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FDIC Federal Register Citations
[Federal Register: March 8, 2007 (Volume 72, Number 45)]
[Page 10533-10537]
From the Federal Register Online via GPO Access []



Office of the Comptroller of the Currency

[Docket No. OCC-2007-0005]


[Docket No. OP-1278]



Office of Thrift Supervision

[No. 2007-09]


Proposed Statement on Subprime Mortgage Lending

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: Notice with request for comment.


SUMMARY: The OCC, Board, FDIC, OTS, and NCUA (the Agencies) request 
comment on this proposed Statement on Subprime Mortgage Lending. The 
proposed statement addresses emerging issues and questions relating to 
certain subprime mortgage lending practices, and it discusses risk 
management and consumer compliance processes, policies, and procedures 
that institutions should implement to respond to these concerns.

DATES: Comments must be submitted on or before May 7, 2007.

ADDRESSES: The Agencies will jointly review all of the comments 
submitted. Therefore, interested parties may send comments to any of 
the Agencies and need not send comments (or copies) to all of the 
Agencies. Please consider submitting your comments by e-mail or fax, 
since paper mail in the Washington area and at the Agencies is subject 
to delay. Interested parties are invited to submit comments to:
    OCC: You should include ``OCC'' and Docket Number OCC-2007-0005 in 
your comment. You may submit your comment by any of the following 
     Federal eRulemaking Portal: 

Follow the instructions for submitting comments.
     OCC Web Site: Click on ``Contact 

the OCC,'' scroll down and click on ``Comments on Proposed 
     E-Mail Address:
     Fax: (202) 874-4448.
     Mail: Office of the Comptroller of the Currency, 250 E 
Street, SW., Mail Stop 1-5, Washington, DC 20219.
     Hand Delivery/Courier: 250 E Street, SW., Attn: Public 
Information Room, Mail Stop 1-5, Washington, DC 20219.
    Instructions: In general, the OCC will enter all comments received 
into the docket without change, including any business or personal 
information that you provide.
    You may review comments and other related materials by any of the 
following methods:
     Viewing Comments Personally: You may personally inspect 
and photocopy comments at the OCC's Public Information Room, 250 E 
Street, SW., Washington, DC. You can make an appointment to inspect 
comments by calling (202) 874-5043.
     Viewing Comments Electronically: You may request that we 
send you an electronic copy of comments via e-mail or mail you a CD-ROM 
containing electronic copies by contacting the OCC at

     Docket Information: You may also request available 
background documents and project summaries using the methods described 
    Board: You may submit comments, identified by Docket No. OP-1278, 
by any of the following methods:
     Agency Web site: 
Follow the instructions for submitting comments at

.     Federal eRulemaking Portal: 

Follow the instructions for submitting comments.
     E-mail: Include the 
docket number (OP-1278) in the subject line of the message.
     Fax: (202) 452-3819 or (202) 452-3102.
     Mail: Jennifer J. Johnson, Secretary, Board of Governors 
of the Federal Reserve System, 20th Street and Constitution Avenue, 
NW., Washington, DC 20551.
    All public comments are available from the Board's Web site at as 

submitted, unless modified for technical reasons. Accordingly, your 
comments will not be edited to remove any identifying or contact 
information. Public comments also may be viewed electronically or in 
paper form in Room MP-500 of the Board's Martin Building (20th and C 
Streets, NW.) between 9 a.m. and 5 p.m. on weekdays.
    FDIC: You may submit comments by any of the following methods:
     Agency Web Site:
 Follow instructions for submitting comments on the Agency Web 

     E-mail: Include ``Statement on Subprime 
Mortgage Lending'' in the subject line of the message.
     Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments, Federal Deposit Insurance Corporation, 550 17th Street, NW., 
Washington, DC 20429.
     Hand Delivery/Courier: Guard station at the rear of the 
550 17th Street Building (located on F Street) on business days between 
7 a.m. and 5 p.m. (EST).
     Federal eRulemaking Portal: 

Follow the instructions for submitting comments.
    Public Inspection: All comments received will be posted without 
change to including any 
personal information provided. Comments may be inspected and 
photocopied in the FDIC Public Information Center, 3501 North Fairfax 
Drive, Room E-1002, Arlington, VA 22226, between 9 a.m. and 5 p.m. 
(EST) on business days. Paper copies of public comments may be ordered 
from the Public Information Center by telephone at (877) 275-3342 or 
(703) 562-2200.
    OTS: You may submit comments, identified by docket number 2007-09, 
by any of the following methods:
     Federal eRulemaking Portal: 

Follow the instructions for submitting comments.
     E-mail address: Please 
include docket number 2007-09 in the subject line of the message and 
include your name and telephone number in the message.
     Fax: (202) 906-6518.
     Mail: Regulation Comments, Chief Counsel's Office, Office 
of Thrift Supervision, 1700 G Street, NW., Washington, DC 20552, 
Attention: No. 2007-XX.
     Hand Delivery/Courier: Guard's Desk, East Lobby Entrance, 
1700 G Street, NW., from 9 a.m. to 4 p.m. on business days. Address 
envelope as

[[Page 10534]]

follows: Attention: Regulation Comments, Chief Counsel's Office, 
Attention: No. 2007-09.
    Instructions: All submissions received must include the agency name 
and docket number for this proposed Statement. All comments received 
will be posted without change to the OTS Internet Site
including any personal information provided.
    Docket: For access to the docket to read background documents or 
comments received, go to
 In addition, you may inspect comments at the OTS's Public Reading Room, 1700 G Street, NW., 
by appointment. To make an appointment for access, call (202) 906-5922, send an e-mail 
to, or send a facsimile transmission to (202) 
906-7755. (Prior notice identifying the materials you will be 
requesting will assist us in serving you.) We schedule appointments on 
business days between 10 a.m. and 4 p.m. In most cases, appointments 
will be available the next business day following the date we receive a 
    NCUA: You may submit comments by any of the following methods:
     Federal eRulemaking Portal: 

Follow the instructions for submitting comments.
     NCUA Web site:

Follow the instructions for submitting comments.
     E-mail: Address to Include ``[Your 
name] Comments on `` in the e-mail subject line.
     Fax: (703) 518-6319. Use the subject line described above 
for e-mail.
     Mail: Address to Mary Rupp, Secretary of the Board, 
National Credit Union Administration, 1775 Duke Street, Alexandria, 
Virginia 22314-3428.
     Hand Delivery/Courier: Same as mail address.

    OCC: Michael S. Bylsma, Director, Community and Consumer Law 
Division, (202) 874-5750 or Stephen Jackson, Director, Retail Credit 
Risk, (202) 874-5170.
    Board: Division of Banking Supervision and Regulation: Brian 
Valenti, Supervisory Financial Analyst, (202) 452-3575, Virginia Gibbs, 
Senior Supervisory Financial Analyst, (202) 452-2521, or Sabeth 
Siddique, Assistant Director, (202) 452-3861; Division of Consumer and 
Community Affairs: Kathleen Ryan, Counsel, (202) 452-3667, or Jamie 
Goodson, Attorney, (202) 452-3667; or Legal Division: Stephanie Martin, 
Associate General Counsel, (202) 452-3198. Board of Governors of the 
Federal Reserve System, 20th Street and Constitution Avenue, NW., 
Washington, DC 20551. Users of Telecommunication Device for Deaf (TTD) 
only, call (202) 263-4869.
    FDIC: Suzy S. Gardner, Examination Specialist, (202) 898-3640, 
Division of Supervision and Consumer Protection; Richard Foley, 
Counsel, (202) 898-3784, Legal Division; or April Breslaw, Acting 
Associate Director, Compliance Policy & Exam Support Branch, (202) 898-
6609, Division of Supervision and Consumer Protection.
    OTS: Tammy Stacy, Director of Consumer Regulation, Compliance and 
Consumer Protection Division, (202) 906-6437; Glenn Gimble, Senior 
Project Manager, Compliance and Consumer Protection Division, (202) 
906-7158, William Magrini, Senior Project Manager, Credit Risk, (202) 
906-5744; or Teresa Luther, Economist, Credit Risk, (202) 906-6798.
    NCUA: Cory Phariss, Program Officer, Examination and Insurance, 
(703) 518-6618.


I. Background

    This proposed Statement on Subprime Mortgage Lending (Statement) 
discusses criteria and factors, including payment shock, that an 
institution should assess in determining a borrower's ability to repay 
a subprime loan. The Statement also discusses consumer protection 
issues and practices, including reminders about some of the existing 
statutes, regulations, and guidance intended to protect consumers from 
unfair, deceptive, and other predatory practices. Finally, the 
Statement discusses the need for policies, procedures, and systems to 
assure that institutions' subprime mortgage lending is conducted in a 
safe and sound manner. The Statement is contained in Section II, below. 
The Agencies \1\ request comment on all aspects of the Statement, 
including, but not limited to, the specific questions that appear in 
Section III.

    \1\ The Agencies consist of the Board of Governors of the 
Federal Reserve System (the Board), the Federal Deposit Insurance 
Corporation (FDIC), the National Credit Union Administration (NCUA), 
the Office of the Comptroller of the Currency (OCC), and the Office 
of Thrift Supervision (OTS), collectively the Agencies.

II. Proposed Statement on Subprime Mortgage Lending

    The Agencies developed this Statement to address emerging issues 
and questions relating to certain subprime \2\ mortgage lending 
practices. The Agencies are concerned that subprime borrowers may not 
fully understand the risks and consequences of obtaining certain 
adjustable-rate mortgage (ARM) products. In particular, the Agencies 
are concerned with ARM products marketed to subprime borrowers with the 
following characteristics:

    \2\ The term ``subprime'' is defined in the 2001 Expanded 
Guidance for Subprime Lending Programs. Federally insured credit 
unions should refer to LCU 04-CU-13--Specialized Lending Activities.

     Offering low initial payments based on a fixed 
introductory or ``teaser'' rate that expires after a short initial 
period then adjusts to a variable index rate plus a margin for the 
remaining term of the loan; \3\

    \3\ For example, ARMs known as ``2/28'' loans feature a fixed 
rate for two years and then adjust to a variable rate for the 
remaining 28 years. The spread between the initial fixed rate of 
interest and the fully indexed interest rate in effect at loan 
origination typically ranges from 300 to 600 basis points.

     Approving borrowers without considering appropriate 
documentation of their income;
     Setting very high or no limits on how much the payment 
amount or the interest rate may increase (``payment or rate caps'') at 
reset periods, potentially causing a substantial increase in the 
monthly payment amount ``payment shock''; \4\

    \4\ Payment shock refers to a significant increase in the amount 
of the monthly payment that occurs when the interest rate adjusts to 
a fully indexed basis. Products with a wide spread between the 
initial interest rate and the fully indexed interest rate that do 
not have payment caps or periodic interest rate caps, or that 
contain very high caps can produce significant payment shock.

     Containing product features likely to result in frequent 
refinancing to maintain an affordable monthly payment;
     Including substantial prepayment penalties and/or 
prepayment penalties that extend beyond the initial interest rate 
adjustment period; and/or
     Providing borrowers with inadequate information relative 
to product features, material loan terms and product risks, prepayment 
penalties, and the borrower's obligations for property taxes and 
    The consequences to subprime borrowers could include: Being unable 
to afford the monthly payments after the initial rate adjustment 
because of payment shock; experiencing difficulty in paying real estate 
taxes and

[[Page 10535]]

homeowners insurance that were not escrowed; incurring expensive 
refinancing fees frequently due to closing costs and prepayment 
penalties, especially if the prepayment penalty period extends beyond 
the rate adjustment date; and losing their home. The Agencies also are 
concerned about the elevated credit risk that is inherent in these 
    The Agencies note that many of these concerns are addressed in 
existing interagency guidance. The most prominent are the 1993 
Interagency Guidelines for Real Estate Lending (Real Estate 
Guidelines), the 1999 Interagency Guidance on Subprime Lending 
(Subprime Lending Guidance), and the 2001 Expanded Guidance for 
Subprime Lending Programs (Expanded Subprime Guidance).\5\

    \5\ Federally insured credit unions should refer to LCU 04-CU-
13--Specialized Lending Activities. National banks should also refer 
to 12 CFR 34.3(b) and (c), as well as 12 CFR part 30, Appendix C.

    While the 2006 Interagency Guidance on Nontraditional Mortgage 
Product Risks (NTM Guidance) may not explicitly pertain to products 
with the characteristics addressed in this Statement, it outlines 
prudent underwriting and consumer protection principles that 
institutions should also consider with regard to subprime mortgage 
lending. This Statement reiterates many of the principles addressed in 
existing guidance relative to prudent risk management practices and 
consumer protection laws.\6\

    \6\ As with the Interagency Guidance on Nontraditional Mortgage 
Product Risks, 71 FR 58609 (October 4, 2006), this Statement applies 
to all banks and their subsidiaries, bank holding companies and 
their nonbank subsidiaries, savings associations and their 
subsidiaries, savings and loan holding companies and their 
subsidiaries, and credit unions.

Risk Management Practices

Predatory Lending Considerations
    Institutions marketing subprime mortgage loans should ensure that 
they do not engage in the type of predatory lending practices discussed 
in the Expanded Subprime Guidance. Typically, predatory lending 
involves at least one, and perhaps all three, of the following 
     Making mortgage loans based predominantly on the 
foreclosure or liquidation value of a borrower's collateral rather than 
on the borrower's ability to repay the mortgage according to its terms;
     Inducing a borrower to repeatedly refinance a loan in 
order to charge high points and fees each time the loan is refinanced 
(``loan flipping''); or
     Engaging in fraud or deception to conceal the true nature 
of the mortgage loan obligation, or ancillary products, from an 
unsuspecting or unsophisticated borrower.
    Institutions marketing mortgage loans such as these carry an 
elevated risk that their conduct will violate Section 5 of the Federal 
Trade Commission Act (FTC Act), which prohibits unfair or deceptive 
acts or practices.\7\

    \7\ The OCC, the Board, the OTS, and the FDIC enforce this 
provision under section 8 of the FDI Act. The OCC, Board, and FDIC 
also have 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 and 12 CFR part 30, 
Appendix C; Joint Board and FDIC Guidance on Unfair or Deceptive 
Acts or Practices by State-Chartered Banks, March 11, 2004. OTS has 
also issued 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). The 
NCUA prohibits federally insured credit unions 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).

Underwriting Standards
    Institutions should refer to the Real Estate Guidelines, which 
provide underwriting standards for all real estate loans.\8\ The Real 
Estate Guidelines state that prudently underwritten real estate loans 
should reflect all relevant credit factors, including the capacity of 
the borrower to adequately service the debt.\9\ The 2006 NTM Guidance 
details similar criteria for qualifying borrowers for products that may 
result in payment shock.

    \8\ Refer to 12 CFR part 34, subpart D (OCC); 12 CFR 208, 
subpart C (Board); 12 CFR part 365 (FDIC); 12 CFR 560.100 and 12 CFR 
560.101 (OTS); 12 CFR 701.21 (NCUA).
    \9\ OTS Examination Handbook Section 212, 1-4 Family Residential 
Mortgage Lending, also discusses borrower qualification standards. 
Federally Insured Credit Unions should refer to LCU 04-CU-13--
Specialized Lending Activities.

    Prudent qualifying standards recognize the potential effect of 
payment shock in evaluating a borrower's ability to service debt. An 
institution's analysis of a borrower's repayment capacity should 
include an evaluation of the borrower's ability to repay the debt by 
its final maturity at the fully indexed rate, assuming a fully 
amortizing repayment schedule. One widely accepted approach in the 
mortgage industry is to quantify a borrower's repayment capacity by a 
debt-to-income (DTI) ratio. An institution's DTI analysis should assess 
a borrower's total monthly housing-related payments (e.g., principal, 
interest, taxes, and insurance, or ``PITI'') as a percentage of gross 
monthly income.
    This assessment is particularly important if the institution relies 
upon reduced documentation or allows other forms of risk layering. 
Risk-layering features in a subprime mortgage loan may significantly 
increase the risks to both the institution and the borrower. Therefore, 
an institution should have clear policies governing the use of risk-
layered features, such as reduced documentation loans or simultaneous-
second lien mortgages. When risk-layering features are combined with a 
mortgage loan, an institution should demonstrate the existence of 
effective mitigating factors that support the underwriting decision and 
the borrower's repayment capacity.
    The higher a loan's risk, either from loan features or borrower 
characteristics, the more important it is to verify the borrower's 
income, assets, and liabilities. When underwriting higher risk loans, 
stated income and reduced documentation should be accepted only if 
there are mitigating factors that clearly minimize the need for direct 
verification of repayment capacity. For many borrowers, institutions 
should be able to readily document income using recent W-2 statements, 
pay stubs or tax returns. A higher interest rate is not considered an 
acceptable mitigating factor.

Consumer Protection Principles

    Fundamental consumer protection principles relevant to the 
underwriting and marketing of mortgage loans include:
     Approving loans based on the borrower's ability to repay 
the loan according to its terms, and
     Providing information that enables consumers to understand 
material terms, costs, and risks of loan products at a time that will 
help the consumer select products and choose among payment options.
    When applying these principles to ARMs marketed to subprime 
borrowers described in this document, communications with consumers, 
including advertisements, oral statements, and promotional materials 
should provide clear and balanced information about the relative 
benefits and risks of the products. This information should be provided 
in a timely manner to assist consumers in the product selection 
process, not just upon submission of an application or at consummation 
of the loan. Institutions should not use such communications to steer 
consumers to these products to the exclusion of other products offered 
by the institution for which the consumer may qualify.
    Information provided to consumers should clearly explain the risk 

[[Page 10536]]

payment shock \10\ and the ramifications of prepayment penalties, 
balloon payments, and the lack of escrow for taxes and insurance, as 
applicable. The Agencies strongly encourage institutions that impose 
prepayment penalties to structure them in such a way that they do not 
extend beyond the initial reset period and, further, provide borrowers 
a sufficient window of time immediately prior to the reset date to 
refinance without penalty.

    \10\ To illustrate: A borrower earning $36,000 per year obtains 
a $200,000 ``2/28'' mortgage loan. The loan has a two-year 
introductory fixed interest rate of 7%, resulting in an initial 
payment of $1,331 and a 44% debt-to-income (DTI) ratio, based on 
principal and interest only; and would be higher after the inclusion 
of taxes and insurance. The spread is 6% over the six-month London 
Interbank Offered Rate (LIBOR), which is 5.5% at the time of loan 
origination. The fully indexed interest rate at origination of 11.5% 
(6% + 5.5%) would cause the borrower's monthly payment to increase 
to $1,956 (or 47%), a 65% DTI ratio, based on principal and interest 

    Similarly, if borrowers do not understand that their monthly 
mortgage payments do not include taxes and insurance, and they have not 
budgeted for these essential homeownership expenses, they may be faced 
with the need for significant additional funds on short notice.\11\ 
Therefore, mortgage product descriptions and advertisements should 
provide clear, detailed information about all of the costs, terms, 
features, and risks of the loan to the borrower. Consumers should be 
informed of:

    \11\ Institutions generally can address these concerns most 
directly by requiring borrowers to escrow funds for real estate 
taxes and insurance.

     Payment Shock. Potential payment increases, including how 
the new payment will be calculated when the introductory fixed rate 
     Prepayment Penalties. The existence of any prepayment 
penalty, how it will be calculated, and when it may be imposed.\12\

    \12\ Federal credit unions are prohibited from charging 
prepayment penalties. 12 CFR 701.21.

     Balloon Payments. The existence of any balloon payment.
     Cost of Reduced Documentation Loans. Whether there is a 
pricing premium attached to a reduced documentation or stated income 
     Responsibility for Taxes and Insurance. The requirement to 
make payments for real estate taxes and insurance in addition to their 
loan payments, if not escrowed, and the fact that taxes and insurance 
costs can be substantial.

Control Systems

    Institutions should develop strong control systems to monitor 
whether actual practices are consistent with their policies and 
procedures. Systems should address compliance and consumer information 
concerns, as well as safety and soundness, and encompass both 
institution personnel and applicable third parties, such as mortgage 
brokers or correspondents.
    Important controls include establishing appropriate criteria for 
hiring and training loan personnel, entering into and maintaining 
relationships with third parties, and conducting initial and ongoing 
due diligence with third parties. Institutions also should design 
compensation programs that avoid providing incentives for originations 
inconsistent with sound underwriting and consumer protection 
principles, and that do not steer consumers to these products to the 
exclusion of other products for which the consumer may qualify.
    Institutions should have procedures and systems in place to monitor 
compliance with appropriate laws and regulations, applicable third-
party agreements and internal policies. An institution's controls also 
should include appropriate corrective actions in the event of failure 
to comply with applicable laws, regulations, third-party agreements or 
internal policies. In addition, institutions should initiate procedures 
to review consumer complaints to identify potential compliance problems 
or other negative trends.

Supervisory Review

    The Agencies will carefully scrutinize risk management and consumer 
compliance processes, policies, and procedures at regularly scheduled 
examinations. Institutions that do not adequately manage these 
functions will be asked to take remedial action. The Agencies will take 
action against institutions that fail to implement or adhere to safe 
and sound standards, exhibit predatory lending practices, or violate 
consumer protection laws, such as the Federal Trade Commission Act's 
prohibition against unfair or deceptive practices or the fair lending 

III. Request for Comment

    The Agencies recognize that the structural evolution of subprime 
mortgage lending in recent years has introduced some products that are 
intended at their outset to be temporary credit accommodations in 
anticipation of early sale or refinancing, rather than longer-term 
amortizing accounts. Such loans typically involve terms that exceed the 
borrower's ability to service the debt without refinancing or selling 
the property. The motivations for these arrangements vary. They may 
include financing in anticipation of the borrower's intended temporary 
residency, expected future earnings growth, or need for a period of 
``credit repair.'' Because of this fundamental shift in the purpose and 
actual repayment expectations of such loan programs, the Agencies are 
particularly interested in public comment on the following specific 
    1. The proposed qualification standards are likely to result in 
fewer borrowers qualifying for the type of subprime loans addressed in 
this Statement, with no guarantee that such borrowers will qualify for 
alternative loans in the same amount. Do such loans always present 
inappropriate risks to lenders or borrowers that should be discouraged, 
or alternatively, when and under what circumstances are they 
    2. Will the proposed Statement unduly restrict the ability of 
existing subprime borrowers to refinance their loans and avoid payment 
shock? The Agencies also are specifically interested in the 
availability of mortgage products that would not present the risk of 
payment shock.
    3. Should the principles of this proposed Statement be applied 
beyond the subprime ARM market?
    4. We seek comment on the practice of institutions that limit 
prepayment penalties to the initial fixed rate period. Additionally, we 
seek comment on how this practice, if adopted, would assist consumers 
and impact institutions, by providing borrowers with a timely 
opportunity to determine appropriate actions relating to their 
mortgages. We also seek comment on whether an institution's limiting of 
the expiration of prepayment penalties such that they occur within the 
final 90 days of the fixed rate period is a practice that would help 
meet borrower needs.
    In addition to the foregoing questions, the Agencies request 
comment on all other aspects of the proposed Statement.

    Dated: February 28, 2007.
John C. Dugan,
Comptroller of the Currency.

    By order of the Board of Governors of the Federal Reserve 
System, March 2, 2007.
Jennifer J. Johnson,
Secretary of the Board.

    Dated at Washington, DC, the 28th day of February, 2007.

    By order of the Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.

    Dated: February 28, 2007.

[[Page 10537]]

    By the Office of Thrift Supervision.
John M. Reich,

    By the National Credit Union Administration on February 28, 
JoAnn M. Johnson,
[FR Doc. 07-1083 Filed 3-7-07; 8:45 am]
BILLING CODE 4810-33-P; 6210-01-P; 6714-01-P; 6720-01-P; 7535-01-P


Last Updated 03/08/2007

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