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We really appreciate your efforts on this. It is my understanding that Representative Shannon is introducing a bill in the House that will do essentially the same sort of thing. We wish you well in your efforts.

Senator DANFORTH. Thank you very much, Mr. Willoughby.
[The prepared written statement of Mr. Willoughby follows:]

Statement
of the

National Association of Mutual Savings Banks

on

S. 1147, Mortgage Debt Forgiveness Tax Act of 1983

before the

Subcommittee on Taxation and Debt Management

of the

Committee on Finance

United States Senate
May 27, 1983

Summary of Principal Points

Although the savings bank industry is experiencing a modest recovery in the present economic climate, it remains very vulnerable to increases in interest rates. The root cause of past problems and current concerns is the industry's extensive holdings of low-yielding, fixed-rate mortgages.

Many institutions have embarked on programs designed to encourage borrowers to prepay these older mortgages by providing the borrower with a "discount" for paying off the loan prior to its scheduled due date.

Existing tax policy, however, imposes a serious penalty on the

borrowers participating in such programs and thus acts as a major disincentive to consumer acceptance. The IRS has issued rules describing the income tax consequences of a typical situation where a homeowner prepays the mortgage in exchange for a discount, and has ruled that the discount must be treated as taxable income (Revenue Ruling 82-202).

S. 1147 would address this situation by overturning the IRS ruling that the discounted amount is to be treated as income to the taxpayer. The savings bank industry strongly supports S. 1147 and similar legislation to remove the Internal Revenue Code barriers to the successful operation of programs to encourage the prepayment of low-yielding mortgages.

We believe that the preferable approach is to provide complete forgiveness of the discounted amount of the prepayment. This approach would be simple for the lender to explain, the borrower to understand and the IRS to

administer, thereby contributing materially to the marketability of prepayment

programs.

Statement
of the

National Association of Mutual Savings Banks

on

S. 1147, Mortgage Debt Forgiveness Tax Act of 1983
before the

Subcommittee on Taxation and Debt Management

of the

Committee on Finance

United States Senate
May 27, 1983

Mr. Chairman, members of the Committee, my name is Keith Willoughby. I am President of the Mutual Bank For Savings, Boston, Massachusetts, and am appearing today on behalf of the National Association of Mutual Savings Banks (NAMSB).

NAMSB is the trade association of the nation's savings bank industry. Located primarily in the New England and Mid-Atlantic states, savings banks are community-oriented financial institutions. In the areas where they are

most heavily concentrated, savings banks are the largest holders of consumer savings, as well as the dominant mortgage lenders among the various types of depository institutions.

Later this year, NAMSB will be merging with the National Savings and Loan League which represents a large number of savings and loan associations located primarily in the Southern and Western states, and I would like to point out that this statement also represents the views of the National League. The total assets of institutions to be represented by NAMSB and the National League are in excess of $350 billion.

We appreciate this opportunity to testify on S. 1147, the Mortgage Debt Forgiveness Tax Act of 1983, and related bills dealing with the discharge of mortgage indebtedness. Although the thrift industry is experiencing a

modest recovery in the current, more favorable, economic climate, it remains very vulnerable to increases in interest rates. The problems experienced by

the industry in the high interest rate environment of the recent past and the cause of our continued concern center on our extensive holdings of low-yielding mortgages. The savings bank asset structure, for example, remains heavily concentrated in long-term, fixed-rate mortgage loans acquired in earlier years. Three-fourths of total savings bank residential mortgages bear rates below 10 percent, and more than one-half of our loans have rates below 9 percent. Savings banks need a lengthy period of relatively low and stable interest rates to work off low-yielding mortgages and thereby generate the earnings needed to compete in a deregulated environment.

To augment this effort, many institutions have embarked on programs designed to encourage borrowers to prepay these older, low-yielding mortgages. Under such programs, the lender agrees to accept an amount less than the total due on the mortgage loan if the borrower agrees to prepay the loan in full, or to substantially increase the monthly payments (and thereby pay the loan back sooner). In short, the borrower is given a "discount" for paying off his loan prior to its scheduled due date.

To date, however, such programs have met with only mixed success. In addition to tax considerations which I'll address in a moment, the great disparity between open-market rates and the mortgage portfolio yields that existed during the 1980-82 period tended to discourage both lenders and borrowers. Lenders already hard pressed--could ill afford to offer the large discounts necessary to attract borrowers into prepayment programs. At the same time, borrowers were enjoying an unprecedented rate of return on their liquid assets and thus were reluctant to give up these yields to "buy out" the principal amount of their mortgages even at a healthy discount.

While it is true that the "gap" between market rates and mortgage portfolio rates has narrowed, this should in no way lessen the important role

which prepayment programs can play in enhancing the competitive posture of the thrift industry. To the contrary, the narrower "gap" may well make such programs more marketable, and it should be kept in mind that the restructuring needs of the thrift industry call for eliminating not just low-yielding mortgages, but also those fixed-rate loans that may be in the middle range of investment returns. Thus, the introduction of S. 1147 and these hearings are extremely timely.

These bills address a most critical component in making prepayment programs feasible. It is obvious that in order for a program of this kind to be a success, it must offer benefits to both parties. Existing tax law, however, imposes a serious penalty on the borrower, and in turn, acts as a major disincentive to consumer acceptance. Section 61(a)(12) of the Internal Revenue Code states that the gross income of a taxpayer includes income from the discharge of indebtedness. exceptions to this rule, but these do not cover the types of transactions we are discussing this morning. In fact, the IRS has issued rules describing the income tax consequences of a typical situation where a homeowner prepays the mortgage in exchange for a discount, and has ruled that the discount must be treated as taxable income (Revenue Ruling 82-202).

Section 108 of the IRC provides certain

S. 1147 would address this situation by providing an additional exception to the general rule of IRS Section 61(a)(12) and, in effect, overturn the IRS ruling. The savings bank industry strongly supports S. 1147 and similar legislation to remove the Internal Revenue Code barriers to the successful operation of programs to encourage the prepayment of low-yielding mortgages. Such a step not only represents a more logical tax policy, but with banking deregulation proceeding apace, government policy should clearly include maximum incentives for asset restructuring by the thrift industry.

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