FRB: Federal Reserve Bank of San Francisco - June 16, 2006 - Transcript

Building Sustainable Homeownership:
Responsible Lending and Informed Consumer Choice

Federal Reserve Bank of San Francisco
101 Market Street, San Francisco, California 94105
June 16, 2006

Agenda | Transcript

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Transcript	Line	Page
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BUILDING SUSTAINABLE HOMEOWNERSHIP:	6	1
RESPONSIBLE LENDING AND INFORMED CONSUMER CHOICE	7	1
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PUBLIC HEARING ON THE HOME EQUITY LENDING MARKET	10	1
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FEDERAL RESERVE BANK OF SAN FRANCISCO	13	1
101 Market Street, San Francisco, California	14	1
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Friday, June 16, 2006	16	1
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REPORTED BY: LAURA A. REDING, CSR NO. 9711	25	1
Friday, June 16, 2006, 8:45 a.m.	1	2
	2	2
MR. OLSON: Good morning. I'm Mark Olson, Federal	3	2
Reserve Board of Governors. We are delighted this is the	4	2
third in a series of hearings that we have had on HOEPA.	5	2
It's a repeat of a series of hearings that were held about	6	2
six years ago that led to at that point implementation of the	7	2
HOEPA regs and others.	8	2
Let me -- let me first of all just outline the day	9	2
and what the expectations are. We have three panels. Heavy	10	2
focus on nontraditional products in the mortgage area. By	11	2
design, we have -- we use the San Francisco, essentially the	12	2
west coast, hearing to focus on that.	13	2
Much of the rest of the country seems to think that	14	2
the nontraditional products are relatively new. As we will	15	2
hear today, they're not new products on the west coast, and	16	2
so your experience here is -- I think will be very valuable	17	2
for our overall understanding of the -- of the role of the	18	2
new products in the marketplace, both the positives and some	19	2
of the issues that are created.	20	2
The first panel will go until 10:30. We will then	21	2
take a break and have the second panel that will go until	22	2
12:30. And then break for lunch and then an afternoon panel.	23	2
Very importantly, at about 3:00, hopefully precisely	24	2
3:00, we will have what we call an open mic time. And	25	2
that's -- at that time it will be an opportunity for anybody	1	3
who would like to speak to speak.	2	3
And if you would -- if you would care to avail	3	3
yourself of that opportunity, there will be a sign-up sheet.	4	3
And that sign-up sheet, it will be -- where will they find	5	3
the sign-up?	6	3
MS. REID: Outside right now but --	7	3
MR. OLSON: Just out the door right here. So make	8	3
sure you've signed up sometime between now and then if you	9	3
would care to avail yourself.	10	3
For the panelists, there will be a -- each of you	11	3
will be asked if you could summarize your comments in five	12	3
minutes. We enforce it.	13	3
MS. REID: I'm your timekeeper. I'll hold up this	14	3
"one minute left."	15	3
MR. OLSON: And what we've discovered -- we didn't	16	3
discover it. It's been coming up. So much of the value of	17	3
these hearings comes out of the dialogue, in the discussion.	18	3
So I think -- and then we will -- a summary for five minutes	19	3
and then we will move on from there.	20	3
Just to introduce my fellow panelists, Leonard	21	3
Chanin, Sandy Braunstein, my colleagues from Washington,	22	3
D.C., and Jack Richards from the San Francisco Fed.	23	3
There are three areas of focus for these hearings.	24	3
Number one has been, of course, the impact of predatory	25	3
lending and the effectiveness of the HOEPA regs. Second has	1	4
been a look at this new phenomenon called the nontraditional	2	4
mortgage products.	3	4
And that -- in the intervening six years, some very	4	4
remarkable things have happened in the marketplace. And what	5	4
has happened essentially is that we have seen through a	6	4
combination of technology and secondary market appetite and a	7	4
highly liquid market, there is a -- whereas the secondary	8	4
market had for many years focused primarily on the conforming	9	4
product, the Fannie and Freddie conforming product, the fact	10	4
that that secondary market now has an appetite for the	11	4
nontraditional product has had a number of implications, both	12	4
good -- largely good frankly because of the -- because it has	13	4
provided a liquid source for more mortgage product, there are	14	4
more people who have access to mortgage money than ever	15	4
before, and a wider variety of a range of products.	16	4
The difficulty comes because of the fact that	17	4
sometimes there are products where we -- that we clearly have	18	4
recognized, where people are put into products that they	19	4
probably shouldn't be, either -- for whatever reason. And	20	4
that's part of what we are -- we're going to probe today.	21	4
The extent to which those products are, in fact -- how	22	4
they're marketed, how they're used, and the experience that	23	4
we've had with them.	24	4
It is hoped -- the expectation is that there will be	25	4
four objectives or four goals that will come out of these	1	5
hearings: Number one, an evaluation of the effectiveness of	2	5
the HOEPA regs; number two, there is -- we will be at some	3	5
point looking to review a Reg Z, and some of the input from	4	5
here will be factored into that review.	5	5
Point number three, we at the Federal Reserve think	6	5
it's part of our responsibility to focus on consumer literacy	7	5
and financial education. That -- and what we are learning in	8	5
these processes will help us provide direction for that	9	5
effort.	10	5
And number four, that is also a responsibility of	11	5
the Fed -- one of the responsibilities that we assume for	12	5
ourselves is to look for opportunities for further research.	13	5
And so those are the four that will hopefully come	14	5
from here.	15	5
In an environment like this, the appropriate use of	16	5
financial products is a shared responsibility. Certainly the	17	5
primary responsibility is for the consumer.	18	5
A consumer in a free society, in a free market,	19	5
there's an underlying fundamental presumption that the	20	5
consumer is responsible for his or her choices and actions.	21	5
However, it is a shared responsibility, and the second part	22	5
of that sharing is with the originator, the initiator of	23	5
those mortgage products.	24	5
There is no question of what -- there's an	25	5
extraordinary knowledge asymmetry, between the knowledge that	1	6
an individual will have when they are taking, especially	2	6
sometimes for the first time, a mortgage product and to try	3	6
to evaluate them in the context of a wide range of products	4	6
that are available.	5	6
I have said before -- and let me say it again	6	6
because it brings it home. Some of you know my background is	7	6
banking. I spent 16 years in the banking industry. I never	8	6
was primarily a mortgage lender, but during those 16 years, I	9	6
was involved in the closing of a lot of -- of a large	10	6
number -- I'm thinking it's roughly a hundred -- mortgage	11	6
loans that I was involved in the closing of.	12	6
And yet every time I went to a closing of my own	13	6
loan, I felt somewhat at a disadvantage in terms of my	14	6
understanding. So I can imagine what somebody that is	15	6
approaching that experience for the first time must feel.	16	6
So there is that clear shared responsibility, the	17	6
consumer and the lender.	18	6
There is a third group that broadly defined that	19	6
has -- we are learning more all the time can make a real	20	6
impact, and that's the community and consumer groups.	21	6
Financial institutions, not intentionally but by their	22	6
nature, I think do not get real close to the broad community,	23	6
especially the low-mod and sometimes the minority	24	6
communities.	25	6
The financial institutions don't have that immediate	1	7
connection that some of the consumer groups do. And we found	2	7
the consumer groups that have that access, that have that	3	7
credibility can bring an education, can bring an	4	7
understanding, but can also bring to the marketplace -- can	5	7
help focus what some of those important issues are. And	6	7
we've heard from some of those groups and we will continue to	7	7
hear from some of those groups.	8	7
Fourth group is the regulators. We are not number	9	7
one. We're not even number two. We shouldn't be. In a	10	7
sense, we're the referees. And it is our responsibility to	11	7
look at the extent to which -- first of all, it is our	12	7
responsibility to implement the laws that congress gives us,	13	7
and most of what we do is implementing laws that congress	14	7
gives us.	15	7
But it's also our responsibility to look at the	16	7
marketplace to see that the -- that the activity in the	17	7
marketplace is consistent with the expectation of the	18	7
existing laws and the risk taking and appropriate behavior of	19	7
the institutions that we regulate.	20	7
So that's our opener. We have four people on the	21	7
panel this morning. I think we will go in --	22	7
counterclockwise, Paul, starting with you.	23	7
So if each of you would introduce yourselves, your	24	7
organization, and then give us a brief summary and then we	25	7
will go -- we'll leave us plenty of time for questions.	1	8
So Paul.	2	8
MR. LEONARD: Thank you.	3	8
MR. OLSON: Anything else I missed? Anything else	4	8
that we should have --	5	8
MS. BRAUNSTEIN: I don't think so.	6	8
MR. OLSON: We didn't sing "I Left My Heart in San	7	8
Francisco," but we're planning to do that at 3:00 when we're	8	8
getting ready to leave. It's a beautiful city. It is	9	8
just -- it is just -- we're reminded when we come here what a	10	8
great place this is.	11	8
Paul.	12	8
MR. LEONARD: Governor Olson, I hope you meant at	13	8
4:00, after the -- after the open mic period. Right?	14	8
MR. OLSON: That was -- that must have been Freudian	15	8
on my part.	16	8
MR. LEONARD: Thank you for inviting me to testify	17	8
here this morning. My name is Paul Leonard. I'm the	18	8
California director of the Center for Responsible Lending.	19	8
The Center for Responsible Lending is a national	20	8
nonprofit policy and research organization focusing on	21	8
predatory lending policy and issues. The organization is	22	8
based in Durham, North Carolina. We also have offices in	23	8
Washington, D.C. and have recently opened our California	24	8
office here in Oakland, California.	25	8
I want to say that these -- I think these hearings	1	9
come at an opportune time, as the subprime mortgage market	2	9
continues to grow and evolve at breakneck speed. Subprime	3	9
lending totaled more than $600 billion in 2005, more than	4	9
doubling in total size just since 2003. And adjustable rate	5	9
ARMs, both -- and interest only ARMs and option varieties now	6	9
account for well over half of the subprime market.	7	9
Having been called to testify at the last minute and	8	9
replacing a panel member who got sick, and having limited	9	9
time to prepare, what I thought I would do, which I think	10	9
will be enlightening, was to walk through this rate sheet	11	9
which we pulled -- I actually pulled off the web this	12	9
morning. It's a rate sheet for a standard 2/28 ARM mortgage	13	9
that's offered by the New Century Mortgage Corporation.	14	9
I've provided you all with copies. And I think that	15	9
the rate sheet, if you'll bear with me quickly, sort of	16	9
highlights a few of the central problems associated with	17	9
adjustable rate and other nontraditional loans.	18	9
The left half of the page you'll see has a matrix	19	9
for fully documented loans. The right half of the page has a	20	9
matrix for stated income loans with you'll notice a 50 to 100	21	9
basis point premium for the -- for the option of having a	22	9
stated income loan, which will speed up the loan processing	23	9
period but has also been a source of rising abuse I think, at	24	9
least from what I've heard in the community. The far right	25	9
column you'll see lists a series of adjustments to rate that	1	10
might apply to any loan.	2	10
These rate sheets are updated every day and provided	3	10
to brokers who are out there working in the marketplace.	4	10
So I wanted to just highlight one example. Assume	5	10
we have a B credit borrower with a FICO score between 600 and	6	10
620, borrowing with an 80 percent loan-to-value and full	7	10
documentation. The PAR rate for this borrower, which I've	8	10
highlighted, would be 7.65 percent.	9	10
If you look over on the right-hand side of the page,	10	10
however, you can see that a broker can earn an additional two	11	10
points, or $6,000, for that -- for closing that loan in a	12	10
yield spread premium if they're able to sell the loan at 125	13	10
basis points above PAR. This would bring the initial rate	14	10
for that loan in at 8.9 percent.	15	10
If our borrower is taking out a $300,000 mortgage,	16	10
initial payments of PAR would be $2,130 per month. With a	17	10
broker who is maximizing their yield spread received from the	18	10
lender, the initial monthly payment would jump to about	19	10
$2,400. In today's market, most subprime lenders are	20	10
underwriting these loans only to cover the initial payment of	21	10
the loan. So it would be for this $2,400.	22	10
There are two key issues I think that I wanted to	23	10
highlight. First was the yield spread premiums and the	24	10
second really important one is the payment shock component of	25	10
these loans.	1	11
After two years -- the rates are fixed at these	2	11
rates for the first two years and then are reset-based on a	3	11
LIBOR index and the lender specified margin. Today LIBOR	4	11
rates are 5.4 percent. And you can see in the left-hand	5	11
column the margin for B credit borrowers is 6.7 percent. So	6	11
the effective rate of two years would rise to 12.1 percent.	7	11
In that case, it would be a $700 increase. A 30 percent	8	11
increase in the monthly payment after just two years in the	9	11
loan.	10	11
Now, not many families that I know of are going to	11	11
be able to afford a 30 percent increase in their mortgage	12	11
after two years, especially when the loan is underwritten	13	11
only for the initial payment. If the rates rise by two	14	11
percentage points, the payment shock will be -- the payment	15	11
shock will be a 50 percent increase in their payment.	16	11
The result, many borrowers will be in mortgages that	17	11
they may ultimately not be able to afford. In an	18	11
appreciating market, they may be able to refinance but will	19	11
clearly lose some equity in covering their closing costs. In	20	11
a cooling market, we expect that there are going to be	21	11
substantial -- substantial folks who fall into the	22	11
foreclosure process.	23	11
This isn't just a hypothetical issue. These loans	24	11
were the standard subprime mortgage in 2004 and 2005. And	25	11
since that time, we've seen a 400 basis point increase in the	1	12
interest rates.	2	12
MR. OLSON: Paul, can you just wrap up?	3	12
MR. LEONARD: Sure.	4	12
MR. OLSON: And then we'll move on.	5	12
MR. LEONARD: Sure. Let me offer a few suggestions.	6	12
MR. OLSON: No, not a few. Or else just give us the	7	12
topics and then we'll come back to them.	8	12
MR. LEONARD: Recommendations for actions:	9	12
Strengthening the guidance and making it mandatory and in	10	12
using FDC Act authority to apply that, the same standards to	11	12
non-depository lenders.	12	12
Second, encouraging congress to opt a suitability	13	12
standard for borrowers to meet the needs in their -- in this	14	12
increasingly complex marketplace which you just referred to.	15	12
And third, we need to fix the incentives that don't	16	12
reward brokers and the system for increasing the rates that	17	12
subprime borrowers face.	18	12
MR. OLSON: Paul, thank you very much.	19	12
Kevin, you're up next.	20	12
MR. STEIN: Thanks. Governor Olson, members of the	21	12
Federal Reserve staff, I want to thank you for coming to San	22	12
Francisco to hold these important hearings and for giving us	23	12
this opportunity to comment.	24	12
My name is Kevin Stein. I'm the associate director	25	12
of the California Reinvestment Coalition. We're a statewide	1	13
advocacy coalition of over 240 nonprofits and public agencies	2	13
that work to promote access to credit and fight predatory	3	13
financial practices in underserved neighborhoods throughout	4	13
California.	5	13
The main massage I want to convey today is that	6	13
we're seeing big problems in the mortgage market in	7	13
California, and we urge the Fed to act to protect home buyers	8	13
and homeowners in the state.	9	13
We are hearing more and more atrocious stories of	10	13
abuse. Many groups and individuals have contacted us in	11	13
anticipation of these hearings, and I hope several of them	12	13
will be able to come testify during the open mic session	13	13
today so that you can hear directly from them.	14	13
Nontraditional loans are being sold aggressively in	15	13
California, and this is contributing to the -- to the chaos	16	13
that we're experiencing. Interest only option ARM and stated	17	13
income loans are being sold to borrowers who cannot afford	18	13
homeownership and who did not understand their loan terms.	19	13
With hundreds of billions of dollars in loans	20	13
scheduled to reset in the next few years, we know that many	21	13
will not be able to make their mortgage payments. As	22	13
payments dramatically increase, these borrowers will have a	23	13
difficult time refinancing into new home loans and those	24	13
that -- those who could refinance will be facing steep	25	13
prepayment penalties, which in California translates into	1	14
thousands of dollars.	2	14
Stated income loans we feel are a recipe for abuse,	3	14
where brokers often inflate incomes of unsuspecting	4	14
borrowers.	5	14
Another problem we see is the persistence of loan	6	14
pricing disparities. In a study that we did based on 2004	7	14
HMDA data, amongst many findings of disparity, we note that	8	14
minority neighborhoods throughout the state were four times	9	14
as likely to get higher cost home purchase loans. And we	10	14
estimate that people of color in California are paying	11	14
millions more per month as a result of higher cost mortgage	12	14
loans. This dynamic obviously means that many families in	13	14
the state are facing lost equity and have less resources to	14	14
support their families.	15	14
We are already witnessing an increase in delinquency	16	14
and foreclosure activity in the state as a result of	17	14
nontraditional mortgage products. This is alarming as	18	14
interest rates are expected to rise and as borrowers of	19	14
nontraditional loans face looming rate increases and resets.	20	14
As far as solutions are concerned, we propose six	21	14
that we hope the Fed would implement to mitigate some of	22	14
these problems.	23	14
One, expand the HOEPA protections by including yield	24	14
spread premiums and prepayment penalties in the points and	25	14
fees calculations. We'd also urge that you lower the HOEPA	1	15
threshold so that the rate trigger is set at six points above	2	15
treasury and the points and fee trigger set at five percent.	3	15
The existing thresholds are unreasonable given the high	4	15
housing costs in California.	5	15
Secondly, we'd urge you to promote informed consumer	6	15
choice by requiring key loan documents to be written in the	7	15
same language as the language in which the negotiation is	8	15
conducted. This is a big problem in California where	9	15
contracts are often negotiated in one language but the loan	10	15
documents are all in English and often with less favorable	11	15
terms than the consumer understood.	12	15
We have a precedent in California Civil Code Section	13	15
1632 which we believe could be the foundation for a broader	14	15
and more encompassing federal requirement.	15	15
Thirdly, we urge the expansion of HMDA reporting	16	15
requirements so that HMDA can better help us identify	17	15
discriminatory lending practices as is its stated purpose.	18	15
And I know the governor has spoken to this issue.	19	15
Amongst other things, we'd urge the inclusion of	20	15
credit score information, the age of the borrower, and,	21	15
pertinent to this discussion, whether a loan is, in fact, a	22	15
nontraditional loan.	23	15
Fourth, we urge the development of due diligence	24	15
standards for the secondary market. We're currently	25	15
conducting research on the secondary market for subprime	1	16
securities in conjunction with Raphael Bostick, the director	2	16
of the Master of the Real Estate Development Program at the	3	16
University of Southern California.	4	16
To date, we've reviewed 99 subprime securitized	5	16
issues from 2005, and we can see the prevalence of	6	16
nontraditional loan products and other problematic loan	7	16
terms. CRC believes the secondary market has no regard for	8	16
whether it is financing predatory loans. Strengthening HOEPA	9	16
will help and expand importance of liability, but broader	10	16
standards are necessary.	11	16
Fifth, we urge the expansion of CRA obligations.	12	16
The Federal Reserve in its analysis that accompanied the	13	16
release of the 2004 HMDA data noted that there were pricing	14	16
disparities that could not be fully explained, and at the	15	16
same time noted that these disparities were lesser within	16	16
banks' CRA assessment areas.	17	16
And we think that's an important finding. At the	18	16
same time the banking regulators continue to hold on to an	19	16
outdated and overly narrow definition of what constitutes a	20	16
bank CRA assessment area.	21	16
MR. OLSON: We'll ask you to stop there and we'll --	22	16
those are important and we'll have -- we'll want to have a	23	16
full discussion on each of those. But thank you.	24	16
Rick.	25	16
MR. LIEBER: Good morning. I'm Rick Lieber, EVP of	1	17
IndyMac, responsible for managing our company's mortgage	2	17
products. And I thank you for the opportunity to share our	3	17
perspective on nontraditional mortgages. And I also thank	4	17
the Mortgage Bankers Association for asking IndyMac to	5	17
represent them on this very important subject.	6	17
For quick background, IndyMac is a $24 billion	7	17
institution. That makes us the largest in Los Angeles, the	8	17
ninth largest in the nation, and we're also the seventh	9	17
largest mortgage originator in the country.	10	17
For the opening remarks, which are tied to five	11	17
minutes, I'd like to make just three key points.	12	17
MR. OLSON: Some of them have gone to five minutes	13	17
and 15 seconds.	14	17
MR. LIEBER: I get an extra ten?	15	17
MR. OLSON: I just took ten seconds of yours, so you	16	17
can --	17	17
MR. LIEBER: Can I have 12 for that interruption?	18	17
First, we think the mortgage products have actually	19	17
typically lagged the industry in innovation and some of the	20	17
features and option ARMs that have existed in other consumer	21	17
products are actually better served in a mortgage product.	22	17
Second key point, we think that most mortgage	23	17
originators originate nontraditional mortgage loans,	24	17
including option ARMs, in a safe manner, a sound manner that	25	17
properly address layered risk. We think that solid	1	18
underwriting has brought about very prudent loan products	2	18
that have predictable performance, and we think this is born	3	18
out in the secondary market.	4	18
Thirdly, third point, we think some of the recent	5	18
innovations in option ARMs that have been offered by both	6	18
IndyMac and other major lenders actually further advance the	7	18
soundness of the products and their appropriateness for	8	18
consumers.	9	18
On the first point, option ARMs provide borrowers	10	18
with one very key benefit and that is flexibility in	11	18
payments. And this allows borrowers who have a reduction in	12	18
income or a sudden expense to be able to handle their	13	18
mortgage payments with much lower risk of default and,	14	18
therefore, much higher odds of not having any risk of losing	15	18
their homes.	16	18
And this is a feature of flexibility that's been	17	18
with -- that consumers have had access to for several years	18	18
with different consumer loan products.	19	18
We actually think it's more prudent for a borrower	20	18
to access these additional borrowings against an asset that	21	18
actually rises in value over time rather than assets that	22	18
don't have an ongoing value, such as a meal or a vacation	23	18
that might be on a credit card.	24	18
An additional component, interest on a mortgage is	25	18
deductible, whereas interest on some of the other consumer	1	19
credit generally is not.	2	19
The second key point, IndyMac and we believe	3	19
actually most national lenders do originate nontraditional	4	19
mortgages in a prudent manner. And a key to this is lending	5	19
with guidelines that guard against the potential for layered	6	19
risk and restrict the lending to borrowers who are, in fact,	7	19
in a position to handle that flexibility. An option ARM, for	8	19
instance, we only lend and most national lenders only lend to	9	19
prime quality borrowers who have a history of responsible use	10	19
of credit.	11	19
And additionally, loan-to-value ratios are typically	12	19
five percent lower on option ARMs than other products. In	13	19
fact, the average loan-to-value on an option ARM is	14	19
approximately 70 percent, and that would mean, with at least	15	19
our standard product, that the loan balance could grow only	16	19
to the point where your advance against value is 77 percent,	17	19
which still leaves a significant amount of equity.	18	19
And if you factor in just a reasonable amount of	19	19
home value appreciation, say three percent, over a three-year	20	19
period, which is the average life of a mortgage loan, there	21	19
actually is no loss of net equity.	22	19
The concept of addressing risk of one loan feature	23	19
being compensated with other guidelines applies to all of our	24	19
core products, the alternative A products. And in a recent	25	19
exam by the regulators on the regular scheduled exam, they	1	20
agreed with that premise and concluded that, in fact, our	2	20
reduced documentation loans, primarily stated income loans,	3	20
were, in fact, less risky than full documentation loans as a	4	20
result of those compensating factors.	5	20
We and I think most industry participants also work	6	20
very hard to make sure that borrowers understand the features	7	20
of the loans that they're taking out. We have a two-page	8	20
option ARM disclosure that in very plain English outlines the	9	20
features of the loans and we believe very clearly illustrates	10	20
the risk of a rising principal balance and the risk for a	11	20
potential significant increase in minimum payment.	12	20
This long history has proved to create a very strong	13	20
secondary market, which I believe supports the premise that	14	20
the products are predictable and reasonable.	15	20
And then last point on new products, we think recent	16	20
innovations with option ARMs have advanced the benefit to	17	20
consumers. For example, we recently released a flex pay	18	20
product that allows for fixed rate for up to five to seven	19	20
years, in addition to continuing to provide the payment	20	20
flexibility. We think -- we've also added features that	21	20
reduces the potential increase in the payment and in the --	22	20
an example, that can reduce the payment by up to a third.	23	20
The conclusion that I would like to make is that we	24	20
should make sure as we add different components to regulation	25	20
and different restrictions on innovative products we don't	1	21
forget the fact that many of this innovation does, in fact,	2	21
bring about additional benefits to the consumers and we don't	3	21
overact in a way that can stifle that benefit in the long	4	21
run.	5	21
I thank you again for the opportunity and I look	6	21
forward to questions.	7	21
MR. OLSON: My goodness, he didn't even need the	8	21
last 12 seconds. You finished right on time.	9	21
Well, we clearly are seeing the -- from the first	10	21
three where the focus will be on the advantages versus the	11	21
risks inherent in these products.	12	21
We'll hear from Bruce and then we'll go to some	13	21
questions.	14	21
Bruce Fuller.	15	21
MR. FULLER: Thank you, Governor Olson. I'm Bruce	16	21
Fuller. I work in the financial planning department for	17	21
World Savings.	18	21
World Savings is one of the largest financial	19	21
institutions in the nation with over $125 billion in assets.	20	21
We operate savings branches in ten states and originate	21	21
residential mortgages, almost entirely option ARMs, in 39	22	21
states.	23	21
We have been making adjustable rate mortgages for 25	24	21
years and have never had a default because of loan structure.	25	21
And the reason is very simple. We have very, very careful	1	22
underwriting and our meticulous ongoing service after	2	22
origination.	3	22
Our overall loss rate, even taking into account the	4	22
deep recession in Southern California in the early '90's, in	5	22
which we saw rapid price appreciation, followed by the	6	22
implosion of the defense industry, high unemployment,	7	22
declines in property values up to 20 percent, has averaged	8	22
less than five basis points since 1981.	9	22
So now some background on adjustables having talked	10	22
about us a little bit. For some time before ARMs were	11	22
originated in 1981, we and other major financial institutions	12	22
in California and throughout the country, together with trade	13	22
groups and others, studied the various forms of adjustables	14	22
that were made elsewhere in the world. The research took us	15	22
to Great Britain and other parts of Europe where ARMs had	16	22
been used for quite a long period of time.	17	22
At the end of the day, when we were deciding which	18	22
type of adjustable to choose, there were basically two	19	22
choices, the option ARM that provides protection against	20	22
payment shock by features such as annual payment caps and the	21	22
borrower's ability to defer interest or what we term the no	22	22
neg ARM that does not allow deferred interest and then is,	23	22
therefore, more likely to result in payment shock for the	24	22
borrower.	25	22
Our experience I think proves the case for the	1	23
option ARM. Contrary to some beliefs, the option ARM loan	2	23
was really never offered only to high-income, wealthy	3	23
professionals. We and other lenders have been offering the	4	23
option ARM since 1981 to the exact same types of borrowers to	5	23
whom we and others are offering fixed rate mortgages during	6	23
the same period of time.	7	23
Over that period we funded over a million and a half	8	23
option ARMs, with an average loan size of 175,000. And our	9	23
company's delinquency rates are well below industry averages,	10	23
including those for institutions who offer only fixed rate	11	23
loans.	12	23
And again, indeed, we have never identified a single	13	23
delinquent loan in our portfolio, much less a foreclosure or	14	23
loss due to the structure of our option ARM product. Our	15	23
option ARM because it's designed, priced, and underwritten	16	23
reasonably is successful by definition.	17	23
Now, what's changed recently? Obviously in recent	18	23
years, the option ARM is being offered by a much wider	19	23
spectrum of lenders, facilitated by the new securitization	20	23
market, technology developments, implementation of automated	21	23
underwriting standards, appraisal monitors, and credit	22	23
scoring.	23	23
While our version of the option ARM has been around	24	23
a long period of time, these new technologies may not be	25	23
fully tested, especially with alternative mortgages. And I'm	1	24
sure we'll get into that more soon.	2	24
We're clearly not here to defend all the practices	3	24
in the marketplace. We have long supported a regulatory	4	24
regime that encourages lenders to provide full and fair	5	24
disclosure to customers and prudently manage their lending	6	24
practices. And that includes the following:	7	24
Avoiding lending practices that can be predatory or	8	24
abusive, providing consumers with clear and timely	9	24
disclosures, maintaining strong underwriting appraisal	10	24
compliance and risk management functions, avoiding diluting	11	24
underwriting standards just to get volume, actively managing,	12	24
monitoring, and controlling risks of default, and regularly	13	24
and continually interacting with customers so that they	14	24
understand what they have and how they should act.	15	24
Of course, these sound practices really are relevant	16	24
to any loan a bank may offer, and we certainly support the	17	24
reemphasis of these principals in the pending interagency	18	24
guidance and the marketplace.	19	24
As one side note, I would also note that other forms	20	24
of equity that people -- ways people use equity such as	21	24
getting fixed rate mortgages and piling equity lines of	22	24
credit on top of it have some of the same risks as	23	24
nontraditional products we're discussing with maybe not all	24	24
of the protections.	25	24
In conclusion, we applaud the agency for issuing the	1	25
close guidance and as in our letter we think the guidance	2	25
needs to more fully address certain emergent practices that	3	25
may put customers in jeopardy, particularly loans that are	4	25
offered with deep initial payment discounts.	5	25
We do not support overly prescriptive underwriting	6	25
rules or mind-numbing stacks of disclosures that no one would	7	25
ever want to read or need to read or will ever read, but we	8	25
look forward to working with the Federal Reserve and other	9	25
agencies to develop appropriate consumer protections.	10	25
Thank you.	11	25
MR. OLSON: We have 200 people on our staff that	12	25
would read every single one of those mind-numbing statistics.	13	25
MR. FULLER: Unfortunately, Herb and the rest of us	14	25
would, too. But I'm not sure the consumers will; that's what	15	25
I'm worried about.	16	25
MR. OLSON: Thank you. Thank each of you.	17	25
Let me go back and ask a couple of follow-up	18	25
questions. And I'm sure my other people on our panel would	19	25
want to do the same.	20	25
Paul, the rate sheet that you handed out would	21	25
show -- obviously the people would want to move into the	22	25
upper left-hand side I would think of -- in each category,	23	25
and would certainly rather be on the left-hand side of the	24	25
page than the right-hand side of the page.	25	25

Professional Reporting Services, Inc., Walnut Creek, California, 800-261-4814

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2006 Hearings

Building Sustainable Homeownership: Responsible Lending and Informed Consumer Choice

Federal Reserve Bank of San Francisco 101 Market Street, San Francisco, California 94105 June 16, 2006

Building Sustainable Homeownership:
Responsible Lending and Informed Consumer Choice

Federal Reserve Bank of San Francisco
101 Market Street, San Francisco, California 94105
June 16, 2006