Guidance on Nontraditional Loans Focuses on Lender Practices

At the Regulatory and Legislative Roundup at the MBA National Secondary Market Conference here, Scott Polakoff, deputy director and chief operating officer, Office of Thrift Supervision, discussed the nontraditional guidance that came out in 2006 and the statement on subprime mortgage lending, which is now being debated by federal regulators before it comes down to the final reform.

Regulators have a responsibility for looking at practices not products, Mr. Polakoff said. "That is so important. It is very common for the industry, for regulators, for Congress, to focus on a product. To say that product is good, that product is bad."

That is not the right approach, he added. "For example, nontraditional mortgages. Are they good or bad? They can be an outstanding tool when used properly or a devious tool when used improperly. How about 2/28 hybrid ARMs? Good or bad? It depends."

Risk layering is part of the problem that got the industry where it is now, and it should help get lenders and servicers out of the problem in the short term. As subprime ARMs reset in 2007, there will be the potential for tighter underwriting, and static or declining home values will effect refinancing, said Mr. Polakoff.

There is a philosophical switch in the way servicers are setting protections for the loans. Before, they used to foreclose as soon as possible, he said. "Now we try and keep people in their homes, which requires a lot of work and outreach from financial institutions. It's surprising to see that first-time homebuyers are likely to go into default, because they are stretched financially, in a home they can't afford, and they have no idea what's involved with buying a home for the first time."

It looks like securitizations in the pooling and servicing agreements allow for modifications on either delinquent or reasonable, foreseeable delinquency. It used to be a lot of people tried to avoid certain levels of debt. Now the debt level is actually considered as a purchasing opportunity, he said.

Regarding the subprime market and the emergency guidance issued in 2001, Mr. Polakoff asked everyone in the room to consider their definition of "subprime," predicting there would be 50 or 60 different variations, including characteristics of FICO scores. The guidance addresses underwriting criteria, consumer protection and policies and procedures.

If the new subprime statement is adopted, it would complement the 2006 Interagency Guidance on Nontraditional Mortgage Product Risks, which did not specifically address the risks of these ARM products.

"The issue I suspect is state banking departments will align with the subprime guidance because it will affect the way they do business. In one way or another, it will affect the way you do business."

Also during the same panel, the director of OFHEO pushed for the passage of a bill that he said will strengthen the nation's housing finance system by enhancing oversight of Fannie Mae, Freddie Mac and the Federal Home Loan Banks.

The approval by the House of Representatives of the Federal Housing Finance Reform Act gives the new regulator the tools necessary to ensure the safety and soundness of the GSEs so they fulfill their congressionally established mission, especially affordable housing, said James Lockhart.

The Office of Federal Housing Enterprise Oversight's strategic goals that are part of its five-year plan include enhancing supervision to ensure the enterprises are adequately capitalized and comply with legal requirements, to provide support for statutory reforms to strengthen their regulatory powers, and to continue to support the national policy, which promotes homeownership and affordable housing.

"There is a significant weakness we have compared to federal bank regulators. We do not have independent litigating authority. Everything has to be approved by Congress," Mr. Lockhart told conference attendees. "We can't hire the people we need to oversee, yet Fannie and Freddie are spending millions of dollars to fix their problems. Full authority over capital is a critical piece."

The enterprises can play a key role in refinancing many of the better subprime loans. He said portfolio growth caps and extra capital requirements will not lessen their ability to serve the growing need to get subprime borrowers into safer and less volatile mortgages.

"There is nothing in the proposed legislation or present rules that provide them from providing liquidity in the market," he said.

On a very large scale, the housing GSEs face a full range of risks including market risk, credit risk and operational risk, which is why a new and stronger regulator is needed, he said. A single housing GSE regulator for Fannie Mae, Freddie Mac and the FHLBanks would create within the government a single regulatory voice focused on the health of the housing finance markets, Mr. Lockhart said.

The new housing news has been the problems in the subprime market, he said, which represents about 15% of the total mortgage market, but it has been the fastest-growing component.

"The subprime news is not good, but I believe the problems will be manageable within existing markets, mortgage servicers' practices and financial institutions including community banks and GSEs," said Mr. Lockhart.

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