BILL ANALYSIS AB 69 Page A Date of Hearing: January 14, 2008 ASSEMBLY COMMITTEE ON BANKING AND FINANCE Ted Lieu, Chair AB 69 (Lieu) - As Amended: January 7, 2008 SUBJECT : Mortgage lending: reporting SUMMARY : Requires mortgage lenders to report to their respective regulatory agency information regarding loan loss mitigation efforts. Specifically, this bill : 1)Requires banks, credit unions, residential mortgage lenders and finance lenders to report data on subprime, prime and alternative mortgage products originated and serviced by those entities. 2)Provides that lenders must provide data on their volume of loans on a monthly basis that includes the following information: a) Loans that are 30 to 59 days past due; b) Loans that are 60 to 89 days past due; c) Loans that are 90 days past due or over; d) Loans from above which were modified in the last 12 months; e) Loans in process of foreclosure; f) Loans where a notice of default (NOD) has been sent; g) Loans where formal foreclosure proceedings have started; h) Loans where foreclosure has been completed; and, i) Loans which entered delinquency within 3 payments of initial rate reset. 3)Requires lenders to report information on the disposition of loan modifications that resulted in the following: a) Deed in lieu; AB 69 Page B b) Short sale; c) Forbearance; d) Repayment plan; e) Loans that were Refinanced or paid in full; f) Modification of the loan terms, such as a principal or interest rate reduction; g) Temporary modifications effective for less than the life of loan; h) Permanent modification effective for life of loan; i) Modification by freezing interest rate at the initial/start rate; j) Modification by reducing the interest rate below the initial/start rate; aa) Modification by reducing the interest rate below scheduled reset rate, but above start rate; bb) Modification with extension of loan terms; cc) Modification with reduction in principal balance; and, dd) Modification using two or more of above modifications (e.g. rate reduction and term change). 4)Requires a summation of reports to be posted on the website of the regulatory agency. 5)Requires the full data results be available to the Legislature upon request. EXISTING FEDERAL LAW, under the Home Mortgage Disclosure Act (HMDA) and implemented by the Federal Reserve Board's Regulation C (12 CFR 203) requires financial institutions to report certain types of data regarding home loans. For each calendar year, a financial institution must report data AB 69 Page C regarding its applications, originations, and purchases of home purchase loans, home improvement loans, and refinancing, as defined. Data must also be given for loan applications that did not result in originations, including applications denied, withdrawn, or closed for incompleteness, as well as applications approved by the institution but not accepted by the applicant. HMDA requires lenders to report the ethnicity, race, gender, and gross income of mortgage applicants and borrowers. Lenders must also report information regarding the pricing of the loan and whether the loan is subject to the Home Ownership and Equity Protection Act. Additionally, lenders must identify the type of purchaser for mortgage loans that they sell. For each application or loan, institutions are required to identify the purpose (home purchase, home improvement, or refinancing), lien status, and whether the property relating to the loan or loan application is to be owner-occupied as a principal dwelling. Regulation C requires financial institutions to identify the following general loan types: conventional, FHA-insured, VA-guaranteed, and FSA/RHS (Farm Service Agency/Rural Housing Service) guaranteed. Institutions must report the property type as a one- to four-family dwelling, multifamily dwelling, or manufactured housing. Financial institutions must report certain geographic data, as well as, the applicant's or borrower's ethnicity, race, sex, and gross annual income. EXISTING STATE LAW provides for the regulation of residential mortgage lenders and California finance lenders by the Department of Corporations (DOC) and for the regulations of state banks and credit unions by the Department of Financial Institutions (DFI). FISCAL EFFECT : Unknown COMMENTS : Need for the bill : The intent of the author is to follow up on the work of DOC and its voluntary collection of loss mitigation data with a requirement on mortgage lender licensees to provide the commissioner this data on an ongoing basis. This bill will provide authority for the commissioner of DOC and DFI to get this data without the constraints of a voluntary system. The author has become concerned in recent months that the AB 69 Page D announcements by lenders and servicers to modify loans is not matching up to the realities on ground. It is also the author's intent to ensure accountability and transparency on the servicing of loan and loss mitigation efforts. It is important that not only can policy makers and regulators have access to data, but that lenders and servicers can have a public forum to reveal their efforts to assist consumers. Finally, it is necessary to gather data to determine the obstacles to loan modification, so in the future, state and federal regulators and policy makers can request alterations to the current modification plans underway. Background : Early in 2007 all signs pointed to a major storm brewing in the mortgage market, marked by growing concern with the performance of securitized adjustable rate mortgages (ARMs). As ARM loans began to default and underperform several large lenders filed for bankruptcy, and others saw massive losses on their balance sheets. Between 2001 and 2006, ARMs as a share of total subprime loans increased from 73% to more than 91%. The share of no-documentation or low-documentation loans increased from 28% to more than 50% and the percentage of borrowers who took out interest only payment loans increased from zero to more than 22%. Furthermore, ARM loans accounted for 44% of new foreclosures in the second quarter of 2007. In California, lenders filed 72,571 NODs on borrowers in the third quarter of 2007, eclipsing a record of 61,541 set in 1996, according to DataQuick Information Systems. Most of the loans that went into default last quarter were originated between July 2005 and August 2006. Actual losses of homes to foreclosure statewide totaled 24,209 during the third quarter, the highest number since DataQuick began recording data in 1988, up 38.7 percent from last quarter and up six-fold year-over-year. (For a more detailed discussion of the mortgage crisis, please see the committee's report from November 2007, Impact of Mortgage Turmoil on California Communities ). The scale of the problem is so large that many lenders begin to retool their operations to handle the increase in borrower calls seeking relief from rapidly rising interest rates. Several lenders and servicers announced plans to identify, early, borrowers who are in trouble or who may become in trouble with the change in their interest rate. However, several press AB 69 Page E reports indicate that borrowers in trouble were not on the receiving end of the help that was promised. Often borrowers were on the phone, after hours of trying to find the appropriate contact, with people at servicing entities that did not have the expertise to handle their situation, or were not authorized to make any decisions relative to the loan. Additionally, mortgage securitization agreements have alot presented obstacles where the loan servicer has a duty to maximize profits to bond holders that reduces incentives to engage in modifications (More on this issue in later sections). Furthermore, the California Reinvestment Coalition conducted a survey (available at http://www.calreinvest.org/system/assets/92.pdf ) 33 of the roughly 80 mortgage counseling agencies across the state which are certified by the U.S. Department of Housing and Urban Development to assist borrowers at risk of foreclosure. The survey found that servicers were not offering modifications at the level or rate that was being publicly represented. Anecdotal evidence provided to the committee from some counseling agencies finds that the average workout is taking four months from initiation of a request for loan modification to a final arrangement. In spite of this disconnect many lenders and servicers have continually pledged to work with troubled borrowers. In September of 2007, the commissioner of DOC designed a voluntary survey to query the loan modification efforts of loan servicers. DFI also engaged in a survey of state chartered banks and credit unions. Subsequent to this survey effort, Governor Schwarzenegger announced an agreement with five of the largest loan servicers to streamline the modification process. In early December 2007, Treasury Secretary Henry Paulson announced an agreement to streamline and establish standards for loan modification and in some cases freezing the interest rate on some loans for five years. This agreement ( http://www.americansecuritization.com/uploadedFiles/FinalASFStat ementonStreamlinedServicingProcedures.pdf ) was reached in conjunction with the American Securitization Forum (ASF), an organization that represents companies that issue mortgage backed securities, as well as investors, loan servicers and rating agencies. The ASF modification parameters sorts subprime borrowers whose rates are about to reset into three categories: AB 69 Page F 1)Those who are current on their loans, have decent credit scores and equity in their homes, and are likely to be eligible for refinancing. The plan "encourages" servicers to refinance these loans without prepayment penalties, but there are no guarantees. 2)Those who are current on their loans but are not eligible to refinance because of poor credit scores or zero to 3% equity in their homes. This is the group that could be fast-tracked into a five-year freeze at the loan's introductory rate, to prevent their monthly payments from shooting up. 3)Those who are delinquent on their loans even at the introductory rate and do not qualify for refinancing. This group could very well end up in foreclosure or have to "short sell" their home if no other option can be worked out. The ASF plan also called for voluntary data collection by its members on loan modifications and workout arrangements. A week after the plan was announced an article appeared in American Banker, A Murky Path to Loan-Mod Transparency that, among other things, questioned the transparency of the plan with "any reporting will be voluntary and may not present a complete picture of modification efforts." Securitized mortgages and loan modifications : As mentioned previously, securitization of mortgage loans often can make modification of a mortgage loan very difficult for both borrower and servicer. When difficulty arises in making payments on a securitized loan, the borrower generally will not be dealing with the local banker with whom there might be an established relationship. Instead, the borrower will be dealing with a servicer. The servicer has responsibilities defined in the securitization documents that are substantially different than those of a lender. The servicer and the trustee are responsible for taking actions that are in the best interest of the investors who purchased portions of the securitization. Protecting the investors means determining the best alternative that would bring the maximum recovery on a defaulted loan on a present-value basis. If the servicer determines that a workout or modification of the loan achieves that goal, then there is an alignment of the investor/servicer/borrower relationship. However, if liquidation AB 69 Page G of the collateral (through a foreclosure or other means) results in the highest net present value of cash flows, the servicer may be bound by the terms of the securitization to pursue this approach to the benefit of the investor despite the resulting detriment to the borrower. Even if a modification to the loan looks like the right approach, other factors might limit the servicer's options. Most securitizations are established as Real Estate Mortgage Investment Conduits (REMICs). The REMIC structure provides considerable tax benefits, (i.e., only the investors are subject to tax, not the conduit itself) but also includes provisions that could limit the flexibility of a servicer to modify a borrower's loan terms in a proactive manner. To qualify for tax-advantaged status, the pool of loans securitized in a REMIC must generally be treated as a static pool, which usually precludes modifying loans in the pool. An exception to this general prohibition allows for modifications when default is reasonably foreseeable. Once a determination is made that default is reasonably foreseeable, most securitization agreements provide significant flexibility for the servicer to modify terms of the loan. This allows for modification of terms when a loan has defaulted, but may prohibit changes to loans that are current. The Internal Revenue Service (IRS) leaves it to servicers to determine what "reasonably foreseeable" means as it relates to default, which makes these determinations dependent upon the facts and circumstances of each mortgage. Aside from the restraints imposed on modifications by the REMIC structure, the personal service agreement (PSA) can also impose barriers to loan modification. The language in each PSA is different and each establishes the rules about how a particular securitization operates or what needs to be done to change those rules. Many PSAs contain more than 200 pages of dense legal verbiage. The PSA provides a blueprint as to how cash flows and losses are allocated and distributed to the various parties, and establishes the rules that the servicer must abide by in managing this critical function in the transaction. The PSA sets forth whether and how a servicer can modify the underlying loans in a securitization. The documents will also identify the other AB 69 Page H parties in the transaction who might have an important role in this decision. If the PSAs terms and conditions regarding modifications prove to be overly restrictive, changing the PSA can be very difficult and may require extraordinary actions, such as obtaining the consent of two-thirds or all of the investors. In some deals, the PSA is quite explicit in allowing the servicer flexibility in modifying delinquent loans, while in other transactions the language is vague. The accounting rules also play an important role in the decisions made by the various parties. Securitization is often used as a balance sheet management strategy, whereby assets sold into a securitization are removed from the seller's books, thus freeing up resources such as capital. The implementation of the ASF plan has opened up this question as to what accounting principle is required for modified loans. Perhaps to for some a relief, the SEC issued an advisory letter on January 8, 2008 that some ARMS could be modified without triggering rules requiring those loans to be moved to their balance sheet. The easing of this accounting risk may encourage some servicers to increase their rates of loan modification. Overall, the ability to securitize pools of such mortgages certainly helped to make mortgage loans available and has reduced the cost of credit for borrowers. However, the securitization structure also has introduced a number of new participants and complexities into the loan relationship, which reduces flexibility for addressing the problems of distressed borrowers. Securitized subprime mortgage loans : In recent history, banks funded mortgage loans through their customer's deposits with mortgage credit dictated by the volume of bank deposits. Furthermore, banks kept loans on their books. In the last two decades, this model has changed with financial institutions selling mortgage loans to other institutions or to investors, with a mortgage market now dominated by non-depository institutions, many of whom, are state licensed and regulated. With this change in lending, many institutions set up loan AB 69 Page I servicing units to collect the mortgage payments and disburse that money to the holder of the mortgage loan, whether that is investors in mortgage backed securities or another financial institutions. The servicer is typically compensated with fees based on the volume of loans serviced. The servicer is generally obligated to maximize the payments from the borrowers to the issuer, and is responsible for handling delinquent loans and foreclosures. The flow of capitol for subprime lending became possible through the rise of Mortgage backed securities (MBSs). MBSs are securities sold to investors like stocks and bonds. MBS are created when originators or financial intermediaries pool large volumes of mortgage loans and sell securities backed by the monthly payments made by borrowers on the underlying mortgage loans. When a homeowner, whose loan is secured in an investment pool, makes his or her monthly payment, the payment combined with the payments of other loans goes into the pool and forms the basis of cash flows for investors. Investors choose their position in mortgage pool based on priority of payments from the pool in the event of a default. The pools typically have several investment grade tranches, ranging from AAA ratings down to subprime rated traunches that would absorb the most losses in the event of default but offer the most return. Bonds are also structured as tranches that collect only interest on the underlying mortgage obligation, or trauches that received payments from the principle payments on the mortgage. Last year, the US mortgage market amounted to 10,000 billion dollars, of which sub-prime mortgages represent 13% of the total market and 9% of nominal gross domestic product (GDP) of the United States. Most of these sub-prime mortgage loans are granted by financial institutions that are not deposit-taking entities and therefore are subject to lower regulatory and supervision requirements compared with those for other banks and deposit institutions. Once the customer uses the loan to buy a house, the debt is noted in the balance sheet of the institution granting the loan. However, in order to boost their business, these institutions relieve themselves of these mortgages and sell them to commercial banks or investment banks. The new holders, in turn, package the mortgages in blocks and issue securitization bonds (CDO, or Collateralized Debt Obligations) using the sub-prime mortgages as security or collateral. That is to say, based on subprime mortgages, they create a new kind of asset that is more easily negotiable in the markets and it is this bond that carries the risk in the operation. To the extent AB 69 Page J that the holders of the mortgages keep paying off their debt every month, these funds are used to pay those who have bought these bonds. The MBS market is the largest fixed income market in the United States. At the end of 2006, approximately $6.5 trillion of securitize mortgage-related debt was outstanding compared to $4.3 trillion of U.S. Treasury securities and $5.4 trillion of corporate debt. CDOs are a global phenomenon extending far beyond national boundaries or domestic capitol controls. JPMorgan estimate that $1.5 trillion in CDOs exist globally with $500 billion in structured finance CDOs meaning those made up of bonds back by subprime mortgages. Amendments : In order to clarify the author's intent and to fix some drafting errors, the committee recommends the following amendments: 1)Clarify that the data being sought is on loans that are serviced by licensees, not originated. 2)Clarify that the intent of the bill is to capture data associated with mortgages for residential home loans. 3)Provide clarity by defining ambiguous terms. 4)Eliminate reference to "savings associations" as they no longer exist in California. 5)Eliminate the current penalty provisions that are inconsistent and unnecessarily punitive. 6)Change existing requirement for data to be made public in aggregate form, and instead provide for data to be accessible on a lender-specific basis. 7)Require reporting, in addition to whether a prepayment penalty was waived, to also include whether any prepayment penalty was paid in association with a loan modification. 8)Extend reporting period for delinquencies to those with 6 payments instead of 3. AB 69 Page K 9)Include category on ARM reset volume similar to that currently collected under DOC's voluntary program. 10)Require greater specificity in regard to loss mitigation efforts that have closed versus those that are in process. 11)Add a data point to determine whether loans are securitized or unsecuritized. 12)Provide DOC and DFI may accept data submitted voluntarily by a federally chartered institution that services loans in California. REGISTERED SUPPORT / OPPOSITION : Support Aaron Myers, Attorney at Law ByDesign Financial Solutions California Coalition for Rural Housing California Reinvestment Coalition (CRC) Center for California Homeowner Association Law (CCHAL) Center for Responsible Lending (CRL) CHARO Community Development Corporation Chrysalis Consulting Group, LLC Civic Center Barrio Housing Corporation Congressman Dennis Cardoza Consumer Action EARN East Bay Asian Local Development Corporation East Palo Alto Council of Tenants (EPACT) Fair Housing Council of San Diego Fair Housing Law Project (FHLP) Fair Housing of Marin Gray Panthers Human Rights/Fair Housing Commission of the City and County of Sacramento Just Cause Oakland Law Center for Families Mission Community Financial Assistance Nehemiah Community Reinvestment Fund AB 69 Page L Pacific Asian Consortium in Employment Predatory Lending Clinic University of San Francisco School of Law Project Sentinel HUD Housing Counseling Programs Public Interest Law Firm Renaissance Entrepreneurship Center Sacramento Mutual Housing Association San Antonio Community Development Corporation Sierra Planning & Housing Alliance, Inc. Opposition California Bankers Association California Chamber of Commerce California Financial Services Association California Independent Bankers California Mortgage Bankers Association Analysis Prepared by : Mark Farouk / B. & F. / (916) 319-3081