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Trial by Jury: A New Front for Predatory Lending

National Mortgage Professional
Dec 10, 2001

The Federal Reserve Board Seeks Comment on Proposed Amendments to Reporting Requirements Under Home Mortgage Disclosure ActSuzanne F. Garwood and Thomas J. NotoHome Mortgage Disclosure Act, HMDA, Federal Reserve Board, Community Reinvestment Act, Amendments The Board of Governors of the Federal Reserve System (the Board) has issued, for public comment, a proposed rule that would significantly revise the reporting requirements for covered institutions under Regulation C (12 C.F.R. §§ 203.1 et seq.), the implementing regulation for the Home Mortgage Disclosure Act of 1975 (12 U.S.C. §§ 2801 et. seq. [HMDA]). Two years ago, the Board requested comments on ways to streamline and update Regulation C. The Board is renewing its focus on this effort in light of issues raised in the Board's recent joint report to Congress with the Department of Housing and Urban Development (HUD) entitled Curbing Predatory Home Lending. Primarily, the proposal would revise Regulation C in three distinct areas: 1. Expanding Required Data--In addition to the 13 items of information that are currently being reported, the revised Regulation C would require lenders to report on four additional items, including the loan's annual percentage rate (APR) and whether the loan is subject to the Home Ownership and Equity Protection Act of 1994 (15 U.S.C. § 1639 [HOEPA]). 2. Expanding Transaction Coverage--The proposal contemplates a four-pronged approach to expanding the types of transactions that would trigger reporting under HMDA: (i) revising the definition of "refinancing;" (ii) revising the definition of "home improvement loan;" (iii) requiring reporting for pre-approvals; and (iv) requiring reporting for home equity lines of credit; and 3. Expanding Institutional Coverage--As proposed, non-depository institutions that are not otherwise exempt, including mortgage companies, that originated $50 million dollars in purchase-money loans or refinancings of purchase-money loans (home-purchase loans) would be covered by Regulation C. This would effectively eliminate the exemption for those institutions whose covered loan originations do not exceed 10 percent of their loan originating volume. Certain proposed changes--particularly a requirement to report APRs and HOEPA status--are extremely significant. HMDA data is widely publicized and many are quick to draw conclusions from them--frequently unwarranted. As noted by the Boston Federal Reserve Bank and many other researchers, HMDA data simply does not contain sufficient information to draw meaningful conclusions about approval and denial rates. However, these studies have not prevented the press and many community groups from arguing that the HMDA data demonstrate widespread discrimination in marketing and underwriting practices by the mortgage lending industry. Disclosure of pricing data presents the same exact risk. There are a variety of factors that legitimately impact pricing that (i) are completely unrelated to prohibited factors, and (ii) are not disclosed in the HMDA data. While regulators now have the ability to obtain and thoughtfully analyze the impact of such factors, the public and press cannot. There can be little doubt that HMDA reporting of pricing data will trigger a new round of discrimination charges against the industry. Moreover, as the origination of HOEPA loans is increasingly argued by some to be a sure indicator of predatory lending practices, disclosure of HOEPA status will also be likely to result in adverse publicity, or worse, for some lenders. I. Background Currently, Regulation C requires that "covered institutions" record and report certain information contained in loans and loan applications to their appropriate supervisory agency. This information is reported on a form called a loan application report (LAR), a sample of which is contained in Appendix A to Regulation C. Mortgage companies that are not subsidiaries of state- or federally-chartered banks or savings associations report to HUD. Once the LARs have been submitted, the Federal Financial Institutions Examination Council1 (FFIEC) aggregates the data into HMDA disclosure statements in a manner designed to demonstrate lending patterns by location, age of housing, income level, sex and racial characteristics. These HMDA statements are distributed by the FFIEC to the reporting lenders on behalf of the FFIEC's member agencies--the Federal Deposit Insurance Corporation, Federal Reserve, National Credit Union Administration, Office of the Comptroller of the Currency, Office of Thrift Supervision and HUD. Lenders are required to make the disclosure statements available at their home offices within three business days of receiving the statements. Also, for other metropolitan statistical areas (MSAs) in which they have offices, lenders must either make a copy of the statements available at one branch per MSA or provide a copy upon written request. Disclosure statements must be available for review by the public for up to five years. Moreover, the FFIEC makes disaggregated data available to the public in electronic form. This data can be manipulated using commonly available software tools to produce analyses of things such as geographic lending patterns and relative approval and denial rates. II. Proposed Revisions A. Expanding Required Data The proposal would supplement existing data collections by requiring the reporting of: (i) the annual percentage rate on the loan; (ii) whether the loan is subject to the HOEPA; and (iii) whether the loan or application involves a manufactured home. The proposal would also revise certain existing categories and provide more options for race or national origin status. In recommending that these additional categories be added to the LAR, the Board was motivated primarily by two factors. First, the recommendations are being made out of a desire to enhance enforcement of the HOEPA and fair lending laws. Second, the Board believes that the information collected as a result of the new data items will be helpful in monitoring and understanding mortgage market developments and the sub-prime market in particular. With respect to the addition of the APR disclosure requirement, the Board hopes that the collection of such information will enhance fair lending enforcement by helping examiners evaluate the pricing activities of lending institutions. The APR also is believed to provide a good benchmark for determining whether a loan should be classified as a prime or sub-prime loan. The ability to distinguish between sub-prime and prime loans is important, according to the Board, for interpreting trends observed in the HMDA data with respect to denial rate patterns and lending practices to various sub-populations. Similar incentives are cited as the motivators for including the HOEPA information. The Board hopes that disclosure of HOEPA status will assist regulators in identifying lenders that are active in that segment of the lending market so that increased scrutiny can be conducted on those lenders that warrant such heightened attention. The Board also is soliciting comment on whether institutions should be required to report the loans-to-value ratio, the reasons why a loan application was denied, and the identities of their parent companies, if any. Lastly, the Board is seeking to amend the reporting of manufactured homes. Presently, manufactured home loans are reported together with loans secured by other "site-built" housing. As many commenters to the 1998 advance notice of proposed rule-making felt that the differing underwriting standards and denial rates for manufactured home loans call for the two to be reported as separate categories, the Board is proposing that loans secured by manufactured housing be separately reported. The Board proposes using the definition of manufactured housing used by HUD, which establishes construction and safety standards for manufactured homes, as the definition of such term for purposes of reporting requirements under Regulation C. Obviously, these changes would be extremely significant. As noted at the outset, HMDA data are often used to draw conclusions that simply are not warranted by the data. Regulators are aware of the shortcomings of the data and, in the examination and enforcement context, review additional unreported factors in determining whether or not they believe prohibited pricing discrimination has occurred. One would hope the Board would carefully consider whether providing an incomplete picture of pricing might not, in fact, be worse than providing no picture at all, particularly when regulators and enforcement agencies do have access to the more complete data that are necessary to any meaningful conclusion. B. Expanding Transaction Coverage Presently, covered institutions are required to collect data regarding applications for, and originations and purchases of, home-purchase and home improvement loans and refinancings of both kinds of loans. The proposed amendments would eliminate much of the discretion enjoyed by reporting institutions with respect to the reporting of refinancings and home improvement loans, as well as adding reporting requirements for preapprovals and home equity lines of credit. 1. Definition of Refinancing Defining covered refinancings has proven to be a continuing issue under Regulation C and the rules have undergone several changes over the years. The Official Staff Commentary to Regulation C indicates that a refinancing of a loan is the satisfaction and replacement of an existing obligation by a new obligation by the same borrower. An institution is permitted, however, to report a transaction as a refinancing if: (i) the existing obligation was a home-purchase or home improvement loan, as determined by the lender; (ii) the applicant states that the existing obligation was a home-purchase or home improvement loan; (iii) the existing obligation was secured by a lien on a dwelling; or (iv) the new obligation will be secured by a lien on a dwelling. The Board is concerned that such discretion results in inconsistent data. In order to eliminate the potential for confusion of the data reported, the Board is proposing to define "refinancing" as a new obligation satisfying and replacing an existing obligation by the same borrower, where both the existing obligation and the new obligation are secured by a lien on a dwelling. The Board believes that this new definition would reduce potentially inconsistent data as all lenders would utilize the same definition for reporting purposes. 2. Definition of Home Improvement Loan A home improvement loan is currently defined as any loan that is for the purpose, in whole or in part, of repairing, rehabilitating, remodeling or improving a dwelling or the real property on which it is located and is classified by the institution as a home improvement loan. The Board is proposing to remove the latter half of the definition, thereby stripping covered institutions of their discretionary power to classify loans as home improvement loans based on the institution's internal classification systems. For example, under the current language provided in the regulation, if a covered institution classifies all installment loans as installment loans without a further breakdown as to the purpose of the loan, it is not required to report any such loans even if the proceeds of a loan are used for home improvement purposes. As the Board believes this practice has resulted in data that is of limited usefulness to the regulators and the public, it therefore is proposing to drop the "classification test" from the definition. As such, covered lenders would be required to report a loan as a home improvement loan if any part of the proceeds is to be used for home improvement regardless of the institution's internal classification of the loan. The Board understands that the ability of the institution to meet the requirements of this proposed amendment relies heavily on the ability of the lender to accurately identify consumers' actual use of loan proceeds. Notwithstanding, the existence of some doubt that lenders will always be able to identify the use to which the proceeds of the loan are put. The Board believes that, by eliminating the discretion that lenders have to classify the loan, the result will necessarily be an increase in the number of home improvement loans that are reported. 3. Pre-Approvals In addition to expanding the definitions of "refinancing" and "home improvement loan," the Board is proposing to add a new category to its list of reported transactions--pre-approvals. Such transactions are not now reported. The agency's recommendation to add pre-approvals to the list of reported transactions tracks an earlier, separate rule-making to expand the definition of "application" under Regulation B, the implementing regulation to the Equal Credit Opportunity Act. For purposes of the amendment, a "pre-approval" is defined as the preliminary approval of a borrower that does not comprise all of the underwriting necessary to finally approve the borrower for the loan, but which provides a written commitment for a loan of money of up to a certain amount and expiring at a specified period of time. Primarily, the agency is concerned that the definition used for pre-approval not be so overly broad as to include pre-qualifications. With this in mind, the Board is proposing to require the reporting of pre-approvals that are made under procedures in which a creditor issues creditworthy persons a written commitment to extend credit that may be limited in three ways: (i) the lender specifies the maximum amount of credit that it commits to extend; (ii) the lender specifies the period of time during which the commitment remains valid; and (iii) the commitment may be subject to conditions. The Board believes that a relatively large number of institutions could be affected by this change since, in recent years, many depository and for-profit mortgage lending institutions have put in place pre-approval programs that qualify potential customers prior to the selection of the property that will secure the loan. By placing a reporting requirement on pre-approval programs, the Board hopes that it will have an opportunity to better evaluate lenders' compliance with fair lending laws. 4. Home Equity Lines of Credit Reporting information with respect to home equity lines of credit (HELOC) that are used for home improvement purposes is currently permissible, but not mandatory, under Regulation C. The Board's proposed amendments would make this option a requirement by mandating the disclosure of information relating to lines of credit secured by the borrower's home. Although it is true that some HELOCs are being reported as home improvement loans under the current version of Regulation C, there is some question that this optional reporting conveys a representative picture of HELOC lending practices. Based on consumer survey information from 1997, the Board estimates that, by expanding the scope of Regulation C to include home equity loans, in excess of two million additional transactions could be reported. For reporting purposes, under the proposed regulation, a HELOC would be defined as an open-end credit plan, as defined by Regulation Z, which is secured by a dwelling. In order to simplify the reporting process, covered lenders would report the full amount of the credit line rather than attempt to ascertain the amount of the loan, if any that would be used for home improvement purposes. C. Expanding Institutional Coverage Institutions "covered" by Regulation C fall into two categories--depository and for-profit mortgage lending institutions. Generally, depository institutions that are covered by Regulation C are banks, savings associations or credit unions that originated, in the preceding calendar year, one home-purchase loan secured by a first-lien loan on a one- to four-family dwelling and either the institution is federally insured or regulated or the loan is insured, guaranteed or supplemented by any federal agency or the institution intended to sell the loan to Fannie Mae or Freddie Mac. However, depository institutions meeting this general definition are exempt from complying with Regulation C if, on the preceding Dec. 31, (i) the depository institution had neither a home office nor a branch office in an MSA; or (ii) the depository institution had assets of $30 million or less. No changes are being suggested by the Board that would expand the number of depository institutions that would be covered by Regulation C. At present, for-profit mortgage lending institutions are covered by Regulation C if their home-purchase loan originations equaled or exceeded 10 percent of their loan originating volume in the preceding calendar year. However, an institution is exempt if: (i) the institution had neither a home office nor a branch office in an MSA; (ii) or the institution's total assets combined with those of any parent company's were $10 million or less on the preceding Dec. 31 and the institution originated fewer than 100 home-purchase loans. The Board is proposing to amend the test for determining whether a for-profit mortgage lending institution is covered under Regulation C by adding a dollar-volume threshold. Under the proposed regulation, lenders would be required to report HMDA data if their prior-year home-purchase originations equaled or exceeded $50 million, even if this amount does not exceed 10 percent of total originations. Although the Board cannot predict the number of additional mortgage lenders that will be covered by Regulation C if the proposal were to be adopted, the rule-making notes that in 1999, of the for-profit mortgage lenders that reported HMDA data, nearly 50 percent originated less than $50 million in home-purchase loans. The Board hopes that by changing the test for coverage, it will broaden the scope of Regulation C to include those lenders that are originating a significant number of mortgage loans, but are not currently reporting such originations because of the size of their non-real estate secured lending practices. III. Other Changes In addition to the substantive changes described above, the Board is proposing to make several technical changes with respect to the format of the regulation. The agency is proposing to streamline the guidance provided for compliance with Regulation C through consolidation and the elimination of redundant information. Informal guidance will continue to be provided in the FFIEC's publication, A Guide to HMDA Reporting: Getting it Right! which reflects those changes finalized by the Board. A copy of this guide is available for downloading at The new format of the regulation would reflect recent amendments made by the Office of Management and Budget (OMB) to prescribe the standards for racial designations for use in federal reporting. As revised, the racial designations that will be utilized in HMDA reporting will be: (i) American Indian or Alaskan Native; (ii) Asian; (iii) Black or African American; (iv) Native Hawaiian or other Pacific Islander; or (v) White. Consumers are permitted to choose one or more designations. Note that since existing reporting systems are designed around the current race/national origin designators, an expansion of race/national origin codes could result in significant programming changes. The proposed rule also seeks comment on an alternative approach to categorizing the loans for reporting purposes. Under the current regulation, the categories of loans reported are: (i) home-purchase loans; (ii) home improvement loans; and (iii) refinancings. The alternative approach would eliminate refinancings and home improvement loans (except for unsecured home improvement loans) as distinct categories. Instead, the categories reported would be: (i) home-purchase loans (subdivided into first- and subordinate-lien loans); (ii) other mortgage loans (similarly subdivided); (iii) HELOCs; and (iv) unsecured home improvement loans. The Board believes that this alternative approach would require the reporting of more loans--which could enhance some depository institutions' performance under the Community Reinvestment Act--while potentially limiting the additional burden for depository institutions because of its similarity to categories familiar to them from the Call Report or the Thrift Financial Report.2 IV. Conclusion The proposed amendments are intended to enhance regulatory efforts to enforce fair lending laws and compliance with the Community Reinvestment Act. Nevertheless, despite the importance of these efforts, the proposal could well result in a large amount of inflammatory--yet fundamentally incomplete--data being disclosed by covered institutions. Moreover, the proposal would require significant changes to software systems, internal classifications and training programs. Accordingly, this proposal represents the most significant change to HMDA in the last 10 years, and institutions would be well-advised to make their views known through the public comment process. Suzanne F. Garwood is an associate in the Washington, D.C. office of Kirkpatrick and Lockhart LLP. She may be reached at (202) 778-9892 or e-mail [email protected]. Thomas J. Noto is a partner in the Washington, D.C. office of Kirkpatrick and Lockhart LLP. He may be reached at (202) 778-9114 or e-mail [email protected]. Footnotes 1The FFIEC was established on Mar. 10, 1979, pursuant to Title X of the Financial Institutions Regulatory and Interest Rate Control Act of 1978 (FIRA), Public Law No. 95-630. The FFIEC is a formal interagency body empowered to prescribe uniform principles, standards and report forms for the federal examination of financial institutions by the Federal Reserve, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency and the Office of Thrift Supervision, and to make recommendations to promote uniformity in the supervision of financial institutions. The FFIEC was given additional statutory responsibilities by Section 340 of the Housing and Community Development Act of 1980 to facilitate public access to data that depository institutions must disclose under HMDA and the aggregation of annual HMDA data, by census tract, for each metropolitan statistical area. 2 The Call Report categories include first-lien, closed-end mortgage loans, junior-lien closed-end mortgage loans, open-end mortgage loans (home-equity lines of credit) and unsecured consumer loans, subdivided into open-end and closed-end loans. The Thrift Financial Report is similar, but does not subdivide closed-end mortgage loans into first and junior liens, and shows unsecured home improvement loans as a subdivision of unsecured closed-end consumer loans. Refinancings are not treated as a separate category in the Call Report or Thrift Financial Report. This article was reprinted with permission from Kirkpatrick & Lockhart LLP's Mortgage Banking Commentary, Dec. 8, 2000 edition.
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