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On September 30, the CFPB released a Data Point report, titled Subprime Auto Loan Outcomes by Lender Type, which examines interest rate and default risk trends across different types of subprime lenders, including how much of the variation of interest rates charged among subprime lenders can be explained by differences in default rates and how much is left to be explained. The report found notable average differences across lender types in the borrowers they serve and the types of vehicles they finance. Banks and credit unions offering subprime auto loans typically lend to borrowers with higher credit scores compared to finance companies and buy-here-pay-here dealerships, the report noted, adding that different lenders also charge very different interest rates on average. According to the report’s sample, a bank’s average subprime loan interest rate is approximately 10 percent, compared to 15 to 20 percent at finance companies and buy-here-pay-here dealerships. The report found that higher default rates were found at lenders that charged higher interest rates, and that “the likelihood of a subprime auto loan becoming at least 60 days delinquent within three years is approximately 15 percent for bank borrowers and between 25 percent and 40 percent for finance company and buy-here-pay-here borrowers.”
However, the report presented statistical analysis that called into question whether differences in default rates fully explained the average differences in interest rates across subprime lender types. As an example, an average borrower with a 560 credit score or higher would have the same default risk whether the borrower obtained a loan from a bank or a small buy-here-pay-here lender, but the estimated interest rate would be nine percent with a bank loan versus 13 percent from a small buy-here-pay-here lender. The report noted that there are other variables, not observed in the data collected, that may explain differences in interest rates charged by different types of auto lenders, such as down payments, vehicle values, variations in borrowers’ access to information, borrowers’ financial sophistication, and variations within lenders’ business practices and incentives.
On September 23, the SEC filed a complaint against two former principals of a subprime automobile finance company for allegedly misleading investors about certain subprime auto loans. According to the SEC, the defendants made false and misleading statements and engaged in deceptive conduct concerning the company’s servicing practices in connection with a $100 million offering backed by a pool of subprime auto loans. The SEC alleged that the defendants took measures to artificially inflate the value of the collateral underlying the offering, such as by (i) including poorly-performing and delinquent loans that were disguised to appear to be performing better than they really were; (ii) applying “fake borrower payments” to delinquent loans; and (iii) extending terms on delinquent loans without contacting the borrower to disguise how far behind the borrowers were on payments. Because of these improper practices, the SEC claimed that servicing and performance information provided by the company to investors at the time of the offering and later on was false. The complaint charges the defendants with violations of the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934, and seeks permanent injunctions, officer and director bars, disgorgement with prejudgment interest, and civil penalties.
On October 17, Nevada Attorney General (AG) Catherine Cortez Masto announced that she had finalized an agreement with a financial institution that requires the financial institution to pay $11.5 million, without admitting fault, to resolve the AG’s investigation into the financial institution’s role in purchasing and securitization of subprime, Alt-A, and payment option adjustable rate mortgages. The investigation focused on whether certain lenders had deceived borrowers about the actual interest rate and payments on their loans, and had originated loans with multiple risk features that led to approval of loans without proper consideration of the borrowers’ ability to repay. The investigation also examined the extent to which the financial institution was aware of the lenders’ allegedly deceptive practices when it bought the loans, and whether the financial institution facilitated these lending practices by financing and purchasing such loans. In addition to the monetary penalty, the agreement stipulates that the financial institution will: (i) only finance, purchase, or securitize subprime mortgage loans in Nevada if it has engaged in a review of such loans and determined that the loans comply with the Nevada Deceptive Trade Practices Act and (ii) not securitize loans where upon review it has reason to believe that the lender has not adequately disclosed to the borrowers the existence of an initial teaser rate, the potential for negative amortization on a loan, the maximum adjusted interest rate or payments, and the potential for payment shock if payments increase after a loan reset or recast.
On August 30, the New York Department of Financial Services extended through September 30, 2013 a temporary order directing New York lenders to disregard the mortgage insurance premium changes effectuated by HUD Mortgagee Letter 2013-04 when calculating APR and fully-indexed rates for purposes of determining whether a loan is a “subprime home loan” under the New York Banking Law.
New York Financial Regulator Issues Guidance on Determination of Subprime Home Loans Under State Law
On July 3, the New York Department of Financial Services (DFS) sent a letter to regulated institutions and issued a temporary order relating to the determination of thresholds for “subprime home loans” under Section 6-m of the New York Banking Law. Due to recent increases in interest rates, many lenders who utilize a loan’s closing date as the time period for determining the “fully indexed rate” feared that they may be originating loans that meet the definition of subprime home loans under Section 6-m. The letter reminds lenders that in 2009, DFS amended Section 6-m of the Banking Law to instruct lenders to use the date that they provide good faith estimates to borrowers as the date for calculating the “fully indexed rate.” The letter also states that the DFS believes that calculating the “fully indexed rate” properly should allay many lenders fears that they may be triggering Section 6-m. Relatedly, recent changes to the calculation of Mortgage Insurance Premiums mandated by the FHA in Mortgagee Letter 2013-04 has increased the annual percentage rate on subject loans and is causing them to fall under Section 6-m’s definition of subprime home loan. To address the issue, the DFS issued a temporary order that, for 60 days from the date of the order, directs lenders not to use the MIP changes effectuated by FHA when calculating the APR and fully indexed rates for purposes of Section 6-m.
On March 21, the Court of Appeals of Ohio, Eighth Appellate District, affirmed a trial court’s dismissal of a suit by the city of Cleveland, which sought damages from several financial institutions involved in the creation of mortgage-backed securities using subprime mortgages from Cleveland, Ohio, real estate. Cleveland v. JP Morgan Chase Bank, N.A., No. 98656, 2013 WL 1183332 (Oh. Ct. App. Mar. 21, 2013). The City alleged that the institutions engaged in a practice of encouraging subprime lending in order to package mortgages together and sell the MBS to investors, and that these practices caused a foreclosure crisis in Cleveland that damaged the City and created a public nuisance. The City also brought an Ohio Corrupt Practices Act (OCPA) cause of action alleging that one institution systematically filed false or misleading paperwork in foreclosure cases. On appeal, the court held that the causal connection between the securitizing institutions and the foreclosure crisis is too far removed, and, even under the most lenient of pleading requirements, the City’s complaint fails to state a valid claim under public nuisance or the OCPA.
On October 30, the U.S. District Court of the Northern District of California dismissed, without prejudice, claims brought by two borrowers alleging that their mortgage lender engaged in fraudulent loan practices which violated RICO. The court held that the claims were time-barred and that the complaint failed to allege facts about predicate acts and a pattern of activity necessary to sustain a civil RICO claim. Cabrera v. Countrywide Fin., No. 11-4869, 2012 WL 5372116 (N.D. Cal. Oct. 30, 2012). The court rejected the borrowers’ arguments that (i) the statute of limitations began to run not from the date they entered into their adjustable rate mortgage, but from the date the rate adjusted, and (ii) equitable tolling should apply because the borrowers’ could not have discovered their adjusted rate absent a forensic loan audit they obtained years into the contract. With regard to equitable tolling, the court held that the plain terms of the mortgage provide information about the rate at issue, which could have been uncovered by “a reasonably diligent investigation of the loan documents.” The court similarly dismissed the borrowers’ claims that the lender discriminated against minority borrowers in violation of the ECOA, as time-barred. It also held that the borrowers, who are Hispanic, failed to state a claim under ECOA in that, although they offered statistical evidence that Hispanics were given less favorable loans than white borrowers with the same risk characteristics, they failed to allege that they themselves qualified for better loans. The borrowers’ claim of unfair business practices under the state’s unfair competition law survived. The court held that the borrowers pled facts sufficient to support their claim that the lender’s effort to initiate a foreclosure while a loan modification was pending violated public policy reflected in the California Homeowner Bill of Rights, even though the specific provision of that statute that prohibits such practices was not codified until after the foreclosure occurred.
ACLU Fair Lending Case Against Mortgage Securitizer Highlights New Fair Lending Litigation Risk; Fair Lending Litigation Against Lenders Continues
On October 15, the ACLU filed a putative class action suit on behalf of a group of private citizens against a financial institution alleged to have financed and purchased subprime mortgage loans to be included in mortgage backed securities. The complaint alleges that the institution implemented policies and procedures that supported the market for subprime loans in the Detroit area so that it could purchase, pool, and securitize those loans. The plaintiffs claim those policies violated the Fair Housing Act (FHA) and the Equal Credit Opportunity Act (ECOA) because they disproportionately impacted minority borrowers who were more likely to receive subprime loans, putting those borrowers at higher risk of default and foreclosure. The suit seeks injunctive relief, including a court appointed monitor to ensure compliance with any court order or decree, as well as unspecified monetary damages. The National Consumer Law Center, which developed the case with the ACLU, reportedly is investigating similar activity by other mortgage securitizers, suggesting additional suits could be filed. The ACLU also released a report on the fair lending aspects of mortgage securitization and called for, among other things, DOJ and HUD to expand their Fair Housing Testing Program, and for Congress to increase penalties for FHA and ECOA violations and provide additional funding for DOJ/HUD fair lending enforcement.
On October 18, three Georgia counties filed suit on behalf of their communities and certain residents against a financial institution the counties allege targets FHA-protected minority borrowers with “predatory high cost, subprime, ALT-A and conforming mortgages without considering the borrowers’ ability to repay such loans.” The complaint claims that the lender’s practices caused and continue to cause minority borrowers to be more at risk of default and foreclosure than similarly situated white borrowers, and, as such, constitute a pattern or practice of discriminatory lending and reverse redlining in violation of the FHA. The counties are seeking injunctive relief and unspecified compensatory and punitive damages.
BuckleySandler’s Fair and Responsible Financial Services Team has extensive experience litigating fair lending cases and assisting financial institutions seeking to manage fair lending risk. For a review of fair lending red flags for banks and strategies for addressing them, see our recent article.
Federal Court Dismisses Fannie Mae Shareholders' Subprime Suit Against Underwriters, Allows Claims to Proceed Against Fannie Mae, Officers
On August 30, the U.S. District Court for the Southern District of New York ruled on multiple motions to dismiss filed in four consolidated cases pending against Fannie Mae, certain former officers, and several banks, related to Fannie Mae’s exposure to certain risky mortgages. In re Fannie Mae 2008 Secs. Litig., No. 09-2013, 2012 WL 3758537 (S.D.N.Y. Aug. 30, 2012). The main class of shareholders alleges that Fannie Mae and certain of its former officers violated federal securities laws by failing to adequately disclose the company’s exposure to subprime and Alt-A mortgages. Separately, institutional investors brought their own federal securities claims, as well as state statutory and common law fraud and negligence claims against Fannie Mae, certain officers, and certain of its underwriters related to the same alleged misrepresentations. Many of the same allegations are contained in SEC enforcement actions pending against a number of the same individual defendants. In a single opinion, the court dismissed certain of the claims but allowed others to proceed. The court allowed to proceed the federal securities claims brought by the main class and two other plaintiffs against Fannie Mae and certain of its officers with regard to Fannie Mae’s subprime mortgage disclosures and risk management controls, but dismissed all state law claims, including those against Fannie Mae, certain officers, and certain underwriters. The court also dismissed in full a suit that one underwriter faced alone because the plaintiffs failed to present evidence sufficient to show the underwriter intentionally provided investors allegedly false information it received from Fannie Mae.
On April 24, the U.S. Securities and Exchange Commission announced that it filed and simultaneously settled a suit alleging that an H&R Block subsidiary engaged in the fraudulent sale of subprime residential mortgage-backed securities (RMBS). The complaint alleges that during a short period at the beginning of 2007, Option One Mortgage, now known as Sand Canyon Corporation, sponsored over $4 billion of RMBS and represented to investors that it would repurchase or replace any pooled mortgage for which there was a breach of a representation or warranty. The SEC alleges that at the time it sponsored the RMBS at issue, Option One was experiencing financial difficulties related to the broader decline of the subprime mortgage market and faced substantial margin calls from its creditors. As such, Option Ones condition would have prevented the company from meeting its obligations to repurchase faulty loans. Further, according to the SEC, (i) Option One failed to disclosure that it was reliant on a line of credit from its parent, (ii) H&R Block was under no obligation to provide that funding, and (iii) Option Ones losses threatened H&R Blocks credit rating at a time when the parent was negotiating the sale of Option One. The SEC did not immediately make the settlement available, but it announced that without admitting or denying the allegations Option One agreed to (i) disgorge over $14 million, (ii) pay prejudgment interest of nearly $4 million, and (iii) pay a $10 million penalty. The SEC touts this latest action as part of financial crisis-related enforcement efforts that collectively have obtained more than $1.98 billion in penalties, disgorgement, and other monetary relief. Though the investigation likely precedes the state-federal Residential Mortgage-Backed Securities Working Group and appears to have been conducted by the SEC alone, the SEC notes its role as co-chair of that group, which seeks to leverage resources to pursue alleged misconduct in the RMBS market. This settlement, comments from the SEC, and the still developing efforts of the RMBS Working Group indicate that institutions should expect continued aggressive pursuit of alleged wrongdoing in the RMBS market. This was made clear by comments from Kenneth Lench, Chief of the SEC Division of Enforcements Structured and New Products Unit that the SEC intends to "take action against those who fail to disclose or downplay important facts that make an investment riskier, even if those risks do not materialize. We remain committed to uncovering misconduct involving complex financial instruments including RMBS. Also of note, the SEC has shown a continued willingness to employ so-called "no-admit" settlements, notwithstanding a challenge to that long-standing practice issued last year by Judge Rakoff of the Southern District of New York. Last month, the U.S. Court of Appeals for the Second Circuit issued an interim decision staying Judge Rakoff's order that denied a significant no-admit settlement and required the SEC to pursue its claims at trial. In doing so, the circuit court stated that it had a significant problem with the district court's decision to dictate policy to an executive administrative agency. Instead, the Second Circuit stated, courts should defer to the agency's judgment on discretionary policy. A final decision on the district court's ruling is still pending with the Second Circuit.
- Sherry-Maria Safchuk to discuss “Hot topics outside of CA” at the California Mortgage Bankers Association Conference
- Jon David D. Langlois to discuss “LIBOR Transition: How will the pieces come together in time?” at the American Bar Association In the Know-Live webinar
- Dissecting the annual federal agency fair lending summit
- Jonice Gray Tucker to discuss “Regulators always ring twice: Responding to a government request” at ALM Legalweek