As the country's strictest law against predatory lending takes effect in Georgia today, mortgage companies large and small are scaling back credit there.
From major players like Chase Manhattan Mortgage Corp. of Edison, N.J., to smaller ones like New Century Financial Corp. of Irvine, Calif., lenders have decided not to make "high-cost" loans in the state because the law's penalties are severe.
The withholding of credit is a predictable side effect of such measures. What makes Georgia's statute noteworthy is that it also targets the secondary market. Under the law, investors - from Wall Street firms to Fannie Mae - buying mortgages can be held liable for violations by lenders and brokers.
"In our opinion, the Georgia law is by far the worst in terms of the secondary market," said Mike Williams, vice president of legislative affairs at the Bond Market Association.
Asked to comment on the law, Countrywide Home Loans of Calabasas, Calif., gave this statement to American Banker: "The harsh restrictions applied to high-cost loans - including extended rescission rights, draconian monetary penalties, criminal prosecution, and full assignee liability - will eliminate the secondary market for these loans."
Freddie Mac has stopped buying high-cost loans in Georgia because of the law.
"We're not at the closing table, we don't have contact with the borrower, so it puts us in an almost untenable position," Freddie spokeswoman Sharon McHale said. "We can't with absolute certainty say that the thousands of loans we buy each month from Georgia would comply with the law."
Subprime lenders need the liquidity the secondary market provides to keep growing. Subprime debt outstanding rose 10% last year, to $550 billion. How much of this volume high-cost loans makes up is uncertain. But according to Ms. McHale, Freddie bought $19 billion of subprime mortgage debt last year, up 46% from 2000.
Fannie Mae has not "made any determination about what we are planning to do in response to the law," spokesman Albert King said. One lender, however, said Fannie Mae has told lenders originating in Georgia that they will be charged higher guarantee fees, or charges levied to ensure principal and interest payments to bondholders.
Georgia is not the only state to go after mortgage loan buyers.
An anti-predator bill approved by the New York legislature in early July would also hold mortgage buyers liable for originators' actions. The measure is still before Gov. George E. Pataki.
Lenders and investors have had six months to prepare for Georgia's law. Gov. Roy Barnes, a Democrat, signed it in April 2001.
Previous measures, such as a North Carolina law that went into effect in 2000, made consumer protection triggers easier to trip and barred the use of loan terms considered predatory, such as single-premium credit insurance.
On the federal level, subprime lending is policed by rules implementing the Home Ownership and Equity Protection Act of 1994. The federal rules apply liability to mortgage loan buyers, but the penalties are much softer than those punishing high-cost loans under the Georgia statute. For instance, buyers of HOEPA loans do not face criminal penalties and can be forced to rescind an illegal loan during its first three years; the Georgia law gives them five years to rescind.
The Georgia law is the country's stiffest not only because it covers all home loans in the state but because it imposes tough restrictions and penalties on subprime loans.
"This legislation, though well intended, presents very serious issues," said Chase spokeswoman Charlotte Gilbert-Biro. "It goes far beyond attacking predatory practices, which is a goal we share. Instead it puts institutions meeting important credit needs in Georgia in responsible ways at very serious risk."
Like Chase, Option One Mortgage Corp., Irvine, Calif., will no longer make high-cost loans in Georgia, according to Dale Sugimoto, vice president of compliance.
The law bars the financing of insurance in any home loan, and bars a creditor or servicer from recommending or encouraging default on an existing loan before or in connection with the closing of a refinanced loan. Violators face penalties including forfeiting the interest paid by the borrower and statutory damages of two times the interest paid; punitive damages; costs and attorney fees; and even criminal prosecution.
The definition of a subprime loan is split into two categories: "covered" or medium-cost loans; and "high cost" loans.
Medium-cost loans are defined as those priced 4 percentage points above the bank prime rate published by the Federal Reserve Board or with points and fees totaling 3% of loan's value.
Finally, the most heavily restricted category of loans are high-cost loans, defined as those with an annual percentage rate of 8 percentage points or more above prevailing Treasury rates or with points and fees totaling 5% of the loan's value. Lenders making these loans face additional restrictions such as a ban on balloon payments and a limit on prepayment periods to two years. As noted, secondary market purchasers are also open to all of the law's penalties by holding "high cost" loans, whether they had a hand in originating them or not. And borrowers may file class actions against them.
Lenders say the fees and points triggers are deceiving because unlike other states, Georgia counts the yield spread premiums that lenders pay brokers.
For comparison, North Carolina's anti-predator law sets high-cost loans at 8% above yields on comparable Treasury securities and the points and fees trigger at 5% and it does not force lenders to include yield spread premiums in the calculation. What's more, North Carolina's law does not apply to open-ended home equity loans - a loophole many companies have used to continue lending in the state.
The federal rules were updated late last year to include credit insurance costs in the points and fees trigger, which is 8% of the loan's value.
Another problem with the Georgia law is its anti-flipping provision. Flipping is a widely acknowledged predatory practice in which a lender or broker refinances the borrower into a costlier loan with the object of causing the borrower to default and taking control of the property.
In refinancing borrowers who have loans less than five years old, lenders must ensure the borrower receives a "net tangible benefit."
That provision convinced Ameriquest Mortgage Co. of Orange, Calif., to cease making all subprime loans - not just high-cost loans - in Georgia. The nation's seventh-largest subprime originator expects originations from its six branches in the state to fall by half, according to Adam J. Bass, Ameriquest's senior executive vice president.
"Nobody has explained that to me," Mr. Bass said of net tangible benefit, "and I haven't seen anything from the Georgia department of banking that defines what that is and how you comply."
Robley S. Rigdon, deputy commissioner with the mortgage division of the Georgia Department of Banking and Finance, said his agency "made some attempt at trying to define that - we looked at a number of states and what they had out there." But he acknowledged, "Nothing is going to protect [lenders] from being sued."
Georgia regulators do not track the volume of subprime lending, but Mr. Rigdon estimated that "high-cost" mortgages make up less than 20% of total subprime lending.
