Superintendent of Banks, Richard H. Neiman, Testifies Before the New York State Assembly Committee on Banks on the Subprime Lending Reform Bill
December 8, 2008
Good morning. Chairman Towns, Chairwoman Millman, and Chairman Benjamin: as the Superintendent of Banks for New York, I appreciate this opportunity to update you on the steps taken by the Banking Department to address the mortgage crisis, including implementation of the Governor’s mortgage legislation package which passed this July.
Thank you for holding the hearing today on this important topic, as we continue working together to respond to the foreclosure emergency.
And I would like to thank the entire legislature for the vision to pass this legislation, which is the most comprehensive in the nation and key to stabilizing the mortgage market in New York. The sharp deterioration in both the financial sector and the general economy over the second half of this year demonstrates how critical it was that the state acted decisively and created these new protections.
Today I would like to brief you on the following three points:
- Origins of the crisis and solutions provided by the new legislation;
- Progress in implementing the legislation and the impact on consumer protection and credit availability; and,
- Other state actions taken to prevent foreclosures.
A. Origins of the Crisis and Solutions Provided by the New Legislation
The origins of the mortgage crisis stem in large measure from increased institutional demand for higher-yielding subprime investments. As stock values fell earlier in the decade, real estate became an appealing investment alternative and property values increased in response to renewed investor appetite. This resulted in a significant increase in institutional investor demand for higher-risk subprime mortgage securities that generate a higher yield.
Lenders were quick to respond to this investor interest through the development and mass-marketing of alternative mortgage products. These alternative products contained unique risks, such as the potential for negative amortization and risk of payment shock as adjustable-rate loans with low initial rates reset. These inherent product risks were combined with underwriting risks, such as 100% loan-to-value financing, no income verification and reduced documentation. These products and underwriting techniques were then applied to consumers with impaired credit histories, with insufficient regard for the borrowers’ ability to repay. There was an underlying and unrealistic assumption by many lenders that housing values would continue to appreciate, with no end in sight.
This spree of undisciplined lending led to a dramatic increase in the number of New York families at risk of losing their homes. The impact of rising foreclosure rates became particularly visible last year. In 2007, there were over 57,000 foreclosure filings on almost 39,000 homes in New York, which was a 10% increase over 2006, and a 55% increase over two years. For 2008, we are on track to surpass the number of filings received last year.
The Governor’s legislation gets to the root of the diverse issues driving these foreclosure numbers, and tackles the mortgage problem from both sides: there are provisions designed to help existing homeowners to avoid foreclosure, as well as new standards to help prevent future crises. The legislation closely aligns with consumers’ needs, whether they already have a mortgage or are shopping for credit. For example:
- To help existing borrowers and prevent unnecessary foreclosures, the Governor’s legislation amends the foreclosure and other real property laws to provide additional opportunities for a loan modification or other workout solution. These provisions became effective September 1, 2008. First, a pre-foreclosure notice is required for subprime and nontraditional loans, which includes contact information for local credit counselors. Second, a mandatory settlement conference for all one-to-four family owner-occupied homes offers another window to prevent foreclosure, even after proceedings have commenced. The legislation also protects vulnerable consumers from foreclosure rescue scams, by prohibiting up-front fees and requiring a written contract for services.
- To help ensure that a similar mortgage crisis never happens again, the Governor’s legislation expands coverage of the state’s existing anti-predatory lending law to include loans up to the conforming loan limit, and creates a new category of subprime loans subject to additional standards as of September 1, 2008. For subprime loans, examples include prohibiting prepayment penalties and abusive forms of yield spread premiums, and the lender must ascertain the borrower’s ability to pay. For all loans, a new broker duty of care to consumers is established.
Other features, such as the registration of servicers beginning July 1, 2009 and the criminalization of mortgage fraud as of November 1, 2008, are further deterrents. The registration of mortgage servicers will allow the Banking Department to collect critical data for monitoring industry loss mitigation efforts. This builds on the work of the State Foreclosure Prevention Working Group, comprised on attorneys general and state banking supervisors, which has encouraged servicers to share this information with the public sector. However, some firms elected not to participate in this voluntary program.
B. Implementation and Impact of the Legislation
Most provisions of the legislation became effective on September 1, 2008. The main exception is the move to register mortgage servicers for the first time, which does not take effect until July 1, 2009. The 2009 effective date is intended to provide the Banking Department sufficient time to develop the necessary rulemaking to establish registration procedures.
To assist the industry in preparing for these effective dates and to ensure compliance with the new mortgage standards contained in the legislation, the Banking Department issued a detailed Industry Letter on August 27, 2008 which is also available on the agency website (www.banking.state.ny.us). This letter was sent to all relevant supervised institutions, related industry groups, consumer groups, and media outlets. The Department’s website has also been updated to provide reference tools, such as the regional lists of housing counselors and the index rates used to determine whether a particular loan is a covered transaction.
Extensive industry education is also ongoing, especially through dialogue with institutions that have questions regarding compliance in specific operational situations. The Banking Department values this educational aspect of its mission, to help prevent future violations and enforcement issues. A detailed list of frequently asked questions with responses is being added to the Department’s website, based on common issues raised by supervised institutions. The proper method for applying index rates to determine whether a loan is a covered transaction has generated numerous questions. The new rules for distressed property consultants and relationship to mortgage bankers, brokers, and attorneys who offer similar services has also been a frequent topic. As the legislation has just become effective, evaluation of industry compliance will be a focus of the next cycle of examinations conducted by the Department.
In evaluating the impact of the legislation over time, we should be guided by the original construct used to develop the bill: to protect consumers while maintaining access to affordable credit.
- On the consumer protection front, there are initial signs that the notice requirements and mandatory settlement conference may be reducing foreclosures. We are encouraged that the rate of foreclosure filings in the third quarter of 2008 is down 10% from its high in the second quarter. Since the law was only in effect for one month in the third quarter, however, a review of the numbers in the fourth quarter of this year and the first quarter of 2009 will provide a fuller assessment over a longer period. While this recent change in foreclosure trends is good news, the level of filings in New York is simply back to where it was during the first quarter, which is still 20% more than last year, and remains unacceptably high. A chart with the most recent quarterly foreclosure data from RealtyTrac® for each county in the state is included with this testimony for comparison.
- In terms of the impact on credit and mortgage lending levels, financial institutions are not required to submit Home Mortgage Disclosure Act (HMDA) data for 2008 until next spring. But anecdotal evidence gathered from in-depth conversations with supervised institutions and other regulators indicates that the subprime market experienced a natural self-correction apart from the law, with originations of subprime loans dwindling due to lack of investor interest. There is a nationwide pullback in lending, even to creditworthy borrowers, that is due to the general instability in the financial markets.
There has also been a significant net decrease in the number of mortgage bankers and mortgage brokers operating in the state. This trend began in the first quarter of 2007, apart from the new legislation, and appears to be driven by the turmoil in the financial markets. Many licensees are experiencing particular difficulty in obtaining warehouse lines of credit and surety bonds.
The most immediate market reaction to the legislation has been the decision by Fannie Mae and Freddie Mac not to purchase New York subprime loans. This decision, while disappointing, was not unexpected, as the government-sponsored entities (GSEs) already did not purchase loans covered by the state’s high-cost, anti-predatory lending statute. The Banking Department is still in conversation with Fannie Mae and Freddie Mac, to encourage them to revisit this decision. The ultimate impact is expected to be minimal in either case, as the GSEs only purchased a tiny fraction of subprime originations in the state, even at the height of the housing boom.
With new standards in place to improve underwriting and address conflicts of interest, such as the new broker duty of care, our immediate emphasis remains on avoiding preventable foreclosures. While progress has been made, the rate of new foreclosure filings is simply outstripping the pace of the industry’s loss mitigation efforts, and this emphasizes the need for broad public sector intervention to complement the legislation.
D. Other State Actions to Prevent Foreclosures
A wide range of state initiatives are underway to help homeowners at risk. Full details on these programs will be provided to the legislature in the next report of the Governor’s HALT Task Force, to “Halt Abusive Lending Transaction,” which will be submitted before year end. The HALT Task force was convened early on in the crisis, to combine the efforts of all state agencies that relate to the mortgage market into a coordinated response.
As the Chair of the HALT Task Force, I would like to offer the following highlights from the upcoming report:
- Outreach. State agencies, in partnership with local legislators, have reached out to affected consumers through a series of foreclosure prevention forums called Operation Protect Your Home. These are unique events that provide borrowers with the opportunity to meet face-to-face with their lender or servicer to arrange a loan modification or other workout agreement. Almost 36,000 homeowners were invited to eight forums held across the state this year. Our most recent forum was held in Suffolk County at the end of September. Others were held earlier in the year in the Bronx, Staten Island, Queens, Brooklyn, Westchester, Buffalo and Nassau County.
Last week the Banking Department launched a public service ad (PSA) campaign to stem foreclosures, which encourages borrowers to contact the Department for direct information as well as referral assistance. The two 10-second spots, which will run on an electronic billboard in Times Square through January 4, 2009, were reformatted for use in local television, radio, and print media across the state. The Ad has been picked up by five televisions networks, four radio networks and two internet news sites, and television and radio networks indicated their intention to run the ad on multiple stations. The PSA was developed at no cost to the state, and was produced using funds earmarked for PSAs that resulted from an enforcement action against a mortgage broker.
- Grants. The foreclosure crisis has strained the already limited capacity of housing counselors, legal services attorneys, and other advocates to help borrowers. As caseloads have grown, the sustained ability of these agencies to respond to this increasing demand for services is a critical issue. The state budget provides $25 million for grants to these organizations, plus the Banking Department has a $2 million grant program funded by fines recouped from enforcement actions. The Department’s funds were allocated by region into three discrete pools, taking into consideration foreclosure rates, existing resources, and geography, to maximize access to services in each county. All state grants will be used for direct counseling and legal services, training and public education and awareness.
- Loan Programs and Servicing. SONYMA expanded the eligibility criteria for its Keep the Dream refinance program, to accommodate the lower credit scores of many borrowers facing foreclosure. A Neighborhood Stabilization Initiative is also under development, to offer loans to eligible homeowners who purchase previously foreclosed homes in hard-hit areas.
And the state has been tireless in calling for servicers to adopt systematic approaches to loan modification, such as the proposal announced by FDIC Chairman Sheila Bair and the settlement with Countrywide. Through the State Foreclosure Prevention Working Group, composed of attorneys general and state bank supervisors, the Banking Department has been meeting with major loan servicers to promote similar approaches to streamlining loan modifications. And through the SFWG has been documenting the state of mortgage loan servicing. A copy of the Working Group’s latest report, compiling loss mitigation results from the top mortgage servicers in the nation, is available on the Banking Department’s website. This report further documents that industry efforts are slipping, with nearly eight out of ten seriously delinquent borrowers not on track for any foreclosure alternative.
- Enforcement. On the enforcement side, the Banking Department created a dedicated Mortgage Fraud Unit, to address deceptive and even illegal practices in the mortgage market. The agency is also partnering with the Department of State to review the operations of “one-stop-shops.” The joint initiative was designed to identify whether consumers were being steered into particular mortgage brokers and/or attorneys by real estate firms. The initial phase of the project disclosed a general failure of these one-stop-shops to clearly inform consumers of their role as a dual agent or to properly disclose broker compensation. To date, these reviews have led to over $250,000 in consumer restitution.
A major component of the anti-fraud campaign includes New York’s participation in the National Mortgage Licensing System (NMLS), a state-run project to register individual loan originators. This system includes extensive security measures and educational requirements. New York was one of the first states to launch the new system and it is estimated that 20,000 mortgage loan originators in the state will be registered by January 2010. The recently passed federal SAFE Mortgage Licensing Act of 2008 is also impacting the state’s effort to register mortgage loan originators. The SAFE Act provides for a federal backup system, should an individual state fail to join the NMLS or fail to adopt comparable standards for originators. New York will need to amend aspects of our registration standards, in particular the education requirement, to conform with the federal law. With nearly 10,000 originators already in process, implementation of the NMLS is a major feature of the Department’s effort to strengthen oversight and enforcement.
A problem this complex is beyond the authority or resources of any one state agency. Indeed, no single state can completely resolve issues impacting the national housing market; constructive engagement with the federal government is vital.
The federal government has taken historic steps to support the markets, including rate cuts, new facilities to increase liquidity, expansions of deposit insurance, and the $700 billion relief package which is part of the Economic Stabilization Act of 2008 that passed in October. While New York supports these actions, there remains much more to be done. Unfreezing the credit markets is critical, but lasting stability requires a solution that addresses the origins of the problem: the escalating number of families who are losing their most valuable asset - their homes.
In response, New York has developed one of the most comprehensive and coordinated responses to the foreclosure crisis in the U.S., that could serve as a model at the national level. While it is still too early to fully assess the impact of the new law, through the Governor’s mortgage legislation and initiatives for outreach, consumer education, counseling grants, and enforcement, New York is taking the right steps to help our residents and our state economy in these challenging times.Thank you for the opportunity to speak with you today, and I would be pleased to answer any questions.