Subprime Lending Update

Subprime lending has continued to be in the spotlight this spring. Much of the attention has been unwanted. Here is a brief update on percolating issues:

• Maryland passed a predatory-lending bill in May that preempts cities and counties in that state from enacting their own predatory lending legislation. Industry representatives welcomed the preemption feature, given the many local battles being waged at the county and municipal level in other states across the country. The Maryland bill does require housing counseling on high-cost mortgage loans, bans the financing of single-premium credit insurance and prohibits lenders from making loans without due consideration of the borrower's ability to repay (i.e., no lending based solely on the equity in the property). High-cost loans under the new statute are those with interest rates 7 percentage points higher than Treasury securities of comparable maturity, or points and fees greater than 7 percent of the loan amount. These threshold triggers are less stringent (cover fewer loans) than many that have been proposed in other jurisdictions over the past 6 months.

• Federal preemption on predatory lending may be in the future. Senate Banking Committee Chairman Paul Sarbanes (D-MD) introduced a predatory lending bill in May and indicated that, depending upon the final form of the bill, he might support a preemption provision.

• The U.S. Treasury Department has been developing a set of subprime lending "best practices" that it intends to encourage lenders to follow on a voluntary basis. The code could also be adopted by banking regulators. According to the American Banker, three issues have yet to be resolved: (1) how to deal with prepayment penalties, (2) yield-spread premiums, and (3) mandatory arbitration clauses. Industry groups and consumer advocates are generally in opposite camps on all 3 issues. The industry argues that all three contractual features are necessary protections for subprime mortgage lenders. The inability to use one or more of these features would raise the cost of making loans, and ultimately reduce the supply of subprime credit. In contrast, consumer advocates claim that all three features are abusive and provide no value to consumers.

• Some good news: subprime mortgage portfolio performance has held up remarkably well, despite the economic downturn. Industry critics (and many analysts and regulators) have been warning that a crisis was looming as rising unemployment put a squeeze on household budgets. Yet, well into the second quarter of 2002, no performance crisis has materialized. To be sure, delinquencies and foreclosures have been rising steadily over the past year. LoanPerformance, a San Francisco-based consulting firm, tracks the delinquency and foreclosure experience of both prime and subprime mortgage lenders. The foreclosure rate for loans in the firm's national database rose about 100 basis points from March, 2001 to reach 5.03 percent in February, 2002. Serious delinquency rates on subprime mortgages rose more than 150 basis points to 7.89 percent in February 2002. Sheila Meagher, vice president of research at LoanPerformance, told the American Banker that the trend was not nationwide. States in the Midwest, particularly Ohio and Indiana, were driving much of the upsurge in delinquencies. Midwestern manufacturing has been particularly hard hit by the recession (see the article on personal bankruptcies in the Forecasts section of this issue).