The National Credit Union Administration (the “NCUA”), along with several other Federal Regulatory Agencies, released a new proposal for monitoring and controlling nontraditional mortgages. The NCUA is becoming increasingly concerned about credit risks without proper control. Twice in December 2005 the NCUA has released proposals for limiting these risks – (1) “Third-Party Servicing of Indirect Vehicle Loans” and (2) “Interagency Guidance on Nontraditional Mortgage Products.” As credit unions continue to maintain growth and extend the best products to their members, the NCUA wants credit unions to limit and control their risk. The purpose of this article is to discuss the most recent publication, “Interagency Guidance on Nontraditional Mortgage Products.”
In the “Interagency Guidance on Nontraditional Products” (the “Guidance”), the NCUA focuses on nontraditional mortgage products such as “interest-only” mortgages and “payment option” adjustable-rate mortgages. Though these products have been around for years, their use is more prevalent today due to the recent real estate market boom. Consumers are seeking large mortgages to buy homes that would traditionally be financially out of their reach.
The problem, as the NCUA sees it, is the lack of principal amortization or even negative amortization, and the potential lack of consumer understanding of the risks associated with these loans. In addition, the NCUA is concerned with the less stringent methods of loan origination and underwriting. Therefore, the NCUA is asking credit unions to: (1) ensure that loan terms and underwriting standards are consistent with prudent lending practices, (2) recognize that these heightened risks are untested in a stressed environment, and (3) ensure that consumers clearly understand the loans and associated risks.
Loan Terms and Underwriting Standards. A nontraditional loan requires a complex level of scrutiny due to the higher payment requirements when the loan begins to amortize. The analysis should include an evaluation of the borrower’s ability to pay the higher rate even though this increase is generally delayed. This lack of analysis is exacerbated by the reduction in loan documentation. Lending institutions should be elevating the underwriting process in nontraditional loans by using more comprehensive verification and documentation procedures. Furthermore, the credit union should be aware of the borrower’s intent to refinance the loan or sell the collateral to repay the loan before full amortization. This philosophy assumes that the borrower will not be able to make loan payments for the life of the loan. This assumption, made by both borrowers and lenders, that a loan will be refinanced or the collateral will be sold within a few years of origination puts an unsafe burden on borrowers and the housing market.
Portfolio and Risk Management Practices. The growth of nontraditional loans has resulted in potentially exaggerated levels of high risk in credit union loan portfolios. This potential unbalance is in a market that is not stress tested. Therefore, credit unions should flag these loans for higher levels of monitoring and loss mitigation. There should be written policies limiting this unbalance and when nontraditional loans are granted, credit unions should maintain capital commensurate with the risk.
Consumer Protection Issues. Though nontraditional loans provide great benefits to consumers, credit unions must communicate in a clear manner and format both the risks and benefits, allowing consumers to make an informed and responsible decision about these products. This communication should help consumers understand the specific risks of these loans and enable them to weigh these risks against the rewards. Emphasis should not be placed on avoiding risk by refinancing or sale of the property.
The full-text of this proposal is available by clicking here. The NCUA was accepting comments on this proposal until February 27, 2006, and those comments can be viewed by clicking here.
Prepared by Brian G. Lauer, Messick & Lauer P.C. 610-891-9000 www.cusolaw.com