Nontraditional Loan Regulation & the Secondary Market

Relevant financial institutions and examining personnel were asked to submit their comments to 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.

The proposed guidance discussed “the importance of carefully managing the potential heightened risk levels created by” nontraditional loan products, such as interest-only loans and adjustable rate mortgages with payment options.

The agencies have proposed assessing a borrower’s ability to repay the loan and any accumulated negative amortization beyond the introductory period once the rate is fully indexed. In addition, the regulators suggest mortgage bankers recognize that certain nontraditional loan products are “untested in a stressed environment and warrant strong risk management standards as well as appropriate capital and loan loss reserves.” The agencies would also like to see that proper disclosures are given to ensure the loan terms and associated risks with these types of loans are clearly understood by the borrower.

Regarding that risk, the Bond Market Association said, “If a particular loan attribute does increase risk, lenders should have flexibility in deciding how to establish mitigating factors to account for additional risk.”

Several respondents commented on the lack of secondary marketing guidance and hoped the agencies would address it more thoroughly in their final issuance — with most agreeing that a guidance from the agencies was welcomed.

The bond group addressed the topic of third party originations by stating that they believed the guidance “should give no direct or indirect support for the theory of assignee liability where loan purchasers would be held legally for the acts, errors, or omissions of the creditors from which they purchase closed and independently funded loans.”

On the other end of the spectrum for third party originations, IndyMac Bank’s chief risk officer, Ruthann Melbourne, told the agencies, “It is not our role to be the regulator for the third-party originators.”

Melbourne said that any deficiency in the Truth In Lending laws “should be addressed through changes in the laws themselves, not indirectly and partially through restrictions on only those loans that are made by or through regulated institutions.

“Current disclosure requirements are ineffective, and as a result, we believe additional disclosures are appropriate and necessary,” Melbourne said.

He added that the agencies could enhance compliance and reduce mortgage fraud by developing a database of individuals and companies in the mortgage industry (including vendors) who have been party to lawsuits involving fraud or other illegal issues.

A few of the comments stressed concerns of over-regulation, while others felt there is a need for new or enhanced borrower disclosures.

In a letter to the agencies David Schneider, Washington Mutual Home Loans’ president, wrote that the “guidance should avoid prescribing specific criteria for different loan types and purposes, and would better capture industry practices and promote responsible innovations if it addressed the broader issue of borrower ability and willingness to pay.”

In other words, he said, the guidance should not interfere with a lending institution’s business model and pricing strategy as long as the products are fair to consumers, and are “safe and sound.”

The Mortgage Bankers Association said the “creation of guidance on nontraditional mortgage products is a positive development given increasing consumer interest in these products and the increasing number of lenders offering such products to meet this consumer demand,” but added that it was “overly prescriptive in mandating special underwriting standards.”

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Regulation of Nontraditional Loans Proposed
Proposed regulations on less traditional mortgages drew sharp criticism from banking and mortgage groups.