• OCC Issues Residential Mortgage Lending Guidelines
  • June 30, 2005
  • Law Firm: Mayer Brown LLP - Chicago Office
  • The Office of the Comptroller of the Currency ("OCC") recently issued Guidelines Establishing Standards for Residential Mortgage Lending Practices ("Guidelines"). 70 Fed. Reg. 6329 (Feb. 7, 2005). The Guidelines apply to the residential mortgage lending activities of national banks, federal branches and agencies of foreign banks, and operating subsidiaries of those entities (except for brokers, dealers, insurance providers, investment companies, and investment advisers which are functionally regulated) and incorporate certain key provisions of the OCC's Advisory Letters 2003-2 and 2003-3 (Feb. 21, 2003). The Guidelines were effective April 8, 2005.

    If a bank fails to meet the standards prescribed by the Guidelines, the OCC may require the bank to submit a compliance plan. Failure to submit a compliance plan or to materially comply with a plan approved by the OCC could result in the bank being subject to appropriate enforcement action to correct the deficiencies.

    The Guidelines are divided into three parts, the first of which explains that they were drafted to protect against national bank involvement in "predatory, abusive, unfair, or deceptive" residential mortgage lending practices. Part II of the Guidelines describes the overarching objectives of the Guidelines, which include the ability of an institution to: (i) manage the risks associated with its mortgage lending activities, including credit, legal, and reputational risks; and (ii) guard against engaging in abusive, predatory, unfair, or deceptive practices directly or indirectly through mortgage brokers or purchased loans. Part III describes the implementation of residential mortgage lending standards, including the avoidance of particular terms, prudent consideration of certain loan terms and special considerations for purchased and brokered loans.

    Prudent Consideration of Certain Loan Terms. The Guidelines state that banks 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 engage directly or indirectly in making residential mortgage loans with the following loan terms, conditions and features: (i) financing single premium credit life, disability or unemployment insurance; (ii) negative amortization; (iii) balloon payments in short-term transactions; (iv) prepayment penalties that are not limited to the early years of the loan, particularly in subprime loans; (v) interest rate increases upon default at a level not commensurate with risk mitigation; (vi) call provisions permitting the bank to accelerate payment of the loan under circumstances other than the borrower's default; (vii) inappropriate assessment and documentation of the consumer's ability to repay the loan in accordance with its terms, commensurate with the type of loan; (viii) mandatory arbitration clauses or agreements; (ix) high interest rate, points or fees that subject to loan to the provisions of the Home Ownership and Equity Protection Act; (x) loans with LTVs in excess of 100%; and (xi) certain payments to home improvement contractors under a home improvement contract from the proceeds of a residential mortgage loan.

    Purchased and Brokered Loans. With respect to residential mortgage loans that a bank purchases, or makes through a mortgage broker or other intermediary, the bank's lending activities should reflect standards and practices consistent with those applied by the bank in its direct lending activities and include appropriate measures to mitigate risks, such as the following:

    • Criteria for entering into and continuing relationships with intermediaries and originators, including due diligence requirements.

    • Underwriting and appraisal requirements.

    • Standards related to total loan compensation and total compensation of intermediaries, including maximum rates, points, and other charges, and the use of overages and yieldspread premiums, structured to avoid providing an incentive to originate loans with predatory or abusive characteristics.

    • Requirements for agreements with intermediaries and originators, including with respect to risks identified in the due diligence process, compliance with appropriate bank policies, procedures and practices and with applicable law, protection of the bank against risk, and termination procedures.

    • Loan documentation procedures, management information systems, quality control reviews, and other methods through which the bank will verify compliance with agreements, bank policies, and applicable laws, and otherwise retain appropriate oversight of mortgage origination functions, including loan sourcing, underwriting, and loan closings.

    • Criteria and procedures for the bank to take appropriate corrective action, including modification of loan terms and termination of the relationship with the intermediary or originator in question.

    Avoidance of Particular Loan Terms. Part III identifies several abusive lending practices that banks should avoid, including equity stripping, fee packing, loan flipping, refinancing of subsidized mortgage loans and not providing a net tangible benefit to the borrower and encouraging default as part of a loan that refinances all or part of a debt.

    Conclusion
    Although many national banks and their operating subsidiaries already have policies and procedures that address these issues, the Guidelines demonstrate the OCC's continuing concerns about predatory lending and the risks associated with certain mortgage loans. In addition, the Guidelines may mute some of the criticism from consumer groups and politicians who have questioned the OCC's commitment to combating predatory lending in light of its preemption regulations. The Guidelines also highlight the need to perform due diligence on third party origination channels.