Industry Letter

Statement on Subprime Mortgage Lending

May 25, 2007

TO: The Institution Addressed

RE: Guidance Statements on Mortgage Lending Standards

In support of its continuing initiatives to protect consumers and promote responsible lending standards, the New York State Banking Department is advising supervised mortgage bankers and mortgage brokers of the following:

  1. The Department’s adoption of the Guidance on Nontraditional Mortgage Product1 Risk developed in cooperation with the Conference of State Bank Supervisors (CSBS) and the American Association of Residential Mortgage Regulators (AARMR) dated November 14, 2006. A copy of the adopted CSBS/AARMR guidance is included with this letter and is also available on the Department’s website.
  2. The proposed Interagency Statement on Subprime Mortgage Lending, which was issued by the federal regulators on February 28, 2007 and is available at http://a257.g.akamaitech.net/7/257/2422/01jan20071800/edocket.access.gpo.gov/2007/07-1083.htm.
  3. The Interagency Statement on Working with Mortgage Borrowers, which was released on April 17, 2007 and is available at http://www.fdic.gov/news/news/press/2007/pr07032a.html.

Adoption of the CSBS/AARMR Guidance on Nontraditional Mortgage Product Risk

Nontraditional mortgage products present unique risks, including risks due to the lack of principal amortization and the potential for negative amortization. While these products have always existed in the marketplace, these products are increasingly being offered to a wider range of consumers who may be unaware of all the unique product features and associated risks. This newly adopted guidance is designed to protect consumers and to offer mortgage providers sound strategies for managing their operations.

The federal regulators have also responded to the concerns presented by nontraditional mortgage products. On October 4, 2006, 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 published final guidance in the Federal Register (Volume 71, Number 192, Pages 58609-58618). These federal guidelines apply to all banks and their subsidiaries, bank holding companies and their non-bank subsidiaries, savings associations and their subsidiaries, savings and loan holding companies and their subsidiaries, and credit unions.

The guidance developed by the CSBS/AARMR, however, applies to state-licensed mortgage bankers and mortgage brokers. This parallel guidance substantially mirrors the federal interagency guidance, except that it does not include those sections of the federal interagency guidance primarily applicable to depository institutions or relating to institutional fiscal soundness. In considering the institutional risks involved with nontraditional mortgage products, mortgage bankers in particular are reminded of the critical importance of maintaining information reporting systems that provide senior management with sufficient data to monitor pipeline and portfolio quality. The Department expects its supervised institutions to ensure that risk management principles are sufficiently robust to withstand unanticipated demands for repurchases from investors. While this topic is outside the scope of the CSBS/AARMR guidance, it remains a point of emphasis for the Department. Through the endorsement of the CSBS/AARMR guidance, the Department is ensuring that all institution types that provide residential mortgage loans will be subject to consistent regulatory standards.

The following lending practices are highlighted in the guidance as presenting increased risk, both to consumers and to lenders:

  • Collateral-Dependent Loans
  • Risk Layering
  • Reduced Documentation
  • Simultaneous Second-Lien Loans
  • Introductory Interest Rates
  • Lending to Subprime Borrowers
  • Non-Owner Occupied Investor Loans

The importance of evaluating the borrower’s capacity to repay the debt, considering the payment by final maturity at the fully-indexed rate with full amortization, is also stressed.

Supervised institutions are strongly encouraged to refer to the guidance when soliciting or originating nontraditional mortgage products. This guidance, however, represents only a minimum standard that the Department will use in evaluating whether or not a mortgage banker or mortgage broker is in compliance with the full range of consumer protection laws in New York State. The adoption of the CSBS/AARMR guidance does not supersede any existing laws, regulations, or guidance, nor does it preclude the Department from issuing further supplemental guidance or regulations on this topic as needed.

The Proposed Federal Interagency Statement on Subprime Lending

On February 28, 2007, the federal regulators issued an Interagency Statement on Subprime Lending that expanded on the principles set forth in the federal guidance on nontraditional mortgage products. Like that guidance, the proposed Interagency Statement on Subprime Mortgage Lending applies only to insured financial institutions and their affiliates. However, CSBS and AARMR have strongly endorsed the proposed statement and are developing a parallel statement for state licensed lenders and brokers that will significantly mirror the final interagency statement.

The Department supports these additional efforts and encourages its lending institutions to take a proactive stance in considering and preparing to comply with the best practices recommendations contained in the proposed Statement. The Department will notify all supervised institutions once the final federal Interagency and CSBS/AARMR statements have been released.

The Federal Interagency Statement on Working with Mortgage Borrowers

The Department further recommends that all supervised institutions refer to the April 17, 2007 Federal Interagency Statement on Working with Mortgage Borrowers as they respond to consumers who may already be experiencing financial difficulty. While that Statement applies only to insured financial institutions and their affiliates, the Department encourages its supervised institutions to follow the principles set forth in the Statement and work constructively with residential borrowers who are financially unable to make their contractual payment obligations on their home loans.

The Department recognizes that workout arrangements may be in the best interests of both the lender and the consumer, when they are consistent both with responsible underwriting standards and with safe and sound lending principles. In order to protect the safety and soundness of their institutions, state mortgage bankers are also expected to conduct their business in accord with sound credit risk management and to maintain adequate loan loss reserves.

The Department reminds all institutions that New York State Banking Law does not require immediate foreclosure on a borrower’s home when there is a payment default, and encourages lenders to cooperate with reputable community-based organizations in assisting overextended borrowers. Further, those institutions that are subject to review under the Community Reinvestment Act may receive favorable consideration for developing fiscally responsible workout arrangements and loan products designed to help borrowers avoid foreclosure.

Conclusion

If you should have any questions about these or any other consumer protection issues, the Department would welcome the opportunity to respond to your inquiry. Mortgage bankers and brokers may direct your questions to Assistant Deputy Superintendent of Banks Albert Gabriel of the Mortgage Banking Division at 212-709-1511. For depository institutions, please address your comments to Senior Bank Examiner Peter Fyfe of the Community and Regional Banks Division at 212-709-1512.

Sincerely yours,

Richard H. Neiman
Superintendent of Banks

Guidance on NonTraditional Mortgage Product Risks

1 Nontraditional mortgage products allow borrowers to defer payment of principal and/or interest. These products are variously referred to as “nontraditional,” “alternative,” or “exotic” mortgage loans and include “interest-only” mortgages and “payment-option” adjustable-rate mortgages. These products allow borrowers to exchange lower payments during an initial period for higher payments during a later amortization period. (back)