Legislation Needs to be Carefully Crafted

One of the last acts of Governor Elliot Spitzer, prior to his resignation, was to proposed legislation to address the subprime mortgage crisis in New York. The New York Association of Mortgage Brokers asked Don Romano to draft their response to the proposal. This is the text of the response.

The New York Association of Mortgage Brokers comments to Program Bill #44

The New York Association of Mortgage Brokers (NYAMB) is the only trade association in New York State that represents the mortgage broker community. It was founded in 1986 and is the State Affiliate of the National Association of Mortgage Brokers (NAMB).

We understand the desire to address the current mortgage crisis and to take whatever action necessary to prevent this situation from ever happening again. We have worked closely over the years with State government as well as the New York State Banking Department, drafting laws and regulations regarding the mortgage industry.

We appreciate the opportunity to comment on this proposed legislation. We are focusing our comments only on the sections that directly impact our business. This does not mean we are supportive of the other sections, it simply means that we are not in the position to comment on areas of the mortgage business that we are not directly involved in.

In Subdivision 1 of section 6-1 of the banking law, paragraph (f) we are creating a new category of mortgage, the “Non-conventional home loan”. The intent is to separate sub-prime mortgages from prime mortgages through the use of a rate and/or fee trigger, modeling it after the existing high-cost mortgage trigger approach. The trigger model, as used to define high-cost mortgages, works reasonably well. It’s not a perfect solution but works adequately for high cost loans. The cost for a high-cost mortgage consists of 2 components, the market price for mortgage money and the addition cost the lender is imposing to address the weaker attributes of the file (risk based pricing). The interest rate trigger which would make a first lien a high-cost loan is 8 percent over the treasury yield. There is no doubt that the additional cost, based on risk based pricing, represents the larger percentage of this spread.

By using the same approach to define a “Non-conventional home loan” we run into an unforeseen consequence. By taking the yield on Treasury Bills and adding 3 percent to create the trigger, market pricing for mortgage money carries enough weight to bring many prime loans into the “Non-conventional home loan” category.

For example, let’s look at the yield on 30 year T-Bills as published on March 10, 2008. That rate was 4.53%. If we add 3 percent to that we end up with a trigger point of 7.53%. The rate for an FHA mortgage on March 10, 2008 is 7.0%, putting us within 0.53% of being a “Non-conventional home loan”. A FNMA conforming rate is at 6.50% but if a “my community” product is used the rate is increased to 6.75%. On March 10, 2008 none of these loans would trigger, but after seeing what has happened in the bond market since August 2007, would anyone be truly surprised if mortgage rates moved up more? If this law was already passed and mortgage rates continued to trend upward, we could be facing FHA and FNMA conforming loans that would be categorized as a “Non-conventional home loan”.

If this law was already in place, all mortgages between $417,000 and $750,000 closed since August 2007, would be “Non-conventional home loans”, since the jumbo fixed rate mortgage has been over 7.53% every day. Do we see the need to protect high net-worth individuals from themselves? This is an immediate unintended consequence of the bill. Any lender that elects to write non-conventional home loans to high net-worth individuals, would be exposed to "predatory borrowers". Borrowers who have the knowledge and the deep pockets to utilize those same consumer protections meant for the non-conventional borrower, would be able to relieve themselves of their financial obligations to their lender, whenever they felt that they would benefit financially.

This would be reason enough to make the prudent business decision and not be involved in originating non-conventional home loans.

We predict that with the passage of the Bill with this language, lenders will immediately stop writing mortgages between $417,000 and $750,000 until the secondary market sets the yield on jumbo mortgages to some percentage less than 7.53%. If the market for mortgage-backed securities continues to worsen, we could see lenders halting all mortgage originations in New York State. This cannot be what the author of this Bill intended.

We need to develop a “Non-conventional home loan” test that truly captures the mortgage that was the real intent of this Bill.

The NYAMB would like to propose two suggestions that can be used as a starting point to address this issue. Current events in the financial marketplace have shown that the spread between conforming loan size pricing and jumbo loans can vary greatly. No longer can we assume that jumbo pricing will consistently be 0.25% to 0.50% higher than a conforming mortgage. With this in mind, our first suggestion is to use a different rate-based trigger point for conforming and jumbo mortgages.

We feel it would be reasonable to use a 1 percent higher trigger point for jumbo mortgages. This will allow the secondary market pricing to respond to investor demand without capturing the mortgages that should not be captured, into the “Non-conventional” category . A closer investigation into the abuses in the sub-prime market over the last several years will show that the vast majority of these loans fall under the conforming loan limit.

Our second suggestion is to raise the rate trigger from 3 to 4 percent for conforming loan sizes. As we have illustrated in the above example, the 3 percent margin over T-Bills doesn’t allow for the secondary market to demand the higher yield on mortgage backed securities over T-Bills that is currently being used, without capturing prime loans in the “Non-conventional” category. In capturing prime loans, we draw attention away from the issue that “Non-conventional” home loans require special protection and at the same time we run the risk that lenders will become reluctant to conduct business in New York State. Reduced availability of mortgage money into our economy will cause additional damage to our housing market.

T-Bill rates are published in every major newspaper daily, making it readily accessible to the consumer. Unfortunately, as recent events have shown us, the spread between T-Bill interest rates and prime mortgages is erratic. An alternative to increasing the margin for the rate trigger that we considered, was to use the FNMA mandatory 60-day delivery rate, instead of the T-Bill. This way we would be using a base rate that is representative of prime mortgages. Our conclusion was that the superior distribution of the T-Bill was too valuable an asset to the consumer. This is why we have recommended the higher margin, as opposed to a different index rate.

The Bill proposes adding a new paragraph, (l). This paragraph confuses the definition of “Yield Spread Premium” and “Upselling”. The proposed definition of “Yield Spread Premium” reads’ “compensation that a mortgage broker receives from a lender for originating a home loan that is more costly than that for which the consumer qualifies, or that is based on, or varies with, the terms of the home loan.” Wholesale lenders, that are lenders dealing with mortgage brokers, recognize the cost benefits to themselves when originating mortgages in this manner. They routinely price their mortgages lower to a mortgage broker than they do to the public, that’s the reason the term “wholesale” is used in the definition. For example, a lender prices a mortgage directly to the consumer at 6.0% with 0 points and to the broker at 6.0% with a 1 point yield spread premium. The broker offers the product to the consumer at 6.0% with 0 points. The broker is being compensated 1 point for placing the mortgage but the consumer is paying the same regardless of which channel is chosen.

The term that is being defined here is “Upselling”. Going back to our example, the broker offers the mortgage to the consumer at 6.25% with 0 points. Here the broker has increased the interest rate in return for higher profits. This practice is what we want to address, not the concept of “Yield Spread Premium”. We also need to recognize that brokers, in designing the right mortgage for their clients, will at times take this additional point as a credit to the borrower to offset closing costs.

Our suggestion is to change the term “Yield Spread Premium” to “Upselling” in the proposed bill. Instead of banning “Yield Spread Premium” on “High cost” and “Non-conventional home loans” we suggest that any “Yield Spread Premium” generated due to “Upselling”, be credited back to the borrower. This still gives the broker the ability to use “Yield Spread Premium” to offset the borrower’s closing costs yet takes all potential economic gain to the broker out of the equation.

Section 590-b is an attempt to write a set of underwriting standards into State Law. We feel this is bad public policy. Underwriting standards are modified in the industry to reflect market conditions and needs. Once something is written into Law, it becomes inflexible. We suggest that restrictions regarding income documentation be done through regulation, not Law. This will afford the consumer protections that are needed today but allow for changes to meet markets needs in the future without needing to draft new legislation. We are all well aware of the time involved in reaching consensus on pending legislation and how rapidly the mortgage market can change. It is not in the best interests of New York residents to create a set of standards that cannot evolve with market conditions.

In paragraph (b) of the same section we are defining the standard of practice for which mortgage brokers are to be held to. The NYAMB has been promoting ethical standards for our members to follow since our inception. We are happy to see that the author of this Legislation is putting into Law what we’ve been promoting to the brokerage industry for decades.

We hope that you understand the basis of our concerns and we look forward to working with you.