BILL ANALYSIS
SB 660
Page 1
Date of Hearing: June 30, 2009
ASSEMBLY COMMITTEE ON JUDICIARY
Mike Feuer, Chair
SB 660 (Wolk) - As Amended: June 23, 2009
SENATE VOTE : 23-15
SUBJECT : Reverse Mortgages
KEY ISSUES :
1)Should a person or entity that sells reverse mortgages owe to
the prospective borrower a duty of honesty, good faith, and
fair dealing?
2)Should, AS IS ALSO REQUIRED IN ab 329 (fEUER), a person who
seeks a reverse mortgage be provided with a checklist
highlighting certain subjects that the borrower should discuss
with an HUD-certified reverse mortgage counseling agency?
FISCAL EFFECT : As currently in print this bill is keyed
non-fiscal.
SYNOPSIS
Consistent with AB 329 (Feuer), this bill seeks to give greater
consumer protections to senior citizens considering a reverse
mortgage. Reverse mortgages, which have become more popular as
baby boomers retire, were designed to give persons of retirement
age and with limited income the opportunity to stay in their
homes while converting home equity into tax-free income or lump
some payments. Unlike a conventional "forward" mortgage where
the borrower makes payments to the lender to bring down debt and
increase equity, in a reverse mortgage the lender makes payments
to the borrower so that debt increases and equity decreases.
While this is a valuable option for many seniors, reverse
mortgages are not for everyone. Many seniors reportedly obtain
mortgages that they may not need, and both consumer advocates
and senior groups agree that such mortgages are risky when
combined with annuities and other insurance products. As a
result, the author and supporters argue, seniors are losing
equity in what is often their only asset: their home. This bill
seeks to address this problem in two ways. First, it imposes on
any person who sells reverse mortgages "a duty of honesty, good
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faith, and fair dealing." Second, this bill would require
enhanced disclosures to prospective borrowers, including a
requirement that borrowers and counselors consider and sign a
prescribed checklist highlighting the risks of reverse mortgages
and alternative means of meeting financial needs. The bill is
sponsored by senior and consumer advocates. It is opposed by
organizations representing lending institutions, primarily on
the grounds that the "duty" created by this bill is not clearly
enough defined to provide guidance to lenders and will likely
lead to increased litigation.
SUMMARY : Provides that a person or entity that sells reverse
mortgages owes to the prospective borrower a duty of honesty,
good faith and fair dealing, and prohibits a lender from
accepting a reverse mortgage application unless the borrower and
counselor complete a prescribed checklist relating to the risks
of, and alternatives to, reverse mortgages. Specifically, this
bill :
1)Provides that a lender, broker, person, or entity who
recommends the purchase of a reverse mortgage in anticipation
of financial gain owes to the prospective borrower a duty of
honesty, good faith and fair dealing. Specifies that the
duties set forth in this bill shall not be construed to limit
or narrow any other duty of a lender, broker, person, or
entity.
2)Specifies that a lender, broker, person, or entity shall not
be deemed to have breached the duty set forth above based on
the actions or omissions of the counseling agency.
3)Provides that no reverse mortgage loan shall be taken by a
lender unless the loan applicant, prior to receiving
counseling, has received from the lender a prescribed form
advising the borrower about the need to obtain counseling and
stating that a reverse mortgage is a complex, legally binding
transaction with important implications for the borrower's
estate.
4)Requires, in addition to the notice required above, that the
prospective borrower receive, prior to counseling, a written
checklist that conspicuously alerts the prospective borrower
to all of the following:
a) How unexpected medical and other events that cause the
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borrower to move out of the home earlier than expected will
impact the cost of the loan.
b) The extent to which the prospective borrower's financial
needs would be better met by options other than a reverse
mortgage, including, but not limited to, less costly home
equity lines of credit, property tax deferral programs, or
governmental aid programs.
c) Whether the prospective borrower intends to use the
proceeds of the reverse mortgage to purchase an annuity or
other insurance products and the consequences of doing so.
d) The effect of the loan on residents who are not
borrowers after all borrowers have died or permanently left
the home.
e) The prospective borrower's ability to finance routine or
catastrophic home repairs, especially if maintenance is a
factor that determines when the mortgage becomes due.
f) The impact that the reverse mortgage may have on the
prospective borrower's tax obligations, eligibility for
government assistance programs, and the effect that losing
equity in the home will have on the borrower's estate and
heirs.
g) The ability of the borrower to finance alternative
living accommodations such as assisted living or long-term
care nursing home residency, after the borrower's equity is
depleted.
5)Provides that the checklist required above be signed by the
agency counselor and by the prospective borrower and returned
along with a required counseling certification, as specified.
Provides that the loan shall not be completed until the signed
checklist is provided to the lender. Specifies that a copy of
the checklist shall also be provided to the borrower.
EXISTING FEDERAL LAW :
1)Establishes, within the United States Department of Housing
and Urban Development (HUD), the Home Equity Conversion
Mortgage (HECM) program to provide federal insurance for
reverse mortgages that meet HUD requirements. Makes the HECM
loan available to persons 62 years of age and older and
provides that the loans, made against home equity, shall not
come due until the borrower(s) dies, moves out of the home
permanently, or sells the home. Provides, however, that loan
may become due earlier if the borrower(s) fails to pay
property taxes or to maintain the home, as specified in the
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loan agreement. Provides that at the time the loan comes due,
the property shall be sold to retire the loan amount with any
residue returning to the estate or heirs of the borrower.
Requires any prospective heir to satisfy the lender's lien
before taking title to the property. (12 USC Section 1715z-20
et seq.; 12 CFR Section 226.33.)
2)Requires that all applicants for an insured HECM loan receive
adequate counseling from an independent third party that is
not, either directly or indirectly, associated with or
compensated by the lender, loan originator, or loan servicer,
or by any party associated with the sale of annuities,
investments, long-term care insurance, or any other type of
financial or insurance product. Requires the lender, at the
time of initial contact, to provide the borrower with a list
of approved HUD counseling agencies. (12 USC Section 1715z-20
(d) (2); 24 CFR 206.41.)
3)Requires all HECM loan counselors to be approved by HUD and
meet HUD standards, as specified. Further requires the HUD
Secretary to develop uniform counseling protocols by July 30,
2009. Protocols shall require a qualified counselor to
discuss, generally, financial options other than a reverse
mortgage, the financial implications of reverse mortgages,
including any tax consequences, or the affect of the loan on
eligibility for government assistance programs. (12 USC
1715z-20 (f) (1)-(5); 24 CFR Section 214.103.)
4)Prohibits the lender or any person involved in the origination
of the HECM from participating in, being associated with, or
employing any party that participates in the sale of other
financial or insurance products, unless the lender or
originator maintains firewalls and other safeguards designed
to ensure that individuals participating in the origination of
the HECM loan shall have no involvement with, or incentive to
provide the borrower with, any other financial or insurance
product. Specifies that a prospective borrower shall never be
required to purchase any other financial or insurance product
as a condition of obtaining a reverse mortgage. (12 USC
1715z-20 (n)-(o).)
EXISTING STATE LAW :
1)Defines "reverse mortgage" as a non-recourse loan secured by
real property that meets all of the following criteria:
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a) The loan provides cash advances to a borrower based on
the equity or value in a borrower's owner-occupied
principal residence.
b) The loan requires no payment of principal or interest
until the entire loan becomes due and payable.
c) The loan is made by a lender licensed or chartered
pursuant to the laws of this state or the United States.
(Civil Code Section 1923.)
2)Establishes, consistent with federal HECM requirements, but
applicable to both HECM and non-HECM loans, certain
requirements for reverse mortgage loans, including a
prohibition on prepayment penalties and interest rate
disclosure requirements. (Civil Code Section 1923.2.)
3)Prohibits a lender from requiring the prospective borrower
from requiring the purchase of an annuity as a condition of
obtaining a reverse mortgage. Provides further that a lender
or broker arranging a reverse mortgage loan shall not (a)
offer an annuity to the borrower prior to the closing of a
reverse mortgage or any right of rescission or (b) refer the
borrower to anyone for the purchase of an annuity prior to the
closing of the reverse mortgage. (Civil Code Section 1923.2
(i).)
4)Requires the lender to refer the prospective borrower, prior
to accepting a final and complete application for a reverse
mortgage, to a HUD-approved counseling agency. Further
requires the lender to provide the prospective borrower with a
list of at least five HUD-approved counseling agencies, at
least two of which provide counseling by telephone. Further
provides that the lender shall not accept a final application
or assess any fees upon the borrower without first obtaining a
certification that the prospective borrower has received
counseling from a HUD-approved counselor, and that the
certification is signed by both the borrower and the
counselor, as specified. (Civil Code Section 1923.2 (j).)
5)Requires, consistent with Civil Code Section 1632, that if the
reverse mortgage is negotiated primarily in Spanish, Chinese,
Tagalog, Vietnamese, or Korean, that the lender must provide a
written translation of the agreement in the language in which
the contract or agreement was negotiated, as specified.
(Civil Code Sections 1923.2 (l) and 1632(b).)
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6)Requires the lender to provide an applicant for the reverse
mortgage with a plain language statement in conspicuous
16-point font type or larger notifying the applicant that a
reverse mortgage is a complex financial transaction that uses
the acquired equity in the home and informs the borrower of
the independent counseling requirement. (Civil Code Section
1923.5.)
7)Provides, to the extent consistent with federal law, that
reverse mortgage loan payments shall be treated as proceeds
from a loan and not as income for the purpose of determining
eligibility and benefits under means-tested programs of aid to
individuals. (Civil Code Section 1923.9.)
8)Provides that all insurers, brokers, agents, and others
engaged in the transaction of insurance owe a prospective
borrower insured who is 65 years of age or older, a duty of
honesty, good faith, and fair dealing. Specifies that this
duty is in addition to any other duty, whether express or
implied, that may exist. (Insurance Code Section 785.)
COMMENTS : The last decade has seen an explosion in the reverse
mortgage market. Reverse mortgages allow persons 62 years of
age of older to convert home equity into tax-free monthly income
or a lump sum cash payment to spend as they wish. In a
conventional "forward" mortgage, the borrower makes payments to
the lender so that debt decreases and equity increases. In a
"reverse" mortgage, the lender makes payments to the borrower so
that debt increases and equity decreases. The borrower
generally does not repay the loan until the last borrower dies,
sells the home, or moves out. However, a lender may demand
repayment if the borrower fails to pay property taxes or allows
the home to fall into disrepair. Most reverse mortgages are
insured by the Federal Housing Administration (FHA) through the
Home Equity Conversion Mortgage (HECM) program administered by
the U.S. Department of Housing & Urban Development (HUD). These
federally-backed loans must meet certain requirements, including
independent third party counseling by a HUD-approved housing
agency. Though fewer in number, so-called "proprietary" reverse
mortgages are not federally insured and are not subject to the
same restrictions and requirements as the HECM loans. Yet, for
the most part, they operate the same way: the borrower receives
payments against the home equity, and the loan generally does
not become due until the borrower dies, moves out, or sells the
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home.
For many "cash poor, equity rich" seniors, a reverse mortgage
often appears to make good economic sense. But reverse
mortgages can also be very costly. In addition to
higher-than-usual origination fees, closing costs, compound
interest, and servicing fees, the borrower is also required to
pay an insurance premium (worth about 2% of the loan) that
protects the lender in case the value of the property falls
below the amount owed on the loan. The total annual cost of a
reverse mortgage is generally much greater the shorter the loan
period. For example, the hoped-for advantages of a reverse
mortgage backfires if a senior becomes ill or takes a fall and
is forced to move out of the home early. Leaving the home makes
the loan come due, and the senior must repay the high up-front
costs and compounded interest while having received little or no
benefit.
Often, according to groups like AARP and Consumers' Union,
senior citizens are unaware that their financial needs may be
better met by alternative and less costly means. For example,
for smaller and immediate needs, the borrower can obtain a home
equity line of credit. If the senior is obtaining a reverse
mortgage in order to pay property taxes, they may not be aware
of local and state property tax deferral programs available to
seniors with fixed incomes. Finally, where a senior lacks funds
to pay for increased medical costs, they may be eligible for
other forms of government aid, including Medi-Cal. While
reverse mortgages often provide a valuable tool for some senior
citizens, there are often more appropriate alternatives. AARP,
for example, while generally praising the benefits of reverse
mortgages in appropriate situations, generally recommends
exploring all other options before obtaining mortgages that may
not be needed and will eventually deplete home equity.
Moreover, AARP advises that using reverse mortgage proceeds to
buy annuities or invest in other products is almost never a good
idea. Even some lending institutions are reportedly in
agreement that reverse mortgage proceeds should not be used to
invest in other financial products; yet the practice continues,
as numerous reports and law suits attest.
The Growth of the Reverse Mortgage Market and Previous
Legislative Responses : Although proprietary reverse mortgages
in some form or another have been around since at least the
1960s, it was not until the development of the federal HECM
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reverse mortgages in the late 1980s and early 1990s that they
became well known. However, the federal program remained
relatively small and stagnant until 2003, when the number of
reverse mortgages suddenly sky-rocketed and became the fasting
growing sector of the mortgage lending industry. The reason for
this rapid growth is not entirely clear, though most reports
point to more aggressive marketing; rising home values; the
aging of the population; and the collapse of the sub-prime
lending crisis pushing brokers, lenders, and loan originators
into the reverse mortgage market. (See e.g. "Demand for Reverse
Mortgages Climbs," Wall Street Journal, January 22, 2009; "Shady
Subprime Lenders Creeping into Federal Mortgage Program,"
Financial Week, January 12, 2009; "Reverse Mortgages: Bad Rap or
Bad Idea?, San Francisco Chronicle, August 1, 2008.) While this
growth may be subject to fluctuations, overall growth is
expected to continue as the population ages.
The first response to this growth in California came with the
enactment of AB 456 (Chapter 797, Stats. of 1997), which defined
"reverse mortgage" and set out minimum requirements that more or
less mirrored then-prevailing federal requirements. (Civil Code
Section 1923 et seq.) While the federal requirements applied
only to the HECM loans, the California provisions apply to both
federally-backed and so-called proprietary loans that are not
subject to HECM requirements. More recently AB 1609 (Chapter
202, Stats. of 2006) added counseling requirements and
restrictions concerning bundling reverse mortgages and annuities
(at least until after the closing and any right of rescission),
that again mirrored federal regulations but applied to HECM and
proprietary loans.
This bill seeks to further advance state regulation of the
reverse mortgage market in two ways: First, it states that any
lender, broker, or person who sells reverse mortgages owes to
the prospective borrower "a duty of honesty, good faith, and
fair dealing." Second, as is the case with AB 329 (Feuer), it
enhances existing notice requirements in state law and requires
that prospective borrowers must be provided with a "checklist"
that alerts them to the risks of and alternatives to reverse
mortgages. The borrower is instructed to go over this list with
a certified counselor, and the checklist must be signed by both
the borrower and the counselor before the reverse mortgage loan
application can be completed. Because the checklist provision
of this bill is substantially similar to AB 329, which was
already heard by the Committee, the remainder of this analysis
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will focus on the "duty" issue.
What is a Duty of Honesty, Good Faith, and Fair Dealing? The
"duty" language in this bill is closely modeled on Insurance
Code Section 785, which imposed upon persons who sold insurance
products to persons 65 years of age or older "a duty of honesty,
good faith, and fair dealing." The logical connection between
that provision and this bill seems fairly obvious: both seek to
create a heightened duty among persons who sell complex
financial products to elderly persons. Other places in
California law make the assumption that people who engage in
commercial and financial transactions with elderly persons are
held to a higher ethical standard, as is implicit in the state
Financial Elder Abuse statute and in Insurance Code Section 786,
which gives persons over 65 years of age 30 days to rescind an
insurance policy. These laws do not necessarily reflect a
paternalistic assumption that senior citizens inevitably have
difficulty understanding complex financial transactions; it is
simply a frank acknowledgment that some elderly persons
experience cognitive changes, as well as changed living
situations, which make them more vulnerable to certain marketing
techniques. Existing law clearly recognizes that senior
citizens deserve something more protective than caveat emptor
and the unrestrained selfishness of the marketplace.
As noted below, opponents allege that "honesty, good faith, and
fair dealing" are such vague and ill-defined terms that they
provide no guidance to persons who must comply with the law and
will provide an open invitation for litigation. However, terms
like "good faith" and "fair dealing" have been used for
centuries in both common law and statute. All contracts, for
example, presume a "covenant of good faith and fair dealing,"
yet this does not inhibit people from making contracts nor
prevent courts from determining whether a party to a contract
has breached the implied covenant of good faith and fair
dealing. But perhaps even more telling, the Insurance Code has
imposed a duty of honesty, good faith, and fair dealing on
persons selling insurance to the elderly for nearly 20 years and
there is no evidence that this has led to a litigation
explosion. Nor is there any evidence that the duty in the
Insurance Code has had any chilling effect on the selling of
insurance to persons 65 years of age or older.
Opponents are correct that the bill does not provide any
examples of what specific kinds of actions on the part of a
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lender might constitute a breach of the duty of honesty, good
faith, and fair dealing. However, this is not the first time
that a statute has codified accepted common law terminology, and
statutes by their very nature tend to be general, since
legislation cannot possibly anticipate every possible instance
that would constitute a violation. In codifying a common law
rule, a legislature does not prescribe or prohibit specific
kinds of conduct so much as it sets forth general principles by
which parties are expected to conduct themselves. Insurance
Code Section 785, after which the duty provision in this bill is
modeled, implies that persons who sell financial products owe a
higher duty of care to senior citizens than they do to other
customers; otherwise, there would have been no reason for adding
this language into the Insurance Code. Even if the provision
was simply an attempt to codify the existing common law covenant
that already applies to all contracts, there would be no reason
to apply it only to contracts involving senior citizens. It is
a standard principle of statutory interpretation that words are
not meant to be superfluous, but are added for a reason. The
duty created by this statute, like the similar duty in the
Insurance Code, would seem to mean that, at a minimum, a person
selling financial products to senior citizens should not take
undue advantage of the buyer's age. It would seem to mean, at a
minimum, that the seller not try to push a product on a senior
citizen without having some reasonable belief that the senior
citizen will derive a benefit. No doubt the vast majority of
the lenders represented by the opponents conduct themselves in a
manner that meets this modest duty, but one can find facts in
news reports and trial court pleadings to suggest that not all
lenders do so. (See e.g. Assembly Judiciary Committee, Analysis
of AB 329. April 21, 2009.)
There is nothing new about imposing heightened duties on those
who sell financial products, including mortgages. For example,
in 1979 the California Supreme Court held that, even in the
absence of a statute, mortgage loans brokers are expected to
fully and accurately disclose all terms to borrowers and "to act
always in the utmost good faith toward their principals."
(Wyatt v. Union Mortgage Company (1979) 24 Cal. 3d 773.) This
bill appears to recognize that these other kinds of duties
exists, which is presumably why the bill states that the duty it
sets forth does not limit "any other duty" that a lender or
broker may have. That is, brokers who sell reverse mortgages,
under the Wyatt holding, may already have a higher, fiduciary
duty to borrowers that goes beyond a "duty of honesty, good
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faith, and fair dealing." Indeed, a fiduciary is not only
expected to consider the best interest of the person entitled to
the duty, but to put the interest of that person ahead of his or
her own interests. However, unlike most standard forward
mortgages, reverse mortgages are not always sold by licensed
brokers who already have an existing fiduciary duty. Thus, one
purpose of this bill is apparently to ensure that all "persons"
who sell reverse mortgages, whether "brokers" or not, owe a
heightened duty (even if it is something less than a fiduciary
duty) to prospective borrowers.
ARGUMENTS IN SUPPORT : According to the sponsor, California
Advocates for Nursing Home Reform (CANHR), heightened duties for
sellers of reverse mortgages are necessary "because reverse
mortgages are very complex and expensive loans and, when
unsuitable, can devastate a senior's estate plan." CANHR points
out that reverse mortgages are risky, especially when
unanticipated, but not uncommon, events occur. For example,
CANHR, points out that although a reverse mortgage holds out the
promise that the senior can stay in the home for the rest of his
or her life, without having to make any mortgage payments, a
number of unanticipated events can make the mortgage come due.
For example, an illness or injury that required long-term
nursing care might make the loan come due long before the senior
has derived any benefit. In addition, CANHR claims, many
seniors are unaware that the lending institutions can demand
payment if the senior citizen fails to adequately keep the home
in good repair. For all of these reasons and more, a senior
citizen should consider all possible consequences and less
costly alternatives, which the checklist, which must be signed
by the counselor and borrower, will force the senior to do. In
addition, the duty provision in this bill will force the lender
to give good faith consideration to whether a loan is
appropriate in light of the senior's circumstances.
Aging Services of California, an association of non-profit
providers of senior housing and residential care, argues that
the recent sub-prime mortgage crisis and the fact that senior
citizens nationwide hold about $4 trillion in home equity should
alert us to potential problems that may lie ahead in the reverse
mortgage market. Aging Services suggest that many of the same
players that sold the irresponsible mortgages that fueled the
sub-prime crisis are moving into the reverse mortgage market.
Aging Services stresses, however, that the purpose of this bill
is not to prohibit the sale of reverse mortgages. Instead, this
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bill offers modest protections, sets forth a minimum standard
for sellers and lenders, and creates a useful checklist that
will force borrowers to give more consideration to risks and
alternatives when discussing their situation with a counselor.
"Without such protections," Aging Services concludes, "thousands
of seniors will be sold reverse mortgages that radically affect
established estate plans, retirement destinations, and even care
for dependent children." Finally, Aging Services writes that
its members have encountered many seniors who find that they
cannot enter a senior living facility as planned because they
have used up the equity in their home through a reverse
mortgage. Without home equity to pay for medical care, seniors
"will find themselves on Medi-Cal at taxpayers' expense, an
expense that the state cannot afford."
ARGUMENTS IN OPPOSITION : As noted above, the financial
institutions that oppose this bill focus almost exclusively on
the bill's "duty of honesty, good faith, and fair dealing."
"Absent clarification," opponents argue, "these ambiguous duties
may expose lenders to legal liability and have a chilling effect
on the reverse mortgage industry."
Opponents also point out that existing state and federal law
already provides comprehensive consumer protections for reverse
mortgage applicants. The vast majority of these mortgages,
opponents claim, are federally insured and covered by strong
consumer protections. Both state and federal law, opponents
add, already require that all borrowers receive HUD-certified
counseling before a loan application may be completed.
Citing the Senate Judiciary Committee analysis, opponents note
that the bill does not detail what specific action would
constitute a violation of the "duty of honesty, good faith, and
fair dealing," and as such, cannot provide any guidance to those
who must comply with the provision. Therefore, opponents claim,
the bill creates uncertainty as to "what legal exposure exists
for violation of this duty and what the reverse mortgage lender
can rely on in order to satisfy the duty of honesty, good faith,
and fair dealing. Absent clear guidance, there is no clear way
for a lender to take steps to ensure that they are in compliance
with the new duty. Given the unanswered legal questions and
ambiguities, this measure would have a chilling effect on
reverse mortgage sales."
Possible Amendments : This bill is scheduled to be heard by the
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Assembly Banking & Finance Committee on Monday, June 29, the day
before it is heard by this Committee. Therefore, any amendments
agreed to the Assembly Banking & Finance Committee will need to
be taken in this Committee.
Pending Related Legislation : AB 329 (Feuer) updates
California's state reverse mortgage law to incorporate recent
changes in federal law relating to conflicts of interest and
cross-selling of reverse mortgages with other financial
products; ensures that recent federal protections will apply to
both federally-backed and non-federally-backed loans in
California; enhances notice requirements and, like this measure,
requires a checklist that must be signed by both the borrower
and a HUD-certified counselor before the loan application can be
completed. (Passed off Assembly Floor by a 68-2 vote and passed
out Senate policy committee. On Senate floor.)
REGISTERED SUPPORT / OPPOSITION :
Support
California Advocates for Nursing Home Reform (sponsor)
AARP
Aging Services of California
California Alliance for Retired Americans (CARA)
California Association of Mortgage Bankers
Opposition
California Bankers Association
California Financial Services Association
California Independent Bankers Association
California Mortgage Bankers Association
Analysis Prepared by : Thomas Clark / JUD. / (916) 319-2334