THOMAS J. CURRY
COMMISSIONER OF BANKS
COMMONWEALTH OF MASSACHUSETTS
on behalf of the
CONFERENCE OF STATE BANK SUPERVISORS
COMMITTEE ON BANKING AND FINANCIAL SERVICES
UNITED STATES HOUSE OF REPRESENTATIVES
May 24, 2000
Mr. Chairman and members of the Committee, thank you for the opportunity to testify today on high-cost lending and the predatory practices associated with high-cost loans by certain lenders around the United States.
I am Thomas J. Curry, Commissioner of Banks for the Commonwealth of Massachusetts, and Chairman of the Conference of State Bank Supervisors. CSBS is the professional association of state officials who charter, regulate and supervise the nation's 6,000-plus state-chartered commercial and savings banks and more than 400 state-licensed foreign banking offices nationwide.
As state regulators we are keenly aware of the elements that make this issue so complex. These include: (1) the clear benefit to consumers nationwide from the wider availability of credit in recent years through "subprime" lending, especially to low-to-moderate income citizens, and other traditionally underserved markets; (2) the abusive and predatory practices that have, at times, been associated with such lending and which can severely harm our most vulnerable citizens, causing them to lose their homes and other assets, and; (3) the frustrations of the states that pass laws and enact regulations to protect consumers and to stop clear predatory practices, but which are often hindered in their efforts by federal preemption.
I can assure you that the issue of predatory lending is at the top of the agendas of many state legislatures and state regulatory agencies. At CSBS's recent 99th Annual Conference in San Francisco, we devoted a great deal of discussion to the issue and looked at the steps several states have taken to limit abuses often associated with high-cost borrowing in order to protect their consumers. I will discuss some of the specific state actions later in my testimony. As state regulators we are working hard to define and identify the extent of the problem, to differentiate between subprime lending and predatory lending, and to offer solutions. However, I must add that all legislators and regulators, both state and federal, should consider whether enforcement of existing laws has been adequately pursued before considering adding new laws or regulations to the books. No amount of lawmaking will protect consumers without the proper enforcement, including well-trained examiners to discover violations, and appropriate sanctions to back it up.
The challenge is to prevent abuses without hindering efforts to incorporate risk-based pricing in ways that expand the lending market and the availability of flexible loan products. In our efforts to protect consumers we must balance our actions in order to avoid the unintended consequence of eliminating consumers' access to the very credit or services they need to improve their economic situation. We commend the Congress and the federal banking agencies for reviewing the adequacy of federal laws and regulations to prevent predatory practices. We suggest that federal preemption itself sometimes has the unintended consequence of limiting state regulators' ability to protect consumers and ensure a healthy banking and lending industry.
Offering solutions is not a new role for us. As you know, the state banking system for years has been the laboratory for innovation and for developing the best practices in both products and services and consumer protections. The states are best positioned to serve this role because it is at the state level that both businesses and consumers have proximity and expect to have access and accountability from their regulatory agencies. Because of this proximity, we are often the first to see trends and problems and the first to develop safeguards that both protect consumers and allow depository institutions and financial services providers to offer innovative products that meet consumer needs.
Many states have responded through statute or regulation to protect consumers from predatory practices. However, it has been the perhaps unintended consequence of federal preemption that has made it difficult for states to offer the protection that their consumers demand. This result was illustrated by the February 7, 2000 General Accounting Office report you requested, Mr. Chairman, on Office of Thrift Supervision and Office of Comptroller of the Currency preemption of state law.
Using the General Accounting Office study and our own survey of the states, CSBS has identified some of the state mortgage lending laws that have been preempted. These laws include: reporting requirements for licensed lenders; prohibitions on prepayment penalties; licensing and bonding requirements for subsidiaries; limitations on up front fees for home equity loans; limitations on late charges; prohibitions on negative amortization; disclosures for high rate, high point mortgage loans; limitations on appraisal fees for home mortgages; and prohibitions on balloon mortgages.
What we have concluded from this report is that preemption is a multi-faceted issue requiring a deeper level of communication between federal and state regulators than we have had in the past. Federal legislation and regulation must consider the consequences of preemption and recognize the important role states play in the area of consumer protection.
The federal Alternative Mortgage Transaction Parity Act (AMTPA) -- which you, Mr. Chairman, referenced in your letter of invitation to this hearing -- is a particularly important example of this preemption problem. Later in my testimony I will discuss the concerns a number of states have with AMTPA, which was discussed in some detail in the GAO report you requested.
First, however, I would like to describe for the Committee how several states are actively addressing concerns related to abusive lending practices.
North Carolina's Predatory Lending Law is the only one in the country that specifically addresses the issue of predatory lending. Specifically, the new law targets "high cost" home loans under $300,000. The definition of a high cost loan under the law is a loan that includes:
(1) An APR that exceeds the Treasury rate by more than 10 points;
(2) Points and fees that exceed 5% of the total loan amount if the loan is $20,000 or higher;
(3) Points and fees of either 8% of the total loan, or $1,000, whichever is less, if the loan is under $20,000;
(4) Prepayment penalties of more than 2% of the amount a borrower had prepaid on their home loan, and;
(5) Prepayment penalty if the borrower pays off the mortgage later than 30 months after closing.
It's important to note how North Carolina lawmakers addressed this issue as they drafted the legislation. The rates, points and prepayment provisions I have just described are not prohibited. The drafters did not want to limit access to credit, as I have said.
But under the North Carolina statute, loans that fall within the definition of a high cost loan trigger a series of protections designed to prevent predatory practices. For example, the statute limits or bans practices that can have the effect of making timely repayment impossible. Some argue that such practices "set up" borrowers to default and thus lose their home. The statute specifically:
The North Carolina statute goes further by preventing "flipping," the practice of refinancing a mortgage even though the new loan has no reasonable net benefit to the borrower. The law also prohibits recommending or encouraging default on an existing loan or other debt in connection with a proposed refinancing.
One of the most important remedies for predatory lending is consumer education and counseling. When individuals understand the lending process and their rights and responsibilities, they are less likely to sign agreements that are not in their best interests. In an attempt to address this issue, the North Carolina law prohibits high-cost home loans unless the borrower receives financial counseling. And the lender must reasonably believe that the borrower will be able to repay the loan. The law also bans the refinancing of prepayment fees or penalties payable by the borrower in a refinancing transaction.
There also is a prohibition against loans that would allow unscrupulous home improvement contractors and lenders from collaborating to provide loans with rates and fees that were beyond the ability of the borrower to repay.
Violations under the North Carolina statute trigger usury penalties, forfeiture of interest and return of twice the interest paid. Treble damages may also be awarded to the borrower. My counterpart in North Carolina, Commissioner of Banks Hal Lingerfelt, says the penalties "clearly have teeth and definitely got the attention of lenders."
In my own state, we have aggressively reviewed the actions of subprime lenders and moved against those entities deemed to be engaged in predatory lending. My division has worked closely with our Attorney General's Office on two egregious cases arising from our licensed examination program. In one case, a lender charged 17 points to a borrower having a debt-to-income of 109%. In another case, a non-bank lender was charging 10 points to consumers a violation of state regulations that prohibit the charging of unconscionable rates or terms. In the latter case, the federal court determined that the company was engaging in unfair and deceptive trade practices and that the company could not charge more than five points. Since that case, five points has been an important threshold when reviewing the practices of lenders in Massachusetts. Those lenders that exceed five points face stricter regulatory scrutiny during examinations.
Our division also issued an industry letter in 1997 on subprime and predatory lending issues warning Massachusetts banks, credit unions and nonbank lenders about the unique financial, legal and compliance risks associated with subprime lending. It also unequivocally states that predatory practices will not be tolerated.
I would also like to comment on the 1994 Home Ownership and Equity Protection Act (HOEPA), which Mrs. Roukema addressed in her April 14 letter to CSBS. It was pointed out that given recent accounts of predatory lending practices, HOEPA is not working as intended. Massachusetts would not object to HOEPA changes, provided that they do not impede on a state's right to develop even stronger consumer protection laws.
In Massachusetts, we are proposing changes to the Commonwealths HOEPA regulations (Massachusetts has an exemption from Regulation Z) that address some of the abusive practices we have seen since HOEPA was enacted six years ago. Our draft proposal will reflect many of the additional consumer protections found in the North Carolina law and New Yorks proposed regulations. We hope that these changes and our vigorous on-site compliance examination program, along with our recently announced statewide toll free consumer mortgage hotline and referral service, will further deter predatory lending abuses in Massachusetts.
The New York Banking Superintendent Elizabeth McCaul has proposed rules pursuant to which a lender must have due regard for a borrowers ability to repay the loan. The proposed rule is out for comment until May 26, 2000 and is likely to become effective sometime this summer. The proposal lowers the thresholds that are set forth in HOEPA, prohibits "flipping" and "packing" and provides an "unconscionability" standard.
In addition, a key provision is meant to ensure that the borrower can afford to repay the loan. This provision creates a presumption that if the total monthly obligations of the borrower do not exceed 50% of his or her verified monthly income, then the borrower can afford to repay the loan. Lenders who make loans with a higher debt-to-income ratio will have to justify that the borrower could afford to repay the loan. If insurance premiums are being financed as part of the loan, the 50% limit is a cap rather than a safe harbor. A lender may charge points and fees, but only if two years have passed since the borrowers last refinancing (or at any time on the new money advanced to the borrower). It further provides that only points and fees not in excess of five percent (other than certain enumerated third party fees such as an appraisal) may be financed. Points and fees above that amount may not be financed. Balloon payments would be allowed, provided the term of the loan was at least seven years. Lenders would be required to provide a disclosure recommending counseling to borrowers as well as a list of counselors approved by the Banking Department and to report annually the credit history of their borrowers to a national credit agency.
The New York State Banking Department is also writing guidelines related to the securitization of subprime loans. The guidelines will focus on ensuring that all loans that are packaged by lenders and sold to investors meet sound underwriting and appraisal rules and comply with applicable federal and state consumer protection laws. Superintendent McCaul, while acknowledging that securitization has resulted in increased capital availability benefiting subprime borrowers, has also noted that securitizations have provided funds for abusive lenders.
New Yorks experience, indeed the experience of all of the States with predatory lending, has provided important information about how enhanced due diligence will serve to ensure that securitizations do not fund abusive loans. Securitizations have provided depth and breadth to a critical market and have increased lending to low and moderate income borrowers. But they have also funded the explosion in predatory lending we are now observing. The securitizations are structured with reps and warranties that protect the underwriters and the investors.
Underwriters traditionally look to simple characteristics such as volume, financial condition and default rates when making underwriting decisions for securitizations. As an example, a low default rate may hide a high refinancing rate that may indicate abusive lending. New York would also encourage underwriters to ensure that the underlying loans are made with an eye toward the borrower's ability to repay and not be based on the value of the collateral. Both examples illustrate how an enhanced due diligence standard will remove abusive loans from securitizations.
The California legislature is currently engaged in a debate over Senate Bill 2128, which includes some of the same provisions found in the North Carolina statute. For example, the proposed law establishes a category of loans that trigger consumer protections. It includes one category of "restricted home loans at APRs that are 6 points or higher than the Treasury rate, or which have total points that are 4% over the loan amount.
The proposed law also prevents equity stripping, which means that lenders cannot advance a home loan if the loan pays off an existing home loan and the terms do not provide a benefit to the borrower. And like the North Carolina law, the proposal requires counseling for the borrower and written proof of the counseling. A lender also must reasonably believe that the borrower can repay the loan. In addition, the financing of life, disability or unemployment insurance must occur as a transaction that is separate from the home loan.
Commissioner of the Office of Banks and Real Estate (OBRE), William Darr, reports that problems exist in Illinois with certain participants in the subprime lending market. The OBRE is taking on the challenge of addressing predatory lending practices while also ensuring that credit remains available to Illinois citizens through the subprime lending market.
The agency is drafting new regulations to combat predatory practices through a three-pronged approach that would: (1) require consumer counseling and education before the signing of a "high risk" loan; (2) require consumer counseling and education before a foreclosure, and; (3) define a "high risk loan." The OBRE is actively consulting with the industry, community groups and other regulators as it drafts these new regulations.
Meanwhile, the agency has been given a mandate by the legislature to move against predatory lending practices; Commissioner Darr reports that his agency's FY 2001 budget includes an additional $400,000 for increased supervision and enforcement efforts related to the problem.
Minnesota, like other states, has not attempted to differentiate between subprime and predatory lending. But mortgage lenders in the state must follow standards of conduct that include prohibitions: (1) on fees when no product or service is provided; (2) on false, deceptive or misleading statements; (3) on making residential loans with the intent that the loan will not be repaid and the lender will obtain title to the property via foreclosure, and; (4) on making a higher cost loan than underwriting or credit scoring data would indicate the borrower is entitled to unless the borrower consents in writing. Regarding usury, Minnesota law was recently amended to require out-of-state lenders to comply with limits on real estate loan rates and charges.
Virginias legislature passed the Mortgage Lender and Broker Act in 1987. The statute supplements the states "Money and Interest" laws, and recognizes differences between first mortgages, where more latitude is allowed in rates, closing fees and loan-associated costs, and loans secured by subordinate liens on homes, which require stricter controls on rates and fees.
The Act requires mortgage companies and lenders not affiliated with state or federal depository institutions to be licensed and supervised by the state, and it prohibits certain abusive practices and provides for enforcement of violators.
Virginia Commissioner of Financial Institutions E.J. Face, Jr. explained that his agency uses three components for preventing predatory lending practices. One is the regulators ability to assess a lenders qualifications to enter the business. The second is thorough monitoring and the third is to effectively penalize violations, deter offenses, and remove repeat offenders, if necessary.
According to Commissioner Face, Virginias laws worked well until recently, when an alternative mortgage lender in Virginia utilized a 1996 Office of Thrift Supervision opinion that preempted state law under AMTPA. A federal court has since enjoined Virginia from enforcing its laws against prepayment penalties, thus preventing the state from acting against the lender. The case is set for hearing before the U.S. Court of Appeals for the Fourth Circuit. Commissioner Face believes that OTSs preemption was unwarranted and has prevented his agency from protecting Virginia consumers.
In New Jersey preemption is also a major concern. New Jerseys Department of Banking and Insurance reports that the states Licensed Lenders Act, which sets rules on net worth, liquid assets and requires examination of mortgage bankers, mortgage brokers, secondary mortgage lenders, consumer lenders and sales finance companies has been preempted by federal law. Prepayment penalty laws and mortgage processing rules for first lien residential mortgage loans have also been preempted.
Mortgage lenders that become operating subsidiaries of federal thrifts, the Department of Banking and Insurance reports, can do business without a state licensed or following the states mortgage processing regulations.
The Department of Banking and Insurance recommends that states be allowed to license subsidiaries of federal thrifts if they engage in an activity that the state licenses, and that states be allowed to prohibit out-of-state entities from lending within the state in violation of the states criminal usury rate.
New Jersey also proposes that federal agencies be required to publish their intention to preempt a state law, provide the state an opportunity to comment on preemption actions, and take the states comments into consideration when the final decision is published. These are important principles that I will talk about in more detail later in my testimony.
Washington State Director of Financial Institutions John Bley highlights that no amount of new law addressing predatory lending can replace the need for aggressive enforcement. Washingtons Department of Financial Institutions recently took a lead in investigating, and then sanctioning, First Alliance Mortgage Company (FAMCO) for predatory lending practices. FAMCO is also under investigation by the U.S. Department of Justice and is being sued by a number of other states. While FAMCO filed for bankruptcy in March, Washingtons DFI and the states attorney general are pressing forward with their charges against the company.
Director Bley notes that weeding out predatory lending requires getting beyond a review of loan files to actual examination of lending practices through follow-up on consumer complaints by individuals who understand predatory practices. Commissioner Bley adds that criminal sanctions of deceptive practices are the most effective deterrent to abusive lending. Attached is an interagency memorandum from the Washington DFI intended to help Washington state examiners identify deceptive and predatory mortgage practices.
Federal Preemption Issues
Our concern about protecting consumers and certain disturbing lending practices provides an important opportunity to review standards for federal preemption. As I have described, the states are working hard to define what practices cross the line from subprime lending into predatory lending. We acknowledge that preemption may, at times, be necessary to facilitate a modern banking system. But preemption must be held to a high standard. It must be used under the principle that it is for the benefit of both business and consumers. What public policy benefits are realized if preemption tips the scales too far in favor of either businesses or consumers?
That is why federal preemption, we argue, must be done in a manner that clearly spells out its necessity and its benefits. We ask Congress to require all federal banking agencies to seek public comment before preempting state consumer protection statutes. As part of the public comment process, the federal agencies should articulate a justification for preemption and explain:
(a) how similar existing federal protections adequately protect consumers, or:
(b) when no federal regulation exists, why the preempted state law is not necessary for consumer protection.
One of the fundamental principles that should guide our discussion of preemption is that all consumers within a state receive equal protection. Based on my own experience most consumers are unaware of whether they are doing business with a federal or state-chartered bank or thrift or a non-bank lender, and believe they have equal consumer protections when dealing with a mortgage lender. Federal preemption should not create an uneven playing field for consumer protection or create confusion about applicable law.
The GAO report on preemption you requested, Chairman Leach, provides support for these principles. The report looked at the effect of the Alternative Mortgage Transaction Parity Act of 1982 on state regulation (AMTPA preempts state laws on alternative mortgage financing arrangements). The report also examined communication and disclosure issues related to preemption by the Office of Thrift Supervision (OTS) and the Office of the Comptroller of the Currency (OCC). At this point I must, however, commend OTS Director Ellen Seidman for her willingness to work with CSBS on issues related to preemption generated by states concerns and the GAOs review. Director Seidmans sincere efforts to address states concerns with OTS preemption practices and her agencys increased communications with the states about preemption, and current request for comment on AMTPA, will benefit consumers.
An issue of particular concern to many state banking regulators is that AMTPA allows state-licensed mortgage lenders to rely on applicable OTS regulations, thus often escaping more stringent state consumer protection laws. As the GAO pointed out in one example, a state law prohibiting lenders from charging excessive prepayment penalties on certain mortgage loans, would not apply to a state licensed housing creditor if it has chosen under AMTPA to be governed by federal regulations. This has created considerable confusion about applicable law as it relates to these state-licensed mortgage lenders.
Many state banking regulators feel that consumers are greatly disadvantaged by such preemption. These state regulators believe that AMTPA often stands in the way of the state enforcing its own laws and thus cracking down on predatory lending practices. Only five states, including the Commonwealth of Massachusetts, passed the necessary laws to opt out of the preemptive effect of AMPTA during the window provided for state action. The mortgage and lending marketplace was much different 15 years ago, and this opt out provision is no longer available to the other 45 states. It is perhaps an appropriate time to for Congress to review AMTPA.
Meanwhile, most consumers shopping for a mortgage typically do not understand that different sets of laws apply to different lenders. The GAO also reported that state officials are concerned about the ability of federal regulators to help those consumers who have problems with mortgage lenders.
As I explained earlier, this Committees focus on predatory lending practices provides an opportunity for the federal government to reconsider and to amend the preemption practices of the OTS and OCC. Both federal banking agencies act on preemption issues and render preemption decisions without having to consult with, or even formally notify, the states. As we have seen in the case of AMTPA, this can have negative consequences for consumers and create frustrating barriers for a state trying to combat predatory lending practices.
The OCC, unlike the OTS, is required under the Riegle-Neal Act to issue a public notice and to seek public comment on certain preemption subjects; the final preemption opinion must be published in the Federal Register. The OCC also must report to Congress annually on preemption actions and the reasons for each action.
Except for this notice and disclosure requirement of the OCC regarding certain preemption subject areas, neither OCC nor OTS has any formal procedures in place for soliciting comments from state regulators or for notifying them of final preemption actions. However, the OTS has recently informally communicated to CSBS that the agency will communicate with CSBS, and affected states about preemption. This has been a step in the right direction and we appreciate OTSs decision to communicate with state regulators.
One finding from the GAO report is especially telling: "Typically, the financial institution that requested an OTS or OCC opinion on whether a particular state law was preempted informed the state bank regulators of the federal preemption decisions. Some state banking officials learned of preemption decisions while addressing a consumer complaint or while conducting a consumer compliance examination."
The GAO reported that state officials want a formalized disclosure process in which states are notified in advance and consulted (emphasis added) when OTS and OCC are considering opining that a particular law is preempted. State officials also want to be notified of final preemption decisions.
At the very least, state regulators and CSBS believe that Congress should include the OTS in the requirement that the OCC follows under Riegle-Neal -- provide a public notice and comment period on its preemption actions and then publish a notice in the Federal Register. Moreover, OTS should also report to Congress annually on its preemption opinions (as required of the OCC in Riegle-Neal).
Finally, I would like to comment on the Presidential Executive Order 13132, which took effect on Nov. 4, 1999. Both state banking departments and the CSBS believe that the Order requires federal regulators to consult with state officials when they are considering preempting state law. The fundamental principle underlying the Order is to strengthen federalism. One provision requires federal agencies to consult when practicable with state and local officials in order to avoid conflicts between state and federally protected interests. A second provision says that a federal agency that plans to preempt state law will provide state and local officials notice and an opportunity to participate in the proceedings. Finally, federal agencies are required under the Order to adopt specific procedures for ensuring meaningful and timely consultation with state and local officials affected by preemption actions.
This is the right approach. As Congress, federal agencies and the states seek to understand the important public policy issues surrounding subprime lending and to regulate and prevent harmful predatory lending practices, it is important to ensure that states are a full partner in the preemption process.
The states are the laboratory for innovation and for developing the best practices in products and services and consumer protections. We are close to our citizens, and a consumers as well as a providers access to a regulator is vital for ensuring a fair and healthy marketplace. States are often the first to see trends and problems and the first to develop safeguards that both protect consumers and allow depository institutions to thrive. Federal policies and procedures should support, not hinder, the states role.
Again, thank you for the opportunity to testify to the Committee. I look forward to responding to any questions you may have.