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The Big Chill

By Kari Santos |

Roundtable-Class Action

The Big Chill

The Obama Administration is learning that you can lead a bank to money, but you can't make it lend. Despite billions of dollars in encouragement, the nation's banks - according to the latest Federal Reserve Bank statistics - are sitting on more than $1.1 trillion in excess reserves.

The big credit chill has also affected the ability of homeowners to borrow against the equity in their houses. In better times, homeowners used home equity lines of credit (HELOCs) as virtual ATMs for remodeling, paying college tuition, consolidating credit-card debt, or even starting a small business. But as property values sank through 2009, many lenders cut their potential losses by abruptly freezing or cutting those lines of credit. Now unhappy homeowners are plaintiffs in nearly 20 federal class actions - a dozen of them in California - that allege violations of the Truth in Lending Act (TILA), breach of contract, and, in many cases, unfair business practices.

"Banks took hundreds of billions in taxpayer money and made promises to Congress to get the economy moving by making loans - and they did the opposite, even cutting existing lines of credit. They're hoarding," says Jay Edelson, name partner at Chicago's Edelson McGuire who has filed several of the California class actions.

Under TILA and its implementing rule, Regulation Z, banks - with few exceptions - may reduce a borrower's credit limit only if the value of the property "significantly declines" or there is an adverse material change in the borrower's financial status (15 U.S.C. § 1647(c)(2)(B); 12 C.F.R. § 226.5b(f) (3)(vi)). The Federal Reserve Board generally interprets a significant decline to be a loss of half the borrower's available equity, less the HELOC limit - not half the total assessed valuation, as some homeowners mistakenly assume. In 2008 the Office of Thrift Supervision warned banks that reducing all HELOCs in a geographic area without assessing the specific property securing each line of credit would violate Regulation Z.

Before the Crash of '08, HELOCs were available at modest fees and low rates of interest, which often was tax deductible. But after two years of unprecedented housing devaluation, lenders turned to sophisticated computer algorithms to justify widespread credit cutbacks. According to Frank A. Hirsch Jr., a partner in the Raleigh, North Carolina, office of Alston & Bird who defends financial services companies, the banks relied on automated valuation models (AVMs) in place of traditional appraisals to freeze individual credit lines in entire neighborhoods.

Statistics from the American Bankers Association show that home equity lending dropped nearly $97 billion from 2007 to 2009. Many homeowners who had used HELOCs as a financial lifeline were caught without warning. Consumer Action, a national nonprofit consumer advocacy group, reported that complaints about sudden HELOC freezes tripled in the 18 months prior to January.

Hirsch says the widespread use of computerized appraisal models has never been tested in the courts, and therefore presents a rich mine of legal questions. Among them:

? How reliable are automated valuation models?

? Can banks be required to disclose their testing procedures and results?

? Does TILA's significant-decline provision permit freezes based on computerized models?

Name partner Matthew Butler of San Diego's Nicholas & Butler says one of his clients found that the assessed valuation of his $1.5 million home had actually risen less than a year after Washington Mutual cut his $500,000 HELOC in half. The bank's reappraisals - which were likely computerized - made its bottom line look better and took place just before it sold troubled assets to JPMorgan Chase. "To put it diplomatically, the timing was curious," Butler says.

Litigation filed so far has challenged the adequacy of notice to home equity borrowers, bank fees assessed even after a credit freeze, and the accuracy of automated appraisals. Hirsch says the industry has no standards for automated valuation systems, so banks use a variety of models.

In January a HELOC case brought jointly by the San Diego office of Robbins Geller Rudman & Dowd and Cleveland's Landskroner Grieco Madden caught the attention of U.S. District Judge William Alsup, who denied a motion to dismiss (Yakas v. Chase Manhattan Bank, USA, NA, 2010 WL 367475 (N.D. Cal.)). "It may well be that a licensed appraiser was not required (without so holding), but that does not translate to an allowance of an AVM, much less a mystery AVM whose particulars are totally a secret," Alsup wrote. He directed that priority in discovery go to "learning the particulars of the AVM method."

So far courts have made only a handful of rulings in the lawsuits. Hirsch predicts that TILA and breach of contract claims eventually will be litigated. "Ultimately, the battleground is whether plaintiffs can get class certification," he says. "Banks may be required to turn over information about how AVM methods work, and that may crystallize the class issue."

Two other targets of HELOC class actions, Wells Fargo and CitiBank, declined to comment on the suits. But Mary Berg, a spokeswoman at Wells Fargo's Home Equity Group, the nation's largest residential second lien lender, confirmed the bank serves 2.3 million households and holds $124 billion in its prime home equity portfolio. "We periodically conduct case-by-case reviews of our customers' home equity lines of credit to make sure that the limits on their accounts are in line with their abilities to repay," Berg says. She added that factors considered by the bank can include credit scores, debt levels, payment histories, and changes to the valuation of a homeowner's property.

Consumers' anger over credit line cutbacks shows no signs of abating. In January, for instance, Florida's incoming state senate president called for hearings to investigate claims that banks had arbitrarily or fraudulently reduced HELOCs. But state regulators have few options. "The short answer is no, we're not looking [to investigate] currently," says a state senate banking committee staffer in California who asked not to be identified. "Part of the reason is the enormous challenge of federal preemption."

The Federal Reserve Board has proposed amendments to both TILA and Regulation Z to improve transparency in home equity lending. But plaintiffs attorney Edelson considers the changes so inadequate that in late February he asked the Fed's inspector general to investigate the extent to which lenders had influenced the recommendations. "What is undeniable," he wrote, "is that the proposed rules do little to protect consumers and, instead, make it even easier for banks to wrongfully deny American consumers and small businesses access to their bargained-for lines of credit."

Pamela A. MacLean, a freelance writer based in the Bay Area, has reported on state and federal courts for 25 years.


Kari Santos

Daily Journal Staff Writer

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