On Dec. 24, Fitch's press release ('Fitch Ratings Comments On Recent Predatory Lending Legislation', available on the Fitch Ratings web site at 'www.fitchratings.com') stated that it had begun a review of recently passed predatory lending legislation to better understand its implications. As with any loan or security analysis, Fitch's approach has been to analyze the relative frequency and severity of a particular loan in order to determine the overall risk factor associated with that loan. The current legal issue concerning predatory lending presents unique challenges to adequately assess the frequency and severity, and ultimately the risk, to a securitization. For example, certain legislation provides an assignee liability clause that adds all parties associated with the trust to the list of potential defendants in a litigation case.

In analyzing severity, Fitch reviewed several different examples of relevant legislation to better understand predatory lending laws. Certain legislation includes the potential for unlimited liability for certain claims. For example, in the GFLA, as it exists today, a court has the ability to establish unlimited damages for punitive purposes. In order to gauge the range of potential damages, Fitch analyzed 20 settled predatory lending cases over the last 10 years. It was determined that damages, on average, have been $76 million per case (ranging from $1 million to $420 million). It should be noted that the majority of these cases were class action lawsuits so it is difficult to extrapolate the damages paid on an individual suit. However, in a recent case, a single borrower sued a lending organization for $100,000 for predatory practices, and was awarded $6 million by the judge.

Upon considering the elements of uncapped assignee liability discussed above, along with Fitch's findings on the potential magnitude of losses resulting from actual claims of predatory lending, Fitch believes that these trusts may be subjected to significant losses, which cannot be determined or estimated in advance. The most effective manner to protect securitizations from this risk is to eliminate exposure to laws relying upon assignee liability clauses.

The frequency with which transactions will be exposed to any lawsuit and potentially subsequent losses is dependent upon many factors. In theory, originators have the ability to fully comply with predatory lending legislation, and expectations for a potential claim to occur could be zero. Fitch contacted 25 originators to further understand the challenges they face to comply with these laws. Originators believe they have implemented procedures that would support their ability to originate loans in compliance with all laws and provide standard representations and warranties in their securitization documents. However, Fitch believes that originators may have a potential to make errors and originate loans that may inadvertently fail to be in compliance with certain laws. The previously mentioned study of 20 settled claims cases supports this concern as each institution would have had policies in place which it believed would have complied with the then existing laws. Therefore, when the compliance law includes an assignee liability clause, Fitch believes a meaningful risk to the transaction exists and would expect some frequency of loss.

Various predatory lending laws may be segregated into different categories pursuant to certain aspects of the legislation. Fitch has the greatest concern with those laws that exhibit assignee liability clauses combined with unlimited severity (such as the Georgia Fair Lending Act, as of Oct. 1, 2002). Therefore, Fitch has concluded that it would not rate transactions with loans subject to the GFLA as it exists today.

Municipalities which may have assignee liability clauses but which contain limited severity (such as New York State Lending Act as of April 1, 2003, and the recently amended New Jersey State Lending Act which has not yet been finalized) would place an upper boundary on the possible losses. The need to quantify this amount is important to any bond analysis. Fitch would analyze each situation pursuant to the particulars of the respective legislation, including the likelihood of an occurrence (the frequency) and the severity of loss on that loan and ultimately the security. While not a rating issue, the level of risk assigned to each affected loan may be high enough that it could effectively not allow for the economic origination and securitization of that loan.

Municipalities which do not have assignee liability clauses present reduced risks to the securities. Although potential damages may or may not be capped, the impact to securitizations is most similar to that associated with any other transactions with which Fitch has concerns in respect to compliance laws. While Fitch does not anticipate these securities will directly bear the risk of noncompliance, Fitch continues to be concerned about the potential impact to originators and servicers as in the past.

As part of its survey, Fitch discussed the policies and procedures which originators implemented in response to the GFLA. During these discussions, Fitch placed particular emphasis on loans that are in securitizations that Fitch has already rated and are subject to the GFLA. Since Oct. 1, 42 prime, Alt A, and subprime transactions have been rated by Fitch that contain Georgia loans subject to the GFLA, representing in aggregate $148.6 million and 973 loans. The transactions range from as few as 1 GFLA loan to as many as 248 GFLA loans. Fitch continues to monitor current developments with regard to the GFLA including the myriad proposed revisions which range from revoking the Act in its entirety to adding a cap to the liability. Fitch will review all affected transactions pursuant to the GFLA as revised, and any other regulatory developments, and will make any rating changes, as necessary.

Source: Fitch Ratings