Five Brothers

Federal Bank Regulators Offer Guidelines for Exotic Mortgage Lending

Last Friday, as had been expected, the five federal departments or quasi-agencies charged with overseeing the nation's banking system jointly issued "guidance" to those banks regarding so-called "exotic" or non-traditional mortgages.

The recent popularity of interest only loans and option payment mortgages has raised concerns about their danger to homeowners and questions about how well their intricacies and risks are understood by borrowers.  The guidelines also cautioned lenders to safefuard themselves against undue risk.

The agencies - The Board of Govenors of The Federal Reserve System, The Office of Comptroller of the Currecny, the Office of Thrift Supervision, the National Credit Union Administration, and the Federal Deposit Insurance Corporation - said in a joint press release that, while products such as these have long been available, the number of institutions offering them has expanded rapidly and they are being offered to a wider range of borrowers who might not be able to qualify for traditional mortgages of the same size.

In testimony before the State Banking Committee late last month the Government Accountability Office estimated that non-traditional mortgages rose from a ten percent market share to a 30 percent share between 2003 and 2005.

the join press release from the five agencies states that while some of the risks concerning regulators are also found in other adjustable rate mortgages, the agencies' concern is elevated with the interest only and option payment product because of the lack of principal amortization and the potential for negative amortization.  Also, institutions are now combining these non-traditional loans with other features that may compound risk, called "risk layering" such as making simultaneous second-lien mortgages (blended or piggy back loans) and offering low or no documentation options in which borrowers are allowed to "state" their income with very little if any verification.

The final guidance - which was put forth in draft form for public comment some months ago - discusses the importance of managing the potential increased risk of these prodcuts.  It suggests several steps that the managment of individual institutions should take: