Predatory Lending: OCC Issues New Guidelines

Following the old advice of something old, something new, the OCC has issued guidelines on establishing standards for national banks on mortgage lending. These guidelines appear as Appendix C to part 30 of OCC's regulations. On the one hand, the guidance does not really contain anything new or different. Most of what the guidelines contain has already been said by the OCC and by other agencies.

What is new is the approach. Issuing these guidelines effectively codifies the previous guidance (all of which remains on the books) and thus provides stronger and more consistent authority. If you can't hear them now, you aren't listening.

The guidelines represent the culmination of a many-year process. As stated in the document itself, the guidelines do not replace previous guidance, such as AL-2003-2. Instead, the guidelines incorporate previous guidance, provide a restatement, and thus bolster the agency's position.

These guidelines apply specifically to banks under the supervision of the OCC - national banks and branches of foreign banks. While a state-chartered bank may wish to breath a sigh of relief at having a different regulator, any such sigh should be short and quick. Once guidance such as this is on the books, it tends to be applied by everyone. In fact, don't be surprised if the other bank regulatory agencies take similar steps in the near future.

High Stakes
The guidelines officially raise predatory lending to a safety and soundness concern. This effectively completes the step taken by the OCC last year to incorporate certain predatory lending practices into the lending regulations. This is the culmination of a gradual but committed process to deal with predatory lending practices.

The first official steps taken by the OCC were enforcement cases, including Providian and The Associates. This was followed by warnings in the form of speeches, and then by Advisory Letters. The Advisory Letters 2003-2 and 2003-3 identified many of the abusive lending practices that the OCC considered problematic and predatory.

Then OCC took the step of preempting state laws on predatory lending and simultaneously placed underwriting requirements in the lending regulations, making certain predatory lending practices a violation of safety and soundness principles. Now this process is capped off with the predatory lending guidelines which the OCC describes as "core elements" of anti-predatory lending guidance.

Coverage
The guidelines apply broadly to any consumer loan secured by a 1-4 family dwelling. Dwellings include houses, condos, co-ops, and mobile homes. In short, if the borrower lives in it, the loan is covered.

The loan must be made for personal, family, or household purposes. It may be made to one or more individuals. Business purpose loans to individuals and loans to an entity other than an individual would not be subject to these standards.

The guidance does not place any limits on the type of loan. It therefore applies to first and subordinate mortgages, home equity lines of credit, home improvement loans, and even temporary financing.

Risk Management
The guidelines are presented in the context of risk management. Predatory lending is identified as a risk which the bank must effectively manage. Risk areas include credit, legal, compliance and reputation. Predatory lending practices must be managed with these risk areas in mind.

The stated goal of the guidelines is to enable the bank to effectively manage risks, including credit, legal, compliance and reputation, associated with consumer residential mortgage lending.

The guidelines also apply to lending that is conducted by operating subsidiaries or through mortgage brokers or other intermediaries, making it clear that a bank cannot elude liability by conducting business through a third party. A transaction one or even two steps removed from the bank is still the bank's problem.

The guidelines do not directly prohibit practices which may be predatory. Instead, they direct the lender to consider the circumstances of the consumers to whom the loans are made. The OCC recommends "heightened diligence" if offering loans that contain questionable provisions to consumers who are elderly, heavily in debt, not financially sophisticated, have language barriers, limited credit histories, or other characteristics that indicate credit vulnerability.

Prudent Practices
The standard for all consumer mortgage lending should be prudence. The guidelines state that lenders should "prudently consider the circumstances, including the characteristics of a targeted market and applicable consumer and safety and soundness safeguards, under which the bank will" lend.

The standards should identify special procedures or levels of care when certain terms, identified as predatory, are included in the loan. The guidelines thus become an official list of potentially predatory practices. When these terms are included in a loan, the lender will come under close scrutiny because the terms are assumed to create a high level of risk.

The "official" list includes equity stripping, fee packing, loan flipping, refinancing of special mortgages, and encouragement of default. These practices share the common denominator of encouraging the consumer to enter into a new mortgage transaction when it is not in the consumer's interest to do so. The combination of the old and new mortgages costs the consumer money that does not bring the consumer any benefit.

While refinancing a special mortgage, such as a subsidized loan or a Habitat for Humanity mortgage, is generally not something done by banks, there are enough reported instances to place this concern on the list. There has also been discussion at the Consumer Advisory Council about whether lenders should be required to document that the terms of the new mortgage are at least as favorable as the terms of the loan being refinanced.

In addition to the official list, the guidelines contain a list of high risk practices. These are presented as requiring "prudent consideration." Prudence becomes particularly important when the lending involves low- or moderate-income borrowers. Each of these practices is most harmful to borrowers with limited resources and/or limited experience.

Prudent consideration of loan terms entails considering the circumstances of the borrower and of the market. Some of the terms triggering the prudent review have been identified in the high cost mortgage rules of Regulation Z. Others are terms or practices that have been identified but not specifically placed in a regulatory context.

Terms triggering prudent consideration include financing single-premium insurance, negative amortization, balloon payments, prepayment penalties, particularly in sub-prime loans, call provisions, absence of evaluation and documentation of the applicant's ability to repay, HOEPA loans, loans in excess of appraised value, and payments made directly to builders or contractors.

Secondary Liability
The guidelines carefully include operating subsidiaries of national banks. In addition, the guidelines reference loan purchases. There is no dodging responsibility by originating through third parties. Moreover, there is a clear responsibility on the purchaser of loans to review the loans for fair practices. The guidelines direct banks to apply the same criteria and standards to these loans as to loans originated within the bank.

When requiring banks to apply the same standards, the guidelines are explicit. The responsibility doesn't stop with review of loans and loan documentation. The bank should also maintain and verify compliance with agreements between the parties, and review the origination functions of the third party.

Effective Date
These guidelines are effective prospectively only. Unlike regulatory interpretations which are essentially a statement or explanation of what the regulation means and has always meant, guidelines can take effect only in the future. In that respect, they are more like an enforcement policy than a regulatory interpretation. The OCC has provided that these guidelines become effective 60 days after publication in the Federal Register.

ACTION STEPS

Review your loan policy and determine whether it deals with predatory lending risks and practices.
Also review the loan policy for prudence - the extent to which the loan officer must consider the circumstances of the borrower.
If risk and prudence are missing, revise the loan policy to reflect these standards.
Now look at loan purchase practices and any loan originations made through third parties. Be sure that there is a level of scrutiny for predatory practices identified in the guidelines.