BILL ANALYSIS
AB 260
Page 1
Date of Hearing: April 14, 2009
ASSEMBLY COMMITTEE ON JUDICIARY
Mike Feuer, Chair
AB 260 (Lieu, Bass, Nava) - As Introduced: February 11, 2009
SUBJECT : RESPONSIBLE LENDING: HIGHER PRICED MORTGAGES
KEY ISSUE : SHOULD PREDATORY LENDING BE REGULATED TO PREVENT THE
MOST EGREGIOUS ABUSES?
FISCAL EFFECT : As currently in print this bill is keyed fiscal.
SYNOPSIS
This bill is substantially similar to last year's AB 1830
(Lieu), which passed this Committee but was vetoed by the
Governor. Supporters of this bill argue that it is needed to
prevent the next mortgage collapse and restore trust and
credibility in California's mortgage market. Most importantly,
it would prohibit certain acts for a defined set of "higher
priced" loans, including loan steering, prepayment penalties,
negative amortization and similar controversial loan provisions
and practices. Although mortgage lenders and brokers are
neutral on the bill, realtors and the Civil Justice Association
remain opposed, arguing that the bill is unnecessary and
one-sided.
SUMMARY : Regulates high priced residential mortgage loans, as
defined. Specifically, this bill :
1)Provides the Department of Real Estate (DRE), Department of
Corporations (DOC) and Department of Financial Institutions
(DFI) with the authority to suspend or revoke the license of
their licensees for violating three existing federal lending
laws: The federal Real Estate Settlement Procedures Act
(RESPA); the federal Truth in Lending Act (TILA); and the
federal Home Ownership Equity Protection Act (HOEPA).
2)Gives authority to the respective licensing agencies (DOC,
DFI, and DRE) to prohibit licensees from engaging in acts or
practices in connection with higher priced mortgage loans that
the licensing agency finds to be unfair, deceptive, or
designed to evade the laws of this state.
AB 260
Page 2
3)Defines "higher priced mortgage loan" as having the same
meaning set forth in Part 226 of Title 12 of the Code of
Federal Regulations (CFR) - i.e., a "higher priced loan" is a
consumer credit transaction secured by the consumer's
principal dwelling for which the annual percentage rate (APR)
on the loan exceeds the yield on comparable Treasury
securities by at least three percentage points for first-lien
loans, or five percentage points for subordinate-lien loans.
4)Provides that a licensed person shall not make, or cause to be
made, any false, deceptive, or misleading statement or
representation in connection with a higher priced loan.
5)Provides that the maximum amount of a prepayment penalty for a
higher priced loan may not exceed 2% of the principle balance
prepaid for prepayment of the loan during the first 12 months
following loan consummation, or 1% of the principle balance of
the loan during the second 12 months following consummation.
6)Provides that a provision of a prepayment penalty that
violates TILA or this bill is a violation subject to the
penalties in this bill.
7)Prohibits the payment of compensation to a broker for
arranging a higher priced loan with prepayment penalty that is
more than they would have received for arranging a higher
priced loan without a prepayment penalty and provides that
when a broker provides mortgage brokerage services, the broker
shall receive the same compensation whether paid by the
lender, borrower or a third party.
8)Prohibits a mortgage broker from steering, counseling, or
directing a borrower to accept a loan at a higher cost than
that which the borrower could qualify based upon the loans
offered by the person with whom the broker regularly does
business.
9)Requires that a mortgage broker must disclose to a borrower in
writing and verbally if they only offer higher priced mortgage
loans.
10)Prohibits a licensed person from making a higher priced loan
that contains a provision for negative amortization, but
allows negative amortization for purposes of a loan
modification.
AB 260
Page 3
11)Provides a cure provision for a licensed person who, when
acting in good faith, fails to comply and within 90 days of
the loan closing and prior to the institution of an action the
licensed person does the following: (a) notify the borrower of
the compliance failure; (b) tender appropriate restitution;
and (c) offer the borrower the option to correct the higher
priced loan or change the terms to make it beneficial to the
borrower.
12)Provides that if a compliance failure was not intentional and
resulted from a bona fide error and within 120 days after
receipt of a compliance or discovery of the failure, the
licensed person shall not be liable if they do the following:
(a) Notify the borrower of the compliance failure; (b) tender
appropriate restitution; or (c) offer the borrower the option
to make the loan comply with the terms of this bill or change
the terms of the loan so that it is beneficial to the
borrower.
13)Provides that a mortgage broker who provides mortgage
brokerage services to a borrower owes a fiduciary duty to the
borrower regardless of whether the mortgage broker is acting
as an agent for any other party in the connection with the
loan transaction.
14)Provides that a licensed person in violation of the
provisions of this bill is also in violation of their
licensing law.
15)Allows the licensing agency or the Attorney General to bring
an enforcement action with a civil penalty of $10,000 per
violation.
16)Allows a borrower to bring a civil action for actual damages
and to recover attorney's fees.
17)Makes the provisions relating to higher priced loans
effective July 1, 2010.
EXISTING LAW:
1)Authorizes federally-chartered financial institutions to
engage in the business of mortgage lending, brokering, and
servicing and governs the rules under which such activities
AB 260
Page 4
may be conducted under a wide variety of laws, including, but
not limited to, the HOEPA, RESPA, TILA, Home Mortgage
Disclosure Act (HMDA), and regulations that interpret those
acts (most notably Regulation C, which interprets the Home
Mortgage Disclosure Act and Regulation Z (Reg Z), which
interprets the TILA).
2)Regulates "covered loans," defined as a consumer loan in
which the original principal balance of the loan does not
exceed $250,000 in the case of a mortgage or deed of trust,
and where one of the following conditions are met: (a) For a
mortgage or deed of trust, the APR at consummation of the
transaction will exceed by more than eight percentage points
the yield on Treasury securities having comparable periods
of maturity on the 15th day of the month immediately
proceeding the month in which the application for the
extension of credit is received by the creditor; or (b) The
total points and fees payable by the consumer at or before
closing for a mortgage or deed of trust will exceed 6% of
the total loan amount. (Financial Code Section 4970(b)(1).)
3)Includes a list of 14 prohibited acts and limitations for
covered loans, including:
a) A covered loan shall not include a prepayment fee or
penalty after the first 36 months after the date of
consummation of the loan. Prepayment penalties are subject
to various limitations and restrictions as specified;
b) A covered loan with a term of five years or less may not
provide at origination for a payment schedule with regular
periodic payments that when aggregated do not fully
amortize the principal balance as of the maturity date of
the loan;
c) A covered loan may not contain a negative
amortization provision unless the loan is a first
mortgage and the lender discloses specified information
about the provision;
d) A covered loan shall not contain a provision that
increases the interest rate as a result of a default;
e) A person who originates covered loans shall not make or
arrange a covered loan unless at the time the loan is
AB 260
Page 5
consummated, the person reasonably believes the consumer,
or consumers, when considered collectively in the case of
multiple consumers, will be able to make the scheduled
payments to repay the obligation based upon a consideration
of their current and expected income, current obligations,
employment status, and other financial resources, other
than the consumer's equity in the dwelling that secures
repayment of the loan;
f) A person who originates a covered loan shall not
refinance or arrange for the refinancing of a consumer loan
such that the new loan is a covered loan that is made for
the purpose of refinancing, debt consolidation or cash out,
that does not result in an identifiable benefit to the
consumer, considering the consumer's stated purpose for
seeking the loan, fees, interest rates, finance charges,
and points.
g) Establishes various penalties and enforcement provisions
for lenders and real estate brokers who violate the covered
loan law. (Financial Code section 4970 et seq.)
COMMENTS : Many observers lay the blame for the current
worldwide economic crisis on the credit crash prompted by
widespread speculative and irresponsible lending practices in
the subprime mortgage market. This bill is intended to address
some of the abusive practices that fueled the disaster that has
lead to the current economic catastrophe, to say nothing of the
personal financial harm suffered directly by borrowers, so as to
ensure that future lending will be more responsible and
beneficial. AB 260 is complimentary to the recent changes to
TILA, discussed in more detail below. The author explains the
need for the bill as follows:
This bill represents a balanced and common sense approach
to rein in the abuses that occurred in the subprime market.
California will lead the nation in following up on the
recent amendments to Federal Regulation Z by adopting
additional stringent standards and regulations for brokers
and lenders.
AB 260 strikes the correct balance between eliminating the
abuses in the subprime market and maintaining viable home
ownership options across California's diverse communities.
With California's high housing prices, it is vital that
AB 260
Page 6
products and practices that can save the consumer money be
available so long as those products and practices are used
responsibly. It would be unacceptable to further widen the
minority home ownership gap or inadvertently harm consumers
with lower incomes.
Some subprime lending has helped millions of people achieve
the American Dream. It is irresponsible subprime lending
that needs to be eliminated. AB 260, with its strong focus
on preventing misconduct by brokers and lenders seeks to
eliminate irresponsible subprime lending, while preserving
access to homeownership.
An editorial in the New York Times last week captures some of
the issues addressed by this bill:
Mortgage brokers are supposed to be impartial advocates who
search out the best possible deal for prospective
homeowners seeking a loan. The mortgage crisis has
revealed a different truth. Too many brokers were far more
interested in earning fat fees for steering their clients
to ruinously priced loans that the borrowers could never
hope to repay.
The numbers are startling. According to a 2008 analysis by
the Center for Responsible Lending, subprime borrowers who
went through brokers actually fared worse than those who
went directly to lenders. Borrowers who used brokers
coughed up additional interest payments ranging from
$17,000 to $43,000 for every $100,000 they borrowed.
Lenders were, of course, complicit, happily issuing
high-priced loans to people with little or no hope of
repaying them. But it was often the brokers who steered
borrowers away from affordable loans and toward the
high-priced loans in the first place.
Many brokers do legitimate work that helps homebuyers sort
through competing loan proposals and make good choices. In
those cases, the fees they get from lenders - typically 1
percent or 2 percent of the loan amount - are fully
justified. But many others, attracted by obscene profits
associated with the subprime lending binge, did not act in
a fair and ethical manner. Congress is finally seeking
ways to rein in these brokers.
AB 260
Page 7
The first step must be to outlaw the kickbacks that lenders
pay brokers for steering clients into costlier loans. At
the height of the boom, brokers typically worked from rate
sheets provided by lenders. These sheets showed not just
the prevailing mortgage rates but the reward that brokers
could reap for bleeding unsuspecting borrowers. To earn
the maximum reward, brokers would entice borrowers into
adjustable-rate loans with prepayment penalties -
discouraging borrowers from refinancing with more
affordable loans and assuring the original lender a
handsome fee if the borrower refinanced.
The most clearly unethical form of payment is the so-called
yield-spread premium. Brokers can claim this premium by
steering a borrower whose credit history qualifies him or
her for say, a 7 percent loan, into a more expensive loan
at a higher rate. Predatory? Yes. And perfectly
acceptable under existing lending laws. A House bill
introduced by Representative Barney Frank, a Democrat of
Massachusetts, would rightly make yield-spread premiums
illegal.
In addition to Mr. Frank's bill, Congress also will be
asked to consider a bill introduced in the House by
Representative Keith Ellison and in the Senate by Senator
Amy Klobuchar, both Democrats of Minnesota.
Based on a forward-looking Minnesota law, the bill would
outlaw collusion between lenders and brokers and would
impose a fiduciary responsibility on brokers and other
mortgage originators, requiring them to find the most
beneficial deal.
The brokers and other mortgage originators will fight these
and other measures tooth in nail. But there can be no real
reform as long as mortgage brokers can be offered kickbacks
and other incentives to steer often na?ve borrowers into
loans that put them at risk the moment they sign the
papers. (Predatory Brokers, New York Times, April 10,
2009.)
Restrictions on Loan Steering. Supporters contend that the
subprime marketplace has incentives, including yield spread
premiums, that entice brokers to put borrowers into costlier
AB 260
Page 8
loans without the knowledge of the borrower. The current
structure of compensation, supporters argue, provides a perverse
incentive to steer borrowers to a riskier loan in order to
increase the broker's compensation. AB 260 attempts to
eliminate this incentive by requiring that regardless of who
pays the broker (borrower, lender or third party); the
compensation must be the same. This provision is intended to
ensure that a broker can receive no more from a lender than the
borrower would pay to the broker in up-front costs. The
intention is to remove the incentive to steer borrowers while
ensuring that consumers can make informed choices about how to
pay for their loan costs. For instance, a broker cannot make
more in compensation from a loan with a yield spread premium
than the same loan without a yield spread premium.
AB 260 also directly prohibits a broker from steering borrowers
to accept a loan at a higher cost than the consumer could
otherwise qualify. Additionally, a mortgage broker that only
originates subprime loans must disclose that fact to a borrower
prior to offering services.
Prohibits deceptive statements. AB 260 contains a broad
prohibition against brokers and lenders from making false or
deceptive statements connected with a subprime loan. This will
require lenders and brokers to be upfront and honest in subprime
loan transactions and ensure that borrowers are not misled with
false statements about their loan.
Cap on Prepayment Penalties . Supporters argue that one of the
most controversial and least understood features of subprime
lending has been prepayment penalties (PPPs), which are
typically a feature of subprime mortgage loans that require that
a borrower pay a percentage amount of their loan should they
pay-off (refinance) the loan within a certain time-frame. On
average, a PPP is around 3% of the outstanding balance of the
loan. With the high cost of homes in California this can range
from $2500 to $6,000. According to First American Loan
Perfomance data, three-quarters of securitized subprime loan
pools originated from 2003 through the first half of 2007 had a
PPP. Furthermore, approximately 55% of subprime ARMs originated
from 2000-2005 prepaid while the PPP was in effect.
As recent media accounts have portrayed, these penalties are a
source of much controversy. Media reports abound with stories
of borrowers "trapped" into ARMs with rates set to rise above
AB 260
Page 9
what they can afford, but they are unable to refinance due to
the prepayment penalty. On the other side of this debate, some
contend that PPPs can actually provide for an interest rate
reduction for the borrower because loans with this feature
command more value on the secondary market. Some contend that
for a borrower who is educated about mortgage loan options, a
PPP may make sense to reduce their interest rate. Others note
that most borrowers do not understand the trade off they are
making, frequently because the imposition of the penalty is not
properly explained in context of the interest rate.
Furthermore, due to the secondary market appetite for these
provisions, the incentive to offer a loan with a prepayment
penalty may have altered some lender's concerns with risk.
The Federal Reserve Board recently adopted changes to federal
Regulation Z allowing PPPs only if: (1) the penalty period does
not exceed five years from loan consummation; (2) the borrower's
debt to income ratio, at consummation does not exceed 50%; (3)
the penalty period expires 60 days prior to an interest rate
reset; and (4) the penalty does not apply if there is a
refinancing by the same creditor or its affiliate.
The final rule bans PPPs for higher priced loans if the payment
can change with the first four years after consummation. With
most adjustable rate loans ranging from two to three years, this
provision effectively bans PPP for ARMs. Additionally, for
loans that do not have a payment change the PPP is limited to
just the first two years after consummation.
In its commentary on the final proposal the Board stated, "The
Board concludes that prepayment penalties' injuries outweigh
their benefits in the case of higher-priced mortgage loans and
HOEPA loans designed with planned or potential payment increases
after just a few years. For other types of higher priced and
HOEPA loans, however, the Board concludes that the injuries and
benefits are much closer to being in equilibrium. Thus, the
final rule prohibits penalties in the first case and limits them
to two years in the second."
AB 260 establishes clear regulations for prepayment penalties.
In addition to the restrictions put in place by recent
amendments to Reg Z, AB 260 caps the amount of the penalty to no
more than 2% of the principle balance in year one of the loan
and no more than 1% of the principle balance in subsequent
years.
AB 260
Page 10
AB 260 also prohibits anyone who arranges a subprime loan from
receiving increased compensation for originating a loan that
includes a prepayment penalty.
Bans Negative Amortization Loans . Many option ARM loans
included scheduled payments that would lead the borrower to owe
more on the loan than its original balance. Once this happens,
the borrower is subject to an extreme payment shock to make the
adjustment or a balloon payment to cover the difference. AB 260
prohibits any subprime loan that could lead to negative
amortization.
Fiduciary Duty Standard. AB 260 codifies a fiduciary duty
standard for mortgage brokers across all loan products. As
opponents note, this duty arguably already arises under case
law. However, supporters believe, clarification and
codification of the standard will ensure that all parties
understand their relationship and obligations without the need
for litigation.
Current State Law Did Not Prevent The Subprime Lending Crisis In
Large Part Because It Provides Only Limited Protections Against
The Most Egregious Predatory Lending Practices. Pursuant to AB
489 and AB 344 in 2001 (codified as Division 1.6 of the
Financial Code), lenders who make "covered loans" must meet
various requirements that give borrowers additional protections
against predatory practices. The covered loan law was the
Legislature's attempt to prohibit the most egregious lending
practices. This law effectively provided for a usury ceiling
beyond which no one would pass. For example, the points trigger
is 8% above comparable yield on treasury securities or 6% of the
loan amount in fees. AB 489 started as a bill to cover loans
five points above comparable securities. Much later, it was
amended to establish the covered loan law with points and fees
triggers more closely related to the HOEPA standard. The intent
of AB 489 was apparently to prohibit egregious practices related
to those loans, such as loan flipping, equity stripping, and
other predatory practices. What happened in effect was that the
covered loan law become a threshold or cap that lenders would
not cross.
Many lenders had underwriting automation processes that would
prohibit them from underwriting a covered loan. While the
covered loan law has apparently been successful in prohibiting
AB 260
Page 11
certain loans with extremely high rates and fees, it does not
address subprime loans. With such a high threshold, millions of
loans could be made below the thresholds, and without
appropriate underwriting standards. Instructively, the Assembly
Committee on Banking Finance reports that it held an
informational hearing in 2005 at which New Century Financial, a
lender with 16 offices in California working with thousands of
independent mortgage brokers, testified:
The current mortgage lending law, AB 489, is working because
it strikes the proper balance between outlawing predatory
lending practices and placing appropriate limits and
restrictions on so-called covered loans while allowing
deserving consumers access to mortgage credit. Given the
state of the California mortgage market and the rising cost
of housing, a great degree of caution should be exercised
when altering consumers' ability to access much needed
mortgage credit.
New Century was one of the first victims of the subprime crisis,
filing for bankruptcy on April 7, 2007.
Substantially Similar Measure Vetoed Last Year. Last year's AB
1830 (Lieu) was a virtually identical bill, vetoed by the
Governor with a message stating:
The goals of this bill are to be lauded and the work and
effort that went into the bill commended. However, I
believe the approach of the bill to address the subprime
crisis overreaches and may have unintended consequences.
First, its provisions will only apply to state regulated
entities, as federally regulated entities will be exempt.
This will create an uneven playing field, putting state
regulated entities at a competitive disadvantage and
consumers will have unequal protections under the law.
Secondly, this bill allows for a private right of action
and allows a plaintiff to recover attorney fees if he or
she prevails. The bill does not allow a defendant to
recover costs if he or she prevails. This provision will
likely lead to increased litigation based on de minimis
violations as plaintiffs attorneys will have much to gain
and little to lose.
Many changes have already occurred to curb some of the past
AB 260
Page 12
lending and brokering abuses. Last year, I signed SB 385
strengthening underwriting criteria to ensure that
borrowers can afford loans. The Federal Reserve Board has
implemented amendments to the Truth in Lending Act
(Regulation Z) to regulate advertising practices and
provide additional protections to the lending marketplace.
I recently signed SB 1137 to provide homeowners with
additional protections against foreclosure and to expand
the rights of tenants. Finally, the President recently
signed the Housing and Economic Recovery Act, which imposes
new oversight requirements on loan originators and contains
many other provisions to assist in economic recovery. All
of these changes need time to take effect. As a result,
further legislation is unnecessary until we can evaluate
the effect of the reforms that have already been enacted.
I am directing the appropriate agencies within my
Administration to implement any of the appropriate portions
of this bill that can be done so administratively. I
encourage the Legislature to work with my Administration to
implement the many pieces of this legislation that could be
helpful to consumers.
ARGUMENTS IN SUPPORT: California ACORN writes in support: "It
is California ACORN's belief that yield spread premiums,
prepayment penalties, and steering practices should be banned
outright to protect families from the tactics used to pad the
pockets of the greedy. Nevertheless, we are in strong support
of AB 260, because we believe that it takes an extremely
necessary, common sense approach to fix a broken system in order
to protect families in the future."
The bill's sponsor, California Labor Federation, states: "The
two million working families we represent are at the epicenter
of the foreclosure crisis, and their stories demonstrate the
need for this legislation. Many of our members saved and
sacrificed to buy their homes, had good credit and steady jobs,
and could have qualified for traditional home loans. Instead,
they were steered into high-cost, high-risk loans they did not
understand and could not afford. This steering was a direct
result of the incentives that were offered to brokers for
placing families in these non-traditional loans with adjustable
interest rates, prepayment penalties, and balloon payments."
According the Labor Federation, "The Wall Street Journal has
AB 260
Page 13
documented that at the peak of the subprime crisis, more than
half of the loans went to borrowers with credit so good they
would have qualified for traditional loans. In 2005, borrowers
with such credit scores got 55% of all subprime mortgages that
were ultimately packaged into securities for sale to investors.
In 2006, the proportion rose even higher, with 61% percent of
subprime loans going to borrowers with good credit. During the
same time period, we saw an increase in mortgage origination by
brokers. As of 2006, mortgage brokers were originating 45% of
all mortgages, and 72% of subprime loans. This bill will
directly address broker steering and will codify a broker's
fiduciary duty to the borrower. It will not ban incentives in
the industry, but will require brokers to put the financial
interest of borrowers ahead of their own."
The Labor Federation concludes, "This bill reflects many months
of negotiations involving industry, consumer groups, and labor.
It is a narrowly-tailored fix to a problem too serious to
ignore."
ARGUMENTS IN OPPOSITION: The California Association of
REALTORS opposes the bill arguing that it is "obsolete before
it can become effective." CAR states, "California is required
by new federal law to separately license or register and
regulate all mortgage loan originators. The new regulatory
scheme is required to be enacted this year. At least three
bills have been introduced to do so, if none become law then HUD
will impose its own system." CAR further contends, "If it is to
avoid unequal enforcement, and actually speak to the lending
environment that will be in place after this year, AB 260 must
impose the same standards and same 'rules of the game' on all
mortgage loan originators. The consumer remedies and
restrictions on behavior should be based upon the fact that the
bad actor is a loan originator, not the regulator with which he
or she has a license." CAR notes that it is "particularly
concerned at the creation of a new right of enforcement by
private parties that includes a one-sided ability for successful
plaintiffs to collect attorney fees. We have historically
supported the longstanding California policy that each side in
litigation must bear its own attorney costs; and that if a
contract attempts to impose attorney fees, then the rule applies
to both sides. Just by encouraging the award of attorney fees,
this bill will encourage speculative litigation. By making the
right to recover them one-sided it will exacerbate the problem
by allowing litigators to potentially win big, but risk little."
AB 260
Page 14
The Civil Justice Association also writes in opposition,
stating: "To begin with, the part of the bill statutorily
creates a fiduciary obligation from the mortgage broker to the
client is unnecessary. (See page 6, lines 27-36.) This
obligation is already required under established case law.
Wyatt v. Union Mortgage Co., 598 P.2d 45 (1979). Additionally,
we are concerned that other provisions in the bill will
encourage abusive lawsuits. These include additional duties and
requirements placed upon lenders and mortgage brokers, and the
award of attorney's fees and costs to a prevailing plaintiff
only."
Prior Related Legislation. A substantially similar measure by
Assembly Member Lieu last year, AB 1830, was vetoed by the
Governor.
REGISTERED SUPPORT / OPPOSITION :
Support
California Labor Federation (sponsor)
ACORN
California Federation of Teachers
Center For Responsible Lending (if amended)
Opposition
California Association of Realtors
Civil Justice Association of California
Analysis Prepared by : Kevin G. Baker / JUD. / (916) 319-2334