SECTION: CAPITOL HILL HEARING TESTIMONY

LENGTH: 3348 words

COMMITTEE: SENATE BANKING HOUSING AND URBAN AFFAIRS

HEADLINE: PREDATORY LENDING PRACTICES

TESTIMONY-BY: MR. JOHN COURSON, CHAIRMAN-ELECT

AFFILIATION: MORTGAGE BANKERS ASSOCIATION

BODY:
Hearing on "Predatory Mortgage Lending Practices: Abusive Uses of Yield Spread Premiums."

Prepared Statement of Mr. John Courson Chairman-elect Mortgage Bankers Association

Tuesday, January 8, 2002

Good morning Mr. Chairman and members of the Committee. My name is John Courson, and I am President and CEO of Central Pacific Mortgage Company, headquartered in Folsom, CA. I am also Chairman- elect of the Mortgage Bankers Association of America (MBA), and it is in that capacity that I appear before you today.

This morning I have been asked to testify before your Committee to present MBA's views regarding the issue of lender payments to mortgage brokers, generally referred to as "yield spread premiums," and how they are to be judged under the anti-kickback provisions of the Real Estate Settlement Procedures Act ("RESPA"). To ensure a clear understanding of our position on this issue, it is important to lay the groundwork by defining the term "yield spread premium," and highlighting the important role that this financing tool plays in mortgage transactions. Definitions:

As a general rule, the term "yield spread premium" is used in the mortgage lending industry to refer to a type of payment from a lender to a mortgage broker, which is paid in the context of "brokered" loan transactions. In such transactions, mortgage brokers generally operate as intermediaries between consumers and lenders. In effect, they function as the interface with prospective borrowers, serving as the "storefront" for mortgage loan products offered by lenders. In this role, mortgage brokers are much more than "retailers" of loans; they perform real and valuable services in the origination phase of the mortgage transaction process. Among other things, mortgage brokers bring borrowers and lenders together and match consumer needs with lender products, they collect pertinent financial information, render advice to consumers, and generate all documentation and verification required for the loan transaction to occur.

It is important to clarify that, for the various goods, services, and facilities they provide in the origination of loans, mortgage brokers are entitled to be compensated. Generally, such compensation will occur in either of two ways. Brokers may collect their full compensation from the consumer directly, in the form of a cash payment. Alternatively, they can be paid, in part or in whole, indirectly by the lender, through the mechanism of a yield spread premium.

The yield spread premium mechanism works by allowing a consumer to choose a higher interest rate in exchange for lower upfront costs. Under this financing tool, the higher interest rate allows lenders to tender an amount reflecting the value of that increased yield to mortgage brokers as compensation for the goods, services, or facilities that they render. In technical parlance, a "yield spread premium" is thus defined as a payment that a lender makes to a mortgage broker that reflects the increased yield over "par" on a particular loan. In practical terms, a yield spread premium is a mechanism that provides borrowers with a vital tool to allow for the financing of some or all of their home loan closing costs.

The yield spread premium mechanism allows mortgage brokers the flexibility to offer consumers numerous options and choices as to the combination of up-front payments and interest rates that best suits the borrower's individual needs. In short, as the interest rate goes up, the borrower's up-front cash contribution goes down. The added financial flexibility afforded by the yield spread premium is extremely important because a vast number of borrowers-especially those who have limited funds for down payments, or who have reached borrowing limits-need the flexibility to finance the required closing costs to achieve homeownership. Those consumers who lack sufficient independent funds literally depend on the YSP option to purchase and/or refinance a home.

I want to clarify, unequivocally, that the yield spread premium mechanism should be restricted to the function I just described, which is to compensate the broker for goods, services, or facilities provided or to allow for the financing of other closing-related costs. If, on the other hand, the yield spread payment does not fit this definition, and the payment is used for purposes other than to compensate brokers for the bona-fide goods, services, or facilities they provide, or to finance other required closing costs, then the payment may be considered suspect, and should be dealt with appropriately. I want to make clear that we do not consider it appropriate to use the yield spread premium mechanism as a means to inflate interest rates in a way that defrauds the consumer into higher loan prices. Nor do we consider it appropriate to use the yield spread premium as a means of concealing referral payments to brokers. To the extent that such abuses do occur, they should be labeled for what they are-violations of the law.

HUD's Policy Statements:

We are in agreement with HUD's formulation of the test for determining the legality of lender payments to mortgage brokers under RESPA. As you know, the rules for determining the legality of payments to mortgage brokers under RESPA's anti-referral fee prohibitions are set forth in a 1999 HUD policy statement, and recently clarified through an additional statement published on October 18, 2001. In those policy statements, HUD has explicitly acknowledged that yield spread premiums are very useful tools to assist consumers in financing homeownership. The policy statement clarifies that yield spread premiums, so long as they compensate the broker for goods, services, or facilities provided in the origination of a mortgage loan, are not in themselves illegal under RESPA. Under HUD's jurisdiction over RESPA's referral fee prohibitions, the policy statement and the subsequent clarification state unequivocally that yield spread premium payments are to be considered illegal if they constitute referral payments or if they incorporate referral fees in the payment. We agree.

HUD's formulation under Section 8 of RESPA correctly recognizes that the legal test for analyzing yield spread premiums (or other lender payments to mortgage brokers) must distinguish between those payments that are legitimate compensation to brokers, and those that are merely referral fees. In setting forth its formulation, HUD tracks the RESPA statute quite closely. As mentioned above, RESPA sets a strict prohibition against kickbacks and referral fees. The statute also states that payments for real goods or services are not prohibited. It is a simple and straightforward test. If you pay a referral fee, you are breaking the law. If, however, the fee is tendered as compensation for real goods, services or facilities, then the payment cannot, by definition, constitute a referral fee or a kickback, and is therefore not prohibited under RESPA strictures.

This is precisely what HUD sets forth in the policy statement formulation. When a lender pays a fee to a mortgage broker, first, one has to lay the foundation and ensure that services, goods or facilities were actually furnished by the mortgage broker. If services, goods or facilities were actually furnished, then one has to make sure that the payment to the broker does not incorporate a referral fee portion that could be deemed illegal under RESPA. According to HUD, this is done by scrutinizing the total of broker payments to ensure that they are "reasonably related" to the value of the services, goods or facilities furnished. Any amount over the "reasonable" level could be deemed to constitute a "referral fee." The "reasonableness" test is the test that HUD has consistently used to judge Section 8 liability in all circumstances since RESPA was enacted.

Note that this "two-prong test" strikes the best possible balance between RESPA's affirmation for fees paid as compensation for goods or services actually provided, and the statute's proscription of referral fees. Note also the internal logic of the HUD two-prong test-the first prong focuses on what the broker provides in the transaction, and the second prong analyzes the fees that were paid for those services. Each step is grounded on statutory language and each step is necessary to the legal analysis under Section 8 of RESPA.

HUD Clarifications:

In large part, the controversy prompting today's hearing appears to be the recent clarification to the 1999 policy statement issued by the Department on October 18, 2001. In that clarificatory statement, the Department declared that it sought to eliminate certain ambiguities with respect to yield spread premiums.

The specific "ambiguity" that HUD sought to remedy stemmed from an appellate decision entitled Culpepper v. Irwin Mortgage Corp., 253 F.3d 1324 (11th Cir. 2001) ("Culpepper III"). In that decision, the Eleventh Circuit Court of Appeals reached a decision that was in direct conflict with the "two-prong" formulation established by HUD under the 1999 policy statement. In that decision, the 11th Circuit described HUD's 1999 policy statement as "ambiguous" and created a new test that resulted in per-se liability for the payment of yield spread premiums.

In issuing the clarification, HUD was abiding by previous congressional directives to articulate clear legal standards. In 1998, Congress expressed concern about the "legal uncertainty" surrounding the test for liability in these cases, particularly in light of the fact that "Congress never intended payments by lenders to mortgage brokers for goods or facilities actually furnished or for services actually performed to be violations of [Section 8 of RESPA]." Congress then specifically "direct[ed]" HUD to issue a "policy statement" in order "to clarify its position" and provide "guidance to . . . the courts."

The 1999 Policy Statement thus represented HUD's Congressionally- mandated effort to promote uniformity on the legality of yield spread premiums under federal law. After the issuance of the 1999 Policy Statement, lenders and mortgage brokers, especially those who had faced years of costly litigation in these cases, justifiably relied on HUD's legal formulations as having finally eliminated litigable issues relating to the governing standard for liability. Indeed, district courts overwhelmingly agreed, and interpreted the 1999 Policy Statement to articulate the "two prong test" that I described above.

The Eleventh Circuit's Culpepper III decision, however, shattered this legal clarity and returned the lending industry to the confusing legal environment that existed before 1999. By finding the 1999 Policy Statement "ambiguous," and articulating a legal test resulting in per-se liability that was entirely separate from the one advanced by HUD, Culpepper III plunged lenders, brokers, consumers, and courts into the same chaotic state that led Congress to direct HUD to act in the first place. A new wave of over 40 yield spread premium RESPA nationwide class actions were filed in the immediate aftermath of Culpepper III. Over 80 class actions were still pending in district courts around the country, with a particularly heavy concentration in the Eleventh Circuit. The risk of inconsistent determinations based on the solitary federal statute at issue in these cases was very real. In the meantime, several district courts outside the Eleventh Circuit were refusing to follow Culpepper III's RESPA liability analysis, and instead continued to accord deference to HUD's Policy Statements.

I note that inconsistencies in the governing legal standard are extremely problematic for lenders. Most wholesale lenders make loans in a variety of geographic regions, and a large number of lenders have truly nationwide operations. There were many lenders who had already successfully defended prior RESPA challenges to their payment of yield spread premium, typically at costs ranging in the hundreds of thousands of dollars. Many of these same mortgage bankers began facing renewed litigation in the Eleventh Circuit where they were exposed to very different standards under the unique rules established by Culpepper III. This renewed legal confusion forced many national lenders to give serious consideration to halting or geographically limiting the practice of offering yield spread premiums, despite its admitted consumer benefits.

It is in the midst of this environment of legal turmoil that the Department decided to clarify RESPA through the 2001-1 Policy Statement. To reestablish clarity, HUD declared that it expressly "disagree[d ] with the judicial interpretation regarding Section 8 of RESPA and the 1999 Statement of Policy" found in Culpepper III. 66 Fed. Reg. 53054-55. In the clarification, HUD sets forth its definitive reading of the law that neither Section 8(a) of RESPA nor the 1999 Statement of Policy supports the conclusion that a yield spread premium can be presumed to be a referral fee based upon the use of a rate sheet, or because the lender does not have specific knowledge of what services the broker has performed.

We believe that HUD acted properly and very responsibly as the regulatory agency that holds jurisdiction and bears the ultimate duty for the proper administration of RESPA. Absent HUD's clarification, the confused legal landscape would have been intolerable in terms of risk and legal exposure. Not only was the Eleventh Circuit's decision irreconcilable with HUD's reading of the law, but it threatened catastrophic industry liability, and also threatened to eliminate from the marketplace yield spread premiums and the critically important role they play in promoting homeownership.

Class Action:

An additional criticism has been that the legal articulation in the 2001 Policy Statement cuts off the possibility of consumer redress under RESPA. The clarifications set forth in the 2001-1 Statement of Policy do not eliminate a single consumer's legal rights. In the 2001 Policy Statement, HUD asserts that, in order to determine whether yield spread premiums violate Section 8 restrictions, it is necessary to look at each transaction individually. Far from immunizing the industry, however, this ruling stems from HUD's longstanding recognition that the origination of mortgage loans, the specific services provided by mortgage brokers, and the difficulty of providing those services, all differ with each loan, each applicant, and each market place or geographical location.

In short, HUD's assertion that RESPA demands individualized loan- by-loan analysis of the level of services performed in relation to the fees paid does not reflect an attempt to relieve industry from liability. It reflects the reality, as recognized by every administration since RESPA was enacted, that each transaction is different and contains unique features that requires varying levels of time, effort, and expertise. Just as the consumer disclosures mandated by RESPA demand individualized disclosures reflecting the specific costs that relate to the specific loan transaction at hand, the analysis of legality under Section 8 of RESPA also demands a tailored examination of the goods and facilities provided or services performed by the broker in the transaction.

Additional Consumer Protections:

As I mentioned above, we all recognize that there are instances where yield spread premiums are used in ways that could be harmful to consumers. We hear reports of consumers who pay egregious interest rates due in whole or in part to wildly inflated yield spread premium fees, or mortgage brokers that conceal yield spread payments in a way that leads to the consumer's detriment.

In this regard, we commend the Chairman in his leadership in holding these hearings, as such problems do require our full attention. We also commend the Department for its initiative to ensure that consumers receive full and meaningful disclosures in the mortgage process. In the 2001 Policy Statement, HUD has articulated the need to strengthen the information provided to consumers by brokers by adding such disclosures as the types of services that the broker will perform, the amount of the broker's total compensation for performing those services (including yield spread premiums), and whether or not the broker has an agency or fiduciary relationship with the borrower. Additionally, the 2001 Policy Statement clarifies that borrowers should be made aware of the trade-off between up-front costs and rates, and that such information should be provided to the applicant early in the loan transaction.

The Secretary has announced that he will push forth with rulemaking in this area. MBA agrees with the Secretary's initiatives and will strive to work with HUD to achieve the best possible regulatory outcome to rid the market of abusive lending practices. We think it is important to point out, that current federal rules and regulations already provide for a great deal of consumer disclosures. We note, for example, that yield spread premium payments are today included as part of the finance charge calculations, and thus, are fully disclosed to consumers through the APR disclosure under the Truth in Lending Act. We note also that these yield spread premium payments must be specifically broken out and separately itemized and disclosed on the Good Faith Estimate and HUD-1 forms under RESPA. That statute also requires that lenders and/or mortgage brokers deliver to consumers a Special Information Booklet that sets forth an explanation of mortgage broker compensation, points, fees, and their interrelationship.

As an industry, we welcome additional disclosure requirements if they truly serve to protect consumers from unscrupulous practices. We note, for instance, that MBA took a leadership role in creating model, voluntary and supplemental disclosures for its members to use. These disclosures provide further explanations of the choices borrowers have to compensate their mortgage brokers- through direct payments, yield spread premiums financed through higher interest rates, or some combination of the two. This additional disclosure was commended and encouraged by HUD, and is now an accepted and routine part of the disclosure process for our membership.

MBA believes, however, that ultimately, we can do much better. We can, and should, construct systems of consumer protection that go beyond mere disclosures. In the end, consumers run the risk of being tricked and deceived as long as consumers are subjected to the arcane and outdated disclosure system that is now mandated by federal law. As with predatory lending, we believe that it is absolutely essential to enact comprehensive reform of the current mortgage lending laws. So long as the mortgage process remains confusing and perplexing, consumers will run the risk of being gouged and defrauded, whether through trickery involving yield spread premiums, or through other schemes that unscrupulous actors will continue to develop to exploit the unwary and unsophisticated. We look forward to working with HUD and the Congress to enact the necessary legislative and regulatory changes necessary to achieve the goals of lasting protections for all consumers.

Conclusion:

To summarize, Mr. Chairman, we reiterate that as we develop more protections and disclosures in this area, we must keep in mind that yield spread premiums are extremely valuable consumer financing mechanisms, and that they are a crucial element in today's housing and mortgage markets. As lenders, government, and consumer advocates, we all share in the responsibility of ensuring that this important financing tool is not abused by unscrupulous actors or damaged by frivolous class action claims. Going forward, we fully support HUD's calls for improved consumer disclosures and we look forward to working with the Department as we advance on this very important endeavor.

Thank you for allowing us the opportunity to share our views with the Committee.



LOAD-DATE: January 9, 2002