PREDATORY LENDING:  PENSION FUNDS

Definition:

Predatory lending encompasses a variety of subprime lending practices.  The Woodstock Institute and the High Risk Home Loan Act in Illinois define predatory mortgage lending as follows:

  

• Excessive fees and interest rates (beyond those necessary to cover costs and reasonable, risk-adjusted returns)
• Marketing which may be misleading, high-pressure or fraudulent
• Packing and financing of unnecessary fees such as credit life insurance
• Frequent refinancing with repeated incursion of new fees which are rolled into the new loan (flipping)
• Terms which trap borrowers into unaffordable financing such as balloon payments and prepayment penalties
• For a first lien, exceeds the yield on U.S. Treasury securities (yield) by 6 percentage points
• For a second lien (or other liens), exceeds the yield by 8 percentage points
• Has points and fees which exceed the greater of $800 or 5% of the total loan

These practices threaten homeownership, especially among lower-income communities.  They threaten the stability of neighborhoods and wealth creation through homeownership.

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Regulatory Environment:

The regulatory environment surrounding predatory lending has led to increased concern in the issue.  A dual regulatory environment exists in which the Federal government is responsible for regulating national financial institutes and states are responsible for regulating state institutions.  The State of Illinois attempted to address the issues of predatory lending in 2003 by passing the High Risk Home Loan Act; however, the state cannot regulate national banks doing business within Illinois.  The predatory lending discussed here deals with home equity loans and refinancing.  Federal legislation has been focused on initial loans to buy houses.  Consequently, national financial institutions are exempt from regulations of predatory lending.

Effect on Pension Funds:

Illinois has over 600 public pension funds with assets for approximately $116 billion.  Speaker Madigan sent a letter to these pension funds earlier this year encouraging them to adopt policies regarding predatory lending.  Financial institutions would have to certify that they are not engaged in any predatory lending practices.  Conservatively, 22% of the investments of the large state pension funds and over 22% of the smaller police and fire pension funds may be affected by predatory lending certification requirements.

There are concerns over how financial institutions would or will respond to a request for certification.  If they refuse to submit to certification, pension funds will have to decide how they exercise their fiduciary responsibility.

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Resources

• Predatory Lending White Paper, The Association of Illinois Public Retirement Systems (pdf)
• Sample Predatory Lending Policy with Certification Form (pdf) or (doc)
• Predatory Lending Questionaire (pdf) or (doc)

More Information:

• Learn more about predatory lending from the Woodstock Institute
• View the High Risk Home Loan Act
• Read about Speaker Madigan’s letter to Pension Funds
• Discuss predatory lending policies on the IGFOA Bulletin Board (members only)