BILL ANALYSIS Ó
AB 406
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Date of Hearing: April 25, 2011
ASSEMBLY COMMITTEE ON BANKING AND FINANCE
Mike Eng, Chair
AB 406 (Davis) - As Introduced: February 14, 2011
SUBJECT : Adjustable rate mortgages: balloon payments
SUMMARY : Prohibits the inclusion of a balloon payment in an
adjustable rate residential mortgage loan.
EXISTING FEDERAL LAW:
Under the Dodd-Frank Wall Street Reform Consumer Protection Act
(Public Law 111-203-July 21, 2010) balloon payments are
prohibited for high-cost loans, which are defined as loans,
generally, that have interest rates at 6.5% above prime.
Additionally, Dodd-Frank requires the Federal banking
regulators, along with the Director of Housing and Urban
Development (HUD), the director of the Federal Housing
Administration (FHA) and the Securities and Exchange Commission
to draft a definition of "qualified mortgage" that gives due
consideration to "prohibiting or restricting the use of balloon
payments, negative amortization, prepayment penalties,
interest-only payments, and other features that have been
demonstrated to exhibit a higher risk of borrower default."
Furthermore, under Dodd-Franks "qualified mortgage" definition
(still subject of additional regulations), a qualified mortgage
cannot include terms that lead to balloon payments. Dodd-Frank
offers a very narrow exception for "balloon loans" that may, by
regulation, be included under a qualified mortgage if certain
underwriting standards are met, and that the balloon loan is
retained in the portfolio of a lender that meets certain asset
size thresholds.
EXISTING STATE LAW:
Provides, under Business & Professions Code Section 10241.4, for
various disclosures concerning balloon payments. Under
financial code 4995.2 bans higher priced loans from containing
provisions that could lead to negative amortization.
FISCAL EFFECT : Unknown
COMMENTS :
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Need for the bill .
According the background supplied by the author's office,
Although sub-prime lending has largely vanished, reforms
such as the Dodd-Frank Act do not go far enough in
eliminating the loan features that have contributed to the
foreclosure crisis, and may not curb features such as
balloon payments sufficiently to prevent future harm when
the state and national economies eventually rebound. The
Center for Responsible Lending has targeted balloon
payments as one of the key indicators of a predatory
lending situation. In addition, federal regulators are
being criticized for pre-empting state attempts to rein in
predatory lending (see attached April 14, 2011 article from
the Los Angeles Times, "Lenders Told to Fix Flaws in
Foreclosures." State legislation to ban balloon payments is
therefore appropriate at this time.
Background.
This committee has covered in detail in various forums the scope
and scale of the subprime lending crisis that precipitated
current economic conditions. Regulators were largely unable to
keep up with growing innovations in residential mortgage
products that transformed product features, largely reserved for
experienced borrowers, into the features to assist first time
homebuyers into acquiring their first home. With a mass of
risky features, coupled with a lack of prudent underwriting and
regulatory standards it is of little surprise that this system
of mortgage lending could not continue. One of the first
responses by regulators was the Interagency Guidance on
Nontraditional Mortgage Product Risks, issued in September 2006,
and the Statement on Subprime Lending, issued in June 2007.
Additionally, SB 385 (Machado), Chapter 301, Statutes of 2007
required California regulators to comply with the parallel
guidance documents developed by the Conference of State Bank
Supervisors and American Association of Residential Mortgage
Regulators for use by state licensees in complying with the
federal guidance documents. This guidance set about prudent
underwriting standards for non-traditional loan products,
meaning those products that allow deferral of principal and/or
interest.
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On January 9, 2008 the Federal Reserve Board (Board) published
proposed rules that would amend Reg Z, which implements Truth in
Lending Act (TILA) and the Home Owner Equity Protection Act
(HOEPA). The proposal included new restrictions and
requirements for mortgage lending and servicing designed to
protect consumers from abusive mortgage product features and
deceptive acts. This proposal created a new class of loans for
coverage called "higher-priced loans." Additionally, in 2009
the Governor signed AB 260 (Lieu) Chapter 629, Statutes of 2009
which incorporated the definition of the Reg Z "higher-priced"
loan definition along with California specific restrictions on
these loans.
Changes to loan features and products have not been the only
response to the subprime crisis. In 2008 Congress passed the
Secure and Fair Enforcement of Mortgage Licensing (SAFE) Act,
pursuant to Title V of the provisions of the Housing and
Economic Recovery Act of 2008 (HR 3221; Public Law 110-289).
The SAFE Act requires mortgage loan originators to register with
a national database, undergo background checks, and comply with
minimum education and ethical requirements.
Just last year, congress passed and the President signed the
Dodd-Frank Wall Street Reform and Consumer Protection Act, the
largest overhaul of financial regulation of this generation.
The Dodd-Frank Act also imposes various changes to the mortgage
finance and origination system. In addition, to imposing
minimum underwriting standards on all mortgages, it proposed
regulations to further corral the securitization and
risk-retention rules of various mortgage products. The risk
retention provisions are designed to force lenders to retain
some risk in non-qualified mortgage loans because lessons from
the subprime crisis have demonstrated that greater care and
accuracy in mortgage lending occurs when the risk of that
transaction cannot be fully passed on to the secondary market.
While Dodd-Frank put forth ground breaking (and very complex)
mortgage lending standards it also empowers and directs federal
regulators, including the new Consumer Protection Bureau to
draft further mortgage lending rules.
In summary, between state and federal laws passed in the last
four years we now have multiple layers and requirements for
non-traditional, higher-costs, higher-priced, qualified, and
non-qualified mortgages, as well as, standards for loan
originators and a new framework for risk retention and secondary
market activity.
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Finally, with the subprime crisis came a massive and sudden
evaporation of capital for the mortgage markets, other than
federal government support. Over the last few years,
subprime/non-traditional lending is hardly a blip on the radar,
if it exists at all for homeowners. With the combination of
changes that have occurred, combined with a lack of real test
cases in the market, it is hard to determine the true impact of
the changes that have already been made. Committee staff
predicts that it may take an additional one to two years to have
a true picture of the sum total of residential mortgage
regulation. At that time, it may become necessary to revisit
state codes for clean-up and general fixes to allow the multiple
layers of regulation to actually work in concert.
Questions and Issues :
1)Considering the changes within Dodd-Frank concerning balloon
payments, is this change really necessary? Dodd-Frank allows
only a very narrow window for the inclusion of balloon
payments, and in situations that would not appear to affect
middle-class homeowners. Additionally, Dodd-Frank allows
future regulations that could ban balloon payments, even under
those narrow circumstances.
2)With additional regulations not yet drafted by federal
regulators, is it appropriate to add on this layer?
3)What evidence exists that loans since the crisis have included
abusive balloon payments? This bill will only apply going
forward, not to any existing loans that may have balloon
payments.
4)The cornerstone of the federal government's foreclosure
prevention strategy is the Home Affordable Modification
Program (HAMP). Under HAMP, balloon payments may be used to
defer interest rate adjustments to help borrowers stay in
their home. Could this ban on balloon payments interfere with
HAMP modifications?
5)Within the supporting documents provided to the committee is
an LA Times Article, Lenders Told to Fix Flaws in Foreclosures
(April, 14, 2011) describing ongoing discussions between
federal regulators and mortgage loan servicers regarding loan
modifications. It includes a sentence, used as justification
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for this bill via reference, that "The bank regulators have
been criticized for failing to stop unsafe lending during the
housing boom and for preempting state attempts to rein in
predatory lending." Many policy makers, and consumer
advocates would agree that federal regulators did not react
quickly enough and in some cases failed to address consumer
protection issues. However, as demonstrated in the background
section of this analysis, congress and the state Legislature
have responded in an effort to mitigate any potential future
crisis. Furthermore, the lack of response pre-subprime crisis
is not an indication of responsiveness post-crisis.
REGISTERED SUPPORT / OPPOSITION :
Support
National Asian American Coalition
The Greenlining Institute
West Angeles Community Development Corporation
Opposition
California Association of Realtors'
California Bankers Association
California Chamber of Commerce
California Credit Union League (CCUL)
California Financial Services Association
California Independent Bankers
California Land Title Association
California Mortgage Association
California Mortgage Bankers Association
Civil Justice Association of California
Securities Industry and Financial Markets Association
United Trust Association
Analysis Prepared by : Mark Farouk / B. & F. / (916) 319-3081