Good morning. My name is Frank Sutkowski and I am Senior Executive Vice President and Chief Lending Officer for Liberty Bank of Middletown, Connecticut. Liberty Bank is a $1.2 billion mutual form institution, which makes it middle-sized nowadays.Liberty bank is active as a real estate lender in both the primary and secondary market agencies. I am also chairman of ACB's Secondary Market Subcommittee and liason with Fannie Mae and Freddie Mac. I have been actively engaged in the issue of the timely dropping of mortgage insurance coverage both for ACB and for my own istitution.
Today I am representing America's Community Bankers, the national trade association for 2,000 savings and community financial institutions and related business firms.
The industry has more than $1 trillion in assets, 250,000 employees and 15,000 offices. ACB members have diverse business strategies based on consumer financial services, and community development.
Let me begin by commending the Chairman and this Committee for addressing the issue of how to ensure that borrowers pay only for the insurance coverage that they need on their 1oans. I can assure you that ACB members have no stake in running that issurance past the point at which it is needed to do any good. We would prefer that the borrowers have the money as an extra cushion for debt service, for other expenditures, or, perhaps best for both depository institution lender and the borrowers, for adding to their savings and investment balances.
ACB has been working with the secondary market GSEs to ensure that their policies on private mortgage insurance (PMI) reflect current market realities and provide for the fastest possible termination consistent with their safety and soundness and the borrowers needs. Most ACB members also retain significant percentage of their loan originations for their own portfolios, especially of selected loan types, and have a parallel interest with the borrower in ensuring that PMI coverage is not retained when the loan-to-value ratio drops to below 75 percent. In such cases, the borrower would be paying for coverage that would not tru1y be in effect: in most cases, PMI covers only down to 75 percent. We would prefer the borrower to have those funds.
My own institution notifies borrowers when we believe that PMI can be safely dropped. We go through continuous portfolio review to ensure that we alert customers when, through either regular loan amortization, special principal paydown(s), or property price appreciation, that PMI coverage can be dropped. A sample customer alert letter is attached to my statement.
We have to recognize however, that PMI coverage deals with a very real threat to lenders' financial stability and to customers credit histories: Unfortunately, real-estate market values do not always move steadily, or even sporadically, in an upward direction. There was a rather painful reeducation of lenders at the start of the l99Os for some historically very strong markets. On both coats,in California and Conecticut,property values took a very sharp correction and only recently is a solid recovery taking hold. My institution still can show more loans than we would like with five years' seasoning and "upside down" values, i.e., where the rent property value is less-than the original sales price.
Regular 1oan amortization is a slow process, though a fraction faster at today's rather moderate rate levels than at the double-digit coupons of the 1970s and 198Os. The main driving force in substantial early improvement in loan-to-current-value ratios is property price appreciation. Even healthy markets will take some time to bring a 95 percent loan down to the 80 percent or 75 percent level where lenders feel comfortable with PMI termination.
From the borrower's perspective, of course, it is normally a case of the-sooner-the better. It is clearly the case that, where PMI would not be required were the loan outstanding to be newly underwritten, appraised, and originated, the PMI on the loan should be dropped. However, getting the 1oan-to-value (LTV) ratio to that point will take some time,generally in excess of 10 years. Especially because most loans have a life of less than l0 years, fewer loans become eligible for PMI cancellation each year than one might think. For instance, my bank's rather exhaustive procedures recently identified only 3 percent of the loans on our books as candidates for PMI cancellation.
Under regulatory guidance for depository institutions, where the real property is the sole collateralization securing a conventional loan, PMI will be routinely required for LTV ratios of 90 percent and above. Most lenders, however, will generally require PMI on loans exceeding an 80 percent LTV threshold. Secondary market standards drive the PMI practices of mortgage bankers who deliver all their product to investors. Those secondary market standards also affect what portfolio lenders do because often some part of the production will be sold also, either immediately or after some seasoning.
The secondary market Government Sponsored Enterprises (GSEs) were major beneficiaries of PMI coverage. We understand that at the depths of the real estate problems in the southwest, pay-offs from PMI companies exceed the earnings of the GSEs, which would therefore have appreciated at a loss had it not been for their-foresight in requiring this coverage.
ACB appreciates the sensitivity that you demonstrated, Mr. Chairman, when you introduced your bil1, S.318, to the legitimate role of this insurance coverage and to focusing on how to ensure that termination does not add to credit risk exposure. S.318 deals with the approach to a threshold LTV value, apparently concentrating on the regular amortization process.
I would like to offer a few comments on S. 318 here, while reserving the more technical issues for the appendix to this statement. First, S.318 focuses on the original LTV, not the loan-to-current value ratio. With regular amortization, along enough period will normally elapse for the "upside down" status of original and current property values to correct themselves, especially in cases where a significant partial prepayment has been made by the borrower. However, where the property value has unfortunately dropped also, the real loan-to-value ratio may not hit the desired trigger point.
This type of complexity is what ACB and others have been addressing in discussions with Fannie Mae. In certain early borrower- initiated PMI cancellation requests, Fannies Mae has proposed that the servicer warrant that the current value of the collateral property is at least as great as at the time of the loan origination. Such a representation would be backed by a required, limited scope "exterior only" appraisal of the overall condition of the property and a review of price trends for comparables in the area.
Those discussions have also raised the possibility of an approach where an automatic lender/investor waiver of the continuation of PMI would be triggered by the passage of half the loan's scheduled maturity, i.e., for a 15 year loan PMI would automatically drop after 7 1/2 years, and after 15years on a 3O year loan. This 'fail-safe' provision would allow some reasonable opportunity for any 'upsidedown' properties to be placed on a better financial footing-by the reasonably foreseeable long-run price appreciation that usually causes real estate markets.
ACE also hopes that we can discuss the 80 percent 'hardwired" value of S. 318. Most PMI coverage goes down to a 75 percent value, and for some properties the required coverage goes even deeper. Again, the maximum term of loan half-life, by implicitly mixing price trends and paydowns, may be an advantageous alterative with benefits for both lender and borrower.
Both sides of the loan transaction would also benefit from user- friendly and efficient notification of PMI cancellation options. Obviously, it is appropriate that the borrower begiven specific information as to the conditions under which PMI required and an appropriate notice at the time of the loan closing is completely acceptable. There is a separate issue about certain loans where the borrower elects to have the lender pay for the PMI coverage rather than buy it separately; this approach can have tax benefits to the borrower and discovered in the appendix).
ACB, however, is concerned that the potential required frequency of notices under S.3l8,as filed, may confuse rather than help some customers. There is an obvious case for supplementing that up-front disclosure with periodic reminders. S. 3l8 requires notice in or with each account statement, but not less than annually. The literal language of S. 318 would require many lenders to make monthly disclosures, starting with the first regular payment month. Many institutions have moved from coupon books to monthly statements, even those using direct debit to the borrowers checking account by standing order. Such institutions may then feel obligated to provide the recomputed loan-to-original value ratio if notice is required every month even though, rounded to two decimals, the percentage would not be shifting perceptibly from month to month in the first years.
Simplifying the requirement in S. 318 that the notice be no less than annual could be a more practical approach and enable coordination with other annual reports to consumers such as their federal tax information returns. It would also avoid borrowers becoming unduly affected by the inevitable tendency to skip over 'boilerplate' disclosures that become routine. Also, it would probably be worthwhile to consider giving lenders the option, within any solution to this public policy and consumer issue, of skipping the notices for the first two years of the loan life. Regular amortization is not going to reduce the LTV that quickly and tend to pay more attention when they are given a 'heads-up' that they can potentially really use.
Avoiding the issuance of notices until they are relevant for the consumer will enable this issue to addressed in the most cost effective way. ACB welcomes the initiative in S. 318 to protect both borrowers and servicers from the added costs of providing disclosures. As a practical matter, however, it would still be difficult for a lender/servicer is bound by an existing contract in both cases. For both transition period and the long run, economizing on cost by making the notices visible enough to be useful to the consumer and targeted enough to be manageable on the business in a highly competitive and thin margin market, even these optimal level costs will be borne by the consumer as market pricing adjusts. It is a shared goal that the consumer benefit from these costs be as large as possible.
It is not a trivial task to handle the real world process of notifying customers that price trends have made it worth their while to check whether a reappraisal can justify dropping their PMI. A system is needed to handle the entire process, from setting up the review cycle, ordering the appraisal, collecting the fee, recording the results, determining whether PMI can be canceled (which is not set be an absolutely inflexible pass/fail test at my institution), notifying the insurer of cancellation if that is the outcome, and adjusting the loan file accordingly.
Attached is the step by step work flow from my institution's procedures manual. As I indicated, my institution is willing to be flexible to help a good customer. If the appraisal produces a loan to current value ratio a fraction away from the target ratio, for a customer with a good payment history in a reasonably solid real estate submarket, we will often let the PMI be dropped to avoid the appraisal fee being wasted and having to go through the exercise all over again a year later. We can offer this flexibility as a portfolio lender. When we have sold the loan into the secondary market, as only the servicer we have to work under the investor's standards. This is why we have been eager to work with the GSEs.
As lenders, ACB members find that the driving force in most PMI cancellation request from customers is property price appreciation. The average loan life is less than the period required to bring the loan to original value below the termination threshold by regular amortization alone. Accordingly, ACB had been engaged in private sector efforts. Especially with Fannies Mae, to address this topic in a truly comprehensive way.
ACB again commends the Chairman and the Committee for raising the profile of a real consumer issue. ACB is deeply committed to resolving this issue to the satisfaction of the public and the Congress. We welcome continued Congressional oversight of the lending community's efforts to produce a private sector solution though the standards that actually go well beyond the situations covered in S.318. ACB recognizes that industry efforts must come to fruition very quickly. Legislation early in the Congress is always an option, and the industry approach, to qualify as a acceptable alternative, has to do more. The public deserves no less.
As indicated at various places in this statement, a number of
more technical issues are covered in an appendix. I would be happy to
address any questions that you may have. Thank for this opportunity to
offer our views on this important topic.
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