Industry Letter
Due Diligence Recommendations Concerning the Eligibility of Loan Purchases and Investments for Consideration under the Community Reinvestment Act

July 26, 2001--revised

To the CEO and CRA Officer of the Institution Addressed:

Re: Consideration of Certain Loans and Investments pursuant to the Community Reinvestment Act

The New York State Banking Department ("NYSBD"), as part of its ongoing effort to strengthen compliance with Section 296-a of the Executive Law, New York State’s fair lending statute, and Part 41 of the General Regulations of the Banking Board (Restrictions and Limitations on High Cost Home Loans), has set forth the guidelines below to assist supervised institutions, their subsidiaries and affiliates in determining whether a loan or investment may be eligible for favorable consideration under the Community Reinvestment Act ("CRA"). The Department has concerns regarding sources of funding for predatory lending activities, and therefore reiterates its position that favorable consideration for CRA purposes will not be given for loans or investments that violate federal or state consumer protection laws, including fair lending regulations. Although institutions may receive a non-binding, advisory opinion from the NYSBD regarding the eligibility of a proposed activity for CRA consideration pursuant to Part 76 of the General Regulations of the Banking Board, these loans and investments should also conform to the following guidelines in order to receive favorable treatment in a Performance Evaluation:

• High Cost Home Loan originations by supervised institutions, their subsidiaries and affiliates, in order to receive favorable consideration under the CRA, must comply with Part 41 of the General Regulations of the Banking Board. The Banking Department’s examiners will routinely sample a portion of an institution’s originations in order to determine such compliance.

• Purchases of High Cost Home Loans, if such loans have been made to low and moderate income borrowers or low and moderate income areas and are otherwise eligible for CRA consideration, should be accompanied by documentation in the files of the purchasing lender sufficient to support the fact that a satisfactory due diligence review was performed by it on such loans.

• Investments in mortgage backed securities, if such securities include underlying High Cost Home Loans to low and moderate income borrowers or low and moderate income areas and are otherwise eligible for CRA consideration, should be accompanied by evidence documenting the extent to which a due diligence review was performed by the investor on the underlying High Cost Home Loans.

Institutions are advised to refer to the attached "Due Diligence Recommendations Concerning the Eligibility of Loan Purchases and Investments for CRA Consideration" for guidance.

Nothing in this letter shall affect the status of any loan or investment that has previously been determined to be eligible for favorable CRA consideration. Moreover, this letter and the above criteria should serve only as a general guideline for determining when a loan or investment may be eligible for CRA consideration. Conformity with the above guidelines does not guarantee that any given loan or investment will be awarded favorable CRA treatment, nor does it guarantee that federal or state laws have not been violated.

Supervised institutions are further encouraged to meet their CRA responsibilities by lending directly to qualified prime applicants and by offering affordable, risk-based priced "non-conventional" loans to those who do not qualify for prime credit, as well as by making indirect investments. If you should have any questions about the Community Reinvestment Act or fair lending not addressed in this letter, we invite your written inquiry and would welcome the opportunity to meet with you to discuss your concerns. 

Very truly yours,

Edward B. Kramer
Deputy Superintendent of Banks
Consumer Services Division

The following are guidelines for determining whether a satisfactory due diligence review has been performed in connection with the purchase of loans or investments warranting favorable CRA consideration by the Department. It is not mandatory that every point raised herein be addressed. Neither is this intended as a comprehensive treatment of such factors, since the particular circumstances relating to loan purchase or investment will dictate the scope and breadth of the issues addressed. Rather, it is designed to provide an overview of certain issues that are likely to be common to mortgage loan purchases and investments.

Recommendations:

Purchasers of loans and investors should make commercially reasonable efforts to satisfy themselves that the loans are made by the originating lender in a manner which is consistent with sound practices, and in compliance with applicable federal and state consumer protection laws in all material respects, including:

Federal laws and regulations:

Truth in Lending Act, especially Section 32, referred to as the Home Ownership and Equity Protection Act ("HOEPA") ;
Regulation Z of the Board of Governors of the Federal Reserve System ;
Real Estate Settlement Procedures Act, especially Section 8 thereof;
Equal Credit Opportunity Act; and
Regulation B of the Board of Governors of the Federal Reserve System.

New York State laws and regulations:

Banking Law Article 12-D; (Mortgage Banking)
Parts 38, 41, 80 and 82 of the General Regulations of the Banking Board (Mortgage Banking);
Section 296-a of the Executive Law (Fair Lending);

Due Diligence

Prior to purchasing or investing in High Cost Home Loans, the purchasing lender or investor performing due diligence should consider choosing statistically relevant samples of loans. For each loan in a sample, it may be desirable for the purchasing lender or investor to perform the following "due diligence" steps (which may be undertaken by one or more expert agents):

• Conduct a credit review of loans included in the sample.

Each loan selected for the sample may be evaluated for the following:

• Verification of ability to repay based on current and expected income, current obligations, employment status and other financial resources. This may include the following: review front-end and back-end ratios; calculate the debt to income ratios to determine if they exceed 50%; calculate residual income to determine if it meets or exceeds guidelines published by the Veteran’s Administration; determine that documents in the loan file reflect the income set forth on the loan application; inquire of the originator what it does to verify the existence and accuracy of the borrower’s income; in those instances in which the DTI ratio exceeds 50% or the residual income is less than the VA guidelines, inquire of the originator as to its basis for believing that the borrower could afford to repay the loan. In collateral based lending that is not prohibited by state of federal statute or regulation, originators may legitimately consider other indicators of a borrower’s ability to repay including credit reports, credit scoring or revenue to be derived from income producing property. In those instances, inquire of the originator what it does to ensure that the borrower has the ability to repay the loan.
• Credit history: Attention should be given to whether credit documents are derived from a nationally recognized credit reporting agency and that they cover a suitable time period relative to the origination.
• Appraisal and Loan-to-value ratio: Determine that the loan amount is supported by a property valuation.

• Conduct a compliance review of loans included in the sample.

For each loan selected for each sample, consider the following:

• Review note, mortgage, title, appraisal, settlement and compliance documentation to determine that all documents have been completed properly in all material respects and reveal no obvious irregularities;
• Determine that all disclosures required by law reflect the relevant transaction; that they have been furnished in full, provided in a timely manner and signed by the applicant (where applicable). For relevant disclosures, see Parts 38, 41, 80 and 82 of the General Regulations of the Banking Board, HOEPA, RESPA, and TILA.
• Compare HUD-1 Disclosure Statement concerning all charges assessed in connection with closing of the loan with those listed in the Good Faith Estimate. Inquire of the originator what it does to ensure that duplicate fees are not charged for the same service. Where there is a total difference of ten percent or more on any individual loan, inquire of the originator what it does to determine the validity of the Good Faith Estimate.
• Determine that loan terms (which may include term of loan, annual percentage rate, points, fees, penalties and charges) reflect quality of credit as set forth in the originator’s credit grades.

• Conduct due diligence with respect to the originator(s) of loans included in the sample:

In its review of each originator included in the sample, the purchasing lender or investor should consider including the following:

• Determining that all material required mortgage licenses are up to date.
• Checking regulatory/consumer complaint record of each originator with state licensing authorities.
• Checking for issues/complaints with independent agencies such as Better Business Bureau, public databases and recognized local community and housing groups.
• Conducting appropriate on-site visit(s) of each originator’s operation to review files, policies and procedures, interview key employees and detect consumer complaints by randomly selecting files for review.
• Reviewing each originator’s fair lending policies, procedures and training program.
• Reviewing each originator’s policies regarding payment of "overages", and the setting and/or payment of mortgage broker fees.
• Reviewing each originator’s marketing materials with particular attention to policies and procedures regarding the use of "cold calling" by door-to-door salesman, home improvement contractors as a source of referral, and mass marketing materials aimed at lower income and minority individuals and areas.
• Reviewing each originator’s loans for extent of first-payment defaults, excessive delinquency ratios, and frequency of attempts to exercise right of rescission by customers.
• Obtaining certification from each originator that all loans have been made in compliance with state and federal law.
• Obtaining description of threatened or pending litigation or administrative action or settlement of any charges with any regulatory agency concerning violations of consumer protection laws; or if none exist, a certification indicating the same.