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University of Connecticut School of Law
April 5, 2004
BY ELECTRONIC MAIL
Communications Division
Office of the Comptroller of the Currency
Jennifer J. Johnson
Secretary
Board of Governors of the Federal Reserve
Robert E. Feldman
Executive Secretary
Federal Deposit Insurance Corporation
Chief Counsel’s Office
Office of Thrift Supervision
Re: Proposed Revisions to CRA Rule
OCC Docket No. 04-06
FRB Docket No. R-1181
FDIC RIN 3064-AC50
OTS Docket No. 2004-04
Dear Sirs and Madams:
This letter conveys our comments on the joint revisions to the
Community Reinvestment Act (CRA) regulation recently proposed by the
four federal banking regulators. Our comments relate to the section of
the proposed rule that addresses the effect of abusive lending practices
on an institution’s CRA rating.
At the outset, we wish to applaud the agencies for taking this
landmark step to recognize and curb the devastating effects of predatory
lending. CRA is not neutral in its incentive effects. CRA can
inadvertently work to condone lending abuses where abuses receive
neutral treatment in CRA examinations. And, it can actually support
abusive lending if banks receive CRA credit for abusive loans.
Conversely, CRA can actively discourage predatory lending by giving
adverse treatment to lending abuses in the CRA ratings process.
The proposed rule takes four important steps in that direction.
First, it strengthens current law by providing concrete examples of
legal violations that would adversely affect CRA ratings. Second, under
the proposed rule, evidence of a pattern or practice of asset-based
lending in home mortgage and consumer loans, where the borrower cannot
be expected to make the loan payments, would also merit adverse
treatment. Third, illegal practices and proscribed asset-based lending
would adversely affect an institution’s CRA evaluation whether the
practices occur in or outside the institution’s CRA assessment areas.
Finally, where an institution designates any loans by an affiliate for
CRA treatment, evidence of prohibited lending practices by that
affiliate within any assessment area would garner adverse CRA treatment.
Comments
1. Given the important progress made by the proposed rule, it is
essential that the above four provisions of the proposed rule not be
rolled back in any way.
2. In addition, in extending adverse treatment to asset-based loans
that are structured with terms that borrowers cannot be expected to
repay, the agencies invited comment “on whether it is feasible to define
any other specific abuses by regulation in a way that both shields
consumers from the costs of the abuse and avoids inadvertently
curtailing the availability of credit to consumers.”
In that respect, we are concerned that the proposed rule overlooks
certain other abusive loan practices that do not benefit borrowers under
any circumstances. In our view, these loan practices are harmful per se
to borrowers. Nevertheless, in many jurisdictions, there is no
across-the-board legal prohibition against these practices. Unless these
loan practices receive adverse CRA treatment, effectively these
practices will be condoned under CRA.
Accordingly, in the final rule, we urge the agencies to expand the
list of practices triggering adverse treatment under CRA to include the
following practices that are harmful per se:
(a) Negative Amortization – Individual consumers gain no discernable
benefit from home mortgages or consumer loans with negative
amortization, except in the limited case of reverse mortgages for senior
citizens or the terminally ill, which are heavily regulated.1
In loans with negative amortization, scheduled payments are not enough
to cover the interest due. Unpaid interest is tacked onto the principal,
causing the principal to mount. With every payment, the borrower goes
deeper into debt and loses more and more equity in his or her home.
Reverse mortgages deplete equity in what is often the borrowers’ largest
asset, prolonging loan repayment for years at added expense to borrowers
and increasing the likelihood of foreclosure.
The Home Ownership and Equity Protection Act (HOEPA) prohibits
negative amortization clauses in high-cost home loans.2 The
concerns underlying the negative amortization provision of HOEPA are
equally valid for all home mortgage and consumer loans. Accordingly, we
would mandate adverse CRA treatment for negative amortization clauses in
all home mortgage and consumer loans except for reverse mortgages
regulated by the Home Equity Conversion Mortgage program of the
Department of Housing and Urban Development.
(b) Single-Premium Credit Insurance Policies -- Single-premium
policies for credit life insurance and other types of credit insurance
or single-premium debt suspension or cancellation contracts that are
marketed in tandem with subprime mortgages are a common abuse. Under
single-premium policies, borrowers pay the same lump sum premium for
insurance or debt cancellation coverage, whether they make their loan
payments through to maturity or prepay their mortgages. Moreover,
single-premium policies are often financed as part of the loan. In some
cases, borrowers have been sold single-premium credit insurance products
even though they were too old to qualify for such insurance. As the end
result, borrowers often pay for needless insurance and assume more
onerous debt obligations. If borrowers want credit life insurance or
lenders require it, lenders could simply charge monthly insurance
premiums. Hence, there is no economic justification for credit insurance
policies or debt suspension or cancellation policies that are marketed
on a captive, single-premium basis. In recognition of the abusive nature
of this practice, a number of major subprime mortgage lenders have
publicly disavowed the use of single-premium policies.3 We
urge regulators to amend the final rule to provide that the use of
single-premium credit insurance or single-premium debt suspension or
cancellation contracts in home mortgage and consumer loans will receive
adverse treatment under CRA.
(c) Steering -- Steering occurs when subprime lenders persuade
unsuspecting borrowers, who are actually eligible for prime loans, to
agree to loans at higher subprime rates. Steering is exacerbated by the
use of yield-spread premiums, which reward mortgage brokers for
convincing borrowers to pay higher interest rates than the lenders are
willing to take. The Mortgage Bankers Association of America has
recognized the pernicious effects of steering in its best practices
guide by counseling mortgage lenders that “[b]orrowers should be offered
loan options commensurate with their qualifications, and such options
and their costs should be clearly explained.” 4
We strongly recommend adverse CRA treatment for steering
prime-eligible customers to subprime home mortgage or consumer loans. To
satisfy this standard, a lender who makes a subprime loan would have to
demonstrate, under underwriting guidelines in effect at the time of the
loan application, that the lender had evaluated whether an applicant who
received a subprime home mortgage or consumer loan qualified for a prime
rate and, if so, had been offered a prime rate.5 Under this
standard, lenders would be allowed a choice of underwriting guidelines
for determining prime eligibility, including Fannie Mae, Freddie Mac, or
private secondary-market models.
(d) Payments by lenders to home-improvement contractors from mortgage
proceeds other than by instruments payable to the borrower or jointly to
the borrower and the contractor, or according to a written escrow
agreement -- Checks made solely payable to home-improvement contractors
can be major inducements to home-improvement scams. Such checks are
already prohibited by HOEPA.6 Making the check payable to the
borrower or jointly to the borrower and the contractor, or disbursing
the loan payments according to a written escrow agreement, are simple
measures that can avoid this needless harm to borrowers. Accordingly, we
recommend that in home mortgage or consumer loans, checks or other loan
disbursements made solely payable to home-improvement contractors
trigger adverse CRA treatment.
(e) Loan with escalating interest rates upon default—Loans with
escalating interest rates upon default reduce borrowers’ ability to
rectify their financial situations, thus increasing the likelihood that
they will lose their homes to foreclosure. Even when borrowers can cure
and resume their payments, they may find that the increased interest
rate and correspondingly larger monthly payments may be unaffordable.
Refinancing, the only avenue through which borrowers can avoid the
increase in monthly payments, may be impossible because, having
defaulted, the borrowers may not be able to secure alternative,
less-costly financing. Loans with interest rate increases triggered by
default do not benefit borrowers and actually increase the likelihood
that borrowers will move from default to foreclosure. In HOEPA, Congress
prohibited higher interest rates upon default in home loans covered by
that statute.7 We believe that all home mortgage and consumer
loans with these terms should receive adverse treatment under CRA.
In addition to the per se harmful practices described above, we
continue to have serious concerns about other abusive practices in the
subprime home mortgage market that also inflict grave harm on vulnerable
individuals, including but not limited to, loan flipping, equity
stripping, excessive
prepayment penalties, yield spread premia, and onerous balloon clause
terms. We urge the agencies to further consider amending the CRA
regulations to discourage such abuses by insured depository institutions
and their subsidiaries and affiliates.
3. Although insured depository institutions have been responsible for
some past subprime lending abuses, the bulk of the problem consists of
predatory lending by nonbank mortgage lenders or consumer finance
companies. Increasingly, such lending is being done by nonbank
subsidiaries and affiliates under the bank holding company or financial
holding company umbrella. Indeed, insured banks and thrifts and/or their
parent companies can profit from subprime activities, while avoiding
reputational risks and safety and soundness concerns, by pushing
subprime operations out to nonbank operating subsidiaries and
affiliates.
Insured banks and thrifts have a choice whether to locate their
subprime lending activities within the depository institution or outside
in a nonbank subsidiary or thrift. Given that choice, a bank or thrift
should not be permitted to evade CRA scrutiny by pushing out its
subprime activities to a nonbank subsidiary or affiliate and then
refusing to designate loans by that subsidiary or affiliate for CRA
evaluation. In the case of operating subsidiaries of national banks,
such evasion would be especially pernicious due to the Comptroller’s
recent preemption ruling, which further privileges subprime operating
subsidiary operations by stating that such operations by national bank
operating subsidiaries are exempt from regulation by and visitorial
powers of the states. For this reason, it is imperative that evidence of
discriminatory, other illegal, and abusive credit practices by any
subsidiary or affiliate automatically merit adverse CRA treatment,
whether or not any loans by that affiliate have been designated for
consideration in a CRA evaluation.
4. Finally, when considering evidence of discriminatory, other
illegal, and abusive credit practices by any nonbank subsidiary or
affiliate, we urge the agencies to consider such evidence with respect
to all geographic locations, not just CRA assessment areas. The concept
of a CRA assessment area is foreign to the business plans of most
nonbank affiliated lenders. To the contrary, the geographic operations
of many nonbank subsidiaries and affiliates with subprime operations are
often nationwide in scope, are not driven by branch locations, and are
generally more far-ranging geographically than the CRA assessment areas
of their bank and/or thrift affiliates.
We appreciate your consideration of our comments.
Sincerely,
Patricia A. McCoy
Professor of Law
University of Connecticut School of Law
Hartford, Connecticut
Kathleen C. Engel
Assistant Professor of Law
Cleveland-Marshall College of Law
Cleveland State University
Cleveland, Ohio
cc: Adrienne Hurt, Esq.
Board of Governors of the Federal Reserve System
1 Reverse mortgages are regulated under the Home Equity
Conversion Mortgage program administered by the Department of Housing
and Urban Development and specifically require mandatory counseling
before closing.
2 See 15 U.S.C. § 1639(f); 12 C.F.R. § 226.32(d)(2).
3 See, e.g., Patrick McGeehan, Household Announces Changes
in Lending Practices, N.Y. TIMES, July 24, 2001; Patrick McGeehan, Third
Insurer to Stop Selling Single-Premium Credit Life Policies, N.Y. TIMES,
July 21, 2001; Adam Wasch & R. Christian Bruce, CitiFinancial Announces
It Will End Single-Premium Credit Insurance Sales, BNA BANKING REP.,
July 2, 2001, at 9–10; Patrick McGeehan, Citibank Set To End Tactic On
Mortgages, N.Y. TIMES, June 29, 2001, at C1.
4 See Mortgage Bankers Association of America, Best
Practices/Legislative Guidelines: Subprime Lending, Legislative
Guidelines Best Practices 3 (2000), available at
http://www.mbaa.org/resources/predlend/.
5 The new rate spread reporting thresholds under the Home
Mortgage Disclosure Act (HMDA) could be used to define subprime home
mortgage loans for purposes of CRA. First lien subprime home mortgage
loans could be defined, for example, as any home mortgage loan whose
rate spread between the annual percentage rate (APR) on the loan and the
yield on Treasury securities of comparable maturity equals or exceeds
three percentage points. See, e.g., Home Mortgage Disclosure, 67 Fed.
Reg. 43218 (June 27, 2002); 12 C.F.R. § 203.4(a)(12).
6 See 15 U.S.C. § 1639(i); 12 C.F.R. § 226.34(a)(1).
7 See 15 U.S.C. § 1639(d); 12 C.F.R. § 226.32(d)(4).
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