Profitwise News and Views

Spring 2003 Issue

High Profile Predatory Lending Cases

Predatory Lending Series
By Steven W. Kuehl
The issue of predatory lending continues to affect communities throughout the nation as deceptive and abusive lending practices remain in credit markets. Predatory lending was last highlighted in our Winter 2000 (PDF,7.2MB) edition. That issue focused on the Mortgage Credit Access Partnership program's continuing role in ensuring fairness in mortgage lending. This edition of Profitwise News and Views (PNV) launches a series of articles that will re-examine the issue of predatory lending within the home mortgage market. This installment provides an overview of efforts to address predatory lending through litigation. Further PNV editions will provide information on efforts among the states in the Seventh Federal Reserve District to address the problem, and a nonprofit's experience with counseling the victims of predatory lending.

High Profile Predatory Lending Cases
This article provides an update on litigation to address predatory lending. The Federal Trade Commission (FTC) has been a leader in the fight against deceptive and abusive mortgage lending and has consistently waged a vigorous enforcement effort to eradicate predatory practices by lenders. The National Association of Attorneys General (NAAG) has also been a major force combating predatory lending through a combined and coordinated effort by state officials. Further, some cases have been settled through a joint effort of the governmental agencies and private plaintiffs' counsel. In the past year, over $784 million in consumer redress was obtained for deceptive lending practices. Following are summaries of the highest profile cases.

Household Finance
In a historic settlement offsite link that will reshape mortgage lending practices, lender Household Finance Corp. agreed with state regulators to change its lending practices-and to pay up to $484 million in consumer restitution nationwide for alleged unfair and deceptive lending practices in the "subprime" market. "This is the largest direct restitution amount ever in a state or federal consumer case," said Iowa Attorney General Tom Miller.

Attorneys general and financial regulators from 19 states and the District of Columbia began coordinating their efforts after identifying a pattern of complaints from borrowers. Many consumers claimed Household charged interest rates far higher than promised, and misrepresented points and pre-payment penalties. They also complained of deception about costly, often unnecessary insurance policies, and that loan fees were often misrepresented or not explained at all. In many of the cases, borrowers' monthly payments jumped dramatically [compared with prior payment schedules], and some consumers were put at risk of losing or did lose their homes. The multi-state investigation alleged that Household violated numerous provisions of state consumer fraud acts and financial regulations by misrepresenting loan terms and failing to disclose material information to borrowers.

State regulators said Household cooperated in the case when the states presented their concerns, working quickly with the investigators to craft a remedy to the practices identified by the states. The settlement includes Household International, Inc. (the parent company), Household Finance Corp., Beneficial Finance Corp., and Household Realty Corp. Household is based in Prospect Heights, Illinois.

Under the settlement, Household agreed to:

Pay up to $484 million in restitution to consumers nationwide, depending on how many states participate
Limit prepayment penalties on current and future home loans to only the first two years of a loan
Ensure that new home loans actually provide a benefit to consumers prior to making the loans
Limit up-front points and origination fees to 5 percent
Reform and improve disclosures to consumers
Reimburse states to cover the costs of the investigations into Household's practices
Eliminate "piggyback" second mortgages

"Owning a home to raise your family in is at the core of the American Dream," said then Illinois Attorney General Jim Ryan. "But because of the alleged deceptive practices in this case, many consumers found that dream turning into a financial nightmare. The states involved are working together to protect our nation's families."

Iowa Attorney General Miller said the historic settlement resulted from a crucial and unique partnership between state financial regulators and state Attorneys General. "Someday, I hope we will look back on this as a turning point in lending to low- and moderate-income Americans when there is a home at stake," he said. "The settlement is unprecedented, both in its amount and in the reform contained in the restrictions it places on questionable lending practices in the future. It is our intention that other lenders will have to live with the same reforms that are spelled out in this settlement."

The settlement was contained in consent decrees and filed in respective state courts throughout the country by the end of 2002. In Illinois, the complaints and consent decrees were filed on December 16, 2002 in the Circuit Court of Cook County. Each state must now design its own restitution plan, since some of the lending practices varied significantly from state to state. The details of the settlement and the process by which consumers can apply for restitution are being finalized and will be announced at a later date.

Consumers should not contact state attorney general or financial regulator offices at this time. Restitution plans for each state will be formulated, and then states and a settlement administrator will inform consumers about restitution terms and procedures under the settlement. According to the Office of the Illinois Attorney General, distribution of funds should begin by early third quarter 2003.

Citigroup Inc.
In March 2001, the FTC sued Associates First Capital Corporation and Associates Corporation of North America (Associates). The FTC alleged violations of the Federal Trade Commission Act through deceptive marketing practices that induced consumers to refinance existing debts with home loans carrying high interest rates, costs, and fees, and purchase high-cost credit insurance. The FTC also alleged violations of several other federal laws, including the Truth in Lending Act, Fair Credit Reporting Act, and Equal Credit Opportunity Act, and with using unfair tactics in collecting loan payments.

Associates was one of the nation's largest "subprime" lenders. In 1999, the total dollar amount of all outstanding loans in Associates's U.S. consumer finance portfolio was approximately $30 billion. Citigroup acquired Associates in November 2000, and merged Associates's consumer finance operations into its subsidiary, CitiFinancial Credit Company. Both Citigroup Inc. and CitiFinancial Credit Company, Citigroup's consumer finance arm, were named as defendants.

On September 19, 2002, the FTC announced that it settled with Citigroup regarding the charges against Associates. In the largest consumer protection settlement in FTC history, Citigroup Inc. will pay $215 million to resolve FTC charges that Associates engaged in systematic and widespread deceptive and abusive lending practices.

"The Commission will not tolerate the fleecing of subprime borrowers through deceptive lending practices such as the packing of unwanted credit insurance on consumers' loans," said Timothy J. Muris, Chairman of the FTC. "As a result of this settlement, as many as two million consumers will receive significant monetary relief in the form of cash refunds or reduced loan balances. I am pleased that Citigroup has agreed to remedy the grave injury caused by Associates and that Citigroup has announced new measures at CitiFinancial aimed at preventing these kinds of problems. If fully implemented, these are positive steps in an industry that for too long has been plagued by deception and abuse."

The settlement will provide $215 million in redress to consumers who bought credit insurance in connection with loans made by Associates between December 1, 1995 and November 30, 2000. The class action settlement will provide an additional $25 million to consumers whose mortgage loans were refinanced, or "flipped," by Associates during the same time period. Together, these settlements will provide $240 million in consumer redress for Associates borrowers. "Redress means that all of the settlement funds will be disbursed back to consumers who purchased credit insurance without knowing they were purchasing credit insurance," said Rolando Berrelez, Assistant Director of the FTC Midwest Region.

The federal district court in Atlanta (which is the court presiding over the FTC's case) has preliminarily approved the settlement pending final approval by the California state court of the class action and certification of the proposed settlement class. The California court is presiding over the class action and has given preliminary but not final approval. FTC attorneys expect the California court to issue final approval unless objectors to the class action succeed.

The FTC's settlement also requires CitiFinancial to provide annual reports to the FTC detailing its practices with respect to the sale and marketing of credit insurance and other add-on products, and the progress and status of steps taken to improve these practices. In addition, for three years, CitiFinancial must maintain documents relating to the sale and marketing of loans, credit insurance, and add-on products, and steps taken to improve these practices.

First Alliance Mortgage Company
First Alliance Mortgage Company (FAMCO), a debtor in bankruptcy, agreed on February 25, 2002 to a settlement of predatory lending charges offsite link that could provide nearly 18,000 borrowers with as much as $60 million dollars in compensation. The suit was brought by the FTC; the states of Arizona, California, Florida, Illinois, Massachusetts, and New York; the AARP; and private attorneys for class action plaintiffs and for individual plaintiffs with unfair lending claims. The agreement settles charges that FAMCO and its chief executive officer violated federal and state laws in making home mortgage loans to customers.

Allegations against FAMCO were that it marketed its loans through a sophisticated campaign of telemarketing and direct mail solicitations. FAMCO targeted its loans to the "subprime" market, which includes homeowners with poor credit ratings who may not be able to qualify for conventional loans. Consumers who visited FAMCO's loan offices in response to the solicitation were subjected to a lengthy sales presentation known as the "Track." The allegations asserted that the "Track" presentation misled consumers about the existence and amount of loan origination fees and other fees that FAMCO charged-which amounted to 10 percent to 25 percent of the typical loan. Allegations also included misleading consumers about increases in the interest rate and the amount of monthly payments on adjustable rate mortgage (ARM) loans, and failure to provide a required disclosure booklet that explains how these loans work.

The settlement, including the bankruptcy liquidation plan which implements the settlement, was approved by the district court on September 9, 2002, and became final and effective on November 19, 2002. The FTC's Redress Fund Administrator began distributing approximately $44 million to borrowers on December 18, 2002. An additional distribution is expected to take place in 2003 as creditor claims against the bankruptcy estate are resolved, outstanding litigation settled, and expected tax refunds received.

Mercantile Mortgage Company, Inc.
The complaint charges that Mercantile Mortgage Company, Inc. (Mercantile), through its lending officers, engaged in numerous deceptive and other illegal practices offsite link to induce consumers to borrow from Mercantile. A significant number of Mercantile's loans were 15-year loans requiring a large lump-sum "balloon" payment at the end of the term, usually 80 percent of the loan amount. According to the complaint, Mercantile misled borrowers by misrepresenting or concealing the balloon payment. In addition, the complaint alleges that, in many instances, Mercantile failed to disclose the balloon payment on the Home Ownership and Equity Protection Act (HOEPA) disclosures, as required by HOEPA, or failed to provide the HOEPA disclosures at all.

The complaint also alleges that Mercantile made misrepresentations about the key terms of its loans, including the interest rate, monthly payment, and prepayment penalty, and that Mercantile violated both the Truth in Lending Act and the FTC's Credit Practices Rule. The complaint also contains an allegation from the U.S. Department of Housing and Urban Development (HUD) that Mercantile violated the Real Estate Settlement Procedures Act by giving and receiving illegal kickbacks for referring loans. In accordance with the complaint, on July 18, 2002, the FTC, HUD, and the State of Illinois announced that Mercantile agreed to settle charges that it deceived borrowers about the terms of their loans.

The settlement required the company to make a $250,000 payment for consumer redress and create a program to offer refinanced loans on favorable terms to certain borrowers with balloon loans. "Many consumers who were deceived will be able to get a free refinance," stated Allison Brown, an FTC attorney who worked on the case. "These consumers will get 30-year fixed rate loans, and they will feel secure knowing that their payment will remain level over the life of the loan."

Conclusion
As federal and state officials continue to examine and take legal action regarding the problem of predatory lending, they will be policing the practices of a growing subprime marketplace. Subprime lenders produced a record $60 billion in mortgages during the third quarter of 2002 and likely will produce a record breaking $220 billion for calendar year 2002. In 2001, the industry produced $180 billion in residential subprime loans, also a record.Â¹ Regulators have in the past year obtained record settlement amounts to redress the victims of predatory lending. They have crafted settlements with an eye toward setting better standards for the subprime mortgage lending industry. Prime examples of these higher standards are: improved disclosures to consumers, particularly regarding credit insurance and up-front points and origination fees; and limiting prepayment penalties to only the first two years of a loan.

Financial education serves as a strong antidote to predatory lending practices and various concerned agencies have made available free publications specifically for homeowners and potential homebuyers.

Notes
¹ See Paul Muolo, Subprime Market as Hot as Prime, National Mortgage News, December 9, 2002, Vol. 27; No. 12; Pg. 1.

Steven W. Kuehl is the consumer regulations director for the Consumer and Community Affairs Division at the Federal Reserve Bank of Chicago. Mr. Kuehl conducts seminars, workshops and frequently writes on matters dealing with consumer banking regulations. Mr. Kuehl served as a senior examiner on consumer regulations compliance and the Community Reinvestment Act with the Federal Reserve Bank of Chicago, and later managed a technical advisory service program targeted to banks in the Seventh Federal Reserve District. Prior to joining the Fed, he was an examiner for the Office of Thrift Supervision. Mr. Kuehl earned a B.S. in Finance and Economics from Carroll College and a Juris Doctor degree from Chicago Kent College of Law.