| March 27, 2006
Office of the Comptroller of the
Currency
250 E Street, SW
Public Reference Room
Mail Stop 1-5
Washington, DC 20219
Attn.: Docket No. 05-21
|
Regulation Comments
Chief Counsel’s Office
Office of Thrift Supervision
1700 G Street, NW
Washington, DC 20552
Attn.: Docket No. 2005-56
|
Robert E. Feldman
Executive Secretary
Attn: Comments/Legal ESS
Federal Deposit Insurance Corporation
550 17th Street, NW
Washington, DC 20429 |
Jennifer Johnson
Secretary
Board of Governors of the
Federal Reserve System
20th St. and Constitution Ave, NW
Washington, DC 20551
Attn.: Docket No. OP-1246 |
Mary Rupp
Secretary of the Board
National Credit Union Administration
1775 Duke Street
Alexandria, VA 22314-3428
Re: Proposed Guidance – Interagency Guidance on Nontraditional Mortgage Products
70 FR 77249 (December 29, 2005)
Dear Sir or Madam:
America’s Community Bankers (ACB)1 appreciates the opportunity to comment on the
Proposed Guidance – Interagency Guidance on Nontraditional Mortgage Products2
(“Proposed Guidance”) issued by the Office of the Comptroller of the Currency,
the Board of Governors of the Federal Reserve System, the Federal Deposit
Insurance Corporation, the Office of Thrift Supervision and the National Credit
Union Administration (collectively, the “Agencies”).
ACB commends the Agencies for issuing the guidance for comment, as we had
requested. We believe that the experience of bankers that have been making these
types of loans for a number of years will provide valuable insights as the
Agencies continue their consideration of this issue.
Mortgage lending is the central function of many community banks. It is critical
to meeting the needs of their communities and it is essential to the health of
the American economy. For many decades, community mortgage lenders have offered
and consumers have chosen alternative mortgage products3 that differ from 30-year
fixed interest rate mortgages.
When properly underwritten, alternative mortgage products, including those with
payment options that can result in negative amortization, confer benefits to
both financial institutions and homebuyers. The American consumer could suffer
greatly from any guidance that imposes unduly restrictive standards on the use
of these mortgage products. Such restrictions could result in lenders being less
willing to offer alternative mortgage products and this would severely limit the
flexibility in financing options that consumers enjoy today. Financial
institutions also benefit from varieties of ARM products because they protect
institutions from the interest rate risk associated with holding long-term,
fixed rate mortgages in their portfolios.
ACB Position
ACB appreciates the Agencies’ concern that the industry’s underwriting standards
at some institutions may have been relaxed at the same time that real estate
markets, in some areas, are showing signs of cooling. We agree that institutions
must use care and prudent practices to originate alternative mortgage products
and to manage portfolios containing these products, but we do not believe it is
necessary to issue guidance to depository institutions to reiterate these
points. If the Agencies, nevertheless, deem it appropriate to issue a final
guidance, we believe that several revisions are needed to avoid excessive
regulatory burdens and restrictions that would hamper the ability of depository
institutions to offer the widest array of products available to serve all of
their customers appropriately. In this comment letter, we explain our
recommendations for these revisions to the Proposed Guidance.
We believe that the types of mortgages that are the subject of the Proposed
Guidance should be referred to as “alternative” mortgages instead of
“nontraditional” mortgages. For many institutions, these products are not
“non-traditional” because they have been offering these products successfully
for many years. In fact, Congress authorized and encouraged origination of
“Alternative” mortgages when it passed the Alternative Mortgage Transaction
Parity Act of 1982.4
ACB opposes a one-size-fits-all approach to originating and managing alternative
mortgage products. Institutions may have unique and well-managed mortgage
operations, which are safe, sound and appropriate. We believe the Agencies
should continue to evaluate each institution individually to identify portfolio
risks.
ACB believes that when underwritten appropriately, alternative mortgages do not
pose undue risks, either singly or in combination. ACB believes that lenders can
protect themselves against market downturns through careful management and
sensible underwriting practices. Thus, ACB believes that restrictive standards
on the use of these mortgage products are unnecessary for regulated financial
institutions.
We are also very concerned that the imposition of restrictive guidelines on
insured depositories might force such institutions to cease making these types
of loans, leaving non-regulated lenders and brokers as the only providers. These
entities do not undergo bank-like examination and supervision and have used
these products, in some cases, to get borrowers into homes they could not
otherwise afford. Restrictions on regulated financial institutions would do
nothing to control the practices of these non-regulated entities.
While we support appropriate disclosure to potential borrowers about the terms
of these alternative mortgage products, we have concerns about the way the
Agencies address disclosure in the Proposed Guidance. We believe that the safety
and soundness of regulated institutions should be the paramount concern of the
Agencies. The Proposed Guidance, however, extends into the notion of requiring
lenders to determine the “suitability” of mortgage products for the individual
consumer. While it is the lender’s responsibility to provide borrowers with
sufficient information for them to clearly understand the loan terms and
associated risks, we do not believe it is appropriate or possible for the lender
to identify or dictate the best mortgage product for individual consumers. One
borrower may place a higher priority on retiring of debt, while another may
place a higher priority on current cash flow.
Our explanation for these recommendations follows. In addressing the Proposed
Guidance, we have segmented our comments into four areas: Loan Terms and
Underwriting Standards; Portfolio and Risk Management; Consumer Protection; and
Questions Posed by the Agencies.
Loan Terms and Underwriting Standards
As is the case with all types of lending, the most important component is the
underwriting. The guidelines in the Proposed Guidance for loan terms and
underwriting standards generally are consistent with the current practices of
most of ACB’s members. However, we are concerned that the Agencies’ approach is
too prescriptive and could limit appropriate use of alternative mortgage
products.
For many ACB members, the loans designated in the Proposed Guidance as
“non-traditional” actually are mortgage products that they have originated for
decades and which have been long-term staples in their portfolios. Negative
amortization home loans have been in wide use in some markets since the early
1980s with no increased incidence of non-performance or default. These products
create unacceptable risks only when not underwritten properly, just as with
fixed rate mortgages. The regulators have been examining banks that have been
originating such loans over this same long period.
Increased flexibility in mortgage loan features does not equate to greater risk.
Alternative mortgage products can reduce, rather than increase, risks to lenders
and borrowers if they are properly managed. Holding ARMs, including IOs and
Option ARMs, in portfolio is a long-standing method for institutions to manage
risks associated with fluctuating interest rates. The lower minimum monthly
payment associated with IOs and Option AMRs also may reduce risk, because they
keep mortgage payments affordable during periods of temporary financial
difficulties, or seasonal income cycles, or when interest rates are rising.
The Proposed Guidance warns against making loans based on collateral value
alone, and irrespective of the borrower’s demonstrated ability to repay a loan.
We agree with the general concept that there should be balancing factors when a
lender accepts a lesser level of documentation and we believe that examiners
should evaluate all elements of a lender’s criteria in determining whether a
specific program feature, such as a relaxed documentation requirement, is
justified.
Further, we believe that equity is a key determinant of risk and, therefore, we
do not believe the Agencies should issue any blanket admonition against lending
to borrowers who cannot demonstrate a particular income level. ACB agrees with
the provision in the Proposed Guidance that loans with short-term “teaser” rates
should be underwritten at the fully indexed rate. That is consistent with
current industry practice. However, this concept should not be extended to
require all loans to be underwritten assuming an increase in the balance because
if the borrower makes the fully-indexed payments that he is qualified to make,
the loan balance will not increase.
We generally agree that underwriting standards should address the impact of
substantial payment increases on the borrower’s ability to repay an ARM loan.
However, the Proposed Guidance makes no distinction between loans with different
lengths of time to the first adjustment. The length of time until a borrower’s
payment adjusts is a very important consideration for loan underwriting. We
believe that the Agencies should recognize that ARMs, with or without negative
amortization, that have a long time to the first payment adjustment pose
substantially less risk than mortgages with a short period until payment
adjustment. For example, loans with a 10-year interest-only period should be
treated differently from loans with a three-year interest-only period. Within a
10-year period, there is a high likelihood that a borrower will sell his home or
refinance the original ARM loan. There is also a high probability that within a
10-year period, the property securing the mortgage will increase significantly
in value.
The Agencies’ concerns about tighter underwriting standards for Interest Only
and Option ARMs may be unwarranted. Our members report that borrowers with
Interest Only and Option ARMs tend to have higher incomes and higher FICO scores
than borrowers with traditional mortgages. The Proposed Guidance also cautions
lenders to assume that borrowers make only minimum payments during the deferral
period when calculating the amount that the loan balance can increase. There is
no evidence to support this assumption. While no aggregate database exists for
alternative mortgages at this time, our members have reported that such
alternative mortgage loans are amortizing more quickly than traditional
mortgages. This would suggest that these alternative mortgage borrowers are
making much more than minimum payments.
When assessing an institution’s exposure on mortgages with simultaneous
second-lien loans, the Agencies should consider all mitigating factors,
including whether the institution has retained all the risk or sold or insured a
portion of it. For example, a home purchase financed with an interest-only
adjustable rate loan for 80 percent of the purchase price combined with a second
trust for the remaining 20 percent of the purchase price could be a prudent
lending practice if, for instance, the lender sells the second trust to an
investor or obtains mortgage insurance on it. Broad prohibitions on such
financing should not be part of the guidelines.
Portfolio and Risk Management
ACB generally agrees that the proposed guidelines for the management of an
institution’s portfolio risk are prudent. However, like the guidelines for
underwriting, they are too prescriptive and broad in scope. They do not take
into account the experience and management practices of lenders that have been
originating and holding these alternative products for many years. As noted
above, many lenders have held large concentrations of mortgages with negative
amortization for decades through periods of economic difficulties without
negative consequences.
We believe that the Agencies should continue to evaluate on a lender-by-lender
basis the existing risk management processes of each financial institution for
the identification of portfolio risk segments and the setting of concentration
limits. We oppose the Proposed Guidance’s insistence that concentration limits
be set for certain loan types, for loans with certain characteristics, and for
loans acquired through third parties. We agree that concentrations should be
monitored for riskier exposures and that some level of portfolio diversification
may be appropriate for some institutions. This monitoring can be done in the
form of concentration triggers that result in a management response, rather than
limits set down as part of board policy. These concentration triggers should be
based on each institution’s portfolio and business model.
The Proposed Guidance prescribes stress testing of key performance drivers such
as interest rates, employment levels, economic growth, housing value
fluctuations, and other factors beyond the control of the institution. ACB
believes that depository institutions already generally employ adequate risk
management practices appropriate for the size of their institutions. Therefore,
the Agencies should allow flexibility in this area and not impose stress-testing
guidelines that necessitate sophisticated financial software and databases where
they may not be warranted.
Stress tests should make “reasonable” worst-case assumptions for default and
run-off rates. The Proposed Guidance should make clear that the need to consider
the borrower’s ability to absorb higher payments does not require unrealistic,
worst-case assumptions about the whole portfolio. Lenders should be able to
consider realistic ranges of default rates and prepayments in their stress
testing.
The Proposed Guidance states that “… the repurchase of mortgage loans beyond the
selling institution’s contractual obligations is, in the Agencies’ view,
implicit recourse” and that “under the Agencies’ risk-based capital standards,
repurchasing mortgage loans from a securitization in this manner would require
that risk-based capital be maintained against the entire portfolio or
securitization.” If an institution decides to repurchase loans because it is in
the best interest of the business at the time and not due to contractual
recourse, we do not believe the entire portfolio should be considered to have
implicit recourse. The Agencies should not impose such recourse when it does not
legally exist between the principals to the transaction (i.e. the buyer and
seller). This aspect of the Proposed Guidance could have unnecessary, negative
ramifications for all regulated institutional lenders regarding their capital
requirements.
Consumer Protection
ACB believes that lenders should provide consumers with sufficient information
so they clearly understand the loan terms and features associated with all
mortgage products, including alternative mortgages. In fact, through regulations
such as Regulation Z5 and Regulation X6 , the regulators already have the
authority to require appropriate disclosures. Therefore, we have several
concerns about the way in which the Proposed Guidance addresses consumer
protection.
In order for disclosures to be effective, they must be received and understood
by consumers before they accept the loan. However, as with other aspects of this
proposal, we are concerned that these disclosures will only apply to regulated
depository institutions, while leaving consumers exposed to misleading claims by
less regulated entities. Any mandate for new, more elaborate disclosure
requirements should apply to all lenders. To accomplish this, any new mortgage
disclosure requirements should be implemented with amendments to Reg Z, the
regulations implementing the Truth in Lending Act.7 The Proposed Guidance should
not call for special disclosures for alternative mortgages that effectively
amend Reg Z only for insured depository institutions. We understand that the
Federal Reserve Board intends to initiate a review of Reg Z this summer and we
recommend that any changes in disclosure requirements be considered as part of
that review.
Further, we find the disclosure guidelines in the Proposed Guidance too detailed
to be easily understood by consumers. It would be useful for the Federal Reserve
Board to consider disclosure requirements that are simple, understandable
statements of the crucial terms of the mortgage.
The Proposed Guidance also suggests mystery shopping and call monitoring as good
methods to ensure that appropriate information is being given to consumers.
While lenders should have in place appropriate techniques as part of an overall
compliance program, we believe lenders should be given broad discretion to use
methods that are effective for their operations. For example, we understand that
mystery shopping has diminished in popularity, while programs for training loan
officers have become more common, as a means to maintain compliance.
The Proposed Guidance calls for institutions to monitor third-party originated
loans to ensure compliance with the institutions’ policies and procedures
regarding disclosures. ACB believes that it is not possible for institutions to
monitor the disclosure practices of brokers and correspondents to the same
extent as employees. What regulated institutions are able to do is control the
disclosures provided in conjunction with the settlement transaction. Also, the
Proposed Guidance seems to imply that this disclosure monitoring requirement is
not limited to the third-party originators and the regulated institutions that
buy the loans, but to subsequent purchasers of the mortgages, including
secondary market purchasers, such as Fannie Mae and Freddie Mac, that have no
mechanism to police all the activities of third parties.
It is also impractical to require lenders to provide disclosure documents to
borrowers while they are “shopping.” A typical mortgage broker offers products
from many lenders, and during the “shopping period,” it is impossible to
determine which lender ultimately will fund the loans.
Questions posed by the Agencies
In the Proposed Guidance the Agencies specifically request comments on three
sets of questions. The questions and our responses follow:
| Question 1: |
Should lenders analyze each borrower’s capacity to repay
the loan under comprehensive debt service qualification standards that
assume the borrower makes only minimum payments? What are current
underwriting practices and how would they change if such prescriptive
guidance is adopted?
|
| Answer: |
As noted above, we do not believe it is necessary to
assume that every borrower would make only minimum payments over the
life of the loan. The experience of ACB members does not seem consistent
with this assumption.
We believe that it is current industry practice for institutions to
underwrite loans with short-term teaser rates to the fully indexed rate.
We do not think there should be a requirement for all loans to be
underwritten assuming fully amortized payments. Similarly, we believe it
is unreasonable and unnecessary to assume worst-case scenarios for all
loans and that requiring an assumption that all borrowers make only
minimum payments would significantly inhibit institutions’ willingness
to make these loans.
|
| Question 2: |
What specific circumstances would support the use of the
reduced documentation feature commonly referred to as “stated income” as
being appropriate in underwriting alternative mortgage loans? What other
forms of reduced documentation would be appropriate in underwriting
alternative mortgage loans and under what circumstances? Please include
specific comment on whether and under what circumstances “stated income”
and other forms of reduced documentation would be appropriate for
subprime borrowers.
|
| |
|
| Answer: |
This question appears to reflect the Agencies’ opinion
that combining an alternative mortgage product with other alternative
features automatically involves “layering” of risk, rather than an
assessment of separate risks. The use of “stated income” in combination
with an alternative mortgage product such as an IO or Option ARM is a
good example of why this might not be true. “Stated income” is often
used to spare self-employed borrowers from onerous documentation
requirements, in situations where other factors, such as credit score or
down payment, indicate low risk. A lower payment during the early years
of the loan, a common feature of alternative mortgage products, allows a
self-employed borrower to devote resources to building a business rather
than to paying down a mortgage and makes it easier to cope with an
uneven cash flow. This example shows that, in some instances, an
alternative mortgage combined with a “stated income” mortgage may be
less risky than “stated income” loans combined with a traditional ARMs
or fixed-rate mortgages.
Generally, ACB does not believe “stated income” and other forms of
reduced documentation would be appropriate for subprime borrowers.
|
| |
|
| Question 3: |
Should the Guidance address the consideration of future
income in the qualification standards for alternative mortgage loans
with deferred principal and, sometimes, interest payments? If so, how
could this be done on a consistent basis? Also, if future events such as
income growth are considered, should other potential events also be
considered, such as increases in interest rates for adjustable rate
mortgage products?
|
| |
|
| Answer: |
Generally, institutions do not assume increases in
future income when underwriting a mortgage. We do not believe this could
be done on an accurate or consistent basis. We also do not believe that
institutions should be expected to consider repayment ability far into
the future for traditional or alternative or types of mortgages. This is
unnecessary for proper risk management. |
Conclusion
ACB believes that the financial health of regulated institutions should be the
main concern of the Agencies. Prudent underwriting, careful portfolio management
and informed borrowers are factors essential to the safety and soundness of
lending institutions. The Proposed Guidance seeks to ensure that insured
depository institutions have adequate controls to make certain that these
factors are applied to their alternative mortgage portfolios. We do not believe
the Proposed Guidance is necessary because depository institutions already
employ sufficient controls to confirm that these necessities are fulfilled.
However, if the Agencies intend to issue a final regulation on alternative
mortgage instruments, it should be substantially modified before adoption. We
believe that the Proposed Guidance imposes excessive regulatory burdens and
restrictions that may impede an insured depository institution from offering the
widest array of products available to serve their communities responsibly,
without demonstration of a corresponding benefit to consumers.
Prudent underwriting practices are the first line of defense against portfolio
risk. Regulated financial institutions already protect themselves adequately
against market downturns through responsible underwriting practices and sound
portfolio management. Therefore, we oppose the imposition of such restrictive
standards on the use of alternative mortgage products by regulated institutions.
We also believe that it is unreasonable to impose on insured depository
institutions restrictive guidelines for alternative products that do not apply
to non-regulated brokers and lenders.
We strongly support simple, informative disclosure of all loan terms to all
consumers by all lenders. We believe that the types of disclosure prescribed in
the Proposed Guidance are unnecessarily complicated and would impose an undue
burden on insured institutions that would not apply to other lenders. In order
to make proper disclosures applicable to all lenders, we recommend that any new
mortgage disclosure requirements be implemented with amendments to Reg Z. The
Agencies should not attempt to make lenders responsible for determining the
suitability of mortgage products for individual consumers. Consumers are
protected by a comprehensive array of existing federal and state laws and
regulations.
ACB appreciates the opportunity to comment on this important matter. If you have
any questions, please contact Janet Frank at 202-857-3129 or via email at
[email protected], or Patricia
Milon at 202-857-3121 or via email at
[email protected].
Sincerely,
Diane Casey-Landry
President & CEO
1America’s Community Bankers is the member driven national trade association
representing community banks that pursue progressive, entrepreneurial and
service-oriented strategies to benefit their customers and communities. To learn
more about ACB, visit
www.AmericasCommunityBankers.com.
270 Fed. Reg. 77249 (December 29, 2005)
3As defined by the Agencies, these products include Interest Only ARMs (“IOs”),
Hybrid ARMs, Option ARMs, and mortgages with relaxed requirements for verification of income.
412, U.S. C , sec. 3801 et seq.
512 CFR Part 226
624 CFR Part 3500
715 U.S.C. 1601 et seq.
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