BILL ANALYSIS
SENATE COMMITTEE ON BANKING, FINANCE,
AND INSURANCE
Senator Ronald Calderon, Chair
AB 260 (Lieu) Hearing Date: July 9, 2009
As Introduced: February 11, 2009
Fiscal: Yes
Urgency: No
SUMMARY Would enact the Higher-Priced Mortgage Loan Law,
effective July 1, 2010, as specified, codify a fiduciary duty
for mortgage brokers, effective January 1, 2010, and authorize
California's mortgage regulators to apply specified federal
mortgage lending laws and regulations to their licensees,
effective January 1, 2010.
DIGEST
Existing federal law
1. Includes a variety of laws that govern the rules under which
mortgage lending, brokering, and servicing may be conducted,
including, but not limited to, the Home Ownership and Equity
Protection Act (HOEPA), Real Estate Settlement Procedures Act
(RESPA), Truth in Lending Act (TILA), Home Mortgage Disclosure
Act (HMDA), and regulations that interpret those acts (most
notably Federal Reserve Board Regulation C, which interprets
HMDA, Federal Reserve Board Regulation Z, which interprets TILA,
and U.S. Department of Housing and Urban Development (HUD)
Regulation X, which interprets RESPA);
2. Generally regulates the federally-chartered financial
institutions that engage in mortgage lending, brokering, and
servicing under six different agencies, including the Office of
the Comptroller of the Currency (OCC), Federal Reserve Board
(FRB), Office of Thrift Supervision (OTS), Federal Deposit
Insurance Corporation (FDIC), and National Credit Union
Administration (NCUA);
3. Additionally regulates lending, brokering, and servicing
activities conducted under federal law using two additional
federal agencies, including HUD and the Federal Trade
Commission.
AB 260 (Lieu), Page 2
Existing law
1. Authorizes residential mortgage lending, brokering, and
servicing under five different laws, including the Banking Law,
Credit Union Law, California Finance Lenders Law (CFLL),
California Residential Mortgage Lending Act (CRMLA), and Real
Estate Law, and the regulations that interpret those laws;
2. Generally regulates the entities that engage in mortgage
lending, brokering, and servicing under three different
departments, including the Department of Financial Institutions
(DFI), Department of Corporations (DOC), and the Department of
Real Estate (DRE);
3. Requires licensees under the Banking Law, Credit Union Law to
comply with the Interagency Guidance on Nontraditional Mortgage
Product Risks, issued in September 2006, and the Statement on
Subprime Lending, issued in June 2007, and requires licensees
under the CFLL, CRMLA, and Real Estate Law 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;
4. Provides for the Covered Loan Law (Financial Code Section 4970
et seq.), which defines a covered loan as one whose interest
rate exceeds a specified trigger amount (calculated differently
than the trigger amount in this bill), or whose points and fees
exceed a specified trigger amount; imposes several prohibitions
on persons who make or arrange a covered loan; and provides for
administrative and civil penalties and civil damages for failure
to comply with the Covered Loan Law.
This bill
1. Would enact a new division of the Financial Code relating
to higher-priced mortgage loans (the Higher-Priced Mortgage
Loan Law), which would apply to licensees under the state's
mortgage lending and brokering laws, and which would be
operative July 1, 2010;
2. Would define a higher-priced mortgage loan for purposes of
that division by reference to Federal Reserve Board
Regulation Z;
AB 260 (Lieu), Page 3
3. Would cap the maximum amount of a prepayment penalty that
may be imposed by a licensed person in connection with a
higher-priced mortgage loan at 2 percent of the loan's
principal balance during the first 12 months following loan
consummation and 1 percent of the loan's principal balance
during the second 12 months following loan consummation;
4. Would provide that a prepayment penalty which violates
Number 3 above or Regulation Z is unenforceable;
5. Would prohibit a licensed person from attempting to avoid
the application of the division by dividing any loan
transaction into separate parts to evade the division, or
any other subterfuge;
6. Would prohibit a licensed person from making, or causing
to be made, a false, deceptive, or misleading statement or
representation in connection with a higher-priced mortgage
loan;
7. Would require a mortgage broker who arranges only
higher-priced mortgage loans to disclose that fact to a
borrower, both orally and in writing, at the time of
initially engaging in mortgage brokerage services with that
borrower;
8. Would prohibit a mortgage broker who arranges a
higher-priced mortgage loan from steering, counseling, or
directing a borrower to accept a loan at a higher cost than
that for which the borrower could qualify based on the loans
offered by the persons with whom the broker regularly does
business;
9. Would prohibit a mortgage broker who arranges a
higher-priced mortgage loan from receiving greater
compensation for arranging a higher-priced mortgage loan
with a prepayment penalty than the broker would receive for
arranging the higher-priced mortgage loan without a
prepayment penalty;
10. Would provide that a mortgage broker who arranges a
higher-priced mortgage loan must receive the same
compensation for providing those mortgage brokerage
services, regardless of whether the compensation is paid by
the lender, the borrower, or a third party;
AB 260 (Lieu), Page 4
11. Would provide that a yield spread premium provision of a
higher-priced mortgage loan which violates the division is
unenforceable;
12. Would prohibit a licensed person from recommending or
encouraging default on an existing loan or other debt prior
to, and in connection with, the closing or planned closing
of a higher-priced mortgage loan that refinances all or any
portion of the existing loan or debt;
13. Would prohibit a licensed person from making a
higher-priced mortgage loan that contains a provision for
negative amortization;
14. Would establish specified civil and administrative
penalties for failure to comply with the division or with
the provisions of Regulation Z relating to prepayment
penalties;
15. Would establish a process that may be used by a licensed
person to avoid administrative and/or civil penalties in
connection with violations of the division, when the
violations are made by a licensed person acting in good
faith;
16. Would allow the provisions of the division to be enforced
only by the Attorney General or the licensed person's
licensing agency, but provide that, notwithstanding this
limitation, a borrower may bring a civil action against a
licensed person to recover the following: a) actual damages
that occur as the result of a violation of the division; and
b) reasonable attorney's fees and costs, if the borrower
prevails in the action;
17. Would provide that the provisions of the Higher-Priced
Mortgage Loan Law are severable;
18. Would codify a fiduciary duty, effective January 1, 2010,
for those who broker mortgages under any of California's
lending laws, make a violation of that fiduciary duty a
violation of the mortgage broker's licensing law, and make a
violation of that fiduciary duty in connection with a
higher-priced mortgage loan a violation of the Higher-Priced
Mortgage Loan Law;
19. Would provide that the fiduciary duty described in Number
AB 260 (Lieu), Page 5
18 above is limited to mortgage brokers who arrange loans
secured by residential real property containing four or
fewer residential units, but would state that nothing in the
section on fiduciary duty is intended to limit or narrow any
other fiduciary duty of the mortgage broker;
20. Would, effective January 1, 2010, give DFI, DOC, and DRE
express authority to enforce TILA, HOEPA, and RESPA, and
their implementing regulations, as if violations of these
federal laws and their implementing regulations were
violations of state licensing laws.
COMMENTS
1. Purpose of the bill As stated by the author: To bring
trust and security back to California's mortgage market,
protect borrowers from the most abusive lending practices
that caused the foreclosure crisis, and reassure the
secondary market that loans bought in California are sound.
2. Background This bill is identical to the final version of
AB 1830 (Lieu) from the 2007-08 Legislative Session, a bill
that was vetoed by Governor Schwarzenegger (veto message
duplicated below).
AB 260, like AB 1830 before it, is based on a law enacted in
2007 in North Carolina (House Bill 1817, whose provisions
became operative on January 1, 2008). It also piggybacks on
changes to Regulation Z that were issued by the FRB on July
30, 2008. The changes to Regulation Z (Federal Register
Volume 73, No. 147, pp. 44522-44614) are generally effective
October 1, 2009, and apply to all federal and state
licensees who engage in the activities covered by the
regulation, including mortgage lending, brokering, and
servicing.
Which loans are covered by this bill? The definition of a
higher-priced mortgage loan contained in Regulation Z, and
used in this bill, is expected to cover all subprime
mortgage loans, some higher-priced Alt-A loans, and some
jumbo loans (i.e., those which exceed the conforming loan
limit). Thus, the definition will not only cover loans made
to people with tarnished credit, but will also cover some
large dollar value loans made to people purchasing expensive
homes.
AB 260 (Lieu), Page 6
Which licensees will be covered by this bill? State-licensed
mortgage lenders and real estate brokers licensed under the
Real Estate Law will be covered by AB 260, whenever they
make or broker a higher-priced loan. If federally-regulated
lenders do not want any aspect of their loan transactions to
be covered by this bill, they need only eliminate their
wholesale channels (those in which a broker arranges the
loan on their behalf). These lenders could continue to
originate loans through retail storefronts and web sites,
without the loans being covered by this bill.
How does this bill differ from Regulation Z? The final changes
to Regulation Z enact four provisions which cover a new
class of loans called higher-priced mortgage loans, two
provisions that apply to all mortgages, one that applies to
mortgage loan advertisements, and one that requires the
provision of transaction-specific disclosures to borrowers,
before the borrowers pay any fee in connection with a loan,
other than a credit report fee. California need not take
any action for these changes to apply to our licensees; they
will apply automatically, when the federal changes become
operative (generally October 1, 2009).
Regulation Z defines a higher-priced mortgage loan as a
consumer-purpose, closed-end loan secured by a consumer's
principal dwelling, with an annual percentage rate that
exceeds the average prime offer rates for a comparable
transaction published by the FRB by at least 1.5% for first
lien loans and 3.5% for subordinate lien loans. The
definition includes home purchase loans, refinancings, and
home equity loans, but excludes home equity lines of credit,
reverse mortgages, construction loans, and bridge loans.
AB 260 adopts Regulation Z's definition of a higher-priced
mortgage loan.
Regulation Z prohibits prepayment penalties on higher-priced
loans, if loan payments can change within the first four
years of the loan. Prepayment penalties are limited to two
years in length on loans whose payments are constant during
the first four years of the loan. Prepayment penalties
cannot be imposed when a lender or its affiliate refinances
a higher-priced mortgage loan originated by that lender.
AB 260 goes beyond Regulation Z in the area of prepayment
AB 260 (Lieu), Page 7
penalties, by capping the amount of an allowable prepayment
penalty to a maximum of 2% of the principal loan amount
during the first year of the loan and a maximum of 1% of the
principal loan amount during the second year of the loan.
Violations of Regulation Z can result in regulatory enforcement
action by either a federal regulator or state Attorney
General, or in a civil claim by a consumer. Consumers who
bring timely action against lenders under the authority
provided by TILA and HOEPA can recover up to four types of
damages: 1) actual damages, 2) statutory damages in an
individual action of up to $2,000, or up to $500,000 or one
percent of the creditor's net worth, whichever is less, in a
class action; 3) special statutory damages equal to the sum
of all finance charges and fees paid by the consumer; and 4)
court costs and attorney's fees. Generally speaking,
consumers have up to one year in which to bring civil action
against a lender for violations of TILA. Consumers have up
to three years in which to bring civil action for violations
of HOEPA.
AB 260 would authorize both administrative and civil penalties,
and suits by consumers, which are in addition to those
provided under federal law.
3. Veto Message of AB 1830 (Lieu)
In an attempt to address various issues to come out of the
subprime loan meltdown, this bill would enact the
Higher-Priced Mortgage Loan Law, restrict the use of various
loan features, codify a fiduciary duty for mortgage brokers,
and authorize California's mortgage regulators to apply
specified federal mortgage lending laws and regulations to
their licensees.
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
AB 260 (Lieu), Page 8
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
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. [After issuance of
the veto message, Committee staff checked with DFI, DOC, and
DRE, to determine whether any of these departments felt they
could implement any portions of this bill administratively.
None believed they could].
I encourage the Legislature to work with my Administration to
implement the many pieces of this legislation that could be
helpful to consumers.
4. Concerns In addition to the concerns cited by the Governor
in his veto message, staff notes that some the bill's
provisions may pose implementation challenges, as described
below.
a. The bill prohibits a broker from steering,
counseling, or directing a borrower to accept a loan
"at a higher cost" than that for which the borrower
could qualify, based on the loans offered by the
AB 260 (Lieu), Page 9
persons with whom the broker regularly does business.
This anti-steering prohibition may be unenforceable,
because the bill fails to provide a time frame for use
in performing the cost evaluation it requires.
Deciding which of two loans is "higher cost" is often
directly dependent on the length of time a borrower
will hold the loan.
Consider, for example, a borrower who opts to buy down
his or her interest rate by paying points at the time
of closing. Past a certain break-even point, the
decision to pay points up front makes financial sense,
because the borrower recoups the cost of those points
through lower mortgage payments, and pays less in the
long-run, as a result of the lower interest rate.
However, if the borrower sells the home or refinances
the loan before the break-even point, the choice to
pay points results in a more expensive loan, because
the cost of the points is not fully recouped through
lower interest payments. Which is the "higher cost"
loan in this instance? Before the break-even point,
the higher points/lower interest rate loan costs more;
after the break-even point, this loan costs less.
b. The "right to cure" provision of AB 260
contains several undefined terms whose meaning could
generate litigation over their meaning, including
"appropriate restitution," "reasonable period of
time," and "appropriate action."
c. The bill would prohibit state-licensed lenders
from making negatively-amortizing, higher-priced
mortgage loans. As noted above, some loans that meet
the definition of a "higher-priced mortgage loan" will
be jumbo loans, used by financially savvy borrowers to
help purchase expensive homes. Existing state law
requires loans that allow for the deferral of
principal (i.e., interest-only loans and negatively
amortizing loans) to be underwritten based on a
borrower's ability to afford the loan at its fully
indexed rate, over the life of the loan. Thus,
existing law requires state-regulated lenders to
ensure that borrowers can afford negatively amortizing
loans, before they can make those loans.
This bill would prevent a state-licensed lender from
AB 260 (Lieu), Page 10
making a negatively amortizing loan to a borrower, if
that loan meets the "higher-priced" loan definition,
even if the borrower can afford that loan. Preventing
state-licensed lenders from offering negatively
amortizing loans to borrowers who may wish to use
these loans to manage cash flows could encourage these
borrowers to choose federally-licensed lenders, over
state-licensed ones.
5. Support . CALPIRG and the California Labor Federation are
co-sponsoring AB 260, "to protect borrowers from some of the
most abusive lending practices that fueled the foreclosure
free-fall." These groups are joined by the American
Federation of State, County, and Municipal Employees
(AFSCME), California State Employees Association, the
Teamsters, and several other labor organizations. The
thousands of working families that these labor groups
represent are at the center of the foreclosure crisis, and
their stories demonstrate the need for this legislation. As
stated by CALPIRG, "AB 260 is a big step towards ensuring
that this never happens again?Taking these steps will help
to repair confidence in the lending industry, and prevent
the next mortgage meltdown."
California ACORN believes that yield spread premiums, prepayment
penalties, and steering practices should be banned outright
(which AB 260 does not do). "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
Center for Responsible Lending would like the same
amendments as ACORN, but has taken a "support if amended"
position.
6. Opposition The California Association of Mortgage Brokers
(CAMB) opposes AB 260, unless it is amended, and raises four
concerns with the bill. CAMB's first concern involves the
imposition of a duty to place the economic interest of the
borrower ahead of the broker's own economic interest. In
expressing concerns about the vagueness and unworkability of
this language, CAMB quotes from a case decided by the
California Supreme Court in 1979 (Wyatt v. Union Mortgage
Company, 24 Cal. 3d 773, 23748). In that case, the court
concluded that specified provisions of the Business and
Professions Code and the Civil Code, working together,
"impose upon mortgage loan brokers an obligation to make a
AB 260 (Lieu), Page 11
full and accurate disclosure of the terms of a loan to
borrowers and to act always in the utmost good faith toward
their principals."
According to CAMB, the four basic duties which comprise
California's common law fiduciary duty are good faith,
loyalty, due diligence, and disclosure. CAMB believes that
a strict reading of the "economic interest" fiduciary duty
language would forbid a broker from collecting a fee from a
borrower, because doing so would arguably place the broker's
economic interest ahead that of the borrower. If a more
relaxed reading of the bill is used, brokers and regulators
will be forced to guess where the size of the fee becomes a
breach of fiduciary duty. CAMB urges that the definition in
Wyatt be adopted as the statutory standard for all licensed
California brokers.
CAMB's second concern involves the anti-steering provision of
the bill, which fails to clearly define how cost should be
measured, and fails to take the impact of time into the cost
equation. CAMB believes that without more guidance about
this provision from the Legislature, brokers and lenders who
work with brokers could defensively restrict loan choices,
based on individual interpretations of the term "higher
cost."
Third, while CAMB feels that the safe harbors offered in AB 260
are well-intentioned, both require the broker to offer the
consumer an option that brokers cannot deliver. To avoid
liability, the broker must change the terms of the loan in a
manner beneficial to the borrower. A broker, by definition,
has no authority to re-write the terms of a loan. A broker
can attempt to get an investor to refinance the questionable
loan, but has no ability to demand such action. CAMB urges
that the bill be amended to delete options (h)(1)(C) and
(D), and (h)(2)(A)(iii) and (iv) on page 10.
Finally, CAMB joins with the California Mortgage Association
(CMA) and California Association of Realtors (CAR) in
opposing the unlevel attorney's fee provision of the bill,
which these groups criticize as one-sided and likely to
generate costly litigation, some of which may have little or
no basis. CMA states that, "for even minor or technical
violations, the bill will encourage lawsuits and can result
in the award of large amounts of fees and costs when there
are little or no actual damages. Courts will spend large
AB 260 (Lieu), Page 12
amounts of time even debating who 'prevailed' in given
cases."
The Civil Justice Association of California (CJAC) joins with
CAMB in believing the fiduciary duty section of this bill
unnecessary, based on the Wyatt v. Union Mortgage case cited
above, and in fearing that the "prevailing plaintiff"
attorney's fee provision will encourage abusive lawsuits.
DRE and DOC sent identical letters, opposing the bill unless it
is amended, and citing as the basis for their opposition the
reasons contained in the Governor's veto message.
7. Prior Legislation
a. AB 1830 (Lieu) from the 2007-08 Legislative
Session: Identical to this bill (though had operative
dates one year earlier than this bill). Vetoed by the
Governor;
b. SB 385 (Machado), Chapter 301, Statutes of
2007: Directed DFI, DOC, and DRE to apply the
Nontraditional Mortgage Product Risk Guidance and
Statement on Subprime Lending documents to their
licensees, authorized the departments to adopt
regulations to clarify the application of the bill, as
specified, and directed specific licensees of each of
the three departments to adopt and adhere to policies
and procedures that are reasonably intended to achieve
the objectives set forth in the guidance documents.
POSITIONS
Support
CALPIRG (co-sponsor)
California Labor Federation (co-sponsor)
AFSCME
California ACORN
California Conference Board of the Amalgamated Transit Union
California Conference of Machinists
California Federation of Teachers
California State Employees Association
California Teamsters
Engineers and Scientists of California
Professional & Technical Engineers, Local 21
AB 260 (Lieu), Page 13
Strategic Committee of Public Employees, Laborers' International
Union of North America
UNITE HERE!
United Food and Commercial Workers Union, Western States Council
Oppose
California Association of Mortgage Brokers
California Association of Realtors
California Mortgage Association
Civil Justice Association of California
Department of Corporations
Department of Real Estate
Consultant: Eileen Newhall (916) 651-4102