Interim Charge #6: Prevalence of Subprime and Predatory Lending Along the Texas Border

1. House Committee on Border and International Affairs Interim Charge #6: Prevalence of Subprime and Predatory Lending Along the Texas Border Texas Department of Banking Testimony of: Gayle L.Griffin – Deputy Commissioner Everette D. Jobe – General Counsel August 12, 2004

2. Table of Contents House Committee on Border and International Affairs

3. Agency Overview • The Department of Banking is entrusted with insuring the safety of the public’s money held by institutions that provide financial services. Statutory duties of the Department of Banking include the chartering, licensing, regulation, supervision and/or examination of: State-chartered commercial banks, State-chartered trust companies, Bank holding companies, Interstate branches of out-of-state banks, Foreign bank offices, Perpetual care cemetery trust funds, Prepaid funeral contract sellers, Check sellers (money orders, traveler’s checks, etc.), and, Currency exchange, transmission, and transportation businesses. House Committee on Border and International Affairs

4. Subprime Lending • A significant issue to consider when discussing subprime lending is how to define the term. • In an Interagency Guideline on Subprime Lending, the federal bank regulatory agencies define “subprime” as borrowers that display a range of credit risk characteristics that may include one or more of the following: • Two or more 30-day delinquencies in the last 12 months, or one or more 60-day delinquencies in the last 24 months; • Judgment, foreclosure, repossession, or charge-off in the prior 24 months; • Bankruptcy in the last five years; • Relatively high default probability as evidenced by, for example, a credit bureau risk score (FICO) of 660 or below (depending on the product/collateral), or other bureau or proprietary scores with an equivalent default probability likelihood; and/or • Debt service-to-income ratio of 50% or greater, or otherwise limited in ability to cover family living expenses after deducting total monthly debt-service requirements from monthly income. House Committee on Border and International Affairs

5. Predatory Lending • “Predatory” loans are characterized as loans with abusive terms, deceptive practices, and the inability of a borrower to repay the loan. But, there is not a broadly accepted definition. • The federal banking agencies view predatory lending as a subset of subprime lending that is "abusive or predatory." They state that predatory loans "appear to be designed to transfer wealth from the borrower to the lender/loan originator without a commensurate exchange of value." • Predatory lending practices generally include at least one of the following three characteristics: • Making unaffordable loans based on the assets of the borrower rather than on the borrower's ability to repay; • Inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced; or • Engaging in fraud or deception to conceal the true nature of the contracted loan obligation from an unsuspecting or unsophisticated borrower. House Committee on Border and International Affairs

6. Predatory Lending • It is widely acknowledged within the regulatory community that federally-insured depository institutions are not major contributors to the predatory lending problem, and the vast majority of predatory lending occurs with nonbank lenders. • Payday loans, though they may be originated within the context of current law, are considered by many to be predatory or abusive in nature due to the excessive interest and fees that are normally paid by the borrower. Payday loans are described as: Small-dollar, unsecured, short-term loans that borrowers promise to pay out of their next paycheck or regular income deposit. They are generally offered at high annual percentage rates. House Committee on Border and International Affairs

7. Institutions Operating in the Marketplace • Many different types of institutions provide credit to Texas consumers. • Some of these lenders include banks, savings associations, credit unions, mortgage companies, and finance companies. All of these are regulated by different state and federal agencies. • To provide a better perspective of the different types of federal deposit insured lenders operating in Texas, the following page is provided. Note that loan data for each entity type is not available. • Data needed to determine how many subprime loans each of these lenders makes is not readily available because current federal operating standards do not require it. House Committee on Border and International Affairs

8. Profile of Texas Banking *CIT - Chartered in Texas | **COT - Chartered outside Texas Information is from the FDIC Summary of Deposits as of June 30, 2003 and the NCUA Semi-annual report. Numbers are in millions. State Chartered Banks, Savings Banks and Credit Unions represent 22% of total deposits in Texas. House Committee on Border and International Affairs

9. Combating Predatory and Abusive Lending • The Department’s policy is to combat predatory lending and abusive practices at any state-chartered bank found to be engaging in such practices. Through the supervisory process, the Department will deter or prohibit predatory and abusive lending practices. These practices would be discovered through on-site examinations, the review of federal agency compliance reports, consumer complaints, or on-site involvement by a supervisor or conservator. Through current Texas law, the Texas Department of Banking has the ability to act on any cases of predatory lending that occurs in Texas chartered banks. Enforcement actions can be taken during or following an on-site examination, as a result of an application submitted to the agency, following a consumer complaint, or at any time the agency feels that action is appropriate and needed. House Committee on Border and International Affairs

10. Combating Predatory and Abusive Lending • The Department’s consumer complaint process: The Texas Department of Banking maintains a toll-free consumer complaint hotline. By statute, all state-chartered banks must provide customers information about how to file a complaint with the Department. In the last fiscal year, Department personnel handled over 3,000 consumer complaints and inquiries.  In all complaint situations, we ask that the consumer file a written account of what happened and include supporting documents.  After receiving the consumer’s complaint and supporting documents, a consumer complaint specialist will research the specific law that relates to the fact situation.   We then forward a summary of the complaint written by the Department’s specialist, along with a copy of the consumer’s filed complaint, to the lender.  The lender prepares a written response to the consumer’s complaint, which they send to us.   Our consumer complaint specialist then reviews the lender’s response and determines if the lender has violated banking law or Department policies with respect to handling of the consumer’s account.  The specialist would also determine if the lender has acted unreasonably or unethically in its dealings with the customer.  In a possible predatory lending situation, where false advertising, deceptive trade practices, misleading lending practices, exorbitant fees, or excessive interest (which may or may not be in violation of the state’s usury caps) are determined to exist, the Department’s legal counsel and senior management would be consulted. Other Department personnel, such as field examiners, would then be brought in to perform an on-site review of the lending facility to determine if any other consumers are affected and if any other circumstances of predatory lending might exist.  If the fact scenario supports an allegation of predatory lending, then the complaint and all supporting documents would be forwarded to the Texas Attorney General for prosecution.    House Committee on Border and International Affairs

11. Combating Predatory and Abusive Lending • We believe that the incidence of predatory and abusive lending practices is more prevalent in low-income areas, which includes counties along the border. However, we have had few complaints or discovered abusive practices relating to our supervised institutions located along the border. In the last fiscal year, we have received only a few isolated complaints by consumers indicating possible predatory lending practices in our state-chartered banks and trust companies.  One related to proper disclosure of the annual percentage rate. In addition, during the course of an on-site examination, we discovered and took action to prohibit a high cost automobile financing scheme. In the fiscal year, we have recovered $37,803 for Texas consumers.   House Committee on Border and International Affairs

12. Combating Predatory and Abusive Lending • Financial literacy and education appear to be the key to reducing the incidence of predatory and abusive lending. Many consumers with minor credit problems or difficulties stemming from unique circumstances wrongly believe that their loan choices are limited only to high-cost lenders, and consequently they do not compare rates of multiple lenders before agreeing to a loan. We believe that consumers that have a high level of financial literacy are more likely to make sound economic choices for themselves and their families. Clearly, improving the financial education of the most common victims of predatory lending, especially lower income households, is important. Consumers need to be educated about the issues that will affect their credit report and the options that are available to them. • Many banks now accept the Matricula Consular card, which is an identification card issued by Mexico’s consulates to its citizens living abroad. The United States Treasury Department has determined that financial institutions may accept Matricula Consular cards as identification, making it easier for Mexican immigrants to obtain banking services. Many banks along the border now accept the Matricula Consular as one form of primary identification. House Committee on Border and International Affairs

13. Combating Predatory and Abusive Lending • The Department supports the following efforts to improve financial literacy: “Money Smart” program – The FDIC started this program to help adults outside of the financial mainstream enhance their financial skills and create positive banking relationships. It includes a set of ten instructor-led training modules covering basic financial topics. The FDIC provides the curriculum free of charge, and banks are increasingly able to provide training to their customers. Training material is available in several different languages. A Federal Reserve Bank program entitled “Don’t Borrow Trouble” helps consumers avoid being the victim of predatory lenders. Other Federal Reserve Bank financial education programs include “Building Wealth: A Beginner's Guide to Securing Your Financial Future” and “There’s a Lot to Learn about Money.” The Jump$tart Coalition for Personal Financial Literacy seeks to improve the personal financial literacy of young adults. Jump$tart's purpose is to evaluate the financial literacy of young adults; develop, disseminate, and encourage the use of standards for grades K-12; and promote the teaching of personal finance. House Committee on Border and International Affairs

14. Federal Legislation • The following federal laws help prevent predatory and abusive lending practices: Equal Credit Opportunity Act (Regulation B) – Makes it illegal to discriminate against borrowers due to their race. Truth in Lending Act (Regulation Z) – Requires accurate disclosure of finance charges and annual percentage rate. Fair Credit Reporting Act – Requires the lender to provide notice to the consumer when it declines an application for credit or takes other adverse action. If adverse action is taken based upon information received from a reporting agency, the consumer must be notified. Community Reinvestment Act (Part 345) – Evidence of illegal or predatory lending practices can negatively impact the bank’s CRA rating and performance. Conversely, programs that include a financial education component about how to avoid abusive loans will improve the CRA rating and performance for a bank. Federal Trade Commission Act (FTC Act) – Makes unfair and deceptive trade practices illegal. Fair Debt Collection Practices Act (FDCPA) – A bank may face reputation risk if a third party debt collector violates FDCPA when collecting the loan. House Committee on Border and International Affairs

15. State Legislation • Though Texas does not have a specific anti-predatory lending statute, the following state laws help prevent predatory and abusive lending practices: Home Equity Loan Provisions (Texas Constitution) – Contains a number of consumer safeguards for home equity loans. High Cost Home Loan Disclosure – Requires that additional disclosures be made for high cost home loans. Usury Ceilings (Title 4, Texas Finance Code) – Sets interest rate ceilings for consumer loans. Collection Practices and Credit Information (Title 5, Texas Finance Code) – Places restrictions on collection practices and the use of credit information. House Committee on Border and International Affairs

16. Preemption of Texas Law • The Office of the Comptroller of the Currency and the Office of Thrift Supervision consistently assert that state law restrictions on lending activities of federally chartered institutions are subject to preemption. • Out of state state-chartered banks enjoy these same federal law preemptions. • Anti-predatory lending statutes, passed at the state level, would consequently not affect a large number of lenders operating in Texas due to this preemption. House Committee on Border and International Affairs

17. Texas is Primarily a Host State • Just under half of the state’s deposits (and loans) are held by out-of-state institutions. These out-of-state entities can import laws from their home state. House Committee on Border and International Affairs