In the wake of Standard & Poor's recent announcement that certain loans falling under the Georgia Fair Lending Act (GFLA) will not be allowed in S&P-rated loan pools, several mortgage lenders have publicly announced that they will pare down or halt all lending activity in that state, setting a precedent for what other states can expect if similar legislation is enacted. The news stunned the originator market, and led to Georgia-originated loans being pulled from pending transactions and at least one investor backing out of priced transactions that had yet to settle.

Observers are concerned because similar anti-predatory lending laws are due for implementation in states such as New York (expected to take effect on April 1) and New Jersey, which make up a much greater portion of non-conforming securitized loan portfolios. Analysts at S&P stated that they are currently looking into the anti-predatory lending legislation in these states as well. Using its proprietary loan-level database, Banc One Capital Markets estimates that average loan exposure to Georgia among sub-prime mortgage lenders is just 3.3%, the lowest exposure being just 0.92% and the highest at 5.5%.

In the week since the S&P announcement, more than several of the largest mortgage lenders have publicly announced that they would close their lending operations in Georgia. The list includes Chase Mortgage, Centex Corp., The CIT Group, Countrywide Home Loans Inc., Option One Mortgage and Saxon Asset Securities, among others. Also, investment banks Credit Suisse First Boston, Greenwich Capital Markets and Lehman Brothers, are said to have ceased conduit-lending activity to mortgage lenders who continue to originate loans that fall under GFLA guidelines. The market is still waiting to hear from other major lenders, such as EMC Mortgage (a unit of Bear Stearns & Co.), Household Finance, IndyMac and Washington Mutual.

Fannie Mae announced back in November that it would not purchase "high-cost loans," starting Jan. 1, 2003, will be considered ineligible for purchase by the GSE. Fannie's policy on the purchase of all conforming mortgages in Georgia has remained unchanged, including the purchase of "covered home loans" under GFLA, as long as they are not "high cost loans." "This is line with Fannie's policy to fight predatory lending and one way to do that is not to purchase loans that have predatory features," said representatives from Fannie.

Freddie Mac also made an announcement last October that it will not buy "high-cost loans" under the Georgia Fair Lending Act, but the GSE is still buying qualifying "covered loans" under the Act.

"S&P is signaling is that they have zero tolerance as a rating agency for any loans that might be [considered] predatory by action, if not by intent," said Michael Youngblood, newly minted director of research GMAC-RFC Securities. "The fact that S&P is signaling such a policy for predatory instruments is a very important and healthy signal to the market."

By contrast, Banc One mortgage researcher Glenn Schultz believes the negative reaction on the part of the lender community will lead states to revise - or altogether scrap - legislation that may reduce consumer liquidity.

"Other states will see liquidity dry up in Georgia, as it did in North Carolina where lending dropped 10% to 15% after its law passed and these laws won't get passed, regardless what consumer advocacy groups say," he said.

Not all newly originated and existing loans fall under GFLA and analysts from S&P said they are not contemplating, at this time, taking action on existing deals. Loans originated in Georgia prior to Oct. 1, 2002 are exempt from GFLA and therefore may still be included in securitized pools. For example, AmeriQuest Mortgage, in the market at the time of S&P's announcement, had roughly 10 Georgia-originated loans in the portfolio, but those loans were originated prior to Oct. 1, 2002, therefore grandfathering them as GFLA exempt. "Because of the nature of the pipeline, we are only beginning to see these types of loans this month," said Susan Barnes, an analyst at S&P.

As of press time, Moody's Investors Service and Fitch Ratings were both due to come out with separate stances on the issue. While sources said the two remaining rating agencies were "being more reasonable," market observers were still not sure what direction the two would take. S&P's reaction was said to be "quite overblown" from the lender's perspective.

Fitch announced on Dec. 24 that it was reviewing the impact of the law taking effect in Georgia, New York, New Jersey and California. "The majority of the provisions of various statutes are aimed at mortgage loans which are below the GSE conforming loan size limits (in New Jersey the statute is aimed at mortgage loans below $350,000), which meet or exceed certain thresholds for APRs or points and fees," the agency said. "In the event that a mortgage loan meets or exceeds the relevant threshold and a creditor or servicer has also engaged in one of the predatory practices enumerated in the relevant statute, a purchaser or assignee of such mortgage loan is subject to all affirmative claims and defenses that the borrower may assert against the original creditor or creditors of the mortgage loan."

Sources also said that because of S&P's announcement, there have been instances where investors actually withdrew their funds between the time deals priced and the settlement date, which, they said, rarely, if ever, happens. Sources reported an investor being let out of a $75 million investment in the recently priced transaction from Option One Mortgage.

Although some companies will stop originating loans in Georgia and in North Carolina (where a similarly restrictive law was passed in 2000), some analysts argue that there will not be material rationing of credit in these states. "Clearly the statute will provide safe harbor to companies that operate within its terms," said Youngblood. "That certainly was the intention of the North Carolina law, on which the Georgia Fair Lending Act was broadly based."

Youngblood explained that depository institutions with offices in Georgia would have an obligation under the Community and Reinvestment Act (CRA) to make credit available in low- and moderate-income areas to individuals.

This is why major companies like Banc of America, Wachovia Bank or Sun Trust Bank have no choice but to continue lending. In other words, certain depository institutions are obliged to make credit available throughout their lending areas and cannot really avoid this responsibility without being subject to the remedial action by the Federal Reserve Board.

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