A harsh antipredatory-lending law in Georgia has triggered a revolt by the rating agencies over something called "assignee liability." It puts secondary market investors at risk if a loan covered by the law finds its way into a pool of securitized loans. It's gumming up the works in the secondary market and raising the call for a federal pre-emption.
AFTER YEARS OF WORKING ON PREDATORY LENDING issues, Donald Lampe, compliance attorney with Womble Carlyle Sandridge & Ricke PLLC, Greensboro, North Carolina, likes to tell a joke that perfectly sums up the industry's frustration with the Georgia Fair Lending Act (GAFLA): Most people in Georgia thought S&P was a cafeteria before GAFLA came along.
Tell that joke to the parents at your kids' next soccer game and you'll most likely get puzzled stares. That is, of course, unless you live in Georgia, where nearly everyone now knows that S&P is Standard & Poor's, the New York-based rating agency that earlier this year refused to rate virtually any mortgage-backed security (MBS) that included a loan originated in Georgia.
With New York--based Moody's Investors Service and Fitch Ratings echoing that decision, some secondary market players fled, some have stayed and many have altered either their product offerings or their terms.
A year from now, you may be able to tell that GAFLA joke in a lot more towns. While Georgia legislators continued to argue over the issue in February, consumer advocates fighting a guerilla war on predatory lenders planned to launch similar legislative missiles in cities, towns and states across the country. Their goal? To create assignee liability that makes secondary market investors financially responsible for predatory lending violations committed by the originators of loans backing their securities.
"It's tough on investors, because they want to ensure that they're not taking on added exposure versus what they're paying for," says Susan Barnes, S&P director. "Issuers don't want to be exposed to credit and legal risks that they can't foresee. Originators and investors can create processes and procedures to ensure that nothing is originated that violates the Act, but it only takes one loan to get through and then, in the case of the existing [GAFLA law], for punitive damages to be imposed on any assignee with no limitation."
Moody's Managing Director Pramila Gupta agrees. "The compliance with Georgia loans is very difficult, because they've got these provisions of net tangible benefit to the borrower, and part of the calculation to APR [annual percentage rate] is points paid to the broker from [any] source," she says. "Given that these loans change hands, it's hard for anyone to capture all the points and fees paid to the broker--to make it foolproof. Then, there's the unlimited liability assignment, which can bring the trust into the lawsuit."
Gupta estimates that Georgia typically produces about 5 percent of the loans backing securities in the MBS market.
At press time, the Georgia legislature was acting on ways to revamp its existing law, including removal of assignee liability. Even if the law is altered, the controversy it has generated is unlikely to end.
"Georgia's law is the toughest fair-lending law in the country. It's the most complex piece of legislation I've seen in all my  years in regulation, and I've seen quite a bit of legislation. There's a lot of gray in here," says David Sorrell, Georgia acting commissioner of banking.
Why are the consumer advocates asking everyone from city council members to state legislators to regulate lenders instead of seeking national legislation?
"From a lobbying point of view, it's easier to get access to state and local officials than it is to get access to national officials," says Kurt Pfotenhauer, Mortgage Bankers Association of America (MBA) senior vice president, government affairs.
The consumer advocacy groups don't see the rating agencies' actions as problematic, nor do they plan to give up on assignee liability. "Some kind of assignee liability has to be maintained, or the protections become meaningless. The ability for lenders to sell the loans on the secondary market becomes a way to avoid liability. What if the original lender goes out of business? Then there's no one if there's no assignee liability," argues Chris Saffert, deputy director of the Financial Justice Center, Brooklyn, New York, led by the Association of Community Organizations for Reform Now (ACORN), which lobbies for low-income consumers.
The rating agencies overreacted when they refused to rate the mortgage-backed securities with Georgia loans, Saffert maintains. "They're definitely influenced by the [mortgage banking] industry. That's who they do business with every day. It was an overreaction to say they wouldn't rate any loan, not just the high-cost loans," he says. Further, the mortgage banking industry tried to use the rating agencies' opinion to get rid of other, unrelated provisions that they didn't like in GAFLA, Saffert says.
And it's not just ACORN pushing for assignee liability extending out to secondary market players. "We still believe that some form of assignee liability is necessary at the state level--in particular, for our members, that there needs to be some form of assignee liability in regard to foreclosure proceedings," says DeCosta Mason, national coordinator for consumer issues for AARP (formerly known as the American Association of Retired Persons). "If a borrower gets a bad loan and they end up in foreclosure as a result of that bad loan, they should be able to raise that bad loan as a defense to that proceeding. What the rating agencies have indicated does suggest that there has to be some limitation on the liability, but it does not suggest that there should be no assignee liability."
A model bill drafted by AARP, the National Consumer Law Center and the Self-Help Credit Union of South Carolina also calls for assignee liability, warns attorney Robert Lotstein, managing partner of Lotstein Buckman LLC, a Washington, D.C., law firm specializing in compliance. "We've explained our position to AARP, but they don't seem to think there's any middle ground," says Neill Fendly, a broker with Camelot Mortgage Inc., Phoenix, and legislative chair of the National Association of Mortgage Brokers (NAMB), McLean, Virginia.
"AARP is well-intended, but they've had the consumer advocates giving them information for so long that they're convinced...