product atd to sell this Countrywide product to unsuspWing borrowers looking for a
gQQd, lo.ng-term, sustainable Io.an.
193.
Given Co.uJryWide'S critical reliance upo.n mortgage brokers to. sell o.ption ARMs, the
complexity of the piduct, and huge potential for borrower harm, Countrywide should have
develQped, emplQyed and facilitated prQper - no.t deceptive - sales techniques. CQuntrywide
also. should have instItuted parameters o.nwhat bo.rrQwers CQuld receive this prQduct.
Countrywide did no.t:
4.
194.
count fY wide's Relationship with One Source Mortgage, Inc. .
.
Countrywide' use and abuse of the o.ption ARM pro.duct is clearly illustrated by the
t
relatio.nship between he co.mpany and an IlIino.is broker who. specialized in selling Co.untrywide
PayOptio.n ARM 100Js, One So.urce Mo.rtgage, Inc. ("One So.urce") .
. 195.
Countrywide JhOUld have been aware of potential issues with One Source Mortgage, Inc.
when it first approvecti the broker to wo.rk as its business partner in Spring 2004 .. At the time
Charles Mango.ld, thelo.wner o.f One So.urce, submitted the company's bro.ker applicatio.n to.
. Co.untrywide, he had
10 fewer than five felo.ny cQnvictiQns .in the State Qf Illino.is.
Specifically,
between 1989 and 2000, Mango.ld was co.nvicted and sentenced to. jail time fQr impro.perly
1
communicating with j urQr, multiple occurrences of felony possession and use of a weapon or
firearm, and driving with a suspended o.r revo.ked license.
49
L-_ _ _ _ _ _ _ _ _ _--L_ _ _ _ _ _ _ _ _ _ _ _ _ _ _
. __ _
196.
In terms of actual conduct, One Source used the illusory one month teaser rate that
Countrywide cOUPIJ with its option -ARM exactly as one would expect - to commit fraud. For
I
example, when deserting the PayOption ARM to consumers, One Source told consumers the
amount of only one payment - the minimum payment. One Source also did not adequately
describe to
consumer~ the distinctive characteristics of PayOption ARMS: the fact that the initial
low interest rate was berely a one month teaser rate or that negative amortization would occur if
the consumers pay
197.
..
01IIy the mInImum
payment.
_
-
One Source frqUentlY did not disclose to consumers any interest rate for the mortgage
loan at all o~ describr only the illusory teaser rate.
198.
One Source told a consumer that his minimum payment of $700 covered all the interest
I
'
-
on his loan. In real it):' , the consumer would have had to pay $1816 a month to make even an
interest-only paymeJ on his loan.
199.
To the extent that Countrywide or One Source provided disclosures to consumers, they
were ineffectual. coLumers reported that they did not learn that One Source's representations
I
about their mortgage 'loans were false until they began to receive statements from Countrywide.
I
200.
-
Countrywide randSOmelY compensated One Source for its fraudulent conduct. One
Source received YSP from Countrywide ranging from $4185 to $1) ,31 0 per loan in the month
of
Mar~h 2006. DUrirg that one month, One Source reeei ved a total of at least $1 00,000 from
Countrywide in the form of yield spread premiums.
20 I.
One Source eigaged in rampant fraud on borrowers' loan applications without the
consumers' knowledge, and which Countrywide then completely failed to detect. Consumers
typically told One soLce their monthly income and even provided pay stubs and tax returns to _
verify their income.
bn
some consumers' loan applications, however, their monthly income was
50
L - - - - - - - - - - - - - t - - - - - - - - - - - - - - - - - - - - - ---
,---------
increased to sometimes even double the correct amount. Because Countrywide coupled
.PayOption ARMs WitJ reduced documentation underwriting, the company failed to discover this
fraud.
202.
For example, One Source listed one consumer's monthly income as $8000 on his
mortgage loan
apPlica~ion. In fact, this consumer earned on;y approximately $3400 to $4000 a
month and provided pry stubs and tax returns to One Source to verify his income. This
consumer was unaware that One Source listed his income as $8000.
203.
countryWide,J purported fraud detection programs failed to catch any of these issues.
Along with this failuJ Countrywide repeatedly bent the rules for One Source Mortgage.
Although it
w~s supplsedlY against company policy, Charles Mangold treated three Countrywide
employees (his prim+ underwriter, the manager of the branch he dealt with, and the closer on
his loans) to flowers and expensive gifts, such as Coach handbags.
204. . In addition, C1untrywide,S stated general policy is that broker files are assigned to
underwri,ters randomly. This policy was not followed in the case of One Source Mortgage. One
underwriter who worJed in Countrywide's Lisle office was often assigned to underwrite One
.
I
Source files and, in 2,06, this underwriter was designated as One Source's primary underwriter.
205.
This underwrrr was discipline,d time and again for errors in her underwriting. Prior to
being assigned to One Source, the underwriter had been counseled several times for, among
other things, quality
~fwork.
Eventually, Countrywide terminated the underwriter. Despite the
documented problems with One Source's primary underwriter, Countrywide failed to detect the
systemic fraud in the Fne Source loan files.
206.
Countrywide did nothing to curb the rampant abuses inflicted by this broker. In fact,
Countrywide did not Len terminate its relationship with the broker until December 2007 - after
51
the Attorney General's Office sued the broker for fraud and served Countrywide with a subpoena
I
seeking documents related to the broker's conduct.
207.
As the One sLrce example illustrates, Countrywide's inducements to brokers combined
with its lack of loan plrameters or any real oversight resulted in brokers steering borrowers to
loans that were exceptonallY risky and routinely qualifying borrowers for loans they could not
actually afford.
208.
As a result of Countrywide's inappropriate marketing, selling and risk layering of its
option ARM product, Illinois borrowers who thought they were refinancing into beneficial loan
product are now facing the possibility of losing all the equity they had built up in their homes or
,
losing their homes eJirelY.
I
B.
Countrywide Indiscriminately Sold Mortgages With High Loan-to-Value Ratios
Regardless of It he Loans' Risky Features
209.
In addition to Irisky products like option ARMs, Countrywide aggressively sold loans
with very high 10an-tLvalue ratios. In recent years, the loan-to-valueratio on many Countrywide
I
loans - that is, the ratio of the home's appraised value to the amount of the loan - reached as
high as' 100%. LoaJ with 100% loan-te-value ("LTV") ratios were sold as a sing;e loan, or
separated into two CQr' current loans: 'a first-lien loan paired with a simultaneously originated
second-lien loan that, together, had a combined loan-to-value ratio of 100%.
210.
These simultaneous second-lien loans were often referred to as "piggyback" loans, and
the combination ora hrst- and second-lien loan with a 100% loan-to-value ratio was commonly
referred to as an "80/10" or "combo" loan.
211.
-,
Countrywide tegUlarty paired the first-lien loan in the 80/20 loans with a second-lien loan
in the form of a prodLt type known as a Home Equity Line of Credit, or "HELOC."
52
212.
The HELOC second-lien loans were sold as open-end revolving lines of credit. But, in
order to avoid exorbitlt
~dd-on charges, borrowers were generally required to draw down the
principal amount of thl HELOCs fully at the time both the first and second-lien loans were
originated, and
count~wide required HELOC borrowers to maintain a "minimum" average
daily balance for sevejal years thereafter to keep the "minimum" balance intact.
213.
.
This loan structure could be comprised of a first-lien loan for 80% LTV piggybacked
with a simultaneous Jcond-lien HELOC for 20% LTV.
214.
Countrywide CLld also achieve this 100% LTV structure with a simultaneously written
second-lien fixed-rate loan. Countrywide boasted to its brokers that it has a "Greater variety of
high LTV, low doc oprions for more borrowers: Enhanced 80/20 Options."
215.
This conduct was profitable. Countrywide applied a higher rate of interest to loans in the
second lien position tJan the rate of interest applied to senior first-lien loans. This rate structure
I
produced a correspondingly higher monthly payment (and income stream for investors) due to
the higher interest ratJ applied to the outstanding principal balance on the junior second-lien
loans.
216.
Countrywide's simultaneous second-lien HELOCs often came with some variation of an
. I
interest-only period. Many of Countrywide's HELOCs had a five-year interest-only period that
could be extended fori another five years - this was called the "draw" period - even if the loan
was already fully
217.
dra~.
For the interest-only period, the required payment would only cover interest. As a result,
a borrower would neilher pay down any of the loan principal nor increase the amount of equity
I
.
.
in the home during th's time. Even if the borrower stayed current on monthly payments in these
loans, they could find themselves owing the entire original loan balance at the end of the interest-
53
only period of the loan tenn. In fact, CountryWide even had HELOCs that were interest only for
. the entire tenn of the loan.
218.
The length of loan tenn of the second-lien HELOC loans was generally shorter than the
length of the loan teT on the first-lien loans. Countrywide often paired junior second-lien
.
HELOCs that contaijed ~bbreviated 15-25 year tenns with senior first-lien loans containing 30year tenns.
219.
.
In these short r-tenn HELOCs that had interest-only features, the loan "reset" after the
.
Iy peno
" de~plre
l ' d f, iIve or ten years
. .mto thI
e Oan tenn. Thl
e oan t hen began to
mterest-on
amortize. Because tJese loans also often had a balloon feature at the end of the loan tenn,
however, they did nJ amortize fully. This meant that a borrower was set up to experience
payment shock tWice! First, the borrower would experience payment shock due to the reset to a
partially amortizing dayment amount. Next, the borrower would experience payment shock at
the end of the loan tel, when the balloon came due. Consequently, at the end of the tenn, the
borrower was faced Lth paying the total outstanding unpaid principal amount of the junior loan,
which came due befJe the end of the tenn of the underlying first-lien senior loan.
220.
To the uninitilted borrower, this balloon payment would arrive deep into the tenn of the
first-lien loan and cJld undennine the borrower's ability to maintain payments on the
underlying first-lien
.
Iran. This set-up was typical of Countrywide's 30/15 Balloon mortgage
loan. A "30115 Ball00n" was available on second loans with I 00% financing. Countrywide
prompted its brokers lo "Qualify more borrowers for 100% financing with our new 30115
Balloon options on sLonds."
54
.
221.
paired
All of these features of Countrywide HELOCs and piggyback loans, especially when
wid~ a loan wilh a combined LTV of 100%, had the potenti'al to force borrowers into
foreclosure or othe"e hann them.
222.
Loans with loan-to-value ratios of 100% combined with low introductory interest-only
payments, or with a Jalloon feature, are very risky. These features increase the risk that
borrowers cannot afftd the loan payments at all or will be unlikely to build any equity in their
I
.
homes when faced with stagnant or a slight reduction in home value. Such borrowers are at risk
of losing their homes if they cannot make the increased payments or cannot refinance. In either
case, borrowers will nave little or no equity with which to work in order to refinance, and may
have to pay out-of-prketiust to sell their home,:
223.
.
.
Not surprisingly, loans with piggyback second-lien loans are more likely to fail. Defaults
on the riskier, higheJate second lien loans expose the entire mortgage structure, both first and
I
.
.
second lien loans, to failure. Standard & Poor's, the largest securities rating agency, analyzed
over a half million firlt-Iien mortgages sold with HELOCs or fixed rate
sec~nds between 2002
I
and 2004 and found that borrowers were 43% more likely to default on those liens than
comparable first mortkages without piggybacks.
224.
'
I
Lending at 100% LTV is particularly dangerous with subprime borrowers who, as
demonstrated by their shaky credit history, are more likely to be without financial breathing
room, with no budgetary margin of error or an adequate safety net to help them weather and get
past even minor life elents, like the need to replace a water heater oran unusually high energy
bill. If they begin to liss payments and, as a consequence, have servicing penalties and late fees
added to their mortgaJe payments, they get turned "upside down" on the equity in their property
and quickly owe more on the Countrywide mortgage than their home is worth.
55
L..-----________+-_____________________________.____
L---~~_l __ _
--1
225.
This risk is mi gnified when paired with reduced documentation underwriting or other
features that further Jcrease the likelihood that the borrower will be unable to afford the loan.
226.
In 2005, couJtryWide qualified borrowers with credit scores as low as 580 for single
loans with 10an-to-vaLe ratios of 100% and for 80/20 piggyback loans.· On the first-lien loan in
a~ 80/20 piggyback IJan combination, borrowers could be sold an interest-only option, whereby
the borrower would iake payments only on the interest for a certain period of time .. During the
period in which the
b~rrower was paying only the interest, the principal balance on first-lien loan
would ·remain the saJe - at 80% offair market value.In 2007, a non-prime stated self-employed
or salaried borrower tUld qualify for an 80120 loan for as much as $850,000 with a minimum
credit score of 640 and could qualify for a loan up to $1 million with a minimum credit score of
680. As countryWidj told its brokers in an ad, "Countrywide®, America's Wholesale Lender®,
Specialty Lending GrLp delivers more options to your Non-Prime Stated Income borrowers!"
227.
A self-emPIOyld borrower with a minimum credit score of640 could get a "100% 'One
Loan' Stated" for up.l $700,000. A stated wage earner with a minimum credit score of 640
could also mortgage 100% of a home's value with an 80/20 loan.
228.
Countrywide told borrowers that there was "GOOD NEWS! Now you can qualify for up
to ) 00% financing wiJhout a recent bankruptcy affecting your FICO score." Countrywide
I
proclaimed "Low credit scores allowed" and "Hard to prove income acceptable."
229. . Countrywide jlso had 80/20 loanprograms that could be paired with a hybrid ARM-
even a hybrid ARM 1ith an interest-only feature.
230.
Countrywide loans made
<;it
100% loan-to-value were imprudently made and were
unsound as wrilten betause they were unsustainable and unaffordable for
borrowers in a stable nousing market.
56
borro~ers, even
Countrywide l!Jtilized Unfair and Deceptive Advertising and Sales Pitches to Push
Mortgages. While Hiding Costs and Risks to Consumers
231. . To further its 199ressive loan origination practices, Countrywide engaged in unfair and
deceptive sales pract+s through telemarketing, direct mailings, newspaper advertisements, and
television and radio commercials in Illinois. Countrywide generally lead consumers to believe
that they could offer donsumers the best loan at the lowest price. Countrywide'S advertisements
. to consumers often hil or obscured the risks associated with
diff~rent mortgage products and
refinancing.
A.
Personalized IJ>irect MailinQs Pushed Consumers to Refinance into Rish Products
232.
Country~ide Jent direct mailings to consumers in an effort to push certain mortgage
products and to induJ current Countrywide borrowers to refinance within a short period of time
after finalizing their 1(, an. Often, the direct mailing appeared to be a personalized letter or email,
including information about consumers' present loans, which deceptively compared present
loans with new offers, and instructed consumers to contact Countrywide quickly.
233 .. For example, fn or about April 15,2005, Countrywide sent borrowers a direct mailing to
refinance into a Pay Option ARM and directed borrowers to contact Countrywide on Saturday,
April 23, 2005. Next lo the consumer's name and address was a highlighted box which stated
the "estimated initiallayment savings" as $15,132 assuming the consumer refinanced into a
PayOption ARM.
234.
This "estimateD initial payment savings" was misleading because it was based on the
consumer paying the ttial rate of I % for an entire year. But with a PayOption ARM, after the
. first month, merely
pa~ing the initial rate of I% would not have covered the principal and
interest of the mortga,e, resulting in negative amortization. Thus, if a consumer opted to
refinance into the advertised program, the consumer would not actually save any money on their
57
payments. To emphasize the "savings," Countrywide hid the method for calculating the
I
'
estimated savings ancl the negative amortization that would result in a tiny font text after the
signature of countrytde' s personal loan consultant at the bottom of the page.
235.
'
The text of thi mailing touted to consumers the benefits of a PayOption ARMs, such as
"free up cash ... , paYihg off high interest credit card debt, invest in income property, saving cash
for the purpose of a ilw home and afford a larger home." However the mailing fai led to
, disclose clearly and conspicuously the many risks and negative ramifications of a PayOption
ARM product.
236.
The promise of "afford a larger home" was deceptive because PayOption ARMs were not
necessarily cheaper tJan fixed rate mortgages. WItile a consumer may have been able to obtain a
larger mortgage with
lI
Pay Option ARM, it did not mean that she could afford to pay it off. An
'
option ARM merely allowed a consumer to choose the amount of a monthly payment. Thus,
some payments could be smaller than those with a fixed rate mortgage, but to prevent negative
amortization, the consumer had to make much larger payments.
237.
Another dire) mailing about refinancing into PayOption A'RMs emphasized the amount
the consumer could c sh-out if he refinanced from a 30-year fixed rate loan to a PayOption
ARM. Again, next to the consumer's name and address was a highlighted box with "Up to
$65,380" and then un ier it, "Please Call Now, 1-800-598-1129."
238.
'
In the text; it Jomised that the consumer could access as much as $65,380 in home
equity through refin'icing into an option ARM with a 4.250% fully indexed interest rate.
Further the mailer stated that this interest rate is lower than the rate of the borrower's current
fixed-rate mortgage.
58
239.
This statement failed to clearly and conspicuously disclose the interest rate and how
Countrywide calculaled the consllmer's home equity, whether it was based on a computer
program or an actual!appraisal. Further, since the rate on this option ARM product would
fluctuate monthly aft r the one-month teaser interest rate expired, the interest rate and payment
. could increase to mole than the consumer's current mortgage rate and payment. To sweeten the
offering, countryWidl offered, "Fasttrack Cash-out Refinancing" which promised to "cut down
I
.
on the amount of qualifying and application paperwork."
I
240.
.
Yet, this mailing did not clearly and conspicuously disclose the risks of refinancing into a
PayOption ARM. At the bottom of the mailing, after the signature of the personal loan
. consultant and in tinYI font, the mailing made a reference to the introductory period. It instructed
the consumer to see another footnote on the second page for an explanation of that footnote. By
-
I
burying this information after the signature, using tiny font and referring the consumer to another
footnote for an eXPlaAation, Countrywide obscured the significant risks of refinancing into a
Pay Option ARM.
B.
Emails Touting Complimentary Loan Reviews Deceptively Induced Consumers to
Refinance
241.
Besides paper mailings, Countrywide also emailed personalized mailings to current
customers on their lor anniversaries, which offered "free" or "complimentary" loan reviews.
242.
·For example, in 2006, Countrywide sent emails to current Full Spectrum Lending
Division consumers tith the subject line "It's Your Anniversary!" In the heading with large
bold font, it stated "Happy Anniversary! Enjoy y~ur complimentary loan review" and then to the
immediate right it had printed Countrywide's telephone number and "Click Here to Get Started,"
which linked the consumer to an on-line loan application.
59
243.
By placing the telephone number and the link immediately after the complimentary loan
review, the email led the consumer to believe that contacting Countrywide would result in an
informational review, not a sales pitch for refinancing.
244.
After the hea1ing, the email congratulated the consumer for being a current customer.
r
Then it proclaimed t1at "many home values skyrocketed over the past year. That means that you
may have thousands
dollars of home equity to borrow from-at rates much lower than most
credit cards." This statement led the customer to believe that the value in her home skyrocketed
to allow her "th6USanrs of dollars of home equity." Yet, the email failed to clearly and
conspicuously dis.close how Countrywide calculated the consumer's equity in her home.
245.
Then the emJ offered an "exclusive interest rate discount of 1/2 %" because the
consumer was a currelt customer. At the end of the email, it emphasized that Countrywide
wanted to provide thel "right" home financing situations to meet the consumer's needs and stated
"Call us now at 1-86d-253-2352 or Click Here."
246.
!fthe consum!r did not respond to this email, Countrywide senf a follow up "Your
Anniversary Review reminder" which stated "If you haven't called for your free Anniversary
Loan Review yet, there is still time." The follow up email created a false sense of urgency, in
which the consumer
h~d to act fast to avoid losing a supposedly great deaL
C.
Television and Radio Commercials: Deceptively Advertise No Closing Cost Refinancing
247.
Besides direct mailings and newspaper ads, Countrywide also used deceptive television
and radio commercials to induce consumers to purchase loans and refinance their mortgages or
obtain home equity Ii,es of credit.
248.
.. .
.
For example, in November 2005, Countrywide ran a television commercial called "Guess
What A" which offere6 a "no closing cost debt consolidation loan." During the commercial, a
60
man informed consUlners to :'act fast" to consolidate their high interest credit cards while
. mortgage interest ratt were low. Although a legal disclaimer disclosed that refinancing or
taking a HELOC mai increase the total number of payments and total amount paid, it did not
disclose that consumers paid for the "no closing costs" through a higher interest rate. Rather, it
just referred consum1rs to Countrywide's website for information on closing costs.
249.
Similarly, in 1UlY 2007, Countrywide ran a television commercial which ag(iin offered a
"refinance with no ci0sing costs." The man in the commercial stated "That's right. At closing
you'll pay absolutely no closing costs. This means more cash for you."
250.
Again, the legal disclaimer obfuscated the truth that consumers paid for "no closing
costs" through a hight interest rate.
~ather, it stated that "borrowers who choose to pay lender
fees and closing costs upfront may qualify for a lower rate."
251.
Countrywide engaged in similar confusing and deceptive advertising in its "Dueling
Announcers" radio cdmmerCial. . In that commercial, Countrywide offered a "no closing cost"
refinance loan and a+n the legal. disclaimer obfuscated the truth that consumers paid for no
closing costs through a higher interest rate. At the end of the commercial, it said that borrowers
who choose to pay IJder fees upfront may qualify for a lower rate. Then it stated "recent trends
show home values fla tening or even declining in some areas." The commercial urged
consumers "[s]o tap into your home's available equity now."
.
252.
I
In addition, this commercial emphasized the benefits of refinancing such as: cash from
the equity, a lower fixL rate, and paying credit card bills. Yet, this commercial failed to
.
disclose clearly and ctsPiCUOUSlY the danger that by removing equity at a time when home
values are stagnant or beClining, consumers could owe more than the value of their homes.
D.
CountrYwide l'sed Deceotive Sales Pitches to Push Riskv Mortgages
L . . . - - - -_ _
61
----L-I_ _ _
~__________
253.
After receiving advertisements, many consumers contacted Countrywide account
.
' d to use deceptJve
. sa I
· ·to·orIgmate
·
executives,
w h0 were I
trame
es SCrIpts
mortgages fior purc hases
and refinancing.
254.
According to
I
interview with a former account executive in Countrywide's retail
.
division, countryWide, instructed employees to sell the "low" monthly payments of each product
and to down play the total cost of the mortgage, the interest rate, adjustable rate, prepayment
~enalty or any other rilks associated with the products.
255.
If consumers q!uestioned the terms of the offered mortgage, account executives would
offer to refinance conLmers into better mortgages at later date, such as in loans with ARMs
often before the rates ldjusted. It was a deceptive promise because the account executives could
I
not predict consumersj ability to refinance, which often depended on whether housing values
continued to appreciate.
256.
According to In
.
intervi~w with a former account executive in the Full Spectrum
Lending Division (COlntryWide'S subprime retail division), Countrywide used scripted
I
telemarketing to solicit both'new borrowers and current Countrywide borrowers for subprime
mortgages.
257.
These potentiall consumers, or sales "leads," included prime borrowers who mistakenly
called Full Spectrum, bonsumers with prime mortgages serviced by Countrywide but who were
late in their payments It least 30 days, consumers who called Countrywide's prime retail lending
division and whose crLit scores were below a certain level, and current Countrywide subprime
borrowers whose loanl had adjustable rate mortgages, balloons or other variable terms.
258 .
.
I . d emp Ioyees to memOrIze
. sa' Ies scnpts,
..
Countrywl'd e lqulre
pnor to attend'"
mg mtenslve
sales training in Illinois or California. Countrywide instructed account executives to use the
62
sales scripts for every conversation with consumers. In fact, the scripts covered the entire loan
origination process, lorn intake to closing, for refinance, purchase and home equity mortgages.
259.
By using the tIes scripts, Countrywide employees deceived and confused consumers so
that consumers woulf not understand the true costs associated with the new loans.
260.,
As described in the New York Times' article, Inside Ihe Counlrywide Lending Spree,
Countrywide used a ' sedu'ctive sales pitch" to convince consumers that Countrywide aspired to
provide consumers with "the best loan possible." Rather than actually providing the best loan
possible, countryWidlled consumers into "high-cost and sometimes unfavorable loans that
resulted in richer cOIlnissions for Countrywide's smooth talking sales force."
261.
.
For example, reCOrding to one former Full Spectrum account executive, COuntrywide's
subprime divisions diU not offer FHA loans to consumers who could have qualified for them and
instead frequently offired costlier or riskier subprime loans.
262.
'
L
As compared
subprime loans, FHA loans have historically allowed lower income
consumers to borrow Loney for the purchase of homes. FHA loans are insured by the Federal
Housing Authority fol consumers with "less than perfect credit" histories and allow for down
payments as low as 3L The majority of FHA loans are 30-year fixed rate loans, rather than
ARMs.
263.
A former account executive provided the following comparison for a consumer with a
down payment of 5%
could have
~or 95% LTV) seeking a $100,000 ioan. With an FHA loan, the consumer
rec~ived a bxed interest rate of 6% for 30 years (with an additional insurance fee of
tUIi Spectrum, th'-account executive'sold the same consumer a subprime
I V, %). Yet, ihrough
loan with 8-10% interest rate and layered with additional risks, such as a prepayment penalty.
63
+-_____________________________.__
L....._ _ _ _ _ _ _ _ _ _ _ _
264.
The deception of providing the best loan for the consumer started right from the
beginning of the sales script with the first telephone call. In fact, according to an interview with
a former Full spectruL empioyee, the 2005 script prohibited
employ~es who spoke with prime .
borrowers who were lerelY 30 days late from mentioning the purpose of their phone call, e.g., to
refinance into' more Jst\y subprime mortgages:
265.
' .
By misrepreselting the purpose of the call and obscuring consumers' possible weakened
credit, Countrywide lL consumers to believe that the call was to discuss servicing issues or even
. .mto a pnme
.1 Ioan, rat her th an re fimancmg
. mto
.
. su b
'
.
re fimancmg
a more expensIve
pnme
mortgage.
266.
Even if consuLers were uninterested in obtaining new mortgages, the sales script
.
provided ways for salt representatives to persuade reluctant consumers. For example, if a
consumer stated that Jhe had paid off a first mortgage, the script advised the account executive to
I
ask about a home equity loan. "Don't you want the equity in your home to work for you? You
can use your equity
267.
fdr your advantage and pay bills or cash out.· How does that sound?"
Another methld utilized in the scripts led consumers into believing that the account
executives were their riends, interested in providing the best loans to conswners. This method
is exemplified by the fUll Spectrum sales script ~hat instructed account executives to build an .
emotional connection Iknown as the "Oasis of Rapport" with consumers before discussing rates,
points and fees. The immediate objective was to get to know the consumer, "look for points of
common
268.
inter~sts, aJ to use first n~es to facilitate a friendly helpful tone."
Countrywide
JISO coached employees to ask questions about the consumer's financial
situation, then lie that the account executive had another customer with the same problems and
say that it was difficult for this other, similar, customer to get a loan from other lenders.
64
269.
By scripting ar emotional connection with consumers, Countrywide led consumers to
believe that account etecutives understood their financial situations and Countrywide would
provide consumers with the best possible mortgages. As a result, consumers were more likely to
accept refinancing, fet, points, higher interest rates, adjustable rate mortgages, and very risky
products, such as oPt+ ARMs.
.
Countrywide Home Loans Servicing LP Utilizes Unfair and Deceptive Practices in the
Servicing of Bbrrowers' Residential Mortgage Loans
270.
When consumLs fall behind on their mortgage loan payments, they call Countrywide
Home Loans servicinl LP ("Countrywide Servicing"), the Countrywide entity that services
consumers' mortgagej. Consumers who ask what can be done to avoid foreclosure proceedings
are often shuffled from person to person and even department to department before reaching .
someone who can acJallY address their concerns.
I
271.
.
Countrywide rrvicing generally demands an initial payment from the consumers prior to
even discussing whetHer anything can be done to keep the consumers in their homes. Because
Countrywide servicink demands this payment prior to doing any analysis of the consumers'
situations, this sChem1 often results in consumers paying money to Countrywide Servicing when
there is no chance of negotiating a workable plan. The money used for "initial payments" could
have been used by cJsumers to pay for moving expenses or finding new housing in the event
that foreclosure was +vilable.
272.
Countrywide Servicing also requires consumers to send their initial payments via
certified checks. Ifa tonsumer's check is not certified, Countrywide Servicing will refuse it
without even attempting to verify whether there are sufficient funds to cover the check. This
needless bureaucracy has led to
Country~ide Servicing rejecting initial payments made on
consumers' behalf by hon-profits and state agencies.
65
273.
For example, one consumer fell behind on her mortgage payments when she was being
t
treated for breast cancL. Trying to help the consumer, her church raised funds to make her
delinquent payment.
check, drawn on the
ChU~Ch:s account, was sent to Countrywide
Servicing. It was reje6ted.
274.
After recei·vinJ the initial payment, instead of doing an analysis on what would be
necessary to allow coJsumers to stay in their homes, Countrywide Servicing's first offer to
consumers is typically to put them on repayment plans. These repayment plans require
consumers both to remain current on their existing mortgage loan payments and also pay an
additional amount to fver any past due payments and rees the consumers have incurred.
275.
A repayment pian is often an unworkable and unaffordable solution to most consumers'
mortgage payment prdblems. Plainly put, if consumers are having problems making their
current payments, th-t is absolutely no reason to think that the consumers will be able to make
even larger payments
276.
r
the future.
One consumerjs experience illustrates the problem. The consumer's monthly mortgage
payment was $1600.
~he fell behind and, in an attempt to salvage the situation, repeatedly called
Countrywide servicinr to try to find a solution. Although the consumer was already having
f
difficulty making her 1600 monthly payment, Countrywide Servicing's solution was to increase
the consumer's payment to $2500 to cover both the existing payment and the past due payments
and fees.
277.
Predictably, the consumer was unable to keep up with the repayment plan and fell even
further behind on her Lortgage. After trying to work with Countrywide Servicing for almost six
months, the company bemanded (and received) a payment of over $5000 from the consumer
. before it would comPlte an analysis and consider the file for loan modification.
66
l . . . - - - - - - - - - - - - - f - - - - -____________.__ ........ .
I
278.
Even when Countrywide Servicing comes up with a loan modification plan, the company
often fails to discuss tt plan with the consumer to
confi~ it is affordable or to send timely
documentation to the Lnsumer regarding the specific details of the plan.
279.
j
For example, consumer called Countrywide Servicing on five separate occasions
I
'
seeking assistance wiT mortgage payments that she was having difficulty making. The
consumer had a loan with an initial teaser interest rate of 9.375% that had jumped to 12.625%.
During the fifth call, tt consumer learned that Countrywide Servicing had decided to reduce the
interest rate on her loal back to the teaser interest rate for an additional five years. Although
Countrywide serVicinr attempted to provide relief to the cons",';er, it failed to actually discuss
with the consumer whether this plan would be affordable. The consumer had sent Countrywide
Servicing financial doLments, so it should have known'that the plan was unaffordable.
Moreover, it took coultrywide' Servicing an additional month to send the consumer
I
documentation of her
tan
.
modification, resulting in the consumer making an incorrect mortgage
payment based on what she had been told on the phone.
280.
Countrywide
s~rViCing representatives have also been difficult to reach when consumers
are trying to catch up 0n their mortgages. For example, a c'onsumer who fell behind in her
mortgage sent count1wide Servicing additional checks for 10 months with the designation that
they were to be applied to her past due payments and fees. When her statements did not appear
to reflect the additioJI payments, the consumer repeatedly called Countrywide Servicing to deal
,
I
with the problem. She was put on hold and transferred from person to person when she called
and was never able to lalk to a Countrywide Servicing representative who could help her figure
I
out the problems with her accQunt.
67
281.
Consumers
Will sometimes try to refinance their Countrywide mortgages in an attempt to
save their homes. Consumers have complained that Countrywide Servicing fails to send them
the payoff statements necessary to complete the refinance in a timely manner. Because the
refinance is delayed, the consumers end up falling even further behind on their Countrywide
mortgages.
282.
On occasion, consumers who fall behind in their mortgages and other debt payments are
forced to declare bJruPtCY. Countrywide Servicing has been sued by United States
Bankruptcy Trustees ln four states over its practices with consumers in bankruptcy. These
trustees allege, amon j other things, that Countrywide Servicing may have filed inaccurate proofs
of claims, filed unwa anted motions for relief from the bankruptcy stay, inaccurately accounted
for funds and made u founded payment demands to consumers after the discharge of their
bankruptcy.
283.
Countrywide ~ ervicing has also acted illegally towards borrowers in foreclosure actions.
In a particularly egregious case, a consumer whose Countrywide mortgage was in foreclosure
returned home to find that Countrywide Servicing had changed her locks and boarded her home.
At the time it boarded the owner-occupied property, Countrywide Servicing had filed a
foreclosure complaint against the consumer, however, no judgment for foreclosure had been
entered and no sale conducted. The consumer's attorney made numerous attempts to contact
Countrywide' servicinl to rectify the situation, It took a week and the intervention of the
I
Attorney General's Office for the consumer to regain access to her home and possessions.
284.
There are also bccasions when Countrywide Servicing acts inappropriately towards
consumers who are nJ in
fore~losure, but have a problem with the application of funds from an,
escrow account.
68
285,.
In one situatic, n, a conswner whose Countrywide mortgage included an escrow for real
estate taxes mistakenly paid her tax bill herself, even though Countrywide Service also paid the
bill. Once this error Las discovered, the consumer's overpayment should have been refunded
directly to her. InsteL, Countrywide Servicing decided to keep a portion of the overpayment in
the
co~sumer's escrol account, purportedly as a "cushion." Countrywide Servicing had no
authority toarbitrariJ keep a portion of the consumer's overpayment and only returned the funds
after mediation throu?h the Attorney General's Office.
STATUTORY PROVISIONS'
286.
Section 2 ofJthe Illinois Consumer Fraud and Deceptive Business Practices Act (815
ILCS 505/2) provide that:
.
Unfair methods of competition and unfair or deceptive acts or
practices, including but not limited to the use or employment of
any debeption, fraud, false pretense, false promise,
misrep~esentation or the concealment, suppression or omission of
any m~terial fact, with intent that others rely upon concealment,
supprer.sion or omission of such material fact, or the use of
employment of any practice described in Section 2 of the "Uniform
Deceptive Trade Practices Act," approved August 5, 1965, in the
condudt of any trade or commerce are hereby declared unlawful
whethcir any person has in fact been misled, deceived or damaged
thereb~. In construing this section consideration shall be given to
the int}1 rpretations of the Federal Trade Commission and the
federal courts relating to Section 5(a) of the Federal Trade
Comm ssion Act.
287.
Section 7 oftlle COQsumer Fraud Act, 815 ILCS 50517, provides in relevant part:
a.
!Whenever the Attorney General has reason to believe that
any pe son is using, has used, or is about to use any method, act or
practic declared by the Act to be unlawful, and that proceedings
in the public interest, he may bring an action in the name
would be
I
of the State against such person to restrain by preliminary or
permanent injunction the use of such method, act or practice. The
Court, in its discretion, may exercise all powers necessary,
includi ~g but not limited to: injunction, revocation, forfeiture or
suspen ion of any license, charter, franchise, certificate or other
69
evidence of authority of any person to do business in this State;
appoi~tment of a receiver; dissolution of domestic corporations or
associktion suspension or termination of the right of foreign
cor~o~~tions or associations to do business in this State; and
restitutIon.
'
b.
In addition to the remedies provided herein, the Attorney
General may request and this Court may impose a civil penalty in a
sum nbt to exceed $50,000 against any person found by the Court
to hav~ engaged in any method, act or practice declared unlawful
under this Act. In the event the court finds the method, act or
practide to have been entered into with intent to defraud, the court
has th1 authority to impose a civil penalty in a sum not to exceed
$50,0 0 per violation.
'
c.
In addition to any other civil penalty provided in this
Sectiop, if a person is found by the court to have engaged in any
, method, act, or practice declared unlawful under this Act, and the
violatibn was committed against a person 65 years of age or older,
the co~rt may impose an additional civil penalty not to exceed
$1 o,odo for each violation.
'
288.
Section 10 of be Consumer Fraud Act, 815 ILCS 505/10, provides that "[i]n any action
brought under the Prolisions of this Act, the Attorney General is entitled to recover costs for the
use of this State."
289.
Section'2 of tHe Illinois Fairness in Lending Act, 815 ILCS 120/2, provides that
(a)
"Finanlial
i~stitution" means any bank, credit union, insurance company,
mortg~ge banking company, savings bank~ savings and loan association,
or oth~ residential mortgage lender which operates or has a place of
busine s in this State.
I
(d)
"Equity stripping" means to assist a person in obtaining a loan secured by
the perSons' principal residence for the primary purpose of receiving fees
related Ito the financing when (i) the loan decreased the persons' equity in
residence
and (ii) at the time the loan is made, the financial
the priAcipal
I
'
institution does not reasonably believe that the person will be able to make
the schbduled payments to repay the loan. "Equity stripping" does not
includd reverse mortgages as defined in Section Sa of the Illinois Banking
Act, Sdction 1-6a of the Illinois Savings and Loan Act of 1985, or
sUbsedion (3) of Section 46 of the Illinois Credit Union Act.
70
290.
Section 3 of the Illinois Fairness in Lending Act, 815 ILCS 120/3 provides in
j
relevant part that:
No financial in titution, in connection with or in contemplation of any loan to any
person, may:
Engage in equit~ stripping or loan flipping.
(e)
291.
Section 5 of the Illinois Fairness in Lending Act, 815 ILCS 120/5(c), provides in
relevant part that:
An action to enjoin any person subject to this Act from engaging in activity in
violation of thi~ Act may be maintained in the name of the people of the State of
Illinois by the tttorney General or by the State's Attorney of the county in which
the action is brought. This remedy shall be in addition to other remedies provided
for any violatidn of this Act.
Count I
Violations of Section 2 of the
Consumer Fraud and Deceptive B"usiness Practices Act, 815 ILCS 505/2
292.
The allegatioJ contained in Paragraphs 1 through 291 of the Complaint are re-alleged
and incorporated
293.
herei~
by reference.
.
As described above, Countrywide's conduct has contributed to the high number of
foreclosures in IIIinoiJ and caused significant harm to the public, the market, and scores of
Illinois borrowers and homeowners.
294.
Countrywide engaged in unfair and/or deceptive acts or practices by originating mortgage
loans to borrowers whb did not have" the ability to repay their loans through practices such as, but
not limited to:
a. Using Iieduced documentation underwriting guidelines to qualify borrowers who
did not have sufficient income or assets to afford the Countrywide loans they
were
S(
Id;
71
b. promtng the use of reduced documentation underwriting guidelines to qualify
borrowers who did not have sufficient income and assets for the Countrywide
loans they were sold;
c. Inflatih g
borrowe~s'
income on loan applications to qualify the borrowers for
countlwide loans;
d. Durint a certain period oftime, qualifying subprime
~rrowers for hybrid ARM
mortgage loans using less than the full- indexed rate;
e.
Durin~ a certain period ofti~e, qualifying borrowers for mortgage loans that had
an intJrest-only payment option using less than the fully-amortizing payment;
f.
Originlting loans that were not designed for long term viability, but for short term
r~fin1cing, as employees and brokers frequently represented that borrowers
could refinance the loan;
g.
.
pro~Jting serial ~efinancing without regard to the increased cost to the borrower
or the [ffordability of the loan, and without disclosing that the ability to refinance
relied tn a perpetual increase in home valuation; .
l
h. Loosefl ing certain underwriting guidelines over time, resulting in the sale of
unaffo dable loans;
. 1.
f
Originating loans with multiple layers of risk, resulting in the sale of unaffordable
I
loans; rd
J.
Allowing exceptions to underwriting guidelines, resulting in the sale of
unaffoLable loans.
.
72
295.
Countrywide engaged in unfair and/or deceptive acts or practices by originating mortgage
loans that exposed bolowers to an unnecessarily high risk of foreclosure or loss of home equity
through practices suJ as, but not limit to:, , '
,
a. Originlting option ARM mortgage loans with one or more of the following
charact~ristics:
illusory introductory teaser interest rates, prepayment penalties:
high 10rn-to-vaIUe ratios, and reduced documentation underwriting;
,
b. Mass marketing and selling option ARM mortgage loans to the general public that
were allY beneficial to specific sophisticated 'segments of the borrower
I
.
pOPula,ion;
c. Marketing and selling option ARM mortgage loans as a beneficial refinance loan
product to current customers in good standing, when that was not the case; and
d. OrigiJting mortgage loans with 100% loan-to-value or combined loan-to-value
ratios ttt included other risky features.',
296.
.
Countrywide ehgaged in unfair and/or deceptive acts or practices by originating
unnecessarily more exrl ensive mortgage loans to unknowing borrowers through practices such
as, but not limited to:
a.
Originating more expensive reduced documentation loans to borrowers who could
have d1cumented their income and assets, without infonning borrowers of the
increased cost; and
b.
Att~chilg
prepayment penalties to borrowers' loans, without ensuring that the
borrowtrs actually received any benefit from the added risk of the penalty.
297.
Countrywide ergaged in unfair and/or deceptive acts or practices by deceptively
marketing and/or advertising its mortgage loans through practices such as, but not limited to:
73
a.
Leading consumers to believe that Countrywide would obtain for them the best
PossiJle loan terms, when, in fact, they did not;
b. AVOidling discussing the interest rate or APR of a loan by shifting the focus to the
montJlY payment in an effort to confuse consumers about the true cost of the
loan;
c. Reprerenting that refinancing into an option ARM could save the borrower
mond when, in fact, the claim of savings was false;
d. AdveJising the one-month teaser interest rates for an option ARM without clearly
and
CO~SPiCUOUSIY disclosing that the rate would increase dramatically the
following month;
e.
Reprel~ntjng to consumers that option ARMs we~e beneficial for consumers in
good slanding on their current Countrywide loans when, in fact, refinancing into
the pJduct was not beneficial for most consumers;
f.
FailinJ to properly inform a borrower of the potential of owing more on his home
I
than what it is worth due to negative amortization if the borrower's house did not
continle appreciating or depreciated in value;
g. Intlatir g borrowers' income information on their loan applications in order to
qualify borrowers for Countrywide mortgages when their income would not have
qualified them for the loan they received;
h. Represlnting to borrowers that they should not worry about the interest rate of
their CLntryWide mortgage because the loans could be refinanced before they
I '
.
became unaffordable;
74
L....-_ _ _ _ _ _ _ _ _ _ _ _ _--"--____________________ _
i.
During a certain period of time, failing to disclose to subprime borrowers that
they wlre qualified at less than the fully-indexed rate for hybrid ARM mortgage
loans
J.
ld
not at a rate sufficient to repay the loan in its entirety;
DurinJ a certain period of time, failing to disclose to borrowers that they were
qUalifild at less than a fully-amortizing payment for mortgage loans with an
intereJonlY payment option and not at a rate sufficient to repay the loan in its
entireJ.
T
k. Advertising that a Countrywide mortgage had "no closing costs" when the closing
costs Jere incorporated in the features of the loan; .
I.
.
RepresLting to current Countrywide borrowers that Countrywide offered
"comJlimentary" or "Free Loan" reviews when in fact, it was a sales pitch to
I current su b"pnme borrowers
' .mto oth
.
re fimance
er'su bpnme
mortgages;
m. Hiding the purpose of subprime sales calls to prime borrowers with late payments,
which ras, in actuality, to refinance borrowers into subprime loans; and
n. Advertising that because the housing market is stagnant or deClining, borrowers
should refinance their homes and take cash out or pay debts, without informing
borrowers of the risk of owing more than the value of their homes.
298.
Countrywide tgaged in unfair andlor deceptive acts or practices by implementing a
compensation structure that incentivized broker and employee misconduct and failed to exercise
sufficient oversight to ensure that such misconduct did not occur through practices such as, but
not limited to:
75
a. ImPle[enting a compensation structure that incentivized employees to maximize
sales of loans without proper oversight, resulting in the sale of unaffordable
I
'1
. I
an d/orl unnecessan yexpenslve oans;
.
.
b. Failini to provide adequate parameters for the sale of option ARMs, resulting in
the prrduct being sold to inappropriate groups of borrowers;
c. Failing to adequately supervise and/or underwrite brokers' use and sale of
reduct documentation loans resulting in the sale of unaffordable or unnecessarily
more expensive loans;
d. FaCilitLng and/or instructing brokers' emphasis of the low teaser rate when
selling option ARMs;
e. Rewaraing brokers for selling loans with certain risky loan features such as
prepayLent penalties without ensuring that borrowers received a benefit from the
I
.
risky features; and
f.
.
.
Slruc+ing the compensation for option ARMs in such a way that brokers were
incentrzed to sell a product that was riskier than necessary - to the exclusion of
other ~roducts - in order to obtain the maximum yield spread premium possible.
299.
Countrywide tome Loans Servicing. LP engaged in unfair andlor deceptive acts or
practices during the servicing of residential mortgage loans through practices such as, but not
limited to:
a. Inducir g borrowers to pay Countrywide Servicing monies under the premise that
Countrywide Servicing would be able to assist distressed borrowers, even though
countJwide
Se~vicing has' not done any analysis to determine whether assistance
was fJsible in light o'fthe borrowers' particular factual circumstances; .
76
b. MiSleajin g borrowers into paying Countrywide Servicing additional monies
under a repayment plan or loan modification plan that Countrywide Servicing
knew 0 should have know was unaffordable; and
c. RecklJsl Y facilitating the foreclosure of borrowers' homes by misleading
.
borrowlrs or failing to respond to borrowers' requests for assistance.
PRA YER FOR RELIEF
WHEREFORE, Plaintiff respectfully prays for the following relief:
A.
A findihg that Defendants have engaged in and are engaging in trade or
commerce within the Leaning of Section 2 of the Illinois Consumer Fraud and Deceptive
Business Practices Ac , 815 ILCS 505/2;
B.
A finding that Defendants have engaged in and are engaging in acts or practices
that constitute violations of Section 2 of the Illinois Consumer Fraud and Deceptive Business
,
I
Practices Act, 815 ILOS 505/2;
C.
An ordL preliminarily and permanently enjoining Defendants from the use of acts
or practices that violatl the Consumer Fraud and Deceptive Business Practices Act including, but
not limited to, the unl1wful acts and practices specified above;
D.
An or~r rescinding, reforming or modifying all mortgage loans between
Defendants and all IllToiS consumers who were affected by the use of the above-mentioned
unlawful acts and practices;
E.
An ordL requiring Defendants to make restitution to all consumers who were
affected by the use of he above-mentioned unlawful acts and practices in the origination of
Countrywide residentT mortgage loans whose homes were lost due to foreclosure on their
Countrywide mortgag loans;
77
F.
An or' er requiring Defendants to make restitution to all consumers who were
affected by the use
0
the above-mentioned unlawful acts and practices in the origination of
Countrywide reSidenj1iai mortgage loans who refinanced their mortgage loans with Defendants or
another residential m rtgage lender;
G.
An or er requiring Defendants to make restitution to all consumers who were
affected by the use "Jthe above-mentioned unlawful acts and practices in the origination of
Countrywide resideJal mortgage loans who are unable to modify their Countrywide mortgages
to a sustainable levellnd are forced to
H.
~elinquish ownership of-their homes;
.
An orc er requiring Defendants to repurchase owner-occupied residential
mortgage loans for al Illinois consumers who were affected by the use of the above-mentioned
unlawful acts and practices that have been sold, transferred or assigned to investors and then to
rescind, reform or mLify any such mortgage loans;
I.
An
I)
Of(
er enjoining Defendants from:
further selling, transferring or assigning mortgage loans originated by
Countrywide by the use of the above-mentioned unlawful acts and
practices that are secured by owner-occupied residential properties in
Illinois;
2)
further selling, transferring or assigning any legal obligations to service
Illinois owner-occupied residential mortgage loans originated by the use
of the above-mentioned unlawful acts and practices; and
3)
initiating or advancing a foreclosure, as an owner or servicer, on any
owner-occupied residential mortgage loan originated by the use of the
above-mentioned unlawful acts and practices and secured by an Illinois
78
property, without first providing the Attorney General a 90-day period to
eview each such loan so that, upon the expiration of the 90 days, the
¥\uorney General may object to a foreclosure based upon unfair or
tleceptive origination or servicing conduct by Countrywide and
fountryWide Home Loans Servicing, LP in order to provide the borrower
with a meaningful opportunity to avoid foreclosure. In the event of the
kttomey General;s objection, no foreclosure sale shali go forward absent
I
court approval.
J.
An ordlr requiring Defendants to establish a "Distressed Property
Reser~e" to
cover costs incurred 'bJ muniCipalities due to vacant foreclosed properties that secured owneroccupied
residen~i~1 mbrtgage loans originated by Countrywide;
K.
An ordir imposing a civil penalty in a sum not to exceed $50,000 against any
Defendant found by the Court to have engaged in any method, act or practice declared unlawful
I
under this the Illinois Consumer Fraud and Deceptive Business Practices Act;
1.
An ordlr imposing a civil penalty in a sum not to exceed $50,000 against any
Defendant found by thl Court to have engaged in any method, act or practice declared unlawful
u':!der the Illinois coJwner Fraud and Deceptive Business Practices Act committed with the
intent to defraud;
M.
An ore er imposing an additional civil penalty not to exceed $10,000 for each
violation of the IIlinOii Consumer Fraud and Deceptive Business Practices Act committed
against a person 65 yers of age or older, as provided in Section 7(c) of the Consumer Fraud and
Deceptive Business Practices Act, 81S ILCS 50SI7(c);
79
L - . . . - - - - - - - - - - - - t - - - -___________...
N.
An orCler requiring Defendants to pay the costs of this action and any costs related
to the 90-day Attornt General review period described above; and
O.
An or6er granting such further relief as this Court deems just, necessary, and
I.
. . bl em
. t h e premises.
equlta
Count II
Violation of the Illinois Fairness in Lending Act, 815 ILCS 120/4
300.
The anegatiots contained in Paragraphs I through 2.99 of
th~ Complaint are re-alleged
and incorporated herein by reference.
301.
Countrywide violated Section 3 of the Illinois Fairness in Lending Act, 815 ILCS 120/3
by engaging in equity stripping when refinancing consumers into mortgage loan products that
I·
.
Countrywide knew or should have known were unaffordable and that decreased the borrowers'
equity in their homJ, with the primary purpose of receiving fees for the refinancing.
PRAYER FOR RELIEF
WHEREFORE, Plaintiff respectfully prays for the following relief:
I
A.
A finling tha~ D.efe~dants have violated th~ I.lli.nois Fairness in Lending Act;
B.
An orer prellmmarIly and pennanerttly enJOlnIng Defendants from the use of acts
or practices that violate the Illinois Fairness in Lending Act including, but not limited to, the
unlawful acts and prJctices specified above;
C.
.
An 01er requiring Defendants to make restitution to all conswners affected by
the use of the above-rentioned unlawful acts and practices; .
D.
.
An order rescinding or refonning all contracts, loan agreements, notes or other
I
evidences of indebte1ness between Defendants and all Illinois consumers ~ho were affected by
the use of the
above-~entioned unlawful acts and practices;
80
E..
An order requiring Defendants to pay the costs of this action; and
F.
An order granting such further relief as this Court deems just, necessary, and
equitable in the premises~
Respectfully submitted,
LISA MADIGAN, IN HER OFFICIAL
CAPACITY AS ATTORNEY GENERAL OF
C~~f)~
V
Jt~KOLE
LISA MADIGAN
Attorney General of Illinois
.
. I
DEBORAH HAGAN, Fhief
Consumer Protection Division
I
JAMES D. KOLE, Chief
Consumer Fraud Bure~u
THOMAS JAMES
SUSAN N. ELLIS
VERONICA L. SPICJR
SHANTANU SINGH .
JENNIFER FRANKL N
MICHELLE GARCIA
CECILIA ABUNDIS I
Assistant Attorneys Gbneral
Telephone: 312-814-3000
100 W. Randolph St., 12th Floor
Chicago, IL 6060 I
81
Chief, Consumer Fraud
Testimony of Martin Eakes, CEO
Center for Responsible Lending and Center for Community Self-Help
I
Before the U.S. Senate Committee on Banking, Housing and Urban Affairs
"Preserving the American Dream: Predatory Lending Practices and Home
Foreclosures"
February 7, 2007!
Mr. Chairman andI members of the Committee, thank you for holding this hearing to
examine the problems of foreclosures and predatory lending in the subprime market, and
thank you for the invitation to speak today.
I testifY as CEO of Self-Help (www.self-help.org); which consists of a credit union and a
non-profit loan fJnd.
For the past 26 years, Self-Help has focused on creating ownership
I
opportunities for low-wealth families, primarily through financing home loans. Self-Help
has provided oveJ $4.5 billion of financing to over 50,000 low-wealth families, small
businesses and n9nprofit organizations in North Carolina and across the country, with an
annual loan loss rate of under one percent. We are a subprime lender. In fact, we began
making loans to deople with less-than-perfect credit in 1985, when that was unusual in
the industry. Welbelieve that homeownership represents the best possible opportunity for
families to build wealth and economic security, taking their first steps into the middle
class. [emphasiie this point because expanding access to homeownership has been
central to SelfHe:lp's mission and it would be counter to everything I believe to
recommend any p,olicies that would diminish beneficial credit to families seeking a better
future.
I
I am also CEO 0fjthe Center for Responsible Lending (CRL)
.
(www.responsiblelending.org), a not-for-profit, non-partisan research and policy
organization dedibated to protecting homeownership and family wealth by working to
eliminate abusivel financial practices. CRL began as a coalition of groups in North
Carolina that Shard a concern about the rise of predatory lending in the late 1990s.
The subprime mo1rtgage market today is a quiet but devastating disaster. The ultimate
effects are very much like Hurricane Katrina, as millions of citizens lose their homes and
the fabric of entir~ communities is threatened. The difference is that this disaster in the
subprime market ,is occurring every single day across the country, house by house and
neighborhood by Ineighborhood. Our analysis of subprime mortgages made in recent
years shows that 2.2 million families will lose their home to foreclosure-foreclosures
that were, for the Imost part, predictable and entirely avoidable through more responsible
lending practices. As housing appreciation slows down in many areas of the country, it is
1
clear that the pro91em will only grow worse. All indications are that subprime mortgage
loans are headed toward the worst rate of foreclosures in modern mortgage market
history.'
i
• Editor's note: This c1rY includes a minor technical correction made after the report was submitted to the Committee.
I
I
I
EXHIBIT
Why does a foreclosure epidemic in the subprime mortgage market matter? First,
subprime mortgages are no longer a niche market; they have become a significant share
of all new mortgages made in America, now making up well over 20 percent of all home
loans originated and currently representing $1.2 trillion of mortgages currently
outstanding. 2 Sedond, homeownership is the best and most accessible way most families
have to acquire wfalth and economic security. Ifhome loans are actually setting citizens
back rather than Helping them build for the future, there are serious ramifications for local
economies and thb nation as a whole. The problem is particularly serious for
communities of cblor, since more than half of African-American and 40 percent of Latino
families who get home loans receive them in the subprime market. 3 If current trends·
continue, it is quite possible'that subprime mortgages could cause the largest loss of
AfriCan-Americat wealth in American history.
Under typical circumstances, foreclosures occur because a family experiences ajob loss,
divorce, illness o~ death. However, the epidemic of home losses in today's subprime
market is well beyond the norm. Subprime lenders have virtually guaranteed rampant
foreclosures by approving risky loans for families while knowing that these families will
not be able to pa1 the loans back. There are several factors driving massive home losses:
•
Risky products. Subprime lenders have flooded the market with high-risk loans,
making thbm appealing to borrowers by marketing low monthly payments based
on low infroductory teaser rates. The biggest problem today is the proliferation of
hybrid adj:ustable-rate mortgages ("ARMs," called 2/28s or 3/27s), which begin
with a fixed interest rate for a short period, then convert to a much higher interest
rate and cbntinue to adjust every six months, quickly jumping to an unaffordable
level.
•
Loose underwriting.
It is widely recognized today, even within the mortgage
I
industry, that lenders have become too lax in qualifying applicants for subprime
4
loans. EJpecially troubling is the practice of qualifying borrowers without any
verificati9n of income, not escrowing for property taxes and hazard insurance,
and failing to account for how borrowers will be able to pay their loan once the
payment adjusts after the teaser period expires.
•
Broker abuses. Today's market includes perverse incentives for mortgage
brokers tol make high-risk loans to vulnerable borrowers. Brokers often claim
that borrowers engage them for their knowledge and generally believe that
brokers arb looking for the best loan terms available. Yet brokers also claim they
do not nedd to serve the borrower's best interests.
•
Investor Lpport. Much ofthe growth in subprime lending has been spurred by
investors' appetite for high-risk mortgages.that provide a high yield. The problem
is that the investor market reaction occurs only after foreclosures are already
rampant and families have lost their homes.
I
2
•
Federal neglect. Policymakers have long recognized that federal law-the Home
Ownership and Equity Protection Act of 1994 (HOEPA)-governing predatory
lending is jinadequate and outdated. Although the Federal Reserve Board
(hereinafter, the "Board") has the authority to step in and strengthen relevant
rules, the~ have steadfastly refused to act in spite of years of large-scale abuses in
the market. For the majority of subprime mortgage providers, there are no
consequerlces for making abusive or reckless home loans.
I respectfully sUbLit that there are simple and effective policy solutions to stop
destructive lendirig practices in the subprime market and return to sound lending
practices. CRL ~akes the following five recommendations:
1. Restore safety Ito the subprime market by imposing a borrower "ability to repay"
standard for all sJbprime loans. Recently federal banking regulators issued "Guidance on
Nontraditional Mbrtgage Product Risks," which recognizes the danger posed by risky
loan products and imprudent underwriting practices. 5 This Guidance should apply to ill.!
subprime ARM 16ans and non-traditional products. Specifically, the agencies should
affirm that this GLidance covers the most widely destructive type of loan today: hybrid
adjustable-rate mbrtgages in the subprime market (2/28s and 3/27s). These loans now
make up the vast Inajority of subprime loans, and they have predictable and devastating
consequences for the homeowners that receive them.
2. Require mortgage brokers to have a fiduciary duty to their clients. This simply means
giving brokers th6 explicit responsibility of serving the best interests of the people who
pay them. Brokets are now managing the most important transaction most families ever
make. Their role lis at least as important as that of lawyers, stockbrokers and ReaItorsprofessions that already have fiduciary standards in place.
3. Require the FJderal Reserve to act, or address abuses through the Federal Trade
Commission. The major federal law designed to protect consumers against predatory
home mortgage IJnding is HOEPA, which has manifestly failed to stem the explosion of
harmful lending dbuses that has accompanied the recent subprime lending boom. As I
will describe beldw, through HOEPA, Congress did provide the Board with significant
authority to addrdss these problems through regulation, but to date the Board has not used
this authority. Gi!ven the Board's record, Congress should give parallel authority to the
Federal Trade Colnmission to address mortgage lending abuses that have gone on for too
long.
4. Require government-sponsored enterprises to stop supporting abusive subprime loans.
Currently Fannie IMae and Freddie Mac are purchasing the senior tranches of mortgagebacked securities backed by abusive subprime loans. By doing so, they are essentially
supporting and cqndoning lenders who market abusive, high-risk loans that are not
affordable. This is clearly counter to the mission of those agencies. The agencies should
cease purchasing jthe securities, the Office of Federal Housing Enterprise Oversight
(Ofheo) should prohibit their purchase, and the U.S. Department of Housing and Urban
3
Development (H~D) should stop providing credit for these securities under HUD's
affordable housing goals.
5. Strengthen prdtections against destructive home lending by passing a strong national
anti-predatory leriding bill. HOEPA has not kept up with the evolution of abuses in the
market, and needs to be updated and strengthened. However, the mortgage market is
constantly changihg,
and it is impossible for any single law to cover all contingencies or
I
to anticipate predatory practices that will emerge in the future. Any new federal law must
preserve the rightlofthe states to supplement the law, when necessary, to address new or
locally-focused lending issues.
While there is a stong need for comprehensive reforms of the subprime mortgage
market, includingl weeding out abuses in how mortgage servicers handle monthly
payments, my prirary focus in these comments will be on loan origination practices and
how high-risk loans in the subprime market are supported and regulated.
I. Background: The Subprime Market and the Evolution of Predatory
Lending6
A. The Subprime Market and the Evolution of Predatory Lending
The subprime matket is intended to provide home loans for people with impaired or
limited credit histories. In addition to lower incomes and blemished credit, borrowers
who get subprimJ loans may have unstable income, savings, or employment, and a high
level of debt relatke to their income. 7 However, there is evidence that many families-a
Freddie Mac resekrcher reports one out of five-who receive subprime mortgages could
qualirr for prime loans, but are instead "steered" into accepting higher-cost subprime
loans.
As shown in the fgure below, in a short period of time subprime mortgages have grown
from a small niche market to a major component of home financing. From 1994 to 2005,
the subprime ho~e loan market grew from $35 billion to $665 billion, and is on pace to
match 2005's recbrd level in 2006. By 2006, the sub prime share of total mortgage
originations readied 23 percent. 9 Over most of this period, the majority of subprime
loans have been rbfinances rather than purchase mortgages to buy homes. Subprime
loans are also ch~racterized by higher interest rates and fees than prime loans, and are
more likely to indlude prepayment penalties and broker kickbacks (known as "yieldspread premiums!" or YSPs).
4
Subprime Mortgage Market Growth and Share of Total Mortgage Market
800~--------------------------~
Annual Loan
Originations ($8)
600
__---.30
% Share of Mortgage
20
Market
400
10
200
IP
Subprime Loans - - - Subprime share of all mortgage originations
I
I
Source: Inside
Mortg~ge Finance
When consideri.l the current state of the subprime market, it is useful to understand how
predatory lendingl has evolved over the past 15 years. When widespread abusive lending
practices in the sJbprime market initially emerged during the late 1990s, the primary
problems involvetl equity stripping-that is, charging homeowners exhorbitant fees or
selling unnecessa~y products on refinanced mortgages, such as single-premium credit
insurance. By firlancing these charges as part of the new loan, unscrupulous lenders were
able to disguise ekcessive costs. To make matters worse, these loans typically came with
costly and abusiv~ prepayment penalties, meaning that when homeowners realized they
qualified for a be~er mortgage, they had to pay thousands of dollars before getting out of
the abusive loan.
r
In recent years, "1hen the federal government failed to act, a number of states moved
forward to pass laws that address equity-stripping practices. Research assessing these
laws has shown t~em to be highly successful in cutting excessive costs for consumers
without hindering access to credit. I I The market has expanded at an enormous rate
during recent years even while states reported fewer abuses targeted by new laws. In
addition, the lead~rship shown by states has helped encourage the adoption of best
practices by resp~nsible lenders and leaders in the mortgage industry. Today, for
example, single premium credit insurance has virtually disappeared from the market,
upfront fees are rltuch lower than they used to be, and prepayment penalties have become
less costly, on avbrage, and last for a shorter period of time.
In spite of these s!uccesses, no one would say that predatory lending has been eliminated.
Prepayment penalties continue to be imposed on 70 percent of all subprime loans, 12 and
many other "old"l predatory practices are still alive and well in today's marketplace:
"Steering," when predatory lenders push-market borrowers into a subprime mortgage
even when they cpuld qualify for a prime loan; kickbacks to brokers (yield-spread
premiums) for selling loans with an high interest rate higher than the rate to which the
5
borrowers actuall)j qualified; and loan "flipping," which occurs when a lender refinances
a loan without pro1viding any net tangible benefit to the homeowner.
In addition, we nor have a second generation of subprime lending abuses: high-risk loan
products that were never intended for families who already have credit problems
(discussed in mor~I detail later in this testimony). The risks posed by these loans are
magnified further ibecause they are designed to generate refinances. These loans typically
begin with a low introductory interest rate that increases sharply after a short period of
time (one to threelyears) and fails to account for escrows for required taxes and
insurance. The very
design of these loans forces struggling homeowners to refinance to
I
avoid unmanageable payments. In other words, the prohibition against flipping that
many states instit~ted has been defeated by the design of a particular subprime mortgage
product that has dbminated the market in recent years.
I
.
While multiple refinances
boost volume for lenders, these transactions often provide only
I
temporary relief for families, and almost inevitably lead to a downward financial spiral in
which the family ~acrifices equity in each transaction. These dangerous subprime hybrid
ARM loan produdts and the ensuing refinances make a high rate of foreclosures not only
a risk, but also a dertainty for far too many families. And the likelihood of foreclosure
will only increasel as housing prices slow and accumulated equity is no longer available to
refinance or sell under duress.
B. Foreclosures ih the Expanding Subprime Market
In the United States, the proportion of mortgages entering foreclosure has climbed
steadily since 1980, with 847,000 new foreclosures filed in 2005. 13 In 2006, lenders
reported 318,000 Inew foreclosure filings for the third quarter alone, 43 percent higher
than the third qual-ter of2005. 14 In the past 18 months, there have been frequent stories
in the media aboJt risky lending practices and surges in loan defaults, especially in the
subprime market. ls
r
6
Subprime Foreclosure Starts as a Percent of
Total Conventional Foreclosure Starts
600/0 ~~~t-~~~~;2'~"~'~'~\"~--~-,--,~,~,:';;----~~~~~~~~
500/0 +----+:--~.i'~,-~~~--~~~~~~~~~~
~~'~~~~--------~--~
.
.
400~ +---~r_~~~~~~~~------~--r_----------------~
/'
30% +-~~~~I~~'~--~-7--~~--~--------~------------~
20% +-___I --------~----------------------------~
10% +----4--------------------------------------------4
0%
I
,.
rl
1
~"J ~"J I ~"J ~"J ~ ~~ ~~ ~ ~<:> ~<:> ~<:> ~<:> ~'o ~'o ~'o
"I
~1'5 ~1'5 tltl'5 ~ ~ ~1'5 ~ ~ ~ ~ ~ ~ ~ ~ ~
,,0' ",,0'
,,0' ,,0' ",,0' ,,0' ,,0' ,,0' ",,0' ,,0' ",0' ,,0' ",,0' ,,0'
Source: MBA National Delinquency Surveys
Figure 2 shows tJat foreclosure filings on subprime mortgages now account for over 60
percent of new cdnventional foreclosure filings reported in the MBA National
Delinquency Su~ey. This fact is striking given that only 23 percent of current
originations are sbbprime, and subprime mortgages account for only 13 percent of all
I
.
outstan d mg mortgages.
Some have apPlatded the growth in subprime lending as a positive break-through in
extending credit. ITo be sure, the community reinvestment movement, civil rights
,
activists, and others-including Self Help-have fought for years to bring investment to
communities thatl have lacked access t~ vital capital.
Yet this increased access has come at great cost to many families, given current subprime
lending practices.1 The pressing issue today is less the availability of home-secured credit
than the terms onlwhich it is offered. For the average American, building wealth through
homeownership is the most accessible path to economic progress, but progress is not
achieved when a family buys or refinances a home only to lose the home or get caught in
a cycle of escalating debt.
For most familieJ, foreclosure is a last resort, often coming in the wake of
unemployment, illness, divorce, or some other personal event that causes a drop in
income. Howevdr, in recent years there has been a surge in subprime foreclosures that
cannot be explairled by a change in employment levels or other factors that typically
drive foreclosure~. Instead, as widely discussed in the press during recent months, the
consequences of loose underwriting practices in the subprime market are now
exacerbated by a ~eneral slow-down in housing appreciation.
7
Researchers have ,examined the relationship between subprime lending and foreclosures,
and the effects on local communities. Some of the strongest research has been conducted
by the Woodstock! Institute, which has analyzed subprime foreclosures in the Chicago
area. Woodstock ire searchers have found high concentrations of subprime lending in zip16
code areas that ha~e a high proportion of minority residents. Woodstock also has
shown that "increases in high cost subprime mortgage lending have been the leading
driver of skyrock6ting foreclosure levels across the Chicago region.,,17 Dan Immergluck
(formerly on Woddstock's staff, now a professor at the Georgia Institute of Technology)
and Geoff Smith ilif Woodstock also investigated the effects of subprime lending and
foreclosures on n6ighborhoods. They found that in Chicago a foreclosure on a home
lowered the priceiofother nearby single-family homes, on average, by 1.44 percent. 18
They also reportea that the downward pressure on housing prices extended to houses that
sold within two ybars of the foreclosure of a nearby house.
About two monthl ago my organization, the Center for Responsible Lending, published a
the first comprehensive, nationwide research conducted on
report that repres6nts
I
foreclosures in the subprime market. The report, "Losing Ground: Foreclosures in the
Subprime Marketl and Their Cost to Homeowners," is based on an analysis of over six
million subprime mortgages, and the findings are disturbing. Our results show that
despite low intere1st rates and a favorable economic environment during the past several
years, the sUbPrimll'e market has experienced high foreclosure rates comparable to the
worst foreclosure experience ever in the modern prime market. We also show that
foreclosure rates will increase significantly in many markets as housing appreciation
slows or reverses! As a result, we project that 2.2 million borrowers will lose their
homes and up tol$164 billion of wealth in the process. That translates into foreclosures
on one in five sutiprime loans (19.4 percent) originated in recent years. Taking account of
the rates at which/ subprime borrowers typically refinance from one subprime loan into
another, and the fact that each subsequent subprime refinancing has its own probability of
foreclosure, this tbnslates into projected foreclosures for more than one-third of
subprime borrorers.
Another key find\ng in our foreclosure report is that subprime mortgages typically
include characteristics that significantly increase the risk of foreclos.ure, regardless of the
borrower's creditl Since foreclosures typically peak several years after a loan is
originated, we fo~used on the performance of loans made in the early 2000s to determine
what, ifany, loan/characteristics have a strong association with foreclosures. Our
findings are consistent with other studies, and show what responsible lenders and
mortgage insurer~ have always known: increases in mortgage payments and poorly
documented incoPle substantially boost the risk of foreclosure. For example, even after
controlling for differences in credit scores, these were our findings for subprime loans
made in 2000:
•
•
Adjustable-rate mortgages had 72 percent greater risk of foreclosure than fixedI
rate mortgages.
Mortgages with "balloon" payments had a 36 percent greater risk than a fixed-rate
mortgage IWithOut that feature.
I
8
•
•
•
Prepayment penalties are associated with a 52 percent greater risk.
Loans witH no documentation or limited documentation of the applicant's income
were associiated with a 29 percent greater risk.
And buying a home with a subprime mortgage, versus refinancing, puts the
homeowner at 29 percent greater risk.
A full copy of the ,1"Losing Ground" foreclosure study and an executive summary appear
on CRL's website at
http://www.responsiblelending.org/issues/mortgage/reports/page.jsp?itemID=31217189.
C. Disparate Implcts of Foreclosures
The costs of subp1ime foreclosures are falling heavily on African-American and Latino
homeowners, since subprime mortgages are disproportionately made in communities of
color. The most r~cent lending data submitted under the Home Mortgage Disclosure Act
(HMDA) show thbt over half of loans to African-American borrowers were higher-cost
loans, a measureIrlent that serves as a proxy for subprime status. 19 For Latino
homeowners, the ~ortion of higher-cost loans is also very high, at four in ten. The
specific figures are shown below:
Share of Higher Cost Mortgages by Race
Based on 2005 Data Submitted Under the Home Mortgage Disclosure Act
I
Group
I
African American
Latino
I
White
I
.
No. of Higher-Cost
Loans
388,741
375,889
1,214,003
% for Group
% of Total
52%
40%
19%
20
19
61
Given the projectld foreclosure rate of approximately one-third of borrowers taking
subprime loans inl recent years, this means that subprime foreclosures could affect
approximately 121 percent of recent Latino borrowers and 16 percent of African-American
borrowers. If this comes to pass, it is potentially the biggest loss of African-American
wealth in Americhn history.
I
However, while the negative impact of foreclosures falls disproportionately on
communities of cblor, the problem is not confined to anyone group. In absolute terms,
white homeownets received three times as many higher-cost mortgages as AfricanAmerican borroJers, and therefore will experience a significant number of foreclosures
as well.
II. Factors Driving Foreclosures in the Subprime Market
A. Risky Products: 2/28 "Exploding" ARMs
Subprime lenderS are routinely marketing the highest-risk loans to the most vulnerable
families and thosi who already struggle with debt. Because the subprime market is
9
intended to serve borrowers who have credit problems, one might expect the industry to
offer loan
that do not amplify the risk of failure. In fact, the opposite is true.
Lenders seek to
borrowers by offering loans that start with deceptively low
monthly paym I even though those payments are certain to increase. As a result,
many subprime! s can cause "payment shock," meaning that the homeowner's
monthly paym I can quickly skyrocket to an unaffordable level.
I
shock is not unusual, but represents a typical risk that comes
ing majority of subprime home loans. Today the dominant type of
subprime loan is I hybrid mortgage called a "2/28" that effectively operates as a two-year
2o
"balloon" loan.
This ARM comes with an initial fixed teaser rate for two years,
followed by rate 'ustments in six-month increments for the remainder of the term of the
10an?1 Com
I
this interest rate increases by between 1.5 and 3 percentage points at
the end of the
:
year, and such increases are scheduled to occur even if interest rates
in the general
nomy remain constant; in fact, the interest rates on these loans generally
can only go up, d can never go down. 22 This type ofioan, as well as other similar
hybrid ARMs (s h as 3/27s) have rightfully earned the name "exploding" ARMs.
Let me provide
exploding ARM
example of the severity of payment shock that can occur on the typical
a $200,000 loan:
ent Shock
(No Change in Interest Rates)
;:;1/1
e
Sc
O/S
$2,500
100%
90%
$2,000
80%
"[
'r;
c
.;:
-
$1,500
0..
C
QI
>0-
-
:E
c
o
::iE
For the 2/28 A
that correspond
conservative, we
have increased s
60%
-;0
30%
>0-
ra
0..
u
40%
E
$500
E
70%
50%
$1,000
QI
0
20%
c
~
.c
QI
c
)(
ra
I-;"
1/1
0
0..
10%
$Teaser Rate
Fully Indexed Rate
$1,311
$1,948
61%
90%
0%
shown in the chart above, we are making conservative assumptions
typical mortgages of this type. To make the example even more
assuming no general increase in interest rates, even though rates
lly in the past three years. The example is based on an
10
introductory teaser
rate of 6.85 percent and a fully indexed rate of 11.50 percent. 23 The
I
loan amount used in this example was $200,000, and, given the common practice of
extending loans ~here the pre-tax debt-to-income ratio is 50 to 55 percent, we assume
that this homeowher had a pre-tax income of $31 ,452, which equates to a post-tax income
of$25,901.
At the end of the ,introductory rate period, this homeowner's interest rate rose from 6.85
percent to 9.85 pJrcent, and the monthly payments jumped from $1,311 to $1,716, and
again six months Ilater to $1,948, an increase of over $600 a month. 24 This would be a
large increase for most families, and is a huge burden for a family that already struggles
with debt. At $1 '1948, this leaves only $21 O/month for all other expenses - including
property taxes anp hazard insurance, food, utilities, transportation, health care, and all
other family needs.
Sadly, and all too! commonly, this hypothetical homeowner had credit scores that wou Id
have qualified him or her for a fixed rate loan at 7.5 percent, which would have translated
of $1 ,398-a challenging debt-load to be sure, but far more
to monthly paymbnts
I
sustainable than the $1,948 fully-indexed monthly payment associated with the 2/28 loan
illustrated above'la payment that can easily increase as interest rates rise.
One would hope ~hat this type ofloan would be offered judiciously. In fact, hybrid
ARMs (2/28s and 3/27s) and hybrid interest-only ARMs have become "the main staples
of the subprime sbctOr.,,25 Through the second quarter of2006, hybrid ARMs made up
81 percent of the Isubprime loans that were packaged as investment securities. That
percent in 2002."
figure is up from
i64
Because of the prpliferation of these loans, payment shock for subprime borrowers is a
serious and widespread concern. According to an article in the financial press that ran a
year ago, homeo+ners face increased monthly payments on an estimated $600 billion of
subprime mortgages that will reset after their two-year teaser rates end?7 Fitch Ratings
calculated that b~ the end of2006, payments would have increased on 41 percent ofthe
outstanding subprime loans. 28
pOin~
Another key
about 2/28s in the subprime market is that they typically come with
large up-front feels compared to adjustable-rate mortgages in the prime market. 29 Very
few borrowers inlthe subprime market can pay these fees directly, so they are paid by
financing them as part of the loan. This cuts into homeowners' equity, essentially
reducing their shJre of ownership. In other words, subprime ARMs routinely find
borrowers trading equity, or ownership, in exchange for the temporary benefit of lower
•
I
mterest payments.
Previously I menlioned that regulators recently issued proposed "Guidance on
Nontraditional Mbrtgage Product Risks" that was a strong attempt to address concerns
about high-risk Idan products. However, the Guidance does not explicitly address 2/28s
or other hybrid Idans in the subprime market. This is a serious omission that runs counter
to the GUidanCe', intent, which is to require lenders ''to effectively assess and manage the.
I
I
11
risks" on loan products with the same characteristics as 2/28s. In particular, the Guidance
focuses on loan p~oducts that defer interest payments. 3D On 2/28s and other subprime
hybrid mortgages~ the change in interest rates is typically so large when the introductory
rate ends that these loan terms may properly be characterized as a contingent deferral of
interest from earl~ years to later years ofthe loan term. 31
I
The magnitude of the interest rate deferral on subprime hybrid ARMs is significantly
larger than that t)jpically found in prime ARM loans. Just last month, Federal Reserve
Board Governor ~usan Bies reached a similar conclusion, stating, "Let's face it; a teaser
loan really is a negative [amortization] loan because you don't pay interest up front.,,32
I
Other federal policy-makers
have concluded that the Guidance should be extended to
I
2/28 hybrid ARMs. Federal Deposit Insurance Corporation Chair Sheila Bair recently
I
.
stated:
The unde~writing standards in the alternative-mortgage guidance
should apply to those [2/28s,] and lenders should make sure there's an
ability to pay ..... [2/28s] were the type of mortgage that certainly was
intended tb be within the spirit of the alternative-mortgage guidance. 33
It is important to lote the insidious effect of limiting the Guidance to non-traditional
mortgage producis such as interest-only loans and option payment ARMs, to the
exclusion of 2/28k. Interest-only loans made up only 21. 7 percent of the subprime
mortgage-backedl securities in 2006, and subprime option ARMs have yet to be
evidenced in substantial numbers. 34 In contrast, 2/28s and 3/27s are the dominant
product in the sutiprime market - the market where the vast majority of abusive lending
occurs and wherel HMDA data shows minorities to be disproportionately represented. By
limiting the Guidance's
protections to products that exist predominantly in the prime
I
market, while failing to cover the most common product in the subprime market, the
regulators have Idft a disproportionate share of minority borrowers without protection.
We recently analJzed a randomly selected sample of North Carolina deeds of trust to
compare the potehtial
payment shock of loans eligible for the Guidance and subprime
I
loans that currently
are
not. We found that the payment shock of non-interest-only
I
suprime hybrid ARMs exceeded that of prime interest-only loans, not to mention prime
hybrid ARMs. Iri addition, we found three characteristics of subprime hybrid ARMs that
make the payment shock worse than that of prime loans - the initial rate serves as a floor
(i.e. the loan rate~ can only adjust higher), while the interest rates on prime loans can fall
as well as increasb; the loans fully adjust an average of2.5 years after origination, versus
5 years for prime loans; and the loans adjust every six months after the teaser expires,
versus every year for prime loans. Our findings suggest that subprime hybrid ARMs carry
scheduled ~ayment shocks that present formidable and often insurmountable hurdles to
borrowers. 5
I would like to thank the six members of the Banking Committee who sent a letter in
early December t6 the federal regulators who issued the Guidance and to the CSBS
12
expressing the view that "these [2/28] mortgages have a number of the same risky
attributes as the i,1terest-only and option-ARMs and, therefore, should be covered by the
new Guidance.,,36! Industry associations have largely opposed this change. I would
respectfully disagree with many of the industry assertions about subprime ARMs, and a
coalition of civil ~ights and consumer groups have recently sent a critique of the industry
claims to this Committee (Attached as Appendix B) .
. Finally, before \eLing the topic of2/28s, I want to address the common assertion that
consumers dema~d these types of loans and should carry all the responsibility for
receiving unsuitable loan products. Through our experience at Self Help and CRL, we
have seen that hotneowners with subprime ARMs or other types of risky loans were
almost never give:n a choice of products, but were instead automatically steered to these
loans, and were given little or no explanation of the loan's terms.
Subprime lenders have indicated that the types of products they offer and how they
underwrite them i;s largely investor-driven. Consider the frank acknowledgement by the
chief executive of Ownit Mortgage Solutions, a state-licensed non-bank mortgage lender
that recently filedl for bankruptcy protection after investors asked it to buy back well over
one hundred million dollars worth of bad loans. Ownit's chief executive, William D.
Dallas "acknowle:dges that standards were lowered, but he placed the blame at the feet of
investors and Wall Street, saying they encouraged Ownit and other supbrime lenders to
make riskier loan~ to keep the pipeline of mortgage securities well supplied. 'The market
is paying me to db a no-income-verification loan more than it is paying me to do the full
documentation lokns,' he said. 'What would you do?",37
These mortgage Jroducts are complicated financial instruments that are not widely
understood outside the financing and investment communities. For most families, buying
or refinancing a ~ouse is a rare event. Very few consumers have facility with concepts
such as "fully-indexed rate," "negative amortization," "prepayment penalties," "yieldspread premiums!" and "hybrid ARMs." Very few people are qualified to assess the
implications of tHe reams of papers they sign when they close on a new loan. Mortgage
I
.
brokers and lenders are the experts, and consumers should be able to trust them for sound
advice and a suidble loan.
It is not hard to fild examples of trust that was betrayed. One prominent example
appeared recentl~ in The Washington Post, which published an article about a barely
literate senior citizen who was contacted by a mortgage broker every day for a year
before he finally took an "alternative" mortgage against his interests. 38 Recently we at
CRL informally dontacted a few practicing attorneys in North Carolina and asked them to
provide example~ of inappropriate or unaffordable loans from their cases. In less than 48
hours, we receiv9d a number of responses, including the cases briefly described in
Appendix A. We also are aware of cases in which the borrower requested a fixed-rate
mortgage, but re~eived an ARM instead. The industry itself has asserted that borrowers
placed in subprime hybrid ARMs could have received fixed-rate loans, and that the rate
difference is "corhmonly in the 50 to 80 basis point range.,,39 This rate bump is less than
13
the increase in rates many borrowers are unknowingly charged by their mortgage brokers
in order to provid6 a hefty yield-spread premium to the broker.
I
B. Loose Qualifying Standards and Business Practices
The negative impact of high-risk loans could be greatly reduced if subprime lenders had
been carefully scrbening loan applicants to assess whether the proposed mortgages are
affordable. Unfo+unately, many subprime lenders have been routinely abdicating the
responsibility of underwriting loans in any meaningful way.
Lenders today hale a more precise ability than ever before to assess the risk of default on
a loan. Lenders Jnd mortgage insurers have long known that some home loans carry an
inherently greaterlrisk of foreclosure than others. However, by the industry's own
admission, underyriting standards in the subprime market have become extremely loose
in recent years, and analysts have cited this laxness as a key driver in foreclosures. 4o Let
me describe somel of the most common problems:
Not considering Jayment shock: Lenders who market 2/28s and other hybrid ARMs
often do not consider whether the homeowner will be able to pay when the loan's interest
rate resets, setting the borrower up for failure. Subprime lenders' public disclosures
indicate that most: are qualifying borrowers'at or near the initial start rate, even when it is
clear from the terfns of the loan that the interest rate can (and in all likelihood, will) rise
significantly, givihg the borrower a higher monthly payment. For example, as shown in
the chart below, J,ublicly available information indicates that these prominent national
subprime lenders ro not adequately consider payment shock when underwriting ARMs:
Sample Underwriting Rules For Adjustable Rate Mortgages41
ENDER
I
I
OPTION ONE MORTGAGE CORP
I
FREMONT INVESiTMENT & LOAN
NEW CENTURY
'
JNDER WRITING RULE
Qualified at initial monthly payment.
Ability to repay based on initial payments due in
the year of origination.
Generally qualified at initial interest rate. Loans to
borrowers with FICO scores under 580 and loano-value ratios of more than 80% are qualified at
fully indexed rate minus 100 basis points.
These underwritiL rules indicate that lenders routinely qualify borrowers for loans based
on a low interest tate when the cost of the loan is bound to rise significantly-even if
interest rates rem~in constant. In fact, it is not uncommon for 2/28 mortgages to be
originated with aJ interest rate four percentage points under the fully-indexed rate. For a
loan with an eighi percent start rate, a four percentage point increase is tantamount to a
40 percent increa~e in the monthly principal and interest payment amount.
Failure to escrow( The failure to consider payment shock when underwriting is
compounded by the failure to escrow property taxes and hazard insurance. 42 In stark
contrast to the pribe mortgage market, most subprime lenders make loans based on low
14
monthly payments that do not escrow for taxes or insurance. 43 This deceptive practice
gives the borrowJr the impression that the payment is affordable when, in fact, there are
significant additi~nal costs. Given that the typical practice in the subprime industry is to
accept a loan if tHe borrower's debt is at or below SO to SS percent of their pre-tax
income, using an lartificially low monthly payment based on a teaser rate and no escrow
for taxes and insurance virtually guarantees that a borrower will not have the residual
income to absorbla significant increase whenever taxes or insurance come due during the
first year or two, or certainly not when payments jump up after year two.
b~
A recent study
the Home Ownership Preservation Initiative in Chicago found that for
as many as one in seven low-income borrowers facing difficulty in managing their
mortgage paymerhs, the lack of escrow of tax and insurance payments were a
contributing factdr. 44 When homeowners are faced with large tax and insurance bills they
cannot pay, the otiginal lender or a subprime competitor can benefit by enticing the
borrowers to refiriance the loan and pay additional fees for their new loan. In contrast, it
is common practibe in the prime market to escrow taxes and insurance and to consider
those costs when looking at debt-to-income and the borrower's ability to repay.45
Low/no documentation: Inadequate documentation also compromises a lender's ability
to assess the true Ilaffordability of a loan. Fitch recently noted that "loans underwritten
using less than full documentation standards comprise more than SO percent of the
subprime sector .1 ... ,,46 "Low doc" and "no doc" loans originally were intended for use
with the limited category of borrowers who are self-employed or whose incomes are
otherwise legitim~tely not reported on a W-2 tax form, but lenders have increasingly used
these loans to ob~cure violations of sound underwriting practices. For example, a review
of a sample of thJse "stated-income" loans disclosed that 90 percent had inflated incomes
compared to IRS :documents, and "more disturbingly, almost 60 percent of the stated
amounts were exaggerated by more than SO percent.,,47 It seems unlikely that all of these
borrowers could ~ot
document their income, since most certainly receive W-2 tax forms,
I
or that they would voluntarily choose to pay up to 1.S percent higher interest rate to get
48
the "benefit" of ai stated-income loan.
Multiple risks in bne loan: In addition, regulators have expressed concern about
combining multiple risk elements in one loan, stating that "risk-layering features in loans
to subprime borrdwers may significantly increase risks for both the ... [Iender] and the
borrower.,,49 Pre~iously I described a brief overview of the increased risk associated with
several subprime Iloan characteristics, including adjustable-rate mortgages, prepayment
penalties, and limited documentation of income. Each of these items individually is
associated with alsignificant increase in foreclosure risk, and each has been characteristic
of subprime loans in recent years; combining them makes the risk of foreclosure even
worse.
C. Broker Abuses and Perverse Incentives
Mortgage brokerS are individuals or firms who find customers for lenders and assist with
the loan process. Brokers provide a way for mortgage lenders to increase their business
without incurring the expense involved with employing sales staff directly. Brokers also
IS
playa key role in today's mortgage market: According to the Mortgage Bankers
Association, mortgage brokers now originate 45 percent of all mortgages, and 71 percent
of subprime loan~.5o
Brokers often detlrmine whether subprime borrowers receive a fair and helpful loan, or
whether they endlup with a product that is unsuitable and unaffordable. Unfortunately,
given the way the current market operates, widespread abuses by mortgage brokers are
inevitable.
First, unlike other similar professions, mortgage brokers have no fiduciary responsibility
to the borrower Jho employs them. Professionals with fiduciary responsibility are
obligated to act iJ the interests of their customers. Many other professionals already have
affirmative oblig~tions to their clients, including real estate agents, securities brokers and
attorneys. Buyin~ or refinancing a home is the biggest investment that most families ever
make, and particUlarly in the subprime market, this transaction is often decisive in
oetermining a fa~i1y's future financial security. The broker has specialized market
knowledge that t~e borrower lacks and relies on. Yet, in most states, mortgage brokers
have no legal res~onsibility to refrain from selling inappropriate, unaffordable loans, or
not to benefit per~onally at the expense of their borrowers. I
Second, the marklt, as it is structured today, gives brokers strong incentives to ignore the
best interests ofh'omeowners. Brokers and lenders are focused on feeding investor
demand, regardle~s of how particular products affect individual homeowners. Moreover,
because of the wcly they are compensated, brokers have strong incentives to sell
excessively expeJsive loans. They earn money through up-front fees, not ongoing loan
payments. To mJke
matters worse for homeowners, brokers typically have a direct
I
incentive to hike interest rates higher than warranted by the risk of loans. In the majority
of subprime trans~ctions,
brokers demand a kickback from lenders (known as "yield
I
spread premiums'I') if they deliver mortgages with rates higher than the lender would
otherwise accept. Not all loans with yield-spread premiums are abusive, but because they
have become so common, and because they are easy to hide or downplay in loan
transactions, unsdrupulous brokers can make excessive profits without adding any real
value.
Experts on mortgage
financing have long raised concerns about problems inherent in a
I
market dominated by broker originations. For example, the chairman of the Federal
Reserve Board, B:en S. Bernanke, recently noted that placing significant pricing
discretion in the Hands of financially motivated mortgage brokers in the sales of mortgage
products can be alprescription for trouble, as it can lead to behavior not in compliance
52
with fair lending laws.
Similarly, a report issued by Harvard University's Joint Center
I
for Housing Studies, stated, "Having no long term interest in the performance of the loan,
a broker's incentire is to close the loan while char~ing the highest combination of fees
and mortgage interest rates the market will bear.,,5
In summary:
MO~gage brokers, who are responsible for originating over 70 percent of
loans in the sUbPlime market, have strong incentives to make abusive loans that harm
I
I
I
I
16
consumers, and no one is stopping them. In recent years, brokers have flooded the
subprime market Fith unaffordable mortgages, and they have priced these mortgages at
their own discreti'on. Given the way brokers operate today, the odds of successful .
homeownership dre stacked against families who get loans in the subprime market.
I
D. The Role of Investors
claim that the costs of foreclosing give loan originators adequate
Lenders sometimes
I
incentive to avoid placing borrowers into unsustainable loans, but this has proved false.
Lenders have be~n able to pass offa significant portion of the costs of foreclosure
through risk-base~ pricing, which allows them to offset even high rates of predicted
foreclosures by a~ding increased interest costs. Further, the ability to securitize
mortgages and trdnsfer credit risk to investors has significantly removed the risk of
volatile upswing~ in foreclosures from lenders. In other words, high foreclosure rates
.
have simply beco'me a cost of business that is largely passed onto borrowers and
.
.
I
sometImes Investors.
It is clear that mohgage investors have been a driving force behind the proliferation
of abusive loans i1n the subprime market. Their high demand for these mortgages has
encouraged lax uhderwriting and the marketing of un affordable loans as lenders sought to
fill up their coffefs with risky loans. For example, approximately 80 percent of subprime
mortgages includbd in securitizations issued the first nine months of 2006 had an
adjustable-rate fekture, the majority of which are 2/28s. 54
.
I
It is particularly disturbing to note that not all of the investment support has come from
private Wall Stre~t firms. Even though Fannie Mae and Freddie Mac, the governmentsponsored enterpfises (GSEs), have a mandate to help families achieve homeownership,
and over the year~ have made a significant contribution, they have been purchasing a
significant share bf securities backed by highly questionable subprime loans-i.e., loans
that were made ~ithout considering low- and moderate-income families' ability to repay.
The GSEs bought about 25 percent of total subprime mortgage-backed securities sold in
55
the first nine moriths of2006. This is an enormous investment in loans that are
producing recordtlevel foreclosures, and destroying the economic stability of AfricanAmerican and Latino families.
disapPointin~
that Fannie and Freddie have not shown leadership in this area, but
It is
instead have competed with other investors to buy securities backed by high-risk
subprime loans tHat hurt consumers and reverse the benefits of homeownership. The
GSEs, with their ~ublic mission, should not be permitted to purchase loans to distressed
or minority or lot-to-moderate income families that do not meet an "ability to repay"
standard. Moreover, the GSEs should not receive credit from the Department of Housing
and Urban Develbpment to meet their affordable housing goals 56 for investing in loans
that generate mas1sive foreclosures and violate a majority of the GSEs' own published
guidelines against predatory mortgage lending. These strong guidelines include, for
example, standarJ!s on the ability to repay, the requirement of escrow accounts for taxes
and insurance, ana a prohibition on prepayment penalties. The GSEs apply these
17
guidelines to loans purchased directly from loan originators, but not to the loans that they
purchase as securities.
I
Further, by investing in loans that lack these basic protections, the GSEs not only
but they actually compound the disadvantages that minority
contravene their Irlission,
I
borrowers face. llhis is because the loans subject to the predatory lending guidelines are
prime, fixed-rate rhortgages where white borrowers disproportionately receive their
loans, while Africhn-American and Latino families disproportionately receive their loans
from the market ihere the GSEs have participated in without applying the guidelines.
Giving the GSEs HUD goals credit for these purchases defeats the very purpose for
which the goals wfre set, namely to incent the GSEs to develop products and outreach
that give borrowers less abusive products than those already available in the subprime
marketplace. Re~arding the GSEs with goals credit for these purchases would be like
giving banks credit under the Community Reinvestment Act for making abusive loans to
low-wealth familibs. To be fair to the GSE's, however, HUD should remove these loans
from both the nu~erator and the denominator of the overall mortgage market when
calculating the petcentage of the affordable housing market that the GSEs meet.
Otherwise, iftheyj stop purchasing the securities, and the loans are taken out of the
numerator, it wou1ld likely be impossible for them to meet their percentage affordable
housing goals, betause subprime loans currently comprise such a large portion of the
market.
Recently, as foreclosure rates have sharply increased, investors are looking more closely
at underwriting pJactices that have produced foreclosure rates far higher than predicted,
and in some instahces have demanded the repurchase of loans that defaulted extremely
quicklt In a few/highly publicized cases, lenders have been forced out of business as a
result. 7 However, defaults that occur after a designated three to six month period are not
the responsibilitylofthe lender. And while recent investor attention may force lenders to
make some adjustments to accommodate investor concerns, it will not help those
borrowers who arf in 2/28s now, many of whom will lose their homes, their equity and
their credit ratings when lenders foreclose on loans that never should have been made.
E. Federal Neglebr
When Congress dassed HOEPA in 1994, subprime loans made up only a very small share
of the total mortghge market, and predatory lending practices were not nearly as prevalent
I
as they were to become a few years later. It would have been helpful to update HOEPA
to keep pace with! the rashes of innovative predatory lending practices that occurred after
the law passed, but with the pace of change in the mortgage market and the challenges of
passing major legislation, that has not been-and never will be-feasible.
On the federallJel, one regulatory agency was given explicit authority to take action:
the Federal Rese+e Board. The Board's primary authority comes through HOEPA,
which provides
Board with broad authority to prohibit unfair or deceptive mortgage
T
I
I
I
I
I
18
lending practices and to address abusive refinancing practices. Specifically, the Act
includes these prdvisions:
DISC~TIONARY
(I)
REGULATORY AUTHORITY OF BOARD.-I
(2) PROHIlBITIONS.--The Board, by regulation or order, shall prohibit
acts or pr~ctices in connection with-(A) mortgkge loans that the Board finds to be unfair, deceptive, or
designed evade the provisions ofthis section; and
(B) refina~cing of mortgage loans that the Board finds to be associated
with abusive lending practices, or that are otherwise not in the interest of
the borroJ,er. 58
t'o
While HOEPA gJnerallY applies to a narrow class of mortgage loans, it is important to
note that Congres~ granted the authority cited above to the Board for ill.l mortgage loans,
not only loans governed by HOEPA (closed end refinance transactions) that meet the
definition of"hig~ cost." Each of the substantive limitations that HOEPA imposes refer
specifically to high-cost mortgages. 59 By contrast, the discretionary authority granted by
subsection (I) refers to "mortgage loans" generally.60
The legislative hiltory
makes clear that the Board's discretionary authority holds for all
I
mortgage loans. The HOEPA bill that passed the Senate on March 17, 1994, and the
accompanying S~nate report, limited the Board's authority to prohibit abusive practices
in connection with high-cost mortgages alone. 61 However, this bill was amended so that
the bill that ultimktely passed both chambers, as cited above, removed the high-cost-only
limitation, and thb Conference Report similarly removed this restriction. 62 The
Conference Repoh also urged the Board to protect consumers, particularly refinance
mortgage borrow~rs.63
b~en
The Board has
derelict in the duty to address predatory lending practices. In spite of
the rampant abuses in the subprime market and all the damage imposed on consumers by
predatory lending-billions of dollars in lost wealth-the Board has never implemented a
single discretionary rule under HOEPA outside of the high cost context. To put it
bluntly, the Board has simply not done its job.
III. Solutions
Congress has a 19n9, proud history of strong policies to support homeownership, but that
task has become r;nore complicated than ever. Supporting homeownership continues to
involve encouraging fair lending and fair access to loans. But supporting homeownership
also means refusihg to support loans that are abusive, destructive and unnecessarily risky.
A few years ago, !the problem of subprime foreclosures likely would have received scant
attention from policymakers, since subprime mortgages represented only a small fraction
of the total mortg~ge market. Today subprime mortgages comprise almost one quarter of
all mortgage originations. The merits of this expanding market are widely debated, but
19
one point is clear: Subprime mortgage credit-and the accompanying foreclosureshave become a major force in determining how and whether many American families
will attain sustain~ble wealth.
I
There are simple, known solutions to help preserve the traditional benefits of
homeownership ahd to address many of the problems I have mentioned today. Here I
.
I
d atlOns:
.
our fiIve r1ecommen
reIterate
1. Restore safety ~o the subprime market by imposing a borrower "ability to repay"
standard for all sUhprime loans. The recently-issued Guidance on nontraditional
mortgage products should apply to all subprime hybrid ARM loans and non-traditional
products. Specifitally, the agencies should affirm that this Guidance covers the most
widely destructivJ type of loan today: 2/28s in the subprime market. We also
recommend that t~ey include the requirement that lenders escrow for property taxes and
hazard insurance 6n subprime loans, and include these payments in the calculation of the
borrower's ability to repay the loan. Further, the Guidance points out the problems with
no-doc loans, and should affirmatively require that lenders verify and document all
sources of income using either tax or payroll records, bank account statements or other
reasonable third-~arty verification.
2. Require mortJge brokers to have a fiduciary duty to their clients. We know it is both
feasible and desirable to require mortgage brokers to serve the best interests of the people
who pay them. B~okers manage the most important transaction most families ever make.
Their role is at lerist
as important as that of stock brokers, lawyers and RealtorsI
professions that areadY have fiduciary standards.in place.
3. Require the Feaeral Reserve to act, or address abuses through the FTC. HOEPA, the
major federal lawldesigned to protect consumers against predatory mortgage lending, has
manifestly failed to stem the explosion of harmful lending abuses that has accompanied
the recent subprirlte lending boom. Congress has provided the Federal Reserve Board
with discretiona~1 authority to address these problems for all mortgage loans, but to date
the Board has not taken advantage of this authority. Given the Board's record, Congress
should seriously consider enlisting the Federal Trade Commission's assistance in
addressing abused that have gone on too long.
I
· government-sponsored
'
. .In ab
' su·b·
4. Requlre
enterprIses
to stop .
InvestIng
uSlve
prIme Ioan
securities. Curreqt1y Fannie Mae and Freddie Mac are purchasing mortgage-backed
securities that include high-risk subprime loans. By doing so, they are essentially
supporting and cdndoning lenders who market abusive, high-risk loans that are not truly
affordable. This i1s clearly counter to the mission of those agencies. They should
voluntarily stop irlvesting in these securities. In addition, HUD should stop giving them
affordable goals 9redit for purchasing these AAA securities (take them out of both the
numerator and depominator in assessing the market), and Ofheo should prohibit the
agencies from adding these securities to their portfolios.
20
....._ _ _ _ _ _ _ _ _ _ _ _ _-J..._ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ .-.
5. Strengthen protections against destructive home lending by passing a new national
anti-predatory le~ding bill. Federal law has clearly not kept up with the abuses in the
changing mortgage market. HOEPA needs to be extended and updated to address the
issues that are driiving foreclosures today. Even should this happen, we need to realize
that it is impossil:He for any single law to cover all contingencies or to anticipate
predatory practicbs that will emerge in the future. Any new federal law must therefore
preserve the right ofthe states to supplement the law, when necessary, to address new or
locally-focused IJnding
issues. While HOEPA is weak, it did recognize the limits of
I
federal law, and therefore functions as a floor, not a ceiling. IfHOEPA had not allowed
states to take actibn, today's disastrous levels of foreclosures would be even worse.
Thank you very luch for the opportunity to testify before you today. I would be happy
I •
to answer any qUfstlOns
you may have.
I
21
APPENDIX A
To illustrate the unfortunate realities of inappropriate and unaffordable 2/28 adjustable
rate mortgages (tRMS), recently the North Carolina Justice Center informally contacted
a few practicing attorneys in North Carolina to provide examples from their cases. They
received a numbJr of responses, including these described below.
. I
1. From affordable loan to escalating ARM.
Through local affordable housing program, a homeowner had a 7% fixed-rate,
I·
30-year mortgage. A mortgage broker told the homeowner he could get a new
loan at a ~ate "a lot" lower. Broker originated a 2/28 ARM with a starting rate of
6.75%, but told borrower that it was a fixed-rate, 30-year mortgage. At the 24th
month, thb loan went up to 9.75%, following the loan's formula of UBOR plus
5.125% Jnd a first-change cap maximum of9.75%. Loan can go up to a
maximurrlI of one point every six months, with a 12.75% total cap. Now borrower
cannot afford the loan and faces foreclosure.
a
2. Tempora!ry lower payments-a prelude to shock.
HomeowAer refinanced out of a fixed-rate mortgage because she wanted a lower
I
monthly payment. The homeowner expressly requested lower monthly payments
that incluaed
escrow for insurance and taxes. Mortgage broker assured her that he
I
would abi'de by her wishes. Borrower ended up in a $72,000 2/28 ARM loan with
first two years monthly payments of $560.00 at a rate of 8.625%. This initial
payment ~as lower than her fixed-rate mortgage, but it did not include escrowed
insuranceland taxes. After two years, loan payments increased every six months
at a maximum one percent with a cap of 14.625%. At the time of foreclosure, the
interest rdte had climbed to 13.375% with a monthly payment $808.75. If the
loan had ~eached its maximum interest rate, the estimated monthly payment
3. ::::o::e:ef::::eO:~rt.
Homeowner
had a monthly payment of $625 and sought help from a mortgage
I
broker to Ilower monthly payment. Broker initially said he could lower the
payment, but before closing said the best he could do was roughly $800. He
that he could refinance her to a loan with a better payment in six
assured b~rrower
I
months. I?reviously he had advised homeowner not to pay her current mortgage
I
payment because the new loan would close before the next payment due date. In
fact, c10sih g occurred after the payment was due, and borrower felt she had to
close. Lokn was a 2/28 ARM with an initial interest rate of 11 % and a ceiling of
18% at ani initial monthly payment of $921. Interest at first change date is
calculate~ at UBOR plus 7%, with a 12.5% cap and a 1.5% allowable
increase/decrease at each 6-month change date. First change date is June 1, 2008.
By appro~imately the third payment, however, borrower could not afford
mortgage layments and is now in default.
I
i
I
•
22
APPENDIXB
February 5, 2007
The Honorable Christopher Dodd
448 Russell Senate Office Building
United States Seriate
Washington, D.d 20510-0702
I
The Honorable Wayne Allard
521 Dirksen SenJte Office Building
United States Seriate
Washington, D.d 20510-0605
The Honorable Jack Reed
728 Hart Senate Office Building
United States Senate
Washington, D.C. 20510- 3903
The Honorable Jim Bunning
316 Hart Senate Office Building
United States Senate
Washington, D.C. 20510-1703
I
The Honorable Charles Schumer
313 Hart Senate 0ffice Building
United States Se~ate
Washington, 0.0. 20510-3203
Dear Senators,
nd
On January 2 , the Consumer Mortgage Coalition (CMC) wrote a letter to Senators
Sarbanes, Allard,1 Dodd, Bunning, Reed, and Schumer arguing that it would be
inappropriate to apply the October 4th Interagency Guidance on Nontraditional Mortgage
Product Risks to kubprime 2-28 ARM loans. On January 25 th , the Coalition for Fair &
Affordable Lendi~g (CFAL) wrote a letter to similar effect to the heads of the federal
banking regulatots. Their arguments are similar in many respects, and, we respectfully
submit, both are Jqually without merit. Subprime 2-28 mortgages (and other hybrid
ARMs with simil~r characteristics such as subprime 3-27 mortgages) present the full
array of risks that drove regulators to issue the Guidance, and should be covered. We
address CMC's a~guments below, and then, to the extent CFAL has raised any further
points meriting rJsponse, we address those briefly as well.
I
Although the CMC tries to link 2-28 subprime ARMs to more established prime hybrid
ARMs, the reality remains that 2-28 subprime ARMs present a radically different risk to
borrowers and cah be covered under the Guidance without introducing new standards on
lower-risk prime l.\RMs. Indeed, the most recent Mortgage Bankers Association
National Delinqu~ncy Survey found that subprime ARMs are starting foreclosure at more
than seven times the rate of prime ARMs in the third quarter of 2006. 1
Many subprime linders still find such lending profitable, however, because of two
factors. First, th~ advent of risk-based pricing allows them to offset even high rates of
I
Mortgage Bankers
~ssociation, National Delinquency Survey, Third Quarter 2006, (Sept. 30, 2006).
1
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23
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predicted foreclosures by adding increased interest costs. Second, the ability to securitize
mortgages and trahsfer credit risk to investors has largely removed the risk of volatile
upswings in foreclosures from lenders. In other words, high foreclosure rates have
simply become a bost of business that is passed onto borrowers and, sometimes,
investors.
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primar~
One of the
purposes of the Guidance is to protect borrowers against payment
shock. 2-28s almost invariably entail a substantial payment shock because of the way
they are designed) underwritten and marketed today. Typical practice in the subprime
industry is to accdpt a loan if the borrower's debt is at or below 50 to 55% of pre-tax
income, using an krtificially low monthly payment based on a teaser rate and no escrow
for taxes and insubnce. This virtually guarantees that a borrower will not have the
residual income t6 absorb a significant increase whenever taxes or insurance come due
during the first yehr or two, or when the teaser rate resets.
I
The harm inflicted by these loans impacts even more borrowers than those affected by the
non-traditional m6rtgages because, first, ofthe explosion in the subprime market -- from
1994 to 2005, it grew from $35 billion to $665 billion, and from 1998 to 2006, the
subprime share otitotal mortgage originations climbed from 10 percent to 23 percent. 2
The second reasoh is that 2-28s are by far the most common product in the subprime
market today;3 thfough the second quarter of 2006, hybrid ARMs made up 81 percent of
the subprime loarls that were packaged as investment securities. 4
Moreover, 2-28s Ld 3-27s are having a particularly damaging impact on communities of
color. Accordinglto the most recent HMDA data, a majority of loans to AfriCanAmerican borrow1ers were so-called "higher-rate" loans,5 while four in ten loans to
6
Latin0 borrowers were higher-rate, the substantial portion of which are 2-28s and 3-27s.
By contrast, apprbximately 80% of home loans during this time period to white families
were convention~1 loans, the sector clearly protected by the Guidance. 7
We have seen thJ borrowers with subprime ARMs were almost never given a choice of
products, but wer~ instead automatically steered to an ARM and were given little or no
explanation ofth6 ARM's terms. These borrowers should have the same right to receive
I
Subprime Mortgag~ Origination Indicators, Inside B&C Lending (November 10, 2006).
3 Hybrid ARMs and hybrid interest-only ARMs have become "the main staples of the subprime sector ."
See Mike Hudson anti E. Scott Reckard, More Homeowners with Good Credit Getting Stuck in HigherRate Loans, L.A. Tirltes, p. A-I (October 24,2005).
4 See Structured Finahce: U.S. Subprime RMBS in Structured Finance COOs, p. 4; Lehman Brothers,
Cause for AI-ARM -~ Comprehensive Toolfor Understanding the Recent Development of the Adjustable
Rate Mortgage and iJ)etermining the Implications on Credit Risk of its Growing Popularity, (June 15, 2005)
at 9.
I
5 54 .7 percent of African-Americans who purchased homes in 2005 received higher-rate loans. 49.3
percent received such loans to refinance their homes.
646.1 percent of Lati'no white borrowers received higher-rate purchase loans. 33.8 percent received higherrate refinance 10ans.IFor the purpose of this comment, "Latino" refers to borrowers who were identified as
racially white and oflLatino ethnicity.
7 See e.g., Debbie Gruenstein Bocian, Center for Responsible Lending Comment on Federal Reserve
Analysis of Home Ubrtgage
Disclosure Act Data (September 28, 2006).
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2
24
"information that is designed to help them make informed decisions when selecting and
using these products" as recommended by the Guidance.
CMC & CF AL Alssertions Answered
ASSERTION: 2j28 subprime ARMs are "well-established" with "default rates that are
comparable to or Isometimes better than those on 30-year fixed rate loans."
ANSWER: The first-lien subprime market is less than a decade old and is only now
being tested for tfue first time as waning house price appreciation exposes weaknesses that
are projected to IJad to 1 in 5 subprime loans ending in foreclosure.
EVIDENCE:
•
•
•
Using housing price forecasts from Moody's Economy.com, a recent Center for
Responsitile
Lending report, Losing Ground, projected that I in 5 (19.4%) of
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subprime ,loans originated in 2006 will end in foreclosure and that subprime ARM
loans havb a greater risk of foreclosure than subprime fixed-rate loans. 9 For
example, the
report found that subprime ARM loans originated in 2002 had a 78%
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greater risk of foreclosure than subprime fixed-rate loans after controlling for
.
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cre d It score.
Multivari~te
regression analysis from the University of North Carolina showed
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that subpr'ime ARMs had a 49% greater risk of foreclosure than subprime fixedrate mortgages after controlling for FICO score, loan-to-value ratio, strength of
lo
income documentation, and economic conditions.
Accordin~ to the Mortgage Bankers Association National Delinquency Survey,
subprime !ARMs have much higher delinquency rates than prime ARMs and
subprime fixed rate loans. The 2006 third quarter data showed that the
delinquenby rate for subprime ARMs was 13.22 percent, compared to 9.59
percent fo'r subprime fixed rate loans and just 3.06 percent for prime ARMs. I I
8 Center For ResponJible Lending, Losing Ground: Foreclosures in the Subprime Market and Their Cost
to Homeowners (Oed. 2006) at 3-5, available at
http://www.responsiblelending.org/issues/mortgage/reports/page.jsp?itemlD=31217189.
9 We have been plea~ed to receive informal confirmation of our projections from various sources, including
major investment fidns. The attached Baltimore Sun article provides a good summary of the paper's
findings and perspective from multiple market participants.
10 Roberto G. Quercih, Michael A. Stegman and Walter R. Davis, The Impact of Predatory Loan Terms on
Subprime Foreclosu~es: The Special Case of Prepayment Penalties and Balloon Payments, Center for
Community Capitalism, University of North Carolina at Chapel Hill (January 25, 2005) at 28-9.
II Mortgage Bankers Association, National Delinquency Survey, Third Quarter 2006, (Sept. 30, 2006) at 7,
9.
25
ASSERTION: "Ulfthe Guidance were extended to 2/28 mortgages, [m]any first-time
borrowers would Ilose the opportunity to own a home."
ANSWER: Loans that borrowers cannot afford do not lead to lasting homeownership
opportunities. Mbreover, the loans in the subprime market are typically debt
consolidation refi'nance loans and do not create new homeownership opportunities.
EVIDENCE:
•
•
Assessing subprime lending from 1998-2004, CRL reports in Losing Ground that
refinance loans were a majority of all subprime originations. 12
A survey published in Housing Policy Debate in 2004 by staff from Opinion
Research Corporation, Freddie Mac, and Equitec revealed that only 14.2% of
subprime borrowers reported taking their loan to purchase a first home. 13 Further,
with projdcted default rates of 19.4% for recent subprime loans, subprime lending
appears td, be on pace to result in a net loss in homeownership in its current form.
of the borrowers in a cohort of sub prime loans refinance into further
Finally, most
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subprime loans, and many of these will also be foreclosed upon; following the
borrower through
subsequent loans rather than just looking at that first loan
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cohort, C~ roughly estimates in Losing Ground actual subprime borrower
foreclosuT rates over 35%.
ASSERTION: "The type of deep discount below the fully-indexed rate that Mr. Calhoun
[ofCRL] address~d
in his testimony is not common." (Referencing testimony before the
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Senate Banking Committee regarding Nontraditional Mortgages on September 20,2006)
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ANSWER: High payment shock is absolutely typical of2-28 subprime ARMs.
EVIDENCE:
•
•
A December
11, 2006 presentation by Fannie Mae Chief Economist David Berson
I
at the Office of Thrift Supervision reported that 2006 subprime ARM loans in
mortgage1backed securities carried an average initial interest rate of7.95% and an
average fully-indexed rate of 11.29% as of year-end (margins averaged 5.93%
over 6-mdnth USD LIBOR)14. For a 2-28 subprime ARM this differential
represents a payment shock of 32% between the initial rate and the fully-indexed
rate.
A mid-ye~r 2006 analysis from Fitch Ratings similarly reported that 2-28
subprime A.RMs carried a built-in payment shock of 29% even if interest rates
I
12 Center For Respon~ible Lending, Losing Ground: Foreclosures in the Subprime Market and Their Cost
to Homeowners (Ded. 2006) at 3-5, available at
http://www.responsitilelending.org/issues/mortgage/reportsIpage.jsp?itemID=31217189 at 46.
13 Howard Lax, Mich:ael Manti, Paul Raca, and Peter Zorn, "Subprime Lending: An Investigation of
Economic Efficiencyi" Housing Policy Debate 15:3 (2004).
14 David Berson, VP lIZ Chief Economist at Fannie Mae, Challenges and Emerging Risks in the Home
Mortgage Business, dresented at the National Housing Forum at the Office of Thrift Supervision
(December 11,2006)[
26
remain unchanged, with LIBOR remaining at 4.27%. With year-end LIBOR at
5.36%, thd Fitch analysis suggests payment shocks of48%.15
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ASSERTION: "We note that both of these features [subprime prepayment penalties and
low-documentati~n loans] can benefit borrowers .... Lenders are able to offer lowdocumentation loans because the technology of predicting loan performance has
.
d"
Improve
...
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ANSWER: Both lofthese features are associated with higher foreclosure risk on
subprime loans arid should certainly be scrutinized in the context of the Guidance.
Limited documentation loans often are used to make loans where it is known that the
borrower's incomb is insufficient to cover the scheduled payments.
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EVIDENCE:
•
•
•
•
UNC researchers found that prepayment penalties and limited documentation
loans nationally were features associated with a 16-20% and a
loans in sJbprime
I
15% increase in foreclosure risk, respectively, after controlling for credit score,
loan-to~value
ratio, economic conditions, and several other variables. 16
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The CRL Losing Ground report finds that prepayment penalties and limited
documendtion on subprime loans nationally were associated with increased
foreclosur~I risk. For example, for loans originated in 2001, controlling for credit
score, the increased foreclosure risk for prepayment penalties and limited
document~tion features on subprime loans were 36% and 26% respectively.17
Similarly, Ion a set of subprime loans from the Chicago area, OCC researcher
Morgan Rpse reported that subprime loans with prepayment penalties and lowincome dOicumentation were more likely to lead to a foreclosure starts for
subprime refinance ARM loans. 18
A report f;om the Mortgage Asset Research Institute (MARl) examined a sample
of stated-ihcome loans and found that 90 percent of borrowers had incomes higher
than those found in IRS files and "more disturbingly, almost 60 percent of the
IS Structured Finance! U.S. RMBS Criteria for Subprime Interest-Only ARMs, FITCH RATINGS
CREDIT POLICY (New York, N.Y), October 4,2006.
16 Roberto G. QuerciJ, Michael A. Stegman and Walter R. Davis, The Impact of Predatory Loan Terms on
Subprime Forec/osur~s:The Special Case of Prepayment Penalties and Balloon Payments, Center for
Community Capitalisb, University of North Carolina at Chapel Hill (January 25, 2005)
17 Center For Respon~ible Lending, Losing Ground: Foreclosures in the Subprime Market and Their Cost
to Homeowners (Oed 2006) at 3-5, available at
http://www.responsib1Ielending.org/issues/mortgage/reportsIpage.jsp?itemID=31217189 at 22.
18 Morgan Rose, OC¢ Working Paper #2006-1, "Foreclosures of Sub prime Mortgages in Chicago:
Analyzing the Role of Predatory Lending Practices."
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27
stated income amounts were exaggerated by more than 50 percent.,,19 Similarly,
140 mortgage brokers (constituting a national sample) found that 43·
a survey 6f2,
I
percent of brokers who use low documentation loan products know that their
borrowerJ "can't qualify under standard [debt-to-income] ratios" because they did
not have ~nough income for the loan. 2o
i
.
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ASSERTION: "Investors set limits on the extent to which loan underwriting can take
this initial "teaset" rate into account. They sometimes ... [require] that loans with an
aggressive initialldiscount be underwritten at the fully-indexed rate."
ANSWER: To p~otect both borrowers and responsible lenders who require underwriting
at the fully index~d rate, it is important that regulators level the playing field by making
this standard applicable to all 2-28 subprime ARMs. It is clear that major subprime
lenders do not un1derwrite to the fully-indexed rate.
I
EVIDENCE:
• A 2005 Option One prospectus shows that the lender underwrote loans to the
lesser of dne percentage point over the start rate or the fully-indexed rate. 21 Yet,
under thid "lesser of' formulation, the latter would typically never apply to 2-28
subprime IARMs.
• As summ~rized in a November 2006 release, New Century's strongest
underwriting practice, which is applied only to borrowers with a credit score
under 58d and a loan-to-value ratio over 80 percent, is to evaluate the borrower's
ability to }epay the mortgage at an interest rate equal to the fully indexed rate
minus on~ percentage point. Other borrowers have their ability to repay screened
at the initial interest rate. 22
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Additional AsseJions By CF AL Answered
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ASSERTION: The Guidance "does not take into account an individual's income growth
over the years."
19 Mortgage Asset Rbsearch Institute, Inc., Eighth Periodic Mortgage Fraud Case Report to Mortgage
Bankers Association! p. 12, available at http://www.mari-inc.com/pdfs/mbalMBA8thCaseRpt.pdf(April
2006).
I
20 "How Mortgage Brokers View the Booming Alt A Market," survey conducted by Campbell
Communications citJd in Inside Mortgage Finance, Volume 23, Number 42 (November 3,2006 available
at http://www.imfuubs.com/issues/imfpubs imf/23 42/news/J 000004789-1.html and cited in Harney,
Kenneth, "The Lowdown on Low-Doc Loans. .. The Washington Post 11125/2006 page F-I (November 25,
2006), available at h~p:llwww.washingtonpost.comlwpdyn/contentiarticle12p061 II 1241AR2006112400503 -pf.html
21 See Option One Prpspectus, Option One MTG LN TR ASSET BK SER 2005 2 424B5 May 3 2005,
S.E.C. Filing 05794~12 at S-50.
.
22 See Adoption of Additional Lending Best Practices. included in "New Century Financial Corporation
Reports Third Quartdr 2006 Results and Provides Outlook for 2007," (November 2,2006) available at
http://news.moneycehtral.msn.com/ticker/article.aspx?Symbol=US:NE W&Feed=PR&Date=20061 102&1 D
=6163344.
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28
ANSWER:
Subprime lenders' public filings make clear that the lenders do not
consider whether the borrower is likely to experience any income growth whatever, but
rather qualify the horrower with a focus on the initial years of payment. 23 In the vast
majority of cases,/the lenders have no reasonable basis for assuming that the borrowers
receiving subprime 2-28s and 3-27s will experience any increase in income.
ASSERTION: Tt Guidance "does not appear to recognize that market forces, including
secondary marketl purchasers' requirements, generally do a better job than regulators at
managing nontraditional risks."
ANSWER: This JroPosition
is negated by industry leaders' own statements. Consider
I
the frank acknowledgement by the chief executive of Ownit Mortgage Solutions, William
D. Dallas, who "abknowledges that [underwriting] standards were lowered, but he placed
the blame at the feet of investors and Wall Street saying they encouraged Ownit and other
supbrime lenders to make riskier loans to keep the pipeline of mortgage securities well
supplied. 'The m~rket is paying me to do a no-income-verification loan more than it is
paying me to do the full documentation loans,' he said. 'What would you do?",24
I
ASSERTION: "Traditional hybrid ARMs offer a significantly lower monthly payment
for the initial fixetl-rate period than an equivalent traditional fixed-rate loan. The rate
difference is comlnonly in the 50 to 80 basis point range."
ANSWER: This lssertion reveals a great tragedy confronting many of the families
currently losing t1~eir homes in foreclosure: for an additional 50 - 80 basis points at the
outset, they couldi have been holding sustainable 30-year fixed rate loans. Gaining little
more than a 50 basis point short-term discount, borrowers are being lured into loans that
will increase by u1p to 3% at the beginning of the 25 th month, cost them substantial equity
stripped through refinancing costs and fees, or force them to lose their home altogether.
basi~
Compare the fixe1 rate cost with the 50 - 100
point bump up that roughly half of
borrowers pay fotI not documenting their income, even though most are employees fully
able to provide W-2's. Or compare it with the extra interest borrowers pay to give their
mortgage brokers,I who originate 71 % of subprime loans,25 a yield-spread
premium/kickback. For example, for brokers who increase a borrower's interest rate
beyond what the~ qualify for by an extra 1.25%, a recent New Century rate sheet rewards
the broker with 2% of the loan amount as a yield-spread premium.
I
.
ASSERTION: "The traditional hybrid ARM structure is especially well suited to the
needs ofnonprim~ consumers who'are looking for a more affordable transitional product
as they reestablish their credit and financial footing."
I
See discussion of G>ption One and New Century underwriting standards, above.
24 Vikas 8ajaj and Christine Haughney, Tremors At the Door -- More People with Weak Credit Are
Defaulting on Mortgbges," New York Times (Fri. Jan. 26,2007) Cl, C4.
23
" MBA Re"",,,h D1" Not." "R.,ldentl,1 Mortgage O,lgln"lon Ch,nnel,," Septemb" 2006.
29
ANSWER: This observation relates to the hybrid ARMs in the prime market, where the
introductory rate ~pically lasts at least 5 years, where lenders escrow for taxes and
insurance, and where borrowers are not subject to prepayment penalties. It is directly
contrary to the fa~ts associated with subprime 2-28 and 3-27 loans, as shown in the data
discussed above.
I
.
ASSERTION: "~Pre-payment] penalties, in fact, generally terminate automatically when
the loan adjusts to the fully-indexed rate. This allows most consumers to achieve a
substantial savin~s through two or three years of the lower rate, rebuild their credit and
to a new lower rate loan without incurring a penalty or having to
then to move protnptly
I
pay the higher adjusted rates for any extended period."
ANSWER: The Lperience of most 2-28 and 3-27 borrowers is contary to the
circumstances all~ged by CF AL. As CF AL acknowledges, the loans are designed so that
the pre-payment ~enalty remains in effect until the time that the rate resets. This means
that the borrowerican almost never avoid both the pre-payment penalty and the increased
rate. As describea above, these loans are typically underwritten to so that a substantial
proportion of2-28 and 3-27 borrowers predictably will not be able to afford the loan
when the rate res~ts,
and so must choose between paying the penalty and defaulting when
I
the payment shock hits. The latter most definitely does not improve the borrower's credit
rating and increades the pressure on the borrower to refinance on the lender's terms.
.
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ASSERTION: "1]F]oreclosures for nonprime loans, including hybrid ARMs, are
dramatically less than the grossly inaccurate 20% rate (' 1 in 5' loans) that some consumer
groups have beeni claiming. Industry data indicate, for example, that the foreclosure
inventory rate during the third quarter of2006 for subprime loans was about 3.9% and the
percent of new n6nprime loan foreclosures was around 1.8%"
I
ANSWER: The CFAL figure is misleading in that it represents reflects the percentage of
outstanding loansi that are in foreclosure at a specific point in time, while the 20% rate is
a cumulative rate jthat reflects the perecentage of loans originated during a year that will
eventually end in Iforeclosure over time. Further, the 20% anticipated foreclosure rate on
subprime 2-28 loans is in fact a conservative estimate based on conservative assumptions
applied to objecti~e loan-level data, and corresponds to data compiled from industry
in our Losing Ground report, described above. In fact, the numbers
sources, as detailJd
I
are hardly inconsistent.
If 1.8% of subprime loans foreclose each quarter over three
I
years, that would ibe 21.6% cumulative foreclosure starts. And the 20% number increases
substantially whenI one tracks the subprime borrower through subsequent subprime
refinancings, each of which has its own risk of foreclosure.
Conclusion
The steep paymerlt shocks on 2-28 subprime ARMs that follow from dramatic scheduled
increases in the iriterest charges just two years into the loan represent precisely the sort of
"deferral of interdst" on loans to "a wider spectrum of borrowers who may not otherwise
.
I
30
qualify for more traditional mortgages" addressed by the Guidance. In the case of2-28
subprime ARMs,lthe change in interest rates is typically so large at year two that they .
may properly be characterized as a contingent deferral of interest from early years to later
years of the loan term. 26 The magnitude ofthis deferral is significantly larger than
typically found irl prime ARM loans.
I
Federal Reserve Board Governor Susan Bies reached a similar conclusion, recently
stating, "Let's facb it; a teaser loan really is a negative [amortization] loan because you
don't pay interestlup front.',27 In addition to being consistent with the notion that these
subprime hybrid {\RMs present a deferral of interest, this quote also illustrates a second
dimension on which subprime ARMs tend to differ from their prime counterparts.
Specifically, low introductory rates on subprime ARMs are typically associated with high
up-front financed fees whereas fees on prime ARMs tend to be much lower. 28 In other
words, subprime !A.RMs routinely find borrowers trading equity in exchange for
dramatically low6r interest payments-thereby producing the same result as negative
amortization.
I
In addition, this deferral of interest is being presented to borrowers with weaker credit
histories who ha~e not traditionally been faced with such large payment shocks. For
these reasons, it remains critical that regulators clarify that the Guidance applies to 2-28
and 3-27 subprirrie ARMs?9
We recognize thal this issue is emblematic of the widespread abuses in the mortgage
market that requite Congressional action. We look forward to working with you all on a
response to these problems.
The contingent na~ure of the deferral (borrowers have to stay in the loan until adjustment to experience
its effects) are much :Iike the contingent nature ofthe deferral of interest in payment option ARMs (where
borrowers only feel the effects if they pay less than the full amount of interest due). In either case, the
Guidance should reqLire that lenders underwrite the loan to standards that ensure the borrower can payoff
the loan should thes~ contingencies occur.
27 Richard Cowden, flies Says Regulators to Consider Principles, Not Products. if They Revise Loan
Guidance, BNA Banking Report, vol. 88 no. 02 (Jan. 15,2007) at 56.
28 Freddie Mac reports that the most common prime hybrid ARM (511 ARMs), had an average initial
discount rate of 1.76lpercentage points and fees and points amounting to 0.5% of the loan amount. Freddie
Mac Releases Results of its 23rd Annual ARA1 Sun'ey, Freddie Mac (January 3,200) available at
1
http://www.freddiem ac.com/news/archives/rates/2007/2007010306armsurvey.html. An article detailing a
survey of borrowers reported that subprime borrowers paid higher fees than prime borrowers. Howard Lax,
Michael Manti, PauliRaca, and Peter Zorn, Subprime Lending: An Investigation of Economic EJficiency, 15
Housing Policy Debate 3, pp571533 (2004).
29 While some have ~ointed to a reference in footnote I in the guidance as evidence that these loans should
not be included, that ifootnote does not clearly address 2-28 subprime ARMs. In it, the regulators explicitly
exclude "fully amortizing residential mortgage loan products." However, in the Appendix to the Guidance
they also make clear ~hat "fully amortizing" refers both to principal and interest. They use an example
where they specifically qualify the term as follows: "a fully amortizing principal and interest payment."
26
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31
Sincerely,
Center for Respon'sible Lending
National ConsumJr Law Center
Consumer Federation of America
Consumer Action
National Lawyers Committee for Civil Rights Under the Law
Rainbow Push
Opportunity' Finance Network
U.S. PIRG
I
National Community
Reinvestment Coalition
I
National Association for the Advancement of Colored People
Acorn
NACA
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CC:
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The Honorable SHeila Bair, Chairman, Federal Deposit Insurance Corporation
The Honorable B~n S. Bernanke, Chairman, Board of Governors of the Federal Reserve
System
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.
The Honorable John C. Dugan, Comptroller of the Currency, Office of the Comptroller of
the Currency
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The Honorable Jof\nn Johnson, Chairman, National Credit Union Administration
The Honorable N6il Milner, President and CEO, Conference of State Banking
Supervisors
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The Honorable John M. Reich, Director, Office of Thrift Supervision
·1
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32
End Notes
I
lOur research finds that one out of every five (19 percent) sub prime loans made in recent years will fail.
This rate is far worseithan the ten-year default rate (14.9%) arising from the "Oil Patch" disaster of the
1980s. See Ellen Schloemer, Keith Ernst, Wei Li and Kathleen Keest, "Losing Ground: Foreclosures in the
Subprime Market an4 Their Cost to Homeowners," December 2006 available at
www.responsiblelending.org, note 18.
2
Inside B&C
2006.
Lendin~ (Sept. 1, 2006); see also INSIDE MORTGAGE FINANCE MBS DATABASE,
I
Nearly 55 percent of African Americans who purchased homes in 2005 received higher-rate loans; 49
percent received suc~ loans to refinance their homes. Slightly more than 46 percent of Latino borrowers
received higher-rate ~urchase loans; about 34 percent received higher-rate refinance loans. See CRL
internal analysis of H:MDA, www.responsiblelending.orglpdfs/HMDA-Comment-9-28-06.pdf.
3
I
See, e.g., Vikas Baj~j and Christine Haughney, "Tremors at the Door - More People with Weak Credit are
Defaulting on Mortgages," The New York Times, citing Inside Mortgage Finance (January 26, 2007).
4
1
See 71 Fed. Reg. 58 609 (October 4,2006) for the federal Interagency Guidance on Nontraditional
Mortgage Product Rikks, issued by the Office of the Comptroller of the Currency, the Federal Reserve
Board, the Federal Deposit Insurance Corporation, the. Department of the Treasury and the National Credit
Union Administratiori. The Conference of State Banking Supervisors and the American Association of
Residential Mortgagcl Regulators (AARMR) followed suit by issuing draft model guidance for state
regulators, which has! been implemented in at least 20 states. For a summary of state issuances, see
http://www.csbs.org/ContentlNavigationMenu/RegulatoryAffairs/FederalAgencyGuidanceDatabase/State
mplementation.htm.
5
i
6
Much of the following material originally appeared in the "Losing Ground" report; cited in note 1.
7
Ira Goldstein, BrinJng Subprime Mortgages to Market and the Effects on Lower-Income Borrowers. p.2
Joint Center for Housing Studies, Harvard University (February 2004) at
http://www.jchs.hdrvard.edu/publications/financelbabclbabc 04-7:pdf.
I
Mike Hudson and E. Scott Reckard, More Homeowners with Good Credit Getting Stuck in Higher-Rate
Loans, L.A. Times, A-I (October 24, 2005). For most types of sub prime loans, African-Americans and
Latino borrowers arelmore likely to be given a higher- cost loan even after controlling for legitimate risk
factors. Debbie Gruenstein Bocian, Keith S. Ernst and Wei Li, Unfair Lending: The Effect of Race and
Ethnicity on the Prick of Subprime Mortgages, Center for Responsible Lending, (May 31, 2006) at
http://www.responsiblelending.org/issues/mortgage/reports/page.jsp?itemlD=293 71 0 I 0; See also Darryl E.
Getter, Consumer Crrdit Risk and Pricing, Journal of Consumer Affairs (June 22, 2006); HowardLax,
Michael Manti, Paul Raca, Peter Zorn, Subprime Lending: An Investigation of Economic Efficiency, 533,
562,569, Housing P61icy Debate 15(3) (2004).
8
J.
I
9
Subprime MortgagJ Origination Indicators, Inside B&C Lending (November 10, 2006).
10 See, e.g., Eric SteJ QuantifYing the Economic Costs of Predatory Lending, Center for Responsible
I
Lending (2001).
II Roberto G. Querc1 Michael A. Stegman and Walter R. Davis, Assessing the Impact of North Carolina's
Predatory Lending Lbw, Housing Policy Debate, (15 )(3): (2004); Wei Li and KeithS. Ernst, The Best
Value in the Subprirrle Market: State Predatory Lending Reforms (2006) available at
http://www .respons ib lelend ing.org/pdfs/rrO I O-State_ Effects-0206. pdf.
33
w.1
12 See, e.g. David
Berson, Challenges and Emerging Risks in the Home Mortgage Business:
Characteristics of Lor;ms Backing Private Label Subprime ABS, Presentation at the National Housing
Forum, Office of Thrift Supervision (December 11,2006).
IJ
fO~c1osures
The rate of new
as a percent of all loans rose from 0.13 in 1980 to 0.42 in 2005; as reported
in the National Delinquency Survey, Mortgage Bankers Association. 2005 new foreclosure filings
statistic from Real~ Trac in Home Foreclosures on the Rise, MoneyNews (February 23, 2006) at
http://www.newsmax.com/arch ives/artiel es/2006/2/23/ 134928 .shtm I.
I
National Foreclosu~es Increase 17 Percent In Third Quarter, Realty Trac (November I, 2006) at
http://www.realtvtracl.com/ContentManagement/PressRe lease.aspx?1 tern ID= 1362
14
5
I
I
.
See, e.g., Saskia Scholtes,
Michael Mackenzie and David Wighton,US Subprime Loans Face Trouble,
I
Financial Times (geCember 7, 2006); Nightmare Mortgages, Business Week (September 11,2006).
16 Geoff Smith, Key 1rends in Chicago Area Mortgage Lending: Analysis of Data from the 2004 Chicago
Area Community Len'ding Fact Book, Woodstock Institute (March 2006) available on the Woodstock
Institute website.
I
17 Dan Immergluck and GeotfSmith, Risky Business: An Econometric Analysis of the Relationship
Between Subprime LJnding and Neighborhood Foreclosures, Woodstock Institute (2004).
18 Dan Immergluck Jd GeotfSmith, "The External Costs of Foreclosure: The Impact of Single-Family
Mortgage Foreclosur~s on Property Values," p. 57,69,72, 75 Housing Policy Debate (17: I) Fannie Mae
Foundation (2006).
I
19 The Home Mortgake Disclosure Act requires most lenders to file annual reports containing specified
information about the "higher-cost loans" they originated. "Higher-cost loans" are those for which the
APR exceeds the ratd on a Treasury security of comparable maturity by 3 percentage points for first liens,
and 5 percentage poi~ts for second liens. FRB analysis of2005 HMDA data indicates that non-Hispanic
whites received over 11.2 million higher-cost loans, compared to 388,471 for African-Americans and
375,889 for Latinos. Authors' calculations from data reported in Robert B. Avery, Kenneth P. Brevoort,
and Glenn B. Canner, Higher-Priced Home Lending and the 2005 HMDA Data, Federal Reserve Bulletin
A I 23, A 160-161 (Sept. 8, 2006), at
http://www.federalreServe.gov/pubs/bulletinl2006lhmdaibuIl06hmda.pdf.
20
21
requir~s
A balloon loan is olne that is not repayable in regular monthly installments, but rather
repayment
of the remaining bJlance in one large lump sum. While 2/28s are not balloon loans, the impact of higher
interest rates at thelend of the two-year teaser rate period, resulting in higher monthly payments, may
force a borrower to seek refinancing.
See, e.g. structurel Finance: u.s. Subprime RMBS in Structured Finance CDOs, p. 2 Fitch Ratings
Credit Policy (Aug1ust 21,2006).
. I
Here we are describing
the 2/28 because it is by far the most common
product in the subprime market,
I
.
but the concerns are ~he same with the 3/27, which differs only in that the teaser rate remains in effect for
three years.
I
22
The typical 2/28 rises to 6-month L1BOR (now 5.35 percent) plus an index of6.5 percent, or almost 12
percent.
23
I
Typically the rate increase at the first adjustment is capped somewhere between 1.5 and 3 percentage
points. On this 10an,Ithe rate reached the fully indexed rate at the second adjustment two-and-a-half years
into the loan.
24
34
25
See Stnlctured Finlnce, note 21.
26
See Stnlctured Finhnce, note 21.
27
Jonathan R. Laing, Coming Home to Roost, p. 26 Barron's, February 13,2006.
28
See Structured Finance, note 21.
29 Freddie Mac repoJs that the most common prime hybrid ARM (5/1 ARMs), had an average initial
discount rate of 1.76 percentage points and fees and points amounting to 0.5% of the loan amount. Freddie
Mac Releases ResultS of its 23'" Annual ARM Survey, Freddie Mac (January 3, 200) available at
http://www.freddiemkc.com/news/archives/rates/2007/2007010306armsurvey.html. An article detailing a
survey of borrowers teported that subprime borrowers paid higher fees than prime borrowers. Howard Lax,
Michael Manti, Paul Raca, and Peter Zorn, Subprime Lending: An Investigation of Economic Efficiency, IS
Housing Policy Debdte 3, pp571533 (2004).
I
I
See Interagency Gl;lidance on Nontraditional Mortgage Product Risks at p. 9.
I
31 The contingent nat~re of the deferral (borrowers have to stay in the loan until adjustment to experience
its effects) are much like the contingent nature of the deferral of interest in payment option ARMs (where
borrowers only feel t~e effects if they pay less than the full amount of interest due). In either case, the
Interagency Guidanc~ should require that lenders underwrite the loan to standards that ensure the borrower
can payoff the loan should these contingencies occur.
30
I
Richard Cowden, Bies Says Regulators to Consider Principles, Not Products,
Guidance, BNA Banking Report, vol. 88 no. 02 (Jan. 15,2007) at 56.
32
if They Revise Loan
'I
Joe Adler, In Brie/;' FDIC May Treat 2128s Like Other Exotics, American Banker, vol 171, no. 220
(November 15,2006); Patrick Rucker, u.s. bank regulators eye new mortgage guidance (January 10,
2007).
33
I
34 See David W. Berkon, Challenges and Emerging Risks in the Home Mortgage Business: Characteristics
I
of Loans Backing Private Label Subprime ABS, Presentation at the National Housing Forum, Office of
Thrift Supervision (qecember II, 2006).
I~tter
January 29, 2006
from CRL to North Carolina Office of the Commissioner of Banks, at II.
Available at CRL's Website at http://responsiblelending.org/policy/regulators/.
35
December 7, 2006 letter from U.S. Senators Paul S. Sarbanes, Wayne Allard, Christopher J. Dodd, Jim
Bunning, Jack Reed, and Charles Schumer to Ben S. Bemanke, Sheila C. Bair, John C. Dugan, John M.
Reich, JoAnn JOhns!", and Neil Milner, at 2.
.
36
Vikas Bajaj and Christine Haughney, Tremors At the Door -- More People with Weak Credit Are
Defaulting on Mortghges," New York Times (Fri. Jan. 26,2007) CI, C4.
37
1
Kirstin Downey, "tv'ortgage-Trapped: Homeowners with New Exotic Loans Aren't Always Aware of the
Risk Involved," Washington Post (January 14,2007).
38
I
January 25, 2007 I~tter from CF AL to Ben S. Bemanke, Sheila C. Bair, John C. Dugan, John M. Reich,
JoAnn Johnson, and Neil Milner, at 3.
39
See e.g., Office oflhe Comptroller of the Currency, National Credit Committee, Survey of Credit
2005. The Office of The Comptroller of Currency (OCC) survey of credit
Undenvriting Praclites
I
40
II
I
I
I
I
I
35
underwriting practice~ found a "clear trend toward easing of underwriting standards as banks stretch for
volume and yield," a~d the agency commented that "ambitious growth goals in a highly competitive market
can create an environfuent that fosters imprudent credit decisions." In fact, 28% of the banks eased
standards, leading thel2005 OCC survey to be its first survey where examiners "reported net easing of retail
underwriting standards." See also Fitch Ratings, 2007 Global Structured Finance Outlook: Economic and
Sector-by-Sector Analysis (December 11, 2006).
424~5
See Option One prLpectus, Option One Mortgage Loan Trust 2006-3
(October 19,2006)
available at: http://wJw.sec.gov/ Archives/edgar/datalI3781 02/000088237706003670/d581 063 424b5.htm;
Fremont Investment and Loan Prospectus, Fremont Home Loan Trust 2006-1 424B5 (April 4, 2006)
available at: http://wJw.sec.gov/Archives/edgar/datalI357374/000088237706001254/d486451_all.htm ;
Morgan Stanley Pros~ectus, Morgan Stanley ABS Capital I Inc. Trust 2007-NC1 Free Writing Prospectus
(January 19, 2007) a~ailable at:
http://www.sec.gov/~rchives/edgar/datalI385136/000088237707000094/d609032fwp.htm; Best Practices
Won't Kill Productioh at New Century, p. 3 Inside B&C Lending (November 24, 2006).
41
42
See, e.g. "B&C EsJow Rate Called Low, " Mortgage Servicing News Bulletin (February 23, 2005)
"Servicers of subp~ime mortgage loans face a perplexing conundrum: only about a quarter of the loans
include escrow acc6unts to ensure payment of insurance premiums and property taxes, yet subprime
borrowers are the IJast likely to save money to make such payments .... Nigel Brazier, senior vice
president for busindss development and strategic initiatives at Select Portfolio Servicing, said only about
25% of the loans inlhis company's subprime portfolio have escrow accounts. He said that is typical for
the subprime industry."
.
43
See, e.g., "Attractiv!e Underwriting Niches," Chase Home Finance Subprime Lending marketing flier, at
http://www.chaseb2b.com/contentlportal/pdf/su bpri meflyers/S ubpri me A UN .pd f
(available 9/18/2006) stating" Taxes and Insurance Escrows are NOT required at any LTV, and there's
NO rate add!", (suggesting that failing to escrow taxes is an "underwriting highlight" that is beneficial to
the borrower). 'Low balling' payments by omitting tax and insurance costs were also alleged in states'
actions against Am~riquest. See, e.g. State of Iowa, ex rei Miller v. Ameriquest Mortgage Co. et ai, Eq.
No. EQCE-53090 ~etition, at ~ 16(B) (March 21, 2006).
44
Partnership Lesson~ and Results: Three Year Final Report, p. 31 Home Ownership Preservation
Initiative, (July 17, :2006) at www.nhschicago.org/downloads/82HOPI3YearReport JuI17-06.pdf.
45
In fact, Fannie MJ and Freddie Mac, the major mortgage investors, require lenders to escrow taxes and
insurance.
I
46
See Structured Finance, note 21, p. 4.
47
Mortgage Asset RJearch Institute, Inc., Eighth Periodic Mortgage Fraud Case Report to Mortgage
Bankers Associati0f!, p. 12, available at http://www.mari-inc.com/pdfs/mbaIMBA8thCaseRpt.pdf(April
2006); see also 200? Global Structured Finance Outlook: Economic and Sector-by Sector-analysis,
FITCH RATINGS ~REDIT POLICY (New York, N.Y), December 11,2006, at 21, commenting that the
use of sub prime hy~rid arms "poses a significant challenge to subprime collateral performance in 2007."
48
Traditional Rate shbet
12/04/06 issued by New Century Mortgage Corporation, a major
subprime lender, sh10ws that a borrower with a 600 FICO score and 80% LTV loan would pay 7.5% for a
I
fully-documented loan, and 9.0% for a "stated wage earner" loan.
49
See Interagency Guidance on Nontraditional Mortgage Product Risks, note 42.
50
MBA Research Daia Notes, "Residential Mortgage Origination Channels," September 2006.
~ffective
I
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I
I
I
I
36
I
About one-third of the states have established, through regulation or case law, a broker's fiduciary duty
to represent borrowe~s' best interests. However, many of these provisions are riddled with loopholes and
provide scant protection for borrowers involved in transactions with mortgage brokers.
51
Be~
Remarks by FedeJI Reserve Board Chairman
S. Bemanke at the Opportunity Finance Network's
Annual Conference, rashington, D.C. (November 1,2006).
52
Joint Center for Housing Studies, "Credit, Capital and Communities: The Implications of the Changing
Mortgage Banking Irldustry for Community Based Organizations," Harvard University at 4-5. Moreover,
broker-originated lo~ns "are also more likely to default than loans originated through a retail channel, even
, after controlling for dredit and ability-to-pay factors." Id. at 42 (citing Alexander 2003).
53
I
54
Inside B&C Lendilg, Inside Mortgage Finance, p. 2 (November 24, 2006).
5S
Inside The GSEs (ian. 3, 2007), p. 4.
I
56 Because of the Congressional charters of Fannie Mae and Freddie Mac, Congress requires each
corporation to aChie~e public purposes that include the requirement that the GSEs devote a percentage of
their business to three specific affordable housing goals: the Low- and Moderate-Income Housing Goal,
which targets familie1s with incomes at or below the area median income, the Special Affordable Housing
Goal, which targets ~ery low income families, and the Underserved Areas Housing Goal, which targets
families living in low-income census tracts or in low- or middle-income census tracts with high minority
populations. See http://www.hud.gov/officeslhsg/gse/gse.cfm
I
57
Patrick Crowley, Repurchases Stinging Subprime Sector, MortgageDaily.com (Jan. 5, 2007).
58
15 USC Section Ui39(1)(2).
I
These limitations Joncem certain prepayment penalties, post-default interest rates, balloon payments,
negative amortizatioA, prepaid payments, ability to pay, and home improvement contracts. See subsections
I 29(c)-(i). High costlmortgages are those "referred to in section 103(aa)."
59
Most subprime abuses
occur with refinance loans rather than loans used to purchase a house (what
I
HOEPA calls a "residential mortgage transaction", Sec. 152(aa)( 1 HOEPA's enumerated protections are
limited to closed endlrefinance loans that meet the high cost standard. However, section (I) refers to
"mortgage loans" generally, which would include purchase-money loans. The fact that section (1)(2)
prohibitions are diredted at two separate types ofloans -- (A) those the Board finds to be unfair, deceptive,
or designed to evadelHOEPA, and (B) abusive refinancings -- provides evidence that subsection (A)
includes purchase money loans as well.
60
».
Sectio~
61 See S. I 275,
129(i)(2): "PROHIBITIONS--The Board, by regulation or order, shall prohibit any
specific acts or practices in connection with high cost mortgages that the Board finds to be unfair,
deceptive, or designe1d to evade the provisions of this section." Reported in 140 Congo Rec. 3020, S3026.
According to the Se~ate Report, No. \03-169, p. 27, "the legislation requires the Federal Reserve Board to
prohibit acts or practices in connection with High Cost Mortgages that it finds to be unfair, deceptive, or
designed to evade th6 provisions of this section."
I
See House Conf. Rep. No. 103-652, p. 161, "the Board is required to prohibit acts and practices that it
finds to be unfair, debeptive, or designed to evade the section and with regard to refinancing that it finds to
be associated with a~usive lending practices or otherwise not in the interest of the borrower."
62
I
"The Conferees retognize that new products and practices may be developed to facilitate reverse
redlining or to evadeithe restrictions of this legislation. Since consumers are unlikely to complain directly
10 Ih' Bm"d, Ih' BOr ,hou1d oon,uit with it, Con,um" Advi,ory Counoil, oon,um" "pre"nloliv",
63
I
I
I
37
lenders, state attornds general, and the Federal Trade Commission, which has jurisdiction over many of
the entities making tHe mortgages covered by this legislation.
I
"This subsection also: authorizes the Board to prohibit abusive acts or practices in connection with
refinancings. Both tlie Senate and House Banking Committees heard testimony concerning the use of
refinancing as a tool {o take advantage of unsophisticated borrowers. Loans were "flipped" repeatedly,
spiraling up the loan balance and generating fee income through the prepayment penalties on the original
loan and fees on the dew loan. Such practices may be appropriate matters for regulation under this
subsection." Id.
38
...
..;
.
.
...'"~.....
,.
"'f""'i' .... Atty. No. 99000
.
;:"
I ,
.~'\
,
...1
~
.
...
IN THE C~CUIT COURT OF COOK COUNTY, ST$.:r;~,o:f, !LLtNOIS
COUNTY DEPARTMENT -- CHANCERY D~VISION G f/1 ?
(."
THE PEOPLE OF TElE STATE OF
ILLINOIS,
Plaintiff,
v.
ONE SOURCE MORTGAGE,
INC.
I
and CHARLES G: MANGOLD,
individually and. as Ptesident of One
I
Source Mortgage, Inc.
. I
DefenBants.
__
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(
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I
.
COMPLAINT FOR INJUNCTIVE AND OTHER RELIEF
I
NOW COMES the Plaintiff, THE PEOPLE OF THE STATE OF ILLINOIS, by LISA
MADIGAN,
Attorne~ General of the State of Illinois, and complains of Defendants, ONE
I '
.
.
SOURCE MORTGAGE, INC. and CHARLES G. MANGOLD, individually and as President of
.
.
I
One Source Mortgage, Inc. and respectfully states as follows:
JURISDICTION AND VENUE
1.
This action is ,rought for and on behalf of THE PEOPLE OF THE STATE OF
ILLINOIS, by LISA MADIGAN, Attorney General of the State of Illinois, pursuant to the
provisions of the conlumer Fraud and Deceptive Business Practices Act, 815 ILCS 505/1 et
I
.
seq., and her common law authority as Attorney General to represent the People of the State of
Illinois.
EXHIBIT
I 0
---------1
I
2.
Venue for this action properly lies in Cook County, Illinois, pursuant to Section 2-101 of
l
the Illinois Code ofCh'il Procedure, 735 ILCS 5/2-101, in that the Defendants are doing
business in Cook colty, Illinois ..
PARTIES
3.
Plaintiff, THE(EOPLE OF THE STATE OF ILLINOIS, by LISA MADIGAN, Attorney
General of the State oflilinois, is charged, inter alia., with the enforcement of the Consumer
I
Fraud and Deceptive Business Practices Act, 815 ILCS 50511 et seq.
4.
I
Defendant ONE SOURCE MORTGAGE, INC. is a licensed Illinois mortgage brokerage
I
company, holding mokgage broker license MB. 6759222 issued by the Illinois Department of
I
.
Financial and Professional Regulations, Division of Banking. ONE SOURCE MORTGAGE has
an office at 5372
S.
NolI
Milwaukee Avenue in Chicago, II.
Defendant CH!ARLES G. MANGOLD is the President and sole officer of ONE SOURCE
MORTGAGE.
MAN~OLD participates. in, manages, controls, and has knowledge of the day-to-
day activities of One Source Mortgage, including residential mortgage loan brokering activities
and placement
o~ adJrtisements in newspapers and direct mail solicitations. MANGOLD is
sued individually and also in his capacity as President of ONE SOURCE MORTGAGE.
6.
MANGOLD Holds an Illinois loan originator certificate of registration (#031.0012220)
.
I
.
issued by the Illinois Department of Financial and Professional Regulations, Division of
Banking.
. 7.
There exists and, at all time relevant hereto, has existed a unity of interest between ONE
I
.
.
SOURCE MORTGAGE and CHARLES G. MANGOLD such that any individuality and
separateness have ceJed to exist. To adhere to such a fiction would sanction fraud and promote
and injustice.
2
COMMERCE
I
"
Section 1(f) bf the Consumer Fraud and Deceptive Business Practices Act, 815 ILCS
"8.
I
"
"
505/1(f), defines ''trade'' and "commerce" as follows:
The teLs 'trade' and 'commerce' mean the advertising, offering for sale, sale, or
distribhtion of any services and any property, tangible or intangible, real,
perso~al, or mixed, and any other article, commodity, or thing of value wherever
situate~, and shall include any trade or commerce directly or indirectly affecting
the pe6ple of this State.
Defendants are and Jere, at all relevant times hereto, engaged in trade and
comme~ce in the State
of Illinois, in that thet offer mortgage brokerage services to the general public of the State of
I
I
Illinois.
I
I
ONE SOURCE MORTGAGE, INC. AND CHARLES G. MANGOLD'S
BUSINESS PRACTICES
I
9.
Charles G. Mangold operates a mortgage loan brokering business, One Source Mortgage,
Inc., that engages in lfair and/or deceptive acts and
I
pr~ctices that violate Section 2 of the
Consumer Fraud and Deceptive Business Practices Act, 815 ILCS 505/2 and Section 2X of the
"
I
Consumer Fraud and Deceptive Business Practices Act, 815 ILCS 505/2X.
10.
I
Since at least :October 2003, Defendants have engaged in, and are presently engaged in,
the business of offeriJg mortgage brokerage services to the general public of the State of Illinois.
.
11.
I
I
Advertising Practices
Defendants advertise their mortgage brokerage services, which include refinancing, to
I
those who wish to obtain mortgage loans for the purchase of homes or lower their monthly
mortgage payments.
12.
Defendants solicit consumers through print advertisements and direct mailings.
13.
For example, IDefendants placed a full page advertisement in the Chicago-Sun Times for
a closed-end line of
I
"
C~dit of $235,000.00 for a monthly payment amount of $656.05. In small
I
I
I
!
I
I
I
I
I
I
3
I
I
.
print, the advertisemeL states "(with as little as 10% down, 620 full doc & 660 stated}." The
advertisement also stales, in even smaller print, "95% LTV, 40 yr AMTZ, OAC, 6.2% apr."
This particular advertilement ran
~n or about December 5, 2005. This advertisement also
represented that obtaiJing a mortgage loan from One Source would lower a consumer's monthly
I
'.
I
.
payments 40-50%. This advertisement is attached as Exhibit 1.
I
14.
The advertiserbent does not disclose that this mortgage loan has an adjustable interest
rate, so the interest ratlI will increase throughout the life of the mortgage loan.
15.
The advertisefent also does not disclose that the interest rate upon which the payment is
I
based is only applicable for the first month of the mortgage loan.
I
16.
In fact, if the Jorrower continues to make the advertised payment after the first month,
the borrower will not tay any of the principal of the mortgage loan and will not even pay all of
the interest that will aLrue on the mortgage loan each month. This is not disclosed on the
I
.
advertisement.
17.
The advertisement does not disclose that, if the consumers fails to pay all the interest that
accrues on the mortgjge loan each month, the unpaid interest will be added to the balance of the
I.
..
mortgage Ioan·due to negative amortization.
18.
Likewise, on
J
about November 15,2006, Defendants solicited consumers through a
1
direct mailing for a cl6sed end line of credit of $681,182.00 for a monthly payment amount of
$1,898.54. At the toplOfthiS direct mailing was a simulated check in the amount of$681,182.00.
1
The back of this direct mailing states, in small print, "* *Based on 1 mth MTA Pay Option Ann
1.45% start rate, 40
JI
amortization, adj. rate based on mthly MTA index + margin - (no taxe
[sic], no ins.)." This 1irect mailing is attached as Exhibit 2.
. 1
4
19.
This direct mLing does not disclose the annual percentage rate applicable
~o the
advertised offer, it oJ1 Y discloses the simple interest rate for the offer.
20.
This direct mLling also does not disclose the amount or percentage of the doWn payment
required to obtain thj advertised offer.
I
21.
The dir~ct m~iling does not disclose, in readily understandable terms, that the interest rate
I
upon which the pay~ent is based is only applicable for the first month of the mortgage loan.
22.
The directmJling does not disclose that, after the first month, the payment of $1898.54
will not pay any oftJe principal of the mortgage loan and that it will:not even cover all of the
I
interest that accrues dn the mortgage loan each month.
I
23.
The direct mailing does not disclose, in readily understandable terms, that the unpaid
I
interest will be addedl to the principal balance of the mortgage loan, causing negative
I
amortization, or an iJcrease in the mortgage loan balance, to occur.
I
i
I
Steering Consumers into Pay Option ARMS
I
24.
Some copsum'ers contact Defendants and are interested in particular types of mortgage
loan products. Some of these consumers are first-time home buyers and other consumers are
interested in refinancing their current mortgage loan. Of these consumers, some are interested in
a mortgage loan With!a fixed interest rate.
25.
them.
'26.
'
I
Defendants t~ll these consumers that fixed rate mortgage loans are too expensive for
I
'
I
Defendants promise that, if consumers accept a different type of mortgage loan,
Defendants will refinLce them into a fixed rate mortgage loan in a year or so.
'I
'
5
!
I
I·
27.
With few excebtions, Defendants steer all of their consumers into one type of mortgage
I
I
loan product for first lien mortgages: pay option adjustable rate mortgages. As sold by
I
.
Defendants, this mortgage loan product has two distinctive features.
I
28.
The first ofthe~e features is a one month "teaser" interest rate. This interest rate is
I
extremely low, generally between 1 and 2%. This. is only the interest rate on the mortgage loan
I
.
for the first month of the loan. After that, the interest rate on the mortgage loan can change
every month. The intlrest rate is baSed on a variable
i~dex plus a fixed margin. The product
sold by Defendants JiCallY uses the "MTA" index, also known as the 12 Month Treasury
Average. This index i!S calculated by averaging the 12 previous monthly values of the actively
I
traded United States ~reasury Securities.
29.
The second diJtinctive feature of the pay option ARM that Defendants originated is the
I
possibility of negativd amortization. With pay option ARMS~ consumers are allowed to choose
which among three pjyment types they will make each month. These
I
pay~ents are: principal
and interest (fully am?rtizing the cost of the mortgage loan so that it will be paid off within the
specified loan term); ibterest only (no principal paid); or the minimum payment.
I
30.
The minimum/payment is less than the amount of interest on the principal amount of the
loan that accrues each~ month. If the minimum payment is made, negative amortization will
occur. In other wordd, the difference between the amount ofinterest that the consumer pays and
I
the amount of accrued interest will be added onto the principal balance of the mortgage loan each
month. If a consumeJ. makes the minimum payment, she will end up with a principal balance
higher than the amojt for which she originally contracted.
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31.
In addition to the one month teaser rate and negative amortization, Defendants' pay
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option ARMS generally have penalties for paying off the mortgage loan within the first three
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. '
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6
.
years of origination. IIf a consumer pays off the mortgage loan within this time period, she will
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.
.
have to pay a penalty~ generally six months interest. This penalty can be well over $10,000.
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Up-Selling
I
32.
Defendants eigage in "up-selling." They steer crediHvorthy borrowers into certain
mortgage loans when the borrowers' credit history and profile would qualify the borrowers for ..
better rates or lower costs.
This also includes steering borrowers who qualify for "prime"
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mortgage loans into "subprime" mortgage loans.
.
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Misrepresentations and Omissions Regarding Disclosure of Mortgage Loan Terms
33.
I
Defendants mrsrepresent the terms of mortgage loans they broker in order to induce
consumers to complete loan transactions. Consumers therefore enter into mortgage loan
I
.
.
agreements
based on the
representations made by Defendants.
.
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Interest Rate and Mothly Payment
34.
When describing the pay option ARM to consumers, Defendants tell consumers the
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amount of only one p~yment, the minimum payment.
35.
Defendants dJ not adequately describe to consumers the distinctive characteristics of pay
option ARMS: the falt that the initial low interest rate is merely a one month teaser rate or that
negative amortizatioJ will occur if the consumers pay only the minimum payment.
36.
Defendants frlquentlY do not disclose to consumers any interest rate for the mortgage
loan at all.
37.
On those
I.
..'
occ~ions when Defendants do describe an interest rate, the only rate that they
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generally describe is the teaser rate.
7
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38.
.
Based on the Defendants' descriptions, some consumers believe that the teaser rate lasts
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,
beyond the first month of the mortgage loan. Some consumers even believe that the teaser rate is
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.
the interest rate for the life of the loan.
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39.
For example, Defendants told one consumer that he would have an interest rate of
0.0950% for the first tear of his loan. After that, the interest rate would be 6.820%. In reality,
.
II
the consumer's intere~t rate went up to 7.500% after the first month of the loan and, as of the
I
date that this Compl~nt was filed, was at 9.125%.
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40.
Defendants tofd one consumer, for example, that the principal and interest payment on
her first mortgage loah was $1196.22 and the principal and interest payment on her second
I
mortgage loan was $16l.25. As of August 2007, the principal and interest payment on this
consumer's first mortgage loan is actually $2306.16 and the principal and interest payment on
.
I
her second mortgage loan is $310.
41.
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Defendants told another consumer that the minimum payment covered all the interest on
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his loan. The conswJer's minimum payment is roughly $700 a month. The consumer would
.
I
have to pay $1816 to make even an interest only payment on his loan.
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42.
.
conswnersd1 not learn that Defendants' representations about their mortgage loans are
false until they begin to receive bills from their mortgage lenders.
43.
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'
.
After the first monthly statement, consumers who have pay option ARMS generally
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receive a bill that has bee payment coupons. The different coupons have amounts listed for a
.
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fully amortizing principal and interest payment, a payment that covers interest only, and a
minimum payment.
44.
The oni y paJent that is close to the payment described by Defendants is the minimum
payment.
.
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8
45.
Therefore, because Defendants told the consumers at loan origination that their payment
I
would be a certain amrunt and the only payment ~lose to that amount is. the minimum payment,
some consumers pay that amount, not understanding the consequences of that payment, that it
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'11 cause negative
. amortlzatlOn.
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46.
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.
On occasion, sbme consumers contact Defendants to figure out why their bills have
multiple payment
~ou~ns. Instead of explaining the ramifications of the different payment
I
coupons, Defendants tell
the consumers to pay the amount closest to the payment Defendants
I
promised while sellinJ the loan.
Amortization
47.
In addition to not adequately disclosing the interest rates and payments associated with
I
.
consumers' mortgage roans, Defendants also misrepresent and omit facts about the negative
amortization associat~ with pay option ARMS.
.
48.
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I!1 the case Of+ost consumers, Defendants do not tell them anything about the negative
amortization feature
of pay option ARMs and that negative amortization will result if the
consumers make only the.low monthly payment promised by Defendants.
49.
Defendants do not even use the phrases "negative amortization" or "principal increase"
while describing pay option ARMS to conslimers.
Prepayment Penalties
SO.
Also, in some bases, Defendants either do not inform consumers about prepayment
I
penalties associated Jith the consumers' loans or misrepresent the terms of the prepayment
penalties.
51.
Consumers are sometimes told that there are no prepayment penalties associated with
their mortgage loans.lsome consumers are told that it would be "no probiem" for them to
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9
. refinance their loans, leaving the consumers with the impression that the loans had no
prepayment penalty whatsoever.
52.
In other casesl some consumers are told that their"
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. only one or two
53.
.
year~.
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prepay~ent
penalties are in effect for
.
.
When these consumers attempt to refinance their loan, they learn that there are
i
prepayment penalties associated with their mortgage loans and/or that the prepayment penalty
exists for three years land is as high as six months interest on the principal loan amount.
" I
54.
Many consunlers are now unable to refinance mortgage loans brokered by Defendants
because of these preJayment penalties.
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55.
I
Other consumers have managed to refinance mortgage loans brokered by Defendants, but
had to pay thousands of dollars in penalties in order to do so.
Broker Compensatiot;l
56.
Finally,
Defe~dants do not disclose the compensation that they will receive from lenders
in exchange for Placlg consumers in certain
I
57.
~ortgage loans until the time of the closing_
This compenJation is noted on consumers' final HUD-I Settlement Statement - a
document that the coisumers do not receive until closing - as a YSP or "yield spread premium."
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58.
.
A yield spread premium is the cash rebate paid to a mortgage broker based on selling an
interest rate above thl wholesale par rate for which the consumer qualifies. The par rate is the
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"
actual interest rate a ~orrower qualifies for with a gi.ven lender. For example, if a mortgage
broker offers a consler a loan of $1 00,000 at an interest rate of 625%, and the consumer's par
rate is 6%, the broke1may earn a yield spread premium equal to 1.0% of the loan amount. This
$1,000.00 fee is paid 'by the lender directly to the broker as a "rebate." Although the consumer is
10
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not charged the fee
di~ectly, the ~onsumer does pay the fee indirectly by paying a higher interest
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rate.
.59.
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In the month Jf March 2006, for example, Defendants received at least $195,000 from
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lenders in the form
60.
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0
yield spread premiums.
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In addition to the compensation Defendants receive indirectly from the borrowers,
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Defendants are also directly compensated by the borrowers for brokering their mortgage loans
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through loan originati,on fees. This compensation ranges from approximately $500 to well over
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$6000 in the form of fees at closing.
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61.
For example, bne consumer paid Defendants $3095 in fees for brokering her mortgage
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loan. On the same loah, Defendants also received a $7800 yield spread premium payment from
the lender of the loan.!
62.
Similarly,
ano~er consumer paid Defendants $4267.50 in fees for brokering her
mortgage loan. On Je same loan, Defendants also received $6035 yield spread premium from
I
the lender.
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63.
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Even at closing, Defendants do not explain what "yield spread premiums" are to
consumers or that thelpayme.ts are in exchange for putting the consumers into a mortgage loan
at a higher interest rate than that for which they are qualified.
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64.
High Pressure Sales Tactics
.
Defendants nhh consumers through the closing on their mortgage loans.
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.
Therefore,
consumers do not ha~e the opportunity to read the documents about their loans or ask questions
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.
about the features of their mortgage loans.
.
65.
On average, Jost consumers' closings are less than thirty minutes. Some consumers had
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closings that lasted o~y ten or fifteen minutes.
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11
~------------------~-----------------------------------------
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66.
When some donsumers attempt to ask questions about their mortgage loans or review
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their mortgage loan Idocuments, they are told that there is no need to pay attention to the
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documents.
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One consumer was even told that "it would take two days to explain everything [about
67.
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.
the mortgage loan] arid
we do not have two days" to complete the closing.
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68.
Because of Dbfendants' tactics, consumers feel pressure to complete the closing without
understanding or evJI reading the mortgage loan documents they receive.
Refinabcing Mortgage Loans into Loans with Less Favorable Terms
I
69.
Defendants refinance consumers' mortgage loans multiple times.
70.
Consumers ar~I deceived into refinancing their mortgage loans by Defendants' promises
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that the new mortgag~ loans have lower payments or will allow them to use equity from their
·1 debts.
homes to payoff other
I .
As described ~bove, Defendants do not adequately disclose the details about these
71.
I
consumers' mortgage! loans to them. Defendants refinance many consumers into mortgage loans
.
I.
that have less favorab~e terms than their previous mortgage loans.
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72.
Defendants.
73.
.
Consumers re~eive no benefit from refinancing their mortgage loans multiple times with
!
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Those conswrlers who refinance for a lower interest rate only receive that rate for one
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month, then the interest rate on their new mortgage loans has the potential to exceed the rate
those consumers had in their original mortgage loan.
.
occasion~ Defendants' errors caused a consumer's mortgage loan to be
refinanced multiple tiLes. ~or example, Defendants promised to broker a mortgage loc;m for a
74.
On at least oJ
consumer in order to
bay offhis credit cards. Defendants were to arrange for the credit card
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12
payoffs through disb~rsements from the mortgage loan proceeds. Defendants, however, failed to
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pay all of the creditorr as promised. Although this was Defendants' error, Defc;mdants told the
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consumer that he woJld have to refinance again in order to payoff additional credit cards.
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Defendants received thousands of dollars in fees for this second refinance. After the second
refinance with One slurce, Defendants again contacted the consumer, stating that they had
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found additional creditors. Defendants told the consumer he would have to go through a third
refinance in order to Jay
off the newly found creditors.
As before, Defendants received
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thousands of dollars ih fees for this third refinance.
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75.
The only partibs
to truly benefit from these multiple transactions are Defendants, who
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receive thousands of dollars in compensation each time they refinance a mortgage loan.
o
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Promises of Refinancing
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76.
Defendants prpmise to refinance the mortgage loans that they broker or originate to.
consumers at a later d1ate into another mortgage loan on better terms and conditions.
77.
Defendants gJnerallY do not follow through on their promise. Even if they do refinance a
consumer's loan,
the~ frequently put the consumer into another pay option ARM, instead of a
fixed rate mortgage.
Misrepresentations on Loan Applications
I
78.
Defendants f~sify income information on consumers' Form 1003 loan applications
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without the consumer~' knowledge.
79.
. Consumers tybiCallY tell Defendants their monthly income and even provide pay stubs
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and tax returns to Defendants to verify their income. On some consumers' loan applications,
.
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however, their monthly income is higher than what they tell Defendants, sometimes even double
.
the correct amount.
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.
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13
80.
FDr example, Defendants listed .one cDnsumer's mDnthly incDme as $9000 .on her
I
mDrtgage lDan applicJtiDn. This cDnsumer makes apprDximately $2200 a mDnth and prDvided
pay stubs and tax rels tD Defendants tD verify her incDme. This cDnsumer was unaware that
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Defendants listed herlincome as $9000 and was surprised to find out that was the figure on her
mDrtgage 1Dan applic~tiDn.
.
STATUTORY PROVISIONS
81.
SectiDn 2 .of the IllinDis CDnsumer Fraud and Deceptive Business Practices Act (815
ILCS 50512) PIOVide1 that: .
UnfairlmethDds .of cDmpetitiDn and unfair Dr deceptive acts Dr
practices, including but nDt limited tD the use Dr emplDyment .of
any de~eptiDn, fraud, false pretense, false prDmise,
misre~resentatiDn Dr the cDncealment, suppressiDn Dr .omissi .on .of
any m~terial fact, with intent that .others rely upDn cDncealment,
suppreksiDn Dr DmissiDn .of such material fact, Dr the use .of
emplDyment .of any practice described in SectiDn 2 .of the "UnifDrm
Deceptive Trade Practices Act," apprDved August 5, 1965, in the
I
cDnduct .of any trade Dr cDmmerce are hereby declared unlawful
wheth~r any perSDn has in fact been misled, deceived Dr damaged
thereby. In cDnstruing this sectiDn cDnsideratiDn shall be given tD
the interpretatiDns .of the Federal Trade CDmmissiDn and the
federa1: CDurtS relating.tD SectiDn 5(a) .of the Federal Trade
CDl1ll11'issiDn Act.
I
82.
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SectiDn 2X .of the IIlinDis CDnsumer Fraud and Deceptive Business Practices Act, 815
ILCS 505/2X, prDvid1s that.
It is an! unlawful practice fDr any perSDn tD prDmDte Dr advertise
any bukiness, product Dr interest in prDperty by means .of
distrib~ting dDcuments designed tD simulate checks Dr .other
negDtiable instruments unless such instrument has printed upDn
bDth it~ frDnt and back, the fDllDwing statement: "This is not a
CheckY. HDwever, it is nDt an unlawful practice under this SectiDn
fDr a perSDn tD distribute fDr cDmmercial purpDses a sample Dr
specWen .of a check Dr .other instrument which is used tD sDlicit
.orders fDr the sale .of that instrument and which is clearly marked
as a nD~-negDtiable sample Dr specimen.
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.
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14
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83.
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Section 7 oftlle Consumer Fraud Act, 815 ILCS SOSI7, provides in relevant part:
.
a.
IWhenever the Attorney General has reason to believe that
any person is using, has used, or is about to use any method, act or
practic~ declared by the Act to be unlawful, and that proceedings
would be in the public interest, he may bring an action in the name
of the State against such person to restrain by preliminary or
penna4ent injunction the use of such method, act or practice. The
Court, In its discretion, may exercise all powers necessary,
includibg but not limited to: injunction, revocation, forfeiture or
suspen~ion of any license, charter, franchise, certificate or other
evidente of authority of any person to do business in this State;
appointment of a receiver; dissolution of domestic corporations or
associ~tion suspension or termination of the right of foreign
corpor~tions or associations to do business in this State; and
restitution.
I
b.
.
i
lIn addition to the remedies provided herein, the Attorney
may request and this Court may impose a civil penalty in a
sum ndt to exceed $SO,OOO against any person found by the Court
to havdI engaged in any method, act or practice declared unlaWful
under this Act. In the event the court finds the method, act or
practi~ to have been entered into with intent to defraud, the court
has the: authority to impose. a civil penalty in a sum not to exceed
$50,00P per violation.
Gener~
c.
!In addition to any other civil penalty provided in this
Sectiort, if a person is found by the court to have engaged ·in any
method, act, or practice declared unlawful under this Act, and the
violati~m was committed against a person 6S years of age or older,
the coo/! may impose an additional civil penalty not to exceed
$10,000 for each violation.
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84.
.
Section 10 of the Consumer Fraud Act,81S ILCS 50S110, provides that "[i]n any action
brought under the proLsions of this Act, the Attorney General is entitled to recover costs for the·
I
use of this State."
8S.
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The federal Trhth in Lending Act, IS U.S.C. §1664, requires the following for
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.
advertisements of CloSed end credit:
i
... (c) Rate offlnance charge expressed as annual percentage rate·
IS
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--
._---_. -----,
!
If any advertislment to which this section applies states the rate of a finance
.
charge, the ad~ertisement shall state the rate of that charge expressed as an annual
I
percentage rate.
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(d) Requisite 9isclosures in advertisement
If any advertisement to which this section applies states the amount of the
downpayment! if any, the amount of any installment payment, the dollar amount
of any finance Icharge, or the number of installments or the period of repayment,
then the advertisement shall state all of the following items:
I
(1) Th~ downpayment, ifany.
(2) Th1 terms of repayment.
86.
(3) Th1 rate of the finance charge expressed as an annual percentage rate.
. II
Regulation Z, ~2 C.F.R. §226.24, which interprets the federal Truth in Lending
I
.
Act, 15 U.S.C. §1601 :et seq., provides the following regulations for the advertisement of
closed end credit:
I
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I
(a) Actually a~ailable terms. If an advertisement for credit states specific credit
terms, it shall state only those terms that actually are or will be arranged or
.
.
offered by the :creditor.
I
.
(b) Advertisen)ent of rate of finance charge. If an advertisement states a rate of
finance charge', it shall state the rate as an "annual percentage rate," using that
term. If the ~ual percentage rate may be increased after consummation, the
advertisement ~hall state that fact. The advertisement shall not state any other rate,
except that a s~mple annual rate Or periodic rate that is applied to an unpaid
.balance may be stated in conjUnction with, but not more conspicuously than, the
annual percen~ge· rate.
I
(c) Advertisezrlent of terms that require additional disclosUres.
I
C1) If ah y of the following terms is set forth in an advertisement, the.
adverti~ement
shall meet the requirements of paragraph Cc)C2) of this
•
I
section:
I
iCi) The amourtt or percentage of any downpayment.
tCii) The number of payments or period of repayment.
. !Ciii) The amount of any payment.
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!
16
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.
bv) The amount of any finance charge.
I
(2) An ~dvertisement stating any of the tenns in paragraph (c)(l) of this
section Ishall state the following tenns; as applicable:
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.
.
(i) The amount or percentage of the downpayment.
~ii) The tenns of repayment.
I
'
(iii) The annual percentage rate, using that tenn, and, if the rate
bay be increased after consummation, that fact.
I
Count I
I
Violation of Secti~n 2 of the Consumer Fraud and Deceptive Business Practices Act,
I
815 ILCS 50512
87.
Defendants enJaged in unfair and/or deceptive acts or practices in the following:
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88.
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Advertising Violations
Using advertisipg solicitations that:
I
a. Failed tb clearly and conspicuously disclose the correct annual percentage rate
I
.
l
(APR) pplicable to the advertised offer;
b. Failed
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~isclose
I
the amount or percentage of the down payment required for the
adverti~ed offer by stating two conflicting down payment amounts' on the
..
i.
so1lCltatIon;
I
c. Failed ~o disclose the tenns of the repayment of the advertised offer;
d. Failed
t~ disclose that the interest rate on the advertised offer is only the interest
I
rate forlthe first month of the mortgage loan;
i
e. Failed
tp disclose that the interest rate on the loan could adjust every month;
f. 'Failed Jo disclose that, if the consumer makes only the advertised payment, the
consJer will not be paying any of the principal of the mortgage loan and will
II
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1..._ _ _ _ _ _ _ _ _ _ _ _....._ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ . _______ _
also not be covering all of the interest that accrues on the mortgage loan each
. month· I
1
g. Failed
disclose that the loan has the potential for negative amortization;
h. Failed Jo
disclose the annual percentage rate (APR) applicable to the advertised
I
offer, ihstead disclosing only the simply interest rate;
I
1.
ioI disclose at all the amount or percentage of the down payment required
Failed
for the iadvertised offer,
i
j.
Failed to disclose, clearly and conspicuously in a readily understandable manner,
I
the te~s of the repayment for this advertised offer.
k.
Omitte~ some of the material terms of the advertised offer from the front s'ide of
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the soliCitation and placed those terms on the reverse;
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I.
Used ~ typeface and point size for material terms that was unreasonably small;
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and
m. Failed ito disclose the tenns of a mortgage loan in accordance with the
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.'
.
requiriments of the federal Truth in~ending Act, 15 U.S.C. §1601 et seq., and 12
C.F.RJ §226.24, which provide the minimum standards for uniform disclo~ure of
I
mortg*ge tenns, thus establishing a per se violation of Section 2 of the Consumer
Fraud kct.
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89.
Loan Origination Violations
I
.
Engaging in the following misrepresentations and omissions in the origination of
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mortgage loans:
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T
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18
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a. Misrepresented to consumers that they will offer the consumer the "best rate" One
sourc~, Mortgage, Inc. has to offer that consumer when, in truth and in fact, such'
.
IS
b.
not
thl
e case;
Misre~resented to consumers that they could save money with lower payments
with alone Source M'ortgage, Inc. mortgage loan, when in fact the promised lower
I
paym~nt did not cover any of the principal and only portion of the interest that
I
accrue'd each month on the mortgage loan;
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c. Engaged
in "up-selling," also known as placing a credit-worthy borrower in a
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mortg~ge loan when the borrower's credit history and profile would qualify the
borroJer for a better rate or lower costs;
I
'
d. Misrepresented
the initial interest rate on the mortgage 'loan lasted longer than one
,
,
month] when that rate in fact increased after the first month and at regular
I
intervaIs thereafter;
I
e. Misrepresented that the negotiated minimum payment was the only payment the
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'
'
consumers had to make on the mortgage loan, although making that payment
would lot payoff any of the principal of the loan and would not cover the interest
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that accrued on the loan each month;
f.
Failed to disclose that; if the consumers made the minimum payment on the
I
mortg~ge loan, the principal of the mortgage loan would increase due to negative
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amortiZation;
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g. Failed to disclose that the consumers would have different payment options aside
I,
from ~e minimum payment and what those different payment options would
cover;
19
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h. Failedlto disclose, after being asked by consumers, the nature of the consumers'
mortgage loans after the consumers received billing statements from their
mortgLe lenders that did not comport with what Defendants told the consumers
I
.
about their
, mortgage loans;
I.
MisreJresented to consumers who were concerned about the paying off their
mortgJge
loans early that they would be able to refinance their mortgage loans,
I
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when in fact their loans had prepayment penalties;
j.
Faiiedlo disclose the yield spread premium that Defendants received for placing
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.
consumers
, in certain mortgage loans until closing;
k. Failed
~o disclose that the yield spread premium was a rebate that Defendants
receivdd
from lenders for placing a consumer in a mortgage loan with an interest
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rate abpve the par rate for which the consumer qualified;
1.
Failed
~o disclose that the consumer indirectly paid the yield spread premium to
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Defendants in the form of a higher interest rate;
m. Failed
L
disclose that the consumers paid Defendants twice for the origination of
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.
their rriortgage loans, directly through origination fees and indirectly through the
yield
s~read premium;
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n. Misreptesented that consumers would benefit from refinancing their mortgage
loans +UltiPle times with Defendants when Defendants did not adequately
disclos~ the details about these consumers' new mortgage loans to them and that
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these tJrms were less favorable than the terms of their previous mortgage loans.
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o. Failed to disclose that consumers receive no benefit from refinancing their
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mortgage loans multiple times with Defendants;
20
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Falsifi~d income in consumers' Form 1003 loan applications; and
p.
q. Engageb in the deceptive practice of rushing consumers through their closings,
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resultitig in the consumers having no time to read and/or understand the mortgage
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loan dopuments that they were signing.
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PRAYER FOR RELIEF
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WHEREFORE, Plaintiff respectfully prays for the following relief:
I
A.
.
.
A findihg that Defendants have engaged in and are engaging in trade or
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commerce within the rpeaning of Section 2 of the Illinois Consumer Fraud and Deceptive
Business Practices AcL 815 ILCS 505/2;
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A find+ g that Defendants have engaged in and are engaging in acts, or practices
B.
that constitute violatiohs of Section 2 of the Illinois Consumer Fraud and Deceptive Business
i
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Practices Act, 815 ILGS 505/2;
An
C.
O~dlr preliminarily and permanently enjoining Defendants from the use of acts
or practices that violatl the Consumer Fraud and Deceptive Business Practices Act including, but
.
I
not limited to, the
D.
unI~wful actS and practices specified above;
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An order permanently enjoining Defendants from engaging in the trade or
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commerce of advertisipg, offering for sale, or the sale of residential mortgage loan brokering,
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loan originating, loan ~ales or servicing within the State of Illinois;
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E.
An order suspending and revoking Defendants' licenses, charters, franchises,
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certificates and all evidence of authority to do business in the State of Illinois, including but not
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.
limited to, its license issued pursuant to the Residential Mortgage Licensing Act;
F. .
An ordL requiring Defendants to make
r~stitution to all consumers affected by
the use of the above-mbntioned unlawful acts and practices;
.
I
I
I
I
I
I
I
I
I
21
I
G.
An order rescinding, reforming or revoking all contracts, loan agreements, notes
I
'
,
or other evidences of indebtedness between Defendants and all Illinois consumers who were
i
affected by the use oflthe above-mentioned unlawful acts and practices;
I
H.
An
ord~r requiring Defendants to pay a civil penalty up to $50,000 for violating
I
the Illinois consumerlFraud and Deceptive Business Practices Act;
I.
An order requiring Defendants to pay a civil penalty up to $50,000 for each
violation of the IllinOil Consumer Fraud and Deceptive Business Practices Act committed with
I
the intent to defraud;
I
I
I
J.
I
An order requiring Defendants to pay an additional civil penalty up to $10,000 per
I,
I
violation of the Illinois Consumer Fraud and Deceptive Business Practices Act found by the
I
.
I
Court to have been co~itted against a person 65 years of age and older as provided in Section
I
7(c) of the Consumer Fraud
and Deceptive Business Practices Act, 815 ILCS 505/7(c);
I
K.
An ordbr requiring Defendants to pay the costs of this action; and
L.
An ordbr granting such further relief as this Court deems just, necessary, and
. ble In
.
equlta
I
th·1
e
preml~es.
I
I
,
'.
Count II
Violation of Section' 2X of the Illinois Consumer Fraud and Deceptive Business Practices
! ,
Act, 815 ILCS505/2X
1-89.
Plaintiff realleJes and incorporates Paragraphs 1-89 as 'if fully set forth herein.
I
90.
Defendants vio~ated Section 2X of the Consumer Fraud Act by using a simulated check
I
in its direct mail solicitations that does not comply with the Consumer Fraud Act.
II
91.
For ex~ple, defendants disseminated a direct mailing on or about November 15,2006
I
I
advertising a closed en~ line of credit of$681,182.00 for a monthly payment amount of
$1,898.54.
II
,
I
i
22
I
92.
At the top of this direct mailing, separated by dashed lines and resembling for all intent
I
.
and purposes a real check, was a simulated check in the amount of$681,182.00.
I
93.
.
Section 2X 0ithe Illinois Consumer Fraud and Deceptive Business Practices Act, 81S
ILCS SOS/2X, prohibits any person from promoting or advertising any business, product or .
!
.
interest in property by means of distributing documents designed to simulate checks or other
I
.
negotiable instrumen~s unless such instrument has printed upon both its front and back, the
.
I
following statement: I'ThiS is not a Check."
94.
.
The simulated
check attached to the November IS, 2006 direct mailing had no disclosure
.
I
on the front and back!ofthe document stating that "[t]his is not a check."
I
9S.
The direct mail solicitation therefore violated 81S ILCS SOS/2X.
I
I
WHEREFORE,
A.
PRAYER FOR RELIEF
Plain~iff respec~fullY prays for the following relief:
I
A finding that Defendants have engaged in and are engaging in trade or
I
commerce within the beaning of Section 2 of the Illinois Consumer Fraud and Deceptive
Business Practices AJt, 81S ILCS S05/2;
B.
I
A finding that Defendants have engaged in and are engaging in acts or practices
that constitute violatiAns of Section 2 of the Illinois Consumer Fraud and Deceptive Business
.
I
.
.
Practices Act, 815 IL€S 505/2;
C.
An ord'er preliminarily and permanently enjoining Defendants from the use of acts
I
.
or practices that violate the Consumer Fraud and Deceptive Business Practices Act including, but
I
not limited to, the unllwful acts and practices specified above;
I
23
I
D.
0
An order permanently enjoining Defendants from engaging in the trade or'
.
I
commerce of adverti~ing, offering for sale, or the sale of residential mortgage loan brokering,
.
!
loan originating,
101
.
.
sales or servicing within the State of Illinois;
I
E.
An order suspending and revoking Defendants' licenses, charters, franchises,
I
0
certificates and all evidence of authority to do business in the State of Illinois, including but not
I
limited to, its license ~ssued pursuant to the Residential Mortgage Licensing Act;
F.
I
An order requiring Defendants to make restitution to all consumers affected by
I
I
.
the use of the above-mentioned unlawful acts and practices;
I
I
G.
An order
rescinding, reforming or revoking all contracts, loan
agreements, notes
I
•
I
or other evidences ofIindebtedness between Defendants and all Illinois
consumers who were
.
I
affected by the use ofjthe above-mentioned unlawful acts and practices;
I
H.
An order
requiring Defendants to pay a civil penalty up to $50,000 for violating
I
the Illinois Consumer! Fraud and Deceptive Business Practices Act;
00
1
I.
An orqer requiring Defendants to pay a civil penalty up to $50,000 for each
I
violation of the Illino~s Consumer Fraud and Deceptive Business Practices Act committed with
I
the intent to defraud; !
J.
An
ord~r requiring Defendants to pay an additional civil penalty up to $10,000 per
I
violation of the Illinoi~ Consumer Fraud and Deceptive Business Practices Act found by the
i
0
Court to have been cOPunitted against a person 65 years of age and older as provided in Section
I
7(c) of the Consumer Fraud arid Deceptive Business Practices Act, 815 ILCS 505/7(c);
0
OK.
I
An ord~r requiring Defendants to pay the costs of this action; and
I
.
L.
An ordh granting such further relief as this Court deems just, necessary, and
i
equitable in the premi*es.
I
I
I
I
24
Respectfully submitted,
LISA MADIGAN, IN HER OFFICIAL
CAPACITY AS ATTORNEY GENERAL OF
ILLINOIS,
C
. E G
Bureau Chief, Consumer Fraud
I
I
SHANTANU SINGH
Assistant Attorney General
LISA MADIGAN
!
Attorney General of Illinois
I
I
CHARLES G. FERGUS, Chief
I
Consumer Fraud Bureau
,,I
VERONICA L. SPICER
Assistant Attorney Geheral
Telephone: 312-814-8p53
SHANTANU SINGH:
Assistant Attorney General
Telephone: 312-814-8(74
I
I
100 W. Randolph St., 12th Floor
Chicago, IL 60601
!
.
I
I
25
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CONGRATULATIONS
You are' preapproved for a new payment of
$1.898,54 .
$
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Based on the loan amount shown above on the check
No Gimmicks!!'! No Games!!!
Just ,1 phone caU
877 -585-2005
My name is ~huck Mangold and I am the President of One Source Mortgage. Unlike other
mortgage brokers who are only interested in refinancing' your mortgage D(~W, my main goal is to give my
client's choices, exalnine their whole financial picture and offer sound' financial solutions for now and
into the futur~. .
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.
My ultimate Igoal is to make all my clients MILLIONAIREs! This may sound like an unrealistic
goal, but I can sho~ you how I've turned many of my current clients into millionaires last year alone. I
do so by showing them how to make financially savvy decisions in these economically changing times, By
just taking one hou~ a week, you can use real esta\e to dramatically improve your net worth!
,
If you are nolt looking 10 become an investor, but just want to save hundreds of dollars every
month I can help y6u with that almost Immediately.
I
much~ride
I take
in my work and excel in what [ do! If you are already seeking mortgage
solutions, call me! I.et me show you how a few minutes of your time could very well translate into a
lifetime savings! t look forward to speaking with you. Make it a priority to call me today; you will be
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glad you did!!!
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Talk to you soon, .
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Chuck Mangold
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One Source Mortgage EQUAL HOUSING OPPORTUNITY MB.6759222
An Illinois Residential Mortgage Licensee ....Equal Housing Lender.
, I
5~72 N. Milwaukee Ave. Chicago, IL 60630
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PHONE: 877·585·2005 FAX: 773-594-6970
www.lsourcemortgll2.Yll1
'-----------------i--------------------- ---- "
PLAINTIFF'S
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calling toll-free li888-50PT OUT_ See PRESCREEN '& OPT-OUT NOTICE below for more information
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walit.to receive prescreened'off~rs o~cj'edlt.frOr\i:thls and other companies; call Equilax toll-free
at 1"888~50PT JUT; or write:. Equlfax.Options, P;O. Box 740123 I\tlanta, GA 30374-0123
•• D• ..., on I mlh MTA pJy Oplion Arn1, 1.45'lb "." r.tc:, 40 yr ImomUllon, adj. rll. bo.ed on mlhly MTA Indc, + marl'"- (no 'II •• no '"' )
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~(EtlrER
FOR
~ RESPONSIBLE
~LENDING
INDYMAC: WHAT WENT WRONG?
How an "Alt-A" Leader Fueled its Growth
with Unsound and Abusive Mortgage
Lending
CRL Report
June 30, 2008
Mike Hudson
In Brief: IndyMac's story offers a body of evidence that discredits the notion that the
mortgage crisis was caused by rogue brokers or by borrowers who lied to bankroll the
purchase of bigger homes or investment properties. CRL's investigation indicates many
of the problems at IndyMac were spawned by top-down pressures that valued short-term
growth over protecting borrowers and shareholders' interests over the long haul.
" ... I would reject a loan and the insanity would begin. It would go to
upper management and the next thing you know it's going to closing. "
-Audrey Streater, former Indymac underwriting team leader in an interview with CRL.
About the Center for Responsible Lending
The Center for Responsible Lending (CRL) is a national nonprofit, nonpartisan research and policy
organization dedicated to protecting home ownership and family wealth by working to eliminate abusive
financial practices. CRL is affiliated with Self-Help, the nation's largest community development financial
institution.
For additional information, please visit our website at www.responsiblelending.org.
EXHIBIT
I
9
Ben Butler, an 80-year-old retiree in Savannah, Georgia got an IndyMac loan in 2005 to build a
modular house. IndyMac okayed the mortgage based on an application that said Mr. Butler made
$3,825 a month in Social Security income.
One problem: The maximum Social Security benefit at the time was barely half that. Mr. Butler
had no idea his income had been inflated by IndyMac or the mortgage broker who arranged the
deal, his attorney maintains. Even if IndyMac wasn't the one that puffed up the dollar figure, the
attorney says, it should have easily caught such an obvious lie. J
Simeon Ferguson, an 86-year-old retired chef, ran into similar problems with an IndyMac loan in
Brooklyn, New York.
His attorneys claim a mortgage broker steered Mr. Ferguson, who was suffering from dementia,
into an IndyMac "stated income" loan program for retirees. IndyMac made no effort to verify
retirees' income, attempting to duck accountability "by deliberately remaining ignorant of the
borrower's ability to pay the mortgage," his lawsuit says. IndyMac's instructions for preparing
the mortgage application required that "the file must not contain any documents that reference
income or assets.,,2
In the case of Elouise Manuel, a 68-year-old Decatur, Georgia retiree, IndyMac instructed the
mortgage broker to send copies of her Social Security award letters with the dollar amounts
expunged: "Need co.py ofSSI letter blacked out for the last 2 yrs wino ref to income.")
Each time, the result was the same: borrowers trapped in loans they couldn't afford.
They are not alone. An investigation by the Center for Responsible Lending has uncovered
substantial evidence that IndyMac Bank and its parent, IndyMac Bancorp, engaged in unsound
and abusive lending during the mortgage boom, routinely making loans without regard to
borrowers' ability to repay. These practices left many deep in debt and struggling to avoid
foreclosure.
CRL interviews with former employees and lawsuits in 10 states indicate that IndyMac
•
•
•
pushed through loans based on bogus appraisals and income data that exaggerated
borrowers' finances;
worked hand-in-hand with mortgage brokers who misled borrowers about their rates and
other loan terms and stuck them with unwarranted fees; and
treated many elderly and minority consumers unfairly.
In interviews and court documents, 19 former employees describe an atmosphere where the
hunger to close loans ruled. They say IndyMac pushed through loans with fudged or falsified
information or simply lowered standards so dramatically that shaky loans were easy to approve.
Letter, Scott Vaughan, attorney at law, to Clarice Paschel, indyMac, October 8, 2007.
ferguson v. IndyMac Bank, U.S. District Court for the Eastern District of New York, filed February 14,
2008.
3Jvlanuel v. American Residential Financing, Inc., et aI, Superior Court of Gwinnett County, State of
Georgia, April 3, 2008.
I
2
2
Most of these ex-employees were mortgage underwriters who were responsible for reviewing
. loan applications to make sure information was accurate and that borrowers could afford the
deals. Many say their efforts to do their jobs were hamstrung by higher-ups.
"I would reject a loan and the insanity would begin," Audrey Streater, a former underwriter and
underwriting team leader for IndyMac in New Jersey, said in an interview with CRL. "It would
go to upper management and the next thing you know it's going to closing.... I'm like, 'What
the Sam Hill? There's nothing in there to support this loan.' ,,4
Disneyland loans
Like many other lenders during the housing and mortgage boom of 2003-2006, IndyMac moved
away from documenting borrowers' incomes and assets - basic information that's crucial to
determining whether consumers can afford a loan.
Take, for example, a $354 million pool of mortgages that IndyMac packaged into a mOrtgagebacked securities deal in June 2006. Less than 10% of the dollar volume involved "fulldocumentation" loans. The rest involved low or no-documentation loans -- mostly "stated
income" loans in which borrowers' income was simply affirmed without supporting evidence
such as tax documents or pay stubs. 5
As recently as the first quarter of 2007, just 21 % of IndyMac total loan production involved "fulldoc" mortgages. 6
As IndyMac lowered standards and pushed for more volume during the mortgage boom of20032006, the quality of loans became a running joke among its employees, according to a former
IndyMac fraud investigator who is cited as a "confidential witness" in a lawsuit in California. 7
The investigator says shoddily documented loans were known inside the company as "Disneyland
loans" - in honor of a mortgage issued to a Disneyland cashier whose loan application claimed an
income of $90,000 a year.
Another witness cited in the case, a former IndyMac vice president, claims chief executive
Michael Perry and other top managers focused on increasing loan volume "at all costs," putting
pressure on subordinates to disregard company policies and simply "push loans through."
Audrey Streater, telephone interview, Center for Responsible Lending.
IndyMac INDX Mortgage Loan Trust 2006-FLXI, Prospectus dated June 14,2006. A check of two other
IndyMac loan pools put together around the same time show a higher percent of "full-doc" loan volume16%to 26%.
6 IndyMac Bancorp Inc., 8K filing with Securities and Exchange Commission, May 12,2008.
IndyMac has now moved decidedly back in the direction offully documenting borrowers income and other
~articulars, with 69% of its loan volume in March 2008 involving "full-doc" mortgages.
Tripp et al v. IndyMac et al. U.S. District Court for the Central District of California, filed March 12,
2007. Unless otherwise indicated, all references to Tripp v. IndyMac refer to the "Third Amended Class
Action Complaint" that was filed with the court on June 6, 2008.
4
5
3
Another former employee quoted in the suit claims Perry told him "business guys rule" and
"[expletive deleted] you to compliance guys." As a result, this ex-employee claims, IndyMac was
about "production and nothing else."
The company says the ex-employees' statements in the lawsuit are a mishmash of hearsay and
speculation, and says the suit is "long on words butshort of substance" and full of "meaningless
fiiler."g The company says the simple truth is that it suffered rising borrower defaults and
plunging profits not because management pushed through bad loans, but because the company
"got caught in the same financial hurricane that affected every other participant in the mortgage
and housing industries.,,9
IndyMac also denies wrongdoing in other lawsuits that it's battling around the nation. At this
point, these cases are still wending their way through the legal process and haven't been proven
in court, so the allegations remain just that - allegations.
"A much more responsible way"
The company says it supports "responsible lending that is free of unfair or deceptive acts or
practices." It says it was a leader in providing clear disclosures to borrowers about the potential
for "payment shock" as adjustable rate loans reset. And it says its pricing disclosures are designed
to make sure borrowers. understand what they're getting. 10
And while it acknowledges it "loosened its lending standards along with everyone else" in an
effort to "compete and grow," it says it did so "in a much more responsible way" than other
lenders. I I
"lndyMac and most home lenders were not 'greedy and stupid,' " IndyMac CEO Perry told
shareholders in February. "Most of us believe that innovative home lending served a legitimate
economic and social purpose, allowing many US consumers to be able to achieve the American
dream of homeownership ... and we still do.,,12
Perry said a good part of the blame for the company's problems lies with forces outside its
control, including the fall in prices of mortgage-backed investments packaged by Wall Street and
the huge decline in home prices and home sales. 13
He's also lashed out at "house flippers" who took advantage of lenders' easy-credit policies.
When IndyMac announced more than $200 million in losses for the third quarter of2007, Perry
Tripp v. IndyMac.
Tripp v. IndyMac.
10 Letter from Richard Wohl, president, IndyMac Bank, to u.s. Office of Thrift Supervision, November 5,
2007. http://www.ots.treas.gov/docs/9/962970.pdf.
11 Matt Padilla, "Lenders and their creative accounting; Part I, IndyMac answers questions about loan
losses," Orange County Register, May 12,2007.
http://mortgage.freedomblogging.coml2007/05/12/Ienders-and-their-creative-accounting-part-i-indymacanswers-questions-about-loan-10sses/
12 Business Wire, "lndyMac Issues 2007 Annual Shareholder Letter," February 12,2008.
13 "2007 Annual Shareholder Letter."
8
9
4
blamed these fast-buck artists for his company's financial stumbles. "A lot of speculators crept
into the market - people who lied about their intent to live in the homes," he told the Los Angeles
Times. Many used second mortgages - known as "piggyback" loans - to snap up houses without
having to put any money down, Perry said. As home values swooned, he added, these speculators
had little incentive to keep paying their mortgages. 14
Some insiders paint a different picture. They describe IndyMac as less a victim than a facilitator
of bad practices. The former vice president quoted in California court documents claims Perry
and other top executives were aware that fraud and lying were rampant in the company's loanapproval process. IS Another ex-employee - the former fraud investigator - claims that the vice
president in charge of the company's fraud investigation department was pressured by upper
management not to report fraud, and in one case was pressured to "sanitize" a report on the
company's loan pipeline. 16
THE COMPANY: Why IndyMac is important
IndyMac is a case study in the rise and fall of America's mortgage market. Its story offers a body
of evidence that discredits the notion that the mortgage crisis was caused by rogue brokers or by
borrowers who lied to bankroll the purchase of bigger homes or investment properties. CRL's
investigation indicates many of IndyMac's problems were spawned by top-down pressures that
placed short-term growth ahead of borrowers' and shareholders' interests over the long haul.
In this sense, the Pasadena, California-based company has much in common with its rival and
one-time parent, Countrywide Financial COrp.,17 and other lenders that grew wildly before falling
on hard times.
IndyMac by the numbers
Total loan production
by year in billions
2003
2004
2005
2006
2007
$29
$38
$61
$90
$77
Mortgage industry
market share
0.8%
1.4%
2.0%
3.3%
3.3%
Return on
average equity
17%
17.4%
21.2%
19.1%
-31.1%
SOURCES: IndyMac filings with Securities and Exchange Commission
E. Scott Reckard, "lndyMac's loss much wider than expected," Los Angeles Times, November 7,2007.
Tripp v. IndyMac.
16 Tripp v. Indyf\'lac.
17 Center for Responsible Lending, "Unfair and Unsafe: How Countrywide's irresponsible practices have
harmed borrowers and shareholders," February 7, 2008. http://www.responsiblelending.org/pdfs/unfairand-unsafe-countrywide-white-paper.pdf.
14
15
5
IndyMac's lending volume and profits soared during the mortgage boom. Loan volume tripled in
three years, approaching $90 billion in 2006. It grew far faster than most of its competitors; its
share of the national mortgage market increased from 0.77% to 3.30% over that span. Profits
more than doubled over those three years, hitting $343 million in 2006.
In 2007 and 2008, however, it suffered a dramatic reversal of fortune. IndyMac's "nonperforming assets"- bankspeak for loans that have gone bad - have been growing at a steep rate.
The firm's dollar volume of non-performing assets exploded I I-fold in 15 months - going from
$184 million (0.63% of assets) at the close of 2006 to $2.1 billion (6.51 % of assets) at the end of
18
the first quarter of 2008. IndyMac generally defines "non-performing assets" as loans that are
at least 90 days overdue or in foreclosure.
As a result of the growing numbers of bad loans and a drop in mortgage originations, IndyMac
posted a $615 million loss in 2007, and a $184 million loss in the first three months of 2008. That
combined loss of nearly $800 million over 15 months means that it has more than given back all
of the $636 million in profits it posted in 2005-2006, at the height of the mortgage boom.
Meanwhile, IndyMac's stock price, which hit its highest level ever at th~ end of2006, topping
$45, has plummeted, falling below one dollar as of June 26, 2008. Long-time shareholders have
lost some 95% of their value in just over two years.
The company has eliminated riskier products such as low documentation Alt-A loans and "piggy
l9
back" loans , and Michael Perry continues to express optimism that the company will tum things
around once the housing market improves.
Alt-A empire
IndyMac's record is also worth scrutinizing because of the ways it differs from many lenders
involved in the mortgage mess.
For one thing, IndyMac's specialty was not subprime loans, but so-called AIt-A loans. While
subprime loans were supposed to go to borrowers with the weakest credit profiles, Alt-A loans
were generally supposed to be aimed at borrowers who had better credit but couldn't document
all their income or assets. These borrowers paid higher rates than traditional prime borrowers, but
lower rates than subprime borrowers.
No lender was more steeped in the AIt-A market than IndyMac. In 2006, IndyMac ranked number
one in the nation among Alt-A lenders, producing $70 billion in volume, or 17.5% of the Alt-A
20
market. Nearly four-fifths of IndyMac's mortgage volume during that span involved Alt-A
21
loans.
IndyMac Bancorp, Form 8K report to Securities and Exchange Commission, May 12,2008.
IndyMac Bancorp, Inc., 10K Report to Securities and Exchange Commission 2007, Feb. 29, 2008.
20
2007 Mortgage Market Statistical AnnuaI- Volume 1," Inside Mortgage Finance.
21 According to Inside Mortgage Finance, Countrywide was close behind in Alt-A volume, at $68 billion,
but that figure represented a much smaller slice -- 15% -- of Countrywide's mortgage production.
18
19
6
Over the past year, much attention has been focused on subprime loans, with references to catch
phrases such as "subprime meltdown." Alt-A lenders struggled to distance themselves from
subprime. In early 2007, Perry argued that Alt-A lenders were being unfairly lumped in with
22
·
su bprIme.
But many of the practices prevalent in the subprime market - including bait-and-switch
salesmanship and slapdash underwriting - also appear to have been common in the Alt-A sector.
Rising defaults have shown that the Alt-A business wasn't as immune from problems as its
proponents argued. As of February 2008, roughly one in seven Alt-A loans nationwide on owneroccupied homes were at least 30 days late, in foreclosure, or already in repossession, according to
the Federal Reserve Bank of New York.23
Taxpayers at risk?
IndyMac is also worthy of note because it didn't rely as heavily on Wall Street financing as many
of the lenders that got into trouble. IndyMac did sell the vast majority of its loans to Wall Street
so they could be packaged into mortgage-backed securities investment deals. However, it
depended less than many lenders on up-front lines of credit from Wall Street to bankroll its loans
before they were sold to investors.
Instead, IndyMac has increasingly relied on federally-insured customer deposits and borrowings
from the Federal Home Loan Bank (FHLB) system:
•
•
•
Its deposits jumped from $4.4 billion at the end of 2003 to $18.9 billion as of March 31,
2008.
Its FHLB borrowings grew from $4.9 billion at the end of2003 to $10.4 billion as of
March 31, 2008.
Together, those two sources of funding represented roughly 94% of its total liabilities on
March 3 1,2008, up from 79% in March 2007. 24
Initially, IndyMac's use of federally-guaranteed sources of funds made the company less
vulnerable to the credit crunch than many other lenders, which went under when Wall Street
firms cut-off their lines of credit. However, IndyMac's reliance on capital from the Federal Home
Loan Bank system, and on deposits that are backed by the FDIC, puts the federal government in
the position of bankrolling loans that may be abusive. It also puts the system at risk of significant
losses as loans go bad.
U.S. Senator Charles Schumer has told federal regulators that he's "concerned that IndyMac's
financial deterioration poses significant risks to both taxpayers and borrowers and that the
Herb Greenberg, "lndyMac's Optimism Will Be Put to Test," Wall Street Journal, August 18,2007.
Federal Reserve Bank of New York, ;;Nonprirne Mortgage Conditions in the United States," January
2008.
24 IndyMac Bancorp, Inc., Form IOQ Report to Securities and Exchange Commission, May 12, 2008.
22
23
7
regulatory community may not be prepared to take measures that would help prevent the collapse
of IndyMac or minimize the damage should such a failure occur.,,25
EMPLOYEES: Working for IndyMac
Audrey Streater worked in the mortgage business for three decades. She can remember a time perhaps a decade ago - when mortgage underwriters "reigned in fear." When an underwriter gave
thumbs up or thumbs down to a loan, it meant something. 26
"Underwriter was spelled O-O-D, and our expertise and our knowledge was taken seriously,"
Streater recalls wistfully.
Things changed. In recent years, she says, underwriting became window dressing -- a procedural
annoyance that was tolerated because loans needed an underwriter's stamp of approval if they
were going to be sold to investors.
That was prevailing attitude at IndyMac during the mortgage boom, but also at other lenders too,
she and several other former IndyMac underwriters say. A big problem, they say, were "stated
income" loans that required no documentation of the borrowers' wages. They say these loans
allowed outside mortgage brokers and in-house sales staffers to inflate applicants' incomes and
make them look like better credit risks.
Even loans that IndyMac billed as "full-documentation" deals may not have been all that
IndyMac presented them to be, according to one lawsuit. 27 The suit says some of IndyMac's "full
doc" loans were supported not by W-2s or pay stubs but by a verification of employment form -paperwork that confirms a borrower has ajob but doesn't authenticate his or her income. The suit
quotes a February 2006 IndyMac document that says, in bold letters, "IndyMac NonPrime will
accept a Verification of Employment for a full documentation loan with no pay stubs or
W2s needed!"
When underwriters tried to block questionable loans, several ex-employees say, brokers and
salespeople went over their heads to management to overturn loan denials. Upper management at
the company's Pasadena headquarters "probably got more involved than they should be," Streater
says.
"It was the nature of the beast that Pasadena created," she adds. "The broker was always right. If
the broker decided to fight it, chances were more than not that he would win."
"A wonderful company"
In all, CRL interviewed 14 former IndyMac employees.
Three said they didn't notice undue pressure to close loans during their time at the company. "It
was a wonderful company to work for. There was never any pressure to push loans through," says
2S James R. Hagerty, "Schumer Asks Regulators For Greater IndyMac Scrutiny," Wall Street Journal, June
26,2008.
26 Audrey Streater, telephone interview with Center for Responsible Lending.
27 Tripp v. IndyMac.
.8
Maisha Smith, a loan conditions specialist for IndyMac in California in 2004 and 2005. She says
the company had strong fraud controls designed to catch bad loans.
Eleven others told CRL that the company funded loans without enough regard for borrowers'
ability to repay. In addition, eight more ex-employees are quoted in the California lawsuit
describing internal pressures to approve dicey loans. 28 All of them are identified as unnamed
"confidential informants." Included among them are two former vice presidents and a former
senior auditor, the suit says.
In court papers, IndyMac dismisses the eight former workers as mostly lower-level, short-term
employees who had no knowledge of top managers' thinking.29 Rather than identifying fraud, the
company says, these former employees simply "disagree with the policies they believe IndyMac
undertook" to pursue a share of the rising mortgage market.
Almost all of the ex-employees interviewed by CRL were underwriters who worked at the
company amid the nationwide mortgage surge. Streater came to IndyMac's Marlton, N.J.,
location as an underwriter in 2005, then worked as a team lead underwriter from 2006 until she
left in mid-2007, supervising eight other underwriters.
IndyMac's underwriters were loyal and proud, Streater says, but many got worn down by the
pressure to book loans. Many were stymied, afraid to make decisions because "somebody is
going to yell at you," she says. Some "were making decisions based on: 'I might as well do this
because it's going to get approved anyway.' "
Tamara Archuletta, who was an underwriter for IndyMac in Arizona in 2006 and 2007, recalls
one inexperienced underwriter who declared: "It's not my money. I don't care.'t30
"Slap in the face"
Wesley E. Miller, who worked as an underwriter for IndyMac in California from 2005 to 2007,
says that when he rejected a loan, sales managers screamed at him and then went up the line to a
senior vice president and got it okayed.31 "There's a lot of pressure when you're doing a deal and
you know it's wrong from the get-go - that the guy can't afford it," Miller told CRL. "And then
they pressure you to approve it."
The refrain from managers, Miller recalls, was simple: "Find a way to make this work."
Scott Montilla, who worked as an underwriter for IndyMac in Arizona around the same time as
Achuletta, says that when salespeople went over his head to complain about loan denials, higherups overruled his decisions roughly half the time.32
Tripp v. IndyMac.
Tripp v. IndyMac.
30 Tamara Archuletta, telephone interview with Center for Responsible Lending.
31 Wesley E. Miller, telephone interview with the Center for Responsible Lending.
32 Scott Montilla, telephone interview with Center for Responsible Lending.
28
29
9
"I would tell them: 'If you want to approve this, let another underwriter do it, I won't touch itI'm not putting my name on it,' " Montilla says. "There were some loans that were just blatantly
overstated .... Some of these loans are very questionable. They're not going to perform."
In some instances, he adds, he was forced to approve loans that later went into default - and as a
result he had points subtracted from his performance score for bad deals he'd tried to block.
"There were very good underwriters in that company," Streater, the New Jersey underwriter,
says. "They just ran roughshod over them .... To tum around and hold them responsible for those
delinquencies is the ultimate slap in the face."
BORROWERS: In Indy Mac's debt
Willie Lee Howard grew up as one of 14 children in a sharecropping family near the rural'
crossroads of Snow Hill, N.C. He attended school sporadically until the end of seventh grade,
when his father pulled him out so he could work in the fields. As a young man in the 1960s, he
migrated north to Washington, D.C., where he picked up work as a construction laborer. He's put
off retirement and, at age 65, continues to work construction, making $15.89 an hour. He tries to
put in as much overtime as he can.
In the spring of 2000, he used a government-subsidized loan to buy a small two-bedroom, onebath house in Northeast Washington. Eight years later, he's battling to save his home in court. He
was the victim of a series of predatory mortgage refinances made by four name-brand lenders that
"took advantage of his illiteracy and lack of sophistication in financial matters," according to a
lawsuit filed for him by the AARP Foun~ation, CRL, and private attorneys.33
IndyMac is one of the lenders.
Howard agreed to the IndyMac loan after getting a telephone solicitation from a mortgage ,broker
working on IndyMac's behalf. Mr. Howard made it clear to the mortgage broker that he could not
read or write, but his loan application erroneously claimed he had had 16 years of education.
As part of the deal, IndyMac paid the mortgage broker a $3,895 ''yield spread premium"industry jargon for an incentive payment that rewards the broker for putting borrowers into loans
with a higher rates or fees than they qualify for. The December 2005 loan had an initial teaser
rate of 1.25% that evaporated after less than two months and rose to 6.58%, and could climb as
high as 9.95% over the life of the loan.
Because it was a so-called Payment Option ARM, he was given a choice of four different
payments. The lowest was the $621.03 he was quoted at closing. That was barely half of the
amount need to cover the monthly interest on the loan, meaning that the rest of the interest was
tacked onto the loan and the amount he owed would keep going up rather than going down. The
loan included a prepayment penalty, which forced Mr. Howard to pay thousands of dollars to get
out of his IndyMac loan when he refinanced with another lender a few months later.
33 Personal details and allegations are from Howard v. Countrywide '-lome Loans Inc. el al, U.S. District
Court for the District of Columbia, March 25, 2008. Along with IndyMac and Countrywide, other lenders
named as defendants include Washington Mutual Bank and WMC Mortgage Corporation.
10
The lawsuit alleges IndyMac violated federal and D.C. law by failing to properly disclose the
loan's terms and putting him into a loan he was unable to repay. In court papers, IndyMac denies
Mr. Howard's claims and suggests he has "unclean hands" in the matter.
Bait and switch
Mr. Howard's allegations echo those in other legal claims against IndyMac. Lawsuits accuse
IndyMac of working with independent mortgage brokers to land borrowers into predatory loans.
Several of the lawsuits claim that borrowers were bamboozled by brokers who promised low, low
rates that would last a year or even five years. Instead, the lawsuits say, the teaser rate evaporated
within one or two months.
A lawsuit in federal court in New York says the complexity of IndyMac's Payment Option ARM
- along with its low teaser rates and low initial payments -- make it "an ideal product to mislead
borrowers" with promises of "low interest rates" and "low payments. ,,34
Another lawsuit claims Perry and other IndyMac executives "knew or should have known" that
numerous mortgage brokers were duping borrowers and pushing them into IndyMac Option
ARMs that weren't suitable for them. 35 In its "zeal to close loans at all costs," the lawsuit says,
management created procedures that "placed speed, efficiency and profitability above making
reasonably sure that their borrowers were not being defrauded into taking out these Option ARM
loans."
In federal court in Pennsylvania, William and Emma Hartman claim a mortgage broker
manipulated them into taking out an IndyMac loan by falsely promising their interest rate and
monthly payments would decrease in a year or less. 36 Other complaints alleging bait-and-switch
tactics by IndyMac and its brokers have been filed in Virginia 37 , Colorado38 , Maine 39, MissoLlri 40
and California. 41
34
Ferguson v. IndyMac Bank, u.s. District Court for the Eastern District of New York, filed February 14,
2008.
35
Zurawski v. tvlortgage Funding Corp. et ai, U.S. District Court for the District of New Jersey February
13,2008.
I-Ialtman v. Deutsche Bank National Trust Co. et ai, U.S. District Court for the Eastern District of
Pennsylvania, December 24, 2007.
37 Mitchell v. IndyMac Bank, U.S. District Court for the Eastern District of Virginia, February 19,2008.
Andre and Christine Mitchell claim they were misled about the costs of the loan and weren't given the
legally required disclosures laying out the loan terms.
38 Brannan v. Indyfvlac Bank, U.S. District Court for the District of Colorado, June 15,2006. Donna and
Donald Brannan claim they specified they didn't want a loan with "negative amortization," in which the
loan balance keeps growing because the payments don't fully cover the interest. Instead, the suit says, the
broker stuck them in "the exact loan they were trying to avoid." In court papers, IndyMac said any losses
the Brannans may have suffered "were the result of the conduct of third parties over whom IndyMac had no
control." The case was settled on undisclosed terms in 2007.
.
39 Darling v. IndyMac Bancorp, U.S. District Court for the District of Maine, October 3, 2006. Joseph and
Roxanne Darling allege a mortgage broker dangled the lure of a 1% IndyMac loan and, in the face of their
doubts, "continued to assure them that the loan was truly a one-percent loan and was not 'too good to be
true.' " The Darlings claim they were given confusing and contradictory loan disclosures and that their
monthly payment wasn't what they'd been promised. IndyMac said in coul1 papers that any mistakes in the
36
II
IndyMac denies the allegations in these lawsuits. It maintains that it goes to great lengths to make
sure borrowers know what they're getting. IndyMac Bancorp president Richard Wohl told
financial analysts in 2006: "We have really good disclosures for our consumers, very plain
English disc\osures.,,42
One of the biggest legal attacks on the company has come in federal court in New Jersey, where
more than 20 lawsuits are targeting IndyMac and the independent brokers that sniffed out loans
for the company. According to one lawsuit, this group of brokers included one, Morgan Funding
Corp., that employed a salesman who had been convicted in 2002 in a $500,000 insurance fraud
43
involving staged auto accidents. Another Morgan salesman had been barred from trading
securities by the National Association of Securities Dealers, the suit says.
The suit claims IndyMac knew brokers were using slippery sales pitches to sell IndyMac loans,
because the company had received repeated complaints about the brokers' tactics. 44 In the case of
Morgan Funding; IndyMac not only had received complaints that the broker had lied to
borrowers; it also had two employees working inside the broker's offices from 2004 to 2007, the
suit says.45 These IndyMac employees provided training to the mortgage brokers that "aided and
abetted" Morgan Funding in deceiving borrowers, the suit claims.
Teaneck, N.J. residents Collin and Dorothy Thomas say their broker, DCI Mortgage Bankers
LLC, promised them an IndyMac loan with a I % rate for the first five years. What they got was
"vastly different" - the I % rate expired a month and a day later. 46 The paperwork, which said
their rate "may" change at that time, was disingenuous - because IndyMac and the broker knew
the rate was going to increase after a month, the Thomases claim.
Another New Jersey borrower, Arnette Games, says a hroker promised her a 2.85% rate on an
IndyMac loan for five years, but the real rate turned out to be 7.71 %. When she complained she
hadn't gotten what she'd been promised, she says, a salesman at the broker told her: "Well,
Arnette, you should have read the fine print.,,47
disclosures were good-faith errors that didn't violate the law. IndyMac paid $20,000 in late 2007 to settle
its dispute with the Darlings.
40 Harris v. Vinson l'vlortgage Services, U.S. District Court for the Eastern District of Missouri - Eastern
Division, March 6, 2008. Pat Harris, a disabled Navy veteran, alleges a broker misled him about the size of
his monthly payments. IndyMac denies the allegations and says Mr. Harris or "third parties" are to blame
for any problems with the loan. SEE Appendix 2.
41 George v. IndyMac Bank, U.S. District Court for the Central District of California, filed April 25, 2008.
Attorneys for Methalee George, an 82-year-old widow, claim she was a victim of elder abuse and fraud at
the hands oflndyMac. The suit alleges that the Option ARM sold to Ms. George was a "deceptively
devised product."
42 Voxant FD (Fair Disclosure) Wire, "Q3 2006 IndyMac Bancorp, Inc. Conference Call," November 2,
2006.
43 Zurawski v. Morgan Funding.
44 Zurawski v. Morgan Funding.
45 Zurawski v. Morgan Funding.
.
46 Thomas v. DCI rvlortgage Bankers, U.S. District Court for the District of New Jersey, September 28,
2007.
47 Glover v. Equity Source.
12
In court papers, IndyMac and the brokers deny wrongdoing. In response to one of the lawsuits,
for example, IndyMac asserts the loan terms were properly disclosed and that borrowers may
have "failed to read the documents provided to them.'.48
Racial discrimination
Some borrowers claim IndyMac has made a habit of targeting minority customers for overpriced
loans. A lawsuit seeking class action status in federal court in IIIinois 49 alleges IndyMac targets
black and Latino borrowers for higher rates than whites. It notes that IndyMac's own data shows
that in 2004 to 2006, minorities borrowing from the company were more than 50% more likely to
receive a high interest rate loan than whites.
The lawsuit claims IndyMac has channeled minority borrowers "into mortgage loans with less
favorable conditions than those given to similarly situated non-minority borrowers." According
to the suit, Earlene Calvin, an Apple Valley, California homeowner, was stuck with a long list of
excessive fees on a $416,000 IndyMac loan arranged by a mortgage broker. The fees included: a
$8,320 loan origination fee to the broker, a $630 "broker processing fee," a $495 "administration
fee~' to the broker and a $725 "funding fee" to IndyMac.
Inflated appraisals
A lawsuit in federal COUlt in New York 50 claims IndyMac used inflated appraisals to grease the
loan process. It alleges IndyMac told outside appraisers the "target value" that they needed to hit
to make a loan go through. The company rewarded appraisers who played ball and hit the values
with more assignments, but punished those who didn't by cutting their assignments, the lawsuit
claims.
One confidential witness in this lawsuit says IndyMac's chief appraiser and other executives were
aware of these practices and allowed them to go on. In fact, the witness says, in-house employees
who were supposed to make sure property values were accurate were intimidated by higher-ups
and told they would be fired if they tried to block fraudulent appraisals.
Falsified paper.work
Another thread that runs through borrowers' legal complaints against IndyMac is the allegation
that their loans were pushed through with falsified paperwork.
In California, Methalee George, an 82-year-old widow, claims an IndyMac employee falsified her
loan application by listing her income as $3,900 a month. Her real income was $2, I 03 a month. 51
In Chicago, Thelma and Carter Ware claim they gave a broker accurate documentation of their
Glover v. Equity Source.
Mables v. IndyMac Bank, U.S. District Court for the Northern District of Illinois - Eastern Division,
filed April 17, 2008.
50 Cedeno v. IndylVlac, U.S. District Court for the Southern District of New York, August 25. 2006.
IndyMac is seeking to have the lawsuit dismissed, arguing that its federal regulator, the Office of Thrift
Supervision, has sole authority to address violations by the lender.
51 George v. Indyl\1ac Bank, U.S. District Court for the Central District of California, filed April 25, 2008.
48
49
13
income and assets, but the broker inflated the appraised value of their home and falsified their
income on an application for two loans from IndyMac. 52 The Wares claim they were rushed
through the loan closing and weren't told they were being given two loans - including one that
carried a prepayment penalty and another that carried a "balloon payment" that .would require
them to come up with a large lump sum after 15 years. The broker took "exorbitant" fees totaling
$12,760 in exchange for sticking the Wares into two "unnecessarily expensive" IndyMac loans
totaling $329,000, their suit says.
Lenders frequently point the finger at borrowers and brokers when information on loan
applications turns out to be fictitious. But borrowers aren't the ones who are in control of the
process and handling the paperwork. Lenders have a responsibility - to their borrowers and to
their shareholders - to thoroughly review loan applications and make sure the information is
accurate. Otherwise, borrowers are likely to get in over their heads, stuck with loans they can't
afford.
Montilla, the former IndyMac underwriter in Arizona, believes many borrowers had no idea their
stated incomes were being inflated as part of the application process: "A lot of times you talked to
the customer and the customer said: 'I never told them I made that much.' "
Archuletta, another former Indymac underwriter, agrees that most borrowers were unaware their
incomes had been inflated. "Some of the borrowers were savvy and knew they were committing
fraud," she says. "But a lot of them really didn't understand the programs. You sit down and
there's 100 pages of stuff - nobody reads through all of that. It's our responsibility to let them
know what they're getting into."
Scott Vaughan, the attorney for Ben Butler, the Savannah, Ga., retiree who claims his Social
Security income was inflated, wrote IndyMac that the income listed in Mr. Butler's application
paperwork "was not provided by Mr. Butler and was a complete fabrication by someone 'in the
loop' so to speak. The mortgage broker and IndyMac are two of the persons/entities in that loop ..
. . There is no amount of income filled in on the original application. Mr. Butler was never asked
to state his income. Any prudent underwriter should have questioned the income considering the
amount/source and required proof. It can only be surmised that this was the income needed to
qualify for the loan."
Vaughan says his client was targeted for fraud and false promises because of his age, race, and
53
limited education. Mr. Butler was told the loan would eventually tum into a reverse mortgage,
and was quoted a monthly payment that was less than a third of what it turned out to be, Vaughan
says.54
52 Ware v. IndyMac Bank, U.S. District Court for the Northern District of Illinois - Eastern Division, April
10,2007.
53 Vaughan letter, and Butler v. John Flucas, Superior Court of Chatham County, State of Georgia, October
24,2007.
.
54 Scott Vaughan, telephone interview with Center for Responsible Lending,
14
Blacked out
Another Georgia case provides an example of a loan application full of obvious red flags that
were missed or ignored by IndyMac's loan-underwriting system, according to an analysis by
Atlanta Legal Aid Society's Home Defense Program, a non-profit legal clinic. 55
Elouise Manuel, 68, has lived in her home in Decatur, Ga., for halfher life. 56 She retired from a
career in food service, making salads and working as a line server. She "is not sophisticated in the
complex financial matters." In 2004, her only income was $527 a month in Social Security.
She owned her home free and clear when she began looking for a loan to payoff home repairs
and other bills. She went to a mortgage broker where a cousin's daughter worked. Ms. Manuel
told the broker she could afford a mortgage payment of no more than $120 a month. The broker
told her she wouldn't have to pay any more than that, and that it would get her the lowest fixed
rate possible.
The loan turned out to be something much different - an adjustable rate mortgage with an initial
teaser rate of 3.875% that lasted one month. The rate quickly jumped to 6% and eventually rose
to 10.25%.
As her monthly payment climbed to around $200 a month, Manuel called IndyMac and learned
she had an adjustable rate loan. She had to get help from her family and apply for food stamps to
keep up with her growing expenses.
How did she get in over her head?
Her la\'tsuit claims IndyMac purposely structured the deal so it was ignorant of her financial
means and ignored clear evidence that something was amiss with the information submitted for
her application. IndyMac specifically instructed the broker to send copies of her Social Security
award letters with the dollar amounts blacked out. In other words, the lender wanted proof that
she was receiving Social Security but didn't want to know how much.
Her IndyMac loan file is full of inaccurate and contradictory information. One document
indicated she was getting $1, I 00 a month in retirement income. Another said she was employed
and earning $2, I 00 a month. Another pegged her income at $3,200 a month. Similarly, IndyMac
paperwork and computer fi les show her assets growing from zero to $2, I 00 to more than $20,000
- all in the matter of 10 days.
Ms. Manuel's lawsuit says she never misstated her income and that given the inconsistencies in
the loan file, IndyMac should have known it needed real verification of her income and assets. It
also knew from the paperwork, the suit says, that she wanted a fixed rate loan, not an adjustable
rate one.
IndyMac told BusinessWeek last year that it followed standard procedure on Ms. Manuel's loan
and that it relies on the broker and the borrower to provide accurate information. 57 It said the loan
5S Letter, from Karen E. Brown, staffattomey, Atlanta Legal Aid Society, to Susan E. McGovney; senior
vice president and corporate compliance officer, IndyMac Bank, August 8, 2007.
56 Personal details and legal claims from Brown letter, and rvlanuel v. American Residential Financing, Inc.,
et aI, Superior Court of Gwinnett County, State of Georgia, April 3, 2008.
15
left Ms. Manuel better off, not worse off -- because the monthly payments were less than what
she'd been paying on the bills it paid off.
A company spokesman said giving instructions to black out Ms. Manuel's income on her Social
Security documents was "an error of judgment." It was the action of an individual employee, the
spokesman said, and not company policy.
In its discussions with the Atlanta Legal Aid Society, company officials questioned Ms. Manuel's
credibility, in part because a relative worked at the mortgage broker. In reply, the legal clinic said
Ms. Manuel never asked anyone to falsify her information, and that records indicate her relative
wasn't involved in preparing the file for submission to IndyMac. 58 It said IndyMac's "statements
implying Ms. Manuel has engaged in criminal activities" were "preposterous."
MANAGERS: Ignoring red flags
In February, IndyMac CEO Michael Perry put out his annual letter to shareholders. 59 "2007 was a
terrible year for our industry, for IndyMac and for you, our owners," he began.
Assessing blame for the nation's mortgage mess, Perry said all home lenders, including IndyMac,
"were part of the problem, and, as IndyMac's CEO, I take full responsibility for the mistakes that
we made."
Like other innovations - "e.g., the Internet, railroads, etc." - creative home lending "went too
far," Perry said, partly because lenders were "too close to it, but mostly because objective
evidence of this credit risk did not show up in our delinquencies and financial performance until it
was too late."
Even if IndyMac had been "blessed with perfect foresight" and pulled back in 2005 and 2006,
Perry said, the company would have still lost money in 2007 because its mortgage operations
would still have cratered thanks to "the broader and unforeseeable collapse" of the Wall Street
apparatus that pooled mortgages into investment deals.
Early warnings
Not everyone is convinced, though, that IndyMac's bad loans were simply the result of
misjudgments made by company leaders as larger market forces swept them toward hidden
shoals. In fact, IndyMac dealt with a number of episodes in recent years that should have
prompted it to be more careful about the loans it was funding and the brokers it was doing
business with.
For example:
57
58
Mara Der Hovanesian and Brian Grow, "Mortgage Mayhem:' BusinessWeek, August 20,2007.
Brown letter.
59
Business Wire, ;;Indytvlac Issues 2007 Annual Shareholder Letter,'· February 12,2008.
16
-- In early 2004, Washington Mutual Mortgage Securities Corp. sued IndyMac for more than $50
million, claiming IndyMac had peddled hundreds of problem loans from 1997 to 2000 to a
Washington Mutual subsidiary. The pool of mortgages, the suit said, included loans with
underwriting issues and inflated appraisals, and others on which borrowers had quickly defaulted,
60
an indication fraud was involved or borrowers couldn't afford the loan from the start.
IndyMac said it was not at fault. The two companies settled the dispute on undisclosed terms.
-- IndyMac became ensnarled in litigation over its relationship with a real-estate development
firm whose owners were convicted of forging documents as part of a scheme to sell overpriced
properties in Pennsylvania's Pocono Mountains in the late 1990s and early 2000s.
A lawsuit61 in federal court alleges IndyMac funded loans arranged by the development firm even
though it had been warned the Poconos were a hotbed of mortgage fraud. The suit claims
IndyMac failed to do due diligence and "became pivotal to the conspiracy" by bankrolling the
deals.
--IndyMac recorded a $9.7 million loss in first half of2006 due to a fraud scheme that was the
result of what Perry described as "massive collusion" between a mortgage broker and a developer
in Michigan and Florida. 62
CEO Perry admitted his company had "gotten a little bit laxed." "We didn't have the focus on
fraud that we should have in this area," he said.
--Indy Mac waited years in some cases before clamping down on mortgage brokers that had fed
the company bad loans.
In 2007, for instance, IndyMac sued a Nevada-based broker, Silver State Mortgage, after 35 out
of36 borrowers in one pool of loans failed to make their first payment. 63 Many of the loans were
made as early as 2005 and IndyMac waited at least a year to demand the broker repurchase the
earliest ones - and continued taking on loans from Silver State even after dicey nature of Silver
State-sponsored mortgages became apparent, attorneys in a California lawsuit have alleged. 64
In another example, IndyMac asserts that 16 out 18 borrowers in a pool of loans brokered by
Geneva Mortgage Corp. failed to make early payments. 65 Two of the bad loans dated back to
2003 and most of the rest were made in 2005. 66 However, IndyMac continued funding loans
brought in by Geneva in 2006 and didn't file suit over the issue until 2007. 67
Washington Mutual Mortgage Securities Corp. v. IndyMac Bancorp, Los Angeles Superior Court,
February 3, 2004.
61 Gaines v. Parisi, U.S. District Court for the Middle District of Pennsylvania, January 11,2006.
62 Voxant FD (Fair Disclosure) Wire, "Q2 2006 IndyMac Bancopr. Inc. Earnings Conference Call," July
27,2006.
63 IndyMac Bank v. Silver State Mortgage, U.S. District Court for the District of Nevada, March 29, 2007.
IndyMac's suit against Silver State was dismissed April 1,2008, at IndyMac's request.
64 Tripp v. IndyMac.
6S IndyMac Bank v. Geneva Mortgage Corp., U.S. District Court for the Central District of California,
March 22, 2007.
66 Tripp v. IndyMac.
67 Tripp v. IndyMac.
60
17
Full speed ahead
Even as IndyMac was taking a less-than-aggressive approach to policing its brokers, the company
was coming under growing pressure from Wall Street investors who were pushing back bad loans
that IndyMac had sold into investment deals. These "kickbacks" swelled from $108 million in
2005 to $194 million in 2006 and $613 million in 2007 alone. 68 IndyMac tried to hide these loans
by launching a special project on weekends in 2006, directing underwriters to aggressively
"rework" loan files on kicked-back mortgages so they could be resold again to other investors,
according to two witnesses in the California lawsuit. 68
Amid these problems - and rising concerns industry-wide about the cooling housing marketIndyMac forged ahead. Instead of pulling back, IndyMac made it clear that its plan was to take
advantage of other lenders' problems to take a bigger slice of mortgage market.
In June 2006, IndyMac predicted the housing slump was halfway over and was touting plans to
open regional centers in Philadelphia, Chicago and other cities and reach for growth in Pay
Option and interest-only adjustable rate mortgages. 69 "If you want to grow in a shrinking market,
by definition you have to take market share," IndyMac president Richard Wohl said.
Three months later, Perry said that "certainly there are negative signs in our industry," but
IndyMac's model made it "more optimistic than the industry overall.,,70
IndyMac's detennination to keep growing as others fell to the wayside or pulled back showed in
its 2006 mortgage production. The lender boosted its lending volume by some 50% in 2006,
during a year when overall industry volume was slightly down.
In March 2007, as the severity of the U.S. mortgage crisis was becoming more clear, Perry issued
a statement designed to calm fears about his company's vulnerability: "Based on an objective
analysis of the facts, talk of the 'subprime contagion' spreading to the Alt-A sector of the
mortgage market is, in our view, overblown.,,71
He said "IndyMac's credit quality shines in relation to the industry, validating our lending
standards and practices."
In August 2007, with world financial markets flailing, IndyMac announced it was planning to hire
as many as 850 fonner employees from its bankrupt rival, American Home Mortgage Investment
COrp.72
Indy Mac Bancorp, Inc., 10K Report to Securities and Exchange Commission 2007, Feb. 29,2008.
Tripp v. IndyMac. .
69 Reuters, "Housing slowdown halfway through, IndyMac says," June 19,2006.
70 Voxant FD (Fair Disclosure) Wire, "IndyMac Bancorp., Inc. at Lehman Brothers 4th Annual
Conference,' September 13, 2006.
71 Business Wire, "lndyMac Provides Additional Credit Loss Analysis on AIt-A and Subprime Lending,"
March 29, 2007.
72 Jonathan Stempel, "lndyMac to hire up to 850 ex-American I-lome workers," Reuters, August 28, 2007.
68
68
18
By 2008, though, it had become apparent IndyMac had overreached, making large numbers of
bad loans and failing to pull back quickly enough as the mortgage industry crashed.
In January, the company announced plans to slash its workforce by 24%, laying off 2,400
employees.
On May 12, the company announced a $184 million loss for the first quarter of the year. It called
the results hopeful, because they were an improvement over the heavy losses it suffered in 2007.
"I am confident IndyMac will be a survivor," Perry said. " ... IndyMac is the last remaining
major independent home lender, and we will be a better company and stronger competitor for
having survived the current crisis period, which should position us well to take advantage of the
opportunities that will surely return.,,73
CONCLUSION
Federal regulators have pointed out that many of the lenders accused of bad practices, such as
Ameriquest, were under state rather than federal supervision. However, IndyMac's record, as well
as Countrywide's, raises questions about whether federal regulators turned a blind eye to
improper practices among the lenders they licensed.
Amid the overheated atmosphere of the mortgage boom, IndyMac and lenders of many different
stripes appear to have abandoned sound decision-making and sustainable growth strategies.
Instead, they chose to take unreasonable risks and reach for spectacular levels of growth that
produced short-term profits but ended in pain for borrowers, shareholders, and communities.
It didn't have to happen this way. Federal authorities - including the Office of Thrift Supervision
- should have kept a closer eye on IndyMac's business model and practices. They had leverage
over IndyMac, given that the company operated as a federally-chartered thrift supported by
deposit insurance and borrowings from the FHLB system ..
IndyMac's story suggests that, in the absence of rigorous oversight, there's little to stop lenders
from getting swept up by market frenzies and embracing reckless practices. This should be
uppermost in policymakers' and citizens' minds as federal and state governments work to clean
up the mortgage mess - and to design rules that will prevent such disasters from happening again.
73 Business Wire, "lndyMac Bancorp Repol1s First Quarter Loss 0[$184.2 million," May 12,2008.
19
APPENDIX I
"Patently unsuitable"
Simeon Ferguson was born in Jamaica in 1921. He moved to the United States in the mid-1960s.
A few years ago, his behavior began to change. He began asking the same question over and over.
He visited a dying daughter in Jamaica, but then forgot he'd visited her. He was suffering from
dementia. 74
By 2006, Mr. Ferguson had been living in his house in Brooklyn for more than three decades. He
was 85 years old, living on a fixed income of $1,126 a month, and had a $360,000 mortgage with
a fixed interest rate of 5.95%.
According to a lawsuit filed in federal court in New York, a telemarketer solicited Mr. Ferguson
to refinance his mortgage. He told a neighbor that he was getting a I % interest rate.
The loan had an initial teaser rate of 1.25%, but jumped to 7.138% after six weeks. His initial
minimum payment was $1,482 a month, already more than his monthly retirement income. In
early 2007, the gap grew even larger, with his minimum monthly payment jumping to $1,903.
It was a loan that was "patently unsuitable" for Mr. Ferguson and "virtually certain to result in
foreclosure," the suit alleges.
.
According to the lawsuit, the loan was made under an IndyMac "stated income" loan program for
retirees, which makes no effort to document borrowers income or determine whether they can
afford the deal. A hallmark of the program, the suit says, was that IndyMac refused to take loan
applications that made any mention of the borrowers' income, "thereby encouraging mortgage
brokers to extend unaffordable loans while attempting to duck accountability by deliberately
remaining ignorant of the borrower's ability to pay the mortgage." In fact, the lawsuit notes,
IndyMac specifies that "the file must not contain any documents that reference income or assets."
In the end, the suit claims, the loan was a scheme targeted at retirees on fixed income, designed to
make loans that strip equity from the borrowers homes and fatten IndyMac's bottom line.
It wasn't until Mr. Ferguson went into the hospital with a bone infection in May 2006 that one of
his daughters took over his financial affairs and discovered the loan. When she asked him why
he'd taken out an adjustable rate loan, he insisted he'd gotten a low-interest fixed rate one.
"It's not that my father went out to buy a home .he couldn't afford, that's not what happened
here," the daughter,Karlene Grant, said. "Somebody solicited him and made him think he was
getting a better deal. Then they made some money and ran.,,75
Personal details and allegations are from Ferguson v. IndyMac Bank, U.S. District Court for the Eastern
District of New York, filed Feb. 14,2008.
7S "Joseph Huff-Hannon, "Facing Foreclosure: Brooklyn Retiree On Verge Of Losing Home As Subprime
Lenders Target Cash-Poor Seniors," The Indypendent, April 25-May 15,2008.
74
20
The broker that arranged the deal initially maintained that Mr. Ferguson had had a lawyer with
him at closing. In response to a complaint to New York banking authorities, the broker said Mr.
Ferguson had been "involved, consulted, and took part through the whole loan process in an
intelligent fashion.,,76 Mr. Ferguson's lawsuit says no lawyer was present and "given that Mr.
Ferguson was suffering from acute dementia at the time of the transaction, it's unlikely he was
engaged and involved in the process."
IndyMac directed more than $21,000 in fees to the broker for arranging the transaction apparently including, the lawsuit says, a large sum that rewarded the broker for "inducing Mr.
Ferguson to take out a loan on terms much less favorable than were otherwise available to him."
76
Ferguson v. IndyMac.
21
Appendix 2
A veteran's story
In late 2006 Pat Harris, a disabled Navy veteran in St. Louis, wanted to catch up on back taxes
and other debts.
A mortgage broker promised Mr. Harris he could refinance his mortgage and payoff his credit
card and tax bills with a loan that would carry a $526-a-month payment. 77
Mr. Harris claims the mortgage professionals involved in the deal exaggerated his income, falsely
listing it as $2,500 a month, or nearly three times his VA pension of $91 0 a month.
Instead of $526 a month, Mr. Harris' payment turned out to be $631 a month, nearly 70% of his
income.
In addition to rolling over his original mortgage, the new loan provided $3,261 in new money to
cover his credit card and tax debts. The settlement charges on the loan, meanwhile, totaled $5,962
- nearly twice the amount of new money provided by the loan.
Now Mr. Harris is suing, claiming IndyMac and the broker took advantage, overcharging him and
flipping from his old mortgage, which had an interest rate of 5.99%, into a new one with an
adjustable rate, which started at 10.5% and could go as high as 16.5%.
"The loan from IndyMac has not benefited the plaintiff," the suit says. "Instead, it has left him
deeper in debt and with a mortgage payment that he cannot afford."
In court papers, IndyMac denies the allegations and suggests that any problems with the loan
were caused by Mr. Harris or by "third parties."
All details and allegations from Harris v. Vinson Mortgage Services, U.S. District Court for the Eastern
District of Missouri - Eastern Division, March 6, 2008.
77
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February
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1001 Connecticut Ave., NW, Suite 510
Washington, DC 20036
202-452-6252
www.consumerlaw.org
PREEMPTION AND REGULATORY REFORM:
RESTORE THE STATES' TRADITIONAL ROLE AS
"FIRST RESPONDER"
A National Consumer Law Center
White Paper
September 2009
Contact:
Lauren K. Saunders
Managing Attorney
LSaunders@nclcdc.org
(202) 452-6252 x 105
EXHIBIT
TABLE OF CONTENTS
EXECUTIVE SUMMARY
I. NATIONAL BANKS HAVE HISTORICALLY BEEN SUBJECT TO STATE CONSUMER
PROTECTION LAWS ............................................................................................................................ 3
A. The Banking System ........................................................................................................................... 3
B. Preemption, States and the Constitution ............................................................................................. 3
C. 1864-1978: Limited Preemption of Laws that Significantly Interfere with National Banks .............. 4
D. 1978-1995: Preemption of State Laws on Interest Rates and Certain Mortgage Terms ..................... 6
E. I 996-Present: National Banks and Thrifts Enjoy Increasing Preemption of Consumer Protection
Laws .................................................................................................................................................... 8
F. State-Chartered Banks Receive Less Preemption .............................................................................. 10
II. THE PREEMPTION OF STATE CONSUMER PROTECTION LAWS HAS HARMED
CONSUMERS ....................................................................................................................................... 10
III. STATES ARE OUR NATION'S FIRST RESPONDERS AND PLAY A VITAL ROLE IN A FULL
CONSUMER PROTECTION .REGIME .................................................................................................... 16
A. Only States Provide Flexible Comprehensive Consumer Protection that Can Attack New Abuses. 16
B. States See Abuses Sooner, React More Quickly, And Provide the Experiments for Federal Law.:. 18
C. Exempting Some Entities Results in Unequal Treatment, Gaps in Protections, and Manipulations to
Exploit Those Gaps ....... :.................................................................................................................. 19
D. Banks Often Take Advantage of State Laws and Should Not Be Able to Cherry Pick What to Use
and What to Ignore ........................................................................................................................... 20
E. Preemption Undermines the Dual Banking System .......................................................................... 21
IV. RESTORING THE STATES' ROLE WILL NOT IMPEDE NATIONAL COMMERCE ................. 22
A. States Laws Tend to Converge; Minimal Differences in Detail do Not Impede National Products 22
B. Other Nationwide Corporations Comply With State Laws; Banks Do In Many Areas and Often
Tailor Their Products to Niche Markets ........................................................................................... 24
C. Congress Can Act To Impose Uniformity in Particular Areas, As It Already Has Done ................. 25
D. The Costs of Uniformly Weak Consumer Protection Outweigh The Minimal Costs Of Complying
With State Laws ............................................................................................................................... 25
V. CONCLUSION ........................................................................................................................ 26
EXECUTIVE SUMMARY
Consumer protection in the financial world has been dramatically weakened in the
last several years by preemption of state consumer protection laws. Broad preemption of
state law is a recent phenomenon; for most of the 150 years since national banks were
created, they have complied with state law. Preemption has harmed states' ability to
respond to financial abuses in both the banking and the nonbank world. Restoring the
states' role as "first responders" is an essential element of regulatory reform.
For most of this nation's history, consumers have depended on states, not the
federal government, to protect them. Even in the banking world, national banks were
expected to comply with state law. Only in the last decade or so have federally-chartered
depositories been able to ignore state laws with impunity.
•
From 1864 to 1978, state laws were preempted only if they prevented or
significantly interfered with national banks' exercise of their powers, or the law
favored state banks over national banks.
•
From 1978 to 1995, preemption of state laws governing interest rates began and
laws covering certain mortgage terms were preempted for any lender, including
nonbanks.
•
From 1996 to the present, national banks have been able to ignore wide swaths of
consumer protection laws.
The preemption of state consumer protection laws has harmed consumers. In area
after area, abuses have followed preemption.
•
Mortgages. The preemption of state laws in the mortgage area is a
significant cause of the current crisis. In 2006, the peak year of
irresponsible lending, national banks, federal thrifts, and their subsidiaries
made 32% of subprime loans, 40% of Alt A loans, and 51 % of interestonly and option ARM loans. A total of over $700 billion in risky loans
were made by entities that states could not touch. States were also
preempted from regulating any mortgage lender on the very terms that
made many mortgages dangerous: balloon payments, negative
amortization, variable rates, and other nontraditional terms.
•
Credit cards. The abuses that eventually led to a federal crackdown - bait
and switch rate increases, abusive fees, payment manipulations - were
allowed to take off and grow due to preemption.
•
Overdraft fees. Federal regulators preempted state laws while watching
programs designed to induce overdraft fees grow into a $27 billion tax on
the very consumers who need those funds the most.
•
Exploding debt, a climate of deception and high rate predatory lending.
The explosion of unaffordable debt that has destroyed many families and
the growth of destructive forms of predatory lending have their seeds in
preemption and the race to the bottom that preemption triggered.
States are our nation's first responders when new threats target consumers.
Restoring their vital role in protecting consumers is a critical piece of regulatory reform.
•
Only states provide comprehensive consumer protection. Flexible state
laws are critical when gaps in protection or new abuses emerge.
•
States see abuses sooner, react more quickly, and can address local
problems before they become national ones. States have the tools and the
incentives to enforce their laws and can augment federal resources.
•
State laws provide the models for federal law. They are an essential
element of our constitutional system of federalism.
•
Exempting some entities from state laws leads to an uneven playing field
and inconsistencies that are easily exploited.
•
Preemption allows banks to cherry-pick those parts of state laws they need
and ignore consumer protections in other parts of those same laws.
•
Preemption undermines our dual banking system.
Contrary to the claims of bank lobbyists, restoring the role of states to protect
individuals from banking and mortgage abuses will not impede nationwide commerce.
•
When new problems arise, states approaches tend to converge. The
uniform law movement and other national organizations promote uniform
and model state laws. The uniform mortgage broker licensing laws that 49
states adopted in the past year are a case in point.
•
Other nationwide corporations comply with state laws, and banks do in
many areas. Banks tailor their products to many niche markets and can
adapt to state variations. Minor differences do not prevent banks from
marketing a standard product.
•
Congress can adopt uniform national rules in particular areas, but state
consumer protections should not be cleaved off with a meat-ax wholesale.
The uniformity achieved by preemption comes at a heavy price. States act when
there is a problem. We have a choice: we can have uniformly weak protection, or vibrant
consumer protection that uses the strengths of our system of federalism.
2
I.
NATIONAL BANKS HAVE HISTORICALLY BEEN SUBJECT TO
STATE CONSUMER PROTECTION LAWS1
For most of their 150 year history, national banks have been expected to comply
with state consumer protection laws. Only in the last decade or so have national banks,
as well as federal thrifts and federal credit unions, been able to ignore state law.
A.
The Banking System
Federal law creates three different types of federally chartered depository
institutions. National banks are chartered under the National Bank Act (NBA) and are
supervised by the Office of the Comptroller of the Currency (OCC). Federal savings
associations, or "thrifts," are chartered under the Home Owners Loan Act (HOLA) and
are supervised by the Office of Thrift Supervision (OTS). Federal credit unions are
chartered under the Federal Credit Union Act (FCUA) and are supervised by the National
Credit Union Administration (NCUA).
Preemption of state laws applicable to national banks and federal thrifts and credit
unions stems from these three federal banking statutes-the NBA, HOLA, and FCUA-and
the regulations under them promulgated by the OCC, OTS, and NCUA, respectively. In
addition, other federal statutes preempt state laws on some specific issues and give state
chartered institutions parity with nationally chartered depositories in some areas.
B.
Preemption, States and the Constitution
The preemption doctrine arises from the Supremacy Clause of the United States
Constitution. If the provisions of a state law are "inconsistent with an act of Congress,
they are void, as far as that inconsistency extends.,,2 Federal regulations have the same
preemptive force as federal statutes,3 as long as the regulation is within the scope of the
agency's authority to promulgate.
There are three general categories of preemption: (1) express preemption (a
federal statute explicitly overrides state law); (2) conflict preemption (the state legislation
is inconsistent or conflicts with federal law); and (3)field preemption (a federal law .
"occupies the field" and ousts all state laws in that area, even those that are consistent
with federallaw).4 Express preemption occurs when Congress states directly that state
law is preempted. Conflict preemption is implicit and arises from court interpretations of
federal law. Field preemption is usually implicit but can be express.
I The tenn "banks" in this paper will at times be used to refer to banks, thrifts, and credit unions. For a
comprehensive discussion of the preemption of state consumer protection laws, see National Consumer
Law Center, The Cost of Credit: Regulation, Preemption, and Industry Abuses Ch. 3 (4th ed. 2009).
2 Gibbons v. Ogden, 22 U.S. (9 Wheat.) 1,31 (1824).
3 Capital Cities Cable v. Crisp, 467 U.S. 691, 699 (1984); Fidelity Fed. Say. & Loan Ass'n v. De la Cuesta,
458 U.S. 141, 153-154 (1982).
4 See Lorillard Tobacco Company v. Reilly, 533 U.S. 525, 541 (2001).
3
Under the Constitution, the federal government is a government oflimited
powers, restricted to those set out in the Constitution. The states, however, are
governments of general powers and the Constitution carefully preserves to the states all
powers that have not been specifically taken away. 5
The system of federalism created by our Constitution has led the Supreme Court
to employ a presumption against preemption of state laws:
[B]ecause the States are independent sovereigns in our federal
system, we have long presumed that Congress does not cavalierly
pre-empt state-law causes of action. In all pre-emption cases, and
particularly in those in which Congress has "legislated ... in a field
which the States have traditionally occupied," we "start with the
assumption that the historic police powers of the States were not to
be superseded by the Federal Act unless that was the clear and
·c
manl!est
purpose 0 fC ongress. ,,6
As discussed below, consumer protection is an aspect of the states' police power-the
power to protect individuals-a traditional area of state activity.
c.
1864 to 1978: Limited Preemption of Laws That Significantly
Interfere with National Banks
The National Bank Act (NBA) was passed in 1864 to create a system of national
banks, in large part to fund the Civil War. At a time when state and federal authorities
were engaged in bloody combat, the NBA protected national banks from state efforts to
destroy them or to give state banks a competitive advantage. Consequently, the NBA
gave national banks the right to charge interest at the higher of two rates: the rate charged
by state banks or an alternative federal rate. 7
In 1864, all states had usury laws and there was no interstate banking. The
alternative usury caps in the NBA-the state cap or the federal one-provide alternative
limits on national banks, not a means to preempt state usury laws. The NBA prohibits
usurious interest and imposes double damages on banks that charge more than the higher
of the two permitted rates. 8
For over 100 years, until the recent wave of preemptive activity in the latter part
of the twentieth century, state laws governing contracts, property rights and transfers,
consumer protection, and other laws applied to the activities of national banks. 9 The
U.S. Const. amend. X.
Medtronic, Inc. v. Lohr, 518 U.S. 470, 485 {I 996) (citations omitted); accord Reid v. Colorado, 187 U. S.
137 (1902).
7 12 U.S.c. § 85.
g 12 U.S.c. § 86. As of August 2009, the alternative federal rate is less than 2%.
9 See generally Arthur E. Wilmarth, Jr., The acc's Preemption Rules Exceed the Agency's Authority and
Present a Serious Threat to the Dual Banking System, 23 ANN. REv. BANKING & FIN. L. 225 (2004) ("OCC
Threat").
5
6
4
.----------------------
------
-
NBA has no preemption provision other than the alternative usury cap. Like every
federal law, the NBA implicitly preempts state laws that conflict with it. But any such
conflict preemption is a narrow exception to the general rule that national banks were
expected to follow state laws. As one of the earliest Supreme Court decisions explained:
[National banks] are subject to the laws of the State, and are
governed in their daily course of business far more by the laws of
the State than of the nation. All their contracts are governed and
construed by State laws. Their acquisition and transfer of property,
their right to collect their debts, and their liability to be sued for
debts, are all based on State law. It is only when the State law
incapacitates the banks from discharging their duties to the
. . [10
government that It. becomes unconstllutlOna
.
For most of our nation's history, national banks have rarely been permitted to
ignore state law. State laws were preempted only if they prevented or significantly
interfered with national banks' exercise of their powers, or the law favored state banks
over national banks. For example, in 1954 the Supreme Court held that national banks
did not have to comply with a New York law that prohibited any banks other than New
York's own chartered savings banks and savings and loan associations from using the
word "savings" in their name. II In other cases, the Supreme Court repeatedly affirmed
that "national banks are subject to state laws, unless those laws infringe the national
banking laws or impose an undue burden on the performance of the banks' functions.,,12
The Home Owners Loan Act of 1933 and the Federal Credit Union Act of 1934
were interpreted similarly to the NBA in the early decades, preempting only state laws
that conflicted with a specific federal law or significantly interfered with federal thrift or
credit union operations. 13
10 National Bank v. Commonwealth, 76 U.S. (9 Wall.) 353, 362 (1869) (holding that state taxes on bank
stock are not preempted) (emphasis added).
II Franklin Nat'l Bank of Franklin Square v. People, 347 U.S. 373 (1954).
12 Anderson Nat'l Bank v. Luckett, 321 U.S. 233,248 (1944); accord Lewis v. Fid. & Deposit Co., 292
U.S. 559, 564-66 (1934); First Nat'l Bank in St. Louis v. Missouri, 263 U.S. 640,656-59 (1924);
McClellan v. Chipman, 164 U.S. 347,356-59 (1896); Davis v. Elmira Say. Bank, 161 U.S. 275,287
(1896) (affirming that "so far as not repugnant to acts of Congress, the contracts and dealings of national
banks are left subject to the state law"); First Nat' I Bank of San Jose v. California, 262 U.S. 366, 368-69
(1923) (recognizing that "[the] contracts and dealings [of national banks] are subject to the operation of
general and undiscriminating state laws which do not conflict with the letter or the general object and
purposes of congressional legislation"); see generally. Wilmarth, OCC Threat, Jr., supra, 23 ANN. REv.
BANKING & FIN. L. 225 (2004).
13 See generally National Consumer Law Center, The Cost of Credit: Regulation, Preemption, and Industry
Abuses §§ 3.5, 3.6 (4th ed. 2009).
5
---
------------.
D.
1978 to 1996: Preemption of State Laws on Interest
Rates and Certain Mortgage Terms
Preemption of state consumer protection laws began with interest rate preemption
in 1978 in the context of credit cards. In Marquette National Bank v. First a/Omaha
Service Corp., 14 the Supreme Court interpreted the National Bank Act to hold that the
applicable state interest rate cap governing lending by national banks was the interest rate
law of the bank's home state, even for loans made to consumers in other states. This
decision meant that a national bank could "export" its own home state laws governing
interest rates, even when the state where the consumer lived and the loan was made was
different.
The decision had the effect of wiping out the usury laws applicable to credit
cards 15 that protected consumers of the other forty nine states. Not surprisingly, the
decision provided national banks a powerful tool to convince states to either mimic the
unlimited interest rates allowed by their sister states or risk losing the jobs and revenue
sustained by a bank's headquarters. Banks had the upper hand: if they convinced the
legislators of just one state to allow sky high interest rates on credit cards, they now had
the power-by threatening to move their operations out of state-to force most other
states to similarly deregulate. That is in fact what happened: national banks with credit
card operations either moved to states with no interest rate caps, or convinced their home
state to deregulate.
Meanwhile, the double-digit inflation of the late 1970s was making it difficult for
mortgage lenders to make loans while complying with state caps on mortgage interest. In
1980 Congress attempted to calm the inflation fires in the mortgage market
passing
the Depository Institution Deregulation and Monetary Control Act (DIDA). I DIDA
completely removed state interest rate caps for most lenders, not just national banks,
issuing loans secured by first mortgages on homes. 17 DIDA also preempted state
limitations on a lender's ability to assess "points," finance charges, or "other charges.''' 8
bl
DIDA also gave all federally chartered or federally insured depository lendersnot just national banks-the right to export their home-state interest rates when lending to
consumers in other states.
Congress went even further in 1982, in a law that opened up mortgage lending to
abuses beyond high interest rates. The Alternative Mortgage Transaction Parity Act
439 U.S. 299 (1978).
Though the immediate impact of the Marquette decision was in the credit card world, as national banks
began offering other products across state lines, it eventually had the impact of eliminating state interest
rate caps in those areas.
.
16 Pub. L. No. 96-221, 94 Stat. 161 (1980), codified throughout Title 12 of the U.S. Code.
17 States were allowed to opt out for a limited time but only 15 states did so and some only opted out of
some aspects of DID A's preemption.
18 States had the ability to "opt out" of the preemption so long as it was accomplished within three years of
enactment. Only 13 states acted in time.
14
15
6
(AMTPA)19 removed states' abilities to limit terms on "alternative" mortgages.
Specifically, AMPTA preempted state laws governing:
•
•
•
Variable rate loans (even those that onl6' go up, and never go
down and exploding adjustable rates);2
Balloon payments;21
Negative amortization and other types of "rate, method of
determining return, term, repayment, or other variation not
common to traditional fixed-rate, fixed-term transactions.,,22
In 1996, the OTS issued a regulation interpreting AMPT A to preempt prepayment
penalties, but when the resulting abuses became clear, it rescinded the regulation
effective in 2003. 23
AMPT A also included a section that preempted state restrictions on due-on-sale
·
24
1
causes
ill mortgages.
Aside from the specific issues of interest rate preemption and certain mortgage
terms, the general rule in effect from 1978 to 1996 continued to be that national banks
were covered by state laws except in those rare instances of conflict with federal law.
For example, in 1996, the Supreme Court held in Barnett Bank v. Nelson that a state law
prohibiting national banks from acting as insurance agents conflicted with a federal law
specifically granting them that power. 25
However, the Court made clear that state laws generally apply to national banks
unless they significantly interfere with the bank's powers:
In defining the pre-emptive scope of statutes and regulations
granting a power to national banks, these cases take the view that
normally Congress would not want States to forbid, or to impair
significantly, the exercise of a power that Congress explicitly
granted. To say this is not to deprive States of the power to
regulate national banks, where (unlike here) doing so does not
prevent or significantly interfere with the national bank's exercise
of its powers. 26
12 U.S.c. § 3801.
12 U.S.c. § 3802(1)(a).
21 12 U.S.c. § 3802(1)(b).
22 12 U.S.C. § 3802(1)(c).
23 12 C.F.R. § 560.34, rescinded by 67 Fed. Reg. 60,542 (Sept. 26, 2002). See also National Home Equity
Mortgage Association v. Office of Thrift Supervision, 271 F. Supp. 2d 264 (D.D.C. 2003).
24 12 U.S.c. § 170Ij-3. That section of AMTPA is known as the Gam-St. Germain Depository Institutions
Act.
25 517 U.S. 25 (1996).
261d. at 31 (emphasis added).
19
20
7
Congress expresslf, approved the Barnett standard in 1999 when it enacted the GrammLeach-Bliley Act. 7
Similarly, in 1994, when Congress authorized interstate banking in the RiegleNeal Act, it added this provision to the National Bank Act:
The laws of the host State regarding community reinvestment,
consumer protection, fair lending, and establishment of intrastate
branches shall apply to any branch in the host State of an out-ofState national bank to the same extent as such State laws apply to
a branch of a bank chartered by that State, except(i) when Federal law preempts the application of such State laws to
a national bank; or
(ii) when the Comptroller of the Currency determines that the
application of such State laws would have a discriminatory effect
on the branch in comparison with the effect the application of such
State laws would have with respect to branches of a bank chartered
by the host State. 28
Thus, the status of preemption for national banks (as well as federal thrifts and
credit unions) in early 1996 was:
•
•
•
E.
Interest rate caps for credit cards and first mortgages were preempted,
and the combination of exportation and deregulation was eroding rate
caps in other areas;
States were preempted from regulating certain mortgage terms
regardless who the lender was;
Otherwise, state laws were not preempted unless they significantly
interfered with the bank's exercise of its powers.
1996 to Present: National Banks and Thrifts Enjoy Increasing
Preemption of Consumer Protection Laws
In 1996, the OCC issued a regulation expanding interest-rate exportation to
include preemption of state laws covering a long list of fees. 29 The regulation was passed
in response to a suit by a California consumer challenging the credit card late fees
charged by Citibank (a South Dakota bank). OTS took the same position. 30
In 1996, in Smiley v. Citibank (South Dakota), the Supreme Court upheld the
OCC regulation. Without deciding whether the fees violated California law, the Court
27
28
29
30
15 U.S.c.
12 U.S.c.
12 C.F.R.
12 C.F.R.
§ 6701 (d)(2)(A).
§ 36(f) (emphasis added).
§ 7.4001.
§ 560.11 O(a).
8
held that state law challenges to the fees of national banks are preempted as long as the
fees are legal in the bank's home state. 31 Not surprisingly, states like South Dakota and
Delaware, where many national banks are located, allow any fees specified in the
agreement with the consumer, regardless whether they are unconscionable or unfair.
In the fall of 1996, after the Smiley decision came out, the OTS finalized a
sweeping preemption regulation. The rule asserts that "with certain narrow exceptions,
any state laws that purport to affect the lending operations of federal savings associations
are preempted. ,,32
To avoid losing their regulated banks to other, more permissive oversight, the
other banking agencies embarked on similar efforts. From 2000 to 2004, the OCC
worked with increasing aggressiveness to prevent the states from enforcing state
consumer protection standards against national banks. For example, the OCC openly
instructed banks that they "should contact the OCC in situations where a State official
seeks to assert supervisory authority or enforcement jurisdiction over the bank, ,,33 and
warned states that national banks need not comply with state laws. 34
The OCC's efforts culminated in 2004, when the agency adopted a regulation
preempting all state laws unless their effect on national bank powers was "only
incidental. ,,35 The regulation allows national banks to ignore state laws regarding
licensing, terms of credit, disclosure and advertising, solicitations, billing, and other
topics.
Both the OCC and OTS also asserted that the subsidiaries of national banks and
federal thrifts-though they are creatures of state law, are not banks, and do not have a
federal charter-can ignore state law to the same extent that their parents can. 36
Though somewhat less aggressive than the OTS and OCC, the National Credit
Union Administration has also enacted regulations preempting state laws as applied to
federal credit unions. 37 However, the NCVA regulation does not extend preemption to
subsidiaries.
Smiley v. Citibank (South Dakota), 517 U.S. 735 (1996), and state-chartered credit unions, 46 Fed. Reg.
24,153 (Apr. 30, 1981). Federal credit unions have a federal usury cap of 18%, but state laws regulating
interest rates and fees are otherwise preempted. See 12 U.S.C. § 1785(g).
J2 61 Fed. Reg. 50,951 (Sept. 30,1996) (enacting 12 C.F.R. § 560.2(a)); see also 12 C.F.R. § 557.11
(preempting state laws regulating deposits).
33. Office of the Comptroller of the Currency, Interpretive Letter No. 957 n.2 (Jan. 27, 2003) (citing oce
Advisory Letter 2002-9 (Nov. 25,2002)) (viewed June 19,2009, at
http://www.occ.treas.gov/inlerp/mar03Iint957.doc , and available at 2003 OCC Ltr. LEXIS II).
34 See, e.g., Office of the Comptroller of the Currency, Preemption Determination and Order, 68 Fed. Reg.
46,264,46,264 (Aug. 5,2003).
3S 12 C.F.R. §§ 7.4007(c), 7.4008(e), 7.4009(c)(2).
36 12 C.F.R. § 7.4006 (OCC); id. § 559.3(h), (n) (OTS).
J7 The Federal Credit Union Act (FCUA) and NCUA regulations and opinion letters preempt state
consumer protections in a wide number of areas, including state anti-predatory lending laws, and laws
related to closing costs, balloon payments, prepayment limits, conditions on the type or amount of security
for a loan, changes of terms in open-end credit, grace periods, and minimum payment disclosure
3J
9
In 2007, the Supreme Court upheld the OCC regulation, including the rule
preventing the states from imposing their inspection and registration requirements on
non-bank subsidiaries doing business in their states. 38
The effect of these regulations is that federal banks, thrifts, and credit unions can
simply ignore wide swaths of state law-even much of the state law of their home state.
F.
State-Chartered Banks Receive Less Preemption
The preemption rights of state-chartered institutions are more complex. Like their
federal cousins, they enjoy preemption of state laws governing interest rates, fees, and
certain mortgage terms. But beyond those specific terms, the scope of preemption is not
as broad, though it varies state to state and issue to issue, and is more a creature of state
parity laws than federal preemption. 39
Another aspect of preemption that exacerbates the discrepancy between the
playing fields for federally and state chartered institutions is that of enforcement. The
ability of the states to enforce any laws-including non-preempted state laws and federal
laws-against national banks, thrifts, or credit unions, or their subsidiaries, is severely
restricted. States can file judicial actions to enforce non-preempted state laws, but they
cannot seek information from the bank to investigate the issue first. 40 Though federal
agencies in theory can enforce state law, they virtually never do. In contrast, state
enforcement of state laws is generally vigorous against state-chartered institutionswhich might be one reason these state institutions do not cause as much trouble.
II. THE PREEMPTION OF STATE CONSUMER PROTECTION LAWS
HAS HARMED CONSUMERS
For consumers, the upshot of all these efforts to preempt state law has been the
predictable failure of consumer protection. Consumer protections eliminated on the state
level were never replaced with federal protections. 41 Though stronger consumer
protection laws are definitely needed at the federal level, restoring states' ability to
protect consumers is a critical part of regulatory reform. Preemption has played a role in
every major consumer protection failure in recent years.
requirements relating to credit card plans. See generally National Consumer Law Center, The Cost of
Credit: Regulation, Preemption, and Industry Abuses § 3.6 (4 th ed. 2009).
38 Watters v. Wachovia Bank, N.A., 127 S. Ct. 1559 (2007).
39 See generally National Consumer Law Center, The Cost of Credit: Regulation, Preemption, and Industry
Abuses §§ 3.7.3, 3.7.4 (4 th ed. 2009).
40 See Cuomo v. Clearing House Association, 129 S. Ct. 2710 (2009).
41 See. e.g.. Adam 1. Levitin, Hydraulic Regulation: Regulating Credit Markets Upstream, 26 YALE J. ON
REG. 143 (2009).
lO
Mortgages. The preemption of state laws in the mortgage area is a significant
cause of the current crisis. Many of the irresponsible loans that led to the foreclosure
crisis were made by entities that could ignore state law.
Mortgage lending by national banks, federal thrifts, and their operating
subsidiaries made up 31.5% - nearly a third - of the most dangerous, subprime loans
during the peak year of 2006. Subprime loans typically were made with no
documentation of income, without regard to ability to repay, and with a host of other
problems such as exploding rates, failure to include escrow in affordability analysis, and
inflated appraisals. Not surprisingly, they have failed in large numbers.
Table 1: Subprime Loans By National Banks and Federal Thrifts 2006
(includes operating subsidiaries)
LENDER
CitiMortgage, NY
WMC Mortgage (GE), CA
Wells Fargo Home Mort., IA
First Franklin (National City
Bank), CA
Washington Mutual, WA
BNC Mortgage, CA (Lehman
Bros. Bank)
Chase Home Finance, NJ
Equifirst, NC (Regions Bank)
TOTAL
RANK
4
5
9
$ (BILLlONSl
$38
33
28
MARKET SHARE
6.3%
5.5%
4.6%
10
11
28
27
4.6%
4.4%
16
17
18
15
12
11
$190
2.4%
1.9%
1.8%
31.5%
Source: Inside Mortgage Finance
'CitiMortgage became an operating subsidiary ofCitiBank in October 2006. Its volume of subprime
originations rose in the 4th quarter, and its market share increased to 10%.
In the Alt A market, the percentage of loans made by banks or their operating
subsidiaries was higher: 40.1 % in 2006, as reflected in Chart 2. Alt A loans were made
to borrowers who did not qualify for a prime loan though they may have had very good
credit. Like subprime loans, Alt A loans were often obtained with little documentation,
weak underwriting and risky features and have turned out to have high foreclosure rates.
11
Table 2: Alt A Loans By National Banks and Federal Thrifts 2006
(includes operating subsidiaries)
LENDER
IndyMac, CA
Washington Mutual, WA
WMC Mortgage Corp. (GE), CA
SunTrust Mortgage, VA
Chase Home Finance, NJ
National City Mortgage Co., OH
CitiMortgage, MO·
ABN AMRO Mortgage Group,
MI (LaSalle Bank)
Wells Fargo Home Mortgage, IA
Flagstar Bank, MI
RANK
(BILLIONS)
1
5
8
11
12
13
14
$70
25
18
10
9
9
8
MARKET SHARE
17.5%
6.1%
4.4%
2.5%
2.4%
2.2%
2.1%
22
24
25
4
4
3
$161
1.1%
1.0%
0.8%
40.1%
TOTAL
$
Source: Inside Mortgage Finance
'CitiMortgage became an operating subsidiary ofCitiBank in October 2006. Its volume of Alt A
originations doubled in 2007 and its market share increased to 6%.
Bank domination was heaviest in the nontraditional interest-only and paymentoption adjustable rate mortgage (ARM) markets: they held 51 % of the total market in
2006, as shown in Chart 3. Typically made to prime borrowers, these loans also had
features that put homeownership at risk. Interest-only loans had initial payments that did
not include principal, making them appear affordable. Payments later increased once
principal repayment began. Payment option ARMs had a fixed initial minimum payment
but not a fixed rate. As rates rose, lenders who made the minimum payment experienced
negative amortization and quickly owed more than their house was worth. Though the
borrowers were prime, the loans were toxic. 42
See, e.g., Allen J. Fishbein & Patrick Woodall, Consumer Federation of America, Exotic or Toxic? An
Examination of the Non-Traditional Mortgage Market for Consumers and Lenders (May 2006), available
at http://www.consumerfed.org/pdfs/Exotic Toxic Mortgage Report0506.pdf; Testimony of Margot
Saunders, Counsel, National Consumer Law Center, on Mortgage Lending Reform: A Comprehensive
Review of the Current Mortgage System, Subcommittee on Financial Institutions and Consumer Credit,
House Financial Services Committee, at 7-10 (Mar. I 1,2009), available at
http://www.consumerlaw.org/issues/predatory mortgage/contentlMortgageLendingRefonn0309.pdf
(describing dangers of payment-option adjustable rate mortgages).
42
12
Table 3: National Bank and Federal Thrift
Payment Option & Option ARM Lenders 2006
(includes operating subsidiaries)
LENDER
Wells Fargo Home Mortgage, IA
Washington Mutual, W A
IndyMac, CA
Golden West Financial, CA
(World SavingslWachovia)
CitiMortgage, MO*
Bank of America Mtg. & Aff.,
NC
Sun Trust Mortgage, VA
Chase Home Finance, NJ
National City Mortgage, OH
First Franklin Financial, CA
(National City Bank)
TOTAL
RANK
2
3
$ (BILLIONS)
MARKET SHARE
17.7%
8.8%
7.0%
4
$94
68
54
7
10
28
4.0%
3.6%
24
21
14
II
3.1%
2.7%
1.7%
1.4%
8
$352
1.0%
51.0%
31
II
12
14
16
20
Source: Inside Mortgage Finance
*CitiMortgage became an operating subsidiary ofCitiBank in Oct. 2006. Its volume of PO/option ARM
lending increased 20% in 2007 and its market share increased to 5.4%.
Overall, in 2006, national banks, federal thrifts, and their operating subsidiaries
were responsible for over $700 billion of the riskiest loans. States could do little to touch
these loans because of federal preemption.
Even for mortgage lenders who were technically still within the states' regulatory
purview, states' ability to regulate many terms was also limited by preemption. Thus the
stage was set for the wild, wild west of mortgages. Each element of a mortgage
transaction that has been immune from state law has led directly to abuses:
•
Interest rates. Preemption of interest rate caps led to a fringe market of highcost predatory mortgages.
•
Point andfees. The ability oflenders to charge high up-front fees and recoup
them immediately by simply adding to the homeowner's loan fed the flames
of equity stripping abuses. 43
•
.Balloon payments. The use of balloon payments also forced homeowners into
repeated home-equity stripping refinancings, as a new loan is generally the
only way to payoff a large balloon payment due at the end of the loan term.
See National Consumer Law Center et al., Comments Regarding the Advance Notice of Proposed
Rulemaking, OTS Docket Number RIN 2550-AB37, 12 C.F.R. Part 560\ No. 2000-34 (July 5, 2000),
available at hllp://www.consumcrJaw.org/issucs/prcdatory mortgagc/NCLC CFA commcnts.shtml.
43
13
•
Negative amortization and variable rates. Equity that shrinks rather than
grows, and low teaser rates that explode to unaffordable levels, are prime
elements of the toxic mortgages that took down the financial system.
Credit cards. The preemption of state laws governing bank fees in 1996 also had
pernicious effects. Credit card companies immediately began using tactics to increase
.
their fee revenue: 44
Credit Card Fees as Percentage of Revenue
1990-2003
33.0%
31.8%
31.0%
~ 29.0%
.. 27.0%
:::I
c
~
25.0%
&!
]I 23.0%
o
~
S
...3:
21.0%
19.0%
17.0%
15.0%
.j--~---r---~--""--~-~--~--~-~---r--~
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2003
Year
The broader preemption of state consumer protection laws allowed a variety of other
unfair and deceptive credit card practices to take off unchecked. States had no power to
address bait-and-switch rate increases, tricks to induce late payments and over-limit
purchases, or payment allocation manipulations. 45 These abuses went on for years until
the Federal Reserve, under the gun of losing its regulatory authority, and Congress, under
a storm of public outrage, finally reined them in.
Overdraft fees. Overdraft fee abuses began shortly after the OCC and the OTS
began expanding preemption. In the late 1990s, bank consultants started promoting
services to banks and credit unions that would encourage consumers to overdraw their
accounts. For example, one website promised that banks could increase non-sufficient
Source: Mark Furletti, Payment Cards Center, The Federal Reserve Bank of Philadelphia, Credit Card
Pricing Developments and Their Disclosure, at 32 (Jan. 2003).(citing October 1999 and July 2000 issues of
CardTrack, CardWeb.com as the source), available at hltp:llwww.philadelphiafed.org/payment-cardsccnter/publications/discussion-papers/2003/CreditCardPricing 012003.pdf. Mr. Furletti updated the
information through 2003 at the request of the Center for Responsible Lending. (E-mail from Mark FurIetti,
March 5, 2003, on file with CRL.)
45 See Plunkett Reg. Restructuring Testimony, supra. at 11-12; Testimony of Arthur E. Wilmarth, Jr.,
Professor of Law, George Washington University Law School, Before The Subcommittee on Financial
House of Representatives
Institutions and Consumer Credit of the Committee on Financial Services.
Hearing on "Credit Card Practices: Current Consumer And Regulatory Issues, at 7-13 (Apr. 26, 2007)
("Wilmarth Credit Card Testimony"), available at
http://financialscrvices.house.gov/hearing 11 0/htwilmarth042607 .pdf.
44
u.s.
14
----~-~--
--
~
-----------,
funds fee income by "100%, 200%, 300% or more!,,46 Federal bank regulators did little
to stop abuses 47 - even intervening in consumer protection lawsuits to argue,
successfully, that state laws protecting consumers against overdraft abuses were
preempted. 48
The deep recession caused by the foreclosure crisis has helped banks in one
respect. Consumers now lose $27 billion to overdraft fees annually.49 These fees come
from consumers who most need every penny. Indeed, much overdraft income comes
from Social Security and other exempt income needed for basic sustenance. 50
Exploding debt and increasing high rate predatory lending. The preemption of
state usury laws through exportation led to a deregulatory race to the bottom as banks
competed to retain their banking industries. The result was an explosion of credit card
debt,51 the consequences of which are now apparent.
A culture of deception. The limited ability of states to address rate and fee abuses
also fed the ever-present culture of deception in the credit marketplace. Substantive state
consumer protections have been eliminated in favor of weak federal disclosures, and the
true cost of various forms of credit--credit cards,52 overdraft loans,53 mortgages 54_is
frequently obscured, made up of hidden fees and interest rate hikes. 55
See NCLC & CFA, Bounce Protection: How Banks Turn Rubber Into Gold By Enticing Consumers To
Write Bad Checks: An Examination of Bounce Protection Plans at 6 n. 33(January 2003), available at
http://www.nclc.orglissues/bounce loans/appendix.shtml.
47 See Testimony of Lauren Saunders, National Consumer Law Center, Before the Subcommittee on
Monetary Policy, Committee on Financial Services, U.S. House of Representatives, Hearing on Regulatory
Restructuring: Safeguarding Consumer Protection and the Role of the Federal Reserve at 16-19 (July 16,
2009) ("Saunders Reg. Restructuring Testimony"), available at
http://www.nclc.org/issues/legislative/contentiTestimony7-16-09.pdf; Testimony of Travis Plunkett,
Consumer Federation of America, and Edmund Mierzwinski, U.S. PIRG, Before the Committee on
Financial Services, U.S. House of Representatives, Hearing on Regulatory Restructuring: Enhancing
Consumer Financial Products Regulation at 12-14 (June 24, 2009) ("Plunkett Reg. Restructuring
Testimony"), available at http://www.housc.gov/apps/listlhearing/financialsvcs dem/micrzwinski submitted with plunkett.pdf.
th
48 See Lopez v. Washington Mut. Bank. FA, 302 F.3d 900 (9 Cir. 2002) (finding California's laws
imposing restrictions on overdraft fees to protect Social Security and Supplemental Security Income
benefits preempted).
49 Ron Lieber And Andrew Martin, "Overspending on Debit Cards Is a Boon for Banks," New York Times
(Sept. 8, 2009).
50 Center for Responsible Lending, Quick Facts on Overdraft Loans, available at
http://www.responsiblelending.org/overdraft-Ioans/research-analysis/guick-facts-on-overdraft-Ioans.html.
51 See Mercatante, The Deregulation of Usury Ceilings, Rise of Easy Credit, and Increasing Consumer
Debt, 53 S.D. L. Rev. 37 (2008). The amount of revolving debt, most of which is credit card debt, is
approaching $1 trillion. See Federal Reserve, Statistical Release G-19, Consumer Credit, available at
http://www.fcdcralrcscrve.gov/rcleascs/gI9.
52 Comments of the National Consumer Law Center et a!. Regarding Advance Notice of Proposed
Rulemaking Review of the Open-End (Revolving) Credit Rules of Regulation Z (Oct. 12,2007), available
at http://www.consumerlaw.orglissues/credit cards/content/open end final.pdf (describing in detail the
way fees have been used to undermine the usefulness of the APR disclosure).
53 See. e.g., Testimony of Eric Halperin, Center for Responsible Lending, Before the u.s. House Committee
on Financial Services, Subcommittee on Financial Institutions and Consumer Credit on Overdraft
Protection: Fair Practices for Consumers (July 11,2007) available at
46
15
III.
STATES ARE OUR NATION'S FIRST RESPONDERS AND PLAY
A VITAL ROLE IN A FULL CONSUMER PROTECTION REGIME
A.
Only States Provide Flexible, Comprehensive Consumer
Protection That Can Attack New Abuses
States, not the federal government, have historically been the source of consumer
protection. Consumer protection is an aspect of the states' broad "police power"-the
power of the states, preserved under the Constitution, to regulate behaviors and enforce
order in order to protect public welfare, security, health, and safety. 56 The federal
government, by contrast, is a government of limited, enumerated powers under the
Constitution. Though the power of the federal government has grown in the last century,
the protection of individuals remains, in the first instance, a state responsibility.
States have a comprehensive network of laws to protect their citizens. This web
of protection in the states is comprised of several levels: first, the traditional Anglo-Saxon
common law, including the rules governing contracts, property rights, and commercial
transactions, and those prohibiting fraud and unconscionability; second, universally
applicable statutory laws such as those against unfair and deceptive acts and practices;
and third, specific laws enacted in response to particular problems, such as those
governing mortgage lending.
On occasion, Congress has passed limited and specific protections. However,
there is no comprehensive network of federal law that protects consumers. There is no
federal common law providing a broad set of rules governing contracts, property
transfers, or commercial transactions. 57
Also, federal law provides consumers with neither the broad nor the specific
protections in state law governing contractual relations, requiring good faith and fair
dealing, or prohibiting unjust enrichment, fraud and deceit, negligent misrepresentation,
or unfair or deceptive acts and practices. Though the federal banking agencies have
authority to stop banks from engaging in unfair or deceptive conduct, they have rarely
done SO,58 and individuals have no direct recourse under federal law against unfair or
deceptive practices. 59
http://www .responsi ble lending. org/overdraft-Ioans/po Iicy-legislation!congress/testimony-o f-eric-ha Iperi n7-11-07.pdf.
54 HUD Final RESPA Rule, National Consumer Law Center's Summary Analysis (Dec. 5,2008), available
at http://www.consumerlaw.orglissues/predatory_ mortgage/contentlRESP Aruleanalysis 120508.pdf.
55 See Elizabeth Renuart and Diane E. Thompson, The Truth, The Whole Truth, and Nothing but the
Truth: Fulfilling the Promise of Truth in Lending, 25 Yale J. on Reg. 181 (Summer 2008).
56 See "Police Power," Wikipedia, hup:llen.wikipedia.org/wiki/Police power; Encyclopedia Britannica,
http://www.britannica.com/eb/article-9060615/police-power.
57 Erie Railroad Co. v. Tompkins, 304 U.S. 64 (1938).
58 See Julie L. Williams & Michael L. Bylsma, On the Same Page: Federal Banking Agency Enforcement
of the FTC Act to Address Unfair and Deceptive Practices by Banks, 58 Bus. Law. 1243, 1244, 1246, n.25,
16
Federal law has always been an overlay rather than a replacement for state law.
The federal government has never set out to enact a comprehensive scheme to take over
from the states the frontline role in protecting consumers. The federal Truth in Lending
Act (TILA), while providing important standardized disclosures about the cost of credit,
was not intended to replace the substantive protections provided by state law. The
Supreme Court "has long recognized that federal law has a 'generally interstitial
character,' in the sense that Congress generally enacts legislation against the background
of existing state law.,,6o
President Obama recognized the importance of state law in our federal system in
one of his first executive orders:
From our Nation's founding, the American constitutional order has
been a Federal system, ensuring a strong role for both the national
Government and the States. The Federal Government's role in
promoting the general welfare and guarding individual liberties is
critical, but State law and national law often operate concurrently
to provide independent safeguards for the public. Throughout our
history, State and local governments have frequently protected
health, safety, and the environment more aggressively than has the
national Government. 61
After the recent mortgage debacle, it should be clear that the state laws protecting
consumers are the last bastion of redress when federal protections fai I. State laws on
fraud, unfair trade practices, unconscionability, foreclosure defenses, good faith and fair
dealing, conspiracy, joint venture, as well as other torts and contract defenses, have been
the primary way many individual homes have been saved from foreclosure. 62 The rich
and textured common law in the states has been particularly useful to the courts as they
1253 (2003); Julie L. Williams & Michael L. Bylsma, On the Same Page: Federal Banking Agency
Enforcement of the FTC Act to Address Unfair and Deceptive Practices by Banks, 58 Bus. Law. 1243,
1244, 1246, n.25, 1253 (May 2003) ("An obvious question is why it took the federal banking agencies
more than twenty-five years to reach consensus on their authority to enforce the [ban on unfair and
deceptive practices under the] FTC Act").
59 The Federal Trade Commission Act bans unfair and deceptive practices, but it is not enforceable by
individuals. 15 U .. S.C. § 45.
60 Watters v. Wachovia Bank, N.A., 550 U.S. 1,23-24 (2007) (Stevens, J., dissenting); Three Affiliated
Tribes of Fort Berthold Reservation v. Wold Engineering, 476 U.S. 877,895 (1986) (The Supreme Court
"has long recognized that federal law has a 'generally interstitial character,' in the sense that Congress
generally enacts legislation against the background of existing state law." (quoting Richards v. United
States, 369 U.S. 1,7 (1962»; Shell Oil Co. v. Iowa Dep't of Revenue, 488 U.S. 19,27 (1988) ("Congress
recognized, however, that because of its interstitial nature, federal law would not provide a sufficiently
detailed legal framework to govern life on [oil drilling platforms].").
61 Memorandum for the Heads of Executive Departments and Agencies; Subject: Preemption (May 20,
2009).
62 See Testimony of Margot Saunders, Counsel, National Consumer Law Center, "HR 1728: Mortgage
Reform and Anti-Predatory Lending Act, " Before House Financial Services Committee (Apr. 23, 2009),
available at http://www.consumerlaw.orglissues/predatory mortgage/contentlTestimony-HR-I728042309.pdf.
17
craft appropriate responses to the new and complex set of problems that have arisen in
recent years.
B.
States See Abuses Sooner, React More Quickly, and Provide
the Experiments for Federal Law
States governments, with fewer residents commanding their attention, are closer
to consumers. Individuals are much more likely to complain to state and local
government agencies than they are to federal ones. States see credit market abuses when
they first arise, before they become an essential part of an industry's profit model.
When specific problems have arisen that are not adequately addressed by more
general laws, whether in the consumer area or any other area, states have traditionally
been the ones to respond. States generally act much more quickly than do federal
lawmakers. Understandably, Congress and federal agencies are more deliberate before
adopting rules that will apply to the entire nation. But even when national attention is
clearly needed, Washington is often slow to act.
Several years into the subprime mortgage crisis, Congress has yet to adopt laws to
address toxic mortgages. The rules adopted belatedly in 2008 by the Federal Reserveyears after given the authority in 1994-were too little and too late. Neither Congress
nor the banking agencies have adopted any rules addressing abuses in the prime market.
In the meantime, though states have been severely hampered by preemption in their
ability to adopt mortgage protections, they have made efforts to use what authority they
have. Several states, including Illinois, New Jersey, New Mexico, New York, North
Carolina, and Ohio, have passed predatory mortgage lending laws.
Similarly, California was the first state to address foreclosure rescue scams in
1979 as a result of a unique problem facing that state with its exceptionally robust and
rising real estate prices. Other states found no need to respond until 2004 when the
scams began spreading. 63 From 2004 to 2009, over half of the states adopted laws to
address foreclosure rescue scams. In 2009, Congress gave the Federal Trade
Commission authority to address the scams. The FTC is now considering such a rule,
following the models and experience under the state laws. But in the meantime, it is the
states that are providing protection to consumers.
States also act more quickly to enforce laws when a financial institution violates
them. In the past decade there have been major multistate enforcement actions taken
against Household, Ameriquest, and Countrywide. State regulators took more than 7,000
mortgage enforcement actions in 2008 alone. 64 Federal bank regulators, by contrast, have
While the housing market was still strong, many of the scams were aimed at ~quity stripping. After the
foreclosure crisis hit, foreclosure consultant scams (extracting a fee in exchange for a false promise of help)
came to predominate.
64 See Mark Pearce, Viewpoint: Far From Blame, States Deserve Vital Reg Role, American Banker (Aug.
26,2009). (The author, Mark Pearce, is North Carolina's deputy commissioner of banks and the president
of the American Association of Residential Mortgage Regulators.)
63
18
been more reluctant to take aggressive action against predatory mortgage lending
abuses. 65
Thus, preserving the role of state.s is essential to protecting consumers from local
abuses that have not commanded national attention and may not receive a federal
response. Allowing states to act as new problems first develop also has the potential to
stop them before they become a widespread, national problem.
On many other occasions, states have been prescient in addressing problems first,
developing models eventually copied in federal legislation. 66 Even in the financial area,
in which states' efforts have been heavily preempted, states have led the way on multiple
issues:
•
Congress adopted protections against identity theft only after several states
did so. Congress omitted the right to a security freeze but most states gave
consumers that right, and eventually the credit bureaus adopted the freeze
nationwide.
•
The "Schumer" box now required for all credit card applications followed
California's rule that consumers be provided a chart showing the interest
rate, grace period, and annual fee.
•
States led the way in stopping long holds on deposited checks, which
Congress followed with the Expedited Funds Availability Act. 67
In these and many other areas, Congress benefitted from having solutions tried out on the
state level first.
c.
Exempting Some Entities Results in Unequal Treatment, Gaps
in Protections and Manipulations to Exploit Those Gaps
A clear lesson of the financial crisis is that protections should apply consistently
across the board, based on the product or service that is being offered, not on who is
offering it. Disparities in the treatment of different institutions lead to a race to the
bottom and anomalies that get exploited.
Preemption of laws for one segment of the market creates a disincentive for states
to regulate other actors. One reason states were reluctant to use their limited authority to
regulate nonbank lenders was the sense that it would be fruitless. As state law could not
affect a significant segment of creditors, states may have perceived that the effect of
65
See Brief of Amici Curiae Center for Responsible Lending et aI., Clearing House Association, L.L.c. v.
acc, No. 08-453 (Mar. 4, 2009); Saunders Reg. Restructuring Testimony, supra, at 5-12.
See Plunkett Reg. Restructuring Testimony, supra, at 36-39 (discussing Clean Air Act, national organic
labeling laws, national "motor voter" laws, and Do-Not-Call Registry), available at
http://www.hollse.gov/apps/listihearing/financialsvcs dem/mier.lwinski - submitted with plunkett.pdf.
67 See id.
66
19
----------.
partial regulation would be to place state lenders at a disadvantage without clear benefits
for consumers.
Preemption allows different rules to be applied to the same product. This in tum
leads to creditor gyrations just to avoid consumer protections. One example of disparate
treatment is in the payday loan area. Payday loans are very high-rate (typically 300% to
400% APR) short term (2- to 4- week) loans that lead to a cycle of exploding debt. In the
1990s, as states started recognizing the evils of payday loans and began re-imposing their
usury rates, payday lenders attempted to gain preemption rights by partnering with state
and national banks. 68 The rent-a-bank partnerships were not completely shut down by
the federal banking regulators until 2006.
Preemption leads to unequal levels of consumer protection that can undermine
protections that do exist. For example, banks are now starting to get directly involved
with payday lending. Bank payday loans take the form of direct deposit "account
advance" loans on bank accounts and prepaid cards, with the same short-term repayment
and similar triple-digit interest rates as traditional payday loans. 69 Though the destructive
effect on consumers is the same, the bank products can ignore state laws. For example,
payday lenders in Ohio must comply with Ohio's 28% payday loan cap but Fifth Third
Bank's account advance product does not. Bank payday loans may be the new wave of
abuse, as banks begin marketing them aggressively and see them as a substitute for the
overdraft loans that are receiving increasing scrutiny.70 Payday lenders hope that the
banks' entry into the payday market will legitimize their own predatory product and
c
.
wea ken protectIons
lor
everyone. 71
D.
Banks Often Take Advantage of State Laws and Should Not Be
Able to Cherry Pick What to Use and What to Ignore
To transact commercial business it is necessary for banks to operate under the
laws of the states in which they do business. The basic rules governing offer and
acceptance of a contract, recordation of security interests, and foreclosure are routinely
used and followed by banks in <ill of their commercial transactions with consumers.
However, while the banks use one'part of these laws to exercise their own rights, they
have too often claimed preemption as to those parts of these same rules and laws that
protect consumers.
68 See Plunkett Reg. Restructuring Testimony, supra, Appendix 3; Saunders Reg. Restructuring Hearing,
supra, at 21-23.
69 See NCLC, Bank Payday Loan ...... They're Baaaaaaaack (June 2009), available at
http://www.consumerlaw.org/issues/payday loans/content/Bank Prepaid Payday Loans.pdf. There are
two main differences between a traditional payday loan and a direct deposit account advance. First, the
advances are made by the same institution that receives the direct deposit of the paycheck or public benefit
check. Second, the term may be much shorter for an account advance, because the loan is repaid as soon as
the direct deposit comes in, which is likely sooner than the full two weeks of a traditional payday loan.
70 See Heather Landy, Turning Fee Revenue into Customer Opportunities, American Banker (June 24,
2009); Chris Serres, Biggest Banks Stepping into Payday Arena, Minneapolis Star Tribune (Sept. 9, 2009).
71 Serres, Biggest Banks Stepping into Payday Arena, supra.
20
For example, banks use state foreclosure laws to collect on mortgages. Yet the
OCC, the OTS and NCUA have all permitted their regulated institutions to ignore
••
consumer protectIOns
In some state Clorec Iosure Iaws. 72
This cherry-picking approach is similar to the OCC's approach to preemption: it
preempts state laws that ~rotect consumers from banks, but leaves untouched state laws
that are helpful to banks. 3
E.
Preemption Undermines the Dual Banking System
Preemption disrupts the balance between state and federal banks by favoring
federal charters over state charters. State-chartered institutions do not enjoy the same
broad preemption rights as federally chartered ones do, and can even led to a charter
change to avoid state laws. 74 "The resulting imbalance threatened to harm a system that
has been a proven laboratory of innovation.,,75 As former FDIC Chairman Don Powell
described in 2005:
The facts of life today with regard to preemption are fairly simple.
A state-chartered bank that wants to do business across state lines
is at a substantial competitive disadvantage relative to a national
bank or federal thrift. ... In my view, there is little doubt what the
current competitive imbalance, if not addressed, means for the
future .... In the end, Congress may choose to level the playing
field and preserve the dual banking system or it may, through
inaction or otherwise, choose not to, and let the dual banking
system fade into history. In my opinion, that would be a mistake. 76
Current FDIC Chairman Sheila Bair agrees that applying the same rules to everyone will
"eliminate the potential for regulatory arbitrage that exists because of federal preemption of
certain State laws.,,77
See, e.g. 68 Fed. Reg. 8,959 (Feb. 26, 2003) (OCC preemption determination of the Georgia Fair
Lending Act); National Consumer Law Center, The Cost of Credit: Regulation, Preemption, and Industry
Abuses § 3.4.6.3 (4th ed. 2009).
73 See Wilmarth Credit Card Testimony, supra, at 9-10.
74 See Paul Wiseman, Industry Lines Up to Fight Consumer Protection Agency, USA Today (Sept. 9, 2009)
(describing Capital One's charter change following West Virginia enforcement efforts). Charter changes to
avoid regulation can happen in both directions, and both from state to federal and within different types of
federal charters. See Plunkett Reg. Reform Testimony, supra, at 7-9 ..
7S Stefan L. Jouret, Jouret & Samito, Ruling in Cuomo Can Be Pro-Industry, American Banker (July 10,
2009).
76 Arthur E. Wilmarth, Jr., Fed. Res. Bank of Chi., "The OCC's Preemption Rules Threaten to Undermine
the Dual Banking System, Consumer Protection, and the Federal Reserve Board's role in Bank
Supervision," Proceedings of the 42nd Annual Conference on Bank Structure and Competition, at 106
(2006) (quoting Sept. 26, 2005 speech by Mr. Powell to the American Bankers Ass'n).
77 Statement Of Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation, On Regulatory
Perspectives On Financial Regulatory Reform Proposals Before The Financial Services Committee,
Us. House Of Representatives, (July 24, 2009), available at
http://www.house.gov/apps/I istlhearing/financialsves dem/sheila bair.pdf
72
21
The OCC's preemption rules have had a very significant impact in encouraging
large, multi state banks to convert from state to federal charters. Between 2004 and 2005
alone JP Morgan Chase, HSBC, and Bank of Montreal (Harris Trust) converted from
state to national charters, moving over $1 trillion of banking assets from the state banking
system. The share of all banking assets held by national banks and thrifts rose from 56%
to 67%, while the share held by state banks declined from 44% to 33%.78
These trends have continued. State banks now make up only 29% of banking
assets. 79 At this pace, state banks are a dying breed.
IV.
RESTORING THE ROLE OF STATES WILL NOT IMPEDE
NATIONAL COMMERCE
The banking system did quite well before state laws were widely preempted in the
last decade or so. Of course, both national uniformity and state flexibility have their
costs and benefits. But overall, the burdens of permitting different state standards are
minimal and are far outweighed by the dangers of eliminating state protections in favor of
a uniformly weak consumer protection.
A.
States Laws Tend to Converge; Minimal Differences in Detail
Do Not Impede National Products
Allowing states to act does not lead typically lead to widely divergent schemes.
States generally look at other state models. After the first states experiment with a couple
of approaches, the states that follow tend to converge on one approach.
For example, California passed the first specific foreclosure rescue scam law in
1979. In 2004, as the scams spread, Minnesota copied the California law with some
improvements. Two dozen other states copied the Minnesota law from 2005 to 2009.
These laws generally only have minor variations. 80
In the privacy area, the 2003 Fair and Accurate Credit Transactions Act allowed
states to take additional actions to prevent identity theft. Since its passage, fully 47 states
and the District of Columbia have granted consumers the right to prevent access to their
credit reports by identity thieves through a security freeze, and the credit bureaus then
adopted the freeze nationwide. 81
The Uniform Laws movement, spearheaded by the National Conference of
Commissioners on Uniform State Laws, has created many uniform or model state lawsmost notably the Uniform Commercial Code-that have been widely adopted by the
Wilmarth Credit Card Testimony, supra, at 11-12.
Data from Conference of State Bank Supervisors (using FDIC data).
80 See National Consumer Law Center, Foreclosures § 15.4.5 (2d ed. 2007 and Supp. 2009).
81 See Plunkett Reg. Reform Testimony, supra, at 37.
78
79
22
states. Often these uniform laws carve out specific areas for individual state variations,
always with a mind to minimizing compliance burdens.
Other national organizations also work to encourage uniform laws. For example,
the Conference of State Bank Supervisors drafted a model mortgage broker licensing law,
which many states have adopted:
The Secure and Fair Enforcement for Mortgage Licensing Act of
2008 (S.A.F.E. Act) is one very recent example of a how this
"floor not ceiling" approach has led to strong and uniform
standards. The S.A.F.E. Act, passed on July 31, 2008, gave the
states one year-until July 31, 2009-to pass legislation to meet
minimum licensing and registration requirements for loan
originators. The states have risen to the challenge and have unified
under a Model State Law. I am pleased to inform the Committee
that, as of today, 49 states and the District of Columbia have
enacted or introduced legislation implementing the S.A.F.E. Act. 82
The National Conference of State Legislatures, the American Legislative Exchange
Council, and other organizations also promote model state laws. Federal agencies can
also work with the states to promote uniform standards.
Differences in state laws tend to be minor ones in areas such as disclosures,
coverage, and remedies that do not prevent the same product from being offered in
multiple states. The minor inconvenience of adding a few words to the fine print in a
contract to comply with individual state disclosures laws is not a significant hindrance to
national commerce.
In areas where Congress has acted, states do not deviate significantly even when
given the chance. Virtually none of the federal consumer protection laws in the financial
area preempt stronger state laws, yet there are few significant state variances. The Truth
in Lending Act, the Electronic Funds Transfer Act, the Fair Credit Reporting Act, the
Fair Debt Collection Practices Act, the Equal Credit Opportunity Act, the Truth in
Savings Act, and a number of others all preempt only state laws that conflict with federal
law and otherwise allow states to go farther. The few state laws in those areas that have
added additional consumer protections have not proven problematic.
Testimony of Joseph A. Smith, Jr. North Carolina Commissioner of Banks on behalf of the Conference
of State Bank Supervisors on "Financial Regulation And Restructuring" Before The Financial Services
Committee United States House of Representatives, at 6 (July 24, 2009), available at
https://www.csbs.org/AMlTemplate. cfm ?Section=Search§ ion= Regulatory Restructuri n g&temp Iate=/
CM/ContcntDisplay.cfm&ConlcnIFilc!D=7171.
82
23
B.
Other Nationwide Corporations Comply with State Laws;
Banks Do in Many Areas and Often Tailor Their Products to
Niche Markets
National employers, department stores, auto makers, national credit reporting
agencies, nationwide debt collection agencies, and makers of other goods and services
can and do follow local laws. Those industries have not needed preemption and the
banking industry does not either.
Banks with multi-state operations have to comply with state laws in some areas,
and routinely adapt to local rules without problems. For example, banks must comply
with state laws regarding contracts, torts, criminal law, the right to collect debts,
acquisition and transfer of property, taxation, and zoning as long as they only incidentally
affect the exercise of national banks' powers.83 Banks must still be cognizant of the
specific-and different-state requirements for a host of state specific issues, such as:
•
•
•
•
Contract law rules (parole evidence rules, what is considered an
acceptance of an offer, what actions are considered anticipatory
breach) vary considerably from state to state.
Rules relating to preserving priority to title of secured property
vary widely.
Some states have judicial foreclosures, some have non-judicial
foreclosures. Many states have rights to cure defaults, some do not.
The terms of these rights to cure vary between states. Some states
have rights of redemption after the sale, others do not.
Rules relating to establishing a presence and running a businessthe taxing authorities, the zoning rules, the employment
compensation requirements-are all different from state to state.
Banks operating in multiple states are sophisticated entities with state-by-state
legal compliance operations and are fully able to deal with regional differences where
they exist. Indeed, many national banks have international operations that require them
to comply with the laws of different countries-many of which are smaller than some
American states. State-chartered banks also operate across state lines even though they
do not enjoy the same full preemption rights that national banks do.
If banks wish to offer a uniform product, they can choose to apply a more
protective law nationwide. Or, if it is more advantageous for the bank to apply that law
only for consumers in a particular state, it can do so.
Banks have shown no difficulty offering a wide array of mortgages, credit cards,
and other products aimed at different sets of consumers based on their income, credit, and
other features. They also differentiate their treatment of different groups of consumers.
83
12 C.F.R. §§ 7.4007(c), 7.4008(e), 7.4009(c)(2), 34.4.
24
A consumer who calls to complain about a credit card fee will get a different response
depending on the volume of spending on the card.
Banks can tailor their products to state markets as well. Sophisticated computers
and automated systems make it easier than ever to adapt products to particular markets.
Those same tools can be used to accommodate differences in state markets.
C.
Congress Can Act to Impose Uniformity in Particular Areas, As
It Already Has Done
Congress can always preempt state law and impose a uniform standard, as it often
has done in the past. For example, Congress passed the Electronic Signature Act in 2001
to standardize the rules for electronic authorizations, preempting state laws in that area. 84
A state law that conflicts with a specific federal law will always be preempted
even ifbanks no longer enjoy the automatic preemption of most consumer protection
laws. For example, state restrictions on due-on-sale clauses are preempted if they
conflict with the Gam-St. Germain Depository Institutions Act, which permits such
clauses.
But preemption should happen issue by issue, after a debate in Congress. State
consumer protections should not have been eliminated across the board through
regulations by the banking agencies.
Even if the National Bank Act, Home Owners Loan Act, and Federal Credit
Union Act are amended to roll back the broad preemption of the last several years, state
laws that significantly interfere with the operation of national depositories will always be
preempted, just as they were in the early days of those statutes. But laws that do not
significantly burden those institutions will not be automatically wiped out.
D.
The Costs of Uniformly Weak Consumer Protection Outweigh
the Minimal Costs of Complying with State Laws
States have no need or desire to legislate if a problem has been fixed. A flurry of
state activity only occurs when states are hearing an outcry of complaints on the ground
and no response is coming from Washington.
The specter of "51 state laws" has been used for years to fight against consumer
protection, but most recognize today that the financial industry would be better off if it
had been subjected to more serious consumer protection laws. For example, in 2005,
mortgage lenders pushed for preemption of the "uneven patchwork" of state laws that
"drives up costs," and yet the estimated cost of complying with state predatory lending
laws in states that had them was only $1 per mortgage. 85
IS U.S.c. § 7001 et seq.
See Center for Responsible Lending, Complying with Laws against Predatory Lending Costs Lenders
About One Dollar per Mortgage (July 26, 2005), available at http://www.rcsponsiblelcnding.org/mcdia84
8S
25
The widespread preemption of state laws in the financial area has eliminated
protection for consumers, wreaked havoc on communities, allowed.abuses to take hold
and spread into national problems, deprived Congress of the benefit ofthe experience of
state approaches, and undermined our constitutional system of federalism. Our national
banking system did quite well before state consumer protection la~s were wiped out, and
the minor inconveniences of some state variations are well worth the added safety value
of allowing states to protect their citizens. As Nobel Laureate Joseph Stiglitz has pointed
out, the cost of regulatory duplication is miniscule compared to the cost of the regulatory
failure. 86
v.
CONCLUSION
The federal government cannot do everything. That much has become quite
apparent with the spectacular failure of consumer protection in the financial world. There
is plenty of fault to go around, and states could have done better too. But they were
operating with two hands tied behind their backs, able only to bite and kick to stop
abusive practices aimed at consumers.
The current crisis should be a wake-up call that everyone--consumers, the
financial industry, and the economy as a whole-is better off with serious consumer
protection. Effective regulatory reform demands a comprehensive system that does not
leave significant gaps in protection, allow new destructive practices to spring up
unhindered by reforms aimed at yesterday'S problems, or ignore local problems until they
reach the point where they command national attention.
Restoring the role of the states as first responders is vital to protecting consumers.
States, with their ears closer to the ground, the ability to react more quickly, flexible laws
that can adapt to new situations, and a set of resources to supplement federal enforcement
efforts, are essential parts of a truly revitalized system of consumer protection.
center/press-releases/archives/complying-with-predatory-Iending-laws-costs-about-one-dollar-perm0l1gage.hlml.
86 "Some worry about the cost of duplication. But when we compare the cost of duplication to the cost of
damage from inadequate regulation-not just the cost to the taxpayer of the bail-outs but also the costs to
the economy from the fact that we will be performing well below our potential-it is clear that there is not
comparison," Testimony of Dr. Joseph E. Stiglitz, Professor, Columbia University, Before the House
Financial Services Committee, at 16 (Oct. 21, 2008).
26
AI07
December 2008
The 2007 HMDA Data
Robert B. Avery, Kenneth P. Brevoort, and Glenll B.
Canner, of the Division of Research and Statistics,
prepared this article. Cheryl R. Cooper, Christa N.
Gibbs, Rebecca Tsang. and Sean Wallace provided
research assistance.
The Home Mortgage Disclosure Act of 1975 (HMDA)
requires most mortgage lending institutions with
offices in metropolitan areas to publicly disclose
information about their home-lending activity. The
infonnation includes characteristics of the home
mortgages that lenders originate or purchase during a
calendar year, the geographic location of the properties related to these loans, and demographic and other
information about the bon·owers.' The disclosures are
intended not only to help the public determine
whether institutions are adequately serving their communities' housing finance needs but also to facilitate
enforcement of the nation'S fair lending laws and to
inform investment in both the public and private
sectors.
Under the 1975 act, the Federal Reserve Board
implements the provisions of HMDA through regulation. 2 In addition, the Federal Financial Institutions
Examination Council (FFIEC) is responsible for collccting the HMDA data and facilitating public access
to the information. 3 Each September, the FFIEC
releases summary tables pertaining to lending activity
from the previous calendar year for eaeh reporting
lender and an aggregation of home-lending activity
by metropolitan statistical area (MSA).4 The FFIEC
also makes available a consolidated data file contain-
I. A description of the items repOlled under HMDA is provided in
uppendix A.
2. HMDA is implemented by RegUlation C (12 C.F.R. pt. 203) of
the Federal Reserve Board. More InfOlTIlallOn about the leguiatlOn "
available at www.federalreserve.gov.
3. The FFIEC (www.ffiec.gov) was estahlished hy federal law in
1979 as an interagency hody to prescrihe uniform examination procedures. and to promote uniform supervision. among the federal agencies responsible for the examination and supervIsion ot financial
institution". The membel agencies are the Board of Governors of the
Federal Reserve System. the Federal Deposit Insurance Corporation.
the National Credit Union Admini<tration. the Office of the Comptroller of the Currency, and the Office of Thrift Supervision.
4. For the 2007 data. the FFIEC prepared more than 63,000
MSA-specific repons on behalf of reporting institutions. These and
other repons are made available to the public by the FFIEC.
ing virtually all the reported information for each
lending institution."
The HMDA data consist of information reported by
about 8,600 home lenders, including all of the nation's largest mortgage originators. The loans reported
are estimated to represent about 80 percent of all
home lending nationwide; thus, they likely provide a
broadly representative picture of home lending in the
United States.
This article presents key findings from the 2007
HMDA data. In doing so. it highlights the notable
changes in relationships that are revealed when the
2007 data are compared with data from earlier years,c,
Because of the importance of the loan-pricing information included in the HMDA data and because of
the recent turmoil in the residential mortgage market,
particularly the higher-priced segment of the market,
much of the focus here is on the data pertaining to that
market segment. 7
5. The only reported items not included in the data made nvnilable
to the public are the date of application and the date on which action
was taken on the dpplication. The"e item" are withheld to help en"ure
that the individuals involved in the application cannot be identified.
6. Previously puhlished asseSl>mentl> include Roben B. Avery.
Kenneth P. Brevoort. and Glenn B. Canner (20071, "The 2006 HMDA
Data." F,'dulIl Rp.I'l'rvp RIII/elill. vol. 93 (December 21). Pl'. A 73A 109: Robert B. Avery. Kenneth P. Brevoort. and Glenn B. Canner
(2006). "Higher-Priced Home Lending and the 2005 HMDA Data."
Fl'{/eral R~sen'e Rullelin. vol 92 (September R). pp. A 123-66: and
Rohel1 B. Avery. Glenn B. Canner. ,tnJ Rohert E. Coo~ (2005).
"New Information Reported under HMDA and Its Appitcallon in Fatr
Lending Enforcement." Fede",l RI'-'<'''''' Bulle/in. vol 91 (Sulllmel).
pp. 344-94.
7. Borrowers In thc hlghcr-prlced market segment generally lall
into one of two market categones-"subpnme" or "near prime"
(~ume[ime, referred [0 ' " ""it-A"). Individuab in the "ubprime
category generally pay the highest prices becaw'e they tend to pose the
greatest credit or prepayment risk. StallslIcs prepared by the lendll1g
industry do not characterize lending as higher priced but rather use the
terms suhprime or u/I-A. Thus. when presenting data from industry
"ouree" on loan perfonnance or other a"pects of the mongage market.
thiS article Will often reler to dala on the subprimc. all-A. or prime
lending market.
Mongdge, with annual percentage rates (APR,. which encompa"
interest rates and fees) above designated thresholds arc referred to here
as "higher-priced loans": all other loans are refelTed to as "lower
priced:' For loans with spreads above deSignated thresholds. reVised
Regulation C requires the reporting of the spread between the APR on
a loan and the rate on Treasury securities of comparahle maturity. The
thresholds for reportmg dllIer hy hen ,lalU,: 3 percentage poinb for
first hens and 5 percentage pOint., tor Junior. or suhordillate. liens.
Further details are in note 12, p. A 126. of Avery, Brevoorl. and
Canner, "Higher-Priced Home Lending and the 2005 HMDA Data."
EXHIBIT
I
S
A 108
Federal Reserve Bulletin 0 December 2008
TURMOIL IN THE MORTGAGE MARKET
Both primary and secondary mortgage markets experienced considerable stress in 2007, a condition that
has continued into 200S.8 Delinquency rates on
higher-pliced home loans, particularly those with
adjustable-rate features, first began to increase notably in 2006; those rates then rose sharply during 2007
and far outpaced the performance problems that also
emcrged in the lower-priced segment of the market. 9
One consequence of deteriorating loan performance and widespread declines in home values was a
sharp contraction in 2007 in the willingness of lenders and investors to offer loans to higher-risk bon'owers or, in some cases, to offer certain loan products
that entailed fcatures associated with elevated credit
risk.lo Moreover. to the extent that credit was still
available, loan prices rose sharply. largely because of
concerns about repayment prospects. In addition.
many lenders whose business models relied on a
robust secondary market to purchase the loans they
originated were forced to cease or curtail operations,
as they could no longer obtain funds to operate or find
investors willing to purchase their loan originations.
Difficulties in the higher-priced portion of the
mortgage market spilled over to other market segments. including the market for loans for large
amounts (the so-called jumbo market), in which
credit spreads widened substantially. The widening of
spreads led to higher interest rates on such loans,
which effectively reduced credit availability. I I
The 2007 HMDA data reflect the difficulties in the
housing and mortgage markets. Many reporting institutions experienced a sharp reduction in loan applica8. See. for example. Randall S. Kros7.ner (2007). "The Challenges
Facing Subprime Mortgage Borrowers," speech delivered at the
Consumer Bankers Associalion 2007 Fair Lending Conference. Washington. November 5. www.federalreserve.gov/newsevents/speech/
kroszner2oo71105a.htm.
9. Data from LoanPerformance, a subsidiary of First American
Core Logic. Inc., show that 20A percent of the suhprime loans with
adjustable-rale features were seriously delinquent al ihe end of 2007.
By comparison, 8.2 percent of fixed-rate subprime loans, 1.0 percenl
of fixed-rate prime loans. and 4.2 percenl of adjustable-rate prime
loans were seriously delinquent at the end of that year.
10. Industry sources indicate that the dollar amount of originations
of subprime loans fell 6H percenl from 2006 to 2007. to a level of only
$191 hillion. Suhprimc loan originalions in 2007 were the smallesl
since 200 I. See Inside Mortgage Finance (2008), The 2()()X Mortgage
Markel Slalislical IIIIIII/al. vol. I: The Primary Markel (Bethesda.
Md.: Inside Morlgage Finance Publicalions).
II. Jumbo loans are loans that exceed the si7.e limits set for loans
Illal Fannie Mae and Freddie Mac are pemlitted to purchase (conforming 103ns). Fannie Mae and Freddie Mac are government-sponsored
enterprises that focus on l"t)J1ventional loans that meet l'ertain size
limits and olher underwnllng cmenn. AVailable data In(licaJe that the
dollar amoul1l of originations of jumho loans fell nearly 30 percent
from 2006 to 2007. See Inside Mortgage Finance., 71te 2008 Mortgage
Markel S/(Ilislicalllllnl/al.
tions and orIginations, particularly in the higherpriced segments of the mortgage market. Also, some
lenders that had previously reported HMDA data
ceased operations during 2007 and did not file a
HMDA report even though they extended loans during part of that year.12 Although nonreporting by
lenders that ceased operations affects the comprehensiveness of the HMDA data each year to some extent,
nonreporting in 2007 had a much larger effect than in
previous years. For 2007, many more lenders than in
earlier years ceased operations because of a bankruptcy or other adverse business event, and the nonreporting institutions accounted for a significant
minOlity of the loans originated in 2006 and an even
larger share of the higher-priced loans made that year.
Most important, the effects of nonreporting in the
2007 HMDA data amplified the measured decline in
higher-priced lending from 2006. The amplification
occurred because some of the lenders that ceased
operations originated loans in 2007, and according to
these institutions' lending profiles in 2006, a disproportionate share of those originations consisted of
higher-priced loans. For this reason, some caution
should be exercised in using the 2007 data to document the full extent of the disruptions in the higherpriced lending market in that year. The efrects of
nonreporting are dillicult to quantify. This issue,
among others, is addressed later in the artide.
GENERAL FINDINGS FROM THE 2007 HMDA
DATA
For 2007. lenders covered by HMDA reported information on 2104 million applications for home loans.
Almost all of the applications were for loans to be
secured by one- to four-family (referred to here as
"single family") houses (table I). These applications
resulted in more than lOA million loan extensions
(data not shown in table). Lenders also reported
information on 4.S million loans that they had purchased from other institutions and on 433.000 requests for pre-approvals of home-purcha'se loans that
had not resulted in a loan origination (data not shown
in table); the pre-approval requests were turned down
by the lender or were granted but not acted on by the
applicant.
The total number of reported applications fell
about 6.0 million, and the number of reported loans
fell 3.5 million-or 22 percent and 25 percent.
12. As in earlier yeUf!\, some in:-.tilution~ ,easeu ()p~ratit)ns he(;aU!~e
ot a merger or acquIsItion. Lendll1g hy Ihese inslltUllOnS IS reported. in
mosl ca,e" hy the a(ljuiring in,titution on " con,oliu"led h",j, or as
two distinci filings.
The 2007 HMDA Data
AI09
I. Horne loan and repnrt1l1g activIty of lendIng 111stllutions covered under the Home Mortgage n1<closure Act. I <)<)()-2007
Numhcr
Applications received for home loans on 1-4 family properties.
and home loam: pun:huscd from another institution ~mllhons)
Year
Applicalions
Home
purchase
1990
1991
1992
1993
1994
....................
....................
....................
.....
....................
1995
1996
1997
1998
1999
....................
....................
3.3
3.3
3.5
4.5
5.2
5.5
6.3
68
80
....
............
8.4
2000
2001
2002 ....................
2003 ............
2004 ....
2005 ...............
2006 .......
2{~)7 . ....
83
7,7
7.4
I
Refinance
Home
Total'
purchased
5.5
6.6
10.0
13.6
10.7
1.4
2.0
1.8
1.5
1.1
1.2
2.1
5.2
7.7
3.8
1.2
1.2
1.4
1.7
2.7
4.5
5.4
114
94
2.1
22
2.0
2.1
6.5
to
98
17.5
24.6
16,1
11.7
10,9
7,6
15.9
140
II 5
82
I improvement I
Loans
I.X
2.0
19
1.5
1.5
2.2
2.5
25
22
Non~, Here "lll.1 in ..tli sub:-'CljUCIH ldhk", \..-omponcnt .. may nol ,urn tu InIal-.
bc::cause of rounding. and. except as noted. appi1catlons exclude requests fur
prc·approval Ihal were denied hy the lender or were accepted hy Ihe lender but
not a.:tcd upon by the bom)w,r_ 10 ;hi' ,111 IC I.:,. , J.rr1io,.'J.tlons arC' lknncd dS h1..--'
ing for a loan on a e:peeific property: rh~y an' rhue: di~"inci from rcqUl"o;;lS for
pn:.-approval. which arc not related 10 a ~pecific propeny.
I f\pplicutlont 101' mulnfamlly hcnne, ure meluded <mly In the total col·
uoms; fur 2007. thc:,e applications numbered 54.232.
respectively-from 2006 (2006 data not shown in
tables). Lending for both home purchase and refinancing fell as slower house price appreciation and, in
some areas, outright declines in property values
diminished the attractiveness of buying and selling
properties or limited opportunities to refinance outstanding loans. The imposition of tighter underwriting standards, an increase in mortgage interest rates,
and the elimination of some loan products used to
stretch affordability also contributed to the reduction
in lending. Finally, a portion of the decline in lending
activity was due to the nonreporting of loans made by
institutions that reported data for 2006 but discontinued operations during 2007.
Reporting Institutions
For 2007, 8,610 institutions reported under HMDA:
3,910 commercial banks, 929 savings institutions
(savings and loans and savings banks), 2,019 credit
unions. and 1.752 mortgage companies (table 2). In
total, the number of reporting institutions fell about
3 percent from 2006, primarily because of a relatively
large decline in the number of independent mortgage
companies-that is, mortgage companies that were
neither subsidiaries of depository institutions nor
Reporters
Disclosure
6.7
7.9
12.0
15.4
12.2
9.332
9,358
9.073
9.650
9.858
24.041
25.934
28.782
35.976
38.750
9.539
9.328
7.925
7.836
7.832
36.611
42.946
47.416
57.294
56,966
rcrort,2
Total'
1.2
10.0
13.0
14.3
21.4
19.9
1.3
1.8
2.1
3.0
11.2
14.8
16.4
24.7
22.9
16.8
23.R
26.4
34J
28 I
2.4
3.8
4.8
72
5,1
19.2
27.6
31.2
41.5
33.3
7.713
7.631
7.771
8,121
8,853
52.776
53.1166
56.506
65,808
72.246
30.2
275
21.4
5.9
62
4.8
36.0
33.7
26.2
8,848
8.886
8.610
78,193
78.638
63.055
32
? Po, rerun (OVer .. the mUllgagc It:nlimg aCllvlty of H lender in a !'lingle met·
mpohtan staustn:al are~l In which it hud un oflice during the )'eilr.
SOUNC.F· I-Ien.' anet jn the ~u~,equcnt tahlc~ and figure except n~ noted. Fed·
cr<il
FlnJllc!.a1 In\tltutlnn\
MorrgDg~
Die:clno;;ure Act
E \aml!latl')n Coull!..'d. dartl
("'WW ffiel' go\'/IUJl(t;}l,
reponed under
lh~
Home
affiliates of bank or savings association holding companies that reported data.
In total, 169 institutions that reported 2006 data did
not report data pertaining to 2007 lending activity
(these institutions ceased operations and were not
merged into, or acquired by, another reporting entity).
Some of the institutions that did not report were
high-volume originators. In the aggregate, these nonreporting institutions accounted for about 2.4 million
loans or applications that did not result in a credit
extension, or about 7 percent of all the loan and
2. Distribution or rt'porters covered by the Home Mortgage
Disclosure Act. hy type of institution. 200n-07
Number
Depository inJlilut~on
Commercial b,mk .....
Savings institution ....
Credit union .........
AI!
Mortgage company
Independent ....
Affiliated' ......
All ...........
All institutions
I
2006
Type
,
I
.,
I
Percent
I
2007
I
Number
Percent
3,900
946
2,036
fj,8R2
43.9
10.6
22.9
77.4
3,910
929
2.019
6.858
45.4
10.8
23.4
79.7
, ,32R
14 q
7.6
226
1.124
628
1.752
131
7.3
20.3
676
2.004
H.RH6
100
I. Sub~id;..If) 01 .. dl:po.'oIlU1), 1il."UIlHHlil Of
company.
8.610
..til
uihltdh.: lIi
100
d
h'Hlk huldlllg
A II 0
Federal Reserve Bulletin 0 December 2008
application records included in the 2006 HMDA data.
(The effects of such nonreporting on the 2007 data are
discussed in more detail later in the anicle.)
Dispositioll of Applicllfiol1s, Loo1/ Types, and
Activities Related to the Home Ownership
and Equity Protection Act
For purposes of analysis, loan applications and loans
reported under HMDA can be grouped in many ways;
here the analysis focuses on 25 distinct product
categories characterized by loan and property type,
purpose of the loan, and lien and owner-occupancy
status. Each product category contains information on
the number of total and pre-approval applications,
application denials, originated loans, loans with prices
above the reporting thresholds established by Regulation C for identifying higher-priced loans, loans covered by the Home Ownership and Equity Protection
Act (HOEPA), and the mean and median annual
percentage ratc (APR) spreads for loans priced above
the reporting thresholds specified in Regulation C
(tables 3 and 4).13 The following sections highlight
some notable aspects of the HMDA data for 2007
and, wherc rclevant, earlier years.
Conventional and Government-Backed Loans
As in earlier years, most reported home loan activity
in 2007 involved conventional loans-that is, nongovernment-backed loans (table 3). Such loans accounted for about 94 percent of all loan extensions in
2007.
The share of all HMDA-reported loans backed by
the Federal Housing Administration (FHA) had fallen
over the past several years, from about 16 percent in
2000 to less than 3 percent in 2005 and 2006.
More-limited product availability and th~ imposition
of tighter underwriting standards in the higher-priced
segment of the conventional mortgage market in 2007
encouraged borrowers to take out FHA loans. Also,
toward the latter pan of 2007, the FHA created a new
lending program. FHASecure, to help qualified individuals with higher-priced conventional loans refi-
13. HOEPA is implemented by Federal Reserve Board Regulation Z (12 C.F.R. pI. 226). Transition rules govcrning the rcpolting of
the expanded IIMDA data create prohlems for assessing the data on
loan pricing. manufaclured-home lending. and pre-approvals. The
Iransition I1Iles had a large infiuell~e on the data reported for 2004 and
much smaller effects on the 2005 and 2006 data. In the 2007 data.
transilion rules affected only about 2.100 appli~,ltion, and 192 loan"
the analyses here exclude those applicaliolls and loans when conSidering data on loan pricing. manufactured-home lending, and preapprovnls.
nance into an FHA loan. 14 The number of FHAbacked first-lien loans used to purchase homes or
refinance a home loan increased nearly 20 percent
from 2006, and the FHA's share of all home lending
increased to 4.6 percent in 2007 (data not shown in
tables). 15 The sharp curtailment of credit availability
in the subprime portion of the market, recent steps to
increase the maximum loan values that are eligible
for FHA loan insurance, and a newly enacted foreclosure prevention law are likely to result in a higher
incidence of FHA-insured lending in 2008. 16
Loan Size and Borrower Incomes
For each loan made, the HMDA data include the
amount bon'owed and the incomes of the borrowers
that were relied on in the loan underwriting decision.
The analysis in this section considers four loan categOlies: (I) conventional loans that met the threshold
for reporting as higher-priced loans under HMDA,
(2) all other conventional loans, (3) FHA-insured
loans, and (4) loans guaranteed by the Department of
Veterans Affairs. The analysis is limited to site-built,
owner-occupied, one- to four-family units, and the
four categories are applied separately to homepurchase loans and to refinancings.
For 2007, about 91 percent of conventional loans
for home purchase and about the same proportion of
such loans for refinancing, whether higher priced or
not, were within the conforming loan-size limits
established for Fannie Mae and Freddie Mac
(table 5).17 Higher-priced loans tended to be somewhat smaller than others; for example, among conventional home-purchase loans, the mean size of
higher-priced mortgages was $208,000, compared
with $248,000 for others (table 5, memo item).
FHA-insured loans tend to be considerably smaller
than conventional loans; the difference reflects the
relatively low insurance limits of the FHA and the
focus of the program on lower- and middle-income
borrowers who tend to buy more modestly priced
14. See U.S. Department of Housing and Urban Development,
Federal Housing Administnltion (2007). "Bush Administration 10
Help Nearly One-Quarter of a Million Homeowners Refinance. Keep
Their Home,." PIC'S release, August 31. www.hud.gov/news/
rclease.cfm?comcnl=pl{)7-123.ct'm.
15. In contra,t. the numher of reported fj"t-lien home-purcha,e
loans or refinancings that Involved loans guaranleed hy the Depanment of VClerans All'ail's fcll aboul 2 pcrcenl from 2006.
16. Housing and Economic Recovery Act ()f 2008. Puh. L. No.
110-289 (2008).
17. For 2007. Ihe conrormlllg loan-Size IInllt was $417.000 for a
slIlgle-unit propeny. with limn, 50 pel'cem hIgher lor p,opert,es III
Ala'''a anel H,lwall. HIgher Ino;l, are abo e,whlt,hed for two-. Ihree-.
and four-unit properties: however. hecause the HMD:'>' data do nOi
distinguish among properties with fewer Ihan five units. the analysis
here uses the $417,000 limit.
The 2007 HMDA Data
homes. For 2007, the mean size of FHA-insured
home-purchase loans was $142,000.
Borrower incomes differ substantially by loan
product and loan pricing (table 6). Most notably, the
mean income of borrowers with conventional loans,
regardless of loan pricing, was about 72 percent
higher than that of borrowers with FHA-insured loans
(data derived from memo items in table). Among
those obtaining conventional home-purchase mortgages, the mean income of individuals meeting the
conforming loan-size limit established for Fannie
Mae and Freddie Mac was $83,600, versus a mean
income of $293, 100 for those exceeding the conforming loan-size limit. Again, among bOiTowers with
eonventionalloans, those using higher-priced loans to
purchase a home or to refinance had a mean income
about 20 percent lower than that of borrowers not
paying higher prices.
Non-Owner-Occupant Lending
Part of the strong performance of housing markets
over the first half of this decade was due to the growth
in sales of homes to investors or individuals purchasing second or vacation homes, units collectively
described as "non-owner occupied." HMDA data help
document the role of investors and second-home
buyers in the housing market because the data indicate whether the subject property is intended as the
borrower's principal dwelling-that is, as an owneroccupied unit. ls
The share of non-owner-occupant lending among
first-lien loans to purchase one- to four-family sitebuilt homes rose in every year between 1996, when it
was 6.4 percent, and 2005. when it reached a high of
17.3 percent (table 7). For 2006, the share fell somewhat. to 16.5 percent, and in 2007 it declined further,
to 14.9 percent. Falling non-owner-occupant lending
likely reflected the reduced incentives for such borrowing as house prices weakened or fell in many
parts of the country and as the imposition of tighter
lending standards for borrowers in this market segment reduced access to credit.
Piggyback Lending
In recent years, so-called piggyback loans emerged as
an important segment of the conventional mortgage
I R. An investment propeny is a non-owner-occupied dwelling that
i~ intended to be continuoll~ly rented. Some non-owner-occupied
units-vucation homes and second homes-are for the primary use of
the owner and thus would not he considered investment propenies.
The HMDA data do not. however, distinguish between these two types
of non-owner-occupied dwellings.
AlII
market, particularly regarding loans to purchase
homes. In piggyback lending, borrowers simultaneously receive a first-lien mortgage and a junior-lien
(piggyback) loan. The piggyback loan finances the
pOition of the purchase price not being financed by
the first mortgage and sometimes any cash payment
that might have been made; the junior-lien loan may
amount to as much as 20 percent of the purchase
price.
Piggyback loans are generally used to reduce the
cost of financing a home purchase. Often. they are
designed to have a first-lien loan that can be financed
at a lower price than a single loan for the total amount
borrowed, such that the gains from the reduced
finance costs on the first-lien loan outweigh the
higher finance costs on the junior-lien loan portion of
the total borrowing. A prime example is the practice
of structuring the first-lien loan to avoid paying for
private mortgage insurance (PM I) (for more infonnation about PM1, see appendix B). Many of these loan
transactions are structured so that the first-lien loan is
eligible for sale to Fannie Mae or Freddie Mac, both
of which require PMI on first-lien loans for amounts
that exceed 80 percent of the value of the property
backing the loan. Another example is the structuring
of the loan transaction so that the first-lien loan can be
more readily securitized in the secondary market.
This practice has been common in the secondary
market for subprime loans. Yet another example
arises when the total amount requested exceeds the
loan-size limits for Fannie Mae and Freddie Mac,
thereby requiring the borrower to pay the higher
interest rate usually charged on jumbo loans. Keeping
the size of the first-lien loan within the amount that
conforms to the loan-size limits of Fannie Mae and
Freddie Mac can possibly result in lower overall
financing costs.
The HMDA data can be used to help document
the extent of piggyback lending over time. However, because not all lenders submit HMDA data.
some of the junior-lien loans that are reported may
not have the corresponding first-lien loan reported,
and some of the first-lien loans that are reported
may not have the associated junior-lien loan reported. Also, some piggyback loans may be home
equity lines of credit (HELOCs) rather than c1oscdend loans. Under the provisions of Regulation C,
lenders need not report HELOCs. Nonetheless, a
loan-matching process can be undertaken to determine which reported junior-lien loans appear to be
associated with a reported first-lien loan. A juniorlien loan was identified as a piggyback to a reported
first-lien loan if both loans (I) were. conventional
A 112
Federal Reserve Bulletin 0 December 2008
3. Djsposilwn of appitcaltnnS tnr hornc Inans. and ol"lginalton and pnclng (If Inal1', hy type of hornt' and type of Inan. 2007
Loans originated
Applications
Loans with APR spread above the threshold I
Type of home and loan
Acted upon by lender
Number
submined
N
um
be
Number
I Number
I Percent
r
denied
denied
Number
I
Distribution, by percentage poinL< of APR spreud
Percent
3-3.99
I 4-4.99 I 5-6.99 I 7-8.99 I
9 or
more
1-4 FAMI\.Y
NON8\1SINESS RELATED'
OWller occupied
Site-built
Home purchase
Conventional
First lien ............
Junior lien ..........
Governmenl backed
First lien ............
Junior lien ..........
4,654,084 4,120,941
927,255
828,053
783,972
170,231
19.0
20.6
2,928,820
548,567
411.263
118,673
14.0
21.6
49.4
79,818
85
16.2
7.5
392,157
1,008
11,504
65
2.9
6.4
91.1
.. .
"
8.550.904 6,920.906 2.759,7 I 5
1,40R,232 1,228,24~ 450,348
W.9
36,7
3,39t,6l)4
6%,443
735,150
120,854
217
19.0
39 I
196
550,551
1,348
493,260
1,138
.
..
17.1
26.8
65.8
6.5
30.0
.3
4.3
3.5
1.7
76.9
3.6
18.5
.1
4.6
33.8
58.0
7.4
32.4
.1
9.5
...
.
Refinance
Conventional
First lien ..
Junior Hen ....... ...
Government backed
First lien ............
..
.
"
342,768
710
288,814
527
91,106
151
31.5
28.7
179,330
316
11.893
1i3
6.6
19.9
92.1
4.3
2.7
liS 1
.9
3I 7
.U
32
First lien ............
Junior lien ..........
Government backed
721,417
949,861
627,577
863,8UO
277,983
34\,244
44.3
39.5
291,043
429,624
87,774
72,114
302
16.8
38.8
21.7
30.3
45.3
8.8
32.5
.5
22.2
First lien ............
Junior lien .....
10,962
3,407
9,614
2,ng
2,347
24.4
31 I
6.666
I ,~77
410
1,044
0.2
59.5
R60
7.6
M2
22.7
39.8
8.0
31.6
2.2
2S.5
347,359
340,661
167,456
49.2
146,395
359.351
146.597
141,807
347.819
132,750
127,179
175.312
50.4
48.5
38.4
94,247
55,069
69,077
57,954
30,880
16,142
IiU
2~
48,899
56.1
23.4
29.1
36.0
908,416
927.485
275,273
813,364
799,914
244,145
167,875
26QM4
87,98 4
20.6
1]7
360
564,719
447,071
129,959
112,711
79,204
31,731
20.0
177
24.4
59.4
19,798
27,267
7,156
17,626
24,630
Ii,Scl7
1,983
2,977
1,074
11.3
12 I
156
14,863
20,707
5,403
881
1,112
149
48,635
43,127
15,488
41i,OS7
37,951
13,35('
1,991
4,333
1.728
43
11.4
12,9
43,063
32,401
11,164
21,389,258 18,337,983 5,952,496
32.5
Junior lien ..........
Home improvement
Conventional
Unsecured
(conventiunal
or government
baekedl ............
...
. ..
..
..
,
..
Manufactured
Conventional. first lien
Home purchase ........
Refinunce ..............
Other ....................
64,384
239
26.2
12.2
31.0
32.9
24.8
9.8
16.5
H
2.0
10.4
15.5
20.0
18 ~
7.3
15.6
21 8
45.0
4.5
(i5
21.6
.5
.4
10.6
5.9
5.4
2.7
60.5
6(\,0
28.9
14.5
165
11.4
23,7
20.2
45.0
\'0
2.7
12.!
.2
.5
2.7
2.904
2.808
491
f..7
8.7
4.4
447
51.1
34.6
23.0
27.9
13.4
11.6
13.2
31.6
15.1
7.S
13.8
5.6
10,441,353 1,907,774
18.3
36.4
15.7
34.1
11,5
2.4
R
J:l5
Non-ow"t!r occupi(!d't
Conventional. first lien
Home purchase ........
Reflnunce ...........
Other ...........
~2
R
B lIS1NESS RilLA TEl>'
Conventional, flr.1 lien
Home purchase ........
Retlnancc_ .
Other ...............
MUL:I'lFAMILY'
Conventional. first lien
Home purcha~c .
Refinance .... ........
Other.
..
Total ...........
.....
NoTl.:: E.\ciuues transition-pc nod applicatIOns ((hose subrnmcd bdore 20(4)
and [rant.lt,nn-pcnod In~n" (thn<:1." tnr whIch the nrpitCrttlon W!l" '\uhmmcrl he·
for.: 20(4).
I. Annual pen:t'nt.l£1: l..llt: (APR) ~PIe.~UJ i;; the ditlt:renl,.:e betwc~n Ihe- APR
on (he Inan lind 'he yield on a cump;,uahle-matulily Treasury seculiry_ The
lhu;.,hulJ rut fir.\l·lil.:n lo;,w" I.' J .'~pr~<J,u ,If 3 pcr...:cntasc pOInlZ'l. lUI jUl1Ior-hcn
ImUls. it is 1I sprt':~ld of 5 pt"rct"ntage poines
.3
6.5
3_ Uusmcss·rclatcd arplic~tinn" and In~", arc those for which the lender rcpnrt"d th;'.f rhe race, ':thniClt)'_ al1d s:'{ rof the o.pplica:1t or co-;:prliCJl1i J,rc "nol
uppli\...tbh.:··. all olhci .tpplkalion ... ,H,d loci"'" ule npnhusinl'~!' related
4. Indudl.'~ .lpph..:ahuns ;,md IUdllS for v. hi!..h O(~upalh;:y s[alus Wd~ mis~ing.
5. Inclurle~ huo;lne",·reinrect Dmi nonbuc;ine,o;-rt"iated npplJcDrlon~ ~nd loan.;;
lur
o""n!.':r-\)~~uplcd
and
Nt't applicable,
llun-uwllcr-lI~\"upicd
propcrlies.
2. Lllan" coveted by (he Home Ownership and Equity Protection Act of
1994 (HOEI'A), which dncs nnt upply 10 home· purchase Inans.
loans involving property in the same census tract,
(2) were originated by the same lender with approxi-
mately the same dates of loan application and clos-
ing, and (3) had the same owner-occupancy status
and identical borrower income, race or ethnicity,
and sex,
7'lle 2007 H M DA Data
A 113
.l. tJi;.pO:;!tH)1l oi apphcluon,; for home lnall~, and origmallon lild pncmg of loun<, hy Iyp~ (,f IH'mc and Iype of loan, 200i-COlifillul'C/
Loans originated
MEMO
Transition-period applications (those submitled before 2004)
Loans wilh APR spread above Ibe dueshold I
APR spread (pereenlage point')
Mean
I
Median
Number (If
HOEPA·
covered
loans:!
Loans OIiginated
Number
submitted
<I/l
6:1
305
3.5
6.7
3.2
6.4
26
~
IQ
o
o
12
50.0
30
20.0
4
25.0
4
25.0
o
2
22.2
o
o
o
o
o
o
u
u
o
o
o
()
o
o
()
o
1.184
810
4
9
4
o
o
o
o
50
94
6
o
3
o
o
5.0
o
o
o
o
5
o
:!5
1
3
16.0
o
o
n
192
14.1
o
3.2
6.4
120
4.8
7.5
4.5
7.3
1.214
2.827
4.5
7.5
3.6
7.4
6
6
o
5.6
5.0
4.8
5.1
4.1
4.4
6.2
3.9
156
5.9
73
3.8
o
3.7
3.8
5.2
o
5.1
6
2
1
9
o
o
o
4.8
11.504
2,115
34
4.2
4.0
60
16
1
3A
6.7
5.1
o
covered
lonns 2
1.6
4.2
1.951
5.n
6
HOEPA·
17
1
3.145
4.4
5.5
<;9
91
67
I
10
Number of
1.488
36
4.5
6.6
5.3
Number
I Pereenl
wilh
APR 'prcnd
n
6.9
4.2
4.3
denied
o
4.8
5.5
5.1
Percent
above threshold
66
4
Number
denied
~2
Extent of piggyback lending. The HMDA data show
that lenders extended a substantial number of juniorlien loans to help individuals purchase homes (for
both owner-occupied and non-owner-occupied purposes) in 2005 and 2006 but that such lending
contracted sharply in 2007. 19 For 2005. lenders
19. A similar matching process was used 10 Idenlify piggyback
loans used for refinancing. HMDA reporting requiremenls. however.
are less comprehensive for refinance loans. and therefore junior. lien
loans used for refinancing are less likely 10 be reported. As a resull. we
do not report data on piggyback loan Iransactions used for refinancing.
o
o
o
o
o
o
2
o
o
o
o
o
2.3
o
o
o
o
o
o
o
()
1)
()
1)
()
o
o
o
()
o
11
9
4
5
I
o
33.3
50.0
o
o
o
o
o
o
o
o
o
o
reported on about 1.37 million junior-lien loans used
to purchase homes; for 2006, they reported on about
1.43 million (data not shown in tables). In 2007,
lenders covered by HMDA reported information on
only about 600,000 junior-lien loans to purchase
homes, a decline of nearly 60 percent from the 2006
level.
Regarding piggyback lending, our matching algorithm indicates that about 12 percent of the 2.9 million 2007 first-lien home-purchase loans on owneroccupied site-built homes for one to four families
A 114
~.
Federal Reserve Bulletin 0 December 2008
Horne-purchase lending that hegan with
:t
request tor pre-approval: DIsposItIon and pric1T1g. hy type of horne, 2007
Requests for pre· approval
Applications preceded by requesL' for pre·approval'
Acted upon by lender
Type of home
Number
denied
Percent
denied
Number
submitted
Number
754.318
95.782
209.478
28.538
27.8
29.8
420.435
54,088
371,847
48.760
37,300
5.585
85,606
95
31,821
13
37.2
13.7
55,236
84
48.944
72
5.524
4
45,358
6,418
22,802
2.361
50.3
36.8
42.728
4,918
37.831
3.632
20,624
1.094
69,916
6.040
16,237
1.850
2.1.2
,06
48.688
4.637
42.570
4.020
0.639
1.032
1.169
209
131
19
112
91
1.126
202
943
102
12
321
34.n
29
220
14
164
35
n
23
I
1,065,267
29.4
632.3%
558,972
77,9-10
Number acted
upon by lender
I
Number denied
1-4 FAMn.Y
NONBUSINESS RELATED'
Owner (Icclipiea
Site·built
Conventional
First lien ......................
Junior lien .....................
Govemment backed
First lien .................
Junior lien
....
.......
Munufactured
Conventional. first lien ...........
Other ............................
Non-owner oecl/pied"
Conventional. firsl hen
Other ...........
...........
Bt;sINESS RELATED'
Conventional. first lien ... , .....
Other .........
llil
MUt.:rIFAMILY'
Convcntion:ll. first lien
Other .....
Total.
NOTE' Excludcc:. trun<:itinn-pcriod rcqucetc;: for prc-appro"nl (thoo;,c c;unmmcd
before: 20(4) Sl'C' general noh~ to tunic 1
I. Thc~(' npplicnl1onc;. are Included In 'he rotal of 21,389,258 reported ,n
tnhle 3.
2. Sec nllle I. I.hle 3.
4
Includes appitcDllon<; and Inano;, for whIch <X"cupancy 'iOtat'I" woe Inlc;sing.
5 1n<.luJ\.'" hu .. int' ..... -r~LHt'J ~ni,.l Ilonhu .. lflt· ... :-.·rcl.th:d applir..;aliun~ and loans
for owner-occ\lpu:~d and non-owner-occupled pfl.'perties
. . . Not applicable.
3. Business-relmed applications and loans are those for which the lender reponed fhal the race, cthnicity. and seX' of the applicant or co-applicant arc "not
all mhcr applil.:aliono;. uno loun.,;, :.In.' nonhu\oincc;~ related.
appJjcLlhl~";
involved a piggyback loan reported by the same
lender, a proportion that was down 45 percent from
2006 (data not shown in tables).
Changing nature of piggyback lending. A comparison of the 2007 HMDA data with the HMDA data for
earlier years suggests that the nature of piggyback
lending has changed. The HMDA data for 2005,
2006, and 2007 can be used to distinguish three types
of piggyback loan aJTangements: (I) those likely to be
used as substitutes for PMI, (2) those intended primarily to keep the size of the first-lien loan within the
limits set for loans that Fannie Mae and Freddie Mac
arc allowed to purchase in a given year, and (3) those
used for other purposes, most likely to facilitate sale
of the loan to the secondary market.
For purposes of this analysis, piggyback loans were
assumed to be in the first category if two conditions
were satisfied: (I) The first-lien loan in a piggyback
loan transaction was not higher priced, and (2) the
combined loan amount of the first- and junior-lien
loans was less than the conforming loan-size limit.
Piggyback loans were assumed to be in the second
category if three conditions were satisfied: (I) The
first-lien loan in a piggyback loan transaction was not
higher priced, (2) the amount of the first-lien loan was
under the conforming loan-size limit, and (3) the
combined loan amount of the first- and junior-lien
loans exceeded the conforming loan-size limit. For
the first two categories of piggyback loans, the presumption is that the piggyback loan was used to
facilitate sales to Fannie Mae or Freddie Mac. Consequently, in the analysis, we distinguish between loans
that have been sold to Fannie Mae and Freddie Mac
and those that might be sold. The third category of
piggyback loans consists of those that do not appear
eligible to be sold to these two entities because the
first-lien loan is higher-priced or the loan amount
exceeds the conforming loan-size limit. 20
The analysis indicates that the share of piggyback
loans used to keep the first-lien loan within the
20. HIgher-priced loans are generally not eligIble for purchase by
Fannie Mae or Freddie Mac. Such loans typically involve elevated
credit rbk or hilve other fealuce, that tend to make them ineligible for
purchase by Ihese institutions.
The 2007 HMDA Data
AilS
4. H(lllll'-pur(;hasc knding Ihal begall willi a rcquc,;1 for pre-approval. DI:.pnSitIlJn and pri<.:ing. by [)pc of home, 2007-C"nt;nlled
Loan originations whose applications were prcccdod by requests for pre-approval
----,----=-------'-'-----'----'--'---:-=--'-'-------1
Loans witb APR spread above the tllreshold'
APR spread
(percenta e points)
Distribution. by percentage points of APR spread
Number
Number
Percent
3-3.99
4-4.99
186
5-6.99
7-8.99
129
2~
719
21.9
3.5
12.5
302.513
35.759
19.003
3.609
6.3
10.1
65.5
41,437
64
1.357
1
3.3
1.6
74.3
9.754
2.425
6,999
331
71.8
13.6
14.3
73.7
23.2
45.2
.3
6.0
15.1
19.9
31,R46
2.209
3.856
405
12.1
60.6
204
18.3
.2
147
52.6
32.3
S03
140
53
12
6.6
8.6
58.5
33.3
15.1
33.3
25.0
125
13
2
10.4
10.0
76.9
20
o
o
7.7
100
o
427.095
35,641
8.3
48.0
17.1
25.4
8.0
9.7
o
17.0
o
7.7
9 or
Mean
more
spread
0
0
o
4.0
5.1
3.4
5 ..1
2.1
5.6
4.3
5.5
3.3
o
o
42
7.1
3.7
6.8
o
I
o
o
o
4.4
5.9
3.8
5.8
o
I
o
o
o
o
o
o
3.9
6.0
3.2
6.0
o
o
o
o
o
()
()
1.5
4.6
4.1
20
o
o
5
()
8.3
()
7.7
Number
~9
14.8
9.4
Percent
denied
36
()
n
Median
spread
Loans originated
Number Number
submitted denied
40
fi4
o
(]
100
MEMO
ApplIcations wnh transition-p"riod requests for preapproval (request submitted before 2004)
8
o
o
Percent
with APR
spread
abovc
threshold
o
0
0
2
o
o
o
o
7
o
85.7
o
o
o
o
o
o
0
o
()
()
I
o
o
()
o
o
()
()
o
()
12
50.0
5. Cumulalive distribution of home loans. hy loan amount and hy Pltlllosc. type. and pricing of loan. 2007
Percent
Upper bound
of loan amount
(thousands of
dollars)'
24 .... ,
49 ........... " ..
74 .. .
99
124 ..
149 .......... " .....
174 .......... .
1<\9
224 ......
249
274 ................ .
299 .... .
324 .......... ..
349 ................ .
374 .......... " .... .
~;~ ........... " ·1
449 .........
..
499.....
..
549 ......... .
599 ................ .
649 .......... " .... .
6Q9
749 .......... ".
799 ................ .
More than 799
Home purchase
Conventional
Lower
priced
I
Higher
priced
I
J
Total
2
10
.3
18
1'3
5.5
2.3
70
15 I
133
232
.135
432
51.4
59 I
~5.0
70.2
74.3
7N3
81.3
84.0
81'2
905
91.2
92.7
94.2
95.2
96.2
96R
97.3
155
2~ 4
37.0
47
.~
15 "
556
450
623
682
530
73 I
77.2
60.4
1\61
71.2
805
75.2
83.4
85.7
87.9
898
914
92.7
946
790
81.9
845
81i 7
906
91.4
93.0
945
95.5
96.4
97.0
100
96.1
97.0
97.8
981
98.6
98.8
100
247.9
194
2079
157
97.7
25.2
975
97.9
100
I
Refinance
Conventional
FHA
I
VA
22
II 3
26.6
42.6
n06
750
85 I
909
942
963
97.7
98 "
99.1
99.7
99.7
998
99.9
999
II~)
100
100
lOll
100
100
100
Lower
priced
Higher
priced
o
7
4
13
8.9
2.3
7 I
lfi.l
26.2
37.2
47.0
55.8
62.8
2~
8.8
18.5
129
47.8
606
704
78.9
85.11
89.3
92 "
94.9
96.7
98.0
99.5
99.6
99.8
999
99.9
100
100
100
100
100
16.4
25.7
145
43.5
'I I
I
I
Total
1.1
.1
10
6.0
17.3
32.7
IO.S
18.5
28.2
~7 '2
46.2
~3 7
608
~8~
69(l
739
779
81.2
R4 I
86.4
82.1
885
848
90.1
91.5
92.9
87.0
9O.S
91.6
93.3
949
95.9
96.8
945
95.5
96.5
972
97.6
98.0
100
94.9
FHA
4.1
642
6"6
73.7
779
80.9
83.8
86.1
90.3
91.2
92.9
I
~o
2
65.1
76.5
R4.S
on.3
R98
714
75.3
934
95.7
973
98.4
99.6
99.7
99.7
99.8
792
99.9
IOU
96.3
97.2
97.9
98.4
98.7
98.9
100
97.8
98.2
100
100
100
100
100
100
100
203.2
157
235.0
186
160.3
149
97.4
I
VA
.1
9
47
13.5
25.2
40 I
53.0
64.5
743
81.7
87.5
91.0
939
95.8
97.5
98.6
99.6
99.8
99.9
99.9
((X)
100
100
100
100
100
MEMO
Loan amount
(rhOl«ands
of dollars)
Menn
", . . . '.
Median' ........... .
No1'l.~:
242.3
142.3
189
134
For dcfinilions of luwer- nnd higher-priced lending, see text note 7.
I. Loan amountS nre reponed under the Home Mortgage Disclosure Act to
the nonrc't S 1.000.
193.1
179
243.9
195
FHA Fedeml Housing Adminislralion.
VA Department of Veterans Affairs.
181.7
168
Federal Reserve Bulletin 0 December 2008
A 116
6. Cumulative distrihlllion of home loans. hy horrower income and hy purpose. type. and pricing of loan. 2007
Percenl
Home purchase
Upper bound of
bon'ower income
(thousands of
dollars)'
J
Conventional
Lower
priced
24 ............ , ......
49 ...................
74 ...................
99 ...................
124 .
149 ..................
199 .................
249 ........
299 ..................
More than 299 . . . .. .
.
I
2.4
24.2
48.2
65.9
774
84.1
915
94.7
Higher
priced
I
5.3
35.1
61.0
76.6
90.0
94.9
96.9
97 ~
100
<161
I
FHA
4.6
43.5
78.1
924
96.9
2.8
25.7
49.9
67.4
785
84.9
91 9
95.0
85.~
100
Total
Refinance
98.4
99 :1
99.6
997
100
965
100
I
VA
Lower
priced
Conventional
Higher
priced
I
I
I
.7
2.7
28.2
22.fi
.>3.6
66.3
87.5
95.7
98.5
998
48.2
67.4
79.4
85.9
927
95.6
96.9
100
61.9
789
87.7
92.0
961
97.6
98.4
100
3.2
25.0
51.2
69.9
81.2
87.3
93.5
96.0
97.2
100
101.3
76
80.6
63
96.8
73
H4.'
72
fiX 2
60
SO 9
99.9
100
100
5.1
Total
I
HIA
2.9
34.2
72.~
91.1
97.4
99.0
997
99.8
99.8
100
I
VA
3.6
29.4
65.8
864
95.5
98.5
99.6
99.9
99.9
100
MEMO
Borrower income.
hy selected
loun type
(lh{)usands
of dollars)'
All
Melln.
Meditm'
, ....
.............
855
IU5.5
77
598
102.8
75
62
53
683
62
M.2
59
67.7
63
HdolV the c:olI/onninK
lOll" size'!o
Mean ....
Mcdi:m' . . . . . ..
Abo," the cOllfonning
.
gS?
70.'
59
N3.6
71
298 I
210
2561
181
29,1
70
69
loall si;;e'"
Mean ..........
Median' ....
NOTE: For Inan~ with two or mufL applil.:;mt!\. HMDA-.. .·ov(;fCU Il!micc!\ (Crort
data on only (wo. Income for two applicants is reported jointly. For defiOitlons
of lower- and highel-pri~cd lending. f.,cc tl!,1 IlI)it.' 7.
I Income Ilmounts nrc repm1ed undt.·r HMDA In Ihe nCHreSf $1.000
2. By size. nil loan< backed by the FHA or VA are conforming.
J. The <:nnfmmlllg luan-~a,c limit e~t .. oh'hcd tor 010(;1 loan purcha<;C's hy
Fannie Mac and Freddie Mac IS $4 17.UOO. For more mformatlOn. see text
note 17.
7. Non-owner-occupicd lending as a share of all first liens
10 purchase one- to four-family site-buill hOllies. by
numher and dollar amount of loans, 1990-2007
Percenl
Year
IQ<)()
.
1991 . . .. . .. . . . . . .. .
1992
1993 ................
1994
1995
1996
1997
1998
1999
................
Number
66
5.6
5.2
5.1
5.7
I
Dollar amount
5.9
4.5
4.0
3.&
43
6.4
64
7.0
7.1
7.4
5.0
5.1
5.8
6.0
2004 ................
80
8.6
10.5
11.9
14.9
7.2
7.6
9.2
10:6
13.1
2005 ................
2006 ................
2007 ................
17.3
16.5
14.9
15.7
14.8
13.8
..........
................
................
................
..
2000 .
2001 ................
2002 ................
2003.
............
21~
2'91
184
20S
6.4
confonning loan-size limit increased in 2007 from
2006 and 2005. For example, the share of lower-
....
Loan~ :anovc
2
163
2' I 2
180
$.417,000, the (onlonl1tng IPan-:-tZC 1IIIl1 1
1.· ... lar.IJI~hcd
for
most loan purchascs by Fannie Mac and Freddlc Mac. arc somctlrn~s referred
It) 1:\'" junlhll 10<111'" FOI illore inr(lfn1uliun .... ee Ic'xl nple~ II and 17
Not npplicahle
FHA Federal Housing Administration.
VA DepartmC'nt
{If
VetC'J"dn~
Atlam•.
priced piggyback loans used to keep the first-lien loan
within the confonning loan-size limits increased from
8.8 percent in 2006 to 12.3 percent in 2007 (data
derived from table 8). The number of piggyback loans
sold to Fannie Mae or Freddie Mac that were used to
keep the first-lien loan within the confOlming loansize limits also increased from 2006 to 2007-by
some 63 percent-despite a sharp decline in the total
number of piggyback loans over this period. 111ese
results suggest that in 2007 relatively more bon'owers
used their piggybacks to take advantage of the lower
rates available on the first-lien portion of their piggyback arrangements than to obtain a needed source of
down payment.
In contrast, the data suggest that the use of piggyback loans as a substitute for PMI declined in 2007
from 2006. This was true of the loans sold to Fannie
Mae and Freddie Mac as well as those that potentially
were eligible for sale. The use of piggyback loans for
purposes that made the loans non-eligible for sale to
Fannie Mae and Freddie Mac also declined significantly. The decrease was most precipitous for higher-
71le 2007 HMDA Data
8. Distrihution of piggyhack
lo~n
transactions involving home purchases. hy status of first-lien Imtrl. 2004-07
Status of first-Iiell loa 11
Higher priccd
A 117
..............
I
2004
Number
105.403
I
Percent
IS 88
I
I
2005
Number
535.004
I
Percent
50.90
I
I
2006
Number
465.154
I
Percent
I
2007
Number
43.75
02.40 I
I
Percenl
10.05
Lower priced
Sold to Fannir Mae or Fn'ddie Mac
Combined with juniul'·licn loan
Total is above the conforming
lonn size .................................
4,503
.81
7.691
.73
10.154
.95
16,546
4.25
cnnfol1ning loan size ...
Not sold to Fannie Mae or FfI!tklie Mac
~~,211
989
76,804
7.31
121,H21
11.46
103.831
26.68
Abo\'e Ihe conforming loan size
62.104
11.12
60,666
5.77
57.138
5.37
32.301
8.30
Thtal is less than or equal to the
Less thun or equal to the confulming loan size
Combined with junior-lien loan
Totnl is above the confomling
lonn sin" .
Totul is less than or equal to the
conforming loan size .....
Tolal lower priced ....
Total
...........................................
40,725
729
43.734
4.16
42.704
4.02
23.761
6.11
290,602
52JJ2
327,270
31 13
366.306
34.45
150.254
38.61
453,167
558,630
81.12
100
516,165
1,051,169
4910
100
598.123
1,063,277
56.25
100
326,693
389,154
83.95
100
NOTE: In piggyhack lenthng. borrowers slInultaneously receive a first-lien
loan and u junior-licn (piggyhack) loan to purchase a home from the same
kndcr For dcfinHlon<: ot hlgh".r. and lowc..~r·prJccd lending. !,(,.'C text note 7; for
i!xplanataon 01 the conlomllng loan size established for most loan purchases by
Fannie Mac and Freddie Mac, sec nOle 3. tahlc f); for definition of jumho
loans, sec note 4. table 6.
priced first-lien loans, which fell 87 percent. This
development was consistent with, and indeed part of,
the more general mortgage market turmoil in 2007.
Piggyback lending and mortgage market difficulties.
Piggyback loans have contributed to the current mortgage market difficulties. As noted, many home purchases financed with piggyback loans were used to
minimize the cash contributions of borrowers toward
the purchase of the property. Because loan arrangements involve little borrower equity at the time of
purchase, if housing prices fall, as they have in many
arcas of the country for the past year' or so, borrowers
may find that they owe more on their combined firstand junior-lien loans than the value of the property.
Borrowers in these circumstances are much more
likely to default than those with an equity stake in the
property.21
Piggyback loan arrangements also can make it
much more difficult to work out loan difficulties
should borrowers fall behind on their loan payments.
If property values have fallen below the amount owed
on the combined loans, the junior-lien holder often
has little prospect of recovering any money if the
property is sold-either through a short sale or as a
consequence of foreclosure. If the holders of the first-
21. Sec Ronel Elul (2006). "Residential Mortgage Default." Federnl Rcselve Bank of' Philadelphia. Busitless Review (Third Quarler).
pp. 21-30; and Kerry D. Vandell (1995). "How Ruthless Is Mortgage
Default? A Review and Synlhesis of Ihe Evidence," Journal of
Housirrg Research. vol. 6 (2). pp. 245-64.
and junior-lien loans are different parties, the interests
of the two loan holders may conflict, and the juniorlien holder may have little interest in working with
the bon'ower or the holder of the first lien on a short
sale or loan modification unless the first-lien holder
provides the junior-lien holder with some financial
incentive.
Little information is available on the frequency
with which holders of first liens and junior liens
differ. The HMDA data provide an opportunity to
examine the relationships among loan holders in
piggyback loan arrangements, as the data include
infOtmation on whether or not a reported loan was
held in portfolio or sold; if the loan was sold. the data
also indicate the type of purchaser.
The analysis here divides lenders into groups based
on the type of originator. The analysis focuses on
piggyback loan transactions· in which the first- and
junior-lien loans were used to buy a property and the
dates of the loan originations occurred in the first
10 months of the calendar year. The date restriction
addresses the concern that loan sales may not be
immediate and that originations near the end of the
year that are reported in the data as retained in
portfolio may not be, as at least some of the loan sales
do not occur until the next calendar year. Because the
pattern of loan holding and sale may differ by the
credit risk embedded in the loans, the analysis is
conducted separately for home-purchase transactions
in which the first-lien loan was higher priced (table 9).
For each group. the analysis indicates the proportion of loan originations in which the lender held both
A 118
Federal Reserve Bulletin 0 December 2008
9. Distnhution of IOlVcf- and Illgh"r-pnccd lirsl-ilcll Inalls 111 plgg)'h:lClo. Inan Il<Ulsal"lwlls IllvIJlvlllg home
or lender and lien sWIlls of loan thaI lender held al year-end. 2004-07
purcha~es,
hy Iype
Percent
Type of lender
Lien stalUS of loan
thul lender held
Depository
at year-end
I
Mongage company
affiliale of
depository
I
Lowcr-pnccd first-hen loans Involved
2004
First lien and junior lien
.
Fi''S1 lien only .................................. .
Junior lien only ....... .
Neither'
Different purchaser type
Same purchaser lype ........ .
TOlal ........... .
MEMO
Percentage of piggyback
lonn originations ............... .
313
29.8
115
13.5
21.0
2.8
6.Q
205
IOU
304
100
Independent
m0l1gage
company
In
323
Total
piggyback loan transactions
10.4
5.4
35
17.2
15.4
5.8
12.7
14.4
473
100
~7.9
100
29.7
17.2
53.0
2005
Fir:;:r lien nnd junior lien
18.4
20(l
Fir.;t lien only
Junior lien only.
33.8
3.2
25.1
3.5
107
2.8
5.2
Neither'
Din'erenl purchaser lype .
Sume purchuser type ... .
Total ....................... .
I
IOU
216
17.2
4.2
66
23.2
124
18.0
100
28.2
IOU
689
32.Y
18.7
48.4
357
383
18
11.1
21.5
61
207
5_2
19
19.5
2.8
89
151
IOU
35.8
255
lOll
11.8
60.4
100
16.0
381
100
329
21 3
45.8
40.9
43.0
5
7.2
67.2
.4
19.3
11.0
1.3
28.3
3R.I
7
7.3
12.8
12.4
100
11.7
5(..7
100
9.6
23.3
IOU
IOU
12.5
445
100
MEMO
Percenlage uf piggyback
loan originations .....
IOU
2006
FI~t lit·" nnd JUnior Ikn
Fir.:;t lien onlv
Junior lien 0I1ly .
l
Neither
DHrerent purchaser iype .............. .
Sume purch:lser type .
~~~~:~...........
"'.1
I
::1
Percentage of piggyback
loan originations ' ....
Z{)07
First lien and junior tien ......... , ............ , ..
Fi~t lien ('only
Junior lien only ..... .
Neither'
""
Dill.rent purchaser type
..
Same purchaser lype ..
'rotul ." .. ,"".,., ................... , ... , .. ,',.
MEMO
Percentage of piggyback
loan originations .............. ,." ...... ,".,.
R3
100
51.9
18.7
Higher-priced first-hen loans mvolved
2004
Firsl lien and junior lien
Fir<>t Hen ()nly ..
Junior lien only .......... , .................... ,'
Neither l
Different purchaser type ...................... .
Same purchaser type ...................... .
Total ................... .
MEMO
Percentage of piggyback
loan originations .
29.4
In
23.~
100
100
piggyback loan transactIOns
6.4
34
2.2
7.2
29
1.7
11.7
75
1.5
9.5
5.7
1.7
8.4
795
IOU
42.6
457
IOU
6.3
730
IOU
12.3
70.8
IOU
28.7
149
56.3
20.7
25.1
I5
147
16.7
1.7
16.5
4.4
4.5
17.1
10.7
3.5
2.4
50.3
100
22.7
44.3
100
14.1
60.5
IOU
13.1
55.7
100
20.5
1~.2
63.3
IOU
2005
First lien and junior lien
Fir<t lien only
Junior lien only ........... .
Neither'
Dillcrenl purchaser type ...... .
Same purchaser Lype .. , .. .
Totul ................... .
MEMO
Percenlage of piggyback
loan ol'iginntions ..
. .. . . . . .I
100
711e 2007 HM DA Data
9.
Di~trihutinn of lowcr- and higher-priced first-lien l(\an~ if) piggyhack loan tr;\n'aclinn.~ invnlving home
of lender and lien slatus of loan Ihat lender held at year-end. 2004-07-Col1lil/ued
pllfcha~es,
hy type
Percent
Type of lender
Lien status of loan
that lender held
at year-end
Depository
I
Mortgage company
atllliate uf
depository
I
Independent
mortgage
company
I
Tutal
2006
Flrst hen and Junior hen ............. .
First lien only .................................. .
Junior lien only .. .
Neilhcr'
Different purchaser type
Same purchaser lype ........... .
Total .............. ..
MEMO
I'crccntag~
15 I
IU.5
98
13.9
6.4
133
17
1.7
100
51i 1
100
125
655
100
IllS
639
100
23.2
21.6
55.2
602
12 ~
t8
1\4"
28.0
2.7
4.5
9
21.5
2.6
62
672
100
111.6
?f ~iggyback
loan oflgloahllns ............................. .
2007
First lien and junior lien .. ,
Fire' lien only
Junior lien only .................. .
Neither'
Different purchaser type
Same purcho"C'r fY('<'
Tntul ..
70
t8 ~
J(X)
80
17
.7
254
5.4
too
100
52.6
80
25
4.1
32.7
59.5
100
J(XI
28.2
100
MEMO
Percentuge of piggyback
loan onglOatlons
333
38.5
Toto,1
2004
First lien and junior lien
First lien only .................. ..
Junior lien only .. .
Neither'
Din'ercnl purchaser type ... .
Same purchaser type ... .
Tntul ............................ .
27.7
12.7
186
2.7
10.6
5.7
32
16.0
139
33.6
32.4
100
11.7
687
100
141
50.8
100
296
t6.9
53.5
31.4
304
26
93.9
17.5
21 I
26
58.1
14.1
3.8
19.3
138
76.2
36.9
SO
30.7
2~
()
134
35.9
M.O
128
50.3
266
174
560
2R 3
28.3
1.5
10.5
21.5
4.5
17.4
5.8
1.8
190
15.6
2.3
7.9
339
100
24.3
3t) 2
100
12 1
62.9
100
13.5
49.5
100
28.6
21.5
49.9
432
39.4
6
24.0
49.7
8
20.7
9.6
1.8
32.4
33.0
1.0
7.3
95
100
9.2
16.3
100
10.7
572
100
8.7
24.9
100
488
220
29.2
260
102
7.2
290
1110
52
Mf.MO
Percentage of piggyback
loan originations
100
2005
First lien and junior lien ..
Firsl lien only ....... .
Juniur lien only
Neither'
Different purchaser lype
Snme purchaser type .......... .
Total ......
48
38
MEMO
Percenlage of piggy hack
loan originations ..
100
2006
F,rst hcn and JunIOr hen
Firet Ikn only
Junior lien only ..
Ncithcr'
Dirferent purchaser type ...... .
Same purchaser type .....
Total
..
... 1
MEMO
Perccntage of piggyback
loan originations ....
2007
First lien and junior lien
First lien only. ... . ... . .. . . . .
Juniur lien only .......... .
Neither'
Different purchaser type ........... .
Same purchacc( type
TOlal ......
':, :::',: :.1
100
MEMO
Percemage of piggyback
loan originations .
Non~:
For dehnltlOn 01 pIggyback lendmg. sec nute to (uble K; lor delml-
lions of lower- and higher-priced lending, see lext note 7.
1- For purchlll;;cr 'YJle~. "cc nppcnctjx A in the text
100
A 119
A 120
Federal Reserve Bullelin 0 December 2008
the first-lien loan and the piggyback loan at the end of
the year or the incidence in which the loan holders
differed. The following three lender categories are
considered: (I) depository institutions, (2) mortgage
company affiliates of depositories, and (3) independent mortgage companies. The analysis examines
loan originations from 2004 through 2007 (excluding
originations from the final two months of each year).
The analysis focuses on these four years because data
on lien status were not included in the HMDA data
for the years hefore 2004.
As mentioned earlier, the mortgage market turmoil
that deepened greatly during 2007 affected many
aspects of the market. including the market for piggyback loans. The HMDA data reflect these events.
Regarding piggyback lending patterns, relationships
found in 2004, 2005, and 2006 are in some respects
similar to, hut in others notably dilferent from, relationships found in 2007. For example, independent
mortgage companies were a significant source of
piggyhack credit until 2007. Before 2007, independent mortgage companies extended hetween 46 percent and 53 percent of the lower-priced piggyback
loans and, depending on the year, between 55 percent
and 63 percent of the higher-priced piggyback loans.
From 2004 to 2006, depository institutions accounted
for ahout 30 percent of the lower-priced piggyback
loans and about 20 percent to more than 28 percent of
the higher-priced piggyback loans. In 2007, the
depositories accounted for a much larger share of the
piggyback loans that were reported-about 52 percent of such loans that were lower priced and about
33 percent of those that were higher priced.
The HMDA data indicate that in most piggyback
loan transactions one or both loans were sold by the
lender. Overall, for loans originated in 2004, 2005, or
2006, both loans in higher-priced piggyback transactions were held in portfolio less than 20 percent of the
time. For lower-priced piggyback transactions, both
loans were held in portfolio somewhat more often.
The experience in 2007 was different, particularly
regarding piggyback transactions in which the firstlien loan was higher priced: Here, in more than
one-half of the transactions, both loans were held in
the originating institutions' portfolios. The relatively
low incidence of piggyhack loan holding for loans
originated before 2007 means that for those loan
transactions in which defaults occur, loss mitigation
prohlems are likely to be more ditlicult.
Patterns of loan holding or sale differ some by
originator. For each of the years considered, depository institutions were more likely than independent
mortgage companies to hold in portfolio both loans in
a piggyhack loan transaction. For example, in 2006,
depositories held both loans in lower-priced piggyhack transactions ahout 36 percent of the time; independent mortgage companies held both loans about
21 percent of the time. Also, in 2006. depositories
were more likely than other originators to hold in
portfolio both loans in a piggyback transaction when
the first-lien loan was higher priced. In 2007, the
likelihood of a depository's holding hoth loans in
portfolio when the first-lien loan was higher priced
increased substantially, from ahout 15 percent of the
transactions in 2006 to about 60 pcrcent. MOltgage
company affiliates of depositories also experienced a
similar substantial increase in the incidence of holding both loans in a piggyback transaction involving
higher-priced first-lien loans: The incidence rose from
10 percent in 2006 to 64 percent in 2007.
Loans Covered by HOEPA
Under HOEPA, certain types of mortgage loans that
have rates or fees above specified levels require
additional disclosures to consumers and are subject to
various restrictions on loan terms. Under the 2002
revisions to Regulation C, the expanded HMDA data
include a code to identify whether a loan is subject to
the protections of HOEPA.2~
Before the release of the 2004 data, little information was publicly available about the extent of
HOEPA-related lending or the number or types of
institutions involved in that activity.23 For 20m,
roughly 1,050 lenders reported extending about 11,500
loans covered hy HOEPA (data not shown in tahles).
Only 11 lenders made 100 or more HOEPA loans, and
most lenders did not report any such loans (data not
shown in tables). In the aggregate, HOEPA-related
lending accounts for a very small proportion of the
mortgage market: HOEPA loans made up less than
0.2 percent of all the originations of home-secured
refinancings and home-improvement loans reported
for 2007 (data derived from table 3).24
22. Thi~ reporting requirement fclal"s 10 whelher the loan is ,ubjcct
to the original protections 01 HOEPA. as detenlllned hy the coverage
test in the Federal Reserve Board's Regulation Z. 12 C.F.R. pt.
226.32(a). The required reporting is notlriggcrcu by the more recently
adopted protections for "higher-priced mortgage loans" under Regulation Z. notwithstanding that those protedi"n, were adopted under
authority given to Ihe Board by HOEPA. Sec 7) Fedel(/J R'·gi.l{a
-14522 (July )0. 200!!).
23. Although the expanded HMDA data provide important new
information. the datn do not capture all HOEPA-related lending. Some
HOEPA loans are extended hv institutions not covered hv HMDA. and
some HOEPA loans made hy HMDA-covered instit,;tions are not
reported under Regulation C. which implements HMOA. n,e extent of
HOEPA-related lending not reported under HMDA is unknown.
24. HOEPA does not apply to home-purcha;.e loans.
The 2007 HMDA Data
(~f
AI21
The 2007 HMDA Data on Loan Pricing
Incidence
The following sections assess the loan-pricing information in the 2007 HMDA data. The analysis consid-
As in earlier years, most loans reported in 2007 were
not higher priced as defined under Regulation C.
Among all the HMDA-reported loans, 18.3 percent
were higher priced in 2007, down significantly from
28.7 percent in 2006 (data for 2007 shown in table 3;
data for 2006 not shown). The incidence of higherpriced lending fell or was little changed across all
loan product categories.
A number of factors account for the decline in the
incidence of higher-priced lending as measured in the
HMDA data. After increasing mildly in the first part
of 2007, interest rates generally fell during the
remainder of 2007 and ended the year well below the
initial levels; the decrease likely contributed to the
observed decline from 2006 in the incidence of
higher-priced loans reported in 2007. Previous analyses of changing patterns in the reported incidence of
higher-priced lending from 2004 through 2005 found
that increases in short-term interest rates relative to
longer-ternl rates help explain a portion of the increase over the period in the incidence of higherpriced lending, as more higher-risk adjustable-rate
loans moved above the HMDA price-reporting thresholds.2~ From 2006 to 2007, the pattern reversed as
short-term rates fell more than longer-term rates.
which suggests that some higher-risk adjustable-rate
loans likely fell below the HMDA price-reporting
thresholds. However, given the magnitude of the
difficulties in the mortgage and housing markets, it
seems very likely that changes in lender and investor
circumstances and risk tolerances, changes in horrower conditions and preferences, and nonreporting
by certain lenders explain most of the reported decline
in the incidence of higher-priced lending. ~6
ers changes in the incidence of higher-priced lending,
APR spreads paid on loans above the price-reporting
thresholds, and a description of the institutions involved in higher-priced lending.
Factors That
Lending
"~fluence
Higher-Priced
The reported incidence of higher-priced lending under
HMDA can be affected by three broad factors (to be
explained shortly) that are related to mortgage market
conditions and the general economic environment
prevailing in a given year. In addition, the extent of
nonreporting by lenders that cease operations dUling,
or shortly after the end of, a calendar year can
influence the incidence of higher-priced lending.
The three broad, market-environment-related factors that influence the incidence of higher-pliced
lending m'e (I) changes in the interest rate environment, parlicularly changes in short-term rates relative
to longer-term rates; (2) changes in the business
practices of mortgage lenders and investors, pmticularly in the aJTay of products offered and the willingness or ability of the parties to bear credit risk (for
example. the willingness to offer loans with high
loan-to-value ratios or adjustable-rate loans with initial discounted interest rates); and (3) changes in the
bon'owing practices and perceptions of consumers
(such as changes in preferences for investment properties or in perceptions of future house price movements) or in consumers' credit-risk profiles (for
example, changes in the distribution of credit risks for
those seeking and obtaining loans).
Aside from the effects that these broad economic
factors may have on the incidence of higher-pliced
lending, changes in the number, size, and product
offerings of reporters can matter. Of particular import
for users of the HMDA data arc the effects on the
incidence of higher-priced lending of lenders that
extended loans during a portion of 2007 but ceased
operations during that year or in early 2008 and,
consequently, did not report any data to the FFIEC. In
most years, nonreporting has little effect on the
HMDA data overall or on any particular aspect of the
data. But, as discussed later, it has a significant
influence on the 2007 data because the institutions
that ceased operations were generally focused on
higher-priced loans, and some of these lenders extended large numbers of such loans in previous years.
Higher-Priced Lending
Rme Spreads for Higher-Priced Lending
Most higher-priced loans have APR spreads within
I or 2 percentage points of the HMDA reporting
thresholds. For example, for higher-priced conventional first-lien loans for owner-occupied site-built
25. See Avery. Brevoort, and Canner. "Higher-Priced Home Lending and the 2005 HMDA Data:'
26. Some oj the change In lender hehavlOr may stem from
regulatory guidance provided by the hank regulatory agencies to
banking instJIu!lons regarding their subprimc and nomradllional lending activities. See Board of Governors of the Federal Reserve
System (2007). "'Federal Financial Regulatory Agencies Issue Final
Statement on Subprime Mortgage Lending:' press release. June 29.
www.federalreserve.gov/newsevents/press!bcreg/20070629a.htm; and
Board of Governors of the Federal Reserve Syslem (2006). "Federal
I'IOanclal Regulatory AgenCIes Issue P,nal Guidance on Nontraditional Mortgage Product Risks," press release. Septemher 29.
www.feueralreserve.gov/ne w sevents/presslbcreg/20060929a.htm.
A 122
Federal Reserve Bulletin 0 December 2008
homes. two-thirds of the loans have spreads within
2 percentage points of the reporting threshold (table 3).
As in earlier years, only a relatively small proportion of first-lien loans have very large spreads7 percentage points or more. Similarly, only a relatively small proportion of junior-lien loans have
spreads of 9 percentage points or more.
sis finds that 243 of the 987 lenders reporting at least
100 higher-priced loans, or about 3 percent of all
reporting institutions, might he classified as specialists (data not shown in tahles). These specialized
lenders accounted for nearly 40 percent of all the
higher-priced lending reported in the 2007 HMDA
data.
Lenders and Higher-Priced Lending
Most institutions covered by HMDA do little or no
higher-priced lending. For 2007, 56 percent of the
8,610 reporting institutions extended fewer than 10
higher-priced loans, and 33 percent of them originated no higher-priced loans (table 10). At the other
end of the spectrum, nearly 1,000 lenders reported
making at least 100 higher-priced loans, and these
institutions accounted for 94 percent of all such loans.
The share of higher-priced lending attributable to the
10 lenders with the largest volume of higher-priced
loans dropped from 59 percent in 2005 to 35 percent
in 2006 and then to 31 percent in 2007 (data not
shown in table).
TURMOIL IN MORTGAGE MARKETS AND
COVERAGE OF THE 2007 HMDA DATA
Excluding government-backed lending, the HMDA
data for 2007 show a substantial decline in mortgage
lending activity from 2006 in all segments of the
market. These declines are apparent whether the
metric used to measure lending activity is loan applications, loan originations, loan purpose or type, or
lending categorized by loan pricing. The HMDA data
can be used to gauge the changes in lending activity
by type of lender, population group, and geographies
sorted along a number of dimensions, including
demographic characteristics or measures of housing
and mortgage market conditions.
Higher-Priced Lending Specialists
Another way to assess the higher-priced lending
market is to examine the extent to which institutions
that originate higher-pliced loans may be considered
"specialists" in that activity-that is, institutions that
have a large proportion of their lending in the higherpriced category. Such specialized institutions can
have a business orientation that is quite different from
that of other lenders. For example, many of these
institutions hold relatively few loans in portfolio and
rely greatly on their ability to sell loans to the
secondm'y market.
Taking 60 percent of loan originations as a benchmark for defining higher-priced specialists, the analy10. Higher-priced lending: Distrihution hy number of
higher-priced loans extended and by the number and
percent of HMDA reporters and higher-priced loans,
2007
Numher of
higher.poiecd
loans extended
0 .................
HMDA rcponers
Number
10-24 .............
25-49 .............
5U-99
100 or more .......
2.804
1.282
726
1.212
881
71S
987
.............
8,610
1-4 ...............
5-9 .....
1'0101
I
Percent
32.6
14.9
8.4
14.1
10.2
83
11.5
100
I
I
Higher·priced loans
Number
0
2.788
4.925
19,425
31.127
5U.742
1.798.767
1,907,774
NOTE. For Jclim\lun of hlghc.r-pnced lending. !l.cc. le.\1 note 7.
HMDA HUllle Mlll1gage Disclosure Act of IY75.
I
Percent
.0
.1
.3
1.0
1.6
2.7
94.3
The E.!Tecls
Operations
(~r
Lenders Thai Ceased
As noted earlier, an issue when using the 2007
HMDA data is that some lenders ceased operations
partway through 2007, yet none of their lending
activity is included in the 2007 data because they
did not report. As part of the HMDA data collection
effort, staff members of the Federal Reserve Board
track each financial institution that is expected to
report (including all lenders that reported data for
the previous calendar year) and contact, or attempt
to contact, those that did not submit a report. 27 In
some cases, nonreporting is due to a cessation of
business; in others, it is the result of a merger,
acquisition, or consolidation. When a merger, acquisition, or consolidation occurs, all lending by the
institutions covered by HMDA in that year is reported by the surviving entity; only when an institution goes out of business is the volume of reported
loans possibly affected. In some cases, a business
closure does not compromise the completeness of
the HMDA data because some of the closed ilistitutions report lending activity for the portion of the
year in which they extended loans.
100
27. Sometime, wllld.;ting d nnnreporting lender b impo,,;ble
because the firm has ceased operations.
AI23
The 2007 HMDA Data
Measuring the Activity of Nonreporters
The Federal Reserve's respondent tracking report
records what happened to each institution that failed
to report. For institutions that ceased operations, the
tracking report also records, to the extent possible, the
month that operations were discontinued. The tracking report indicates that 169 institutions that reported
HMDA data for 2006 ceased operations during 2007
(or the very end of 2006) and did not report lending
activity for 2007 (for a list of the institutions that
ceased operations and did not report, sec appendix
table A.I, which has been posted separately as an
Exccl file).28 Of these institutions, two were subsidiaries of banking institutions, and the remainder were
independent mortgage companies. (All other lenders
that ceased operations in 2007 either reported data for
2007 or were merged or acquired, and their 2007
lending activity was reported by the surviving entity.)
It appears impossible to know how many loans
these 169 institutions originated in 2007 before discontinuing operations. To help gauge their potential
importance, an analysis of the lending activity of
these institutions as recorded in the 2006 HMDA data
was undertaken. Specifically, the 2006 HMDA data
were reaggregated to exclude the lenders that ceased
operations and did not report in 2007. Although many
of these lenders extended relatively few loans (30 percent of the lenders. extended fewer than 250 conventional first-lien loans for site-built properties in 2006),
a few were among the nation's leading lenders in
2006. Moreover, some of these institutions were
particularly active in the higher-priced segment of the
home-purchase or refinance market. In the aggregate,
these companies accounted for nearly 15 percent of
the higher-priced conventional first-lien loans for
site-built properties repOlted in 2006, and they accounted for about 8 percent of all conventional firstIicn loans for such properties (data not shown in
tables).2'1
Time Pattern of Lending Activity
The dates of loan origination reported in the HMDA
data can be used to review the pattern of monthly loan
extensions over the course of 2006 and 2007 to help
distinguish the effects of the mortgage market turmoil
on reported loan activity from the effects of closed
lenders not reporting 2007 activity. For this analysis,
we focus on home-purchase and refinance lending for
site-built properties. The volume of home-purchase
originations peaked in June 2006 and declined over
the rest of the year {figure I). The pattern for refinancings was less consistent, as monthly originations
varied over the course of the year, with high points
reached in both March and October 2006.
Data for 2007 show a substantial falloff in activity
from December 2006. The abrupt decline from December 2006 to January 2007 is likely a result of a
combination of nonreporting by the 169 institutions
that ceased operations and the mortgage and housing
market turmoil in 2007 that caused most lenders to
reduce origination activity. Among home-purchase
loans, the greatest fallolf in reported activity was in
the higher-priced segment, in which originations
dropped some 32 percent from December 2006 to
January 2007. Overall, home-purchase \ending fell
I.
Volume of homc-purchasc and rdinance loans
uriginatcd. Highcl- and lower-priced l(liln~. and ~uch
lorin' c\cluding Iho,," origillall'd hy l'i"\cd lenders. hy
month of origination. 2006-07
HIgher priced
(thou.~nd~
Lower priced (thou~nnds of loans)
of loans)
Home purchase
ISO
-
400
-
300
-
ZOO
100 -
50
100
I I , ,
I
,
,
!
,
,
!
•
I,
,
I
,
,
I
,
t
I
I
Hlght'I' prit'ed (thousllnd... orludn ... )
Refinance
200
-
300
-
200
-
100
150
100
50
I I "
I ' , I ' , I "
2006
I ' , I ' ,
I
,
,
I
,
'
I I
2007
NOTE: The data are mnnlhly L03"~ an,," ('onv("nti()T'lal lir.. t-licn mortgages
28. The list of lenders that ,ea.,ed operation, and did not report i, "'
comprehensive as "",sIble al Ih" lIme. If addlllOnal infonnullOn
becomes availahle. the list will he updated.
29. Calculations exclude home-improvement loan, Hnd hu,ine,srelated lonns.
for site-buill pr(lpeI1ies. and exclude vU"ine'5s l('Inns Closed lenders nre
!e:,(h'r\. :~.ll rl'fx1rlCd d.,I.1 Llr 200fl t1lh!cr Ihc H(llnc M{\llga&l' J)i"dn~t1rc ACf
IHMDA) but that subsequently ceased operations and did not report HMDA
data I'm 2007. For delinllions 01 hIgher- and lower·pnced loans. sec text
note 7 .
• Excluding loans originated by closed lenders.
A 124
Federal Reserve Bullelin 0 December 2008
that most of the decline in reported lending from 2006
to 2007 was due to the effects of the market turmoil
and not nonreporting.
27 percent over this peliod. A similar pattern was
found for refinancings.
To better evaluate the effects of nonreporting on
loan volumes in the early part of 2007, the loans of
the 169 lenders that ceased operations and did not
rep0l1 were removed from the total loan volumes
reflected in the 2006 HMDA data. Excluding these
lenders reduces by about 25 percent the differences in
the level of home-purchase (and refinance) lending
reported between the end of 2006 and January 2007.
The reduction is larger for the higher-priced loan
segment (about 42 percent), a finding that reflects the
greater focus of these institutions on that segment of
the market. The fact that a large. drop in lending
activity is still observed after removing from the 2006
data the institutions that ceased operations indicates
II. Distributioll \)[
high~f-pric~d
Higher-Priced Lending by Lender Type
Lending activity can be described by type of lender.
Four groups of lenders are considered here: depository institutions and three types of mortgage
companies-namely, independents, direct subsidiaries of depository inslitutions, and affiliales of depository institutions. In 2004 and 2005. independent
mortgage companies originated about one-half of the
higher-priced conventional first-lien loans related to
site~built homes and about 30 percent of all conventional first-lien loans (table II). Depository institutions extended about one-fourth of the higher-priced
lending. by type uf lender, and
illciJ~nl'e
at cal'll type uf lender. 2004-()7
Percent except a!O noted
I
Higher·priced loans
Type of lender
Number
I
Distribution
I
IncidenCe!
I
ME~1O:
Number
All hlans
I
Disiribulion
2004
Independenl mortgage company .....
Deposilory ............... .
Subsidiary of deposilory ................. .
Affiliale of depo<itory .
TOlal ................................. .
789,337
403,661
179.375
IR7,296
1.559.669
50.6
25.9
11.5
12.0
100
IndependeOl mOIl gage company .......... .
Deposilory .......... .
Sub~idil\ry of depository ...... .
Amlinlc of deposilory
TOlal ...................... .
1.525.424
670,1J24
)81.228
357.689
2.934.365
52.0
22.8
11 ()
12.2
100
IndependeOl mOllgage company .......... .
Deposilory ......
. .................. .
Subsidiary of deposilory ................. .
Affilinle of depo<itory
TOlal.
1,280,987
800.421
346.882
377.286
2.80557t;
45.7
2R.5
12.4
13.4
100
Independenl m()flgage company .......... .
Deposilory
.... .
Subsidiary of deposilory ................ ..
Affiliale of depo<itory
Total ...
880.927
R00.421
338.758
377,286
2.397,392
36.7
33.4
14.1
100
IndependeOl mOltg!lge company .......... .
Deposilory ............................. ..
Sub~idinry of depo,itory ................ ..
Allilinle of depository .
TOlal ..................... ..
292.571
654.176
229.340
252.739
1,428,826
20.5
45.8
16.1
17.7
100
255
80
90
IR.6
14.0
3.093,777
5,017,334
1.99],212
1.006,481
11,110.804
27.8
45.2
17.9
9.1
100
3.684.489
5.217.810
1.842.652
1.157.421
11.902.372
31.0
43.8
15.5
9.7
100
3,083,947
4.2R5.896
1.517,564
996.614
9.884.021
31.2
43.4
t5.4
10.1
100
2005
41.4
128
21) 7
309
24.7
2006
41.5
18.7
22.9
37.9
2~4
201l/i (excluding loans by closed lenders)
I~
7
37.6
18.7
22.5
~7
9
26.3
25.6
2.341.193
4.285.896
1.508.231
996,614
9,131,934
16.5
11)9
100
1.453.385
4.408.656
1,158.064
622,571
7.642.676
19.0
57.7
15.2
8.1
100
46.9
2007
Non::: COllventional fil'st·licn mOltgagcs for site-built prope.11ics; excludes
hu ... inr~" ll):Jn, F(lr ddinitiun
{If
hi,!;her-pri.:eJ lending, 'ce te,.;t Iwtc 7
20.1
14.8
19.8
40.6
18.7
I. Closed lenders are lenders Ihal reported dala (or 2006 undel' Ihe Home
Mortgage DI.<;c!u:~L:te AC! (HMDA) but !h~! . . ubsclluentl) .. cased lJpel;1tiul1~ and
did not rcporl HMDA data ror 2007.
The 2007 HMDA Data
loans and about 45 percent of all loans. The HMDA
data for 2006 show that independent mortgage companies accounted for a somewhat smaller share of the
higher-priced .loan market (but a nearly equivalent
share of the entire market); In that year. these companies extended 46 percent of the higher-priced loans
and 31 percent of all loans.
As noted earlier. in 2007, turmoil in the subprime
mortgage sector caused a number of lenders to cease
operations, curtail their activities, or transfer their
business to others; all but two of the institutions that
ceased operations were independent mortgage companies. The HMDA data portray the diminished role of
independent mortgage companies in the homelending market: In 2007, these companies originated
2 I percent of the reported higher-priced loans and
19 percent of all loans.
The reduced role of the independent mortgage
companies in the 2007 HMDA data is due partly to
some of these lenders ceasing operations and partly to
a curtailment of activity among surviving institutions
of this type. Because the independent mortgage companies that ceased operations in 2007 did not report
any activity, it is impossible to determine the magnitude of their lending in 2007: To help gauge their
potential importance, the 2006 HMDA data were
re-aggregated to exclude the independent mortgage
companies that ceased operations during 2007 and
did not report. Excluding these closed institutions
reduces by some 31 percent the number of higherpriced loans originated by lenders in the independent
mortgage company category in 2006 and raises by
between about 14 percent and 17 percent the share of
higher-priced lending accounted for by the other
types of lenders in that year (data derived from
table II).
In the 2007 HMDA data, depository institutions are
the leading providers of higher-priced loans. In part,
this finding is a reflection of the sharp reduction in
lending by independent mortgage companies (both
those that continued to operate throughout 2007 and
those that closed and did not report). The increased
role of depository institutions in the higher-priced
segment of the market is not an indication Of expanded lending; the number of higher-priced loans
that depository institutions extended in 2007 was
some 18 percent below the corresponding total for
2006. Rather, the increased role of such institutions
reflects the large contraction in activity of other
institutions in this part of the market.
AI25
2006 Lending Profile of the 169 Closed
Institutions That Did Not Report
One way to learn about the activities of the institutions that ceased operations in 2007 and did not report
data is to examine the nature of their lending activities in 2006 and to compare it with the lending of the
other reporting institutions ror that year. For the
analysis, lending activities are described by a wide
range of bon-ower, location, and loan characteristics
and by local housing or mortgage market conditions
(table 12).
The analysis identifies many dift'erences between
the lending activities of the 169 institutions in 2006
and those of the other HMDA reporters. Most striking
is the much higher incidence of higher-priced lending
for the 169 institutions than for the other reporters.
This difference is revealed in the profile of lending
alTayed by either bon-ower income or by race or
ethnicity of the borrower. For all income categories,
the incidence of higher-priced lending for the 169
institutions is about double the rate for the other
HMDA reporters. Also striking is the very high
incidence of higher-priced lending for blacks (74 percent) and Hispanic whites (63 percent) among the 169
lenders. Regarding their overall lending, the 169
lenders extended a higher share of their loans to
blacks and Hispanic whites than the other HMDA
reporters, and they also extended a higher share of
loans to bon-owers in census tracts with larger fractions of minority populations or lower incomes.
In 2006, the 169 institutions tended to extend
somewhat larger loans and nearly double the share of
piggyback loans. The loans they originated also were
more likely to he for properties in the western region
of the country and in metropolitan areas that experienced greater recent declines in home values and
greater increases in mortgage delinquencies.
Changes in Lending Activity by Borrower
alld Geography
The HMDA data can be used to track changes in
mortgage market activity between 2006 and 2007.
Over this period, the mortgage market transitioned
from one characterized by a relatively high incidence
of higher-priced lending and of mortgage loan sales to
one with a substantially lower share of hoth higherpriced lending and loans sold to the secondary mar-
A 126
Federal Reserve Bulletin 0 December 2008
12. Distrihution of all loans and of lower- and higher-priced loans. Hnd incidence of lower- Hnd higher-priced Icnding. for the
I ()C) e\'''l'U Icnd"" Hnd ror ;tIl IIlh,'! knlic". hy charal'wri,lic IIf h"nll\V~r and III' Inan and by 1""Hillll or 1'1','pcrty, ::!OOI)
Percent
Closed lenders
Characteristic nnd status
Alllo"n.
I
L<lwor,pl i.ed loan.
I
i
I
All olher lenders
Highe.r-pi iced loans
i
I
All ioall'
i
I
Lv'Wer~pdt.:ed
loans
I
I
Higher-priced loans
I
Distribution Distnbution Incldence l Distribution Incidence 1 Distnbutlon Dlstnbution jlncidcncc I Distribution Incidence'
BORROWER
",eornt! ralio (ptrcent of area
tnedian)l
lo\\'el' ......................
Middle .........
'·Ugh ... , .....................
MI~~,"g'
.
.
..
TOlal ..
..
Millori/), SIOluS
12.1
90
70.5
84
100
11.2
75
70.3
111
100
45.2
407
48.6
642
48 N
12.9
104
70.8
59
100
54.8
5<) 3
51.4
35 ~
51 2
14.5
10.6
69.0
59
100
14.4
104
69.3
60
100
72.7
71.8
73.6
747
731
100
27.3
282
26.4
25.3
26.7
227
97
14.6
4.5
712
100
65
12.5
5.1
76.0
100
49.3
63.0
83.4
78.9
73.9
189
20.7
29
575
100
50.7
37.0
166
21.1
26.1
24 S
232
30.7
46.0
100
689
68.4
80.2
73.5
29.1
39.4
31.5
100
31.1
31.6
19.8
26.5
17.8
5
63.fj
28.0
4('4
25 h
100
36.4
25.8
217
26.7
14.9
11.2
68.3
56
4
Black 01' African American ...
Hi .. ponh.' white .
..
Aslan.
Non-Hispanic white ......
TOUlI' ....................
16.7
22.1
43
569
100
Sex
Single female
Single mule .............
Joint female and male" ......
TOlal' ....................
9~
675
100
261
361>
55 I
54.1
45.6
35
48.0
100
73.9
634
449
45.9
54.4
31 I
40.0
28.8
100
277
31>.7
35.7
100
40.4
41.7
56.3
455
340
42.9
23.1
100
59 Ii
583
43.7
54.5
33.0
42.2
100
153
490
357
100
8.7
,04
40.9
100
263
473
527
460
208
479
31 3
100
73.7
"27
473
540
20.5
480
115
100
100
742
7H1
73.3
O",ner-occupauC')' Sla/US
O,,'ncr ............
Non-owner' ................ :
...
TOlal'
85 I
14.9
100
85 I
14.9
100
460
45.9
460
850
15.0
100
540
54.1
540
862
13.8
100
81i.3
13.7
100
73.4
73.2
733
86.2
13.8
lOll
2~ 6
26.8
2f07
Type 01 property
1-4 family sile-buill .......
Manufaclured home ....
TOlal' ..........
991
7
100
54 I
26.2
54.0
98.0
100
459
73R
460
998
2
100
9R 6
14
100
73 R
499
73.3
962
3.8
100
21i 2
50.1
26.7
Piggyback sratus
Piggyback"
NOI piggyback ..............
TOlal' ........
232
76.8
100
198
80.2
\00
393
48.0
46.0
26 I
739
100
61).7
520
54.0
12.7
103
~7.3
100
897
100
59.3
754
73.3
19.5
Sf) 5
100
40.7
24.6
26.7
18.9
208
19.5
183
103
12.1
398
100
46.9
39.S
3~ 5
43.2
522
45.3
18.3
229
155
13.1
30.2
100
53.1
60.2
22.6
212
164
13.2
26.6
100
74.9
706
20.8
24,4
56.8
47.8
'4.7
22.1
221
11i7
13.7
25.5
100
70.6
76.7
73.3
17.5
15.1
22.3
Ion
25.1
29.4
28.0
29.4
23.3
26.7
180
31.7
44.4
570
45.2
29.3
49.9
209
100
6(\ 3
55.6
43.0
54.8
179
50.9
31.2
100
147
5().2
35.1'
100
(\04
72.2
82.6
73.3
21i 5
53.1
2004
100
39.6
27.8
17.4
26.7
178
52
25.R
LOAN
Ammmi of 10011 (Ihollsands
t..ess Ihan
dollars)
100 .......
100-249 ..........
250 or more ........
Total'''!
,
.. ,
........
99
n
4
20
100
4~
3n
LOCATION OP PROPERTY.
BY FREDUIE MAC REmON\}
NortheuSI ...................
Soulheasl
North Central ..
Soulhwest.
.. . ........
\Vest
' , ..
.. , ....
Talui; .................
nl
12.7
345
100
M~
720
CENSUS TRACT OF PROPERTY
IlIcom~
J'alio
m~d;(lIJ)1U
(pcrc~nl
of a"1J
Lower ... ..........
Middle ................. ...
Hi~~L~i';·::::::::::: ...... ..
,
24.2
49.2
266
100
4H.4
336
100
ket. As noted, a comparison of lending activity in
thcsc two ycars is complicated by an unden'cporting
of loans in 2007 because some lenders went out of
business during the year and did not report HMDA
data. Most of the lenders that did not report data for
2007 cxited the market by the middle of that year, and
therefore underreporting of data is much less likely to
be a problem for the last half of the year. Conse-
quently, to reduce the unceltain effects of unden'eporting, wc comparc mortgagc market activity in the first
six months of 2006 with that in the last six months of
2007.
The comparison focuses primarily on the changes
in the number of originated loans, although changes
in the number of applications and of denials are also
examined. Comparisons of loan originations are made
The 2007 HMDA Data
Al27
12. Distrihution of all loans and I)f lower- and higher-priced loans, and incidence of 10\\lcr- and higher-priced lending, for the
169 closed lenders and for all other lenders, hy characteristic of borrower and of loan and hy locat.ion of property.
2006-Colllillued
Percent
Closed lenders
CharBctcri.c:tic alld
.c:tnlu~
All loans
J
Distnbuuon
Racial or ethnic composition
(minorilies as a percent of
I' ol'u/mion)
Less than 10 .............
10-50 .............
50 or more .......
Total'
22.0
485
.I
Tt)tal~
..........
IDi~tnbutiun Ilo~IJcnl:e
I
All other tenders
Higher~priccd
lO(lm";.
All 10al1s
iDl:,lnbutwn Ilncldt:nce
I
I
Lnwer-priced loan"
I
44.3
3~ I
11K)
510
50.1
65.3
100
3~ 4
47.9
197
100
34.5
49.2
16.3
100
7RO
75.3
UK)
49.0
499
34.7
452
173
32.8
49.9
IIX)
9R
30.0
60.1
100
ZAO
42.t
55.5
46.11
237
35.2
41.1
1011
74.n
57.9
44.5
54.!)
1:\ 9
30.6
55.5
100
10.2
28.5
<;46
33R
11.6
100
55.9
32.4
46.4
436
45.7
45.4
5H
516
11.7
100
349
tt.6
100
56.4
54.3
54.6
273
43.0
29.7
100
442
43.3
49.5
45.2
285
46.5
25.1
100
55.8
56.7
50.5
54.8
205
I
Higher-priced loans
I
I
Dl:HnbutJtln Dl!)trioutlUn jlncldcnce 1 DI:-.hibuliun Incidence 1
23.9
535
226
100
2Q.~
C"dit scnrf of hormw~rs
(percelll of morrgag~
bO'1YJwer.~ Wilh scort'S
below 600)11
20 or more .....
10-20.
Less than 10 ................
I
Lower-priced loans
26.7
44.3
2~ 9
100
22.0
24.7
39.2
26.7
53.7
68.4
81.0
100
n:t
24.1
36.3
39.6
1011
40.3
31.6
19.0
26.7
443
41.9
13.8
100
444
41.8
t3.8
100
73 h
73.5
74.0
73.6
44.3
42.1
t3.6
100
264
26.5
26.0
26.4
370
42.9
20.1
100
36.7
42.4
20.9
100
72.7
72.3
76.4
73.3
37.8
44.5
17.8
100
27.3
27.7
23.6
26.7
61.3
!iO.~
73.3
MSA OP PROP~RTY
R~ClI
price apprec:iatiou of
~aJ estate (percent) 12
-8 nr
Ie."~
-8-0 .............
...................
o or more
Toral~
....................
Chlll1ge ;n cJelinquincy ratt!
W5~~nl~;~
.
279
0.5-2 .......................
2 or more ...................
TOlnl!'i ....................
44.9
27.2
100
NOTE: Conventional Jl~t·lien ml.lng.!t;c,," [or hnmc purr.:n.l\'c nf r~lln.mi.-t·
jill
~ine:k·fumil)· t.llU~CS.
c:\dudcs blJ~im:~:. IlI.Ir.!>. Fll[ Jefinili\ln \,If du.\ed It!nJcrs.
sce note I. table II: for definition, of lower- and higher-priced lending, sce
7.
1. DlstnbullOn sums horizontally.
2. Aorrowcr income is the totlll income relied upon by the lender 10 the loan
underwriting. Income is cxprcs~~d rciative to thl.! ml.!dian family income of the
metropolitnll slatisticni area tMSA) or statewide non-MSA in which [he ProPT
erlY heing purchased is located "L(lwe-r" i~ lee: .. thnn gO percenf of the median:
"middle" i!'o NO pcrcrnt (0119 flt!leel'll; and "high" is 120 reu.:ent or mon'
3. Infomlation for income or propcrty locntion was missing on the
applicntion.
text note
·t Clllcgonc... fur race lind t:lhnh.lly ft.:lll,t"1 Ihe rl'~'I"cd ('l.md;lrd ... L"lnhli,hl:d
in 1997 by lhc OIlIL:c 01 ~h.tnagcll1cnl ano Budget. Apphcanl~ an: plac~~d under
only one cnlcgory 1'01 ral..c dud ":'llHH~iI)'. gcnclally «\.\o..OldlOg to the race 1)110
crhnicllY t)1 Ill.: pCI:-,on II'-Icd 111"(
:hl' flPpl+CaflllO f{fl ..... CVCf. untl!!1 HH.C. Ihe
Oil\..' oppliC;.lnl rcp0rtcd the ~i"gle l1c"igna~
Oil
application I:" dC'lgnatcJ a~ jlmJl II'
tit.. n of IJohilc find the othel repl..lrlcU une or mOle Inlnonl), races. It the appllcD.
Hun I.'" nut .Ill!!:! bL:! mure lh ... n one f<l.:e. 1\ l~pj\lt~d. Iht" 1(111I\\... ln& dC"-Ign,1111\11'"
ure Ill~h.k Ir "'( ic",,,' IV-II IliinorilY f.lH· ... ,Ht.' l"'Ill,"ed, the .lrrh . . <tlion j, dC"lg.
nafed as f\l"O or mo,.~ minor;,." mrn: if Ihe firs.t pcr~(\n listed on an applicatIon
reports rwo rutcs. J.nl.! ~lr.e. 1:-. whIle. Jb~ :JppltL.t!iJln I.'" ....I!Cgilll7.cd under the minority rue\!. For 10<111 . . v.illl /'W() (lj !)Hln.; l.lprii~ •.m(". )..:nJt:r . . \o..ovcrcu und...:r till'
Ilome Mortgage Oi~cloe:urt" Al't report dDt:'! 0n 0nly {WO
5. Excludes loan.c: fnr whl ...·h the mfonnntlOn *01' (h~ characlcnI:t!c wn~ "w.e:ing on the uppli .. ..ltiu:1 ... r.J lUJ.Ds dcr.:m:;J bU:-'lnc~" lelated ur :1lulllfo.lffili),.
for both lower-priced and higher-priced loans. Within
the category of higher-priced loans, differentiation is
made by the size of the reported APR spread. Loans
for home purchase and for refinancing are examined
separately, and the analysis is restricted to first-lien
loans secured by a site-built property. Unlike some of
6. On the uppJII.. J.lh1n, lor 'he~\! IlJullil. one dppht.dnt reponed "male," and
(he llth~r [cported "fcm.\lc." For fem.tk. and fUi malt:.. ~mly sole applk,lOb
were conSIdered. Exclude~ loane: for which ~C)( wa~ mis~ing on Ihe application
and loans involving two females or two males.
7. Inclutlc..~ lOans I'm which Ut...~upanf".:)' :-.latu~ WUil mbsing.
K. ~or detlnlllOn ot pIggyback lending. sec note to table 8.
9 Fn.'ddi<..· Mac define\; 1(e: rt.'gio", a~ follow~: Nnrtlwott· N Y, N J , Pn,
Del, Md. 0 C, Va. \V.V. PR Maine, N I-l. Vt, Md';', , }{ I, Conn, VI,
esc, Tenr: , K\', Ga , ALl, Fl.,., Mi"~ , Nnrrh C(:nrra! Ohin.
Ind, ill, MIch. W". Mum Il~wa. j\; n, S j), S,"uII,WI'H TI!\;'I:o., Li.I, N M .•
Okl;,. Ark., Mo, Kfln. Cillo. Neh ""yo: Wert· Ci\lif, Art?, Nev" Orc ..
\Vne:h , Utah, I<bhQ, Mont. Hnwrdi. Alaska. Guam
SOfl,'ua.n· N
10 The
incoml' cat<..'g('1ry 0t
u c..;cn:-.u'" !ruel
IS
the mccilan family Income
Of
th<..·. tract relatrvc to that at the metropolitan statIstical area (MSA 1 or stat\!wlde
nOfl-MSA in whil..:"h the llnet ie:·lnl..':lIcrl. "Lower" ie: Ie"\) than 80 perccnt of the
m~dtdn. "nlilittle' I~ im per.:enl 10 119 perJ.:cnt: ;jnd 'hlgh'" IS 120 percenl or
more.
II Duta from Ellllltax 11I'Dwn from crcdJl records 0' IIldlvldunls us 01 Dc·
~~~mher 1.1.201.16 A ....... ole lteltlW (100 gent<Hllly (Olltlllm ... wuh Iwnuweo. In Ihe
o;.uhp"'lJt' ptlfjlOn (If Ihe lIlongagt:' mark-l'l Indudc~ all h~lrrllwcrs wuh an oulstanding mOl1gagc regardless of the year in which the loan was taken oul.
12. Huu!'olng prll.:c index Jrom Ihc OI1i"c \jf Fcdelo.ll Hpw.lng F.nlerplbe
(hcr~igh( Htlu"l,.; prl!"''': dl;:1.ngl.!~ ~<1kulilt\!d u:-'Ing lill:' pcC,"CIII change In th~' Inde'( from the fourth qu::trtCl' of 2006 thro~:£:11 the firs: qU:U1cr of 2008. Dascd on
ITlcdJan h("llTIC valucs lor a comtanl 2000-dehncd geography.
Irum Trcno Dd(U, .t proJud of Tliln:-.Unron LLC. The
change in (he m0l1gage delinquency rilte is calculdted using ddinqut'.ncy rates
from the fourth quarter 1.11' 2003 to lhe f0U11h quancr of 2007.
(he
change
U.
In
Dclinyut.:n~)' rdtc~
the earlier analyses, we do not differentiate between
government-backed and conventional loans. Changes
in the number of loan originations are examined by
bon-ower race or ethnicity. bon'ower income, censustract income, and owner-occupancy status of the
property securing the loan.
A 128
Federal Reserve Bulletin 0 December 2008
[he nllmher of 103n 3rrlica[inn~. d~'ninl,. and originatinn,. and change in [he numher of lower- and high<!rpriced originaliolls. for all loans and for jumbo loan,;. hy (;haradcri,lk ,)f hOl'lowcr and uf census Iran.
2006:H I through 2007:H2
D. Change in
A. Home purchase
Pcrcenl
Applications
Loans originated
Higher priced
Dlslnbullon. by percentage
points of APR s read I
Characteristic
of bOITower and
of census tract. by
owner-occupancy
stants of proper!)'
Number
acted Number
upon by denied
lender
All
Lower
priced
All
5 or
3-3.99
4-4.99
. more
Jumbo
Applications
Number
actcd Number
upon by denied
lender
All
Lower
priced
Highcr
priced
OWNER OCCUPIED
BORROWER
Mlnorit),
S!1IIUS
2
-31.9
--42.1
-23 I
-20 I
-27.5
-25.7
-30.7
-20.7
-180
-292
-35.2
-48.8
-262
-218
-263
-2.3
-26.8
-15 }
-143
-98
--694
-75.7
-73.4
--600
-71.1
11.2
-25.0
-24.7
-114
-11.2
--46.7
--66.4
-712
--476
-560
-890
-94.0
-93.1
-885
-91.1
-17.1
-57.3
-35.9
-31.7
-3t' 5
-107
-32.5
-26.9
-12 I
-190
-572
-72.8
-434
--402
-388
-1'17
-65.1
-362
-37.1
-312
-74.5
-83.1
-75.6
-623
-71.4
-30.8
-24.6
-14.0
-19.8
-22.9
-30.3
-217
-120
-20.3
-24.1
-30.0
-273
-16.4
-20.3
-22.6
5.2
-4.7
..(,.0
-11.7
-9.2
--65.7
--6(15
-Ii 1.6
-546
-59.2
437
-\.2
61
13.7
15.4
-328
-44 6
_54!>
-35.8
-380
-880
_90.6
-'IO!>
-88.8
-88.9
-150
-10.9
-165
-20.7
-26.9
-7,4
-12.2
_105
1.9
-1:1.3
-259
-702
-537
-38.6
-42.6
0
--65.0
-34.9
-37.8
-875
-82.4
-500
--63.3
-70.0
-295
-369
-17.5
-20.0
-23.6
-247
-288
-14.7
-197
-23.2
-318
-421
-21l.2
-21 I
-24.7
77
-644
-703
-75.1
-71.0
-67.9
289
-6.4
-11
6
3.0
-47.0
-64 0
-li89
-497
.-S4.0
-900
-94.7
-934
-<10 I
-91.3
-14 1
-13 I
-88
-122
-10.1
-2H
-338
-31.7
28
-29.6
-II 7
-129
-IS.S
-292
-58.3
-3S.6
-420
-40.9
-141i
-468
-31.4
--406
-36.1
-556
-80.5
-80.3
-56.9
-68.2
-31.8
-488
-23.6
-16.9
-21.9
-li1.6
-10.3
_154
-23 9
-12.9
-217
-364
-38.7
-573
-270
-19.6
-266
-68.4
--69
-35.8
-15.8
-13.3
-146
-67.7
-72.9
-81.5
-61.2
-71 3
-703
-.3
-297
-239
-15.7
-17.6
-70.2
-57.5
-75 I
-759
-51.\
--6L9
--64.8
-947
-936
-87.0
-90.9
-80.7
-38 I
-577
-34.6
-30.7
-35.9
-51.2
-13.4
-34.:1
-27.9
-12.5
-20.6
-2.9
-57.2
-72.9
-420
-39.1
-44.9
-64.3
-36.6
-64 3
-34.4
-36.1
-37.7
-64.6
-7M
-83.9
-75.7
-62.3
-73.6
--63.6
Lower ........................
Middle .......................
High
-32.9
-24.8
-248
-29.5
-22.6
-IR 5
-26.2
-27.2
-27.1
-13.2
-13.2
-16.3
-70.0
-liS.8
-66.7
-8.1
-10.3
-20.4
-53.9
-52.7
-57.7
-90.8
-90.3
-90.0
-36.8
-37.2
-36.4
-19.3
-19.3
-19.8
-46.S
-47.0
-45.5
-38.8
-40.0
-38.8
-73.0
-72.9
-72.8
. . .. . .. ..
-25.2
-23.4
-26.9
-14.4
-67.1
-12.4
-54.1
-90.4
-36.6
-19.5
-45.9
-39.0
-72.9
NON-OWNER OCCUPIED7
TOlal ..............
-382
-292
-41.5
-32.6
-64.5
-52.0
-57.1
-86.1
-37.5
-25.3
-44.5
-40.2
-64.7
Total .........................
-27.4
-24.4
-29.3
-17.3
-66.6
-25.7
-54.7
-89.9
-36.7
-20.2
-45.7
-39.2
-71.9
Black or African American ....
Hi~panic white ...............
Other minority) ....
.
Non-Hi':}',"ic white ......
Missing
........ , .........
Minori!)' status, by income
ratf.Ror.~15
Luwer
Black or African Amclican .
Hispanic,
wh.ite.~
...
Other minority' ........
Non-Hispanic white ........
TOlal ....................
Middle
Black or Afdenn Am\!rican
Hispnnic white ....
Other minority~ ............
Non-Hispanic white
TOlal ....................
High
Blnck or Arrican Amelican ..
Hispanic white ....
Other minority:\ ..
Non-Hispanic white
TOlal
.......
Missing4
CENSUS
-77 I
-89.~
-444
-51 II
TRACt· OP Pl!OI'ERTY
IIICOI1l~ raltgory6
Total owner occupied
Non::: Convcnllnnoti ilr-..t·ilt·n mllI1E.Jbc~ Itlr ~llt.".bul;! PII)Pl'111l", c\dUUt;<;'
!ui.ln,., .1;~J nppli ... .!tiuo,.,. appli;;.llivlb in U S 1(,lfil,lne~, an . .! .1pph~iHlun.;,
mi5~ing cel\w'·'ract infornHlIlon For denm'lC'n'\ of iower· and hlgher-pnced
lending. sec tc:(1 note 7: for dcfinilinn nfjumhn Inane;. ~cc note 4, l::Jhlc n
1. S~C nole I. Hlble J.
husine~,)
2. Sec nOlc 4. tnhlc 12.
Changes in Lending Activity by Characteristic of
Borrower and Census Tract
All borrower and census-tract groups, whether characterized by race or ethnicity, income, or owneroccupancy status, experienced a decline in the number
of loan originations for home purchase and for refinancing (tables l3.A and 13.B, column 3). The percentage decline in loan originations was largest for
.1 ULlI.'T m1!1Urll),
Ndllve Hav..lu,m
1.11'
"l)J1;"I!'t:'l
III AmCrll"dn l:H.!.'J.Il
U; t\la!'>k.~1
.'JallvC. A:'IIJIl.
and
olher Pacific Islander.
4, Inf(lrmntJ<'ln ({"of the charactenstlc was
~ Scc nnte 2 table 12
6. Sec nole 10. lable 12.
mJs~lng
on the application.
t
7
'ncluci('(. "rr1icn"nnc nnct Innne tor whIch oc("ur:'ln(,'y 'Iatue
WrlC
ITw;:cdng
Hispanic whites and for blacks. For example. homepurchase loans to Hispanic white and black bon'owers
fell 49 percent and 35 percent respectively. while sllch
loans to non-Hispanic white borrowers fell 22 percent
over the same period. Even when changes for borrowers of similar income levels are compared, differences
across racial or ethnic groups are found. However, the
overall differences across income classes, whether
The 2007 HMDA Data
1."\.
AI29
Change III the numher or" Inan applicatIOns, denials, and originatIons. and change in the numher of lower- and higherpriccd origill,llions, fur all lo,1Il~ ,1m! for jumho loans, by cilar,ldcrislic of hurrowcI and of n~llSU' Iract.
·2{){)fi:HI Ihrough 2007:H2-Co/lliflued
B.
Refinance
P\!rCCIH
Applicalions
Loans originated
Higher pliced
Distrihuliun. hy percenlnge
points of APR spread 1
Characterislic
of borrower and
of census lI'Dct. by
owner-occupancy
stnlus of property
Number
acted Number
upon by denied
lender
All
Lower
priced
All
5 or
Jumbo
Applications
Numhe
aCled Number
upon by denic'tl
lender
All
LO\\o'cr
priced
Higher
priced
15.0
26.5
162
11.1
-9.8
-61.8
-58.9
-49 I
-49.6
-47.3
-57.2
-55.2
-45.2
-48.4
-44.4
-68.6
-67.4
-fiM
-55.7
-57.0
6.2
203
2:n
-4.6
-4.9
19.1
42.4
4.5
5 I
-60.8
-54.2
-50.0
-27.0
-382
-32.0
-39.2
--49.0
-17.6
-28.0
-88.5
-90,5
-556
-63.9
-71.6
-9.3
-12.8
_111
-26.0
37.9
40.8
35 0
37
7.3
--69.8
-63.7
-54.8
-67 ~
-64.9
-58.7
-55.7
-49.4
-6'2 :2
-58.3
-80.9
-84.2
-81.5
-N37
-82.3
-276
-24.0
-24.1
-27.7
-2/\ 1
-3,1
130
23.2
13.8
12.1
97
.8
-fi2.0
-48.5
-49.0
-50.4
-,2.3
-57.9
-55 I
-44.4
-47.7
-47.9
-53.9
-fi7.9
-67.3
-66.0
-55.2
-60.n
-44.2
3-3.99
4-4.99
-59.0
-63.4
-fiO R
-51.9
-62.5
-23.8
-17.9
-256'
-20.3
-19.5
-51.6
-552
-512
-42.9
-57.4
-71.8
-81.9
-795
-71.2
-79.5
-25.3
-22.1
-232
-28.2
-27.0
-61.1
--66 0
-55.3
-58.0
-515
-47:5
-522
-72.6
-82.6
-750
-72.3
-747
-518
-59.1'
-49 I
-72 3
-82.4
-7R 5
-717
-74 q
more
OWNER OCCUPIED
BORRO"'F.R
AfiliorilY status '2
Black or African American ....
Hispani~ wh,itc\ ...............
Other mmonly' ..............
Non-HiTanic while ...........
Missing .......... _....... _..
-18.3
-15.7
-122
-15.6
-29.4
-.1
19.1
14.6
-3.8
-28.8
-37.4
-40.6
-24.4
-33.1
-2.\.6
-16'2
_11<1
-2<11\
-266
-11.4
40
-16
-194
-216
-39.3
-355
-272
-29.9
-127
-14 <;
-140
-10.5
-160
-17.N
91
24.5
16_7
-3.3
-4.1
-31\ 5
-39.5
-30.1
-25.3
-29.5
-105
-115
-99
-6.1
-96
-408
191
29 I
25.0
15.0
110
-30.Q
-16.0
-2M
-22 3
-15.5
-16.8
Mmorlly ..slaws, by Income
cmtgory'
Lower
Blnck or Afncan American ..
Hispanic White.
Othcr minorityJ
Non-Hispanic while ....
Total
Middle
Black or African American.
Hispanic white
Olhcr minority' ............
Non-Hi<:.pnnic while
Totu! ...
High
Black or African American.
Hispanic whire ..
Other minOlity·l
Non-I{i~panic white
Total
I
Missing'"
-32H
-11.~
--60~
-18.7
-169
-548
-589
-25.9
-22.fi
_.~4 2
-22.8
-240
-II 7
-23.8
-19.8
-144
-15.5
-590
-65.8
-61.2
-5<13
-5N 5
-210
-16.9
-25.4
-219
-215
-31"
-419
-30.6
-18.4
-24 I
-44 <;
-219
-:129
-23.0
-11.3
-15 I
-42.7
-55.3
-609
--61.1
-47.0
-52.7
-542
_1114
-77
-17.9
-10.1
-101
-544
--44 7
-,01
-51.5
-35.2
-411\
-503
-705
-814
-81.8
-70.0
-742
-57.3
-59.3
-51.4
--467
-48.3
-74.8
-73.0
-77.8
-25.7
-264
-26.3
to. I
8.9
8.7
-51.5
-51.7
-50.7
-49.9
-49.3
-48.0
-59.1
-60.9
--61.0
-26.4
90
-51.1
-48.5
-6Q.r,
-9.K
-14.3
--4~
1
-507
-~~
:'i
10.~
-588
CENSUS TRACT OF PROI'ERTY
IlIcom~ (.'{lfcgOT),6
Lower ........ _...............
Middle ...........
High ..
TOlal owner occupied
....
NON-OWNER OCCUPIED?
Total ....
Total ...........
-23.2
-17'1
-15 <I
-10.6
-75
-1.1
-29.0
-28 'I
-28.8
-21.0
-15.'1
-178
-55 I
-51i.8
-22.0
-212
-17.1i
-18.3
-68
-288
-t73
-51\ 5
-206
--48.2
-74.4
-78
23.9
-230
-83
-605
-37.4
-49<)
-813
-19.1
!62
-400
-32.8
-6".2
-17.4
-4.8
-28.2
-16.4
-56_9
.,.22.9
-48.3
-75.0
-25_8
9.5
-50_1
-47_2
--61.1
NOTE: See nutes to rable 13.A.
measured by the bon-ower's income or the median
income for the census tract, are much smaller than the
differences across racial or ethnic groups. There are
two notable exceptions: (I) The number of refinance
loans to high-income borrowers declined less than the
number to middle- or lower-income borrowers, and
(2) lending to borrowers with missing income declined
much more than that to borrowers whose income was
reported. Loans to borrowers with non reported income
may include a disproportionate share of stated-income
or no-documentation loans. two products that experienced a sharp decline in 2007.
Most of the reduction in loan volume appears to be
driven by declines in the number of applications_ A
pOltion of the decline in loan originations is also
accounted for by a modest increase in denial rates.
The increase in' the denial rate is due to a smaller
reduction in the number of denials (tables 13.A and
13.B, column 2) than in the number of applications
(column I).
A 130
Federal Reserve Bullelin 0 December 2008
The falloff in loan volumes differed substantially
across loan-pricing categories. For example, the number of home-purchase. loans with APR spreads of
5 percentage points or above declined almost 90 percent, whereas the number of lower-priced homepurchase loans declined only 17 percent. Differences
in declines across pricing categories appear to explain
at least a p0l1ion of the racial differences described
earlier. For example, when comparisons are made for
borrowers within each of the 12 combinations of
borrower income and loan-pricing categories, the
decline in home-purchase lending to blacks was
lower than the decline in such lending to nonHispanic whites in 10 of the 12 cases. Thus, the much
larger overall decline in lending to blacks must be
driven by the fact that blacks in 2006 were disproportionately in loan-pricing categories that experienced
very large rates of decline. This pattern was less
evident for refinance loans: Black borrowers tended
to have greater declines than non-Hispanic whites,
even when the comparison was made for bon'owers
of the same bon'ower income and loan-pricing category. However, these within-category differences
were much smaller than the overall racial differences
between black and non-Hispanic white borrowers.
Generally, the large differences in the rates of decline
in lending to Hispanic whites and non-Hispanic
whites persisted across the loan-pricing categories.
These differences appear to have been driven primarily by geography. For example, the rate of decline in
higher-priced home-purchase lending to Hispanic
whites was 15 percentage points greater than the
decrease in such lending to non-Hispanic whites.
More than two-thirds of this difference can be attributed to differences in the distribution of Hispanic
whites and non-Hispanic whites across MSAs (data
not shown in tables). This finding suggests that the
higher rates of decline in lending to Hispanic whites
can be attributed primarily to a higher proportion of
Hispanic white borrowers in MSAs where lending
has declined the most.
The recent mortgage market turmoil has raised
concerns about the condition of the market for loans
above the conforming loan-size limit established by
Fannie Mae and Freddie Mac (jumbo loans). The
2006 and 2007 HMDA data provide an opportunity to
profile changes in this market segment. The number
of jumbo loan originations declined from the first half
of 2006 to the last half of 2007 by a larger percentage
than overall lending (46 percent compared with
29 percent), and it did so for every demographic
category. Further, for both lower-priced and higherpriced loan categories, declines in loan originations
were greater for jumho loans than for overall lending.
The difference was particularly large for lower-priced
loans. For example, jumbo 10wer-pJiced refinance
loans fell by almost one-half, while overall lowerpriced refinance loans declined 16 percent.
Changes in Lending by Type of Lender
Changes in the number of loan originations differ
substantially across types of lenders (tables l4.A and
14.B). For example, the number of higher-priced
refinance loans originated by independent mortgage
companies declined 85 percent between the first half
of 2006 and the last half of 2007. In contrast. the
number of such loans OIiginated by depository institutions within their assessment areas actually rose
8 percenl over the same peJiod.}O These ditferences
are indicative of depository institutions' larger market
shares (in total lending and higher-priced lending) in
their assessment areas. However, the data in these
tables show that the shift in market share from
independent mortgage companies to depositories in
their assessment areas has had very different patterns
across racial or ethnic groups. For example. depository institutions experienced an increase in their
volume of lower-priced home-purchase lending to
black borrowers in their assessment areas by about
one-fifth for each income category. In contrast, lowerpriced home-purchase lending by depositories 10 nOI1Hispanic white borrowers in their assessment areas
fell for each income class. Similar differences are
shown for higher-priced loans. Overall, higher-priced
home-purchase lending by depository institutions in
their assessment areas fell 17 percent, whereas higherpriced lending to black borrowers fell only 3 percent.
Another way of looking at differences in loan
originations across types of lenders is to examine how
the changes differed across geographies that were
predominantly served by specific lender types in 2006
(tables 15.A and 15.B). Here we identify those census
tracts where 50 percent or more of the loans in 2006
were originated by ( I) independent mortgage companies, (2) depository institutions in their assessment
areas. or (3) lenders that went out of business during
2007 (this group includes the 169 lenders that did 110t
30. Larger commercial banks and savings associalions covered by
the Community Reinvestment Act of 1977 (CRA)-genel'ally those
wilh asselS of $1 billion or more-are required to identify the census
tracts in their CRA assessment areas as of the end of each calendar
year. That infonnation was used to determine which loans in the
HMDA data were for propertIes wlthm the lenders' CRA assessment
areas. When lenders were part of a hank or thrift holding company. Ihe
combined a"es,ment area, of all banks in the holding company were
used for the analysis.
The 2007 HMDA Data
report HMDA data for 2007 as well as those lenders
that went out of business and either reported 2007
HMDA data or were merged or acquired).
Higher-priced home-purchase or refinance lending
declined more than the overall market in census tracts
that in 2006 were primarily served by lenders that
went out of business by 2007. This was also true for
census tracts that had been heavily served by independent mortgage companies. In contrast. the decline in
higher-priced lending in census tracts that were primarily served by depository institutions in their
assessment areas was smaller than the declines in
other census tracts. Patterns for lower-priced loans
are less consistent. For example. the number of
lower-priced home-purchase loans in census tracts
that in 2006 were primarily served by lenders that
went out of business in 2007 declined less than the
number of such loans extended to borrowers in other
census tracts. In contrast. the number of lower-priced
refinance loans in census tracts that were primarily
served by lenders that went out of business in 2007
declined at a higher rate than the number of these
loans in other census tracts.
Differences in the rates of decline across racial or
ethnic groups for these census tracts characterized by
concentrated lending are sometimes quite large. For
example. higher-priced home-purchase loans to black
borrowers in census tracts primarily served by lenders
that went out of business declined 70 percent between
the first half of 2006 and the last half of 2007. In
contrast. higher-priced home-purchase loans to nonHispanic whites declined 53 percent over the same
period. Interestingly, the number of lower-priced
home-purchase loans to black borrowers in these
census tracts increased 7 percent, while the number
extended to non-Hispanic whites in the tracts decreased 3 percent.
We also look at census tracts concentrated by
factors other than lender type. Specifically, we examine census tracts of two types: (I) those where 50
percent or more of the originated loans in 2006 were
higher priced and (2) those where 50 percent or more
of the loans were sold in the secondary market. The
data indicate that the decline in the number of higherpriced loan originations in the second half of 2007
was greater in census tracts with a high concentration
of sold loans in 2006 (72 percent) than in census
tracts with a high concentration of higher-priced
lending (57 percent). For both home-purchase and
refinance loans, and for both higher-priced and lowerpriced loans. census tracts with high concentrations of
sold loans showed higher-than-average declines.
AI31
Changes in Lending by House Price Movements
To investigate the potential relationship between
changes in housing market conditions and changes in
lending activity from 2006 to 2007, metropolitan
statistical m·eas were grouped into two categories
con·esponding to the percentage changes in the House
Price Index of the Office of Federal Housing Enterprise Oversight (OFHEO) from the first quarter of
2003 through the fourth quarter of 2006. 31 Each of the
two groups was split again according to the percentage changes in the index from the fourth quarter of
2006 through the first quarter of 2008. This process
grouped census tracts in MSAs into those that, in the
initial period, had either relatively weak growth or
strong growth in home values and. in the more recent
period, had small decreases. large decreases, or
increases in home values.
As noted, the HMDA data show a marked decline
in lending from 2006 to 2007. The falloff in lending
activity is related to the pattern of house price changes
over the previous few years. MSAs that experienced
larger declines in house prices from the fourth quarter
of 2000 through the first quarter of 2008 generally
expelienced larger declines in loan activity than
MSAs in which house prices did not fall (tables \o.A
and \6.B). Furthermore. in MSAs where house prices
declined, the fall in home mortgage activity was
relatively greater in those MSAs that had experienced
larger house price appreciation from the first quarter
of 2003 through the fourth quarter of 2006. Thus, the
MSAs that experienced both the sharpest declines in
recent house prices and the largest increases in house
prices in the preceding four years experienced the
largest declines in mortgage activity. For example. the
volume of lower-priced home-purchase lending for
owner-occupied properties fell 53 percent in MSAs
that experienced large recent declines in home values
after experiencing significant run-ups in such values
in the preceding four years. By comparison, areas that
also had large recent declines in house prices but
smaller house price appreciation before 2006 experienced a decline of lower-priced home-purchase lending for owner-occupied properties of about 5.3 percent. The severity of declines in home lending was
larger for higher-priced loans than for lower-priced
loans regardless of the changes in house price patterns in recent years.
31. OFHEO·s House Price Index has heen renamed Ihe Federal
HOll,ing f'in;tnce Agency Hou,,~ Price Index. Mo,e information aholll
the index i, availahle at www.otheo.g(w/hpi.a'px.
A 132
Federal Reserve Bulletin 0 December 2008
14. Change in the numher of lower- and higher-priced loan originations. hy type of lender and hy characteristic of hon'ower
and of census trael. 2006:HI lhrough 1007:H2
A.
Home purchase
Percenl
Lower.pliced loans
Characteristic
of borrower and
of census traCI. by
owner·occupuncy
status of propel1y
All
Type of lender
Depository. by
pruperty location
Wilhin
OULside of
aSSC.!I!oImcn[
areal
I
u~:-.c~:,mcnl
Higher-priced loans
Independent
mortgage
All
company
Type of lender
Depository. by
properly localion
Out,ide of
Within
I:bSC~smcnt
Ii:o.sc:-.smcnt
area
area'
I
. areH
Independenl
mortgage
compan),
OWNER OCCUPIED
BORROWER
Miuority storus 2
Black or African American ....
Hispanic. wh.il., ...............
Olher nllnonly' ...............
Non.HIT"me whue ......
Missing .....................
-2.3
-26.8
-15.3
-143
-9.8
17.8
-.9
1.5
-41
7.0
4.8
-30.2
-17.4
-14 I
-3.9
-27.0
-47.6
-35.5
-20.5
-33.7
-69.4
-75.7
-73.4
-hO.O
-71.1
-2.7
-24.0
-16.7
-174
-23.0
-63.0
-69.9
-68.0
-52 I
-53.7
-8~.2
123
-186
-17.5
-165
-22.9
-23.7
-657
-60.5
-54.6
-59.2
-16
-17.2
-16 I
-20.5
-17.4
-60.0
-55.0
-572
-47.7
-52.1
-84.3
-83.6
-R33
-77.9
-81.2
1.7
-13.8
-162
-209
-lh7
-64 6
-69.9
-66.2
-S·H
-60 J
-K70
-90.5
-873
-R2.6
-R6 I
-87.0
-91.5
-90.4
-82.7
Mmorrrv status, by mcom£ccJIt'Rory~
Lower
Black or African American .
Hispanic white .............
Other minority=' ............
Non-Hispanic white ........
TOlro
Middle
Black or Afl;c"n American ..
Hispanic white .............
Other minority' .
.
Non-Hispanic white ........
Tntal ..................
High
Black or African American ..
Hisp8ni~ wh,ile" .............
Olher mmonly' ......
.
Non·Hispanic white ........
Totnl ....................
Mi..:;c;ing"
52
-4.7
-6.0
-11.7
-9.2
206
8.2
I3
-5.1
-.4
7.7
-13.1
22.5
9.1
5.9
-12.2
-10.1
-2.2
-ll.S
-75
-11.2
-8.0
-ld.6
-9.4
-27.7
-226
-24.3
15
11.9
-19.1
-124
-13 0
-10 R
2
-644
-70.3
-75 I
-71.0
-67 Q
-6.9
-35.8
-IS R
-13.3
-14.6
-677
17.1
-7.1
15
-2.7
-1.0
-40.8
-.7
-37.5
-19.0
-13.2
-14.8
-64 9
-33.3
-58.2
-36.6
-29.9
-33.5
-804
-72.9
-81.5
-77.1
-61.2
-71.3
-70.3
-3.5
-29.5
-15.5
-5.7
-12.5
-48.7
-66.7
-77.0
-73.1
-53.9
-63.8
-4R.R
-89.2
-94.0
-92.5
-85.0
-89.8
-91 I
-1:12
-13.2
65
-1.0
-4.7
-143
-11.9
-16.~
-lli4
~1S 9
-30.7
-:12.4
-70.0
-65.8
-M7
-145
-19.2
-ISS
-62.3
-57.5
-SR I
-88.9
-85.8
-81\ 8
-14.4
-1.5
-13.9
-32.1
-67.1
-17.2
-58.S
-80.9
NON-OWNER OCCUPIED
Total .........................
-32.6
-15.3
-33.6
-56.9
-64.5
-16.0
-57.4
-91.8
Tolal .........................
-17.3
-3.6
-17.4
-35.5
-66.6
-16.9
-58.6
-87.7
-SR
-2~
CENSUS TRACT OF PROPERTY
I"comr catcgOl), (\
Lower .........
Middle ..
High ....
..
':1
TOlnl owner occupied
7
NOTE. COfi\'en(jonnl fir';l-llen mortgugf''' fot "Ile-huill propel£lt'!', fll;ciutie.,
"u"inc" .. 101M" ror dl'liolilon .. of hl\l,>u- dnd IIIgh..:r-pr1I..:nl knJiog, "("1,; (ex(
nOlc 7.
I. Include .. lenolng hy nonhunk nttiliufe", In 'he u...... e ...... menr Mea ... of dero~n~
(ory institutions covered by the Community Reinvestment Act of 1977. For
more information. sec text note 30.
2. Sec nole 4. luhle 12.
House price changes in the initial period affected
the magnitude of changes in refinance and homepurchase markets differently. Markets that experienced strong gains in home values from 2003 to 2006
experienced smaller declines in refinance lending
relative to the declines in home-purchase lending than
did markets that witnessed the same recent changes in
home values but weaker initial house price increases.
This may he hecause those refinancing henefited from
.1_ Oihel rfunllnry {'(ln~I~U, of ;\men~an lndldfl nr ;\Iu,ka Naflve. ,\"mn. and
Nittlv\,: HawaIIan (If (Ithl'r PW':ltif.: hlanJl:r.
4. InformatIOn for the charactenstlc was mis!'ing on the application.
5. See nlile 2, t<Jhle 12
6. Sec note 10. table 12.
7. Includef; louns for which occupuncy status was missing.
the earlier increase in home values and had more
equity to extract or to offer as a down payment on the
new loan.
Changes in Lending by the Severity of Changes
in Mortgage Delinquency Rates
To investigate the potential relationship between
changes in mortgage market conditions and changes
The 2007 HMDA Data
AI33
14. Change in the numher of lowcr- and higher-priced loan ong1l1atlons. hy type of lender and hy characteristic of h<m'ower
and of (;(;m.lIs traCl. 2006:H I through 2007:H2-COIZliflued
B.
Refinance
Percent
Characteristic
of horrower and
of census tract, by
owner-occupancy
All
status of proptrty
Lower-priced loans
Higher-priced loans
Type of lender
DeposilOry, by
property locatioa
Wlthon
Outside 01
Type of lender
Depository, hy
property location
W,thon
OUL,ide of
nS1\c:o.:o.nlcnl
areal
I
d..\sc')'!oml.!nt
Independent
mortgage
All
compJ.ny
al'lsc~smcnt
areal
area
J
u~sc:-.smcn(
Independent
mortgage
company
area
OWNER OCCUPIED
BORROWER
Minority staru.~
Black or African American.
Hispanic, wh,ite . • . . . . " • . • • . . .
-3H
-56.7
-450
-303
-486
-WO
-63.4
--1\08
-S19
-1,25
-I 5
18.6
-13.2
-106
-S.7
-17.6
-162
-R 1
20
-9.8
-14.3
-13.8
-187
-16.9
-9.6
--8.2
-87
-210
-\7 9
-2.1
-1.4
-10.4
-115
-7,4
-206
-38.5
-27.9
-25.7
-289
-117
-23.8
-198
-14.4
-IS 5
-10.9
-166
-183
-14.9
-I~ 2
1.7
-8.8
-118
-6.9
-49
Hispanic white ............
Othel' minorily" ...
.
Non-Hispanic white
Totnl ..
Miso.:ing"
-21.9
-329
-23.0
-11.3
-15 1
--427
-153
-16.3
-125
-7.0
--85
-24 I
-12 I
-241
-163
-2.7
OlNSUS TRAer or PROPF.RTY
Income Cal~gory6
Lower .. ,. , .... , ....... , ......
Middle ........
High ....
-21.0
-159
-17.8
Totnl owner occupied
-17.3
Other mmonty'J ........
Non.HiTnnic whitl'
Missing.
..
-16.0
-28.4
-2n
-155
-168
-12.5
-15.6
-4~.3
~5
-52.5
-512
72
67
-<146
-84.1
-89.0
-R76
-R34
-812
-61 I
-66.U
-60.1>
-54.8
-58.9
-164
-10.8
-26.7
-10.5
-13.5
-4Q4
-53.1
--18.7
-42.8
-45.5
-845
-899
-858
-84.2
-84.2
-2~ 9
-492
-31 8
-25.0
-:107
-596
-65.8
-61.2
-54.3
-585
1.6
95
-84
.8
.7
-46 ~
-555
-51.9
-41.2
-447
--842
--l!9 I
-86.1
-83.4
-83.9
-55.3
-60.9
-61 I
-47 U
-52.7
-no
-542
239
526
2/i 4
346
37.6
-200
-410
-530
-53.2
-38.8
-43 (l
-6:n
-49 R
-312
-393
-683
-39.0
-353
--843
--l!89
--l!9.1
-829
-84.1
-804
-14.7
-135
-120
-10.8
-62
-9.7
-42.2
-33.8
-38.8
-59.3
-55.1
-50.8
4.7
5.7
14.7
--45.9
-10.9
-44.4
-85.2
-83.5
-83.7
-13.2
-8.0
-36.8
-56.5
7.2
-42.8
-84.0
-I~.~
-~81)
Minoril)'l'tlltlls. by income
category'
Lower
Black or African American.
Hispanic white .......
Other minority'.
,
Non.Hi"punic white
Total
Middle
Black or Africnn American.
Hisp~mic white .............
Other minority"\
.
Non-Hispnnic white ........
Totnl ..............
High
Blnck or African American . .
NON-OWNER OCCUPIED'
Totnl ......
Total ......
-53
-83
78
-2.2
-46.9
-605
17.3
-47.0
-92.8
-16,4
-11.0
-7.4
-37.7
-56.9
8.3
-43.2
-84.9
NOTF.: See noles Itl lahle 14.t\,
in lending activity from 2006 to 2007, census tracts in
MSAs were grouped into three categories according
to the percentage change in their MSA-wide rate of
serious mortgage delinquency from the fourth quarter
of 2003 through the fOUl1h quarter of 2007.32 This
process grouped census tracts in MSAs into those that
32. Mortgage market delinquency rates by MSA were obtained
from the Trend Data database; Trend Data is a registered trademark of
TmnsUnion LLC (producL~.trendatatu.com/faqs.asp). Trend Data are
hased on the credit records of a geographically stratified random
sample of about 30 million anonymous individuals drawn each quarter
since 1992. The rate of serious morlgage delinquency is the percentage
of out'tanding lIlurtgage, lhat ale 90 or Illure day' delinquent or in
foreclosure at Ihe time Ihe sample is pulled.
had relatively healthy, moderate, or weak-performing
mortgage markets over the past few years.
The 2006 and 2007 HMDA data show that changes
in lending activity across MSAs were related not only
to the magnitude and timing of changes in home
prices but also to changes in mortgage performance.
In particular. the falloff in loan activity was larger in
MSAs that experienced the largest percentage increases in their rates of seIious mortgage delinquency
from the fourth quarter of 2003 through the fourth
quarter of 2007 (table 17). This pattern held for both
lower- and higher-priced lending and for virtually all
demographic groups. For example. for lower-priced
Federal Reserve Bulletin 0 December 2008
A 134
15. Change in the numher of lower- and higher-pnced loan origirwtions. hy type of loan concentration and hy charactenstic
of horrowc.r and of ccnsus Iraet. 2006:H I Ihrough 2007:H2
A. Home purchase
Percent
Lower-priced loan originations
Characteristic
of borrowcr and
of census tract. by
owner-occupancy
status of propeny
OWNER OCCUPIED
BORROWER
Millorit)' status"
Bluck or African American ....
Hispanic while ...............
Other minority' ...............
N<?n-.Hi~nnic white .......... ,
MISSIng .............
Minority status. by ;"comt
caltgor)' 7
Lower
Blnck or Afticnn Americnn ..
Hispanic white
Other minority'
Non-Hispanic white
Total • • • • • • • • • • i . . . . . . . . .
Middle
Black or African American ..
Hispanic white ...
Other minority!' ............
Nnn-Hi~ptlnic
white
Higher-priced loan originalions
DeposLender
itorv
out-ofwithin
business mortgage assesscompany
loan
mcnt area
loan
concellloan
concenconcentrntion 2
tration
tration~
Independent
All
lowerpriced
Higherpliced
loan
concentrotion
-2.3
-26.8
-15.3
-14.3
-98
-\09
-34.4
-9.7
-15.2
-72
-19
-29.0
-17.3
-14.1
-105
6.~
-2.1>
-27.1
4.0
-28
-7 I
-30.3
-21.2
-164
-17.3
5.2
-47
-6.0
-117
-9.2
68
-2
4.3
-99
-7.3
65
-5.7
-5.3
-\08
-7.7
115
-8.0
24.8
-94
-5.7
7.7
53
-22
-.8
76
-193
-11.7
-121
-10.7
79
-<13
31.7
-13 I
-8.8
-122
-101
Sold
loan
concen-
tration I
-II 8
-89
All
higherpriced
Higherpriced
loan
concentration
5I
-10.8
10.7
-9 I
-2.4
-09.4
-75.7
-73.4
-<100
-71 I
-<12.2
-75.4
-70.3
-499
-62.8
80
2.2
22
-81
-4.4
95
-8.1
-10.1
-<1.5
-9.2
-<15.7
-{>05
-44 8
2.8
12 I
-8<1
-32
-11.4
-80
9.7
-360
-40
1.4
-6.7
-<12.0
-2
Sold
loan
conccnu'ation l
DeposIndeLender
itory
pendent
out-ofwithin
mortgage
business
assesscompany mcnl arca
loan
loan
loan
concenconccntration 2
concentratinn
tration:\
-78.3
-76.7
-<16 I
-75.2
-70.1
-82.7
-76.0
-5~ 9
-82.0
-71.9
-79.1
-78.7
-78.3
-39.0
-45.6
-37.1
-30.6
-35.7
-54.6
-59.2
-42.1
-548
-34.7
-38.4
-<185
-{>3.S
-668
-606
-64.4
-67 (I
-66.7
-567
-44.6
-(>1.6
-1i73
-62.2
-675
-57.4
-62.9
-37.3
-41.7
-34.4
-33.5
-35.2
15.2
-102
12.1,
-9.0
-64
-6J 4
-703
-75 I
-7\0
-<17.9
-48.8
-<157
-50
-47.8
-51.9
-73.8
-?H6
-145
-68.7
-134
-69.4
-837
-<194
-51.5
-129
-71.4
-761
-75.3
-66.6
-12.4
-24.2
-435
-38.8
-32.6
-34.5
-10.9
-42 I
-254
-17.6
-22.1
-758
.4
-t07
15 I)
-7.6
-3.6
-41.5
-72.9
-815
-111
-61.2
-71.3
-10.3
-70.7
-80 :I
-72 9
-54.5
-65.2
-59.8
-75.4
-H~ 5
-68.1
-76.9
-72.6
-75.2
-86.6
-19."
-59.1
-79.9
-60.6
-76.4
-84.5
-~1 5
-69.4
-78.8
-13.3
-50.6
-5\.1
-356
-24.9
-29.8
-5\.7
-<II t;
-722
-6fi
I
ToUtI ...
High
Black or African American ..
Hispanic, wh.itc .••..•.... '
Other mtnonty3 . . . . .
.
Non-Hi.panic white ........
Total . .. . .. . . . . . . . .. .. . .
Mi..::..::ingt-.
-6.9
-358
-158
-13.3
-14.6
-67.7
-17.8
-421
-104
-15.1
-15.2
-593
-6.8
-382
-193
-12.8
-16.0
-73.4
CENSUS TRA('T Of PROPERTY
Income category"
Lower
Middle ........ ..
High ......... ..
-132
-112
-163
-9.3
-127
-163
-14.8
-147
-148
-2.5
-li.3
-112
-17.6
-170
-21)0
-3.4
-3.1
-70.0
...<;5.8
-9 J
~67
-60.0
-51>.5
-(11)
-73.8
-7 I. Ii
_111
-77.0
"'<;8.5
-712
-76.2
-73.0
-116
-38.3
-3\2
-34.7
Total owner occupied
-14.4
-14.7
-14.8
-6.4
-18.2
-6.2
-67.1
-59.1
-72.3
-73.8
-73.8
-33.6
NON-OWNER OCCUPIED"
TOIIII .........................
-32.6
-23.8
-39.5
-16.6
-40.4
-\3.8
-64.5
-45.9
-69.6
-66.7
-69.9
-40.6
Tolnl .........................
-17.3
-16.0
-18.8
-7.9
-21.7
-7.3
-66.6
-57.0
-71.7
-72.6
-73.1
-35.1
.
NO'It·,; Sec general note
Lcmhng In
10
fnhle 14.A. Lonn ('onccnlfmion ic:. hy ('('nc.uc:. [rncr.
u ccn!-ous Irtt~i 110. defmed U~ i,.Ofii..cnluHCd II 50
pl!H;cnt 01 mUle uf
the lo.ms originated in the hact in 2006 hud a p.utit:uldf ..:h'U,,'tcli!'olic ur if ~o
()cfCent or more of the loans originated III the IraCt 10 that year wcre originated
by a panicul", I) pc of knoeL
I. Suld loans are loans ,old by the uliginatur within the calendar year of
originatioll,
2. Lender" thul went oul of hu~,"c"" l'onqc;t 01 kndcrs Ih~t ('co. ... cd 0penllIun. dunng 2007 (this group includes the 169 lenders that did not repon data
for 20m under the Home Mongage Disclosure Act as well as tho.e lenders
that went out of busincss and either reponed 2007 HMDA data or wcrc merged
or i\1.·4uircd).
home-purchase loans. the decline in lending in MSAs
experiencing smaller increases in delinquency rates
was about one-half of that in MSAs experiencing
very significant changes in delinquency rates. The
decline in lending was particularly severe for higherpriced loans in MSAs with very significant increases
~
~()r CXpl~"tlflOn nt
-HIO
lending within a~~C!,lanent aren, !<oce n{'lfe I. table 14_A.
4. Sec note 4. table 12.
5. O(jl~l lIIinorily cl)Jl!'i~b \If American Indian or Ahtski.l Nalivt:, Asian, and
Nntlve HawaIIan or other Pacific 1~;Iandcr.
"
Inlorm1.ltloll IfI! \ht' ~hllrUI.l":!l'l!"" wa .. ml~~lng (In the application.
7. See nute 2. table 12.
8. See note 10. table 12.
9 See nole 7. table 12.
in delinquency rates: Lending of such loans fell more
than 81 percent from 2006 to 2007. The relationship
between the decline in lending activity and the severity of changes in mortgage delinquency was similar
for refinancings, although the falloff in activity was
more muted.
71le 2007 HMDA Data
15.
AI35
Change in the numher of lower- and higher-priced loan originations. hy type of loan concentration and by chaJ"actel istic
of bon'ower and of census tract. 2006:HI through 2007: H2-Colltinlll'd
B.
Refinance
Percent
Lower-pliced loan originations
Characteristic
of harrower and
of census lr.u:t. ~y
owner-occupancy
status of property
All
luwerpriced
Higher-priced loan originalions
Dcpos.
ilory
within
Lender Ilnde.
oUl-ofpendent
Hi\lher-I Sold
All
b'
mortgage a:-.:.c ... ~pnced
loan
ul~~~" company ment area higherloan
concen. priced
con~en(ration I
Juan
cnncen-I loan
tratlon I
' tration:! con~cn- concen-
I
I
Higherpriced
loan
concentralian
Sold
ioan
coneentration'
(ration
tration:i
-3.5
-20.2
7.2
-90
-103
-59.0
-Q3.4
-QO.R
_,1.9
-m 5
-43.7
-55.3
-51.2
-3Q9
-480
-Q3.4
-66.2
-Q5.8
-,99
-M9
-61.1
-66.0
-606
-548
-58.9
-31.4
-45.2
-460
-37.0
-39.6
-59.6
-612
-54.3
-58.5
-53
-4.7
-39 ,
-55.1
-MQ
-61 I
-470
-527
-,42
I
J
Lender
out·of-
ou ... inC's,..;
loan
concen·
trntion l
Independent
mnrtgage
Depository
within
a~SCSS-
company
ment area
loan
loan
concell- eonccntration
tration;~
-QI.O
-64.2
-QO.4
-50.8
40
-Q5.1
-66.4
-QS.4
-Q2.3
-Q6.&
-12.7
-32.6
-31.2
-15.8
-30.2
-65.8
-69.0
-653
-Q2.0
-64.9
-60.9
-QS.7
-509
-51.9
-QJ.3
-Q7.3
-Q9.5
-67 I
-Q3.5
-Q6.&
-19.1
-41.0
-50.5
-22.0
-25.4
-4' ,
-57 Ii
-5~ I
-44.5
-48.1
-MO
-QQ.2
-65.S
-61.0
-M.4
-MS
-Q5.9
..,f;34
..,f;85
-2n2
-61)
5
-54.6
-Q2.5
-67.9
-64.6
-Q6.6
-39.7
-22.3
-21.8
-507
-'95
-~Ii
R
~11
-6" 5
..,f;°0
-50.7
-'81
..,f;2 ,
-637
-484
-574
-lQ.O
-Q26
-M4
-512
-3q ~
-435
_'>,67
-85
-2Q I
-200
-04
-11.1
-13.0
OWNER OCCUPIED
BORROW~R
Mi,rority .~tnllU4
Black or African American ....
Hispanic, wh,ite ~ ...............
-I,.,
-16R
-32.0
-40.2
-20.1
-21.8
-20.1
-15.7
-27.0
-25.9
-17 7
-190
-297
-27.5
-34.5
-34.9
-2~ ,
-2& 7
-9.8
-14.3
-13.8
-187
-16.9
-18.9
-20.8
35
-215
-\9.7
-10.1
-16.3
-205
-205
-18.1
-22.5
-23.0
-262
-184
-22.2
-4.9
-S.I
_II 4
-86
-23.1
-Q.5
-12.9
599
-13.9
-11.4
-11.7
-HS
-198
-14.4
-15.5
-24.9
-317
-218
-20.1
-21.2
-127
-249
-215
-17.0
-17.8
-321
-342
-22 5
-19.6
-26.7
4.9
77
-39
.4
-26.0
3.0
-21.8
-6.3
-6.9
-7.4
-21.9
-12 Q
-230
-11.3
-15.1
-427
-37:1
-41 R
-10.4
-~O 2
-220
-467
-214
-290
-27.0
-12.1
-346
-~R 1
-25.8
-172
-258
-51 2
19 "
lR 1
31 5
188
-298
-50 R
Lower
Middle .......................
High .......................
-210
-159
-178
-18.8
-23n
-217
-In
-221
-185
-314
-249
-21 5
-307
-280
-287
-114
-23-122
-593
-55 I
-56 &
-377
-40.9
-47.6
-Q38
-62.5
-63.2
-Q27
-54.9
-57.9
-64.2
-Q3.&
-19.8
-17.2
-22.4
.........
-17.3
-22.9
-19.3
-26.9
-28.8
-8.3
-56.5
-43.6
-63.0
-59.6
-Q4.7
-18.8
NON-OWNER OCCUPIED·
Tulal .........................
-8.3
-11.7
-10.2
-12.2
19.8
3.5
-60.5
-4S.7
-Q5.8
-Q7.3
-QS.7
-29.4
-16.4
-21.8
-18.3
-25.2
-27.4
-6.9
-56.9
-44.1
-Q3.3
-QO.7
-Qs.2
-19.9
Other Inmol1ry ...............
Non-Hispanic white.
Missingti ..
-16.0
-2S.4
-22.3
-30.6
-35.9
-27.3
_IU8
Minorit)' .'itatllS. by income
cllIegory'"
Lower
Black or African Amcrican ..
Hispanic, wh.ite~ .............
Olher mmonly" ............
Nun-Hi"'ranic white
TOlal ....................
Middle
Block or African Amcrican ..
Hispanic while ......
Olher minorily!li
Non-Hispanic white
........
Total ....................
High
Black or African American
Hispanic white ..
Other minorilY'
Non-Hispanic white
Total ......
Mic:~ing6
CENSllS TRAct" OP
Income C'GugoryK
-1~8
-4q
1.8
_1~4
~.7
-MR
-5~
3
..,f;93
-QOO
..,f;25
-54.6
-2.4
PROP~TY
Total o,\'ncr occupied
Totu •................
-<>60
NOli".: Sec noles In table 15.A.
DIFFERENCES IN LENDING OUTCOMES BY
RACE, ETHNICITY, OR SEX OF THE
BORROWER
The HMDA data allow comparisons of the outcomes
of the lending process across borrowers grouped by
their race, ethnicity, or sex. Three outcomes are
considercd here: (I) the incidence of higher-priced
lending. (2) the mean APR spreads paid by borrowers
with higher-priced loans, and (3) denial rates. Analyses of HMDA data from earlier years revealed substantial differences in the incidence of higher-priced
lending and in denial rates across racial and ethnic
lines; analyses further showed that such differences
could not be fully explained by factors included in the
HMDA data. 33 Studies also found that differences
across groups in mean APR spreads paid by those
with higher-priced loans were generally small.
The analysis herc uses the 2007 HMDA data to
examine these three lending outcomes across racial.
ethnic, and gender groups. The analysis focuses on
conventional first-lien home-purchase and refinance
33. See Avery. Rrevoort. and Canner. "The 100ft HMDA Data" and
"Higher-Prit'ed Home .Lending and the 2005 HMDA Data"; see also
Avery, Canner. and Cook. "New Information Reported under HMDA."
A 136
Federal Reserve Bullelin 0 December 2008
10. Change in Ihe numher of lower- and higher-priced loan originations. hy recent change in hOllse price index in
mctropolitan sialislical area and by characICrislic of borrower and of census lrael. 2006:HI Ihrough 2007:H2
A. Home purchase
Percent
Lower priced
Chnrncteristic
of bon'ower and
of census tnlet. by
owner-occupancy
SUltliS of p"'perry
Higher priced
Change in house prif:'Qindcx in MSA.
Change in house prif:Qiln~cx in MSA,
2006:Q4 10 2008: I (percenl)
2006:Q4 10 2008: I (percent)
L.'lfge decrease Small decrease
Increase
Increase
Large decrease S mall decrease
(-8 or less)
(-8·0)
(0 or more)
I (-8 or lessJ
1-8·0J
I 10 or more)
Loans I
Loans
Change
in
house
price
mdex
m
MSA.
Change 10 house price mdex 10 MSA.
10 all
10 all
2003:01 10 2006:04 (percent)
2003:Q1 to 2006~ ~ccnt)
MSAs
MSAs
Large
Small
LIlrge
Large Small
Large
Small
Large
Small
Small
Large.! Small
incrca.\c incrcl.i't' inc(cu.'-c inn,,",",:"""'.'" Incrca."c
1O(,'rcu~c InCl'ca~l' Im:n:asc Inl'rf.'UW mel case incrcasc
(less
(30 or
(less
(30 or
(less
(30 or
(less
(30 or
(less
(30 or
(30 or
(less
than 30) more) than 30) more) than 30) more)
than 30) more) than 3U) more) than 30) more)
I
!
!
OWNER OCCUPIED
BORROW~R
Mi"ol'ity
statUJ I
Black or African American ....
Hi"'ru",~ Wh,ltC'2 ...
Other mmonty .....
N~n.Hispanie white ..
Mls~1ng'
....
-217
-2.9
-17 7
-159
-15 "
-10.2
-8.5
-2C1 7
-121
-140
-29.1
-31 7
5.1
-12.5
-9.h
-15.3
-27.4
-18.4
-14.1
-159
20.9
215
43.3
6.Y
121
7.2
-14.0
-9.6
-13.4
-110
6.4
-12.1
-11 0
-17.1
-148
18.6
-3.6
117
-7.9
-4.0
-6.4
_1~4
-4~
4
-31J
16
8
-48
-117
-5.4
-~
-IR.8
8
-45
-R.O
-110
-II.~
1.5
-3 "
-306
-12.9
28
-12
-8 I
-10 I
65
-69.9
-71> ~
-745
-627
-726
-57.9
-660
-61 I
-1>28
-81.2
~1)2
-8~
b
-1'10 R
-57.4
-467
-765
-83.5
-769
-8~ 6
-66.5
-574
-70 I
-68.8
-71.9
_771
-74.4
-682
-73.5
-67.5
-588
-576
-,,07
-425
-524
J..y 7
-6'\ "
-658
-65 ~
J..62
-li58
-60 8
-1>5.4
-'\45
-594
-670
-670
-64 9
-1>4 4
-66.4
-(,0 Ii
-54 ~
-59.6
-60.3
-54.0
-58.9
-,72
-57.8
-799
-79.7
-72.1
-71 ~
-746
-61.7
-66.3
-726
-800
-750
-71.0
-74.8
-'>99
-57.7
-<,7 1
-60.2
-63.3
-63.9
-63.0
-583
-61.6
-62.4
-72 2
-503
-628
-566
_748
-792
-7; 7
-1;74
-73.4
-72.2
J..2.4
-51.8
-51 2
-49.8
-54 I
-65.3
-589
-58.1
-590
-50.7
-53.6
-65.2
-583
-585
-58.0
-~6H
-60.1
-553
-62.6
-61.2
-58.8
-58.9
-570
-6U.1
Minority status, by income
Calt'gOI),4
Lower
Blnck or African American ..
Hi$pnnic white
Olher minorilY' ............
Non-Hispanic while ........
Toral . . . . .. . . .. . .. . . . . .
Middlc
.
Black or African American ..
Hispanic white .............
Other minoriry2..
.
Non·Hispanic while ........
Total .......
High
-4~
J...I
-1.2
13.7
2.5
_71
-2.8
-13.0
-125
-30
-132
-8.7
-IQ I
-14 I
-11 "
-.2
-19
-104
-106
-87
55
-7.1
29
102
-2.1
_144
-12.1
-88
75
.5
-82
-9.5
-65
-710
-75.7
-65.1
-69.9
-577
-70 ;
-491
-49.7
-56.7
~O
79
7 I
-29
-7.2
3
-483
-608
-49.5
-;81
-M.7
-836
-879
-845
~
-~Q.R
-77 5
-60.8
-622
-646
-606
-59.4
-735
-70.1
-58;
-589
-61.8
-69.6
-56.3
-59.5
-9.9
-7R
-13.0
-I 13
-u
-26.0
-11.1
-17.2
-15.7
_19
-28
-709
-687
-677
-5J:l
-12 I
-~ 2
-55
-1 17
--15.4
_849
-825
-790
-19.0
-28.8
-66.3
-61.1
-80.2
-58.6
-17.8
-8.6
-7.4
-69.1
-55.1
-82.4
-61.5
-72.4
-59.6
-58.4
-21.5
-9.8
-10.8
-68.5
-56.6
-82.0
-60.9
-71.9
-59.0
-58.6
-'>~.;
-;06
-JY7
-58.;\
-107
-34.1
-10.2
-18.0
-17.2
-70.6
Middle .......................
High .........................
-14.0
-14.8
-10.8
-302
-154
-79
-324
-33 I
-321
-117
-96
-100
-148
-19.1
-17.5
Total owner occupied .........
-36.1
-5.3
-52.9
-15.4
-41.0
NON-OWNER OCCUPIED·
Totnl .....
.. . ............
-15.5
-14.6
-32.6
-10.0
..............
-18.5
-14.0
-37.1
-10.5
.
_~
4
-73.M
-77.9
-569
7.6
8I
.4
-5.9
...
-779
-IS
-339
-54.0
-365
-13.5
-180
~1i1;~ing:'
-72 ;
-1>1 6
-38
-132
_104
-I I 5
-60.9
-~,,6
_71.4
-819
-780
-644
-71 ~
-71l6
-7.9
-369
-164
-14.8
-160
Black or African American ..
white
Hi~pnnic
Olher minority' ............
Non-Hispanic white ........
Total . . .. ... .
-~()~
-68.2
12 I
64
-5 I
-;~
-n4
-S-1
CF.NSU.' TRACT OF PROPERTY
Illcome (.'a/~gQIJ·!'o
Lo\ver ..................
Totul
NOTE: Sec general nutc tu table 14.A.
r Sec nOh. . 4. table 12
2 Other minority c('IMiq" of I\men('~n Indion nr 1\1no;;;ko Nati\'C', AI; 13 11 , find
N~ui\'c Hnwullun or Olhcr PUCIII" (.. lander
3. Infornmuon tor the charnc(~nst1c was Inlsslng un Ihe apphcatll>n.
-I>~
-n7
5. Sec nole 10. ,ab Ie 12.
6 ,,,~~Iud(' .. In3on'\ for which occupancy s.tatus was missing.
MSA Metropolitan stD""tlcal area
SOllRCF: For hnu,,(' pnCt· Index, Ollkc 01 Fcdcrni Houo;ang Enl('rpnsc O\'cr~
>lghl lwww.utheo.gov/hp •. aspx).
4. Sec note 2. tnhle 12.
loans for owner-occupied, one- to four-family, sitebuilt homes, as these are the loan product categories
included in the HMDA data with the largest number
of reported loans.
Although the HMDA data include a variety of
detailed infonnation about mortgage transactions,
many key factors that are considered by lenders in
credit underwIiting and pricing are not included.
However, analysis using the HMDA data can account
for some factors likely related to the lending process.
Specifically, the HMDA data allow an accounting for
property location (for example, the same metropolitan area), income relied on in underwriting, loan
amount, time of year when the loan was made. and
the presence of a co-applicant. To the extent that
some of these HMDA factors are not used directly in
The 2007 HMDA Data
AI37
16. Ch:mge in the numher of Inwer- and higher-priced loan origination<. hy recent change in hOll'e price index in
mCln>pulilan ~lali,;li\:,d ,lie.. dnd by ..:hamcleli'lic of burrower and uf cel1'U~ Iract. 200(, HI lhrough 2007:H2COHlinlle.d
B. Refinance
Pcn,:clH
Lower priced
Change
Higher prkcd
house price IIldex
MSA,
Chllnge In house price index in MSA.
2006:Q4 to 2008:Q I (percent)
2006:Q4 to 2008:QI (percent)
Large decrea,e Small decrease
Increase
Large dccrcac;c
Small dccrcol'c
Increase
(-8 or less)
(-8-0)
(0 or more)
(-8 or Ie,s)
(-8-0)
(0 or more)
Loans
Loans
Changc in house price index in MSA.
Change in house price index in MSA,
to all
to all
2!XJ3:QI to 2006:Q4 (percent)
2<Xl3:QI to 2006:Q4 (percent)
MSAs
MSAs
Small
Large Small
Large Small
Large
Small
Large
Small
Large Small
Large
Increase mcrease mcrease Increase Increase Increase
Increase Increase IOcrease Increase Increase increase
(less
(.10 or
(less
(30 or
(less
(.10 or
(less
(30 or
(less
(30 or
(less
(:10 or
than 30) more) than 30) more) than 30) more)
than 30) more) than 30) more) than 30) more)
Charncteristic
of horrower and
of census tmet. by
owner-occupancy
status of property
In
In
OWNER OCCUPIED
BORROWER
Minor;ty status 1
Hispunic, wh,ile., ...............
Other nunonty- ...............
Non-Hispanic white
-16.R
-29.2
-23.2
-17 I
Missing~
BIsck or African American . ...
..........
-IS,S
-37.9
-186
14.3
-246
-324
-49.4
-444
-42.4
-42.7
-377
-102
-14,4
-14.4
-19.3
-17.3
-38,5
-188
-19.8
-32.5
-31,3
-123
-248
-200
-155
-16.7
-236
-6.3
-2.0
-II I
-57
-16.4
-20 I
-14.7
-17,3
-15,7
14.2
50
10.2
.0
101
13.7
284
10.1
6
88
-60.7
-64.\
-62.5
-55.4
-033
-72.0 -73.1
-73.8 . -70.8
-43.9
-73.2
-68,5
-68.9
-67,0
-810
-57.2
-53.\
-55.2
-54.7
-655
-64.2
-63.5
-60.8
-59.7
-04,7
-52.8
-55.6
-46.9
--16.2
-504
-39.8
-35.2
-40.6
-39,3
-53.8
-,~R 7
-28,3
-28.5
-37.2
-144
-110
-36
-12.0
-19.4
-17.5
-12.5
-126
-12.0
-20.4
-17 6
7.R
-5.7
-4.5
-11.8
-80S
132
236
-1.1
-7.5
-30
-628
-<>67
-62.7
-58.2
-61.4
-739
-704
-57.7
-<>9.4
-72 0
-74.3
-74.1
-73,9
-61.0
-<>36
-60.7
-58.4
-'>0,3
-61;0
-<>85
-65.1
-64.8
-'>64
-58.9
-62.8
-53.7
-50.1
-54.4
-46.3
-48.1
-52.7
-45.4
-47.7
-405
-305
_60
-288
-298
-46.6
-38.4
-385
-399
-395
-20
-79
-15
-119
-106
-130
-18.1
-18,4
-174
-169
27.8
10,2
11.8
.7
4,2
150
27 I
100
.8
38
-610
-'>6.6
-630
-57.4
-60 8
-70,5
-82,1
-1'072
-1\8,6
-715
-752
-740
-748
-73.4
-738
-549
-59,5
-57,0
-558
-575
-'>5.2
-1'034
-62.3
-(,44
-502
-'i18
-48.6
-47.3
-49.1
-38.0
-359
-40.9
-41.1
-42.9
-366
--16
396
-154
-143
-12.0
-52.8
-483
-43.4
-42.8
-436
-61.0
-I I
150
16.R
I
1.6
-31.7
-20.2
-18 Q
-10 I
206
-2J Q
-13 R
-176
-43,2
-\26
-46.4
311
24.0
12,7
152
-20.9
237
47 I
22 J
10.3
13.4
-33.8
-574
-61.7
-62,'i
-S1.2
-S5.7
-54.5
-655
-65 Q
-48
-'>S,9
-<>6.4
-79.7
-718
-<>9,5
-73.1
-'>6,1
-67,7
-55.4
-49 ~
-34.4
-47.9
-47.6
-48.9
-57.5
-60.6
-585
-58.0
-53.8
-567
-50.4
-3')Q
-398
-37.4
-38,S
-4U.4
-58.5
-199
-15.7
-26.2
-293
-30.2
-55.0
-219
-180
-187
-364
-27 7
-162
-433
-43.6
-41 I
-152
-III
-47
-150
-167
-18.8
-4,0
24
62
5I
4.6
14
-'>06
-58.6
-583
-72 3
-713
-671
-70&
-7U)
-66.4
-60,1
-55.3
-546
-624
-62.2
-61.2
-505
-480
-51.4
-42.8
-41.0
-419
-10,1
-15.3
-24,8
-7.1
-7.1
-.5
83
-62.6
-655
-74.0
-60.4
-<>3.0
-54.4
-53.2
-188
-248
-42.6
-97
_17 I
2.9
16
-591
-70,8
-699
-564
-620
-494
-41.7
-18.0
-24.2
-40.7
-9.5
-16.2
2.6
.U
-59.4
-70.1
-70.3
-56.9
-62.1
-50.0
-42.8
.6
Millor;tv status. b" income
CDUgorj·4
.
Lower
Black or African American
Hispani~ wh,ite 2 ..
Othel nuullfllY ............
Non-Hispanic white ........
Total . .. . . .. . . . . .. . .. . . .
Middle
Black or African American.
Hispanic white ........
Other minority2
.
Non-Hi~p~nic
white
Total ....................
High
Black or African American ..
Hispani~
wlt,i(e... .............
Other mmonly- ...
Non~Hi~puni(:
white
Total
Missing'\ .. .. . . . . .. . . . .. . ..
...
-~3N
-II R
-764
-728
-60.1
CI!NSUS ThACT OF PROPERTY
Income CmeROf),!I
Lower.
Middle
High ..
Total owner occupied
..
NON-OWNER OCCUPIED"
Tutal .......
Totul ......
..... ... , ....
NOTE: Sec note, to table 16.A.
loan underwriting or pricing, they are included in the
analysis as proxies for at least some of the factors that
are considered. Because of the focus here on specific
loan product categories, the analysis alrcady accounts
in broad tenns for loan type and purpose, type of
property securing the loan, lien status, and owneroccupancy status. Given that lenders offer a wide
variety of conventional loan products for which basic
telms can differ substantially, the analysis can only be
viewed as suggestive.
The pricing analysis focuses on both the incidence
of higher-priced lending and the mean APR spreads
paid by borrowers with higher-priced loans. Comparisons of average outcomes for each racial, ethnic, or
gender group are made both before and after accounting for di tferences in the bon-ower-related factors
cited earlier (income; loan amount; location of the
property, or MSA; presence of a co-applicant; and. in
the comparisons by race and ethnicity, sex) and for
differences in borrower-related factors plus the spe-
Federal Reserve Bulletin 0 December 2008
A 138
17. Change in [he numher of 10wcl"- and high.:r-priced loan originations for horne purchase and for refinancing, hy change in
rnorlgag<: dclillljul'nlY raw in I11Cllupulilan 'l;ili,ll~al ,lIca ,IIlU hy dl,lIa~l<:ri'lic 01 bUff " .... CI and
l'cnsu, lract.
2006:H I through 2007:H2
ur
Percent
Homc purchase
Lower priced
Charneteristic
of borrower and
of census oncl, by
owner·occupnncy
stalUs of property
Refinance
Higher priced
l..ower priced
Higher priced
Ch,mge in mortgage delinquency rale in MSA (percent) I
Small
Very large Small
Very large Small
Very large Small
Very large
Large
Large
Large
Large
change
change
changc
increase increase
increase increase
increase Increase changc increase increase
(less than (5(}"'2oo)
(200 or (less Ihan (5(}"'2oo)
(200 or (tess Ihan (5(}"'2oo) (200 or (tess Ihan (5(}"'2oo) (200 or
50)
50)
more)
more)
50)
more)
50)
more)
OWNER OCCUPIED
BORROWER
Minor;ty swtllS:!
Block or African American ....
2.7
-44
Hic;:prmiC' white ....
..
.
Olher minority' ............... 1 -14.1
-123
N~n •.Hi~anic white
.
Mlc;:!Omg.
....
. ..
14
-4.4
_274
-12.7
-168
-12.6
-18.5
-4,,9
-22.4
-221
-25.9
-63.7
-SN.6
-62.5
-573
-622
-70.7
-73.5
-63.6
-72 7
5.9
-79
-8.9
-13.5
-62.3
-54 Q
-57.5
-56.1
-58 I
-81.5
-863
-82.0
_74.7
-Xl 6
10.9
19.0
4.9
-16
Kg
-17.7
-21.2
-17.6
-17.3
-I~ 5
-49.0
-45.1
-35.0
-37.7
-355
-46.9
-41.5
-43.1
-43.4
-55.7
-66.2
-66.0
-64.6
-61.3
-67.5
-73.3
-70.7
-70.5
-66.7
-65.7
-69.0
-6H
-65.6
-56.6
-62.7
-690
-6f, 0
-67.9
-64.8
R7
148
-2.7
-10.1
-5.5
-15.4
-15.0
-20.5
-22.5
-2/).S
-3X5
-13.5
-30.9
-29.8
-51.5
-495
-52.3
-49.2
-5t.3
-69.7
-710
-65.4
-63.8
-67.2
-77.7
-734
-74.1
-70.2
-72.2
-66.4
-68.8
-75.5
-74.2
-73.2
-71.0
-72.6
-74.~
Minoril\' status, hr illcomt!
CUlt-gory' !I
•
Lower
Black or African American ..
Hi~pnnic white ...
Other rninority~ ......
Non-Hispanic whire ........
Total .........
Middle
Black or African American ..
Ihspnnac white ......
Other minority) ..........
Non-Hispanic white ........
TOlal ....................
High
Blnck or African Amc~C'an
Hispanic while .
Oth<!r minorlly3 ....... ....
Non·Hispanic white .......
Tolnl ..... ..
Missing" .....................
2.6
-4.X
-12.7
-13.1
-105
-lOS
24.6
220
273
-3.1
3.1
8.7
-21
-149
-1t.6
-8.8
4.3
-232
-125
-16.3
-14.6
19.4
-3.1
III
-S.I
-4.4
-65.6
-63.7
-M 5
-61.7
-63.2
-72.0
-77(,
-745
-66.5
-71.9
-81.6
-80.8
-77.3
-72.8
-78.1
15.5
18.9
,0
-1.8
1.5
-13.3
-19.0
-162
-18.0
-17.6
-v; 4
-36.1
-45.3
-419
-46()
-45.()
-46.8
,.9
3.1
-10.6
-92
-64
-59.8
_7.1
-309
-8.0
_14 X
-145
-7t.3
-341
-5(; 3
-28.3
-269
-326
-74.0
-63R
-552
-64.4
-529
-562
-66.7
-71 (;
-788
-75.1
-65.5
-719
-71.9
-84 I
-8S.4
-83,3
-77,4
-845
-72.9
IS 4
33.9
14.4
7.8
103
-28.9
-2n.2
-19.7
-13.2
-10.6
-12 l
-41.9
-S29
-48.8
-35.9
-390
-403
-58.6
-3".3
-30.1
-31.8
-34.4
-367
-53.5
Lowcr ........
Middle .......................
High .........................
-48
-86
-13.0
-15.n
-16.6
-16.4
-26.8
-261
-58.4
-59.9
-59.5
-70.6
-69.0
-26.3
-6~.6
-84.3
-H19
-77.8
4.8
1.9
-1.0
-18.5
-IR 3
-17.0
-42.0
-395
-36.6
.........
-2R.3
-39.5
-43.6
-58.8
-68.4
-76.8
5.8
-11.3
-9.8
-163
-264
-594
-694
-81.8
1.3
-12.5
-19.7
-29.2
-59.3
-69.2
-81.1
1.8
CF.NSUS
TRACT
-"".R
-2R 3
-45.0
-39.8
-33,K
-61\ ()
-63.3
-65.7
-56.3
-71.7
-69.4
-69.8
-64.2
-66.3
-52.1
-47.8
-64.5
-6-1.0
-63.2
-71.1
-692
-63.2
-24.5
-51.9
-65.1
-73.7
-17.9
-390
-46.0
-64.0
-68.5
-17.2
-37.5
-46.6
-64.1
-69.0
-60 5
-60.1
-64.3
-57.0
-594
OF PROPF..TY
Illcoml' category 6
Totnl owner occupied
NON-OWNER OCCUPIED'
TOlal .
Total ..............
NOTF.: Sec general nole 10 tnble 14.A.
I. Mortgage delinquenC'y rate i~ the percentage of mortgage borrowers 90
days or more delinquent; calculated usmg dC'llnquency rates for each metropolilan slatisli(ul nrc a (MSA) r,um 2003.04 lu 2oo7.Q4.
2. See nole 4. luble 12.
3 Other minority conqc;:t" ( I f I-\rn,""n\:~n IndH.lfl i'f Ala,ku Native::, A1Iian, and
Native Huwallan' 01' other PaCific Islander.
cific lending institution used by the boO'ower. 34 The
method of controlling for these factors is to group
borrowers into cells in which the individuals in each
cell are similar along each dimension considered.
34. Excluded from the prlcmg analysts ure applicants residing
oUlside Ihe 50 slates and the Disirici of Columbia as well as applications deemed 10 be business relaled.
4.
5.
6.
7
Infurmation 1'01' lhc charactcnsl1c was
Sec note 2. lable 12.
Sec note 10. table 12.
inciulil" loans tur which ot't'upancy
SOURCE:
-45.5
-4~5
nHs~lIlg
on the applicatIOn.
'lulU" wa~ mi~"ing
For delinquency rale slarisrics. Trend Data, n product of Trans-
Union LtC.
Comparisons for lending outcomes across groups
are of three types: gross (or "unmodified"), modified
to account for borrower-related factors (or "borrower
modified"), and modified to account for borrowerrelated factors plus lender (or "lender modified"). For
purposes of presentation, the bOITower- and lendermodified outcomes shown in the tables are normalized so that, for the base comparisoll grO//p (non-
The 2007 HMDA Data
Hispanic whites in the case of comparison by race
and ethnicity and males in the case of comparison by
sex). the mean at each modification level is the same
as the gross mean. Consequently, the borrower- and
lender-modified outcomes for any other group represent the expected average outcome under the assumption that the members of that group had the same
distribution of control factors (income, loan amount,
and the like) as the base comparison group.
As noted earlier, mortgage market conditions
changed significantly over the course of 2007. To
help account for the possible effects of these changing
conditions on the patterns of lending outcomes across
population groups, the tables presented in this section
show loan activity by half-year for both 2006 and
2007. Our analysis of the lenders that did not rep0\1 in
2007 but that did so in 2006 indicates that by the
second half of 2007 virtually all of these lenders had
gone out of business. As noted. these lenders tended
to be relatively more focused on the higher-priced
segment of the market and on lending to minority
bon·owers. Consequently, the lending data for the
second half of 2007 likely reflect a "truer" picture of
the entire market for that period than the data for the
first half of 2007. which do not include loans extended
during this period by lenders that ultimately ceased
operations and did not report.
Although the focus of the discussion that follows is
on dift'erences in lending outcomes across groups, it is
important to keep in mind that, as shown earlier. the
overall, or gross, incidence of higher-priced lending
in 2007 fell sharply from 2006. This drop was
experienced by all groups of borrowers regardless of
race, ethnicity, or sex. The decline is apparent when
comparing the unmodified incidences in higher-priced
lending in 2007 for different groups with the unmodified incidences experienced by these groups in 2006.
Il1cidel1ce of Higher-Priced Lending by Race
and Ethnicitv
The 2007 HMDA data, like those from earlier years,
indicate that black and Hispanic white borrowers are
more likely, and Asian bOITowers less likely, to obtain
loans with prices above the HMDA price-reporting
thresholds than are non-Hispanic white borrowers.
These relationships are found for both home-purchase
loans and refinancings regardless of the specific
period considered (tables 18.A and 18.B). Gross
differences in the incidence of higher-priced lending
between non-Hispanic whites, on the one hand, and
blacks or Hispanic whites, on the other, are large, but
these differences are substantially reduced after controlling for borrower-related factors plus lender. Dif-
AI39
ferences in the incidences of higher-priced lending
between Asians and non-Hispanic whites are generally relatively small.
In the second half of 2007, for conventional homepurchase loans, the gross mean incidence of higherpriced lending was 29.5 percent for blacks and
9.2 percent for non-Hispanic whites, a difference of
20.3 percentage points (table 18.A). Borrower-related
factors included in the HMDA data accounted for
4.3 percentage points of the difference. Controlling
further for the lender reduces the remaining gap to .
11.1 percentage points. The results for Hispanic
whites are similar to those for blacks. The difference
between the gross mean incidence of higher-priced
lending for Hispanic whites (24.3 percent) and the
con'esponding incidence for non-Hispanic whites
(9.2 percent) is 15.1 percentage points. Borrowerrelated factors included in the HMDA data accounted
for 5.7 percentage points of the difference. Controlling further for the lender reduces the remaining gap
to 6.2 percentage points. The situation for Asians
differs greatly from that for blacks or Hispanic whites:
Compared with non-Hispanic whites, Asians had a
lower mean incidence of higher-priced lending for
home-purchase loans on both a gross and a modified
basis.
Comparing the differences in the incidences of
higher-priced lending between the various minority
groups and non-Hispanic whites in the second half of
2006 with the differences between these groups in the
second half of 2007 reveals relatively little change in
the gaps modified for borrower-related factors plus
lender. For example, the fully modified gap between
blacks and non-Hispanic whites was 13.4 percentage
points in the second half of 2006 and 11.1 percentage
points in the second half of 2007. Similarly, the fully
modified gap between Hispanic whites and nonHispanic whites was 6.6 percentage points in the
second half of 2006 and 6.2 percentage points in the
second half of 2007.
Rate Spreads by Race and Ethniciry
The 2007 data indicate that among borrowers with
higher-priced loans, the gross mean prices paid by
black borrowers are moderately higher than-and
those paid by Hispanic white bOlTowers are nearly the
same as-those paid by non-Hispanic white borrowers (tables 19.A and 19.B). Asian borrowers with
higher-priced loans also paid about the same mean
prices, on average, as non-Hispanic whites with such
loans. These relationships are little influenced by an
accounting for borrower-related factors or the specific
lender used by the bon·owers.
A 140
I~.
Federal Reserve Bulletin 0 December 200S
Incidence of higher-priced lending. unrnoditied and modified for horrower- and lender-related factors. for conventional
lir,t liens on (,wner-occupied. onc- 10 fOlil-family. ~ile-hulil home.'. by half-year ttl which loan was originated and by
nice. (:thnicity. ,tIlU s<.:x of borrower. 2006-07
A. Home purchase
Perc('nt except as "med
Rucc. cthnicity, und sex I
Number of
loans
Modified incidence. by
modification faclor
Unmodified
incidence
Borrowerrelated
I
Number of
loans
Borrowerrelated
plus lender
Mud'tied ,"c,denee. by
modification factor
Unmodified
incidence
Borrowerrelated
I plus
B~cla't~r
lender
2006
HI
Racf mlltr than whiu oniv
Americnn Indian or Alaska Native .........
Asian ....................................
Black or African American ................
Nutive Hawuiian or other Pacific Islander ..
'Iwo or more minority races ...............
Joint ........ ...
Mi~!:in8 .
While. by clh"idlY
Hi!'p:mk' white .
Non-Hispanic white
SrJr
Onc male
One I~malc ....................
Two males
Two females ...
H2
22.fi~R
35.4
16.8
50.5
34.4
29.6
t77
IR7.627
285
30.9
15.8
50.1
30.4
30.5
244
31.2
235.2R~
1.219.990
48.1
181
36.9
18 I
245
18 I
229.008
1.186.928
45.1
17.3
34.0
17.3
23.9
17.3
615.262
461.907
18.871
15.819
33.2
318
24.6
26.9
33.2
30.9
246
238
33.2
32.0
246
24.4
020.402
463.186
17541
15.248
31.4
30.0
23.3
25.5
31.4
29.3
23.3
21.5
31.4
30.2
23.3
22.6
11.059
96.781
156.337
9.427
1.038
25.4
17.3
30.8
23.4
19.8
20.0
23.6
10.557
90.424
162.369
9.348
1.074
22.033
190.450
32.9
16.7
51.1
33.5
25.7
113
29.9
30.8
14.7
45.9
28.1
26.7
23.0
32.3
23.4
16.5
30.7
21.9
20.6
19.6
23.2
2007
I
HI
H2
RlU:~
other I/lOIl whitt 011/"
American Indian or Ala~1c3 Nati\'e .
Asian ....... , ................. ,' .........
Black or African American ...
Native Hawaiian or other Pacific 1.lander
Two or more minority races .......
Joint
7.437
75.1i10
110,747
6.410
902
rvli\;~ing
While. by t'th"iciry
Hispanic white
Non-Hispanic white
22.0
9.6
21 I
37R
146.171
20.8
155
104
167
34.1
19.5
116
152
21 :1
152,901
1.031.059
31 R
lI.S
sm.4~R
21) R
19.3
16.4
17.7
IR.7MI
172
t 10
245
15.4
157
13.1)
162
6.241
70.ROt
86.220
5.347
974
17.769
131.177
175
51i
295
14.1
10.6
7.3
114
14.7
1i.9
25.2
14.4
11.8
11.3
15.4
15.1
7.8
20.3
12.8
127
10.5
123
239
11.8
17(;
11)9.034
919507
24.3
9.2
186
9.2
15.4
9.2
21).M
18.7
11i.4
15.0
20.8
19.5
16.4
16.5
41)5.6~9
IS 9
301.836
14.145
11.886
14.4
12.8
12.8
159
13.6
12.8
11.4
15 <)
14.3
12.8
12.6
99
I IS
StX
One mule
One female ..............................
T\\'o males ...............................
Two fcmales .............................
362.266
14.504
12.553
NOTE: Excludes transition-period loans (those lor which the application was
submitted before 2(04). For definition of higher-priced lending. sec texl nole 7;
tor e1Cplnnl1tltln of 01()(hflt-8I1nn fnctllr~, ~t"t" [("'I[I
Pricing
D~Uerences
by Sex
The 2007 HMDA data, like those in previous years,
reveal relatively little difference in pricing outcomes
when borrowers are distinguished by sex, although
single males experienced a somewhat higher modified incidence of higher-priced lending than single
females (tables IS.A and 18.B). The mean APR
spreads paid by females are virtually the same as
those paid by malcs after accounting for the prcsence
or absence of a co-bon'ower (tables J9.A and 19.B).
Denial Rates by Race, Ethnicity, and Sex
Analyses of the HMDA data from earlier years have
consistently found that denial rates vary across appli-
I. Sce nole 4. table 12. Loans takcn oul jointly by a malc and female arc
not lubulaled here because they would nol be directly comparable wilh louns
taken (lui hy nne non'ower ('r by Iw(' bO!1'owers of the same sex.
cants grouped hy race or ethnicity. For each hroad
loan product category in 2007 (first or second half),
American Indians, blacks, and Hispanic whites had
higher gross denial rates than non-Hispanic whites;
blacks generally had the highest rates, and Hispanic
whites had rates between those for blacks and those
for non-Hispanic whites (tables 20.A and 20.B). The
pattern for Asians was somewhat different, as the
gross denial rate for them was either lower than. or
very similar to, the rate for non-Hispanic whites,
depending on the period and the loan purpose.
Controlling for bOJT()\ver-related factors in the
HMDA data reduces the differences among racial and
ethnic groups. Accounting for the specific lender used
hy the applicant almost always reduces differences
The 2007 HMDA Data
AI41
I R. Incidence of higher-priced lending, unmodified and modified for horrower- and lender-related factors, for conventional
first liens on owner-occupied. unc- to fuur-famlly. site-built homes, by half-yc<u in whu.:h
mec. cthnicity, and sex of borrower. 2006-1J7-Cu/Llilllu~d
10<111
\Va, originated and hy
B. Refinance
PcrccnI except as noted
Modified incidence. by
Number of
Rocc. cthrticity, and sex I
loans
modification factor
Unmodified
incidence
Borrowerrelated
Number of
I Borrower·
related
loans
Modified incidence. by
modification faclar
Unmodified
incidence
Borrowerrelated
plus lender
I plus
B~~~I;drlender
2006
I
HI
H2
Rac~ oth~r
thall whilt ollly
American Indian or Alaska Native .....
Asian ....................................
Black or African American..... . ..
.
Native Hawaii~ Of, other Pucific Islander ..
'1
Two
01'
more mInonty races ...............
Joint.
.
Missing. ... . . ...
W/tile, by elhllicit)'
Hispanic white"
Non,Hispanic while
SO.t
One male
..
..
..
......
................
. .................
One female .....
T\vo Innles ...............................
Two females
...................... " .....
28.~
14.030
61.485
195.050
12.282
1.474
11,091
281,183
312
17.6
52.0
31.1'
27.1
254
31;.3
349
22.2
494
36.5
29.5
31.5
42.3
24.7
31.9
28.3
28.6
16.4
296
13.718
66.388
202.412
11.796
1.439
20,784
289,263
34.4
21.5
53 I;
36.3
28.8
27.0
401
37.6
25.2
508
38.9
29.3
341
45.1
29.9
25.8
34.4
31.4
33.4
27.8
32.()
213.338
1.296.597
35.4
25.0
36.4
250
28.4
250
223,825
1,3011.339
39.9
265
37.7
265
31.0
265
591,431i
506.018
13.457
15,620
33.4
34.1
26.3
33.2
31,4
32.8
26.3
28.9
33.4
33.1
26.3
27.2
605,743
527,701
13,879
15,559
35.8
36.6
27.0
35.1
35.8
35.6
27.0
30.ti
35.8
35.8
27.0
26.0
2007
-.l
HI
Rafe other than ,,,,'M,e only
American Indian or Alaska Native
Asian.
Black or African American. .... ... .
Native Hawaiian or olher Pacific Islander ..
Two or more minoriry races...
..
Joint................
. .. . . ,
Missing. . ... . . ... . ..
.
.
,,
.
II
Whiu. by elllnicity
Hispunic white ...........
..........
Non-Hispanic white
.
H2
11,481)
63.999
158,416
9.518
1,434
19,892
258,895
28 I
154
44.6
25.7
202
19./i
295
31.0
175
416
29.1
232
248
35.3
22.1
188
27.1
24.3
222
204
25.2
8.028
44,318
108,245
6,283
1.122
14.413
179.528
23.9
84
368
18.9
14.1
17.2
2U.6
26.2
135
35.4
24.3
161
21ti
25.7
18.2
14.9
22.6
19.0
187
17.0
20.1
ISO,394
1.238.650
302
19.8
28 :19.8
234
19.8
121.IiIS
935,658
22.3
16.2
~1.9
16.2
191
16.2
~46,14tJ
266
27.6
210
2M ~
2t;6
267
210
24 ()
26.6
26.5
21.0
227
381.21)4
327.198
1f1,211\
11.371
19.9
21.1
17.4
24.2
19.9
19.8
17.4
20.2
19.9
19.4
17.4
188
Sa
One
One
Two
Two
male
felllale ........
male.::
females "
451,279
12,931
13,992
NOTE: S~C nol..:s 10 table I R.A.
further. although unexplained differences remain between non-Hispanic whites and other racial and ethnic groups.
With regard to the sex of applicants, sole male
applicants have marginally higher gross and modified
denial rates than single females. Also, dual male
borrowers and dual female borrowers generally have
very similar denial rates. which are somewhat lower
than those for single applicants.
Some Limitations (l the Data in Assessing
Fair Lending Compliance
Information in the HMDA data, including borrower
income, loan amount, location of the property, date of
loan origination, and the specific lender used, is
insufficient to account fully for racial or ethnic differences in the incidence of higher-priced lending; significant differences remain unexplained. Similar patterns are shown in racial or ethnic differences in
denial rates. In contrast, only small difl'erences across
groups were found in the mean APR spreads paid by
those receiving higher-priced loans. Regarding the
sex of bon'owers, some very small differences were
found in lending outcomes,
Both previous research and experience gained in
the fair lending enforcement process show that unexplained dift'erences in the incidence of higher-priced
lending and in denial rates among racial or ethnic
groups stem in part from credit-related factors not
available in the HMDA data, such as measures of
A 142
Federal Reserve Bullelin 0 December 2008
19. Mean A PR spreads. unmodified and modified for horrower- and lender-related factors. for higher-priced convcntional first
lic.ns on owner-occupied, onc- tn four-family, site-buill humes. by half-year In which loan was onglnaled and by racc,
clhnicity, and sex of bOIl'()\\'er. 2006-07
A. Home purchase
Pcrccnlugc points except as nOled
Number of
Unmodified
higher-priced
mean spread
loans
RHCC. clhnicity. and sex I
Modified mean spread, by
modification factor
Bon'Owerrelated
I
Borrowerrelated
plus lender
Number of
Unmodified
higher-priced
mean spread
loans
Modi fled mean spread. by
modification factor
Borrowerrelated
I B~~~)t;r
plus lender
2006
HI
Ract OlMr Ihan whit,. on/v
American Indian or Alaska Nalive .........
3,911
16.307
88.335
3.247
Asian ....................................
Black or African American ................
Native Huwuilan or other Pacific Islander ..
l\Vo or more minority races ...............
Joint ..... "., .......
White, by clhnicily
Hispanic \\'hilC ...........................
Non-Hispimic white .........
S'J<
One
One
Two
Two
II
male ............
female . . .. . . . . . . . .. .
males ..
females .......
.
5.23
5.13
5.64
5.22
5.38
534
5 43
5.17
5.15
5.34
5.14
5.16
S 19
5.2R
3,478
15,089
82,903
3.130
276
3,999
53,557
5.69
5.25
5.42
530
5 41
113,136
221,352
5.28
516
5.20
516
210,792
147,065
4.634
4,254
5.33
535
5 15
541
307
Mi""ing.
5.25
. H2
5.11
5(,.977
5.12
4.97
5.66
5.17
5.43
5.30
551
5.13
5.07
5.59
5.15
5.45
5.29
5.55
5.11
5.11
5.31
5.17
5.37
5.12
526
5.18
516
103,286
204,795
524
5 I}
516
513
514
513
5.:1)
534
515
531
5.31
5.15
524
5.30
5.31
5.23
545
5.30
533
194.624
138,870
4,084
3,8R9
5.31
5.23
535
5.30
5.29
523
532
3.~03
2007
HI
atlltr llrall whi/~ on/)'
American Indi~m or Alaska N3th'~
A .. ian
Black or African American
Native Hawaiian or other Pacific Ic;Iandcr
Two or more minority races.
loint ...........
Missing.
H2
Rac~
1,634
7,295
41,836
1,332
140
1,95K
24.339
4.71
450
5.24
480
5.05
496
496
4.fog
459
5.19
481
517
4M
509
47}
4 (,7
492
477
4.91
4 RO
486
48,619
121,526
4.77
4.66
470
466
4.71
466
26.4$)4
84.94J
401i
4.06
4.13
4.06
407
4.06
104,020
6<),928
2,377
2,2t9
4 RO
480
4.RS
; tR
4.RIl
482
4.R'I
4.99
4.NO
4.~1
64.664
43.499
4 RS
4.R8
I,RI2
1524
4.14
411
4 14
426
414
410
<1 14
4.10
4.14
4.12
4 14
4.40
1.093
1,96R
25,395
754
103
I,}U6
14,928
407
444
402
440
4 19
4.21
4.17
394
447
4.17
435
4 19
4.33
4.08
401
432
410
434
4.0K
4.23
390
While. h,Y flhllicir),
Hi..;pnnic whitl' ....
NOll-Hispanic white
s.-'
One mule
One female
Two males.
Two female..:
..
... 1
I
NOTH: Spread IS the dlnercnee bClween the annual per.·entage ratc (APR) on
the 10lln and the yield on n comparable-maturity Treasury security. Excludes
Il'lln\IOnn-pencx1 ill:,", (Iho ... (" for whIch the HrrI1l.:a".m Wll~ !<.uhmitlect before
200';), FOI dclinition 01 higher-priced lending. see lexl nu(e 7; lor ex.planatlOn
of modification factors, sec text. See also notc I. table IS.A.
credit history (including credit scores), loan-to-value
and debt-to-income ratios, and dilferences in choice
of loan products, Differential costs of loan origination
and the competitive environment also may bear on
the differences in pricing, as may differences across
populations in credit-shopping activities.
Differences in pricing and underwriting outcomes
may also reflect discriminatory treatment of minoIitics or other actions by lenders, including marketing
practices. The HMDA data are regularly used to
facilitate the fair lending examination and enforcement processes, When examiners for the federal
banking agencies evaluate an institution's fair lending
risk, they analyze HMDA price data in conjunction
with other information and risk factors, as directed by
the Interagency Fair Lending Examination Procedures.:lS Risk factors for pIicing discrimination include, but are not limited to, the relationship between
loan pricing and compensation of loan officers or
brokers, the presence of broad pricing discretion, and
consumer complaints.
It is difficult to draw conclusions from the HMDA
data about changes in the fair lending environment
from 2006 to 2007. For example. denial rate differences between non-Hispanic whites and minorities
35. The Interagency Fair Lending Examination Proc'edures are
available al www,ffiec.govIPDF/fairlend.pdf.
The 2007 HMIJA Data
II).
Al43
Me~n APR spreads. unmodified and modified for h(II1(1wl!r- and It:nd.:r-rel;ltc.d facwr,. for higher-priced cOllvclltlt)nai hrSl
licns on owner-occupied. OIlC- III flllll-family. site-huill home,;, hy half-yeal in whi.:h loan wa~ originated and by race.
clhnicity. and sex of borrower, 2006-07-Contillued
B. Refinance
Percentage poinls except as nOled
Rucc, cthnicity, and sex I
Number of
Unmodified
higher-priced
mean spread
loans
Modified mean spread, by
modification factol'
Bon owcrrelated
Number of
Unmodified
higher-priced
mcan sprcad
loans
I B~~~t;t
plus lender
Modificd mean spread. by
modification factor
Borrowcrrelaled
I B~~~I~r
plus lender
20U6
I
HI
H2
Race other lhall whi/~ 0111','
American Indian or Alaska Native .....
Asian ...... ..
Black or African American ..... .
Native Hawaiian or other Pucific islander . .
Two or more minority races . ..............
Joint ...
Missing . .
W.lliu, ~)y e/~l1icity
HISPUIllC white ..... .
Non-Hispanic while ..
I
Sex
One male
One female . . . .. . . .. . . . .. .
T\\'o Innles ...............................
Two females ...........
.
4.376
10.815
101,506
3.819
400
5 14
5 II
542
529
5.27
5.154
5 OR
5.09
509
5.37
521
5.18
5 IJ
101.960
~ ,~
~
75,512
527
5.13
.522
~24.3S4
197,567
172.441
3,533
5,IR5
5.2Q
5 }O
5.08
5 17
5.14
5.14
5.23
521
5.20
~ Iii
5 Iii
415
5.604
115. 9 55
5 13
.5 17
S\3
89.2'1i
343."55
529
528
5.08
5.11
q9
529
5.08
499
216.H21
192.926
3.743
5.461
,Ii
4.720
14.281
IO~,401)
4.2R~
4.98
4.68
5.30
501
5.20
4.96
520
5.05
4.91
524
5.07
5.31
507
525
5.09
5.00
508
5.03
5.11
5.03
~
02
5.04
498
509
5 12
5.02
5 II
5.09
5.09
5.02
5.00
5.()9
5.()9
5.02
SJ)9
2007
I
HI
Ral:~
H2
mht'r than whilt. only
American Indian or Alaska Native .... .....
Asiun '"
Black or African American ... ....
Native Hawaiian or other Pacific Islander ..
Two or more minority races.
Joint .............. .
Missing ......
3.227
9.848
70.62R
2,450
289
1,891
76.469
4.79
437
5.12
4.70
485
4 R5
502
4.77
472
507
4.79
54,477
245,074
479
4.79
14\314
124.764
2.721
1.994
4.88
" 09
4.92
4.88
489
491
482
1,918
3.733
39,R36
1.189
158
2,474
37,003
4.73
4.11
491i
4.49
482
4.69
460
4.79
4.44
500
4.81
4.94
4.82
472
4.67
4 51
475
4.67
4.63
4.64
459
4 R7
479
4 R9
4.79
27.151
151.120
44n
4.58
4.1iO
4.58
462
458
4 RR
4.R8
4.88
490
4.85
490
491
4.88
4.87
4.90
491
75.729
68,930
1,781
2.756
456
4.60
4.57
472
456
4.56
4.57
4.56
4.54
4.57
4.61
4.R~
492
480
White. by etlmidry
Hispanic white
Non-Hispanic white
S•.x
One male
One female
Two
...............
mnlc~
'T\vo female ...
;114
459
NOTE' S~C nnlc to tobk~ 19 A
widened from 2006 to 2007, although this development may have reflected differences in the credit
characteristics or other circumstances of the pools of
borrowers in the two years and not unfair treatment
by lenders. Similarly, differences between nonHispanic whites and minorities in the incidence of
higher-priced lending generally declined, although
the fully modified differences narrowed proportionately less than the gross differences. Given the substantial decrease in overall higher-priced lending, it is
difficult to know if this mUTowing of the differences in
the incidence of higher-priced lending was due to any
change in the relative treatment of minorities or to
changes in the credit profiles of marginal borrowers
resulting from declines in applications .and increased
denial rates.
ApPENDIX A:
REQUIREMENTS OF REGULATION
C
The Federal Reserve Board's Regulation C requires
lenders to report the following information on homepurchase and home-improvement loans and on refinancings:
For each apl)licatioll or loan
• application date and the date an action was taken on
the application
• action taken on the application
- approved and originated
- approved but not accepted by the applicant
- denied (with the reasons for denial-voluntary
for some lenders)
A 144
Federal Reserve Bullelin 0 December 2008
20. Denial nltes on 3pplication~. unlllodified and modified for horrmvt'l'- and lender-related fact()I'~, for conventiollal first liens
011 owncr-()l'wpicd, one- [0 [,)UI-family, ,iIC-buill humo.:s. by h,llf-ycar in whkh .. ppli<:alillil was a,lcd upon by lender and
by race, elhnicity, and sex of applicalll, 2006-07
A. Home purchase
PCn:~nt
c.'\ccpl as nmed
Number of
apphcauons
aCled upon
by lender
Race. cthnicily. and sex I
Modified denial rale. by
modification factor
Unmo<hfied
denial rale
Bon'owerrelaled
I
Blln'owerrelated
plus lender
Number of
applications
acled upon
by lender
Modified denial rale. by
modification factor
Unmodified
denial rale
Borrowerrelated
I B~;r~t~~r-
plus lender
2006
HI
H2
Rac~
OlIU!r than ",hitt only
American Indian or Alaska Nalive .........
17.523
135.942
......
Asian ..................
Black or African American ....
Native Hawaiian or oth~r Pacific Islander.
'(\\.'0 or more minority races ...............
Joint ..............
2liS.677
14,401
1.470
29.107
300.7"7
Mi" .. ing
White. by eth"idty
Hi"panir white .
Non-Hispanic white
......
S,.x
One male ................................
.......
One female
...... .............
Two males ......
Two females ........
26.7
17.3
30.9
23.1
20.5
I).R
24.3
22.6
148
27.2
210
18.8
170
23.4
19.3
149
215
183
16.3
14.9
17.9
17.123
12R,4<;;
287.49 I
14.703
1.669
28.674
310.302
25.0
1~ 8
32.3
238
19.9
13.4
24.1
21.7
140
28.2
19.3
18.0
16.8
23.8
17.1
148
21.5
166
16.8
14.6
17.S
357.209
1.543,650
247
13.2
20.0
13.2
175
132
}61,957
1,519.786
262
13 I
207
131
17.6
13 I
915.120
658.209
26.074
21,860
21.J
20.7
19,9
19.5
21.3
20.1
19.8
IS.O
21.J
20.6
19.8
18.6
91S.501
676.289
24.431
21.462
22.1
21.3
18.6
19.4
22.1
20.8
18.6
16.9
22.1
21.2
18.6
16.9
2007
HI
RlICf OIIJ~r lhall whitf ollh'
American Indian or Alaska Nath'c ........
Asian ...
Black or African American.... . ..
Native· Hawaiian or other PaC'ific t,,'andcr
TWo or more minority races ...
t;:~:ing .
While. bv nh"icirv
Hi"panic whitt· .
Non-Hispanic while
Sex
One male .............. ..
One female ................... ..
Two males
Two femalc ..
I
.1
•.
H2
12.326
101i.59'
206.186
10.<;40
1.184
24,610
233.947
28.6
17,1
36.0
282
259
1-17
254
25.1
14.1i
31 Ii
230
247
257.135
1.307.913
T'9,062
527.172
20.708
IS.053
10.301
24.4
214
15.0
239
21 1
219
154
181
15R,701
8.896
1.440
23.715
20 7 ,299
27.0
17.7
342
2(,7
21 3
14.4
236
23.8
15.2
293
21.4
193
17.6
21 5
20.0
t5.1
219
195
19.3
153
167
29.9
13.3
224
13.3
197
13.3
191.83S
1.187.866
300
13.2
210
13.2
197
13.2
229
22.2
21.4
22.1
22')
217
21.4
206
22.9
22.1
21.4
20.2
610.149
440.646
20.420
17.131
22.4
20.9
20.6
20.0
22.4
20.6
20.6
18.1
22.4
21.2
20.6
IS.7
IH"
Ifl4.233
NOTE; includ~.~ tran(,;ition-pt·riod :lppiir:ltions {tho,=(' "ubmined before 20()4}
For c'(plnnntion of modification factors. see text. See also note I. table IS.A.
- withdrawn by the applicant
- file closed for incompleteness
• pre-approval program status (for home-purchase
loans only)
- pre-approval request denied by financial institution
- pre-approval request approved but not accepted
by individual
• loan amount
• loan type
- conventional
- insured by the Federal Housing Administration
- guaranteed by the Veterans Administration
- backed by the Farm Service Agency or Rural
Housing Service
• Iien status
- first lien
- junior lien
- unsecured
• loan purpose
- home purchase
- refinance
- home improvemenl
• type of purchaser (if the lender subsequently sold
thc loan during the year)
- Fannie Mae
-Ginnie Mac
- Freddie Mac
- Fanner Mac
- Private securitization
- Commercial bank. savings bank, Of savings
association
The 2007 HMDA Data
Al45
lO. Denial rates on applications. unmodified and modified for horrower- and lender-related factors. for conventional first liens
on owncr-oc\:upicd. llllC- III fOlil-ramily. ~iIC-buill IWll1c,;. hy halr-yc'lI in which appli"alion wa, "clcd upon by Icnder and
by llIee. ctltnicity. <tIld ~e.\ or ,lpplicanL 2006-07-CvlIlillll(,d
B. Refinance
Pcrccm except as nOled
Number of
applicalions
aCled upon
by lender
Race, cthnicity, and sex I
Modified denial rute. by
modificalion faelor
Number of
Unmodified f--"=="T::::::-="'--l applicalions
denial rale
BorrowerBo~otw~r- acted upon
relaled
pl~~ fe~dcr
by lender
I
Modified denial rale, by
Unmodified f--"rn::::o",d",ifi",c",at,.,io",n:-,f",ac",to",r_ _
denial rate
Borrowcrrelated
I BO~Ot~r-
pl~~ fC~ldcr
2006
I
HI
Rae/! arlltr ,}um while on/v
American Indian or Alaska Native ........ .
31.582
Asian ... .............................. '"
IM.OO7
Bluck or African American ............... .
Native Hawaiian or uther Pacific Islander . .
431,030
23,560
2,8M
17.091
D6,949
Two
01'
more minority races . ............. .
Joint
Mis~ing
While.
.
44.3
28.3
44.8
35.8
40.0
14.0
~()
2
44.8
33.6
46.1
41.7
43.U
4f) ~
51 :>
38.7
35.3
39.0
37.8
36.1
31i 4
313
.1f,.7
31 3
H2
32,175
111,165
452.812
23.877
3,074
31>,939
3~ 0
30 I
711,M~
45.0
27.1
44.9
37.0
4U.9
34 I
4~ 7
44.2
33.0
46.0
41.9
43.4
19 q
47.6
35.7
33.8
38.1
37.0
36.8
11.7
37.2
hv ethn;cif)'
Hispanic white .
Non-Hispanic while
387,40'1
2,IW,168
414,344
2.163,111
337
1,172,R49
975,86A
25.8%
30,478
16.9
35 ~
365
35.2
30.0
3() U
Se.l:
One male
One female
Two males ............ .
Two females
1.1 ~ I ,237
950.223
1R.3
31.0
2~.0Ii4
36~
29,107
188
22.1
21.2
36.5
402
35.7
2007
I
HI
Race OIhfr than whitt. only
American Indian or Alaska Native·
32,148
Asian ....... .
B lack or African American ........... .
Nalive Hawaiia~ or. other Pacific ISlander .. 1
1\YQ or more mmonry races. . . . . .
."
loinl.... . ' . .
. . . . . "I
:~:::~:): ';l;~'i~;~ ..
Hi~P3"ic
white
Two male"
Two females ........................ .
51.0
51 3
43.6
514
355
41.4
31>4
422
27.626
90,733
329,444
2,928
32.643
1>02
356
55.9
49.7
53 U
44.5
56.1
38.8
56.4
51.5
539
48.8
5lXl917
507
4t) 7
43.6
39.5
44.9
44.6
470
40.3
412
32.7
318,369
1,167.691
47.3
357
46.6
35.7
43.4
35.7
406
39.1
40.1
405
891 (21)
717.686
22,430
20,191
442
42.3
41 I
462
44.2
41.4
43.1
43.8
442
42.6
431
41.7
46.5
504
445
498
41.3
17,394
49.2
38.<1
485
418
37.1
394
377,11>8
I 2,149,801
40 I
321
317
42.0
39.8
1,125,730
888,877
25,M3
29,119
406
39 I
40 I
434
38 I
s.-"
One male
One female
54.2
30 I
408,342
21.457
1,276
38,139
646545
.. I
Non-Hispanic while ....................
1II,fiRI
H2
II
406
4f) I
408
NOTE: Sec nOle to table 20.A.
-
Life insurance company, credit union. mortgage
hank. or finance company
Affiliate institution
Other type of purchaser
For each applicant or co-applicant
•
•
•
•
race
ethnicity
sex
income relied on in credit decision
For each property
• location, by state, county, metropolitan statistical
area, and census tract
• type of structure
- one- to four-family dwelling
- manufactured home
- multifamily property (dwelling with five or more
units)
• occupancy status (owner occupied. non-owner occupied. or not applicablc)
For loans suf~iecl 10 erin' re[}orling
• spread above comparable Treasury security
For loans slt/~iect to the Home Ownership
and Equity Protection Act
• indicator of whether loan is subject to the Home
Ownership and Equity Protection Act
A 146
Federal Reserve Bulletin 0 December 2008
APPENDIX B:
PRIVATE MORTGAGE INSURANCE DATA
Historically, mortgage lenders have required prospective borrowers to make a down payment of at least
20 percent of a home's value before they will extend a
loan to buy a home or refinance an existing loan. Such
down paymcnts are required because experience has
shown that homeowners with little equity are substantially more likely to default on their mortgages.
Private mortgage insurance (PM!) emerged as a
response to creditors' concems about the elevated
credit risk of lending backed by little equity in a home
as well as to the difficulties that some consumers
encounter in accumulating sufficient savings to meet
the required down payment and closing costs.
PMI protects a lender if a borrower defaults on a
loan; it reduces a lender's credit risk by insuring
against losses associated with default up to a contractually established percentage of the claim amount.
The costs of the insurance are typically paid by the
borrower through a somewhat higher interest rate on
the loan.
In 1993, the Mortgage Insurance Companies of
Amel;ca (MICA) asked the Federal Financial Institutions Examination Council (FFIEC) to process data
from PM! companies on applications for mortgage
insurance and to produce disclosure statements for
the public based on the data. J6 The PM! data largely
36. Founded in 1973. MICA is the trade association for the PM!
indu'lry. The FFIEC prepare, disclosure ""temen!, for each of the
PMI companies. The statements are available at the corporate head-
min-or the types of information submitted by lenders
covered by HMDA. However. because the PMI companies do not receive all the information about a
prospective loan from the lenders seeking insurance
coverage, some HMDA items are not included in the
PMI data. In particular, loan-pricing information,
requests for pre-approval, and an indicator of whether
a loan is subject to the Home Ownership and Equity
Protection A~t are unavailable in the PMI data.
The seven PMI companies that issued PMI during
2007 submitted data to the FFIEC through MICA. In
total, these companies acted on nearly 2 million
applications for insurance: 1.4 million applications to
insure mortgages for purchasing homes and about
540,000 applications to insure mortgages for refinancing existing mortgages. PMI companies approved
92 percent of the applications they received. Approval
rates for PMl companies are notably higher than they
are for mortgage lenders because lenders applying for
PMI are familiar with the underwriting standards
used by the PMI companies and generally submit
applications for insurance coverage only if the applications are likely to be approved.
0
quarters of each company and at a central depository in each metropolitun statistical area (MSA) in which HMDA data are held. The
central depository also holds aggregate data for all the PMI cmnpallIcs
actIve on that MSA. In addItIon, the PMI data are avallahle from the
FFIEC al www.tliec.gov/reports.htm.
()
Comptroller of the Currency
Administrator of National Banks
Washington, DC 20219
August 15,2001
VIA FIRST CLASS MAlL
Susan Heruichsen
Assistant Attorney General
Office of Attorney General
State of California
110 W. A Street, #1100
San Diego, California 92101
Dear Ms. Heruichsen:
En'closed please find a memorandum issued by the Office of the Comptroller of the· Currency
("OCC") on the processing of referrals received from state Attorneys General and other state
officials ("State Officials") of potential violations of consumer laws by national banks. The.
OCC developed these internal procedures in response to matters raised at a meeting with you and
other Assistant Attorneys General on May 9,2001. The policy set forth in the memorandum will
facilitate effective communication between State Officials and the OCC concerning national
bank compliance with consumer laws. We appreciate you bringing these matters to our attention
and encourage you to bring any other concerns regarding national banks to our attention.
Please feel free to share this memorandum with your colleagues and other State Attorneys
General. Should you have questions, please do not hesitate to call me at (202) 874-5200.
-
u~
StiP~
Daniel P.
Deputy Chief Counsel
c~:
Assistant Attorneys General:
Julie Brill, Vennont
Linda Conti, Maine
Prentiss Cox, Minnesota
Deborah Hagan, Illinois
Shirley Stark, New York
Attachment
EXHIBIT
T
..
~' c""'," )
.....
:MEMORANDUM'
, ,
Comptroller of the Currency
Administrator of National Banks
Washington, DC 20219
To:
Distribution
From:
JUlie 1. Williams, First Senior Deputy Com
~.-.~hief Counsel
Date:
Au\]'ust 13,
2001
Subject:
Referrals from State Attorneys General and Other State Officials
PURPOSE
This memorandum establishes a policy for the OCC's processing of referrals received from state
Attorneys General and other state officials (hereinafter collectively referred t<;> as "State
Officials") of potential violations of consumer laws by national banks. For pwposes of this
memorandum, a "referral" means any written or telephonic communication regarding a
complaint or series of complaints against a nati~nal bank: alleging a violation of state' and/or
federal consumer laws, where: (1) a State Official has expressed an intention to bring an action,
or (2) a State Official has requested information or assistance from the OCC in resolving the '
alleged violation, Contacts with, or correspondence received from State Officials that do not
meet this definition, such as the transmittal of individual or isolated consumer complaints, should
be forwarded to the Customer Assistan~e Group in Houston, Texas ("CAG"),
,The policy set forth in this memorandum is intended to recognize the necessi ty for greater
communication between State Officials and the OCC in situations of mutual concern regarding
national bank compliance with consumer laws. The policy also recognizes the importance of
notification of the initiation of an action. Clarifying the procedures to be followed regarding
these referrals will ensure effective communication between the State Officials and the OCC,
All information provided to the OCC by the State Officials should be accorded confidential
treatment.
PROCEDURES
. District Office Responsibilities
The District Counsel serve as a primary contact for State Officials making referrals to the OCe.
Set forth below are the procedures that District Counsel should follow upon receiving referrals
from State Officials.
2
Delegate'd Banks
District Counsel are responsible for receiving referrals fro~ State Officials, conducting a review
of the referrals ~6 determine whether additional information is needed to process the referral,
contacting the referring State Official to obtain such information, and iri accordance with the
procedures listed below, notifying and providing information to the appropriate' District and
Washington offices.
Within ten (10) calendar days of receipt of a State Official referral in a District office, the District
Couns~l shall notify the Deputy Comptr911er responsible for the oversight or supervision of the
bank (hereinafter, the ~'appropriate Deputy Comptroller"), the appropriate Compliance Assistant
Deputy Comptroller, the Deputy Comptroller for Community and Consumer Policy ("DCCCP")
and the Deputy Comptroller for Compliance Operations ("DCCO") (hereinafter collectively .
referred to as "appropriate OCC personnel") of the referral. In addition, the District Counsel
shall notify the CAG of the referral within ten (10) calendar days of receipt of a State Official
referral in a District office and provide all relevant documentation.
.
For written referrals, within. ten (10) calendar days of receipt of the referral, the District Counsel
shall provide a copy of the Stat~ Official's. letter and all relevant documentation to the Director of
the Enforcement and Compliance Division ("E&C Director") and Director of the Community·
and Consumer Law Division C'CCL Director").
For tel~phonic referrals, within ten (10) calendar days of receipt of the referral, the District
Counsel shall provide the following information to the appropriate OCC personnel and the E&C
and. CCL Directors:
. name, charter number, address, telephone and fax number of institution;
name and position of a contact person at the State Official's office; and
concise, specific description of the matter being referred, or information or
assistance being requ.ested.
In consultation with the offices listed b~low, District Counsel are responsible for recommending
the type of enforcement action, if any, the OCC should take to resolve or respond to the referral.
In accordance with District office and agency-wide policies and procedures, District Counsel are
also responsible for making a written recommendation to the District Supervision Review
Committee or Credit Card Supervisory Review Committee, as appropriate. District Counsel and
the E&C Director will coordinate on the review and staffing of State Official referrals and in the
case of recommended enforcement actions, the presentation of these matters to the Washington
Supervision Review Committee ("WSRC").
Non-Delegated and Large Banks
Within ten (l0) calendar days of receipt of a referral from a State Official concerning a nondelegated or large bank, District Counsel shall notify the E&C and CCL Directors of the referral'
and provide any relevant documentation received to the E&C Director.
3
Washington Office Responsibilities
Delegated Banks
For delegated banks, the E&C Director is responsible for coordinati:t:lg with the District Counsel
and CCL Dire,ctor on the review of State Official referrals. Within ten (10) calendar days of
receipt from a District Counsel of any relevant documentation relating to a State Official's
referral, the E&C 'Director will forward copies to the DCCCP and the DCCO. Withiij ten (10)
calendar days of receipt of a written referral directly from a State Official concerning a delegated
, bank, the E&C Director shall notify the appropriate District Counsel'ofthe referral and forw~d ,
copies of any infonnation or ~aterials received to the District Counsel, the DCCCP, the DCCO,
the CAG and the CCL Director. "
,
'
Non-Delegated and Large Banks
For non-delegated and Large Banks, the E&C Director is responsible for receiving State Official
referrals, reviewing such referrals to determine whether additional information is needed,
contacting the referring State Official to obtain such infonnation, and notifying and providing the
information listed below to appropriate District and Washington offices.
'
For written and telephonic referrals, within ten (10) calendar days of receipt of the referral from a
State Official, the E&C Director shall notify the appropriate Deputy Comptroller (and the
Examiner in Charge in the case of a Large Bank), the DCCCP, the DCCO, the CAG, and the
CCL Director'ofthe referral. In addition, the E&C Director shall forward copies or-any
information or materials received from a S,tate ,Official or District Counsel in cOIll1ection with a
referral or request to each of the above-referenced offices. '
For-telephonic referrals, the E&C Director or the CCL Director shall provide the following
infonnation to the appropriate Deputy Comptroller (and the Examiner in Charge in the: case of a
Large Bank), the DCCCP, and the DCCO:
name, charter number, address, telephone and fax number of institution;
name and position ofa contact person at the State Official's office; and
concise, specific description of the matter being referred, or infonnation or
assistance being requested.
In consultation with appropriateOCC personnel, the E&C and CCL Directors shall recommend
the type of action, if any, the OCC should take to resolve or respond to the referral. In the case
of a resolution involving a proposed enforcement action, the E&C and CCL Directors, in ,
consultation with appropriate OCC personnel, shall make a written recommendation to the
WSRC. On matters raising privacy issues, consultation in both of the foregoing instances shall
include the appropriate Assistant Chief Counsel. Thereafter, recommended actions will be
presented to, as appropriate, the Senior Deputy Comptroller for Mid-Size and Community Banks
or the Senior Deputy Comptroller for Large,Banks for approval.
4
The E&C Director is also responsible for notifying the appropriate State Official upon the
initiation of an enforcement action pertaining to a national b,ank.for which.a referral was made.
The procedures outlined in this memorandum dO.not supersede and are intended to be consistent·
wit,h the procedures for bringing enforcement actions set forth in the Policies and Procedures
Manufll 5310-3 (Rev), Enforcement Action Policy, and other relevant policy issuances.
.
Distribution:
District Deputy Comptrollers'
District Counsel
Compliance Assistant Deputy Comptrollers
Britton
Roeder
Rushton
Jee
Long
Jaedicke
Schneck
HarTlJIl aker
McCormally
Bylsma
Sharpe
Stipano
Natter
Friend
Stone
Golden
-_._ .......... -....... .... ...
-:
'
~
What's New
Community
~
t.BA.
Information
I ~ I ~ I ffm I f..!lli; I IiQ.lA I ,Ell; I J:illQ I
I Customer Assistance Brochure I
I Customer Assistance Group I
~
Careers
~
Who is the OCC?
Directory
f.Wills;
Information
Regulatory
Information
Related
s.Ik:i
year 2000
Informatlgn
The Office of the Comptroller· ofthe Currency (OCC) is an agency ofthe
United States Department of the Treasury. The OCC charters, regulates, and
supervises over 2,500 national banks to ensure a safe, sound and competitive
national banking system that supports the citizens, communities and
economy of the United States. The Comptrqller's Office also supervises
federally licensed branches and agencies of foreign banks. The national
banks fund the agency ·through assessments paid by the banks based on their
assets and fees they pay for special services.
What Is a National Bank?
Qg;
Home page
Site Search.
A national bank is a financial institution chartered by the Office of the
Comptroller of the Currency. National banks can usually be identified
because they have the words "national" or "national association" in their titles
or the letters N.A. or NT&SA following their titles. National banks represent
about 28 percent of all insured commercial banks in the United States,
holding 57 percent of the total assets of the banking system.
Customer
Assistance
If You Have a Problem With a National Bank
Treasury
Homepage
Sybject
!mW
privacv PolicY
Contact Us
E-mail
via
It is best to try to resolve a complaint directly with your bank before
involving an outside agency. If you are unable to do so or are uncertain about
whether your complaint falls under our jurisdiction, the OCC Customer
Assistance Group can help you.
General inquiries about banking laws or practices often can be answered on
the phone by a customer assistance specialist. The specialist may also be able
to suggest other ways for you to try to resolve your problem directly with the
bank.
Wben resolution seems impossible, you may file a formal complaint with the
OCC.
of5
12/08/2000 1:28 PM.
The OCC Customer Assistance Group
.
.
The OCC Customer Assistance Group was created to answer questions, offer
guidance, and assist consumers in resolving complaints about·national banks.
Contacting a Customer Assistance Specialist
You can reach one of the Office of the Comptroller of the Currency's
customer assistance specialists by:
• Telephoning 1-800-613-6743, toll-free (business days 9:00 a.m. to
3:30 p.m. CST); .
..
• E-mailing - E-mail to Customer.Assistance@occ.treas.gov;
• Fax - Faxing to -1-713-336-4301 or;
• Sending mail to Customer Assistance Group
1301 McKinney Street
Suite 3710
Houston, TX 77010
Filing a Formal Complaint
You may file a formal complaint about a national bank with the OCC by
writing and sending (or faxing) a letter -- no special forms are required -- to
the Customer Assistance Group at the above address.
.
Your fax or letter should identify the national bank about which you have the
complaint by providing the bank's full name and address. Explain the nature
of your problem and tell us' what resolution you are seeking. Do not forget
to give us YOUR name, address, and a telephone number where
you can be reached during the day, tis welL
When You Contact the OCC
When we receive your call about a complaint, a customer assistance
specialist will request certain information from you abo'ut your complaint. He
or she will evaluate your information and attempt to resolve your problem
while on the phone. Should the specialist not be able to resolve your
complaint immediately, he or she may request that you send additional
information to assist in their research. The specialist will assign yo':! a case
number and tel] you exactly what they require you to provide, so that your
case research can continue.
When we receive your written complaint or additional docurrientation that
was requested by one of our customer assistance specialists, we will send you
an acknowledgment and assign your case to a customer assistance specialist.
They will research your complaint and contact the bank for an explanation of
of5
12/08/2000 1:28 PIv
...... ....
",
.
what happened. The specialist may request that you provide additional
documentation and will identify exactly what it is that they might require.
The'OCC will notify you after the bank responds. Complaints caused by
bank error or misunderstanding are often resolved voluntarily by the bank.
When You Need Other Help
Many complaints stem from factual or contract disputes between the bank
and the customer. Only a court oflaw can resolve those disputes and award
damages. Ifwe find that your case involyes such a dispute, we will suggest
that you consult an attorney for assistance.
.
The OCC regulates only NATIONAL BANKS, not all types of fmancial
institutions. If your complaint involves a bank cir other institution not
regulated by the OCC, we may refer it to another agency. We will notify.you
if we do so. You should not have to resubmit your complaint or
accompanying documentation. However, you may be contacted if the other
agency needs additional information.
Consumer Help Is Available From These Agencies:
Office of the Comptroller of the Currency
(Regulates national banks)
Customer Assistance Group
1301 McKinney Street
Suite 3710
Houston, TX 77010
1-800-613-6743
E-mail: Customer.Assistance@occ.treas.gov
Internet: http://wwW.occ.treas.gov
The Office of Thrift Supervision
(Regulates federal savings and loans (S&Ls) and federally chartered
savings banks (F.S.B.s))
Office of Consumer Programs
1700 G Street, NW
Washington, DC 20552
(202) 906-6237
1-800-842-6929
E-mail: consumer.complaint@ots.treas.gov
.Internet: http://www.ots.treas.gov
The Federal Reserve Board
(Regulates state banks that are members of the Federal Reserve
System)
12/0812000 1:28
p~
-_ _--------------;-------------------------------,
...
,
..
. ..
"
~.'
...
Division of Consumer and Community Affairs
Federal Reserve Board
Washington, DC 20551
(202) 452-3946
Internet: http://www.bog:frb.fed.us
The Federal Deposit Insurance Corporation
(Regulates Federally insured state banks that are not members of the
Federal Reserve System)
Division of Compliance and Consumer Affairs
550 17th Street, NW
Washington, DC 20429
(202) 942-3100
1-800-934-FDIC
Email: consurner@fdic.gov
Internet: http://www.fdic.gov
The National Credit Union Administration
(Regulates federal credit wtions)
1775 Duke Street
Alexandria, VA 22314-3428
(703) 518-6300
Internet: http://www.ncua.gov
Federal Trade Commission
(Regulates other lenders)
Consumer Response Center
6th and Pennsylvania Avenue, N.W.
Washington, DC 20580
(202) 326-2222
Email: consumerline@ftc.gov
Internet: http://www.fic.gov
Department of Housing and Urban Development (HUD)
(Enforces Fair Housing Act)
.
.
Office of Fair Housing and Equal Opportunity
451 Seventh Street, S.W., Room 5100
Washington, DC 20410
(202) 708-4252
1-800-669-9777
Internet: http://www.hud.gov
of 5
12/0812000 1:28 PI
AL 2002· 9
o
.
:0'
acc ADVISORY LETTE.R ".
:
Comptroller of the Cur'rency
Administrator of National Banks
Subject:
.,
"
.'
' ' ' .. ,'
. :,' .!I.,:
Questions Concerning
Applicability and Enforcement' of
State ·Laws:· Contacts From State
Officials
... .':.' ..
\.,
,.!" •• ',:
:
TO:
C'hiefExecutive Officers of all National Bimks', Department
Examining Personnel
..'
and Division Heads, and All
.~~ '(.~::.:'"
. .:
..,... . ..
.... ,
. :t· ".: t'. ;.".:~.; .:
"
.'
PURPOSE
.
,p_.
This advisory Jetter describes 'the gen~ral principles that apply in detennining whether a state law::·.:,1~·:'.. :.. '
is applicable to a national bank.: It also describes the starutory.authorityofthe OCC to regulate.'·':. ~~::·::. ' ..
natiopal banks, to examine national banks for compliance with federal and applicable .state laws;· .,.... ;~;" ;-.'.
and to enforce these laws. Finally, it'adyises national banks to consult With the OCC if state ':!:~": ..." .. ,
officials contact them concerning the potential application of a state law, or if these officials seek·~:' ":;':'
information concerning a national bank~:s operati<;>ris. .
:'
.<' ...
BACKG,ROUND
Recently, we have been asked for guidance on the role of state officials in the enforcement of. ". .
state laws that may affect national bank operations: The applicab~lity of state laws to nationai .. :,' . : '.
banks and their operating subsidiaries - and the authority to enforce those laws -- raise complex.
issues of both federal preemption and the s~tutory 'authority of the bcc as ·the sup~rvisor and '.':
regulator of natjrmal banks. ~ Due to the. often complex nature of the determinationS 'regarding"
the application and enforcement of state law in particular instance, this advisoryletter notifies ' .
. national banks.to consult with ~e OCC'on such.matteI"$: .. In addition, it. encourages state officjals
to contact the OCC when they have infomlation that would be rele~ant to the acc in its
supervision ofnationalbanJcs"and their compliance with applicable laws, or if they seek
infonnation from national banks: We appreciate the interest of state officials in these issues, and
this advisory is designed to swrunarize the standards that are applicable in this area.
a
..
.....
~"
.
~.
I In most instances, the OCC is responsible for enforcing federal laws that apply to national banks or to' their
..
operating subsidiaries. However, some federal statutes also specifically give enforcement BUthOrity to s~te
. ", . " .
anomeys general.' See, e.g., 15 USC 1681s(c) (Fair Credit Reporting Act). Even in these instances, issues may arise
. ".
as to the appropriate role ora Slate official with respect to a national bank's activities. Thus, the procedures
discussed in this advisory letter should also be followed by national banks in instances involving any state attorney" "
general enforcement action under federal Jaw.
. , ..
Date: November 25, 2002
Page '}"rif 5,!'"
EXHIBIT
I
19
U
"
I--
.... "._-
-
Applicability of State Laws to National Banks
The National Bank Act was enacted in 1864 to create.a new system of nationally chartered banks
that would operate independently of state regulation. 2 Since that time, courts have recognized.
the essentially federal character of national banks,3 and the Supreme Court has repeatedly held ......
that sUbjecting national banks' federally authorized activities to state regulation and supervision\",:' j
would conflict with their federally derived powers andwith the p~oses for. which the national";" .
4
banking system was established. In one such decision, the Court noted that national banks are . '.
"instnunentalities" of the federal government and stated that "any attempt by a 'State to define'..: .....
[the] duties [of a national bank] or control the conduct of (the] affairs (o.fthe national b3.nk] is"':'::':::.
void whenever it conflicts with' the laws of the United States or frustrates the purposes of ~e.;· '..:::' ..
national legislation or impairs the efficiency of the bank to discharge the duties for wlUch ihvaS·~:.' ." "
created.',5
..
..
..
Essential to the character of.nation~ b~s and the national banking system is the Imifo~ and ':. ".'
consistent regulation of national banks by federal staridards. 6 . To that end, Congres's vested'iii the··. ;·:: ...'
ecc broad authority to regulate the conduct ofnation~ banks except where the authority to::~:. '\ :.\.. '.
issue such regulations has been "expressly and exclusively" given to another federal regula~6ry:"'''; . ..'
agency. !2·use 93a. State law could be applicable.lonational banks, however, in. limited :.', .'.:":;':'. .
circumstances when it does not conflict' or interfere with the national bank' s e~ercise its :~> ~~<i:.·
powers. Thus, for instance,. one federal court recently Doted that states retain some power to ,.'. :':::.J.':,
regulate national b~s in ~eas s~c~ as "contracts, d~~t collection, acquisition and transfer <?f. :.:: ;':, ': ' ' ':,:
property, and taxation, zorung, cnmmal, and tort law.
.
.' ....... '. " . ~ r~' '.'
',-. :' .
.:.
of
I
Bank ofAm, v. City and County ofSan FranCiSCO, 309 F.3d 551, '561 (9 th Cir. 2002) (citing Cong. Globe, 38th
..
0"
...
•• ' . : . ' , ' ;
.' .....
'.
Cong" I" Scss" 1.451 (1864».
. ":, .'.
l See, e.g., Davis v. Elmira Savings -!Janie, 161 U.S. 275, 283 (1896) ("Cn)ational banks are instrumentalities of the : ..
Federal government").
.'
.
• See Easton v. Iowa, 188 U.S. 220, 229, 231.3i (1903), in which the Supreme Court explained:.
(Federal legislation concerning national banks) has' in View the erection of a system extending ~ouih~ut:.\.. :;· ..
the country, and independent, so far as powers conferred are concerned, of state legisla.tion which. if '.: :'. ':: .
permitted to be applicable, might impos.e,Iirn,i.tations and restrictions as various and numerous as the states:·... :~ : .
... [W)e are unable to perceive that Congress intended to leave the field open for the states to attempt to .:: :.: ;' .
promote the welfare and stability of national banks by direct legislation. If they had such power it would" ':. "
have to be exercised 'and limited by their own discretion, and confusion would neces'sanly result from' '.
.
control possessed and exercised by two independent authorities .
.......
See also Barnett Bank of Marion CoUllty, N.A. v. Nelson,.s 17 U,S. 25, 32 (1996) (the powers of national banks are
.
"grants of DUthOrity not normally limited by, but rather ordinarily pre-empting contrary state law.').
S First Nat 'I Bank ofSan Jose v, California, 262 U.S, 366, 368, 369 (1923). See also Bank ofAm., 309 F.3d at 561'"
(state attempts "to control the conduct of national banks are void if they. conflict with federal law, frustrate the
.
'rurposes of the National Bank Act, or impair the efficiency of national banks to discharge their duties").
Such standards may be embodied explicitly in OCC regulations, or in other federal law, including various fedellll
consumer protection laws, such·as the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer
Act, the Real Estate Settlement Procedures Act, the Equal Credit Opportunity Act, and the Fedellll Trade
..... ...
Commission Act. See IS USC 1601 et seq.; 12 USC 4301 et seq,; 15 USC 1693 et seq.; 12 USC 2601 et seq:; ·1~ .....:. . .':::::
USC 1691'et seq,; IS USC 45. However, whether or not the DCC bas specifically addressed a national bank activity'" :.... .
in a regulalion, all national'bank operations must be conducted in a safe and sound manner, in accordance with the' . " ...'
OCC's supervisory standards,
.
"',;', .
7 Bank of Am" 309 F.3d at S59,
..
Dale: November 25, 2002
:. I :~• • • • ,'''; :.~
... -.-... -...- - - - . - - - - - - - - - - . - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - I
.Supervision o/National Banks andEn/orcem.e!,' 0/Applicable Laws
In addition to uniform federal standards for regulation of national banks, Congress provided for a
complementary system of uniform federal oversight of the activities of national banks as an
integral component of the national banking system. Exclusive federal oversight, uniform federal
regulation, and state law preemption constitute three essential and distinctive eleme1)ts ~f the
. . . .
. .
.
national bank charter. 8
Congress provided that the uniform federal'standards that would govern national baDks - arid
..
state laws, where federal law makes them applicable - would be enforced by a single, federal
...:
supervisor, the ecc. By statute, national banks generally are not subject to any visitoril}l.power$ ......... :~ ....
".
.
. : ... .. :,.' .:" .
except as authorized ~Y federal law: .
.
No national bank shall be subject to any visitorial powers except as authorized
by Federal law, vested in the courts of justice or'such as shall be, or have been
'exercised or directed by Corigress or by either House thereof or by any committee
of Congress or of, either House duly authorized. 9
,
.
'.
.. '
.
.
:
,-
........
'.. ::/::;~ ..
'.
. :>{":?:.':~.'.:" ....:.
.. "
. '"'"
, .: .~":I.
'"
12 USC 484(a). The ecc IS specifically authorized under the National Bank Act to "examine·'...: :.::. :.
every national bank as often as the Comptroller of the Currency shall deem.necessary," and ec'C .:-;:-: '.'
examiners have the power to '.'make a thorough examination of all the affairs of the bank.": 12 ".:" .. :..:: ': .
USC 481. Thus, except in specialized instances where federal law makes provision for aoothe?·:·:-::;.; ":' :
regulator to have a role, the OCC's visltoriai)Jowers are exclusive with respect to activities that· :': .:.,: .. ' "
are authorized or pelDlitted for national banks under federal law or regula.tion,· or by OCC ". ": -' ../~ .
issuance or interpretation.
: . :.
Congress reaffmned the ecc's exclusive visitorial powers in 'the Riegle-Neal Interstate Banking
and Branching Efficiency Act of.l994.· Pub. 'L. 103-328, 108 Stat. 2338 (1994). Congress'"
'. '"
provided in that legislation that specified types oflaws of the "host"'state in which a national
bank has an interstate branch are applicable, unless fede~al iaw preempts their application to'
..
national banks. However, Congress stated that "[t]he provisions of any State law t6 which a' . . " .. ':
·hrar.:h of a nationat'bank is subject under this paragraph shall be enforced, with respect to such,.: . :.,>:.
branch, by the Comptroller of the Currency." 12 USC ?6(f)(1)(B).1 0 '
: : .. :.
Moreover, OCC regulations pr;~ide for comparabie treatment of national bank operating subsidiaries. The OCC's
regulations slate: "Unless otherwise provided by Federal law or OCC regUlation, State laws apply to national bank
operating subsidiaries to the same extent that those' laws apply to the parent national bank." 12 CFR 7.4006. III
addition, 12 CFR S.34(e)(3) provides that "(a)n operating subsidiary conducts activities authorized under this section
pursuant to the same authorization, tenns and conditions that apply to the conduct of such activities by its parent
national bank."
.
.
9 "Visitorial" powers generally refer to the power to "visit" a national bank to examine the conduct of its business
and to enforce its observance ofappJicable laws. See, e.g., Guthrie v. Harkness, 199 U.S. 148, 158 (1905) (the word.'
"visitation" means "inspection; superintendence; direction; regulation") (internal quotations omitted). Section 484
provides an exception to the OCC's exclusive visitorial authority for state examlners inspecting for compliance with
state unclaimed propi;rty or escheat laws upon reasonable cause to believe the bank has failed to comply with those
laws. 12 USC 484(b).
~o See also National State Bank v. Long, 630 F.2d 981, 989 (3"' Cir. 1980) ("[EJnforcement of the state statute is the
responsibility of the Comptroller of the Currency rather than the State Conunissioner.")
I
','
Date: November 25, 2002
"
Page":fof 5' .,.'.
.
The ecc's regulations also set forth the agency's exclusive visitorial authority, providing that,
subject to limited exceptions, only the ecc may.exercise visitorial powers with respect to
.
national banks. 12 CFR 7.4000(a)(1). These exclusive visitorial p~wers include:
. 1. examination of a bank,
.
2. inspection ofa bank's books and records,
.'.
3. regulation and supervision of activities authorized or pennitted PUfsuant to fedefaJ: . ; ':'
bailking law, and
.
. :.,
4. enforcing compliance with any applicable federal or state laws concerning those .... ,.
activities.
:':,!
~ ....
. .. : ·t',
0 ' , ' '"
.'
: ,....
,'. '• .'...~ ,t.:.
12 CFR 7.4000(a)(2)(i - iv).
.
..: .:', ~'~:' . '.~
p~oCEbuRE
The acc recognizes thai state officialsmay.from time to rime possess infohnation that would'be.;.:·
valuable to the OCC in cormection with' its oversight of national banks, or ~ay seek to obtaIn': .. ,.. ;
information from national banks concerning their operations. Given the complexity of issues. . ..
that can arise with respec~ to whethe~ a state l.aw is applicable· to national bank operations, the·\/:'.·:': :
enforcement of any such laws, or
proprietY of disclosure ofinfonnation concerning'a nationaL::":
bank's operations, the ecc h:as established· the following procedure to ·address circulnsttulces ':<:
when state. officials raise issues concerning potential violations of laws by national banks, ': .:, ...'.. ::.;.,:':
including ~hen state officials may seek information from it national bank about its' compliance :·r;. ·f;::.
wi th any law or for other ~wposes:. .
.. . .
. .. ...
..
.
, ., ;~ ..'. <:: ..
the
e
o
<:::...
State officials are urged to contact tbe.OC:C if they have any information to indicate.; ...
that a national b~ may be violating federal or an applicable state law or if they seek. .. ' ..
information concer:ning a national bank's operati~ns. The ecc will revieV{ any such, .. : ..,:
information and, if appropriate, take supervisory action, which may include an
. .. .. . .
enforcement action, if it concl~~es that a national bank has violated an.applicable. Jaw:'.:' .... '
are
National banks should contact tbeOCC if they
contacted by a state ~fficial seeking'
information from the bank that may constitute an attempt to exercise visitation or
.
enforcement power ~vetlhe bank.. Nationa~ banks are encouraged to consult with the
ecc as soon as possible following the initial contact by a state official on ~hether such
request may conflict with the federal standards applicable to the regulation and
supervision of national banks. Following such consultation, the'OCC may want to
contact the state official directly to discuss the state's inquiry and to obtain any
... .
information that the,state migllt.posses.s t,hat may be relevant to the OCC's supervision of'.::· :. .
the bank.
. !'.'
• .1 '
Dale: November 25, 2002 .
.. f'sgE(4'
Of 5
. ...
'
OCC Contacts:
•
Director, Enforcement and Compliance Division,.at (202) 874-4800 (for inquiries by
state officials and questions about this Advisory Letter) .'
•
Director, Community and Consumer Law Division, at (202) 874-5750 (for inqUiries by.
state officials and questions about this Advisory Letter)'
.... . .
.
.
,
"
.
". The acc District Co'wi's~l for the district in which the baDk is.·headq~aitered (for .'
inquiries by state officials). .
.•
Director. Legislative and RegwatciryActivities'Oivision, at(20~) 814-5.o90(fo/· ..
questions about preemption and visi~orial power~ generally) .
';.',
. '"
Julie L. Williams .
..
First Senior Deputy Comptroller
and
Chief COWlSel
.
.
....
...
".
'
.
.•
,
I·
'.
"
..... ,...
Dale: November 25, 2002
PageS of5
",
Mortgage system crumbled while regulators jousted
Page I of 5
Vi
seattle(!l)
http://www.seattlepi.com/business/382860_mortgagecrisisll.html
Mortgage system crumbled while regulators jousted
Saturday, October 11, 2008
Last updated October 13.200810:49 a.m. PT
By ERIC NALDER
P-I INVESTIGATIVE REPORTER
Federal bank regulators fought over turf with state agencies while America's mortgage lending system
grew increasingly unstable and then fell apart.
When state investigators spotted questionable loan practices, the feds rejected their help and informed
the state that it had no business looking into the affairs of federally chartered institutions. Scott Jarvis,
director of the Washington state Department of Financial Institutions, said his files are full of letters
from federal bank regulators, bankers and other lenders politely telling his office to take a hike.
In a typical case in late 2002, state bank examiners believed National City Mortgage was violating the
state's Consumer Loan Act by charging extra fees on mortgages, said Kwadwo Boateng, the state's chief
bank examiner. When asked to explain the costly "discount loan fees, underwriting fees, processing fees
and marketing fees," National City Mortgage sought intervention from federal regulators, records show.
The investigation was stopped by federal decree.
At the company's request, Julie Williams, general counsel of the federal Office of the Comptroller of the
Currency, wrote National City a letter in January 2003 saying the state had no right to examine or even
visit its offices. Because National City's parent bank in Cleveland was chartered with the OCC, the
federal agency pre-empted the state's authority. National City attached Williams' letter to a missive to
the state in February 2003, asking state investigators to stay away.
And here's the kicker. The federal agency didn't go after the mortgage fee complaint because it had no
authority to enforce state consumer protection laws, Boateng said.
"We dropped the case," he said.
National City spokesman Todd Morgano said he wasn't aware of the case, but "in general we fully
cooperate with all of our regulators."
"Pre-emption is about the application of uniform, national and ... rigorous standards," said Williams,
who is also the first senior deputy comptroller at the OCC. "It is not about getting out of rules and being
allowed to play in a more relaxed environment."
Williams increasingly pre-empted state regulatory actions starting in 2002, about the time subprime and
nontraditional mortgage lending was beginning an astounding climb, from $267 billion in originations
nationally to more than a trillion by 2005, according to Inside Mortgage Finance, a tracking newsletter.
Mortgages sold as pools on Wall Street created a fire storm of irresponsible lending that peaked in 2006
and smoldered afterward with widespread foreclosures and today's financial instability . •_ _ _ _~~-"
EXHIBIT
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I --\~/I------
Mortgage system crumbled while regulators jousted
Page 2 of5
The OCC's federal cousin -- the Office of Thrift Supervision -- wasn't far behind in the pre-emption
effort. For example, Washington and other states have been waging a battle with the OTS and State
Farm Bank over the state's right to license the bank's mortgage brokers and originators.
"We don't need dual supervision," said State Farm Bank general counsel Todd Haynes, who expressed a
strong preference for the feds. "They've done a fine job."
That's not the opinion of others, nor is it reflected in statistics regarding enforcement actions that show
almost nothing from the feds in the area of consumer protection.
"National banks and their operating subsidiaries function without meaningful law or enforcement," said
Rep. Barney Frank, D-Mass., then ranking member of the House Financial Services Committee, in a
toughly worded letter to federal Comptroller John Dugan three years ago. He said that's because the feds
have shoved aside state regulators without filling the "regulatory void."
He pointed out that the comptroller's office lacked the ability to enforce state consumer protection laws,
yet repeatedly shielded national banks from state investigations, as it did with National City. Both
federal agencies have imposed "visitorial" bans, meaning state investigators can't even visit their
chartered institutions for interviews.
"What value is an applicable state consumer protection law if there is no one to enforce it?" asked
Frank, who is now chairman of the committee.
Nothing has significantly changed since Frank wrote the letter to Dugan, except for a U.S. Supreme
Court decision last year that more firmly barred the door to state investigators.
Other laws encourage concurrent federal and state investigations of consumer violations regarding credit
repair and telemarketing fraud, said Joseph Vincent, state DFI general counsel.
Most big depository and lending institutions -- like Wells Fargo and Washington Mutual -- are chartered
by either the comptroller's office or the thrift supervisor. Washington's Department of Financial
Institutions, as well as bank regulators in other states, charter or license community banks, financing
firms, credit unions and mortgage brokers. Deciding who oversees you is mostly voluntary in the
banking world.
Banks are governed by a patchwork of federal and state laws, which are notably weak at the federal
level in the areas of predatory lending and consumer protection, according to law professors, attorneys
and other experts. Some states, like North Carolina, New Jersey and New York, have passed tougher
predatory lending laws with provisions holding Wall Street liable for financing bad loans. But the two
federal agencies in recent years have increasingly shielded their chartered banks, and by extension Wall
Street financiers, from states' laws.
Assistant state Attorney General David Huey, who has handled some of the state's biggest predatory
lending cases, wants Congress to empower state regulators to investigate federally chartered banks.
Federal and state regulators should work closely together, he said, just as state attorneys enforce the
federal anti-trust Sherman Act.
Without that authority, Chuck Cross, former Washington state regulator and currently vice president of
the Conference of State Bank Supervisors, and others said they watched federally chartered institutions
such as Washington Mutual founder in their own backyards, while federal regulators did nothing to stop
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Mortgage system crumbled while regulators jousted
Page 3 of 5
the bleeding.
Cross said he had an inside source at WaMu who told him he wouldn't believe what was going on with
its questionable underwriting activities. Bill Longbrake, recently retired WaMu vice chairman, said the
bank reported to its stockholders problems with loans made by a subsidiary, Long Beach Mortgage, but
those problems were solved over time to the satisfaction of the OTS.
Jarvis said the community banks under his office's supervision didn't wade into the risky subprime and
nontraditional lending waters the way nationally chartered banks did. One of the largest, Sterling
Savings Bank in Spokane, didn't engage insubprime or nontraditional loans, spokeswoman Jennifer Lutz
said. Nor did Cascade Bank in Everett, bank President and Chief Executive Officer Carol Nelson said.
Two-thirds of bank deposits in the state are regulated by the federal regulators, Jarvis said.
Jarvis acknowledged that some mortgage brokers and other financial institutions under his agency's
watch participated in the risky lending behind the current crisis.
But the numbers support his contention that the state was a better guardian.
The federal OCC took about a dozen formal enforcement actions against banks for "unfair and deceptive
practices" in the current decade, agency spokesman Robert Garsson said. The other federal agency,
OTS, took about half as many, in "the five to six range," OCC Chief Operating Officer Scott Polakoff
said. States, by contrast, took 3,694 enforcement actions against mortgage lenders and brokers in 2006
alone, according to congressional testimony.
The quality of local oversight varies from state to state, said Longbrake, who was WaMu's liaison to
regulators. Yet state regulators are more innovative than the feds, he said. He encouraged them to work
together.
Pre-emption is a good practice, said Peter Wallison, co-director of the American Enterprise Institute's
market deregulation program. Complying with 50 different sets of rules is expensive to banks and
consumers, he said.
But recent events show that predatory and reckless lending comes at a cost to taxpayers, leading to the
$700 billion federal bailout.
Congressional testimony, court records, interviews, academic papers and news stories over the past
decade reveal contrasting trends with state and federal bank regulators. The states work together. The
federal agencies compete with each other, and with the states.
The feds were set up as rivals. Bank oversight is "the only place I know of where regulated entities get
to pick their regulators," said Kathleen Keest, with the Center for Responsible Lending.
The two agencies exist on funds assessed from members, though the president appoints their directors.
"They are competing with each other for the business," said Keest, a charge officials at both agencies
denied.
In what appears to be an enticement to state-chartered banks, the OTS on its Web site boldly advertises
its ability to pre-empt state laws and regulators.
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Mortgage system crumbled while regulators jousted
Page 4 of5
"Our examiners are very focused on predatory lending, and on inappropriate lending," the OCC's chief
operating officer Polakoff said.
To its credit, the OCC participated in a settlement in 2000 with Providian National Bank forcing it to
pay $300 million to consumers for deceptive credit card practices. But according to publicity afterward,
the California state attorney general and the San Francisco district attorney forced the issue.
Williams and Polakoff said they work behind the scenes, privately counseling banks to change their
lending practices without taking public action. Washington's Jarvis said that's part of the problem,
"when it comes to protecting the public, we do a much better job."
Cross described feeling a chill reading what he called a "how to rip people off' manual he obtained by
subpoena from state-chartered First Alliance Mortgage Company, a California company. It bluntly
instructed employees how to trap vulnerable customers in a room, distract them with banter and stick
them with outrageous fees and rates they couldn't afford, he said.
The Washington Department of Financial Institutions forced First Alliance to leave the state. Joining the
effort were an Alameda County, Calif., deputy prosecutor, state attorneys general around the country,
and the Federal Trade Commission, which operates separately from the federal bank agencies. The
company owners -- who declined to talk with the Seattle P-I -- sought bankruptcy protection. They also
paid $60 million to victims in a settlement.
As a result of the same investigation, Lehman Brothers also was found liable in a federal lawsuit in
California for knowingly financing the First Alliance lending practices, a rare case where a Wall Street
firm was held liable for 'financing abusive loans.
Lehman filed for bankruptcy protection in mid-September, leading to what has become the notorious
sound bite from presidential candidate John McCain, long a supporter of market deregulation, that "the
fundamentals of our economy are strong."
State investigators -- led by Washington -- produced other big settlements with Household Finance for
$484 million in 2002 and Ameriquest for $325 million in 2006. Ameriquest was owned by nowdeceased Roland Arnall, a multimillion-dollar contributor to President Bush's 2004 re-election
campaign.
Earlier this week, Countrywide Financial Corp., recently acquired by Bank of America, agreed to reduce
loan payments and halt foreclosures, at a cost of$8.7 billion nationwide. California, Illinois and'Florida
led that multistate effort.
Cross said certain state regulators, all members of the Conference of State Bank Supervisors, consult
regularly to coordinate battles against predatory lending. He cited Gov. Chris Gregoire as a leading
participant when she was attorney general, as well as her successor, Rob McKenna.
But the feds won the pre-emption war, unless Congress overturns the whole system next year. Frank has
indicated he might try.
The U.S. Supreme Court ruled in a split decision last year that the acc has absolute right to insist on
exclusive oversight without states intervening. The case involved Wachovia, a Charlotte, N.C.-based
lender that subsequently crumbled under an avalanche of subprime problems and is now up for sale.
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--
Mortgage system crumbled while regulators jousted
-------------------------,
Page 5 of 5
But Joe Vincent, general counsel for Washington's bank regulator, said he doesn't care what the
Supreme Court ruled. "It was wrong," he said.
SECOND OF A TWO-PART SERIES
NO LIABILITY: Wall Street was shielded from lawsuits that would have protected borrowers and halted
a frenzy of buying and selling that ultimately led to the current financial meltdown.
Read the first part of the series at seattlepi.comI382707.
P-/ news researcher Marsha Milroy contributed to this report. Reporter Eric Nalder can be reached at
206-448-8011 or ericnalder@Seattlepi.com.
© 1998-2010 Seattle Post-Intelligencer
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.--------~-----------
-
--- - - - - - - -
C)
Comptroller of the Currency
Administrator of National Banks
Washington, DC 2021
OCC Working Paper
IThis paper is a work in progress circulated to stimulate discussion and comment.1
Economic Issues in Predatory Lending
July 30, 2003
This paper contains a summary and analysis of key statistics and studies on the issue of predatory lending.
The piece specifically addresses the major questions that have been raised on this topic:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
What is a predatory loan?
How and 'to what extent are banks engaged in predatory lending?
Do high interest rates and fees represent predatory practices?
What is the relationship between interest rates charged on subprime loans and borrower risk?
Is the structure of interest rates among subprime credit grades similar to that within the speculative
grade corporate bond market?
Are elevated risks in the subprime relative to the prime market simply a matter of degree, or is there
also a difference in kind?
To what extent do higher servicing and other costs account for the level of subprime interest rates?
What is the evidence for lack of competition and pricing inefficiency in the subprime market?
What is the evidence that subprime providers earn excess profits or economic rents?
Do anti-predatory laws effectively restrain abusive lending?
What is the evidence that anti-predatory laws restrain legitimate lending?
Is the pattern of subprime lending activity in lower income and minority locales different than that in
higher income areas?
What is the quantitative evidence regarding the percentage of subprime borrowers who could have
qualified for a prime loan?
What is the role for eRA in curbing predatory lending abuses?
GLOBAL BANKING & FINANCIAL ANALYSIS
'EXHIBIT
I
\rJ
I. Summary
Concerns about predatory lending abuses have prompted financial service providers, banking regulators
and legislators to seek ways to curb these practices while maintaining legitimate credit flows to subprime
borrowers. Proponents of anti-predatory measures argue that there is substantial evidence that such
legislation has inhibited predatory lending tactics without damaging the burgeoning subprime market.
It has also been argued that inexperienced borrowers are steered by predatory lenders into loans that are
overpriced relative to the borrower's risk profile. This is viewed as justification for government
intervention to protect the most vulnerable in society. Moreover, many suggest that predatory practices
are often specifically aimed at minority and elderly borrowers, for whom traditional banking services are
often less accessible. A series of HUD studies (2000)1 has documented the concentration of subprime
lenders in low-income and minority communities in five cities including Atlanta, Los Angeles, Baltimore,
New York and Chicago. HUD found that subprime loans were three times more likely in low-income
neighborhoods than in high-income neighborhoods and five times more likely in African American
neighborhoods than in majority neighborhoods.
A study prepared by Calvin Bradford (2002) 2 on subprime lending patterns in all of the nation's 331
metropolitan areas reports similar findings and asserts that the magnitude of these disparities raises
serious questions about the extent to which risk alone could account for such patterns. Bradford's
analysis suggests that racial disparities actually increase as income increases suggesting that a portion of
subprime lending is occurring with borrowers whose credit histories would qualify them for lower-cost,
conventional prime loans. There are also those analysts who suggest that CRA be utilized to create
disincen'tives to banks that engage in or provide indirect support for predatory lending.
By contrast, others who have analyzed the market for subprime credit have obtained results that suggest
that regulatory and legislative initiatives to combat predatory practices are unnecessary and may be
counterproductive. They believe that self-regulation and better enforcement of existing laws represent the
best practical solution to predatory practices. Indeed, there is substantial empirical evidence that antipredatory statutes can impede the flow of mortgage credit, especially to low income and higher-risk
borrowers, and that any reduction in predatory abuses resulting from these measures is probably achieved
at the expense of many legitimate loans.
North Carolina, which recently enacted legislation in this area, has been the subject of some analytical
research. A recently released study by Roberto G. Quercia, Michael A. Stegman, and Walter R. Davis
(2003)3 examined changes in subprime lending activity before and after enactment of North Carolina's
anti-predatory law. The authors conclude that there has been a large decline in subprime refinance
originations with predatory terms. They also indicate their research suggests that lending to high-risk
applicants, which they define as having FICO scores below 580, in North Carolina has followed patterns
similar to those in states without anti-predatory statutes. This implies that there was no reduction in
access to credit among these borrowers as a result of the law. However, the authors do not address the
impact of the law on subprime borrowers with FICO scores in the 580-660 range, which is recognized as
the heart of the industry, and they also acknowledge that their results could be impacted by changes in the
structure of the data base used in the analysis. On the other hand, Gregory Elliehausen and Michael Staten
(2002/, report lending to borrowers in North Carolina with FICO scores below 580 actually weakened
more than for any other credit group after the law began to be implemented. s Their analysis suggests that
the decrease in lending to low income and higher risk borrowers in North Carolina was due to increased
underwriting costs, potential legal liability and other factors associated with the law. The study also
shows that the interest rates on loans within all credit grades before and after enactment of the first part of
the statute closely reflected the loans' risks.
2
In fact, the North Carolina statute is actually considered less onerous than those enacted in other states.
One of the most important channels through which anti-predatory laws can impede credit flows is by
reducing the willingness of agency and non-agency securitizers to buy loans originated in a covered
jurisdiction. This can prompt lenders to cut back or eliminate their loan originations in these jurisdictions.
By disrupting the secondary market, the impact of these laws can potentially go beyond simply reducing
the number of loans with specifically forbidden features, such as prepayment penalties in the case of the
North Carolina law. Whereas the government-sponsored enterprises (GSEs) have not announced
restrictions on the purchase of mortgage loans in North Carolina, they have cut back or even eliminated
entirely their purchase of high cost and other loans in Georgia and New York as a consequence of more
severe anti-predatory laws enacted in those states.
In November 2002, Fannie Mae announced that it would not purchase mortgages that qualify as "highcost home loans" under the Georgia Fair Lending Act. Fannie Mae reissued this "no-buy" policy in
March 2003, following the amendments to the Georgia law. In March, Fannie Mae also announced that it
would not purchase loans that qualify as "high cost home loans" under New York Banking Law § 6-1.
Freddie Mac has similar "no-buy" policies concerning "high cost home loans" subject to the amended
Georgia Fair Lending Act and the New York law. In addition, Fannie Mae will not purchase any
mortgage originated in Georgia between October 1,2002 and March 7, 2003, due to "continued
uncertainty in the marketplace" regarding those-loans originated following enactment of the original
Georgia Fair Lending Act and the date of the amendments. Freddie Mac has adopted a similar policy.
Indeed, anti-predatory laws with vaguely defined compliance procedures or that involve unlimited
potential liability make securitization of loans originated in that jurisdiction problematic, since lender
violations may siphon off funds available to pay investors. When the magnitude of potential damages is
exorbitant, it may be difficult to shield investors in these securities sufficiently to obtain an investment
grade rating. When this occurs, loans subject to a particular statute may be effectively unsecuritizable. 6
Indeed, all of the major rating agencies have recently announced severe strictures for the rating of MBS
pools connected with loan purchases in Georgia, New York and New Jersey. This could easily end up
restricting subprime activity in those states even more severely than has been the case in North Carolina.
Opponents of expanded anti-predatory legislation typically assert that the concept of abusive lending has
been defined too broadly and that the higher interest rates typically associated with subprime mortgages
are for the most part justified by the elevated level of risk inherent in this form of lending. For example,
economists point out that interest rates on lower-quality subprime loans are higher than those for better
quality subprime mortgages. In late 2002, subprime loans classified with a "C" credit grade carried an
average interest rate of 11.8%. Those graded in the "B" category carried a I 0.6% average rate.
Meanwhile, subprime loans within the "A" credit grade carried a still lower 9.4% rate. The relationship
between delinquencies and interest rates paints a similar picture. Delinquency rates climb steadily for
subprime loans with higher interest rates. This suggests that subprime lenders are charging higher interest
rates to riskier borrowers.
In addition, empirical data suggest that subprime loans are different from prime loans in terms of the
greater variety and complexity of risks and this also affects pricing. While FICO scores are good
predictors of delinquency patterns in both the subprime and prime markets, the pricing discrepancies
between the two markets cannot be expected to conform solely to differences in traditional risk measures.
In the prime market, for example, as loan-to-value ratios decrease (i.e., as equity increases) the
delinquency rate decreases, as would be expected. In the subprime market, by contrast, LTVs have little
relationship with loan performance. Analysts who have studied the subprime market find that loans to
borrowers with blemished credit histories are more costly to service than the relatively commoditized
mortgage loans extended to prime borrowers. This also accounts for the higher interest rates on subprime
loans.
3
In the view of some analysts, the subprime market suffers from pricing inefficiencies that enable financial
service providers to extract excessive profits or above-normal returns. However, as a relatively new
market, it would not be surprising to observe high returns prevailing in the short term. As the market
matures, as seems to be happening quickly, pricing will become increasingly competitive. Indeed,
interest rate spreads have narrowed in the subprime market relative to prime loans since the early 1990s
when the market first started to take off. In the early I 990s, the spread between prime mortgage rates and
A- rated subprime mortgages, was some 250 basis points. These have narrowed and at present are
approximately 175-200 basis points. This has occurred despite the small number of subprime mortgage
lenders. At present there are only 178 lenders engaged primarily in supplying subprime mortgage credit
out of a total of over 7,000 bank and nonbank home mortgage lenders. Moreover, since 1999, the number
of subprime lenders has actually declined by 74 due to a string of bankruptcies and consolidations in the
industry.
The substantially higher risks and servicing costs associated with subprime lending, and perhaps the drop
in the number of subprime lenders, appear to account for the lion's share of the pricing differential
between subprime and prime mortgages. Therefore, the empirical data do not support the contention that
subprime providers in the aggregate are earning excess profits. The low interest rate environment which
has boosted demand and allowed lenders to spread their costs over more units of production is probably
temporary. If rates should rise, or if the employment situation should deteriorate further, it is possible that
housing prices could pull back. Consumer balance sheets, especially among lower income and riskier
borrowers, could also deteriorate and subprime losses could jump, placing subprime lenders under
financial pressure. There are tangible risks in making the blanket assertion that the subprime sector is
earning abnormal returns, as even the current rate of profitability in the industry could easily dry up under
less favorable economic circumstances.
The success enjoyed by many subprime providers in the mid-1990s reversed itself swiftly as the financial
markets entered a period of turmoil. From late 1997 through the following year, subprime lenders that
had underestimated prepayment rates and loan defaults were forced to restate the value oftheir servicing
rights, resulting in a shrinkage of their capital base. Market participants drove down the value of the
outstanding debt and asset-backed securities of sub prime lenders. 7 Simultaneously, the financial turmoil
of the late 1990s engendered severe capital market disruptions. This drove up funding costs for subprime
providers and in some cases these firms were squeezed out of the capital markets entirely. In fact, during
1998, Wall Street cut back its purchases of mortgage-backed securities and in particular the subordinated
portions of subprime securitizations, thus seriously truncating secondary market liquidity of these loans.
As a result, several subprime lenders were forced to file for bankruptcy protection during 1998. In
addition, according to the FDIC, subprime lending was involved, at least to some extent, in each of the
three most costly depository institution failures of 1999.8
There is little data suggesting that banks themselves are engaged in predatory lending to any significant
degree. Banks already face disincentives to originating subprime mortgages, especially loans that might
be perceived as predatory. Banks are sometimes cautious about increasing lending to consumers with
impaired credit since they could come under increased scrutiny for charging higher interest rates or for
having to implement more foreclosures in a community. Subprime lending also has the potential to raise
increased safety and soundness issues for banks. 9
Although some banks engage in subprime lending, most banks are not subprime lenders. According to
HUD, there were 178 lenders whose business focus was subprime mortgage lending in 200 I. The
majority, or 112 (63%), were independent mortgage companies. Of the remaining lenders, 30(17%) were
non-bank affiliates and only 36 (20%) were depository institutions or their direct subsidiaries. These
depository institutions represented only 0.6% of the 6,423 depository institutions that filed HMDA reports
4
in 2001. 10 Rather, an overwhelming proportion of subprime providers are non-bank mortgage lenders or
finance companies. II Some of those lenders are independent companies others are non-bank affiliates or
subsidiaries of insured banks.12
II. Background: Trends in the Subprime Market
Nationally, subprime mortgage originations have skyrocketed since the early 1990s. Finance companies,
non-bank mortgage companies and to a lesser extent commercial banks have become active players in this
area. Several factors contributed to the rapid growth of the subprime mortgage market including: (i) the
Tax Reform Act of 1986, which eliminated the deductibility of most consumer interest payments except
for mortgage interest; (ii) increased securitization of subprime loans which facilitated expanded capital
flows to the subprime market; 13 (iii) growing competition in the prime market which squeezed margins on
loans to higher-quality borrowers, thus pushing lenders increasingly toward the subprime market; (iv) the
rapid escalation in home prices during the 1990s which allowed borrowers more money with the same
loan-to-value ratio. More recently, the low interest rate environment has led to an unusually robust
housing sector. This has also powered expansion in subprime originations.
The subprime segment of the mortgage market is undergoing rapid transition. Prior to the early 1990s,
most subprime mortgages were small-balance second liens. During the 1990s, by contrast, the subprime
market has shifted to originating primarily first lien mortgages. By 1999, over 75 percent of loans in the
subprime mortgage market were first liens. At the same time, the lion's share of these subprime first lien
mortgages, or 82 percent, were used for refinancing rather than for purchasing a home. 14 Subprime
refinance mortgages are typically smaller than prime refinance mortgages. According to 1998 HMDA
data, the median loan amount for a subprime refinance mortgage was $63,000 compared to $98,000 for a
prime refinance mortgage. IS
Chart 1
In 1994, just $34 billion in subprime mortgages were
originated, compared with over $213 billion in 2002
(Chart 1). The proportion of subprime loans compared
with all home loans also rose dramatically. In 1994,
subprime mortgages represented 5.0% of overall
mortgage originations in the U.S. By 2002, the share had
risen to 8.6%. Meanwhile, securitized subprime loans
increased from $11 billion in 1994 to $83 billion in 1998
before retreating back to $60 billion in 1999. The
fallback was likely related to turmoil in the industry
during that period that resulted in increased failures and
consolidation. 16
Subprime Mortgage Originations
250 ,,-_---,...-,...-,...-,...-,...--,...----,
;;
200 + - - - - . . . . . , - - - - - - - _ 1
c
~ 150+---~-----_I
~
!
loOf.---------_Ii
8
1994
Source: U.S. Dept. of the
Treasurv. 2003 MMSA
2002
Year
III. Review of Major Economic Issues in Predatory Lending:
This section provides a summary of the major predatory lending issues. We examine the arguments of
proponents of anti-predatory lending laws as well as the often more formal statistical analyses published
by economists in this area. A good deal of the piece also represents our own analysis. While proponents
of anti~predatory measures assert that there is substantial evidence that such legislation has inhibited
predatory lending tactics, others who have analyzed the market for subprime credit have obtained results
that suggest that any reductions in predatory lending achieved by such measures come at the expense of
fewer legitimate loans as well.
5
Issue #1: What Is A Predatory Loan?
There is no single, generally accepted definition of a "predatory loan." Indeed, disagreements over the
definition of predatory lending have often served to confuse the debate over this issue. The federal Home
Ownership and Equity Protection Act (HOEPA) of 1994 has served as the basis for many of the
definitions generally in use at present. The act classifies mortgage loans with relatively high interest rates
and fees as potentially predatory and imposes upon them a range of additional consumer protections: The
term has been employed loosely by community groups, policymakers and regulators to refer to a wide
range of practices.
Kathleen Engel and Patricia McCoy (2001) define predatory lending as exploitive loan practices
involving one or more of the following five characteristics: (i) loans structured to result in seriously
disproportionate net harm to borrowers; (ii) rent seeking that is harmful to borrowers; (iii.) loans
involving fraud or deceptive practices; (iv) other instances of lack of transparency in loans that are not
actionable as fraud; (v) loans that require borrowers to waive meaningful redress. 17 Other participants in
the debate, such as the Association of Community Organizations for Reform Now (ACORN), assert that
predatory lending occurs when loan terms or conditions become "abusive" or when borrowers who should
qualify for credit on better terms are targeted instead for higher cost loans. IS
Within the academic literature on predatory lending, economists typically suggest that judgments as to
whether a loan's price is high or abusive in the absence of additional concrete economic analysis of
underlying risks, costs and other fundamentals, such as the level of demand for credit, are not a valid
basis for defining predatory lending. These analysts point out that without a precise definition, many of
the published figures on predatory lending abuses become less convincing. There have been a variety of
estimates on the societal costs of predatory lending released in the media. However, a closer examination
of some of these studies suggests that with even slight definitional or methodological changes, a case
could be made for significantly smaller estimates of abusive lending costs.
Predatory loans can occur in a variety oflending areas, including home mortgages, auto loans, credit
cards and payday loans. Researchers have typically directed their efforts at analyzing predatory
residential mortgage lending due to the more severe financial consequences to borrowers resulting from
abusive tactics in this area. 19 Specific terms or measures that many associate with predatory lending
include high interest rates and fees, balloon payments, high loan-to-value ratios, excessive prepayment
penalties, loan flippings, loan steering and unnecessary credit insurance.
Issue #2: How and To What Extent Are Banks Engaged In Predatory Lending?
Banks and their direct subsidiaries are not major participants in the subprime market and there is scant
evidence that they are engaged in predatory lending practices. Putting aside for the moment the issue of
what actually defines a predatory loan, banks could potentially participate in predatory lending through a
number of channels. The most important of these is simply through direct lending by originating
predatory mortgages. There are also indirect and inadvertent ways in which banks could facilitate
• "HOEPA loans" are closed-end loans secured by a consumer's principal dwelling (other than a reverse mortgage or
a loan to finance the acquisition or initial construction of the home) that are higher cost because they exceed
specified statutory and regulatory interest rate or fee thresholds. Such loans are subject to specific disclosure
requirements and substantive restrictions. Among other things, HOEPA prohibits negative amortization, increases in
the interest rate upon default and balloon payments for covered loans with a term of less than five years. It also
restricts the use of prepayment penalties and due on demand clauses in covered loans. HOEPA also prohibits the
~efinancing of a covered loan to another covered loan in the first year of the loan, unless the refinancing is in the
borrowers interest.
6
predatory lending practices. There is the potential that banks could inadvertently buy securities that were
issued on RMBS pools (i.e. pools of residential, mortgage-backed securities) containing predatory loans.
Banks could also unintentionally facilitate predatory lending practices through the use of third party loan
brokers. In order to prevent indirectly supporting abusive practices, banks are expected to establish
appropriate due diligence and monitoring procedures to adequately address such ri~ks.
There is little data suggesting that banks themselves are engaged in predatory lending to any significant
degree. The majority of mortgage loans to LMI (Iow-to-moderate income) borrowers t and in LMI
neighborhoods are originated by lenders covered under eRA. However, eRA-covered institutions are
primarily prime lenders. Between 1993 and 1998, eRA-covered institutions accounted for eighty-three
percent of the growth in prime loans to LMI borrowers. By contrast, eRA covered institutions were
responsible for only fifteen percent of the increase in subprime loans during the same interval. 2o :
According to HUD, there were 178 lenders that concentrated primarily on subprime mortgage lending in
2001. The majority, or 112 (63%), were independent mortgage companies. Of the remaining lenders,
30(17%) were non-bank affiliates and only 36 (20%) were depository institutions or their direct
subsidiaries. These depository institutions represented only 0.6% of the 6,423 depository institutions that
filed HMDA reports in 2001. 21 Rather, an overwhelming proportion of sub prime providers are non-bank
mortgage lenders or finance companies. 22 Some of those lenders are independent companies others are
non-bank affiliates or subsidiaries of insured banks. 23
Issue #3: Do High Interest Rates and Fees Represent Predatory Practices?
High interest rates and fees could be the result of a variety offactors unrelated to predatory practices.
However, some suggest that interest rates on subprime loans, if they reach a sufficiently high level, are in
and of themselves evidence of predatory practices. A similar argument is made for high fees. Indeed, as
mentioned earlier, since its passage in 1994, the federal Home Ownership and Equity Protection Act
(HOEPA) has classified mortgage loans with relatively high interest rates and fees as potentially
predatory. In recent years, many state and local governments have also enacted or proposed their own
t As defined under CRA, LMI borrowers are those having household incomes that are less than eighty percent of the
local median family income. [Engel and McCoy (citing Litan), p.1 footnote 3]
t The data as to bank involvement in predatory lending is therefore vague, although there is some anecdotal
evidence on the issue. Numerous borrowers sued the failed subprime lender Superior Bank in alleging that the
institution engaged in predatory lending (Federal regulators seized Superior Bank in July 200 I.) The plaintiffs have
alleged that Superior encouraged them to take on loans they did not need or could not afford, and engaged in various
types offraud. Separately, the U.S. Department of Justice brought fair lending actions against Fleet Mortgage Corp.
(U.s. v. Fleet Mortgage Corp. is May 7,1996 (E.D.N.Y.» and Huntington Mortgage Corp. (U.s. v. Huntington
Mortgage Co. is Oct. IS, 1995 (N.D.Ohio» for allegedly charging higher rates or fees to minorities than similarly
situated nonminorities. [From Engel and McCoy, p.7 and p.14, footnote 47]
At the same time, a more recent case found no evidence of abusive practices. This involved a revised regulation
issued by OTS to implement the Alternative Mortgage Transaction Parity Act. In supporting the OTS's decision to
distinguish between supervised depository institutions and unsupervised housing creditors and to retain preemption
of state laws with respect to the former, but not for the latter, the State Attorneys General stated: "Based on
consumer complaints received, as well as investigations and enforcement actions undertaken by the Attorneys
General, predatory lending abuses are largely confined to the subprime mortgage lending market and to nondepository institutions. Almost all of the leading subprime lenders are mortgage companies and finance companies,
not banks or direct bank subsidiaries." [Brief for Amicus Curiae State Attorneys General, National Home Equity
Mortgage Association v. OTS, No. I :02CV02506 (GK) (D. D.C. filed March 21, 2003) at 10-11.)]
7
regulations that impose even more restrictive regulations than does HOEPA. The first statute below the
federal level for regulating high-cost mortgage loans was enacted in North Carolina in July 1999. That
law covers more loans than the federal law and its restrictions are more severe. A recent law enacted in
Chicago defined predatory loans as any mortgages with interest rates more than five percentage points
above the yield on U.S. Treasury securities of comparable maturity.
.
Others who have analyzed the market for subprime credit, point out that loans with higher interest rates
than those seen in the conventional prime market are not necessarily predatory. The higher interest rates
on these loans may simply reflect the higher risks and servicing costs associated with subprime lending.
To some extent, higher rates may also reflect robust demand for subprime credit (empirical examination
these issues is taken up later on).§
Table I
Subprime Mortgage Market Data"
Share of All 2001 I-Family Mortgage Originations·
JO-Year, Fixed APR Interest Rate··
Serious Delinquency Rate •••
Loss Rate (% of original UPB) ••••
AIt-A or A-Minus
AA
A
AA+
0.47
3.42
1.94
7.2
9.1
9.4
I 36
5 88
10 19
005
051
105
!!
.{;
0.87
10.6
15 83
164
0.66
11.8
21 00
280
CC or D
0.89
12.75
23.56
262
All Subprime
8.25
9.83
1044
1 10
Source: Data collected and assembled by Cutts and Van Order (citing B&C Lending. Option One. Loan Performance. and Inside Mortgage Finance.) Notes following
are edited version ofCutt's &Van Order·s.• Share of all mortgages based on 2001-dollar volume of onglnatlons. Inside B&C Lending (2111102). InsIde Mortgage
Fmance (1/25/02). and OptIon One Mortgage Corporation (June 2002» .•• Interest rates are from the week ended 9/612002. Rates are APRs calculated using average
points and fees with simple Interest rate uSing the standard APR formula; Pnme rates are from InsIde Mortgage Finance (9/6/02); Subpnme rates are from Option One
Mortgage Corporation (OOMC) for Legacy Plus Platinum (AA+) and Legacy (all others) program loans for Colorado and Utah. LTVs are assumed to be 80% in .11
cases except C and CC quality loans. whIch assume 75% and 65% LTVs. respectIvely. Option One's pnces are wholesale; to get retaIl pnces 50 bps were added for
avera lC broker compensation . ••• Delinquency and loss data from OPtion One Mortgage Corporation (2002). ····Loss rates are total net cumulative losses.
Issue #4: What Is The Relationship Between Interest Rates Charged on Subprime Loans and
Borrower Risk?
The concept that high interest rates in and of themselves represent an abusive practice is a popular
argument in some quarters. However, others make the more economically sophisticated assertion that
one of the key symptoms of predatory lending is a lack oj correlation between price and borrower risk.
They assert that vulnerable and
Table 2---::---=-_'fr"_ _ _ _ _ _- .
inexperienced borrowers are
Prime Mortgage Market Data
sometimes steered by predatory
All
Prime
lenders into loans that are
Conventional
FHA
overpriced relative to the
9.43
82.32
Share of All 2001 I-Family Mortgage Originations •
borrower's risk profile and that as a JO-Year, Fixed APR Interest Rate··
6.14
6.11
Serious Delinquency Rate •••
0.55
4.45
result subprime lenders make
Loss Rate (% ofori2inal UPB) ••••
0.29
0.01
excessive profits.
Source: Data collected and assembled by Cutts and Van Order (citing B&C Lending Loan Perfonnance.
By contrast, economists generally
view the subprime lending area as
and Inside Mortgage Finance.) Notes following are edited version ofCutt's &Van Order·s. • Share of
all mortgages based on 200 I-dollar volume of originations. Inside B&C Lending (211 Jl02).lnside
Mortgage Finance (1/25/02).·· Interest rates are from Inside Mortgage Finance for the week ended
9/6/2002. Rates are APRs calculated using average points and fees with simple interest rate using the
standard APR formula .... Delinquency rates from Loan Performance. San Francisco. CA as of June
30.2002. ····Loss rates based on Freddie Mac experience for conventional conforming loans; FHA loss
rates from are from Weicher (2002). Loss rates are total n;.:;et:..;c",um=ul.:::at,-,iv~e.:..:lo::::ss::;es:::.._ _ _ _ _ _ _-,
§ Banking regulators generally designate a "subprime" borrower as having one of the following characteristics: two
or more 30-day delinquencies in the last 12 months; one or more 60-day delinquencies in the last 24 months;
judgment, foreclosure, repossession, or charge off in the prior 24 months; bankruptcy in the last 5 years; a high
default probability as measured by a credit score of 660 or below; or a debt service-to-income ratio of 50% or
greater. (See oee Bulletin 2001-6.) Generally, a credit score of 680 qualifies a borrower for consideration for a
prime loan, whereas a score below 620 virtually eliminates the possibility.
8
26
highly competitive with a strong correlation between price and borrower risk. The empirical evidence
shows that as interest rates on subprime loans rise the probability of default and the probability of loss
given default also increase.
For example, the data demonstrate that subprime mortgages have significantly higher delinquency rates
than prime mortgages. As illustrated in Table I, serious delinquency rates for subprime mortgages in the
aggregate were 10.44% in late 2002 (seriously delinquent rates are the percentage of loans that are over
90 days past due or in foreclosure). This is far above the serious delinquency rate for all prime
conventional mortgages of 0.55% (Table 2).
Chart 2
Serious Delinquency Rates for Prime and Subprime
Mortgages by Credit Score
25.-------------------------~------~~
20~~:~----------------~------···--~----~
~
~
15~0:~~--------------------------------~
'1--f;rrr--------------------------:-l
t~
~ +-u-P'r-. -L~:1. ,'- L:i.L,. J. : .I[l~ nL.,. .Unrl_._lr.;.L.~,. L:m~mJ. ,. l:.Jfil:
~CL,....~--I
'" '" ~ ~ ~ '" ~ ~ ~
~ ~ [
~ '".
. ~ ~ ~ ~ '"~ ~ ~ ~ * ~ . «
10
IJf-
~;.
1
on
L,..:!ilL:.l.'.,..Lrr.1:L',..l:."-'cL,..o..,..
~
on
y
0
0
0
0
i3
~
In addition, delinquencies increase
steadily with paper grade in the subprime
market. As illustrated in Table I, for
subprime loans issued in 2002, AA+
subprime credit"" was associated with
serious delinquency rates of 1.36%. AA.
A, B, C and CC subprime credit were
associated with steadily rising serious
delinquency rates of 5.88%, 10.19%
15.83%,21.00% and 23.56%
respectively.
Credit Score
Moreover, as illustrated in Chart 2, based
on data assembled by OTS from the
Mortgage Information Corporation (MIC) database,27 the relationship between credit score and serious
delinquency rates is similar to that between paper grade and delinquency rates, with a steady rise in
delinquencies as credit score decreases. tt
Source: OTS (citing MIC). LTV. < 80%
Similar to delinquencies, losses on subprime loans are also higher than on prime loans. As illustrated in
Tables I and 2, the average loss rate for subprime loans in 2002 was 1.10% versus 0.0 I % for all
conventional prime loans. That these loss rates appear low can be deceptive. Loss rates on residential
.. Mortgage underwriting guidelines differ among lenders. Within the subprime sector, borrowers are often graded
from the least risky "A minus" borrower to the most risky "0" grade borrower. However, these grades are not well
defined across the industry. Mortgage Information Corporation (MIC) defines "A minus" as the least risky of its
subprime grades. By contrast, Option One Mortgage Corporation, the source for the subprime data used in Table I,
relies on its own unique subprime classification system. Option One's AA+, AA and A grades are similar to what
are typically referred to as AIt-A and A-minus subprime grade loans, and their CC grade loans are similar to what
are typically referred to as "0" grade subprime loans in the mortgage industry. [Information on Option One from
"On the Economics of Sub prime Lending," by Amy Crews Cutts and Robert Van Order, March 2003, p.4, footnote
6.]
Although there is a close overall relationship between paper grade and credit score, there is also considerable
variability of credit scores among subprime mortgages in each grade level. In the MIC database, for example, the
median "A-" subprime mortgage had a credit score of630, although scores ranged from a high of670 to a low of
low of 590. The median B subprime mortgage had a credit score of 570, with scores ranging from a high of 61 0 to a
low of 550. Under the Option One system, the A credit grade is associated with credit scores ranging from 660 to
560. The B grade with 640 to 540. [Information on Option One from Cutts and Van Order, appendix Table 4.
Information on MIC from, "What About Subprime Mortgages," Mortgage Market Trends, Research and Analysis,
Office of Thrift Supervision, Washington, ~C. Volume 4, Issue 1, June 2000, p.IO.]
tt
9
portfolios are generally subdued compared with other lending areas since they are collateralized. A loss
rate on a residential portfolio of 1.10% is considered high. Loss rates among Band C grade subprime
loans in the Option One sample (Table I) actually averaged around 2.2% in 2002.
Table 3
Percentage Distribution of
Subprime and Prime
Mortgage Originations By
Year
(By $ Volume)
Subprime
Mortl:ol:es
33.3%
36.2%
16.6%
7.1%
2.8%
1.6%
0.9%
1.6%
1999
1998
1997
1996
1995
1994
1993
Pre1993
Source: OTS (ciling MIC)
Prime
Mortl:ol:es
19.2%
30.8%
10.0%
7.3%
5.2%
5.5%
11.9%
10.2%
In addition, the loss rates reported in Table I tend to understate the
severity of risks in the subprime area. High volume growth has
repressed aggregate loss rates throughout the residential market in
general (loss rates on recently originated loans are generally low relative
to more mature loans). In addition, the average age of outstanding
subprime loans is lower than in the prime area (Table 3). This tends to
"cover up" the severity of losses in the subprime relative to the prime
area when judged by the average cumulative loss rate figures presented
in Tables I which encompass all vintages. Examination of cumulative
loss rates for earlier vintages of subprime loans provides a more
revealing picture. According to data from Moody's, while cumulative
loss rates on the 200 I and 2002 vintages of subprime loans currently are
just 0.84% and 0.1 % respectively, cumulative losses on the 1996, 1997
and 1998 vintages are a far higher 4.78%,4.49% and 4.77%.
The higher losses associated with subprime lending suggest that this is a
much riskier undertaking than the prime area. This does not imply, however, that profits in the subprime
sector should necessarily be below those in the prime sector. In order to offset the greater risk, as well as
the higher servicing and other costs associated with subprime lending, providers charge higher interest
rates. In fact, according to traditional investment
Chart 3
theory, subprime lending should provide higher
Interest Rates and Serious Delinquency Rates in the
expected returns than prime lending specifically
Subprime Sector
due to the higher risk. 28
Table I contains 30-year fixed interest rates for
subprime loans issued in 2002 by paper grade. As
expected, interest rates on lower quality loans are
higher than those for the better quality subprime
mortgages. While the average 30-year fixed
interest rate for all conventional prime loans in the
aggregate was 6.14%, AA+, AA, A, B, C, and CC
subprime loans carried rates of7.2%, 9.1%, 9.4%,
10.6%, I \.8% and 12.75% respectively?9
<=8
8-9
9-10
10-11
"-12
12-13
13-14
14-15
15-16
>16
Coupon Rate
Source: OTS (citing MIC)
The relationship between interest rates and delinquencies paints a similar picture. As illustrated in Chart
3, serious delinquency rates on subprime loans climb fairly steadily for loans with higher interest rates.
These data support the view that subprime lenders are charging higher rates to riskier borrowers. (The
decline in serious delinquency rates for the highest interest rate category is probably not meaningful.
According to OTS, only one percent of loans in the MIC sample data carry a coupon of over 16 percent.
This makes it difficult to draw any solid conclusions.io
Issue # 5: Is The Structure ofinterest Rates Among Subprime Credit Grades Similar To That
Within the Speculative Grade Corporate Bond Market?
The corporate bond market is highly competitive. Yield spreads between bonds with varying credit
ratings tend to accurately reflect differences in underlying risk. The data show that spreads between
adjacent credit grades in the subprime market are generally analogous to those between ratings categories
10
in the speculative grade corporate market. This suggests that interest rates in the subprime market also
accurately account for differences in risk between credit grades.
Table 4
Spreads in the Subprime Mortgage and
As illustrated in Table 4, the spread
Speculative Grade Corporate Bond Markets
between AA + and AA subprime
Subprime
Corporate
Subprime
Corporate
mortgage loans in the Option One
sample (from Table I) was 190
BBB BB+
BB+ BBIBBbasis points in September of 2002.
Spread (bps)
246
190
23
30
Meanwhile, the spread between
BBB and BB+ corporate bond
yields was a similar 246 basis points at that time. Spreads on corporate bond yields are fairly volatile
over the course of the business cycle relative to those in the subprime lending area, so a spread of246
basis points could be considered generally in the same range as the 190 basis point spread observed in the
subprime market. In the corporate bond area, BBB is the lowest rating within the investment grade
category, while BB+ represents the first rung of the speculative category. These two bond rating
categories can be considered as more or less analogous to the Option One AA+ and AA subprime
categories. Meanwhile, the 23 basis point spread between BB+ and BBIBB- rated corporates is also
within the same general range as the 30 basis point spread between AA and A subprime loans.
Admittedly, the subprime and corporate markets are very different structurally. In addition, as mentioned
above, cyclical factors that have short-term impacts on corporate bond yields, especially macroeconomic
shocks that can spark rapid flights to quality, add a great deal of volatility to corporate yield spreads that
is often less pronounced in the subprime mortgage market (the period encompassing the financial market
turmoil in the late 1990s was a notable exception). However, the general correspondence between spreads
in the speculative corporate bond market and those in the subprime area provide some additional evidence
that the subprime market is well functioning and competitive.
Issue #6: Are Elevated Risks In The Subprime Relative To The Prime Market Simply A Matter of
Degree, Or Is There Also A Difference in Kind?
Empirical evidence suggests that subprime loans are different from prime loans in terms of the variety and
complexity of risks, not simply in terms of the degree of risk, and this also probably impacts pricing. As
discussed in the previous section, subprime loans default far more frequently than prime loans. In
addition, however, subprime loans prepay both when interest rates decline and when credit worthiness
improves. Prepayment risk is, therefore, greater for subprime loans. Cumulative monthly prepayment
rates for subprime loans are typically 1.5 to 2 times higher than those for prime loans during periods of
stable interest rates. (During periods when interest rates have fallen sharply, prime prepayment rates have
risen above those in the subprime sector. However, these periods have tended to be brief.)3) In addition,
unlike prime mortgages, more mature subprime mortgages tend to be riskier. This is the case because, in
the absence of other factors atypical in the prime market, such as prepayment penalties, they might have
prepaid had the borrower's creditworthiness improved. In addition, prepayments of subprime mortgages
are more difficult to predict than those of prime mortgages.
Moreover, in the prime market, as the loan-to-value ratio decreases (I.e., as equity increases) the rate of
serious delinquency decreases. This is the expected relationship. In the subprime market, by contrast,
LTVs have little relationship with loan performance. For example, as illustrated in Table 5, for prime
borrowers in the highest-risk category, delinquency rates are 12.49% when LTVs are above 90%. With
LTVs under 70%, (in other words, with increased equity), the delinquency rate for prime borrowers falls
dramatically to 4.2%. By contrast, the highest-risk subprime borrowers show a 27.39% delinquency rate
with LTV s above 90%. However, when LTV s fall below 70%, delinquency rates in the subprime market
11
remain high, in this case at 28.07%. This pattern is repeated for both prime and subprime borrowers in
each risk category. 32
Table 5
Prime and Subprime Loan Performance by
FICO Score and LTV
(Percent of Loans Ever 90+ Days Delinquent
By contrast, higher FICO scores remain
excellent predictors of delinquency
patterns in both the subprime and prime
markets. As illustrated in Table 5,
delinquencies decline as FICO scores
Prime Market
Subprime Market
increase (i.e. as credit worthiness
increases) for every LTV category. This
LTV
FICO Score
FICO Score
suggests a difference in the structure of
Very
Very
risk between the two markets. In other
High
High
Low
Medium
Low
Medium High
High
T2.49
2.11
0.68
27.39 W5 8.27
3.51
words, differences in risk between prime
G.T.
90%
and subprime borrowers cannot be
164
047
1474
945
437
2412
456
80%- 8.41
accounted for simply with reference to the
90%
3.02
0.23
27.42
15.52
11.01
7.39
70%- 6.01
1.00
traditional stratification of credit scores
~~;~ 4.20 2.00
0.64
0.15
28.07
12.01
7.25
3.16
and other underwriting criteria. Since
70%
greater equity does not appear to help
Sou~ce: Cuns and Van Ord~r ~citing Loan Performance. San Francisco, CAl Data is for ~ens of
subprime borrowers stave off financial
medIUm home pnce appreclBlIon. FICO score category. Low «620), Med (620-660), High
•
••
.
(660-720); Very High' (>720). Table format based on display by Cuns and Van Order.
dIfficultIes, thIs further Increases the
disparity in risks between the two markets from the point of view of lenders. Therefore, pricing
discrepancies between the two markets also cannot be expected to conform solely to differences in
traditional risk measures. 33 As underscored by recent failures of subprime providers, success in subprime
lending requires more effective internal controls and risk management expertise than in the prime area.
:us-
Issue #7: To What Extent Do Higher Servicing and Other Costs Account For The Level Of
Subprime Interest Rates?
Some economists and lenders also argue that loans to borrowers with blemished credit records, lower
income and cash flow concerns are more costly to service and originate than the relatively commoditized
mortgage loans extended to prime borrowers due to lack of standardization in underwriting. U They assert
that this, in addition to higher risks, also accounts for the higher interest rates on subprime loans.
Currently, servicers typically charge 50 basis points for servicing subprime portfolios. The going rate for
servicing prime portfolios is generally around 25 basis points. This implies that it costs 25 basis points
more to service a subprime portfolio than a prime portfolio.
However, this figure may be somewhat low. Because the subprime industry is still relatively young,
firms continue to wrestle with the proper figure for servicing costs. Soon after mortgages are originated,
50 basis points may indeed cover all servicing costs ofa subprime portfolio. However, as the portfolio
matures and delinquencies rise, servicing costs inevitably increase. Subprime portfolios are of much
more recent vintage than prime portfolios (Table 3) due to the more recent development of the industry.
As discussed earlier, since loans closer to origination have lower loss rates (Table 6), the rapid growth of
subprime loan volume has held down losses as a percentage of overall loans outstanding. This could be
holding down actual servicing costs in the short term. Therefore, it is possible that 50 basis points may
underestimate the true long-term cost of servicing these portfolios. Market participants generally agree
that the industry continues to grapple with establishing an accurate estimate of long-term servicing costs.
n The typical subprime median refinance loan amount of$63,000 is also smaller than the $98,000 for the median
prime loan. This makes the associated fees higher as a percentage of the loan amount.
12
Separately, in a published interview on the topic of subprime lending, the CEO of Union Acceptance
34
Corp. estimated that it costs 225 basis points to service a subprime portfolio of auto loans. According to
Table 6
Union's CEO, this is three times
greater than the 75 basis point cost of
Cumulative Loss Rates
servicing Union's prime portfolios
Subprime Sector
(i.e. an additional 150 basis points to
Vintage
Months
service the subprime portfolio).
From
Union is an auto lender that used to be
Origination
2001
2002
engaged in subprime lending but
recently exited the market. Although
0.04%
11
006%
007%
009%
007%
008%
010%
Union's assessment referred to
22
34
46
S8
62
78
0.46%
1.58%
2.83%
3.73%
3.99%
4.78%
0.65%
2.11%
3.31%
4.22%
4.49%
0.83%
2.27%
3.61%
4.77%
0.79%
2.10%
3.31%
0.78%
2.06%
0.84%
subprime auto loans, it nevertheless is
suggestive that a subprime portfolio
may be more costly to service than
current industry estimates.
Source: Mood's, ace.
In September 2002, the interest rate
on prime conventional mortgages with SO% LTVs was 6.14%. The interest rate on subprime mortgages
for borrowers with 6S0 FICO scores and SO% L TVs was S.1 % (these rates include average points and
fees). A subprime borrower with a 6S0 FICO score would be among the lowest risk applicants receiving
a subprime mortgage. (Borrowers with FICO scores of 6S0 often qualify for prime mortgages.)
Therefore, these SO% LTV mortgage products extended to conventional prime borrowers and 6S0
subprime borrowers can be considered as roughly similar.
The difference or spread between the mortgage rates on these prime and subprime loans is 196 basis
points. In 1997, Freddie Mac estimated the difference between A- prime and A- subprime rates as 215
basis points, based on their own internal data and analysis. 35 Since interest rate spreads between the
prime and subprime markets have narrowed a bit since that time, our estimate of a 196 basis point spread
seems reasonable.
Given that the spread between prime and subprime rates is 196 basis points, and assuming that it costs 40
basis points more to service a subprime portfolio than a prime portfolio (this estimate of 40 basis points
seems reasonable given the foregoing discussion), then this leaves an additional 156 basis points in spread
(196 - 40 = 156) as being attributable to the greater risks inherent in subprime lending and other factors
other than servicing costs.
Of this 156 basis points residual, we estimate that approximately III basis points is due specifically to
differences in risk. As calculated from Table I, the average jump in interest rates between various grades
of subprime loans, which, as discussed earlier, is strongly related to increases in risk alone, is III basis
points. This III basis points is also a reasonable estimate of the portion of the prime/subprime spread
attributable just to differences in risk (interestingly, this estimate is similar to those published by Freddie
Mac 36 using a more accounting-based approach).
.
Together, the 40 basis points attributable to the greater servicing costs of subprime credit plus the
additional III basis points attributable to higher risk amounts to 151 basis points. This is just 45 basis
points less than the 196 basis point interest rate spread between SO% LTV conventional prime mortgages
and SO% LTV subprime mortgages to borrowers with 6S0 FICO scores. Although this is admittedly a
very rough calculation, it nevertheless suggests that in the aggregate, the gap between prime and subprime
rates is largely explained by differences in risk and servicing costs between the two markets and that
subprime rates therefore do not appear to be particularly out of line with underlying risk and cost
considerations.
13
In addition, there are other factors besides risk and cost that can impact mortgage pricing. These could
also account for a substantial portion of the remaining 45 basis points in spread between subprime and
prime interest rates that is not explained by differences in risk and servicing costs. For example, borrower·
demand for subprime credit has been strong and has probably been outstripping supply. This could also
be supporting stronger pricing in the subprime market (this issue is taken up more fully under Issue #9).
Issue #8: What Is the Evidence For Lack of Competition and Pricing Inefficiency in the Subprime
Market?
For most subprime borrowers and lenders, the subprime market is a legitimate channel to make credit
available at a return commensurate with the risk undertaken. If subprime markets are competitive, the
higher interest rates charged by lenders may be justified, given the additional risks and costs involved.
At the same time, some view the subprime market as suffering from pricing inefficiency and less than full
competition where lenders make excessive profits.
One widely cited study regarding the issue of inefficiency and abnormal returns in the subprime market
was performed by Lax, Manti, Raca and Zorn at Freddie Mac (2000). For the study, Freddie Mac
designed and commissioned a survey that was performed by the Gallup Organization from a sample of
borrowers who obtained mortgages between January 1996 and June 1997. The borrower sample was
obtained from DataQuick. The survey responses, which included the type of mortgage held by the
borrower (prime or subprime) and borrower demographics, were supplemented with individual credit
histories such as payment histories and FICO scores, which Freddie compiled separately from a credit
depository. The Freddie Mac study examines three separate findings in concluding that there are
inefficiencies in the subprime relative to the prime market:
•
The first finding is that risk, while by far the single most important factor in determining if an
individual ends up in the subprime market, is not the only factor. Other borrower characteristics
such as age, level of education, being less familiar with mortgage types, searching little for the
best rates and responding to an offer of "guaranteed" loan approval all also played some role in
determining whether a borrower ended up in the subprime market. The study asserts that the
market justification for the subprime sector is to fund higher-risk mortgages. Therefore, the
study'S finding that factors other than risk are significant in explaining why borrowers end up
with subprime mortgages is an indicator of some market inefficiency.37
•
Second, the study questions subprime borrowers as to their satisfaction with their mortgages and
the service they receive from subprime lenders. The survey found that subprime borrowers were
generally less satisfied customers than prime borrowers. This was also taken as an indicator of
reduced efficiency relative to prime lending. 38
•
Third, the study attempts to determine to what extent increased risk and costs account for the
difference between mortgage interest rates in the prime and subprime sectors. (This is similar to
the analysis we performed in the previous section although our assumptions and methodology
were slightly different). Using 1997 interest rate data, Freddie Mac researchers found that Amortgage rates in the subprime sector averaged 215 basis points above A- rates in the prime
sector. (The prime loans included in the analysis are mortgages purchased by Freddie Mac and
scored as A- through an internal underwriting model. The subprime loans are mortgages included
in subprime pools purchased by Freddie Mac that were scored A- by the subprime lenders
originating the mortgages. All loans consisted of first-lien, 15-year, fixed rate financings.) The
Freddie study asserts that roughly 90 basis points of the 215 b.p. spread can be accounted for by
differences in risk. They base this 90 b.p. figure on their finding that among similarly graded
14
loans from prime and subprime lenders, loans from subprime lenders often default at rates three
to four times those from prime lenders. This is similar to the I II basis point figure we arrived at
by observing the average jump in interest rates between various grades of subprime loans, which
as we point out, is highly correlated to increases in delinquency rates and risk.
The authors then estimate that servicing costs for subprime loans are an additional 25 basis points
more than those for prime loans. They base this on their conversations with industry experts, and
as mentioned in the previous section, this figure represents a generally accepted rule of thumb
within the industry. This is slightly lower than the 40 basis point figure for additional servicing
costs that we used in our analysis. Freddie then sums the factors for risk and servicing costs
which amounts to I 15 basis points. Since the spread between prime and subprime rates
calculated by Freddie earlier was 2 15 basis points, this means that risks and servicing costs do not
explain 100 basis points of the prime-subprime spread. The authors of the Freddie study
concl ude that this 100 basis points of unexplained spread represents a measure of subprime
inefficiency.39
The authors of the Freddie Mac analysis concede that none of these three studies of efficiency are
conclusive alone and each has its flaws. In combination, though, the evidence adds up, according to the
analysis, to a strong case for inefficiency. However, it is useful to examine some of the potential issues
with each of the findings. In the first study, for example, the measure of risk employed does not precisely
capture the role that risk plays in allocating borrowers between the prime and subprime markets (this is
pointed out by the authors themselves). The study places its emphasis on default risk. However, as
discussed in a pervious section, prepayment rates are on average much higher in the subprime market. §§
As pointed out by the Freddie analysis, this is an element of risk to lenders and investors not addressed in
the study. In addition, underwriters typically examine a whole range offactors not considered by the
Freddie study when assessing risk. Therefore, the risk factors used by Freddie may underestimate the
risks inherent in subprime lending (a point also conceded by the authors of the analysis).40
Moreover, in its attempt to explain the gap between subprime and prime mortgage rates by estimating risk
and servicing costs, the Freddie Mac study does not consider the impact of demand factors on these
spreads. As analyzed in the following section, demand may be outstripping supply for subprime credit
and this could be playing a considerable role in pricing in this area. In addition, the Freddie study's
estimate of servicing costs may be a bit low in light of the data on cumulative loss rates that we examined
earlier.
Issue # 9: What Is The Evidence That Subprime Providers Earn Excess Profits?
A common assertion in some quarters is that subprime providers earn abnormally high profits. However,
the empirical evidence suggests that in the aggregate the earnings of these firms appear to be in line with
underlying supply and demand fundamentals. Indeed, the evidence that subprime lenders earn .
abnormally high profits (also known as economic rents) tends to be anecdotal. In the Freddie Mac study
discussed in the previous section, the authors assert that while some analysts suggest that the subprime
sector is highly competitive, discussions with focus groups of market participants indicate that the
competition is in reality more for customers than over rates and fees. According to the authors of the
Freddie Mac study, these same focus groups noted that subprime lenders spend a great deal of money
originating mortgages through sales calls, direct mail, advertising and brokers fees. The Freddie analysis
concludes that combined with the history of market entry and consolidation around the time of the study,
There are also prepayment penalties in much of the subprime market. However, subprime lenders don't collect
their origination fees upfront but build them into the loan amount. So, if a borrower refinances shortly after
origination, lenders absorb the cost. This is the reason for the prepayment penalties.
§§
15
this provides additional circumstantial indications that, at least in 1997, the subprime sector generated
excess profits or economic rents. 41
However, the Freddie Mac study does not attempt to demonstrate directly that these rents actually exist.
In fact, the authors concede that it is difficult, if not impossible, to accurately assess the competitive
nature of an industry solely on the basis of focus groups and surveys, such as those employed in their
study. In addition, as pointed out in the study, since the survey was taken, the subprime industry has been
buffeted by financial turmoil, bankruptcies and consolidations and the profits of some of the remaining
firms have come under pressure.
In any case, as a relatively new market, it would not be surprising that high returns might prevail in the
short term. However, as the subprime business matures, as appears to be occurring rapidly, pricing would
be expected to become increasingly competitive. Indeed, this seems to be the case. Interest rate spreads
in the subprime market have been compressing since 1993. For example, the spread between prime
mortgage rates and A- rated subprime mortgages, was some 250 basis points in the early 1990s. These
have narrowed and at present are around 175-200 basis points. 42
As discussed earlier, the risks and costs associated with subprime lending are significantly higher than
those in the prime sector. These factors account for the lion's share of the pricing differential between
subprime and prime mortgages. In addition, there are indications that demand for subprime credit is
currently outstripping available supply. While perhaps a temporary phenomenon, this could also be
propping up subprime margins and interest rates. Since mid-2000, the sharp decline in interest rates has
propped up demand for overall home mortgage credit in both the prime and subprime areas. Since the
second quarter of2000, the 10-year Treasury yield has fallen from 6.44% to 3.57%, or 35.7%.
Correspondingly, aggregate net household home
mortgage borrowing has surged by a similar
Households: Uabilltles: Homa Mortgages
32.2%.
~ Chanve - Ve., to Vea,
811.1 Nonfl nancial Sedore SuDDly of Funds to Credit Markets
"" Chanve
As illustrated in the inset to the right, the present
cycle has been an unusual one in that growth in
aggregate household home mortgage borrowing
has far outstripped the increase in aggregate
supply of funds to credit markets. In prior
periods of economic weakness, the overall
supply of funds to credit markets softened.
However, demand for home mortgage credit
contracted even more sharply.
18
:Ve., to Vea,
811 S
18 .
12
However, this cycle has also been unusual in
that the recession has largely been the result of a
80
85
90
95
00
collapse in business capital spending. This has
SOurce: Federal Reserve Board !Haver Matytlca
resulted in an unusually large decline in the
business demand for funds. As illustrated in the inset on the next page, which contains actual dollar
flows, the collapse in the business demand for funds has freed up sufficient funds to accommodate the
unusually large surge in household demand for mortgage credit. This is an important reason, in addition
to Fed easing, why prime mortgage rates have come down so sharply despite the surge in household
demand for mortgage credit.
However, while the overall supply of credit to U.S. mortgage markets has kept pace with surging demand,
this has probably not been the case in the subprime sector. The sharp decline in U.S. interest rates has
16
propped up demand in the subprime and prime markets about equally. From 2001 to 2002, subprime
originations grew 22.9%, slightly faster than prime originations which advanced 22.3%.
However, according to HUD, at present, there are
only 178 lenders engaged primarily in supplying
subprime mortgage credit out of a total of over
7,000 total bank and nonbank home mortgage
lenders. Moreover, since 1999, the number of
subprime lenders has actually declined by 74, due
to a string of bankruptcies and consolidations in the
industry (Chart 4). These disruptions to the
marketplace raise the possibility that the supply of
subprime credit may not be keeping pace with the
unusual surge in demand and this may be keeping
subprime rates slightly higher than otherwise would
be the case. Recall, that by our calculations,
differences in risk and cost explain all but 45 basis
points of the spread between subprime and prime
mortgage rates. This residual could easily be
explained by even a slight imbalance between the
supply and demand for subprime funds.
I-busdlads: Ualilities: I-t:rre ~
S<\AR. BI.$
I'b1firmciaJ 9Jsiness: Ucm: OecIt Mmlt Instn.IrTB'ts
S<\AR. BI.$
eoo
eoo
eoo
eoo
200
200
\~-~~/------------------~---~O
Therefore, the empirical data do not support
the contention that subprime providers are
earning economic rents. In fact, the general
Number of Subprime Lenders
low rate environment which has boosted
300
demand and allowed lenders to spread their
~ 250
,
costs over more units of production is
'a
; 200
probably temporary. As mentioned earlier,
...J
'0 150
the
present housing cycle is highly unusual. In
rr
,g 100
the
periods leading up to previous recessions,
c..
~f.t-~
E
as
well
as during the earlier stages of those
:i 50
If-~
prior recessions, Fed tightening typically
o
resulted in sharp contractions in housing starts
1993 1994 1995 1996 1997 1998 1999 2000 2001
and home mortgage demand (first inset on
Year
previous page). By contrast, the present cycle
Sourco: HUD
has been characterized by persistent Fed rate
cuts which have bolstered housing demand throughout the past several years in an effort to counter the
depressive effects of the collapse in capital spending (and other depressive influences such as the
widening trade imbalance). This has also resulted in continued strong increases in home prices in
comparison with past recessionary episodes when home prices decelerated sharply.
Chart 4
..
~
hrt-if-i~
I
1~1
"
However, if rates should back up at some point up, or if the employment situation should deteriorate
further, it is possible that housing prices could pull back. Consumer balance sheets, especially among
lower income and riskier borrowers, could also deteriorate and subprime losses could jump placing
subprime lenders under financial pressure. There are tangible risks in making the blanket assertion that
the subprime sector is earning abnormal returns, as even the current rate of profitability in the industry
could easily dry up under less favorable economic circumstances.
17
;-----------------------------------------------------------
Issue #10: Do Anti-Predatory Laws Effectively Restrain Abusive Lending?
Proponents of anti-predatory measures stress that there is substantial evidence that such legislation
inhibits predatory lending tactics and that these measures do not impede legitimate credit flows. A recent
analysis by Quercia, Stegman and Davis (2003) on the impact of the North Carolina law examined
changes in subprime lending activity before and after the statute was implemented:" The study was
based on an analysis of 3.3 million subprime loans covering 1998-2002 supplied by Loan Performance
Inc. (LP). Overall, the study concludes that, after the law was fully implemented, the subprime market in
North Carolina behaved "essentially as the law intended -- there was a reduction of loans with predatory
terms without a restriction in access to or increase in the cost of loans to borrowers with blemished
credit.'.43
In particular, the study found a reduction in subprime originations from 1999 to 2000 due to a decline in
the number of refinance originations (these types of loans, according to the authors, are most often
associated with predatory abuses), not loans for purchase, with most of the decline associated with loans
having terms specifically defined as abusive or predatory by the new law. The analysis reports an overall
reduction of about 5,300 subprime loans between the pre- and post-implementation periods. From this
perspective, according to the study, the observed decline cannot be considered undesirable or
unanticipated by policymakers. 44
In addition, the study reports that loans to borrowers with credit scores below 580 in North Carolina have
actually increased by almost one-third since the law was fully implemented. This growth is consistent
with that in neighboring states (except Tennessee). This demonstrates, according to the authors, that
changes in North Carolina's regulatory environment have had no detrimental impact on the supply of
subprime credit to these high-risk borrowers. 45
The findings in Quercia, Stegman and Davis appear to contradict some of the assertions of earlier
analyses of the North Carolina Law performed by Keith Harvey and Peter Nigro (2002) and Elliehausen
and Staten (these are analyzed in the following section). However, much of the disagreement with other
analyses is largely definitional. Some of these issues include:
•
The study defines a predatory loan simply as a loan having the presence of the terms listed in the
law. Since the North Carolina law prohibits these terms, it would be expected that the number of
loans containing these terms would be reduced. However, as discussed earlier, there is
substantial debate over what a predatory loan actually is.
•
The study notes that out of the reduction of 5,300 subprime loans from the pre- to postimplementation period, there were 2,800 fewer loans with prepayment penalty terms, 1,600 fewer
loans with balloon payments and 650 fewer loans with combined LTVs over 110%. However, the
study does not calculate the degree of overlap of these terms. A single loan could contain one,
two, or all three terms. This means that the total reduction in loans with some kind of predatory
term could range from 2,800 to 5,050. If there was a good deal of overlap, this could mean that
••• The North Carolina law was enacted in stages beginning in July
1999. The law's anti-predatory features
included a HOEPA-like trigger mechanism for classifying closed-end mortgage loans as "high-cost" loans. The law
was enacted in two phases. In October of 1999, three features of the law took effect. First, prepayment penalties
were prohibited for loans up to $150,000. Second, permissible classes offees were defined for loans secured by real
property and for fees to be paid to third parties in association with the loan. Finally, consumer home loan refinancing
transactions were prohibited where they failed to provide a borrower with a reasonable, tangible net benefit (the "no
flipping" provision). The remaining requirements of the law took effect on July 1, 2000.
18
the law did restrain a substantial number of legitimate loans even by the study's criteria. If there
was 100% overlap, this would mean that 47.2% of the decline in lending was non-predatory by
the authors' definition of the term.
•
The study's conclusion that there was no reduction in access to mortgages among borrowers with
blemished credit in North Carolina following implementation of the state's anti-predatory law is
based in large part on how it defines the issue. In defining high-risk or blemished credit, Quercia,
Stegman and Davis consider only those borrowers with identified FICO scores below 580. These
are indeed very high-risk applicants and originations to these borrowers did increase following
enactment of the law according to the Loan Performance Inc. (LP) data used in the study.
However, loans to borrowers identified as having such low FICO scores represented only 21.2%
of all subprime originations in North Carolina at the time of the law's implementation according
to the LP data.
The study does not provide results for borrowers with FICO scores in the 580-660 range, which
encompasses the largest category of sub prime borrowers and represents the heart of the industry.
Rather, it only considers the smaller below 580 and above 660 categories. Borrowers with FICO
scores between 580 and 660 are also considered as having blemished credit. All of the major
bank regulatory agencies define borrowers with FICO scores of660 or below as having, "a
relatively high default probability.,,46 At the very least, the bottom half of the 580-660 range (i.e.,
580-620), is generally acknowledged as denoting high risk by the standards of many market
participants. Lenders often will not even consider a score below 600, some as high as 620. The
study indicates that overall subprime loans in North Carolina dropped by 17.0% following
implementation of that state's anti-predatory law, and suggests that much of that decline comes
from the 580-660 range.
•
Weaknesses in the data structure complicate interpretation of the Quercia, Stegman and Davis
study. As pointed out by the authors,ttt the Loan Performance database used in the analysis
expanded its coverage from 41 percent to 50 percent of the total subprime market over the period
encompassed by the study. In addition, LP improved its data reporting. Between 1998 and 200 I,
there was a reduction of over 50 percent in the number of records in the database with missing
FICO scores. Therefore it is risky to draw conclusions about division of changes in lending by
FICO scores because it is not known how reduction in missing FICO scores is distributed across
the ranges. For example, the increase in originations among borrowers with identified credit
scores below 580 noted by Quercia, Stegman and Davis may simply be due to changes to the
coverage in the LP database during the study period. It is possible that credit scores in the under
580 category are over-represented among the missing data. 47 This would have made it appear
that originations to these borrowers grew relatively more strongly than was actually the case.
Indeed, Elliehausen and Staten (2002), relying on the American Financial Services Association
(AFSA) database that included loan information from nine major finance companies
encompassing a substantial component·ofthe subprime lending business, report different findings
than Quercia, Stegman and Davis. The AFSA database did not expand or alter its data reporting
over the pre-and post enactment periods of the North Carolina law, but continued to encompass
the same group of nine firms. In contrast to Quercia, Stegman and Davis's conclusions,
Elliehausen and Staten suggest that lending to borrowers in North Carolina with FICO scores
ttt Our comments on the database are adapted from those provided by Quercia, Stegman and Davis, footnote 8, p.
18.
19
below 580 actually weakened more than to any other credit group after the law began to be
implemented. 48 Therefore, rather than having no impact on borrowers with blemished credit, the
evidence suggests that lending to high-risk borrowers declined significantly following
implementation of the North Carolina law.
Issue #11: What Is The Evidence That Anti-Predatory Laws Restrain Legitimate Lending?
There is a good deal of empirical evidence to suggest that anti-predatory statutes impede the flow of
mortgage credit, especially to low income and higher-risk borrowers, and any reductions in predatory
abuses resulting from these measures is probably achieved at the expense of many legitimate loans.
There are three primary means through which anti-predatory lending measures can potentially impede the
flow of legitimate credit to homebuyers:
•
First, lenders may simply be reluctant to extend credit in jurisdictions covered by these laws due
to the increased legal risks they entail. For example, some of the documentation requirements of
the new laws may impose unacceptable risks of legal liability for creditors (predatory and
legitimate) active in the high-cost mortgage market. Thus, these measure risk restricting credit
beyond those loans offered by predatory lenders. The Georgia predatory lending law which took
effect on October I, 2002 raises the potential for large punitive damages. The law also requires
lenders to document that a refinancing of a loan less than ·five years old provides a "net tangible
benefit" to the borrower. The American Banker reported that this provision convinced Ameriquest
Mortgage Co. (Orange, CA), the nation's seventh-largest subprime originator, to stop making all
subprime loans in Georgia.
•
As mentioned in the previous section, another way that anti-predatory laws can impede credit
flows is by hindering the ability oflenders to sell loans originated in that jurisdiction into the
secondary market. This can prompt lenders to cut back their loan originations in that jurisdiction.
As mentioned in the summary to this piece, the GSEs have taken a number of steps to reduce the
possibility that they will purchase predatory loans. These actions further reduce the liquidity of
these mortgages by restraining demand for such loans in the secondary market. Although the
GSEs are much smaller participants in the subprime market than the non-agency aggregators,
Fannie Mae and Freddie Mac have shown increasing interest in the subprime business in recent
years either through direct purchases of subprime loans or through purchases of non-agency
mortgage-backed securities. The GSEs are also involved in guaranteeing repayment of securities
issued by the private aggregators.
•
Finally, anti-predatory lending measures can reduce lenders willingness to extend loans in a
jurisdiction due to the increased costs of complying with the provisions of the law or decreased
profit margins resulting from the law. In general, these laws increase underwriting costs since
lenders must institute additional controls and procedures to ensure that they do not make loans
that fall into the high cost category. Even apart from their higher rates, subprime loans are more
likely to trigger the high-cost tripwires contained in anti-predatory measures. On average, loans
in the subprime mortgage market are smaller than loans in the prime market. Partly as a result,
subprime loans tend to have significantly higher fees and rates than for prime loans. However,
even if the fees were the same for prime and subprime loans, since subprime loans generally are
smaller than prime loans, the fees would be higher as a percentage of the loan amount. 49 (The
North Carolina law also expanded the legal and reputationalliability of lenders.)
20
Based on an analysis of data from nine major finance companies active in North Carolina and neighboring
states, Elliehausen and Staten (2002)50 concluded that there was a significant and large decline in the
number of closed-end mortgages active in North Carolina as a result of the passage of the state's antipredatory lending law. The study does not attempt to disentangle the reasons for the decline in lending.
As mentioned above, these laws reduce the availability of credit through a number of channels (greater
legal liability, the negative impact on the secondary market for these loans and the increased costs to
lenders associated with complying with the laws.) In aII probability, aII of these factors played a role in
the reduction of subprime lending in North Carolina.
The finance company data used in the EIIiehausen and Staten study had the advantage that it contained
information on borrower risk characteristics. OveraII, according to the Elliehausen and Staten data, the
number of subprime mortgage originations in North Carolina declined by about 14% as a result of the
law. This confirms the decline observed in the broader HMDA data for North Carolina presented
previously. In addition, the study also found that significant declines occurred only in North Carolina and
only among the lower income borrowers. Neither the higher income borrowers in North Carolina nor
51
borrowers in a comparison group of states not affected by the law experienced significant declines.
Moreover, the EIIiehausen and Staten analysis demonstrates that the declines in closed-end subprime
mortgage lending in North Carolina counties were found only in the higher-risk segment of the market.
Chart 5 contains the percentage of subprime loans within each risk-score category that were originated in
North Carolina during the pre-enactment period. It also contains the percentage of loans within each risk
category in the period foIIowing enactment of the initial prohibitions of the law on October I, 1999
through just before the final implementation date on July I, 2000. 52 In the period after the first phase of
the law became effective, there was a clear decline in the percentage of loans originated in the higher-risk
(lower FICO score) categories. The lower-risk (higher FICO score) categories, by contrast, experienced
an increase in the percentage of originated loans. 53
In addition, the annual interest rates on
Chart 5
loans before and after passage of the
Perentage Distribution of First Mortgage Originations In North
North Carolina anti-predatory law
Carolina by FICO Score Before and After Law
broadly reflected the loans' risks,
25T-~~~~~----------------~
according to the study. Table 7
presents the average risk premium on
20~~~~------------~------~
mortgage loans originated in North
D97 01-99 03
Carolina by the nine finance companies
.9904-0002
under review (risk premium is defined as
1 0 +-~...jll-"':the difference between the interest rate
on mortgage loans and the interest rate of
a Treasury security of comparable
maturity) for a range of FICO score
categories. The data suggest a strong
<500 500- 550- 580- 600- 620- 650- 680+
549 579 599 619 645 679
relationship between credit risk and risk
premiums both before and after the North
FICO Score
Source: Elliehausen & Staten, (citing AFSA data).
Carolina law began to be implemented.
Borrowers with higher incomes and
higher FICO scores generaIIy paid lower interest rates. If the law had indeed driven out predatory lending
in the state, as suggested by proponents of the legislation, then subprime pricing after enactment should
have shown a stronger relationship with borrower risk than before enactment of the law. However, these
data do not suggest that the fundamental pricing structure of subprime loans in North Carol ina was
altered. According to the authors of the study, the data suggest that the North Carolina statute did impede
21
the flow of mortgage credit to higher-risk borrowers, and any reductions in predatory lending were
probably achieved at the expense of fewer legitimate loans. 54
Table 7
Average Risk Premiums in
North Carolina by FICO Score
Risk Premium (%)
FICO Score
Before
Enactment
After
Enactment
5.7%
680+
6.1%
6.4%
6.4%
650·679
6.7%
6.7%
620·645
6.9%
6.9%
600·619
7.2%
7.1%
580·599
7.3%
7.2%
550·579
7.5%
7.3%
500·549
500
7.9%
7.2%
Source: Elliehausen and Staten (citing AFSA);
Risk premium is the difference between interest
rate on loans and rate on comparable maturity
Treasury security. Before enactment period is
from QI97 to Q3 99. After enactment is from Q4
The study does have a number of shortcomings, however. The
authors maintain that the data used in the analysis are highly
representative of the subprime mortgage market in general and
that the volume of subprime lending activity captured by their
data is a substantial component of all subprime lending.
However, while these data do indeed contain information on
borrower risk characteristics, they do not cover the entire market,
as does the HMDA data. It is also a smaller sample than covered
by the LP database. In addition, the nine finance companies used
in the Elliehausen and Staten study are the largest in the
marketplace and therefore probably receive the most scrutiny
from the government. So, these firms may not be the worst
offenders as far as predatory lending tactics are concerned.
In addition, the AFSA database used in the study only covered
..
.
h
h
f
h'
h
loan origmatlOns t roug June 0 2000, one mont prior to t e
final implementation date of the law. Some of the law's
99 to 22000.
prohibitions were enacted in late 1999. So, the database did
cover this period. Elliehausen and Staten assert that since lenders had full knowledge of all of the law's
final provisions ahead of time, they would have adjusted their lending behavior in advance of the final
implementation date. However, this remains an open question at this juncture. 55
A study by economists Harvey and Nigro that used the broader HMDA data examined the effects of
predatory lending laws enacted by the cities of Chicago and Philadelphia. The results tended to
compliment those of the Elliehausen and Staten analysis. The Chicago law focuses on banks.
Specifically, it bars the City of Chicago from placing any of its $1 billion in municipal funds at banks
with predatory loans (defined as mortgages with interest rates five percentage points or more higher that
the yield on U.S. Treasury securities of comparable maturity). The Philadelphia law, which was
subsequently preempted by a state law, imposed an escalating series of limitations and sanctions on all
mortgage lenders, based on the spread between the mortgage rate and comparable Treasury securities.
The analysis concludes that although it is likely that the state and city predatory lending laws may have
reduced or eliminated some predatory practices, the results suggest that policymakers n'eed also be
concerned about their impact on legitimate subprime lending. The reduction in subprime lending after the
passage of the laws was significant and it is likely that a good portion of this was not predatory in
nature. 56
Issue #12: Is the Pattern of Subprime Lending Activity in Lower Income and Minority Locales
Different Than That In Higher Income Areas?
Studies by HUD and other researchers have documented the high rates of subprime lending in lowincome and minority communities. Each year HUD identifies a list of lenders that are engaged in
predominantly subprime lending (50% or more). The lists are updated each year based on conversations
with lenders and information obtained from HMDA data analysis, trade publications, and lenders
websites. According to the HMDA data from 2001, minority borrowers represent 17.5% of all borrowers
in the prime segment of the mortgage market. However they account for more than 36% of borrowers in
the subprime segment. Low-and moderate-income borrowers also are disproportionately represented in
the subprime market. Roughly 39% of prime borrowers have low to moderate incomes while 54.3% of
subprime borrowers have low to moderate incomes.
22
In 2000, HUD issued a report entitled "Unequal Burden: Income and Racial Disparities in Subprime
Lending in America" documenting the concentration of these lenders in low-income and minority
communities in five cities including Atlanta, Los Angeles, Baltimore, New York and Chicago. They
found that subprime loans were three times more likely in low-income neighborhoods than in highincome neighborhoods and five times more likely in black neighborhoods than in white neighborhoods. 57
More recently, a study prepared by Calvin Bradford (2002) on subprime lending patterns in all of the
'nation's 331 metropolitan areas, states that there are "widespread" racial disparities in subprime lending
activity nationwide and that African Americans and Latinos have a disproportionately representation in
the subprime lending market and that these patterns persist across all income levels and throughout the
58
nation.
Issue # 13: What Issues Are Raised By These Disparities?
These disparities raise the specter that lower income and minority groups are more often the victims of
predatory lending or at the very least are being poorly served by the industry. According to the Bradford
study, the racial disparities in levels of subprime lending do not, in and of themselves, constitute
conclusive proof that there is widespread discrimination in the subprime lending markets, However,
Bradford asserts that these disparities do raise serious questions about the extent to which risk alone could
account for such patterns. He argues that the issue of whether there is racial exploitation in the subprime
markets essentially rests on two issues, First, are the disparities in subprime lending related to race?
Second, can these disparities be fully explained by legitimate risk factors?59
In the view of many community groups active in the predatory lending debate, as well as of some
researchers, risk alone does not explain the racial disparities, They point to the absence of active
mainstream prime lenders in minority markets which they assert has increased the chances that borrowers
in these communities paying higher interest rates. For example, the assertion by Bradford that racial
disparities actually increase as income increases suggests that a portion of subprime lending is occurring
with borrowers whose credit histories would qualify them for lower-cost, conventional, prime loans, In
addition, the level of disparity presented in studies which showed African American households had more
credit problems than majority households was not equal to the level of disparities seen in subprime
lending. 60
Issue# 14: What Is The Quantitative Evidence Regarding The Percentage Of Sub prime Borrowers
Who Could Have Qualified For A Prime Loan?
In a 1996 release, Freddie Mac estimated that from 10% to 35% of borrowers who obtained mortgages
from the subprime market could have qualified for a conventional loan through Loan Prospector (Freddie
Mac's automated underwriting system).61 These and other similar statistics have been viewed by some as
evidence of steering or some other form of predatory practice.
As discussed earlier, risk plays a dominant role in determining whether or not a borrower ends up in the
subprime market. Table 8, which was assembled by OTS, shows the percent of subprime mortgages in
the MIC database within specific credit score categories. These data generally support the case that less
creditworthy borrowers receive the great majority of subprime mortgage loans, as 81 % of subprime loans
62
have credit scores below 660. As discussed earlier, all of the major regulatory agencies use 660 as the
cutoff point to denote borrowers that are at high risk of default. In addition, many prime lenders generally
regard 680 as the point at which a borrower comes into consideration for a prime loan. Over 88% of the
MIC subprime mortgages are associated with credit scores below 680,
23
At the same time, 11.8% of borrowers with credit scores above 680 received subprime mortgage loans.
This is at the very low end of the range estimated in the Freddie Mac release. It is probable, therefore,
that the Freddie Mac figures represents a substantial overestimate. Indeed, the range estimated by Freddie
was made in 1996 when the subprime market was in a significantly less competitive stage of its
Table 8
development. In addition, automated underwriting does not take into
account many of the non-quantitative factors that can influence
Percentage Distribution of Sub prime
Mortgages by Credit Score
denial rates. The Freddie Mac researchers themselves pointed out
that lack of financial sophistication played a large role in the
Credit Score
behavior of these borrowers and do not necessarily view these
figures as evidence of predatory practices.
0.02%
Under 400
400 to 479
480-519
520-539
540-559
560-579
580-599
600-619
620-639
640-659
660-679
680-699
700-719
Over 720
Issue# 15: What Other Data Exist On The Issue of Racial
Disparities in Subprime Lending?
J.I
6.2
7.5
9.9
11.2
11.8
12.1
11.5
9.7
7.2
4.8
3.2
3.8
Empirical studies suggest that the subprime market is highly
competitive and that the disparities that do exist are for the most part
due to differences in credit risk among groups of borrowers. The
widely cited Freddie Mac study of the subprime market discussed
under Issue #8 in this piece attempted to look separately at race and
ethnicity, in addition to those of borrower risk, educational
background, age and effort expended in searching for the best rate on
Source: OTS (citing MIC); Percent ligures
a mortgage loan. As mentioned previously, the study found that
,--=,ba;;;;s~ed:...;o;..;;n;..:$,-,v-,,-o.;.:;lu;;.;.m;.;;es;;.;..._ _ _ _ _ _ _--,
borrower risk was by far the most important factor in explaining whether or not an applicant took out a
subprime loan. The study also determined that education, age and search effort were significant, though
less important factors than risk. However, Freddie Mac also determined that their data provided no
evidence that race or ethnicity had any significant independent impact on whether or not a borrower
ended up with a subprime loan when statistically controlling for risk, search effort, educational
background, age or other demographic factors. 63
Other empirical data appear to support this contention. As mentioned earlier, some researchers assert that
one of the symptoms of predatory lending in a locale is the lack of a close connection between the interest
rates charged on subprime mortgages and borrower risk. They argue that predatory lenders steer less
sophisticated applicants into loans that are overpriced relative to the borrower's risk profile. If this were
indeed the case, then a law that eliminates predatory lending should result in the re-establishment of a
close relationship between price and borrower risk. 64
Table 9
Subprime Market Loan Originations in the Pre- and Post- Legislation Periods
Minority Borrowers
Total
Subprime
Origination
in North
Carolina
Minority
Subprime
Originations
In North
Carolina
Percent of
Total
Subprime
Originations
In North
Carolina
Minority
Subprime
Originations
In
Neighboring
States
Percent of
Total
Subprime
Originations
In
Neighboring
States
Before Law
41,203
8,482
20.6%
23,653
22.48%
After Low
35,157
7,116
20.24%
27,388
25.38%
% Change
-14.67%
-16.1%
15.79%
Source: Harve
24
In North Carolina,
according to HUD data,
minorities represent over
one fifth of all subprime
borrowers (Table 9).
Therefore, these
borrowers should figure
significantly in the risk!
pricing structure
observable on subprime
loans within the state. As
mentioned above, if antipredatory laws were
successfully eradicating
this form of lending, then
there should be a shift in the relationship between price and borrower risk on subprime loans following
the imposition these statutes resulting in a stronger connection between price and underlying borrower
risk.65
However, econometric studies do not support this contention. For example, according to Elliehausen and
Staten, in North Carolina, the relationship between the average risk premium -- defined as the difference
between the mortgage rate and the interest rate for a Treasury security with a comparable term -- and
FICO scores of borrowers was very similar both before and after the state's anti-predatory law began to
be implemented. Prior to enactment,
higher borrower risk (i.e. lower FICO
Chart 6
Mean Risk Premiums in North Carolina and
scores) was associated with higher risk
Comparison Group States by FiCO Score
premiums. After the law began to be
implemented, the relationship between risk
8.5 + - - - - , - - - - : - - - - - - : - - - - - - - - - - \
premiums and FICO scores of borrowers
C
8~~-~-~-----------_1
was very similar. Higher risk borrowers
~ 7.5
continued to pay virtually the same higher
·e2! 7 +---:-------:----'---'--.~""_c:::=_=-------_;
risk premiums. If the legislation actually
c..
~ 6.5 +-..:.:.;..'-'------'--~--'--___,reduced predatory lending in the state, then
there should have been a significant change
~ 6~---:-~--~---------in the relationship between risk premiums
Source:
and FICO scores after enactment.
<500 500- 550- 580- 600- 620- 650- 680+
Elliehau
However, this was not the case (Chart 6).66
549 579 599 619 645 679
sen &
Staten.
AFSA
FiCO Score
-+-NC. 97 01-99 03
_NC. 99 04-00 02
In addition, to the positive relationship
Comp .. 97 01·99 03 ~Comp .. 99 04-00 02
between risk and risk premiums in both
periods in North Carolina, there was also a
similar relationship in a group of surrounding states where no such legislation was enacted. As illustrated
in Chart 6, the level of average risk premiums in North Carolina and surrounding states, for loans with
scores in the.same FICO range, differed by no more than about 50 basis points during the pre- and initial
post-enactment periods. Therefore, according to Elliehausen and Staten, the data do not suggest that the
relationship between interest rates on subprime loans and borrower risk in North Carolina was altered,
relative to the comparison states, as a result of the state's anti-predatory law. This casts further doubt on
the view that the decline in lending in North Carolina following the passage of the anti-predatory statutes
resulted entirely from eliminating predatory practices. 67
Issue #16: What is the Role for CRA In Curbing Predatory Lending Abuses?
As it is currently implemented, CRA does not penalize banks that engage in predatory lending, directly or
indirectly. Some policymakers and researchers have recommended that CRA be utilized to create
disincentives to banks that engage in or provide indirect support for predatory lending. Engel and McCoy
(2002) recommend that federal bank regulators use CRA to penalize behavior that could further predatory
lending. They identify two justifications for the use of CRA in reining in predatory lending. The first
justification stems from CRA's goal of encouraging banks to serve the credit needs of their communities.
IfCRA is creating incentives for banks to engage in predatory lending, then CRA is actually defeating
one of its stated goals according to Engel and McCoy. The second justification, according to the two
professors arises from the fact that banks are the recipients of special government privileges in the form
of exclusive charters, federal deposit insurance and so forth. These subsidies are considered part of the
rationale for imposing CRA obligations on banks. Ifbanks use these privileges to harm the communities
they serve, there is a role for CRA in scrutinizing bank activities. 68
25
A potential issue with Engel's and McCoy's analysis is that its conclusions rest upon a number of
assumptions, each of which is not entirely clear-cut. For example, the two professors state that "predatory
lending has surged" and therefore, there is a role for CRA to rein in these abuses However, as analyzed
earlier, while anecdotal evidence suggests that predatory lending is a problem, its magnitude remains
unclear, particularly among banks. Moreover, despite the fact that many economists and other
researchers have examined the issue, there remains much debate over whether the higher rates and fees
charged on many subprime loans are predatory or simply reflect higher borrower risk, servicing costs or
demand factors related to the macroeconomy. In addition, Engel's and McCoy's own report points out
that predatory lending by banks is probably insignificant due partly to a whole host of disincentives.
Another assumption of Engel and McCoy, is that banks are subsidized by the taxpayer supported deposit
insurance system and other factors. They assert that banks receive special government privileges in the
form of exclusive charters, federal deposit insurance and so forth. According to Engel and McCoy, these
subsidies are considered part of the rationale for imposing CRA obligations on banks. 69 However, there is
actually a good deal of debate among economists as to whether or not banks are actually subsidized. For
example, a rough measure of the fair value of deposit insurance is what banks pay customers for
uninsured deposits, over and above what they pay custo!TIers for insured deposits. Surveys of institutional
brokers on Wall Street typically demonstrate that well-capitalized banks typically pay little or no
premium for uninsured money. At the same time, banks must pay for deposit insurance and in addition
incur considerable expense to comply with a broad array of regulatory requirements.
Endnotes:
I U.S. Department of Housing and Urban Development (2000), "Unequal Burden in Atlanta: Income and Racial Disparities in
Subprime Lending," Washington, D.C. Companion studies were also performed by HUD for Baltimore, Los Angeles, and New
York and Chicago.
"Risk or Race? Racial Disparities and the Subprime Refinance Market," A Report of the Center for Community Change,
prepared by Calvin Bradford, Calvin Bradford & Associates, LTD. May 2002, Executive Summary.
2
l "The Impact of North Carolina's Anti-Predatory Lending Law: A Descriptive Assessment," Roberto G. Quercia, Michael A.
Stegman, Walter R. Davis, Center for Community Capitalism, The Frank Hawkins Kenan Institute of Private Enterprise,
University of North Carolina at Chapel Hill, Chapel Hill, NC 27599-3440, June 25, 2003.
"Regulation of Subprime Mortgage Products: An analysis of North Carolina's Predatory Lending Law," by Gregory
Elliehausen and Michael Staten, Credit Research Center Working Paper #66, November 2002.
4
The before and after periods looked at by Elliehausen and Staten were different than those used in the Quercia, Stegman and
Davis study. The pre-enactment period used by Elliehausen and Staten went from the first quarter of 1997 through the third
quarter of 1999, immediately prior to the implementation date of the first set of new regulations under the North Carolina antipredatory statute on October I, 1999 (essentially the same as the period used in the Quercia, Stegman and Davis study).
However, the AFSA database ends its coverage in June of2000, one month before the final implementation date of the law.
Therefore, the second period examined in the Elliehausen and Staten study only includes originations from the fourth quarter of
1999 through the second quarter of 2000. Elliehausen and Staten assert that because the statute was phased in over 12 months,
the impact of the North Carolina measure would be seen on originations before the final implementation date (July 1,2000). He
concedes that the window for detecting alterations in lending patterns following passage of the North Carolina law is brief.
However, he points out that parts of the statute (most notably the prohibition on prepayment penalties) became effective as early
as October I, 1999 and all of the new regulations were known to lenders as early as July 1999. So, Elliehausen and Staten (p. 10)
assert that it is reasonable to expect that creditors would not wait for the law to be fully effective to adjust their lending behavior.
5
"Impact of Predatory Lending Laws on RMBS Securitizations," by Christine Lachnicht, Moody's Investors Service, Structured
Finance, Special Report, March 26, 2002, pp. 1,5.
6
"Predatory Lending," HUD Treasury Special Report, U.S. Department of Housing and Urban Development 451 7th Street S.W.,
Washington, DC 20410. p. 44.
7
26
8
HUD Treasury Special Report, p. 44.
"The CRA Implications of Predatory Lending," Kathleen C. Engel and Patricia A. McCoy, 29 Fordham Urban Law Journal
1571 (2002) forthcoming, p.16.
9
10
Engel and McCoy, p. 7, footnote (citing HUD).
II Engel and McCoy, p. 19 (citing Robert E. Litan et a!., The Community Reinvestment Act After Financial Modernization: A
Baseline Report 2 (2000).
12
Engel and McCoy, p. 19 (citing HUD Treasury Report).
13
HUD Treasury Special Report, p. 30.
14
HUD Treasury Special Report, p. 31.
15
HUD Treasury Special Report, pp. 31.
16
HUD Treasury Special Report, p. 41.
11
Engel and McCoy, pp. 2-3.
18 "Separate and Unequal: Predatory lending In America," Association of Community Organizations for Reform Now, November
2002, p. 2.
19
Engel and McCoy, p. 7.
20
Engel and McCoy, pp.15-17 (citing Litan)
21
Engel and McCoy, p. 7, footnote (citing HUD).
22
Engel and McCoy, p. 19 (citing Litan).
23
Engel and McCoy, p. 19 (citing HUD Treasury Report).
These data appear in the first appendix table of: "On the Economics of Subprime Lending," by Amy Crews Cutts and Robert
Van Order, March 2003 (obtained from the Freddie Mac Website, http://www.freddiemac.com/corporate/reports/).
24
These data appear in the first appendix table of: "On the Economics of Subprime Lending," by Amy Crews Cutts and Robert
Van Order, March 2003 (obtained from the Freddie Mac Website, hllp://www.freddiemac.com/corporate/reports/).
25
"What About Subprime Mortgages," Mortgage Market Trends, Research and Analysis, Office of Thrift Supervision,
Washington. DC. Volume 4, Issue I, June 2000, p. 2.
26
"What About Subprime Mortgages," Mortgage Market Trends, Research and Analysis, Office of Thrift Supervision,
Washington, DC. Volume 4, Issue I, June 2000, p. 2.
27
2M
Mortgage Market Trends, OTS, p. II.
29
Culls and Van Order. p. 4-5.
30
Mortgage Market Trends, OTS, p. 12.
Based on data appearing in Figure lin the appendix of: "On the Economics of Subprime Lending," by Amy Crews CutlS and
Robert Van Order, March 2003. The study cites Loan Performance, and the Freddie Mac Primary Mortgage Market Survey as
the original source for the data.
31
27
32
Cutts and Van Order, p. 5.
33
Cutts and Van Order, p. 5.
34
Specialty Lender Weekly, September 11,2000.
35 "Subprime Lending: An Investigation of Economic Efficiency," Howard Lax, Michael Manti, Paul Raca, Peter Zorn,
Corresponding author: Peter Zorn, Freddie Mac, December 21, 2000, p. 18.
36
Lax, Manti, Raca, and Zorn, p. 18.
37
Lax, Manti, Raca, and Zorn, p. 22.
3M
Lax, Manti, Raca, and Zorn, p. 17.
39 Lax, Manti, Raca, and Zorn, pp. 17-19. The authors point out that their analysis does not take into account the higher average
origination points and fees paid by subprime borrowers. So their figure of 100 basis points may underestimate the degree of
inefficiency in the subprime market, according to the study. However, spreads have come down since the time of the study, so
this would counter some of that effect.
40
Lax, Manti, Raca, and Zorn, pp. 12-16.
41
Lax, Manti, Raca, and Zorn, pp. 19.
42 In Lax, Manti, Raca and Zorn, p. 20, it states: " ... Nor is there the overall standardization of products, underwriting and
delivery systems that is found among prime lenders. Increasing price competition in the sub prime sector is likely changing this,
enhanced by the recently more aggressive entry ofpnme market participants."
43
Quercia, Stegman and Davis, pp. 21-22.
44
Quercia, Stegman and Davis, pp. 21-22.
45
Quercia, Stegman and Davis pp. 1-6.
46
Interagency Guidance on Subprime Lending, originally issued on March 1,1999.
These changes in the database are pointed out in the study, and our comments on the database are adapted from those provided
in the study. [See Quercia, Stegman and Davis, footnote 8 on p. 18].
47
4M
See endnote 5.
49
Elliehausen and Staten, pp. 13-15.
"Regulation of Subprime Mortgage Products: An analysis of North Carolina's Predatory Lending Law," by Gregory
Elliehausen and Michael Staten, Credit Research Center Working Paper #66, November 2002.
50
"Regulation of Subprime Mortgage Products: An analysis of North Carolina's Predatory Lending Law," Credit Research
Center Working Paper #66, November 2002, by Gregory Elliehausen and Michael Staten.
51
52
See endnote 5.
53
Elliehausen and Staten, p. 14 and appendix Chart 4.
54
Elliehausen and Staten, pp. 14-15.
55
See endnote 5.
28
Comments from a memorandum by Peter J. Nigro to Jonathan Fiechter entitled: "Summary of Research of Predatory Lending
Law. " The memo summarized an earlier piece entitled: "How do Predatory Lending Laws Influence Mortgage Lending in Urban
Areas? A Tale of Two Cities," by Keith Harvey and Peter J. Nigro, Unpublished Abstract, March 2002.
56
U.S. Department of Housing and Urban Development (2000), "Unequal Burden in Atlanta: Income and Racial Disparities in
Subprime Lending," Washington, D.C. Companion studies were also perfonned by HUD for Baltimore, Los Angeles, and New
York.
57
"Risk or Race? Racial Disparities and the Subprime Refinance Market," A Report of the Center for Community Change,
prepared by Calvin Bradford, Calvin Bradford and Associates, LTD. May 2002, Executive Summary.
5R
59
Bradford, Executive Summary.
60 "Regulation of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation
(Freddie Mac)" 65 Fed. Reg. 65,044, 65,053 (Oct. 31, 2000).
"Automated Underwriting: Making Mortgage Lending Simpler and Fairer for America's Families," Freddie Mac, ch. 5 and pp
5-6 (Sept. 1996).
61
62
Mortgage Market Trends, OTS, p. 8.
('3
Lax, Manti, Raca, and Zorn, pp. 15.
M
Elliehausen and Staten, pp. 14-15.
65
Elliehausen and Staten, pp. 14-15.
61,
Elliehausen and Staten, pp. 14-15 .
. 67
Elliehausen and Staten, pp. 14-15.
"The CRA Implications of Predatory Lending," Kathleen C. Engel and Patricia A. McCoy, 29 Fordham Urban Law Journal
1571 (2002) forthcoming.
(,R
69
Engel and McCoy, pp. 20-23.
29
The Impact of Federal Preemption of State Anti-Predatory
Lending Laws on the Foreclosure Crisis
Research Report
Center for Community Capital
University of North Carolina, Chapel Hill
Revised March 29,2010
EXHIBIT
I
X
Table of Contents
Executive Summary ....................................................................................... iii
1. Introduction ................................................................................................ I
2. Literature Review ........................................................................................ 3
2.1 Coding of State Anti-Predatory Lending Laws .......................................... 3
2.2 Impact of State Anti-Predatory Lending Laws on Foreclosure Rates ......... 4
2.3 Impact of Federal Preemption ................................................................. 5
3. Data ............................................................................................................ 7
3.1 State Anti-Predatory Lending Law Data .................................................. 7
3.2 Columbia Collateral File Data ................................................................. 8
4. Research Approach ................................................................................... 11
5. Empirical Results ...................................................................................... 16
6. Conclusion ................................................................................................ 20
References .................................................................................................... 21
ii
Executive Summary
Federal preemption of state anti-predatory lending laws C'APLs") has received increased
attention in recent debates over the subprime crisis. This is because lending by preempted
lenders accounts for a significant share of the mortgage market and federal laws regarding
mortgage lending had been substantially less restrictive than many state laws before the crisis.
As policy makers try to deal with mounting foreclosures, it is important to understand the role
that federal preemption had played in the foreclosure crisis. The overall goal of this study is to
examine the impact of federal preemption, namely the 2004 preemption of state laws by the
Office of the Comptroller of the Currency on the performance of loans preempted and those that
remained subject to stronger APLs.
We examine whether OCC preemption had an effect on the behavior of lenders during the
subprime boom and thus also had an effect on the foreclosure crisis that followed. Our a priori
expectation was that after the OCC preemption, the quality of mortgages originated by
preempted lenders would become worse in states with strong APLs because preempted
institutions were no longer required to abide by more stringent state regulations, and that this
deterioration in underwriting standards increased default risk in these states.
In this study, we test this contention by examining the performance of mortgages originated by
lenders in states with and without APLs, before and after the 2004 OCC preemption. More
narrowly, we test for a preemption effect in two ways: changes in the quality and performance of
loans originated by OCC lenders and changes in the performance of loans originated by lenders
subject to different regulators. By focusing on a large sample of privately securitized nonprime
mortgages, we are able to identify the extent to which the 2004 ruling contributed to the
foreclosure crisis that followed. The results suggest that preemption resulted both in deterioration
in the quality of and in the increased default risk for mortgages originated by OCC-regulated
lenders in states with anti-predatory lending laws. More narrowly, they show that OCCpreempted lenders increased their share of loans originated with risky subprime characteristics.
Similarly, they show that loans originated by OCC-preempted lenders were more likely to
default in APL states after the OCC preemption. Finally, the results show that in the refinance
market the increase in default risk among OCC lenders often outpaced that of independent
mortgage companies that remained subject to stronger APLs after 2004.
The study has important policy implications for the current regulatory reform debate. The larger
increase in default risks of OCC-regulated lenders after the preemption suggests that even during
the subprime boom, state APLs did protect consumers from risky mortgage products. It also
suggests that the OCC preemption removed those protections for covered lenders who gained
market share in the origination of risky subprime loans that led to the foreclosure crisis. We
believe that these results provide compelling support for policy proposals that require the Federal
law to provide a regulatory floor while allowing states to adopt stronger APLs based on local
conditions. Re-examining federal preemption on the basis of these results is likely to better
protect consumers and to help ensure against future excesses in the mortgage market.
iii
.----------------------------------------
-----
The Impact of Federal Preemption of State Anti-Predatory Lending Laws on
the Foreclosure Crisis
1. Introduction
Federal preemption of state anti-predatory lending laws (APLs) has received increased attention
in recent debates over the subprime crisis. This is because federal laws regarding mortgage
lending had been substantially less restrictive than many state laws in recent years and because
lending by preempted lenders accounts for a significant share of the mortgage market. As policy
makers try to deal with mounting foreclosures, it is important to understand the role that federal
preemption may have had in the subprime boom and the resulting foreclosure crisis. The overall
goal of this study is to examine the impact of federal preemption, namely the 2004 preemption of
state laws by the Office of the Comptroller of the Currency (OCC) on the recent mortgage
foreclosure crisis.
There is ample justification for this examination. As research has shown, many loans features
and mortgage underwriting practices addressed by state anti-predatory lending laws have been
associated with higher default risks (Calhoun and Deng 2002; Ambrose, LaCour-Little, and
Huszar 2005; Quercia, Stegman, and Davis 2007; Immergluck 2008; Pennington-Cross and Ho
20 I 0). These include features such as prepayment penalties, balloon payments, lack of
verification of borrowers' repayment capacity, and very high interest rates and fees. There is also
some preliminary research that demonstrates that an effective APL improves the quality of loans
originated by giving lenders an incentive to tighten underwriting standards, thereby reducing
default and foreclosure rates (Goodman and Smith 2009). In a descriptive analysis, Ding,
Quercia, and White (2009) find a lower foreclosure rate in states with stronger mortgage market
regulations.
Federal preemption of stronger state laws may lead to riskier underwriting standards and
undermine the protections states have put into place. The Office of Thrift Supervision (OTS)
exempted federally chartered thrifts and their operating subsidiaries from state anti-predatory
lending laws (and broadly from many credit regulations) in 1996. In February 2004, the OCC
officially preempted national banks and their operating subsidiaries from most state laws
regulating mortgage credit, including state anti-predatory lending laws, arguing that they should
only be subject to federal laws regulating mortgage credit. As a result, mortgage lenders
regulated by the OCC were free to disregard state laws and therefore mortgage loans made by
these lenders generally were not subject to restrictions on loan terms or requirements to verify a
borrower's ability to repay. Considering the ever-growing share of subprime mortgages
originated by national banks, thrifts, and their subsidiaries-all preempted by federal laws 1 there is some debate whether such preemption is to blame, at least in part, for the current
foreclosure crisis (Belsky and Essene 2008; Bostic, Engel, McCoy, Pennington-Cross, and
1 In fact, mortgage lending by preempted lenders accounted for a significant share of the market. The share of highcost loans that were preempted in APL states increased from 16 percent in 2004 to 46 percent in 2007. Although
"high-cost" or "higher-priced" are not strictly analogous to "subprime," many researchers use these three terms
interchangeably.
1
Wachter 2008b). It should be noted that the 1996 OTS preemption came early on in the
development of the subprime market, while the OCC preemption seems to have coincided with
the beginning of the explosive growth in that industry when underwriting standards overall were
declining (Demyanyk and van Hemert 2008). In the present study, we focus on the impacts of the
latter.
We contend that federal preemption did affect the behavior of lenders during the subprime boom
and thereby had an impact on the foreclosure crisis. There is good evidence that some types of
loan features tend to be used less in states with APLs and that restrictive laws can reduce the
flow of subprime credit (Pennington-Cross, Chomsisengphet, Bostic, Engel, McCoy, and
Wachter 2008). The less restrictive federal regulation would therefore result in more
originations of risky loans and changes in the product mix of preempted lenders. In tum, this is
likely to lead to changes in patterns in mortgage performance. Our a priori expectation was that
after the OCC preemption, the quality of mortgages originated by preempted lenders would
become worse in states with strong APLs because they were no longer required to abide by more
stringent state regulations, and that this deterioration in underwriting standards would increase
default risk in these states. We also expected this effect would be strongest in the refinance
market where state APLs were more stringent.
In this paper, we test this contention by examining the performance of mortgages originated by
lenders in states with and without APLs, before and after the 2004 OCC preemption. More
narrowly, we test for a preemption effect by examining changes in the quality and performance
of loans originated by OCC lenders and changes in the performance of loans originated by
lenders subject to different regulators. By focusing on a large sample of privately securitized
nonprime mortgages, we are able to identify the extent to which the 2004 ruling contributed to
the foreclosure crisis that followed. We compare the product mix and the probability of default
of mortgages originated by preempted lenders before and after the 2004 OCC preemption in
states with and without APLs. The results support our a priori expectations and suggest that
preemption resulted both in the deterioration in the quality of loans, and in the increased default
risk for mortgages, originated by OCC lenders in states with strong anti-predatory lending laws.
Notably, the increase in default risk of OCC-regulated lenders in the refinance market outpaced
that of independent mortgage companies, which also originated a large share of subprime loans
but which remained subject to state laws. These effects are statistically significant for both fixed
and adjustable rate refinance loans. We believe that these results provide strong support for
policy proposals that would have the Federal law provide a regulatory floor while allowing the
states to adopt stronger APLs based on local conditions. (We note that the findings are sensitive
to the inclusion or exclusion of one outlier.)
The remainder of the study is divided into five sections. In Section 2, we review the recent
studies on the impact of state anti-predatory lending laws and the impact of federal preemption.
In Section 3, we describe the method used to identify the impact of federal preemption. In
Section 4, we describe the dataset used for this study, including the unique dataset created by
merging private securitizations and the Home Mortgage Disclosure Act data. Section 5 presents
2
our regression results. In the final section, we summarize the results and derive policy
implications.
2. Literature Review
Since 1999, when North Carolina passed the first state anti-predatory lending law, researchers
have tried to understand how APLs impact the mortgage market, including credit flows, cost of
credit, and mortgage product substitution. Recent research has started to examine how APLs
affected the use of more exotic loan types and how state laws impacted mortgage foreclosure
rates across states and neighborhoods. One area that has received almost no empirical attention
is the impact of federal preemption. This is an important omission since addressing the causes of
the current crisis may require understanding the role played by federal preemption. To provide
the background and context to the present study, in this section, we review the literature on the
coding of APLs, the impact of APLs on mortgage foreclosure rates, and the impact of federal
preemption.
2.1 Coding of State Anti-Predatory Lending Laws
During the period leading up to the subprime foreclosure crisis, from 2000 through 2007, many
states adopted laws regulating subprime mortgage lending. The laws were intended to curb socalled predatory practices while permitting non-abusive subprime lending to develop (Li and
Ernst 2007). Most of these state laws were modeled after the federal Homeownership Equity
Protection Act (HOEPA) adopted in 1994, 2 although there are several states that took various
different approaches. The federal HOEPA statute restricts loan terms for mortgages with high
prices, based on either the APR or the total points and fees imposed. The mini-HOEPA laws, in
tum, can be divided between those that replicated the federal coverage and restrictions, and those
that extended HOEPA to either cover more loans, or restrict more contract terms, or both.
Because there is significant variation in the coverage arid strength of APLs across different states,
most researchers have developed a set of indices to quantify the substantial variation in the laws.
Ho and Pennington-Cross (2006) created a two-component index of state laws. The first
component, "coverage," reflects the extent to which a law extends market coverage beyond
HOEPA; the second component, "restriction," reflects the extent to which a law restricts or
requires specific practices on covered loans. Bostic et al. (2008a) further added the enforcement
index, which includes measures of assignee liability and enforcement against originators.
However, it seems the different components ofthe composite index of state laws may have
"slider effects" in which the strength ofthe coverage component offsets the effects of the
restriction component. For example, stronger restrictions are likely to reduce subprime loan
volumes while increasing the coverage of a state law may in fact mitigate this effect since
2 Home Ownership and Equity Protection Act, Pub. L. No.1 03-325, subtit. B of tit. 1, §§ 151-158, 108 Stat. 2160
(1994).
3
because potential applicants may feel more comfortable applying for a subprime loan if a lending
law covers their application (Bostic et al. 2008a).
In a few other studies, researchers have used a simple dummy to indicate whether a state had
adopted the APL at a particular time (e.g. Pennington-Cross et al. 2008). But there is also a
fundamental difference between the states that extended restrictions on subprime mortgages
beyond federal requirements, and states that simply copied federal HOEPA restrictions into their
state statutes. Some state laws did not extend coverage beyond mortgages covered by federal law.
In several instances, the intent of these laws was to preempt local laws and ordinances that
imposed greater restrictions than federal law. So it is important to distinguish between these two
types of state laws when comparing results.
Another approach employed in Li and Ernst (2007) ranks state laws according to the type of
loans covered, points-and-fees triggers, substantive legal protections, and remedies available to
borrowers. The advantage of this approach is that it is easier to derive policy implications based
on these measures. But because they finished their study in 2006, many APLs that were adopted
in recent years were not considered in their study. In this study, we developed a state law coding
system for high-cost or predatory mortgage laws and overcome some limitations in previous
coding.
We reviewed the existing studies, including Pennington-Cross et al. (2008), Bostic et al. (2008a),
and Li and Ernst (2007). We also reviewed the description of state laws in several treatises,
including Renaurt, Keest, Carter, Wu, and Cohen (2009) and Nelson and Whitman (2007),
reviewed various rate matrices that reflect mortgage originators' understanding of state laws,
particularly for prepayment penalty restrictions, and then reviewed statutory language itself. A
summary of states with strong APLs will be discussed in the Data section and more details about
the coding system can be found in Ding, et al. (2009).
2.2 Impact of State Anti-Predatory Lending Laws on Foreclosure Rates
One line of research has started to investigate whether differences in regulatory environment,
including state anti-predatory lending laws, contribute to differences in the quality of loans
originated and subsequent rates of foreclosure. Many of the features covered under APLs, such
as the use of prepayment penalties, balloon payments, lack of verification of borrowers'
repayment capacity, and very high interest rates and fees, have been associated with higher
default risk. Calhoun and Deng (2002) and Quercia, Stegman, and Davis (2007) found that
subprime adjustable-rate mortgages (ARMs) have a higher risk of foreclosure because of the
interest-rate risk, the underwriting using teaser rates, and other such practices. At the aggregate
level, the share of ARMs appears to be positively associated with market risk, as measured by
house price declines (lmmergluck 2008). Subprime hybrid ARMs, which usually have
prepayment penalties, bear particularly high risk of default at the time the interest rate is reset
(Ambrose, LaCour-Little, and Huszar 2005; Pennington-Cross and Ho 20 I 0).
As to prepayment penalties and balloons, Quercia et al. (2007) found that compared to loans
without these features, refinance loans with prepayment penalties are 20 percent more likely to
4
experience a foreclosure, while loans with balloon payments are about 50 percent more likely.
Prepayment penalties also tend to reduce prepayments and increase the likelihood of delinquency
and default among subprime loans (Danis and Pennington-Cross 2005). Ding, Quercia, Li, and
Ratcliffe (2008) identified that ARMs, prepayment penalties, and broker originations all
contribute significantly to subprime loans' increased risk of default.
Although the literature does document a clear link between these product features and
foreclosures, given the limited publicly available information on loan performance, very few
studies have linked state APLs explicitly to local- or state-level foreclosure rates. After
controlling for housing market conditions, we would expect to find lower foreclosure rates in
states with stronger mortgage market regulations. In a working paper, Goodman and Smith (2009)
suggest that the laws governing mortgage underwriting, mortgage foreclosures, and the potential
costs to the lender differ substantially across states. Based on the foreclosure rate data
constructed from Lender Processing Services Applied Analytics, Inc. (LPS) data and a
hierarchical linear model, they found some evidence that mini-HOEPA laws reduce the level of
foreclosure. The results suggest that higher lender costs for foreclosure and stringent controls on
predatory lending are connected to lower foreclosure rates. However, since Goodman and Smith
are only able to use a cross-sectional dataset for one particular month, their paper's applicability
may be limited. The presence of seasoned loans in the dataset could introduce significant bias,
since loans could have been originated before the enactment of state laws. It is also unclear
whether the results can be generalized to other time periods. In addition, Goodman and Smith
use the law index from Bostic et al. (2008b), which did not cover years after 2005. As
regulations are being proposed and amended to address the current mortgage crisis, further
research in the area of laws and regulations and the measurement of their effectiveness is needed
(Richter 2008).
2.3 Impact of Federal Preemption
In the United States, residential mortgage lenders have been regulated by a complex web of
national and local regulatory bodies. National banks and Federal thrifts (those chartered at the
national level) are supervised by the OCC or the OTS, respectively. Before Federal preemption,
they were also subject to many of the laws of the states in which they, and their subsidiaries,
operate before federal preemption. In contrast, state banks and thrifts (those chartered at the state
level) are supervised by either the Federal Reserve System (FRS) or the Federal Deposit
Insurance Corporation (FDIC) and by their chartering state. The National Credit Union
Administration (NCUA) supervises credit unions. Finally, non-depository independent mortgage
companies are regulated by the Department of Housing and Urban Development (HUD) and the
Federal Trade Commission and they are subject to state regulations too.
Federal preemption fundamentally changed the regulatory structure for many lenders. The OTS
issued a regulation in 1996 that broadly exempted federally chartered savings and loan
institutions and their operating subsidiaries from state laws regulating credit. OTS-regulated
institutions were therefore free to disregard the state laws discussed above throughout the study
period. On August 5, 2003, the OCC issued a Preemption Determination and Order stating that
the Georgia mini-HOEPA statute would not apply to National City Bank, a national bank, or to
its operating subsidiaries, including non-bank subprime mortgage lender First Franklin Financial
5
Company. The OCC then issued a broad preemption regulation, effective February 12,2004, that
exempted national banks and their operating subsidiaries from most state laws regulating
mortgage credit. 3 The OCC maintained that its regulations override a number of state laws that
conflict with a national bank's exercise of its banking powers. Consequently, prior to August 5,
2003, national banks and their subsidiaries were likely subject to state mortgage laws, while after
February 12, 2004, they clearly were not.
Federal preemption has intensified the regulatory competition in this dual regulatory system. By
allowing certain mortgage lenders to be exempted from complying with state mortgage laws,
preemption makes national charters more attractive, relative to state charters, to many
4
institutions. There are several possible negative outcomes from preemption. First, it could result
in banks abandoning one regulatory system in favor of the other that may seem more favorable.
Now subject to a more relaxed regulation environment, these lenders may feel freer to originate
riskier loans, previously covered by stronger state regulation, leading to relatively more
foreclosures. Second, preemption could make the regulators unwilling to impose appropriate
standards on the institutions they regulate, since banks or thrifts can let regulators compete
again;t one another. Third, preemption might help push the market towards looser underwriting
standards, particularly if the direct consequences of these riskier standards are not immediately
obvious (e.g., during a housing boom). Thus, the preemption could upset the balance of the dual
banking system and cause a systematic failure.
There has been almost no empirical research and only minimal discussion on the impact of
federal OCC preemption. Harvey and Nigro (2004) suggest that the APL in North Carolina
might have a unique impact on non-bank lenders, which are generally not subject to the same
federal oversight as their bank competitors and therefore are perceived as being more likely to
engage in predatory lending than banks. However, there is evidence that over this time period,
many non-bank lenders were acquired by national banks, thereby avoiding anti-predatory lending
laws. Burnett, Finkel, and Kaul (2004), for example, found a shift in subprime lending from nonbanks to banks in North Carolina after the 1999 passage of the APL, as well as a change to a
significantly higher share of originations by subprime bank lenders in North Carolina than in the
control states. The authors suggest that the consolidation in the financial services industry -in
particular, the acquisition of subprime lenders by bank holding companies-during the study
period may help to explain this finding. They also surmise that another factor driving the results
was that bank lenders expected the state anti-predatory lending law eventually to be preempted
by federal laws for federally regulated institutions. Similarly, Harvey and Nigro (2004) found
that, following adoption of the law, subprime lending by bank lenders held steady while
subprime lending by non-bank lenders fell in North Carolina, in comparison with the control
states.
12 C.F.R. 34.4(a)(4), 69 Federal Register 1904 (Jan. 13,2004).
4 Federal bank regulators employed other regulatory techniques during the housing bubble to address concerns about
lax loan underwriting, but these were less restrictive than strong state APLs. For example, federal regulators
addressed the repayment ability issue through non-binding guidelines, bank examinations, supervisory orders, and
sanctions. Thus, preemption did not entirely eliminate oversight of loan terms, but it displaced binding state laws
with the less stringent and more opaque federal regulatory structure.
3
6
Because of the collapse of the subprime sector starting late 2006, it is important to understand
how mortgage market regulations-and who was covered by what-influenced both the
deterioration in lending standards and ultimately loan performance. Due to data availability and
the timing of the action relative to the growth of the subprime market, we focus on the impacts of
the OCC 2004 preemption in the empirical analysis presented below. Did the originations of
prime, subprime, and loans with predatory characteristics shift from the non-preempted to
preempted institutions? Did the OCC preemption affect the default rates of loans originated by
national banks? Did the preemption lead to riskier underwriting standards and higher
foreclosures? The existence of federal preemption and APLs creates a natural experiment for an
evaluation of the effectiveness of different modes of regulation. The regression analysis in this
study complements the descriptive analysis presented in our earlier descriptive examination
(Ding et al. 2009).
3. Data
In this section, we describe the data sources used in the analysis. We first describe our coding
system of state laws based on their coverage and strength regulating the subprime market. Then
we describe the unique dataset created by merging HMDA with a large sample of private-label
securitizations. We also used data from several other sources to control for house price dynamics
and neighborhood characteristics.
3.1 State Anti-Predatory Lending Law Data
To develop a state law coding system for high-cost or predatory mortgage laws, we reviewed
various rate matrices that reflect mortgage originators' understanding of state laws and then
reviewed statutory language itself. We identified that mini-HOEPA laws were adopted in 25
states and the District of Columbia on or before December 31, 2007. 5 In addition, five states
(Michigan, Minnesota, Nevada, Texas, and West Virginia) passed significant subprime mortgage
regulation statutes that were not HOEPA extension statutes and not based on rate and fee triggers.
A number of other states had laws adopted prior to 2000 that restricted prepayment penalties,
balloon payments, or negative amortization for all mortgages.
Of the mini-HOEPA laws, eight (Utah, Pennsylvania, Nevada, Oklahoma, Ohio [prior to 2007],
Maine [prior to 2007], Kentucky, and Florida) did not extend coverage beyond mortgages
covered by federal law. In several instances, the intent of these laws was to preempt local laws
and ordinances that imposed greater restrictions than federal law. There is thus a fundamental
difference between the states that extended restrictions on subprime mortgages beyond federal
requirements, and states that simply copied federal HOEPA restrictions into their state statutes.
We developed and coded a set of law variables to describe state laws that could affect the type of
subprime mortgages made and the default and foreclosure rates of mortgages in a given state.
Arkansas. California. Connecticut. District of Columbia, Florida, Georgia. Illinois, Indiana, Kentucky, Maine,
Maryland. Massachusetts, Nevada, New Jersey, New Mexico. New York. North Carolina, Ohio, Oklahoma,
Pennsylvania. Rhode Island, South Carolina, Tennessee, Texas, Utah, and Wisconsin.
S
7
The binary variable ineffect, modeled on Pennington-Cross et al. (2008) and Bostic et al. (2008b),
in combination with the effective date variable for the same state and law, is intended to identify
states with mortgage statutes that could plausibly have an impact on high-cost or subprime
mortgage lending (Figure 1 and Table 1). A value of 1 was assigned for the ineffect variable to
the states with any restrictions on charging or financing points and fees, credit insurance,
prepayment penalties, balloon payments, negative amortization, determination or documentation
of income or repayment ability, and/or significant counseling requirements, so long as the state
law covers any share of the subprime (or the entire) mortgage market below the HOEPA rate
and/or fee triggers. A value of zero (0) was assigned to the ineffect variable for the eight states
with HOEPA copycat statutes, which is a departure from some prior studies. During the study
period, virtually no mortgages were made nationwide that would have been covered by
HOEPA's high-cost thresholds (Avery, Brevoort, and Canner 2007). While some of the eight
statutes imposed minor additional restrictions not found in federal law on high-cost loans above
the HOEPA triggers, it is doubtful that a difference in regulation of a negligible slice of the
mortgage market would affect the outcome variables.
So, based on our definition, states with strong APLs prior to 2007 include Arkansas, California,
Connecticut, Georgia, Illinois, Indiana, Maryland, Massachusetts, Michigan, Minnesota, New
Jersey, New Mexico, New York, North Carolina, Rhode Island, South Carolina, Tennessee,
Texas, West Virginia, and Wisconsin, as well as the District of Columbia. A few states (Maine,
Rhode Island, and Minnesota) made significant amendments after December 31 2006 but we are
not aware of other post-2004 amendments that would change the coding for any state. 6
3.2 Columbia Collateral File Data
To study the impact of federal preemption on loan performance, the data must include
information about loan originations and the regulatory agency governing the lending institution,
loan product characteristics, and mortgage performance. By merging the private-label
securitization data from the Columbia Collateral file (CCF) with HMDA, we are able to make
these variables available for individual mortgages since the CCF data provides rich information
on loan features and mortgage performance, while HMDA provides important lender information
and borrower income data.
Loan-level data, known as the Columbia Collateral file, provide detailed mortgage information
for a national sample of nonprime loans (White 2009; Quercia and Ding 2009). 7 These cover
mortgage pools for which Wells Fargo serves as trustee; the pools are serviced by many of the
leading mortgage servicing companies. The data are available through remittance reports
produced by the trustee and its servicing companies on many mortgage pools, altogether
representing more than four million outstanding mortgages.
Maine made significant amendments in 2007, having enacted a copycat statute previously, so it is treated as
ineffect=1 for originations after 2008. Minnesota made significant amendments in 2007 but they did not change the
value of the ineffect variables. Rhode Island's statute was first effective December 31,2006. We are not aware of
other post-2004 amendments that would change the coding for any state.
6
7 These investor report files are available at www.ctslink.com. administered by the Corporate Trust Services group
of Wells Fargo Bank, N.A.
8
The CCF dataset consists of monthly loan-level data on nonprime home purchase and refinance
mortgages that have been packaged into private-label mortgage-backed securities. It includes
mortgages with different interest rate structures (fixed rate, adjustable rate, hybrid rate, interest
only, balloon,), different purposes (refinance or purchase), different property types (one-to-four
family or multifamily), and different lien statuses (first-lien, second-lien, and others). The data
contains loan-level data including the loan interest rate, loan-to-value (LTV) ratio, borrower
credit score at origination, origination date, loan amount, whether the loan was based on low- or
no-documentation, whether there were prepayment penalties, and whether the loan required a
balloon payment. The monthly performance reports provide loan-level details on loan
characteristics, defaults, foreclosures, bankruptcy, and losses on foreclosed homes.
To study of the impact of federal preemption, all loans originated from January I, 2002 through
December 31, 2006 in the CCF dataset were initially included in the sample, allowing us to
follow cohorts before and after the 2004 OCC preemption. We focus on the performance of these
loans during the period from December I, 2006 to December 31, 2008. So we can gauge their
loan performance through the height of the subprime foreclosure crisis. After 2008, the
combination of the recession, rapid rise in unemployment, and the changing policy environment
make it difficult to isolate the impact of APLs and federal preemption on loan performance
(Immergluck 2009).
HMDA data provide rich information on the lenders who originated the mortgages, demographic
and other information on borrowers, the geographic location of the property securing the loan,
and some characteristics of the home mortgages. HMDA's extensive coverage also provides a
broadly representative picture of home lending. 8 To obtain the information on the regulatory
structure of lenders, we merged the CCF data with HMDA data using variables that are common
in both datasets. We matched data using a geographic crosswalk file that sorted CCF and HMDA
loans into the census tracts of the purchased property and then matched loan originations on the
following variables: origination date, loan amount, lien status (for loans originated in 2004 and
later), and loan purpose.
By pooling all the monthly remittance reports together, we started with more than 3.5 million
mortgages that were originated from 2002 to 2006 and were still active as of December 2006.
After the match, 9 we had a sample of 2.5 million private securitizations originated from 2002 to
2006, representing about 30 percent of subprime and Alt-A mortgages, and about 5 percent of all
u.S. mortgages. The number of national banks and subsidiaries with at least 1,000 originations
was 25 in the matched dataset. The top five national banks include Bank of America, Wells
Fargo Bank, National City Bank, JP Morgan Chase Bank, and Countrywide Bank. Included in
the matched dataset are over 400,000 mortgages in foreclosure during the study period
(December 2006 to December 2008). This compares with about two million foreclosures as of
December 2008, so our sample includes almost 20 percent of all mortgages in foreclosure.
The match rate is about 70 percent for different cohorts of mortgages in the CCF data, ranging from 57 percent for
the 2002 originations to 82 percent for the 2003 originations (Table 2).
9 Estimations are based on National Delinquency Survey data for the first quarter of2007 (Mortgage Bankers
Association 2008). The National Delinquency Survey data are estimated to cover 85 percent of the residential
mortgage market.
8
9
The matched dataset includes all the static loan characteristics at origination as well as added
information about the borrower's income and information about which regulator oversaw the
lending institution that originated the loan. Specifically, the field for agency code in the HMDA
data identifies the regulating agency - whether OCC, OTS, FRS, FDIC, NCUA or HUD -- that
supervises the lender in question.
Of course, it needs to be noted that the matched sample does not represent a statistically random
sample of all mortgage loans or all nonprime mortgage loans. A few caveats about the Columbia
Collateral file data need to be mentioned. First, the coverage of the CCF data is limited to
securitized subprime and alt-A mortgages, which obviously do not represent the entire mortgage
market. The CCF data does not include the portion of nonprime loans that are held in portfolio.
Therefore, any systematic difference between loans held in portfolio and those that are
securitized may limit the applicability of our results to the portfolio loan market.
Second, only seasoned loans that were still active as of December 2006 are included in this
study; thus, we missed the loans that were terminated before December 2006. For example, loans
could be dropped out of the pools if they were foreclosed or prepaid, and there could be some
inevitable systematic differences between the seasoned loans and those early terminations.
Third, the representativeness of the study sample may be limited for some old cohorts and for
some lender types. In particular, the coverage of nonprime loans originated by state banks
(regulated by either FRS or FDIC) and by credit unions (regulated by NUCA) was quite
limited. lo
Finally, although our sample is national in scope, loans tended to be geographically concentrated
in high-growth states. For example, there is an over-representativeness of loans in California,
which had nearly a quarter of all loans. II
In other respects, the mortgages in the study sample should be typical of nonprime mortgages
originated between 2002 and 2006. Nevertheless, given that nonprime mortgages account for
more than half of all foreclosures, and that the vast majority of nonprime loans that" led to the
crisis were securitized,12 a study of a sample which covers one fifth of the foreclosures should
provide important insights as to the impact of government regulation in the nonprime market.
10 We found a limited coverage of this matched sample for the FRS and FDIC loans: originations by FRS and FDIC
lenders accounted for less than 15 percent of all subprime loans. Compared to the 30 percent to 40 percent coverage
for originations by the OCC and OTS lenders, this dataset may not allow us to conduct a meaningful analysis of the
FRS and FDIC lenders. Using the HMDA data, we constructed a sample of subprime originations (based on the
subprime list approach for originations before 2004) and high-cost loans (for originations after 2004) that were not
sold to government sponsored enterprises (GSEs) as a proxy of the population of private securitizations.
11 The HMDA data show that California's market share in the conventional mortgage market was around 16 percent
during the study period (2002-2006).
.
12 According to the National Delinquency Survey, the number of subprime mortgages that were in foreclosure
accounted for about 47 percent of the two million mortgages in foreclosure in the fourth quarter of2008 (MBA
2008). About 59 percent of subprime loans were securitized in 2003, and this rate increased to over 80 percent in
2006 (Inside Mortgage Finance 2008). So the securitized subprime loans should account for a significant share of
the total foreclosures during the study period.
.
10
For simplicity, we focus on conventional, 30-year, first-lien mortgages and mortgages with nonmissing value of origination credit scores, occupancy type, property type, or loan amount.
Because the focus of the study 'is the impact of the OCC preemption, loans originated by federal
thrifts and their subsidiaries, originations by state banks (regulated by FRS or FDIC) and credit
unions (regulated by NCUA) were also excluded. OTS lenders were not considered because their
preemption came early on in the development of the sub
@FedFRASER