By Natalie Abrams, Esq., Assistant General Counsel; Maureen Coleman, Esq., Assistant General Counsel; and Susan Barnes, Director, of Standard & Poor's Ratings Services
Increased access to mortgage loans has led to increased home ownership across the U.S. While this growth in home ownership is positive, it has become evident that some of this increase has unfortunately occurred simultaneously with a rise in predatory lending practices. Among others, these predatory practices include the following: charging excessive interest or fees; making a loan to a borrower that is beyond the borrower's financial ability to repay; charging excessive prepayment penalties; encouraging a borrower to refinance a loan notwithstanding the lack of benefit to the borrower; and increasing interest rates upon default.
To protect borrowers from unfair, abusive and deceptive lending practices, the U.S. government and numerous state and local governmental bodies have enacted anti-predatory lending statutes. Typical statutes include provisions that:
* Limit the interest rates and fees that a lender may charge;
* Preclude lending to borrowers without regard to their ability to repay;
* Require refinance loans to provide a net tangible financial benefit to the borrower;
* Prohibit excessive prepayment penalties and balloon payments;
* Require disclosure to the borrower of various loan provisions; and
* Require counseling for borrowers who are planning to take out certain loans that are governed by these laws.
Internationally, governments are also focusing on the same issue. For example, the U.K. Department of Trade and Industry announced that a radical overhaul of the U.K.'s credit laws will be brought forward in late 2003. This overhaul will be aimed at clamping down on loan sharking, magnifying the small print of loan agreements and putting a stop to irresponsible lending. Among other effects, the changes to the law are expected to allow consumers to exit unfavorable credit deals without fear of excessive charges, and increase the transparency of rules related to the early termination of credit agreements.
Although anti-predatory lending statutes in the U.S. are designed to protect borrowers from predatory lending practices, the statutes may also have the negative effect of reducing the availability of funds to such borrowers. First, a lender might reduce its lending in a given state to protect itself from being found in violation of the state's anti-predatory lending statute. Second, a lender might reduce its business because the cost of lending in accordance with a statute's provisions might be uneconomical. Third, a lender might reduce its activities within a given state if the market for the sale of loans made within the state is effectively eliminated. This would occur, for example, if an anti-predatory lending statute imposes liability on purchasers or assignees of loans governed by the statute, and potential purchasers and assignees thus reduce their purchasing to avoid liability under the statute.
In addition to possibly reducing the availability of funds to borrowers intended to be protected by anti-predatory lending statutes, these statutes might reduce the availability of funds to pay investors in securities backed by mortgage loans made in the relevant states. (Indeed, given the expansion of individual investments in securities through various retirement and pension plans, these investors might actually be the very same borrowers the statutes are intended to protect.) Reduction in the availability of funds to pay investors in MBS might occur if an anti-predatory lending statute imposes liability on purchasers or assignees of mortgage loans (assignee liability) for holding loans that violate a statute (predatory loans), even if the purchaser or assignee did not itself engage in predatory lending practices. Therefore, in performing a credit analysis of structured transactions backed by residential mortgage loans, Standard & Poor's Ratings Services evaluates the impact an anti-predatory lending statute might have on the availability of funds to pay investors in the rated securities.
In performing this evaluation, the two most important factors that Standard & Poor's considers are whether an anti-predatory lending statute provides for assignee liability and, if so, what penalties the statute imposes on assignees for holding predatory loans.
Standard & Poor's defines assignee liability as liability that attaches to a purchaser simply by virtue of holding a predatory loan. If Standard & Poor's determines that there is no assignee liability, Standard & Poor's will generally permit loans covered by the statute to be included in rated transactions. If, on the other hand, a given state's anti-predatory lending statute does permit assignee liability, Standard & Poor's will evaluate the penalties under the statute. If damages imposed on purchasers are not limited to a determinable dollar amount, that is, the damages are not capped, Standard & Poor's will not be able to size the potential liability into its credit analysis. Therefore, these loans cannot be included in rated transactions. If, on the other hand, monetary damages are capped, Standard & Poor's will be able to size in its credit analysis the potential monetary impact of violating the statute. Standard & Poor's looks at all types of potential monetary damages, including statutory, actual and punitive damages. Even if capped damages can be sized, it may not be economical for a lender to make such loans if the credit enhancement required might equal or exceed the monetary value of the loan. For example, if a statute provides for punitive damages (even if these damages are capped), the amount of the damages may well exceed the loan value.
In rating a transaction, Standard & Poor's will also review both a seller's compliance procedures (to determine if they are effective to identify which loans are subject to assignee liability and which loans are predatory) and a seller's creditworthiness (to determine if a seller is willing and financially able to repurchase any predatory loan for a purchase price that would make a securitization trust whole for any costs incurred in connection with the predatory loan). These factors assume increased significance in transactions in which the seller proposes to include loans with assignee liability.
Standard & Poor's has stated that, as a public policy matter, it is in favor of statutes that attempt to curb predatory lending. Standard & Poor's also acknowledges, however, that its role is to evaluate the credit risk to investors associated with anti-predatory lending legislation and not to recommend public policy. The making of public policy is the responsibility of elected officials.