Interagency Guidance on Nontraditional Mortgage Product Risks

58609

Federal Register / Vol. 71, No. 192 / Wednesday, October 4, 2006 / Notices

7. To determine whether Terry Keith

Hammond willfully and/or repeatedly

violated § 73.1015 of the Commission’s

rules by failing to provide full and

complete responses and documents as

directed by letters of inquiry issued by

the staff of the Enforcement Bureau on

June 14, 2004, and August 10, 2004; and

8. To determine, in light of the

evidence adduced pursuant to the

foregoing designated issues, whether the

captioned application for renewal of the

license for Station KBKH(FM) should be

granted, or denied.

Copies of the Order to Show Cause,

Notice of Opportunity for Hearing, and

Hearing Designation Order are being

sent by certified mail, return receipt

requested, to Terry Keith Hammond. To

avail himself of the opportunity to be

heard, Terry Keith Hammond, pursuant

to § 1.91(c) and § 1.221 of the

Commission’s rules, 47 CFR 1.91(c) and

47 CFR 1.221, in person or by his

attorney, must within 30 days of the

release of this Order, file in triplicate a

written notice of appearance stating an

intention to appear on the date fixed for

the hearing and present evidence on the

issues specified in this Order. Terry

Keith Hammond pursuant to § 73.3594

of the Commission’s rules, 47 CFR

73.3594, shall give notice of the hearing

within the time and in the manner

prescribed in 47 CFR 73.3594, and shall

advise the Commission of the

publication of such notice as required

by 47 CFR 73.3594(g).

Federal Communications Commission.

Marlene H. Dortch,

Secretary.

[FR Doc. E6–16217 Filed 10–3–06; 8:45 am]

BILLING CODE 6712–01–P

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the

Currency

[Docket No. 06–11]

BOARD OF GOVERNORS OF THE

FEDERAL RESERVE SYSTEM

[Docket No. OP–1246]

FEDERAL DEPOSIT INSURANCE

CORPORATION

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

[No

ederal Communications Commission.

Marlene H. Dortch,

Secretary.

[FR Doc. E6–16217 Filed 10–3–06; 8:45 am]

BILLING CODE 6712–01–P

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the

Currency

[Docket No. 06–11]

BOARD OF GOVERNORS OF THE

FEDERAL RESERVE SYSTEM

[Docket No. OP–1246]

FEDERAL DEPOSIT INSURANCE

CORPORATION

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

[No. 2006–35]

NATIONAL CREDIT UNION

ADMINISTRATION

Interagency Guidance on

Nontraditional Mortgage Product Risks

AGENCIES: Office of the Comptroller of

the Currency, Treasury (OCC); Board of

Governors of the Federal Reserve

System (Board); Federal Deposit

Insurance Corporation (FDIC); Office of

Thrift Supervision, Treasury (OTS); and

National Credit Union Administration

(NCUA).

ACTION: Final guidance.

SUMMARY: The OCC, Board, FDIC, OTS,

and NCUA (the Agencies), are issuing

final Interagency Guidance on

Nontraditional Mortgage Product Risks

(guidance). This guidance has been

developed to clarify how institutions

can offer nontraditional mortgage

products in a safe and sound manner,

and in a way that clearly discloses the

risks that borrowers may assume.

FOR FURTHER INFORMATION CONTACT:

OCC: Gregory Nagel, Credit Risk

Specialist, Credit and Market Risk, (202)

874–5170; or Michael S. Bylsma,

Director, or Stephen Van Meter,

Assistant Director, Community and

Consumer Law Division, (202) 874–

5750.

Board: Brian Valenti, Supervisory

Financial Analyst, (202) 452–3575; or

Virginia Gibbs, Senior Supervisory

Financial Analyst, (202) 452–2521; or

Sabeth I. Siddique, Assistant Director,

gory Nagel, Credit Risk

Specialist, Credit and Market Risk, (202)

874–5170; or Michael S. Bylsma,

Director, or Stephen Van Meter,

Assistant Director, Community and

Consumer Law Division, (202) 874–

5750.

Board: Brian Valenti, Supervisory

Financial Analyst, (202) 452–3575; or

Virginia Gibbs, Senior Supervisory

Financial Analyst, (202) 452–2521; or

Sabeth I. Siddique, Assistant Director,

(202) 452–3861, Division of Banking

Supervision and Regulation; Kathleen C.

Ryan, Counsel, Division of Consumer

and Community Affairs, (202) 452–

3667; or Andrew Miller, Counsel, Legal

Division, (202) 452–3428. For users of

Telecommunications Device for the Deaf

(‘‘TDD’’) only, contact (202) 263–4869.

FDIC: Suzy S. Gardner, Examination

Specialist, (202) 898–3640, or April

Breslaw, Chief, Compliance Section,

(202) 898–6609, Division of Supervision

and Consumer Protection; or Ruth R.

Amberg, Senior Counsel, (202) 898–

3736, or Richard Foley, Counsel, (202)

898–3784, Legal Division.

OTS: William Magrini, Senior Project

Manager, Examinations and Supervision

Policy, (202) 906–5744; or Fred Phillips-

Patrick, Director, Credit Policy, (202)

906–7295; or Glenn Gimble, Senior

Project Manager, Compliance and

Consumer Protection, (202) 906–7158.

NCUA: Cory Phariss, Program Officer,

Examination and Insurance, (703) 518–

6618.

SUPPLEMENTARY INFORMATION:

I. Background

The Agencies developed this

guidance to address risks associated

with the growing use of mortgage

products that allow borrowers to defer

payment of principal and, sometimes,

interest. These products, referred to

variously as ‘‘nontraditional’’,

‘‘alternative’’, or ‘‘exotic’’ mortgage

loans (hereinafter referred to as

nontraditional mortgage loans), 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

These products, referred to

variously as ‘‘nontraditional’’,

‘‘alternative’’, or ‘‘exotic’’ mortgage

loans (hereinafter referred to as

nontraditional mortgage loans), 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.

While similar products have been

available for many years, the number of

institutions offering them has expanded

rapidly. At the same time, these

products are offered to a wider spectrum

of borrowers who may not otherwise

qualify for more traditional mortgages.

The Agencies are concerned that some

borrowers may not fully understand the

risks of these products. While many of

these risks exist in other adjustable-rate

mortgage products, the Agencies

concern is elevated with nontraditional

products because of the lack of principal

amortization and potential for negative

amortization. In addition, institutions

are increasingly combining these loans

with other features that may compound

risk. These features include

simultaneous second-lien mortgages and

the use of reduced documentation in

evaluating an applicant’s

creditworthiness.

In response to these concerns, the

Agencies published for comment

proposed Interagency Guidance on

Nontraditional Mortgage Products, 70

FR 77249 (Dec. 29, 2005). The Agencies

proposed guidance in three primary

areas: ‘‘Loan Terms and Underwriting

Standards’’, ‘‘Portfolio and Risk

Management Practices’’, and ‘‘Consumer

Protection Issues’’. In the first section,

the Agencies sought to ensure that loan

terms and underwriting standards for

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hree primary

areas: ‘‘Loan Terms and Underwriting

Standards’’, ‘‘Portfolio and Risk

Management Practices’’, and ‘‘Consumer

Protection Issues’’. In the first section,

the Agencies sought to ensure that loan

terms and underwriting standards for

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1 Nine of these letters requested a thirty-day

extension of the comment period, which the

Agencies granted.

2 Letter to J. Johnson, Board Secretary, et al. from

N. Milner, President & CEO, Conference of State

Bank Supervisors (Feb. 14, 2006); Letter to J.

Johnson, Board Secretary, et al., from B. Kent,

Chair, State Financial Regulators Roundtable.

3 Media Release, CSBS & American Association of

Residential Mortgage Regulators, ‘‘CSBS and

AARMR Consider Guidance on Nontraditional

Mortgage Products for State-Licensed Entities’’

(June 7, 2006), available at http://www.csbs.org/

Content/NavigationMenu/PublicRelations/

PressReleases/News_Releases.htm. The press

release stated:

The guidance being developed by CSBS and

AARMR is based upon proposed guidance issued in

December 2005 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.

The Federal guidance, when finalized, will only

apply to insured financial institutions and their

affiliates. CSBS and AARMR intend to develop a

modified version of the guidance which will

primarily focus on residential mortgage

underwriting and consumer protection. The

guidance will be offered to State regulators to apply

to their licensed residential mortgage brokers and

lenders

ration.

The Federal guidance, when finalized, will only

apply to insured financial institutions and their

affiliates. CSBS and AARMR intend to develop a

modified version of the guidance which will

primarily focus on residential mortgage

underwriting and consumer protection. The

guidance will be offered to State regulators to apply

to their licensed residential mortgage brokers and

lenders.

nontraditional mortgage loans are

consistent with prudent lending

practices, including credible

consideration of a borrower’s repayment

capacity. The portfolio and risk

management practices section outlined

the need for strong risk management

standards, capital levels commensurate

with the risk, and an allowance for loan

and lease losses (ALLL) that reflects the

collectibility of the portfolio. Finally,

the consumer protection issues section

recommended practices to ensure

consumers have clear and balanced

information prior to making a product

choice. Additionally, this section

described control systems to ensure that

actual practices are consistent with

policies and procedures.

The Agencies together received

approximately 100 letters in response to

the proposal.1 Comments were received

from financial institutions, trade

associations, consumer and community

organizations, state financial regulatory

organizations, and other members of the

public.

II. Overview of Public Comments

The Agencies received a full range of

comments. Some commenters

applauded the Agencies’ initiative in

proposing the guidance, while others

questioned whether guidance is needed.

A majority of the depository

institutions and industry groups that

commented stated that the guidance is

too prescriptive. They suggested

institutions should have more flexibility

in determining appropriate risk

management practices. A number

observed that nontraditional mortgage

products have been offered successfully

for many years

, while others

questioned whether guidance is needed.

A majority of the depository

institutions and industry groups that

commented stated that the guidance is

too prescriptive. They suggested

institutions should have more flexibility

in determining appropriate risk

management practices. A number

observed that nontraditional mortgage

products have been offered successfully

for many years. Others opined that the

guidance would stifle innovation and

result in qualified borrowers not being

approved for these loans. Further, many

questioned whether the guidance is an

appropriate mechanism for addressing

the Agencies’ consumer protection

concerns.

A smaller subset of commenters

argued that the guidance does not go far

enough in regulating or restricting

nontraditional mortgage products. These

commenters included consumer

organizations, individuals, and several

community bankers. Several stated

these products contribute to speculation

and unsustainable appreciation in the

housing market. They expressed

concern that severe problems will occur

if and when there is a downturn in the

economy. Some also argued that these

products are harmful to borrowers and

that borrowers may not understand the

associated risks.

Many commenters voiced concern

that the guidance will not apply to all

lenders, and thus federally regulated

financial institutions will be at a

competitive disadvantage. The Agencies

note that both State financial regulatory

organizations that commented on the

proposed guidance—the Conference of

State Bank Supervisors (CSBS) and the

State Financial Regulators Roundtable

(SFRR)—committed to working with

State regulatory agencies to distribute

guidance that is similar in nature and

scope to the financial service providers

under their jurisdictions.2 These

commenters noted their interest in

addressing the potential for inconsistent

regulatory treatment of lenders based on

whether or not they are supervised

solely by state agencies

ial Regulators Roundtable

(SFRR)—committed to working with

State regulatory agencies to distribute

guidance that is similar in nature and

scope to the financial service providers

under their jurisdictions.2 These

commenters noted their interest in

addressing the potential for inconsistent

regulatory treatment of lenders based on

whether or not they are supervised

solely by state agencies. Subsequently,

the CSBS, along with a national

organization representing state

residential mortgage regulators, issued a

press release confirming their intent to

offer guidance to State regulators to

apply to their licensed residential

mortgage brokers and lenders.3

III. Final Joint Guidance

The Agencies made a number of

changes to the proposal to respond to

commenters’ concerns and to provide

additional clarity. Significant comments

on the specific provisions of the

proposed guidance, the Agencies’’

responses, and changes to the proposed

guidance are discussed as follows.

Scope of the Guidance

Many financial institution and trade

group commenters raised concerns that

the proposed guidance did not

adequately define ‘‘nontraditional

mortgage products’’. They requested

clarification of which products would

be subject to enhanced scrutiny. Some

suggested that the guidance focus on

products that allow negative

amortization, rather than interest-only

loans. Others suggested excluding

certain products with nontraditional

features, such as reverse mortgages and

home equity lines of credit (HELOCs).

Those commenting on interest-only

loans noted that they do not present the

same risks as products that allow for

negative amortization. Those that

argued that HELOCs should be excluded

noted that they are already covered by

interagency guidance issued in 2005.

They also noted that the principal

amount of these loans is generally lower

than that for first mortgages

nes of credit (HELOCs).

Those commenting on interest-only

loans noted that they do not present the

same risks as products that allow for

negative amortization. Those that

argued that HELOCs should be excluded

noted that they are already covered by

interagency guidance issued in 2005.

They also noted that the principal

amount of these loans is generally lower

than that for first mortgages. As for

reverse mortgages, the commenters

pointed out that they were developed

for a specific market segment and do not

present the same concerns as products

mentioned in the guidance.

To address these concerns, the

Agencies are clarifying the types of

products covered by the guidance. In

general, the guidance applies to all

residential mortgage loan products that

allow borrowers to defer repayment of

principal or interest. This includes all

interest-only products and negative

amortization mortgages, with the

exception of HELOCs. The Agencies

decided not to include HELOCs in this

guidance, other than as discussed in the

Simultaneous Second-Lien Loans

section, since they are already covered

by the May 2005 Interagency Credit Risk

Management Guidance for Home Equity

Lending. The Agencies are amending

the May 2005 guidance, however, to

address the consumer disclosure

recommendations included in the

nontraditional mortgage guidance.

The Agencies decided against

focusing solely on negative amortization

products. Many of the interest-only

products pose risks similar to products

that allow negative amortization,

especially when combined with high

leverage and reduced documentation.

Accordingly, they present similar

concerns from a risk management and

consumer protection standpoint. The

Agencies did, however, agree that

reverse mortgages do not present the

types of concerns that are addressed in

the guidance and should be excluded

s pose risks similar to products

that allow negative amortization,

especially when combined with high

leverage and reduced documentation.

Accordingly, they present similar

concerns from a risk management and

consumer protection standpoint. The

Agencies did, however, agree that

reverse mortgages do not present the

types of concerns that are addressed in

the guidance and should be excluded.

Loan Terms and Underwriting

Standards

Qualifying Borrowers

The Agencies proposed that for all

nontraditional mortgage products, the

analysis of borrowers’ repayment

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4 This is similar to the standard in the Agencies’

May 2005 Credit Risk Management Guidance for

Home Equity Lending recommending that, for

interest-only and variable rate HELOCs, borrowers

should demonstrate the ability to amortize the fully

drawn line over the loan term.

capacity should include an evaluation

of their ability to repay the debt by final

maturity at the fully indexed rate,

assuming a fully amortizing repayment

schedule. In addition, the proposed

guidance stated that for products that

permit negative amortization, the

repayment analysis should include the

initial loan amount plus any balance

increase that may accrue from negative

amortization. The amount of the balance

increase is tied to the initial terms of the

loan and estimated assuming the

borrower makes only the minimum

payment.

Generally, banks and industry groups

believed that the proposed underwriting

standards were too prescriptive and

asked for more flexibility. Consumer

groups generally supported the

proposed underwriting standards,

warning that deteriorating underwriting

standards are bad for individual

borrowers and poor public policy

n and estimated assuming the

borrower makes only the minimum

payment.

Generally, banks and industry groups

believed that the proposed underwriting

standards were too prescriptive and

asked for more flexibility. Consumer

groups generally supported the

proposed underwriting standards,

warning that deteriorating underwriting

standards are bad for individual

borrowers and poor public policy.

A number of commenters suggested

that industry practice is to underwrite

payment option adjustable-rate

mortgages at the fully indexed rate,

assuming a fully amortizing payment.

Yet several commenters argued that this

standard should not be required when

risks are adequately mitigated.

Moreover, many commenters opposed

assuming a fully amortizing payment for

interest-only loans with extended

interest-only periods. They argued that

the average life span of most mortgage

loans makes it unlikely that many

borrowers will experience the higher

payments associated with amortization.

Additionally, many commenters

opposed the assumption of minimum

payments during the deferral period for

products that permit negative

amortization on the ground that this

assumption suggests that lenders

assume a worst-case scenario.

The Agencies believe that institutions

should maintain qualification standards

that include a credible analysis of a

borrower’s capacity to repay the full

amount of credit that may be extended.

That analysis should consider both

principal and interest at the fully

indexed rate. Using discounted

payments in the qualification process

limits the ability of borrowers to

demonstrate sufficient capacity to repay

under the terms of the loan. Therefore,

the proposed general guideline of

qualifying borrowers at the fully

indexed rate, assuming a fully

amortizing payment, including potential

negative amortization amounts, remains

in the final guidance

ully

indexed rate. Using discounted

payments in the qualification process

limits the ability of borrowers to

demonstrate sufficient capacity to repay

under the terms of the loan. Therefore,

the proposed general guideline of

qualifying borrowers at the fully

indexed rate, assuming a fully

amortizing payment, including potential

negative amortization amounts, remains

in the final guidance.

Regarding interest-only loans with

extended interest-only periods, the

Agencies note that since the average life

of a mortgage is a function of the

housing market and interest rates, the

average may fluctuate over time.

Additionally, the Agencies were

concerned that excluding these loans

from the underwriting standards could

cause some creditors to change their

market offerings to avoid application of

the guidance. Accordingly, the final

guidance does not exclude interest-only

loans with extended interest-only

periods.

Finally, regarding the assumption for

the amount that the balance may

increase due to negative amortization,

the Agencies have revised the language

to respond to commenters’ requests for

clarity. The basic standard, however,

remains unchanged. The Agencies

expect a borrower to demonstrate the

capacity to repay the full loan amount

that may be advanced.4 This includes

the initial loan amount plus any balance

increase that may accrue from the

negative amortization provision. The

final document contains guidance on

determining the amount of any balance

increase that may accrue from the

negative amortization provision, which

does not necessarily equate to the full

negative amortization cap for a

particular loan.

The Agencies requested comment on

whether the guidance should address

consideration of future income or other

future events in the qualification

standards. The commenters generally

agreed that there is no reliable method

for considering future income or other

future events in the underwriting

process

oes not necessarily equate to the full

negative amortization cap for a

particular loan.

The Agencies requested comment on

whether the guidance should address

consideration of future income or other

future events in the qualification

standards. The commenters generally

agreed that there is no reliable method

for considering future income or other

future events in the underwriting

process. Accordingly, the Agencies have

not modified the guidance to address

these issues.

Collateral-Dependent Loans

Commenters that specifically

addressed this aspect of the guidance

concurred that it is unsafe and unsound

to rely solely on an individual

borrower’s ability to sell or refinance

once amortization commences.

However, many expressed concern

about the possibility that the term

‘‘collateral-dependent’’, as it is used in

the guidance, would be interpreted to

apply to stated income and other

reduced documentation loans.

To address this concern, the Agencies

provided clarifying language in a

footnote to this section. The final

guidance provides that a loan will not

be determined to be collateral-

dependent solely because it was

underwritten using reduced

documentation.

Risk Layering

Financial institution and industry

group commenters were generally

critical of the risk layering provisions of

the proposed guidance on the grounds

that they were too prescriptive. These

commenters argued that institutions

should have flexibility in determining

factors that mitigate additional risks

presented by features such as reduced

documentation and simultaneous

second-lien loans. A number of

commenters, however, including

community and consumer

organizations, financial institutions, and

industry associations, suggested that

reduced documentation loans should

not be offered to subprime borrowers

ions

should have flexibility in determining

factors that mitigate additional risks

presented by features such as reduced

documentation and simultaneous

second-lien loans. A number of

commenters, however, including

community and consumer

organizations, financial institutions, and

industry associations, suggested that

reduced documentation loans should

not be offered to subprime borrowers.

Others questioned whether stated

income loans are appropriate under any

circumstances, when used with

nontraditional mortgage products, or

when used for wage earners who can

readily provide standard documentation

of their wages. Several commenters

argued that simultaneous second-lien

loans should be paired with

nontraditional mortgage loans only

when borrowers will continue to have

substantial equity in the property.

The Agencies believe that the

guidance provides adequate flexibility

in the methods and approaches to

mitigating risk, with respect to risk

layering. While the Agencies have not

prohibited any of the practices

discussed, the guidance uniformly

suggests strong quality control and risk

mitigation factors with respect to these

practices.

The Agencies declined to provide

guidance recommending reduced

documentation loans be limited to any

particular set of circumstances. The

final guidance recognizes that mitigating

factors may determine whether such

loans are appropriate but reminds

institutions that a credible analysis of

both a borrower’s willingness and

ability to repay is consistent with sound

and prudent lending practices. The final

guidance also cautions that institutions

generally should be able to readily

document income for wage earners

through means such as W–2 statements,

pay stubs, or tax returns.

Portfolio and Risk Management

Practices

Many financial institution and

industry group commenters opposed

provisions of the proposed guidance for

the setting of concentration limits

dent lending practices. The final

guidance also cautions that institutions

generally should be able to readily

document income for wage earners

through means such as W–2 statements,

pay stubs, or tax returns.

Portfolio and Risk Management

Practices

Many financial institution and

industry group commenters opposed

provisions of the proposed guidance for

the setting of concentration limits. Some

commenters advocated active

monitoring of concentrations of

diversification strategies as more

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5 12 CFR part 226 (2006).

6 24 CFR part 3500 (2005).

7 See 12 CFR part 226.24(c) (2006).

8 See elsewhere in today’s issue of the Federal

Register. (Proposed Illustrations of Consumer

Information for Nontraditional Mortgage Products).

appropriate approaches. The intent of

the guidance was not to set hard

concentration limits for nontraditional

mortgage products. Instead, institutions

with concentrations in these products

should have well-developed monitoring

systems and risk management practices.

The guidance was clarified to reiterate

this point.

Additionally, a number of financial

institution and industry association

commenters opposed the provisions

regarding third-party originations. They

argued that the proposal would force

lenders to have an awareness and

control over third-party practices that is

neither realistic nor practical. In

particular, many of these commenters

argued that lenders should not be

responsible for overseeing the marketing

and borrower disclosure practices of

third parties.

Regarding controls over third-party

practices, the Agencies clarified their

expectations that institutions should

have strong systems and controls for

establishing and maintaining

relationships with third parties

ractical. In

particular, many of these commenters

argued that lenders should not be

responsible for overseeing the marketing

and borrower disclosure practices of

third parties.

Regarding controls over third-party

practices, the Agencies clarified their

expectations that institutions should

have strong systems and controls for

establishing and maintaining

relationships with third parties.

Reliance on third-party relationships

can significantly increase an

institution’s risk profile. The guidance,

therefore, emphasizes the need for

institutions to exercise appropriate due

diligence prior to entering into a third-

party relationship and to provide

ongoing, effective oversight and

controls. In practice, an institution’s risk

management system should reflect the

complexity of its third-party activities

and the overall level of risk involved.

A number of commenters urged the

Agencies to remove language in the

proposed guidance relating to implicit

recourse for loans sold in the secondary

market. They expressed concern that the

proposal added new capital

requirements. The Agencies clarified the

language in the guidance addressing this

issue. The Agencies do not intend to

establish new capital requirements.

Instead, the Agencies’ intent is to

reiterate existing guidelines regarding

implicit recourse under the Agencies’

risk-based capital rules.

Consumer Protection Issues

Communications With Consumers

Many financial institution and trade

group commenters suggested that the

Agencies’ consumer protection goals

would be better accomplished through

generally applicable regulations, such as

Regulation Z (Truth in Lending) 5 or

Regulation X (Real Estate Settlement

Procedures).6 Some commenters stated

that the proposed guidance would add

burdensome new disclosure

requirements and cause a confusing

overlap with current Regulation Z

requirements. They also expressed

concern that the guidance would

contribute to an overload of information

currently provided to consumers

such as

Regulation Z (Truth in Lending) 5 or

Regulation X (Real Estate Settlement

Procedures).6 Some commenters stated

that the proposed guidance would add

burdensome new disclosure

requirements and cause a confusing

overlap with current Regulation Z

requirements. They also expressed

concern that the guidance would

contribute to an overload of information

currently provided to consumers.

Additionally, some argued that

implementing the disclosure provisions

might trigger Regulation Z requirements

concerning advertising.7 Some

commenters also urged the Agencies to

adopt model disclosure forms or other

descriptive materials to assist in

compliance with the guidance.

Some commenters voiced concern

that the Agencies are attempting to

establish a suitability standard similar

to that used in the securities context.

These commenters argued that lenders

are not in a position to determine which

products are most suitable for

borrowers, and that this decision should

be left to borrowers themselves.

Finally, several community and

consumer organization commenters

questioned whether additional

disclosures are sufficient to protect

borrowers and suggested various

additional measures, such as consumer

education and counseling.

The Agencies carefully considered the

commenters’ argument that consumer

protection issues—particularly,

disclosures—would be better addressed

through generally applicable

regulations. The Agencies determined,

however, that given the growth in this

market, guidelines are needed now to

ensure that consumers will receive the

information they need about the

material features of nontraditional

mortgages as soon as possible.

The Agencies also gave careful

consideration to the commenters’

concerns that the guidelines will

overlap with Regulation Z, add to the

disclosure burden on lenders, and

contribute to information overload.

While the Agencies are sensitive to

these concerns, we do not believe they

warrant significant changes to the

guidance

terial features of nontraditional

mortgages as soon as possible.

The Agencies also gave careful

consideration to the commenters’

concerns that the guidelines will

overlap with Regulation Z, add to the

disclosure burden on lenders, and

contribute to information overload.

While the Agencies are sensitive to

these concerns, we do not believe they

warrant significant changes to the

guidance. The guidance focuses on

providing information to consumers

during the pre-application shopping

phase and post-closing with any

monthly statements lenders choose to

provide to consumers. Moreover, the

Agencies do not anticipate that the

information outlined in the guidance

will result in additional lengthy

disclosures. Rather, the Agencies

contemplate that the information can be

provided in brief narrative format and

through the use of examples based on

hypothetical loan transactions.8 We

have, however, revised the guidance to

make clear that transaction-specific

disclosures are not required. Institutions

will still need to ensure that their

marketing materials promoting their

products comply with Regulation Z, as

applicable.

As previously discussed, some

commenters, including industry trade

associations, asked the Agencies to

include model or sample disclosures or

other descriptive materials as part of the

guidance to assist lenders, including

smaller institutions, in following the

recommended practices for

communications with consumers. The

Agencies have determined not to

include required model or sample

disclosures in the guidance. Instead, the

guidance provides a set of

recommended practices to assist

institutions in addressing particular

risks raised by nontraditional mortgage

products

uidance to assist lenders, including

smaller institutions, in following the

recommended practices for

communications with consumers. The

Agencies have determined not to

include required model or sample

disclosures in the guidance. Instead, the

guidance provides a set of

recommended practices to assist

institutions in addressing particular

risks raised by nontraditional mortgage

products.

The Agencies have determined that it

is desirable to first seek public comment

on potential model disclosures, and in

a Federal Register notice accompanying

this guidance are seeking comment on

proposed illustrations of consumer

information for nontraditional mortgage

products that are consistent with the

recommendations contained in the

guidance. The Agencies appreciate that

some institutions, including community

banks, following the recommendations

set forth in the guidance may prefer not

to incur the costs and other burdens of

developing their own consumer

information documents. The Agencies

are, therefore, requesting comment on

illustrations of the type of information

contemplated by the guidance.

The Agencies disagree with the

commenters who expressed concern

that the guidance appears to establish a

suitability standard, under which

lenders would be required to assist

borrowers in choosing products that are

suitable to their needs and

circumstances. It was not the Agencies’

intent to impose such a standard, nor is

there any language in the guidance that

does so. In any event, the Agencies have

revised certain statements in the

proposed guidance that could have been

interpreted to suggest a requirement to

ensure that borrowers select products

appropriate to their circumstances.

Control Systems

Several commenters requested more

flexibility in designing appropriate

control systems. The Agencies have

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been

interpreted to suggest a requirement to

ensure that borrowers select products

appropriate to their circumstances.

Control Systems

Several commenters requested more

flexibility in designing appropriate

control systems. The Agencies have

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58613

Federal Register / Vol. 71, No. 192 / Wednesday, October 4, 2006 / Notices

1 Interest-only and payment option ARMs are

variations of conventional ARMs, hybrid ARMs,

and fixed rate products. Refer to the Appendix for

additional information on interest-only and

payment option ARM loans. This guidance does not

apply to reverse mortgages; home equity lines of

credit (‘‘HELOCs’’), other than as discussed in the

Simultaneous Second-Lien Loans section; or fully

amortizing residential mortgage loan products.

2 Refer to the Appendix for additional

information on reduced documentation and

simultaneous second-lien loans.

3 Refer to Interagency Guidelines Establishing

Standards for Safety and Soundness. For each

Agency, those respective guidelines are addressed

in: 12 CFR part 30 Appendix A (OCC); 12 CFR part

208 Appendix D–1 (Board); 12 CFR part 364

Appendix A (FDIC); 12 CFR part 570 Appendix A

(OTS); and 12 U.S.C. 1786 (NCUA).

4 Refer to 12 CFR part 34—Real Estate Lending

and Appraisals, OCC Bulletin 2005–3—Standards

for National Banks’ Residential Mortgage Lending,

AL 2003–7—Guidelines for Real Estate Lending

Policies and AL 2003–9—Independent Appraisal

and Evaluation Functions (OCC); 12 CFR 208.51

subpart E and Appendix C and 12 CFR part 225

subpart G (Board); 12 CFR part 365 and Appendix

A, and 12 CFR part 323 (FDIC); 12 CFR 560.101 and

Appendix and 12 CFR part 564 (OTS). Also, refer

to the 1999 Interagency Guidance on the

‘‘Treatment of High LTV Residential Real Estate

Loans’’ and the 1994 ‘‘Interagency Appraisal and

Evaluation Guidelines’’

valuation Functions (OCC); 12 CFR 208.51

subpart E and Appendix C and 12 CFR part 225

subpart G (Board); 12 CFR part 365 and Appendix

A, and 12 CFR part 323 (FDIC); 12 CFR 560.101 and

Appendix and 12 CFR part 564 (OTS). Also, refer

to the 1999 Interagency Guidance on the

‘‘Treatment of High LTV Residential Real Estate

Loans’’ and the 1994 ‘‘Interagency Appraisal and

Evaluation Guidelines’’. Federally Insured Credit

Unions should refer to 12 CFR part 722—Appraisals

and NCUA 03–CU–17—Appraisal and Evaluation

Functions for Real Estate Related Transactions

(NCUA).

revised the ‘‘Control Systems’’ portion

of the guidance to clarify that we are not

requiring any particular means of

monitoring adherence to an institution’s

policies, such as call monitoring or

mystery shopping. Additional changes

have also been made to clarify that the

Agencies do not expect institutions to

assume an unwarranted level of

responsibility for the actions of third

parties. Rather, the control systems that

are expected for loans purchased from

or originated through third parties are

consistent with the Agencies’ current

supervisory policies. As previously

discussed, the Agencies have also made

changes to the portfolio and risk

management practices portion of the

final guidance to clarify their

expectations concerning oversight and

monitoring of third-party originations.

IV. Text of Final Joint Guidance

The text of the final Interagency

Guidance on Nontraditional Mortgage

Product Risks follows:

Interagency Guidance on

Nontraditional Mortgage Product Risks

Residential mortgage lending has

traditionally been a conservatively

managed business with low

delinquencies and losses and reasonably

stable underwriting standards. In the

past few years consumer demand has

been growing, particularly in high

priced real estate markets, for closed-

end residential mortgage loan products

that allow borrowers to defer repayment

of principal and, sometimes, interest

al mortgage lending has

traditionally been a conservatively

managed business with low

delinquencies and losses and reasonably

stable underwriting standards. In the

past few years consumer demand has

been growing, particularly in high

priced real estate markets, for closed-

end residential mortgage loan products

that allow borrowers to defer repayment

of principal and, sometimes, interest.

These mortgage products, herein

referred to as nontraditional mortgage

loans, include such products as

‘‘interest-only’’ mortgages where a

borrower pays no loan principal for the

first few years of the loan and ‘‘payment

option’’ adjustable-rate mortgages

(ARMs) where a borrower has flexible

payment options with the potential for

negative amortization.1

While some institutions have offered

nontraditional mortgages for many years

with appropriate risk management and

sound portfolio performance, the market

for these products and the number of

institutions offering them has expanded

rapidly. Nontraditional mortgage loan

products are now offered by more

lenders to a wider spectrum of

borrowers who may not otherwise

qualify for more traditional mortgage

loans and may not fully understand the

associated risks.

Many of these nontraditional

mortgage loans are underwritten with

less stringent income and asset

verification requirements (‘‘reduced

documentation’’) and are increasingly

combined with simultaneous second-

lien loans.2 Such risk layering,

combined with the broader marketing of

nontraditional mortgage loans, exposes

financial institutions to increased risk

relative to traditional mortgage loans.

Given the potential for heightened

risk levels, management should

carefully consider and appropriately

mitigate exposures created by these

loans

are increasingly

combined with simultaneous second-

lien loans.2 Such risk layering,

combined with the broader marketing of

nontraditional mortgage loans, exposes

financial institutions to increased risk

relative to traditional mortgage loans.

Given the potential for heightened

risk levels, management should

carefully consider and appropriately

mitigate exposures created by these

loans. To manage the risks associated

with nontraditional mortgage loans,

management should:

• Ensure that loan terms and

underwriting standards are consistent

with prudent lending practices,

including consideration of a borrower’s

repayment capacity;

• Recognize that many nontraditional

mortgage loans, particularly when they

have risk-layering features, are untested

in a stressed environment. As evidenced

by experienced institutions, these

products warrant strong risk

management standards, capital levels

commensurate with the risk, and an

allowance for loan and lease losses that

reflects the collectibility of the portfolio;

and

• Ensure that consumers have

sufficient information to clearly

understand loan terms and associated

risks prior to making a product choice.

The Office of the Comptroller of the

Currency (OCC), the Board of Governors

of the Federal Reserve System (Board),

the Federal Deposit Insurance

Corporation (FDIC), the Office of Thrift

Supervision (OTS) and the National

Credit Union Administration (NCUA)

(collectively, the Agencies) expect

institutions to effectively assess and

manage the risks associated with

nontraditional mortgage loan products.3

Institutions should use this guidance

to ensure that risk management

practices adequately address these risks.

The Agencies will carefully scrutinize

risk management processes, policies,

and procedures in this area. Institutions

that do not adequately manage these

risks will be asked to take remedial

action

ess and

manage the risks associated with

nontraditional mortgage loan products.3

Institutions should use this guidance

to ensure that risk management

practices adequately address these risks.

The Agencies will carefully scrutinize

risk management processes, policies,

and procedures in this area. Institutions

that do not adequately manage these

risks will be asked to take remedial

action.

The focus of this guidance is on the

higher risk elements of certain

nontraditional mortgage products, not

the product type itself. Institutions with

sound underwriting, adequate risk

management, and acceptable portfolio

performance will not be subject to

criticism merely for offering such

products.

Loan Terms and Underwriting

Standards

When an institution offers

nontraditional mortgage loan products,

underwriting standards should address

the effect of a substantial payment

increase on the borrower’s capacity to

repay when loan amortization begins.

Underwriting standards should also

comply with the agencies’ real estate

lending standards and appraisal

regulations and associated guidelines.4

Central to prudent lending is the

internal discipline to maintain sound

loan terms and underwriting standards

despite competitive pressures.

Institutions are strongly cautioned

against ceding underwriting standards

to third parties that have different

business objectives, risk tolerances, and

core competencies. Loan terms should

be based on a disciplined analysis of

potential exposures and compensating

factors to ensure risk levels remain

manageable.

Qualifying Borrowers—Payments on

nontraditional loans can increase

significantly when the loans begin to

amortize. Commonly referred to as

payment shock, this increase is of

particular concern for payment option

ARMs where the borrower makes

minimum payments that may result in

negative amortization

of

potential exposures and compensating

factors to ensure risk levels remain

manageable.

Qualifying Borrowers—Payments on

nontraditional loans can increase

significantly when the loans begin to

amortize. Commonly referred to as

payment shock, this increase is of

particular concern for payment option

ARMs where the borrower makes

minimum payments that may result in

negative amortization. Some institutions

manage the potential for excessive

negative amortization and payment

shock by structuring the initial terms to

limit the spread between the

introductory interest rate and the fully

indexed rate. Nevertheless, an

institution’s qualifying standards should

recognize the potential impact of

payment shock, especially for borrowers

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58614

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5 The fully indexed rate equals the index rate

prevailing at origination plus the margin that will

apply after the expiration of an introductory interest

rate. The index rate is a published interest rate to

which the interest rate on an ARM is tied. Some

commonly used indices include the 1-Year

Constant Maturity Treasury Rate (CMT), the 6-

Month London Interbank Offered Rate (LIBOR), the

11th District Cost of Funds (COFI), and the Moving

Treasury Average (MTA), a 12-month moving

average of the monthly average yields of U.S.

Treasury securities adjusted to a constant maturity

of one year. The margin is the number of percentage

points a lender adds to the index value to calculate

the ARM interest rate at each adjustment period. In

different interest rate scenarios, the fully indexed

rate for an ARM loan based on a lagging index (e.g.,

MTA rate) may be significantly different from the

rate on a comparable 30-year fixed-rate product

adjusted to a constant maturity

of one year. The margin is the number of percentage

points a lender adds to the index value to calculate

the ARM interest rate at each adjustment period. In

different interest rate scenarios, the fully indexed

rate for an ARM loan based on a lagging index (e.g.,

MTA rate) may be significantly different from the

rate on a comparable 30-year fixed-rate product. In

these cases, a credible market rate should be used

to qualify the borrower and determine repayment

capacity.

6 The fully amortizing payment schedule should

be based on the term of the loan. For example, the

amortizing payment for a loan with a 5-year interest

only period and a 30-year term would be calculated

based on a 30-year amortization schedule. For

balloon mortgages that contain a borrower option

for an extended amortization period, the fully

amortizing payment schedule can be based on the

full term the borrower may choose.

7 The balance that may accrue from the negative

amortization provision does not necessarily equate

to the full negative amortization cap for a particular

loan. The spread between the introductory or

‘‘teaser’’ rate and the accrual rate will determine

whether or not a loan balance has the potential to

reach the negative amortization cap before the end

of the initial payment option period (usually five

years). For example, a loan with a 115 percent

negative amortization cap but a small spread

between the introductory rate and the accrual rate

may only reach a 109 percent maximum loan

balance before the end of the initial payment option

period, even if only minimum payments are made.

The borrower could be qualified based on this

lower maximum loan balance.

8 A loan will not be determined to be ‘‘collateral-

dependent’’ solely through the use of reduced

documentation.

9 Interagency Guidance on Subprime Lending,

March 1, 1999, and Expanded Guidance for

Subprime Lending Programs, January 31, 2001

the initial payment option

period, even if only minimum payments are made.

The borrower could be qualified based on this

lower maximum loan balance.

8 A loan will not be determined to be ‘‘collateral-

dependent’’ solely through the use of reduced

documentation.

9 Interagency Guidance on Subprime Lending,

March 1, 1999, and Expanded Guidance for

Subprime Lending Programs, January 31, 2001.

Federally insured credit unions should refer to 04–

CU–12—Specialized Lending Activities (NCUA).

with high loan-to-value (LTV) ratios,

high debt-to-income (DTI) ratios, and

low credit scores. Recognizing that an

institution’s underwriting criteria are

based on multiple factors, an institution

should consider these factors jointly in

the qualification process and may

develop a range of reasonable tolerances

for each factor. However, the criteria

should be based upon prudent and

appropriate underwriting standards,

considering both the borrower’s

characteristics and the product’s

attributes.

For all nontraditional mortgage loan

products, an institution’s analysis of a

borrower’s repayment capacity should

include an evaluation of their ability to

repay the debt by final maturity at the

fully indexed rate,5 assuming a fully

amortizing repayment schedule.6 In

addition, for products that permit

negative amortization, the repayment

analysis should be based upon the

initial loan amount plus any balance

increase that may accrue from the

negative amortization provision.7

Furthermore, the analysis of

repayment capacity should avoid over-

reliance on credit scores as a substitute

for income verification in the

underwriting process. The higher a

loan’s credit risk, either from loan

features or borrower characteristics, the

more important it is to verify the

borrower’s income, assets, and

outstanding liabilities

ue from the

negative amortization provision.7

Furthermore, the analysis of

repayment capacity should avoid over-

reliance on credit scores as a substitute

for income verification in the

underwriting process. The higher a

loan’s credit risk, either from loan

features or borrower characteristics, the

more important it is to verify the

borrower’s income, assets, and

outstanding liabilities.

Collateral-Dependent Loans—

Institutions should avoid the use of loan

terms and underwriting practices that

may heighten the need for a borrower to

rely on the sale or refinancing of the

property once amortization begins.

Loans to individuals who do not

demonstrate the capacity to repay, as

structured, from sources other than the

collateral pledged are generally

considered unsafe and unsound.8

Institutions that originate collateral-

dependent mortgage loans may be

subject to criticism, corrective action,

and higher capital requirements.

Risk Layering—Institutions that

originate or purchase mortgage loans

that combine nontraditional features,

such as interest only loans with reduced

documentation or a simultaneous

second-lien loan, face increased risk.

When features are layered, an

institution should demonstrate that

mitigating factors support the

underwriting decision and the

borrower’s repayment capacity.

Mitigating factors could include higher

credit scores, lower LTV and DTI ratios,

significant liquid assets, mortgage

insurance or other credit enhancements.

While higher pricing is often used to

address elevated risk levels, it does not

replace the need for sound

underwriting.

Reduced Documentation—Institutions

increasingly rely on reduced

documentation, particularly unverified

income, to qualify borrowers for

nontraditional mortgage loans. Because

these practices essentially substitute

assumptions and unverified information

for analysis of a borrower’s repayment

capacity and general creditworthiness,

they should be used with caution

d for sound

underwriting.

Reduced Documentation—Institutions

increasingly rely on reduced

documentation, particularly unverified

income, to qualify borrowers for

nontraditional mortgage loans. Because

these practices essentially substitute

assumptions and unverified information

for analysis of a borrower’s repayment

capacity and general creditworthiness,

they should be used with caution. As

the level of credit risk increases, the

Agencies expect an institution to more

diligently verify and document a

borrower’s income and debt reduction

capacity. Clear policies should govern

the use of reduced documentation. For

example, stated income should be

accepted only if there are mitigating

factors that clearly minimize the need

for direct verification of repayment

capacity. For many borrowers,

institutions generally should be able to

readily document income using recent

W–2 statements, pay stubs, or tax

returns.

Simultaneous Second-Lien Loans—

Simultaneous second-lien loans reduce

owner equity and increase credit risk.

Historically, as combined loan-to-value

ratios rise, so do defaults. A delinquent

borrower with minimal or no equity in

a property may have little incentive to

work with a lender to bring the loan

current and avoid foreclosure. In

addition, second-lien home equity lines

of credit (HELOCs) typically increase

borrower exposure to increasing interest

rates and monthly payment burdens.

Loans with minimal or no owner equity

generally should not have a payment

structure that allows for delayed or

negative amortization without other

significant risk mitigating factors.

Introductory Interest Rates—Many

institutions offer introductory interest

rates set well below the fully indexed

rate as a marketing tool for payment

option ARM products. When developing

nontraditional mortgage product terms,

an institution should consider the

spread between the introductory rate

and the fully indexed rate

e amortization without other

significant risk mitigating factors.

Introductory Interest Rates—Many

institutions offer introductory interest

rates set well below the fully indexed

rate as a marketing tool for payment

option ARM products. When developing

nontraditional mortgage product terms,

an institution should consider the

spread between the introductory rate

and the fully indexed rate. Since initial

and subsequent monthly payments are

based on these low introductory rates, a

wide initial spread means that

borrowers are more likely to experience

negative amortization, severe payment

shock, and an earlier-than-scheduled

recasting of monthly payments.

Institutions should minimize the

likelihood of disruptive early recastings

and extraordinary payment shock when

setting introductory rates.

Lending to Subprime Borrowers—

Mortgage programs that target subprime

borrowers through tailored marketing,

underwriting standards, and risk

selection should follow the applicable

interagency guidance on subprime

lending.9 Among other things, the

subprime guidance discusses

circumstances under which subprime

lending can become predatory or

abusive. Institutions designing

nontraditional mortgage loans for

subprime borrowers should pay

particular attention to this guidance.

They should also recognize that risk-

layering features in loans to subprime

borrowers may significantly increase

risks for both the institution and the

borrower.

Non-Owner-Occupied Investor

Loans—Borrowers financing non-owner-

occupied investment properties should

qualify for loans based on their ability

to service the debt over the life of the

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ncrease

risks for both the institution and the

borrower.

Non-Owner-Occupied Investor

Loans—Borrowers financing non-owner-

occupied investment properties should

qualify for loans based on their ability

to service the debt over the life of the

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58615

Federal Register / Vol. 71, No. 192 / Wednesday, October 4, 2006 / Notices

10 Federally insured credit unions must comply

with 12 CFR part 723 for loans meeting the

definition of member business loans.

11 Refer to OCC Bulletin 2001–47—Third-Party

Relationships and AL 2000–9—Third-Party Risk

(OCC). Federally insured credit unions should refer

to 01–CU–20 (NCUA), Due Diligence over Third

Party Service Providers. Savings associations

should refer to OTS Thrift Bulletin 82a—Third

Party Arrangements.

12 Refer to ‘‘Interagency Questions and Answers

on Capital Treatment of Recourse, Direct Credit

Substitutes, and Residual Interests in Asset

Securitizations’’, May 23, 2002; OCC Bulletin 2002–

22 (OCC); SR letter 02–16 (Board); Financial

Institution Letter (FIL–54–2002) (FDIC); and CEO

Letter 163 (OTS). See OCC’s Comptroller Handbook

for Asset Securitization, November 1997. See OTS

Examination Handbook Section 221, Asset-Backed

Securitization. The Board also addressed risk

management and capital adequacy of exposures

arising from secondary market credit activities in

SR letter 97–21. Federally insured credit unions

should refer to 12 CFR Part 702 (NCUA).

loan. Loan terms should reflect an

appropriate combined LTV ratio that

considers the potential for negative

amortization and maintains sufficient

borrower equity over the life of the loan

lso addressed risk

management and capital adequacy of exposures

arising from secondary market credit activities in

SR letter 97–21. Federally insured credit unions

should refer to 12 CFR Part 702 (NCUA).

loan. Loan terms should reflect an

appropriate combined LTV ratio that

considers the potential for negative

amortization and maintains sufficient

borrower equity over the life of the loan.

Further, underwriting standards should

require evidence that the borrower has

sufficient cash reserves to service the

loan, considering the possibility of

extended periods of property vacancy

and the variability of debt service

requirements associated with

nontraditional mortgage loan

products.10

Portfolio and Risk Management

Practices

Institutions should ensure that risk

management practices keep pace with

the growth and changing risk profile of

their nontraditional mortgage loan

portfolios and changes in the market.

Active portfolio management is

especially important for institutions that

project or have already experienced

significant growth or concentration

levels. Institutions that originate or

invest in nontraditional mortgage loans

should adopt more robust risk

management practices and manage these

exposures in a thoughtful, systematic

manner. To meet these expectations,

institutions should:

• Develop written policies that

specify acceptable product attributes,

production and portfolio limits, sales

and securitization practices, and risk

management expectations;

• Design enhanced performance

measures and management reporting

that provide early warning for

increasing risk;

• Establish appropriate ALLL levels

that consider the credit quality of the

portfolio and conditions that affect

collectibility; and

• Maintain capital at levels that

reflect portfolio characteristics and the

effect of stressed economic conditions

on collectibility. Institutions should

hold capital commensurate with the risk

characteristics of their nontraditional

mortgage loan portfolios

Establish appropriate ALLL levels

that consider the credit quality of the

portfolio and conditions that affect

collectibility; and

• Maintain capital at levels that

reflect portfolio characteristics and the

effect of stressed economic conditions

on collectibility. Institutions should

hold capital commensurate with the risk

characteristics of their nontraditional

mortgage loan portfolios.

Policies—An institution’s policies for

nontraditional mortgage lending activity

should set acceptable levels of risk

through its operating practices,

accounting procedures, and policy

exception tolerances. Policies should

reflect appropriate limits on risk

layering and should include risk

management tools for risk mitigation

purposes. Further, an institution should

set growth and volume limits by loan

type, with special attention for products

and product combinations in need of

heightened attention due to easing terms

or rapid growth.

Concentrations—Institutions with

concentrations in nontraditional

mortgage products should have well-

developed monitoring systems and risk

management practices. Monitoring

should keep track of concentrations in

key portfolio segments such as loan

types, third-party originations,

geographic area, and property

occupancy status. Concentrations also

should be monitored by key portfolio

characteristics such as loans with high

combined LTV ratios, loans with high

DTI ratios, loans with the potential for

negative amortization, loans to

borrowers with credit scores below

established thresholds, loans with risk-

layered features, and non-owner-

occupied investor loans. Further,

institutions should consider the effect of

employee incentive programs that could

produce higher concentrations of

nontraditional mortgage loans.

Concentrations that are not effectively

managed will be subject to elevated

supervisory attention and potential

examiner criticism to ensure timely

remedial action

s with risk-

layered features, and non-owner-

occupied investor loans. Further,

institutions should consider the effect of

employee incentive programs that could

produce higher concentrations of

nontraditional mortgage loans.

Concentrations that are not effectively

managed will be subject to elevated

supervisory attention and potential

examiner criticism to ensure timely

remedial action.

Controls—An institution’s quality

control, compliance, and audit

procedures should focus on mortgage

lending activities posing high risk.

Controls to monitor compliance with

underwriting standards and exceptions

to those standards are especially

important for nontraditional loan

products. The quality control function

should regularly review a sample of

nontraditional mortgage loans from all

origination channels and a

representative sample of underwriters to

confirm that policies are being followed.

When control systems or operating

practices are found deficient, business-

line managers should be held

accountable for correcting deficiencies

in a timely manner. Since many

nontraditional mortgage loans permit a

borrower to defer principal and, in some

cases, interest payments for extended

periods, institutions should have strong

controls over accruals, customer service

and collections. Policy exceptions made

by servicing and collections personnel

should be carefully monitored to

confirm that practices such as re-aging,

payment deferrals, and loan

modifications are not inadvertently

increasing risk. Customer service and

collections personnel should receive

product-specific training on the features

and potential customer issues with

these products.

Third-Party Originations—Institutions

often use third parties, such as mortgage

brokers or correspondents, to originate

nontraditional mortgage loans.

Institutions should have strong systems

and controls in place for establishing

and maintaining relationships with

third parties, including procedures for

performing due diligence

features

and potential customer issues with

these products.

Third-Party Originations—Institutions

often use third parties, such as mortgage

brokers or correspondents, to originate

nontraditional mortgage loans.

Institutions should have strong systems

and controls in place for establishing

and maintaining relationships with

third parties, including procedures for

performing due diligence. Oversight of

third parties should involve monitoring

the quality of originations so that they

reflect the institution’s lending

standards and compliance with

applicable laws and regulations.

Monitoring procedures should track

the quality of loans by both origination

source and key borrower characteristics.

This will help institutions identify

problems such as early payment

defaults, incomplete documentation,

and fraud. If appraisal, loan

documentation, credit problems or

consumer complaints are discovered,

the institution should take immediate

action. Remedial action could include

more thorough application reviews,

more frequent re-underwriting, or even

termination of the third-party

relationship.11

Secondary Market Activity—The

sophistication of an institution’s

secondary market risk management

practices should be commensurate with

the nature and volume of activity.

Institutions with significant secondary

market activities should have

comprehensive, formal strategies for

managing risks.12 Contingency planning

should include how the institution will

respond to reduced demand in the

secondary market.

While third-party loan sales can

transfer a portion of the credit risk, an

institution remains exposed to

reputation risk when credit losses on

sold mortgage loans or securitization

transactions exceed expectations. As a

result, an institution may determine that

it is necessary to repurchase defaulted

mortgages to protect its reputation and

maintain access to the markets

econdary market.

While third-party loan sales can

transfer a portion of the credit risk, an

institution remains exposed to

reputation risk when credit losses on

sold mortgage loans or securitization

transactions exceed expectations. As a

result, an institution may determine that

it is necessary to repurchase defaulted

mortgages to protect its reputation and

maintain access to the markets. In the

agencies’ view, the repurchase of

mortgage loans beyond the selling

institution’s contractual obligation is

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13 Refer to 12 CFR part 3 Appendix A, Section 4

(OCC); 12 CFR parts 208 and 225, Appendix A,

III.B.3 (FRB); 12 CFR part 325, Appendix A, II.B

(FDIC); 12 CFR 567 (OTS); and 12 CFR part 702

(NCUA) for each Agency’s capital treatment of

recourse.

14 Refer to the ‘‘Interagency Advisory on Mortgage

Banking’’, February 25, 2003, issued by the bank

and thrift regulatory agencies. Federally Insured

Credit Unions with assets of $10 million or more

are reminded they must report and value

nontraditional mortgages and related mortgage

servicing rights, if any, consistent with generally

accepted accounting principles in the Call Reports

they file with the NCUA Board.

implicit recourse. Under the agencies’

risk-based capital rules, a repurchasing

institution would be required to

maintain risk-based capital against the

entire pool or securitization.13

Institutions should familiarize

themselves with these guidelines before

deciding to support mortgage loan pools

or buying back loans in default.

Management Information and

Reporting—Reporting systems should

allow management to detect changes in

the risk profile of its nontraditional

mortgage loan portfolio

uired to

maintain risk-based capital against the

entire pool or securitization.13

Institutions should familiarize

themselves with these guidelines before

deciding to support mortgage loan pools

or buying back loans in default.

Management Information and

Reporting—Reporting systems should

allow management to detect changes in

the risk profile of its nontraditional

mortgage loan portfolio. The structure

and content should allow the isolation

of key loan products, risk-layering loan

features, and borrower characteristics.

Reporting should also allow

management to recognize deteriorating

performance in any of these areas before

it has progressed too far. At a minimum,

information should be available by loan

type (e.g., interest-only mortgage loans

and payment option ARMs); by risk-

layering features (e.g., payment option

ARM with stated income and interest-

only mortgage loans with simultaneous

second-lien mortgages); by underwriting

characteristics (e.g., LTV, DTI, and

credit score); and by borrower

performance (e.g., payment patterns,

delinquencies, interest accruals, and

negative amortization).

Portfolio volume and performance

should be tracked against expectations,

internal lending standards and policy

limits. Volume and performance

expectations should be established at

the subportfolio and aggregate portfolio

levels. Variance analyses should be

performed regularly to identify

exceptions to policies and prescribed

thresholds. Qualitative analysis should

occur when actual performance deviates

from established policies and

thresholds. Variance analysis is critical

to the monitoring of a portfolio’s risk

characteristics and should be an integral

part of establishing and adjusting risk

tolerance levels.

Stress Testing—Based on the size and

complexity of their lending operations,

institutions should perform sensitivity

analysis on key portfolio segments to

identify and quantify events that may

increase risks in a segment or the entire

portfolio

ical

to the monitoring of a portfolio’s risk

characteristics and should be an integral

part of establishing and adjusting risk

tolerance levels.

Stress Testing—Based on the size and

complexity of their lending operations,

institutions should perform sensitivity

analysis on key portfolio segments to

identify and quantify events that may

increase risks in a segment or the entire

portfolio. The scope of the analysis

should generally include stress tests on

key performance drivers such as interest

rates, employment levels, economic

growth, housing value fluctuations, and

other factors beyond the institution’s

immediate control. Stress tests typically

assume rapid deterioration in one or

more factors and attempt to estimate the

potential influence on default rates and

loss severity. Stress testing should aid

an institution in identifying, monitoring

and managing risk, as well as

developing appropriate and cost-

effective loss mitigation strategies. The

stress testing results should provide

direct feedback in determining

underwriting standards, product terms,

portfolio concentration limits, and

capital levels.

Capital and Allowance for Loan and

Lease Losses—Institutions should

establish an appropriate allowance for

loan and lease losses (ALLL) for the

estimated credit losses inherent in their

nontraditional mortgage loan portfolios.

They should also consider the higher

risk of loss posed by layered risks when

establishing their ALLL.

Moreover, institutions should

recognize that their limited performance

history with these products, particularly

in a stressed environment, increases

performance uncertainty. Capital levels

should be commensurate with the risk

characteristics of the nontraditional

mortgage loan portfolios. Lax

underwriting standards or poor portfolio

performance may warrant higher capital

levels

r ALLL.

Moreover, institutions should

recognize that their limited performance

history with these products, particularly

in a stressed environment, increases

performance uncertainty. Capital levels

should be commensurate with the risk

characteristics of the nontraditional

mortgage loan portfolios. Lax

underwriting standards or poor portfolio

performance may warrant higher capital

levels.

When establishing an appropriate

ALLL and considering the adequacy of

capital, institutions should segment

their nontraditional mortgage loan

portfolios into pools with similar credit

risk characteristics. The basic segments

typically include collateral and loan

characteristics, geographic

concentrations, and borrower qualifying

attributes. Segments could also

differentiate loans by payment and

portfolio characteristics, such as loans

on which borrowers usually make only

minimum payments, mortgages with

existing balances above original

balances, and mortgages subject to

sizable payment shock. The objective is

to identify credit quality indicators that

affect collectibility for ALLL

measurement purposes. In addition,

understanding characteristics that

influence expected performance also

provides meaningful information about

future loss exposure that would aid in

determining adequate capital levels.

Institutions with material mortgage

banking activities and mortgage

servicing assets should apply sound

practices in valuing the mortgage

servicing rights for nontraditional

mortgages. In accordance with

interagency guidance, the valuation

process should follow generally

accepted accounting principles and use

reasonable and supportable

assumptions.14

Consumer Protection Issues

While nontraditional mortgage loans

provide flexibility for consumers, the

Agencies are concerned that consumers

may enter into these transactions

without fully understanding the product

terms

In accordance with

interagency guidance, the valuation

process should follow generally

accepted accounting principles and use

reasonable and supportable

assumptions.14

Consumer Protection Issues

While nontraditional mortgage loans

provide flexibility for consumers, the

Agencies are concerned that consumers

may enter into these transactions

without fully understanding the product

terms. Nontraditional mortgage products

have been advertised and promoted

based on their affordability in the near

term; that is, their lower initial monthly

payments compared with traditional

types of mortgages. In addition to

apprising consumers of the benefits of

nontraditional mortgage products,

institutions should take appropriate

steps to alert consumers to the risks of

these products, including the likelihood

of increased future payment obligations.

This information should be provided in

a timely manner—before disclosures

may be required under the Truth in

Lending Act or other laws—to assist the

consumer in the product selection

process.

Concerns and Objectives—More than

traditional ARMs, mortgage products

such as payment option ARMs and

interest-only mortgages can carry a

significant risk of payment shock and

negative amortization that may not be

fully understood by consumers. For

example, consumer payment obligations

may increase substantially at the end of

an interest-only period or upon the

‘‘recast’’ of a payment option ARM. The

magnitude of these payment increases

may be affected by factors such as the

expiration of promotional interest rates,

increases in the interest rate index, and

negative amortization. Negative

amortization also results in lower levels

of home equity as compared to a

traditional amortizing mortgage product.

When borrowers go to sell or refinance

the property, they may find that

negative amortization has substantially

reduced or eliminated their equity in it

even when the property has

appreciated

t rates,

increases in the interest rate index, and

negative amortization. Negative

amortization also results in lower levels

of home equity as compared to a

traditional amortizing mortgage product.

When borrowers go to sell or refinance

the property, they may find that

negative amortization has substantially

reduced or eliminated their equity in it

even when the property has

appreciated. The concern that

consumers may not fully understand

these products would be exacerbated by

marketing and promotional practices

that emphasize potential benefits

without also providing clear and

balanced information about material

risks.

In light of these considerations,

communications with consumers,

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15 These program disclosures apply to ARM

products and must be provided at the time an

application is provided or before the consumer pays

a nonrefundable fee, whichever is earlier.

16 The OCC, the Board, and the FDIC enforce this

provision under the FTC Act and section 8 of the

FDI Act. Each of these agencies has also issued

supervisory guidance to the institutions under their

respective jurisdictions concerning unfair or

deceptive acts or practices. See OCC Advisory

Letter 2002–3—Guidance on Unfair or Deceptive

Acts or Practices, March 22, 2002; Joint Board and

FDIC Guidance on Unfair or Deceptive Acts or

Practices by State-Chartered Banks, March 11, 2004.

Federally insured credit unions are prohibited from

using any advertising or promotional material that

is inaccurate, misleading, or deceptive in any way

concerning its products, services, or financial

condition. 12 CFR 740.2

nfair or Deceptive

Acts or Practices, March 22, 2002; Joint Board and

FDIC Guidance on Unfair or Deceptive Acts or

Practices by State-Chartered Banks, March 11, 2004.

Federally insured credit unions are prohibited from

using any advertising or promotional material that

is inaccurate, misleading, or deceptive in any way

concerning its products, services, or financial

condition. 12 CFR 740.2. The OTS also has a

regulation that prohibits savings associations from

using advertisements or other representations that

are inaccurate or misrepresent the services or

contracts offered. 12 CFR 563.27. This regulation

supplements its authority under the FTC Act.

17 Institutions also should review the

recommendations relating to mortgage lending

practices set forth in other supervisory guidance

from their respective primary regulators, as

applicable, including guidance on abusive lending

practices.

18 Institutions also should strive to: (1) Focus on

information important to consumer decision

making; (2) highlight key information so that it will

be noticed; (3) employ a user-friendly and readily

navigable format for presenting the information;

and (4) use plain language, with concrete and

realistic examples. Comparative tables and

information describing key features of available

loan products, including reduced documentation

programs, also may be useful for consumers

considering the nontraditional mortgage products

and other loan features described in this guidance.

19 Institutions may not be able to incorporate all

of the practices recommended in this guidance

when advertising nontraditional mortgages through

certain forms of media, such as radio, television, or

billboards. Nevertheless, institutions should

provide clear and balanced information about the

risks of these products in all forms of advertising.

20 Consumers also should be apprised of other

material changes in payment obligations, such as

balloon payments

recommended in this guidance

when advertising nontraditional mortgages through

certain forms of media, such as radio, television, or

billboards. Nevertheless, institutions should

provide clear and balanced information about the

risks of these products in all forms of advertising.

20 Consumers also should be apprised of other

material changes in payment obligations, such as

balloon payments.

21 Federal credit unions are prohibited from

imposing prepayment penalties. 12 CFR

701.21(c)(6).

including advertisements, oral

statements, promotional materials, and

monthly statements, should provide

clear and balanced information about

the relative benefits and risks of these

products, including the risk of payment

shock and the risk of negative

amortization. Clear, balanced, and

timely communication to consumers of

the risks of these products will provide

consumers with useful information at

crucial decision-making points, such as

when they are shopping for loans or

deciding which monthly payment

amount to make. Such communication

should help minimize potential

consumer confusion and complaints,

foster good customer relations, and

reduce legal and other risks to the

institution.

Legal Risks—Institutions that offer

nontraditional mortgage products must

ensure that they do so in a manner that

complies with all applicable laws and

regulations. With respect to the

disclosures and other information

provided to consumers, applicable laws

and regulations include the following:

• Truth in Lending Act (TILA) and its

implementing regulation, Regulation Z.

• Section 5 of the Federal Trade

Commission Act (FTC Act). TILA and

Regulation Z contain rules governing

disclosures that institutions must

provide for closed-end mortgages in

advertisements, with an application,15

before loan consummation, and when

interest rates change

s

and regulations include the following:

• Truth in Lending Act (TILA) and its

implementing regulation, Regulation Z.

• Section 5 of the Federal Trade

Commission Act (FTC Act). TILA and

Regulation Z contain rules governing

disclosures that institutions must

provide for closed-end mortgages in

advertisements, with an application,15

before loan consummation, and when

interest rates change. Section 5 of the

FTC Act prohibits unfair or deceptive

acts or practices.16

Other Federal laws, including the fair

lending laws and the Real Estate

Settlement Procedures Act (RESPA),

also apply to these transactions.

Moreover, the Agencies note that the

sale or securitization of a loan may not

affect an institution’s potential liability

for violations of TILA, RESPA, the FTC

Act, or other laws in connection with its

origination of the loan. State laws,

including laws regarding unfair or

deceptive acts or practices, also may

apply.

Recommended Practices

Recommended practices for

addressing the risks raised by

nontraditional mortgage products

include the following:17

Communications with Consumers—

When promoting or describing

nontraditional mortgage products,

institutions should provide consumers

with information that is designed to

help them make informed decisions

when selecting and using these

products. Meeting this objective

requires appropriate attention to the

timing, content, and clarity of

information presented to consumers.

Thus, institutions should provide

consumers with information at a time

that will help consumers select products

and choose among payment options

ers

with information that is designed to

help them make informed decisions

when selecting and using these

products. Meeting this objective

requires appropriate attention to the

timing, content, and clarity of

information presented to consumers.

Thus, institutions should provide

consumers with information at a time

that will help consumers select products

and choose among payment options. For

example, institutions should offer clear

and balanced product descriptions

when a consumer is shopping for a

mortgage—such as when the consumer

makes an inquiry to the institution

about a mortgage product and receives

information about nontraditional

mortgage products, or when marketing

relating to nontraditional mortgage

products is provided by the institution

to the consumer—not just upon the

submission of an application or at

consummation.18 The provision of such

information would serve as an

important supplement to the disclosures

currently required under TILA and

Regulation Z or other laws.19

Promotional Materials and Product

Descriptions. Promotional materials and

other product descriptions should

provide information about the costs,

terms, features, and risks of

nontraditional mortgages that can assist

consumers in their product selection

decisions, including information about

the matters discussed below.

• Payment Shock. Institutions should

apprise consumers of potential increases

in payment obligations for these

products, including circumstances in

which interest rates or negative

amortization reach a contractual limit

, features, and risks of

nontraditional mortgages that can assist

consumers in their product selection

decisions, including information about

the matters discussed below.

• Payment Shock. Institutions should

apprise consumers of potential increases

in payment obligations for these

products, including circumstances in

which interest rates or negative

amortization reach a contractual limit.

For example, product descriptions

could state the maximum monthly

payment a consumer would be required

to pay under a hypothetical loan

example once amortizing payments are

required and the interest rate and

negative amortization caps have been

reached.20 Such information also could

describe when structural payment

changes will occur (e.g., when

introductory rates expire, or when

amortizing payments are required), and

what the new payment amount would

be or how it would be calculated. As

applicable, these descriptions could

indicate that a higher payment may be

required at other points in time due to

factors such as negative amortization or

increases in the interest rate index.

• Negative Amortization. When

negative amortization is possible under

the terms of a nontraditional mortgage

product, consumers should be apprised

of the potential for increasing principal

balances and decreasing home equity, as

well as other potential adverse

consequences of negative amortization.

For example, product descriptions

should disclose the effect of negative

amortization on loan balances and home

equity, and could describe the potential

consequences to the consumer of

making minimum payments that cause

the loan to negatively amortize. (One

possible consequence is that it could be

more difficult to refinance the loan or to

obtain cash upon a sale of the home).

• Prepayment Penalties

product descriptions

should disclose the effect of negative

amortization on loan balances and home

equity, and could describe the potential

consequences to the consumer of

making minimum payments that cause

the loan to negatively amortize. (One

possible consequence is that it could be

more difficult to refinance the loan or to

obtain cash upon a sale of the home).

• Prepayment Penalties. If the

institution may impose a penalty in the

event that the consumer prepays the

mortgage, consumers should be alerted

to this fact and to the need to ask the

lender about the amount of any such

penalty.21

• Cost of Reduced Documentation

Loans. If an institution offers both

reduced and full documentation loan

programs and there is a pricing

premium attached to the reduced

documentation program, consumers

should be alerted to this fact.

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22 For example, marketing materials for payment

option ARMs may promote low predictable

payments until the recast date. Such marketing

should be avoided in circumstances in which the

minimum payments are so low that negative

amortization caps would be reached and higher

payment obligations would be triggered before the

scheduled recast, even if interest rates remain

constant.

Monthly Statements on Payment

Option ARMs. Monthly statements that

are provided to consumers on payment

option ARMs should provide

information that enables consumers to

make informed payment choices,

including an explanation of each

payment option available and the

impact of that choice on loan balances.

For example, the monthly payment

statement should contain an

explanation, as applicable, next to the

minimum payment amount that making

this payment would result in an

increase to the consumer’s outstanding

loan balance

mation that enables consumers to

make informed payment choices,

including an explanation of each

payment option available and the

impact of that choice on loan balances.

For example, the monthly payment

statement should contain an

explanation, as applicable, next to the

minimum payment amount that making

this payment would result in an

increase to the consumer’s outstanding

loan balance. Payment statements also

could provide the consumer’s current

loan balance, what portion of the

consumer’s previous payment was

allocated to principal and to interest,

and, if applicable, the amount by which

the principal balance increased.

Institutions should avoid leading

payment option ARM borrowers to

select a non-amortizing or negatively-

amortizing payment (for example,

through the format or content of

monthly statements).

Practices to Avoid. Institutions also

should avoid practices that obscure

significant risks to the consumer. For

example, if an institution advertises or

promotes a nontraditional mortgage by

emphasizing the comparatively lower

initial payments permitted for these

loans, the institution also should

provide clear and comparably

prominent information alerting the

consumer to the risks. Such information

should explain, as relevant, that these

payment amounts will increase, that a

balloon payment may be due, and that

the loan balance will not decrease and

may even increase due to the deferral of

interest and/or principal payments.

Similarly, institutions should avoid

promoting payment patterns that are

structurally unlikely to occur.22 Such

practices could raise legal and other

risks for institutions, as described more

fully above

ent amounts will increase, that a

balloon payment may be due, and that

the loan balance will not decrease and

may even increase due to the deferral of

interest and/or principal payments.

Similarly, institutions should avoid

promoting payment patterns that are

structurally unlikely to occur.22 Such

practices could raise legal and other

risks for institutions, as described more

fully above.

Institutions also should avoid such

practices as: Giving consumers

unwarranted assurances or predictions

about the future direction of interest

rates (and, consequently, the borrower’s

future obligations); making one-sided

representations about the cash savings

or expanded buying power to be

realized from nontraditional mortgage

products in comparison with amortizing

mortgages; suggesting that initial

minimum payments in a payment

option ARM will cover accrued interest

(or principal and interest) charges; and

making misleading claims that interest

rates or payment obligations for these

products are ‘‘fixed’’.

Control Systems—Institutions should

develop and use strong control systems

to monitor whether actual practices are

consistent with their policies and

procedures relating to nontraditional

mortgage products. Institutions should

design control systems to address

compliance and consumer information

concerns as well as the safety and

soundness considerations discussed in

this guidance. Lending personnel

should be trained so that they are able

to convey information to consumers

about product terms and risks in a

timely, accurate, and balanced manner.

As products evolve and new products

are introduced, lending personnel

should receive additional training, as

necessary, to continue to be able to

convey information to consumers in this

manner. Lending personnel should be

monitored to determine whether they

are following these policies and

procedures. Institutions should review

consumer complaints to identify

potential compliance, reputation, and

other risks

new products

are introduced, lending personnel

should receive additional training, as

necessary, to continue to be able to

convey information to consumers in this

manner. Lending personnel should be

monitored to determine whether they

are following these policies and

procedures. Institutions should review

consumer complaints to identify

potential compliance, reputation, and

other risks. Attention should be paid to

appropriate legal review and to using

compensation programs that do not

improperly encourage lending

personnel to direct consumers to

particular products.

With respect to nontraditional

mortgage loans that an institution

makes, purchases, or services using a

third party, such as a mortgage broker,

correspondent, or other intermediary,

the institution should take appropriate

steps to mitigate risks relating to

compliance and consumer information

concerns discussed in this guidance.

These steps would ordinarily include,

among other things, (1) Conducting due

diligence and establishing other criteria

for entering into and maintaining

relationships with such third parties, (2)

establishing criteria for third-party

compensation designed to avoid

providing incentives for originations

inconsistent with this guidance, (3)

setting requirements for agreements

with such third parties, (4) establishing

procedures and systems to monitor

compliance with applicable agreements,

bank policies, and laws, and (5)

implementing appropriate corrective

actions in the event that the third party

fails to comply with applicable

agreements, bank policies, or laws.

Appendix: Terms Used in This

Document

Interest-only Mortgage Loan—A

nontraditional mortgage on which, for a

specified number of years (e.g., three or five

years), the borrower is required to pay only

the interest due on the loan during which

time the rate may fluctuate or may be fixed

ns in the event that the third party

fails to comply with applicable

agreements, bank policies, or laws.

Appendix: Terms Used in This

Document

Interest-only Mortgage Loan—A

nontraditional mortgage on which, for a

specified number of years (e.g., three or five

years), the borrower is required to pay only

the interest due on the loan during which

time the rate may fluctuate or may be fixed.

After the interest-only period, the rate may be

fixed or fluctuate based on the prescribed

index and payments include both principal

and interest.

Payment Option ARM—A nontraditional

mortgage that allows the borrower to choose

from a number of different payment options.

For example, each month, the borrower may

choose a minimum payment option based on

a ‘‘start’’ or introductory interest rate, an

interest-only payment option based on the

fully indexed interest rate, or a fully

amortizing principal and interest payment

option based on a 15-year or 30-year loan

term, plus any required escrow payments.

The minimum payment option can be less

than the interest accruing on the loan,

resulting in negative amortization. The

interest-only option avoids negative

amortization but does not provide for

principal amortization. After a specified

number of years, or if the loan reaches a

certain negative amortization cap, the

required monthly payment amount is recast

to require payments that will fully amortize

the outstanding balance over the remaining

loan term.

Reduced Documentation—A loan feature

that is commonly referred to as ‘‘low doc/no

doc’’, ‘‘no income/no asset’’, ‘‘stated income’’

or ‘‘stated assets’’. For mortgage loans with

this feature, an institution sets reduced or

minimal documentation standards to

substantiate the borrower’s income and

assets

payments that will fully amortize

the outstanding balance over the remaining

loan term.

Reduced Documentation—A loan feature

that is commonly referred to as ‘‘low doc/no

doc’’, ‘‘no income/no asset’’, ‘‘stated income’’

or ‘‘stated assets’’. For mortgage loans with

this feature, an institution sets reduced or

minimal documentation standards to

substantiate the borrower’s income and

assets.

Simultaneous Second-Lien Loan—A

lending arrangement where either a closed-

end second-lien or a home equity line of

credit (HELOC) is originated simultaneously

with the first lien mortgage loan, typically in

lieu of a higher down payment.

Dated: September 25, 2006.

John C. Dugan,

Comptroller of the Currency.

By order of the Board of Governors of the

Federal Reserve System, September 27, 2006.

Jennifer J. Johnson,

Secretary of the Board.

Dated at Washington, DC, this 27th day of

September, 2006.

Federal Deposit Insurance Corporation.

Robert E. Feldman,

Executive Secretary.

Dated: September 28, 2006.

By the Office of Thrift Supervision.

John M. Reich,

Director.

By the National Credit Union

Administration on September 28, 2006.

JoAnn M. Johnson,

Chairman.

[FR Doc. 06–8480 Filed 10–3–06; 8:45 am]

BILLING CODE 4810–33–P, 6210–01–P, 6714–01–P,

6720–01–P, 7535–01–P

VerDate Aug<31>2005

14:45 Oct 03, 2006

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