[Federal Register Volume 65, Number 66 (Wednesday, April 5, 2000)]
[Proposed Rules]
[Pages 17811-17818]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-8375]


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DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 560

[No. 2000-34]
RIN 1550-AB37


Responsible Alternative Mortgage Lending

AGENCY: Office of Thrift Supervision, Treasury

ACTION: Advance notice of proposed rulemaking.

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SUMMARY: The Office of Thrift Supervision (OTS) is reviewing its 
mortgage lending regulations to determine their effect in today's 
markets on not only savings associations and their customers but also 
on state-regulated housing creditors who may be making alternative 
mortgage transactions under the Alternative Mortgage Transactions 
Parity Act and their customers. This advance notice of proposed 
rulemaking (ANPR) seeks public input on questions OTS will consider as 
part of that review. OTS could pursue a variety of regulatory 
approaches to help ensure that the lending regulations are meeting the 
purposes for which they were intended: encouraging the safe and sound, 
efficient delivery of low-cost credit to the public free from undue 
regulatory duplication and burden. The agency welcomes comments on the 
advantages, disadvantages, and potential interactions and side effects 
of various approaches. The agency is particularly interested in public 
input on potential approaches that will facilitate thrifts? efforts to 
responsibly address the lending needs of traditionally underserved 
markets, consistent with safe and sound operation.

DATES: Comments must be received on or before July 5, 2000.

ADDRESSES: Please send comments to Manager, Dissemination Branch, 
Information Management and Services Division, Office of Thrift 
Supervision, 1700 G Street, NW., Washington, DC 20552, Attention Docket 
No. 2000-34. Hand deliver comments to 1700 G Street, NW., lower level, 
from 9:00 a.m. to 5:00 p.m. on business days. Send facsimile 
transmissions to FAX Number (202) 906-7755 or (202) 906-6956 (if the 
comment is over 25 pages). Send e-mails to public.info@ots.treas.gov">public.info@ots.treas.gov 
and include your name and telephone number. Interested persons may 
inspect comments at 1700 G Street, NW., from 9:00 a.m. until 4:00 p.m. 
on business days.

FOR FURTHER INFORMATION CONTACT: Donna Deale, Manager, Supervision 
Policy, (202) 906-7488; Theresa Stark, Project Manager, Compliance 
Policy, (202) 906-7054; Paul Robin, Assistant Chief Counsel, (202) 906-
6648; Ellen Sazzman, Counsel (Banking and Finance), (202) 906-7133; 
Koko Ives, Counsel (Banking and Finance), (202) 906-6661, Regulations 
and Legislation Division, Office of Thrift Supervision, 1700 G Street 
NW., Washington, DC 20552.

SUPPLEMENTARY INFORMATION:

I. Goals of the ANPR

    Savings associations have long played a major role in providing 
responsible, affordable home financing. Over the past 25 years, 
however, the types of loans they have offered--and the competitors they 
face--have changed considerably. In today's market, mortgage lenders 
offer potential borrowers a wide variety of options besides the 
traditional 30-year fixed-rate purchase money mortgage. A secondary 
market has developed that has narrowed the interest-rate spread on high 
quality mortgages. Securitization, once available only for high quality 
fixed-rate mortgages, now funds much of the subprime market. Changes in 
tax laws have encouraged home equity lending for traditionally 
unsecured consumer lending purposes.
    As the mortgage market has changed over time, so too have OTS's 
lending regulations, currently codified at 12 CFR part 560. These 
regulations are based in large part on the assumption that most 
components of a loan contract should, within the bounds of safety and 
soundness, be a matter of negotiation between the borrower and the 
lender. In our experience, that assumption has proven sound for the 
overwhelming majority of traditional mortgage loans made by savings 
associations. One of the key issues on which we want public input in 
this ANPR is whether that assumption holds true for newly developed 
types of mortgage products--in both the purchase money mortgage and 
home equity contexts.
    We recognize that data about the characteristics of these new 
products and the markets to which they may be targeted is still being 
developed. We encourage commenters to share data with us about market 
trends and the types of loans, lenders, and borrowers involved in 
various transactions and products. We are particularly interested in 
data involving high-cost lending and the subprime market, as we believe 
thrifts are not engaged in significant levels of these activities. 
Because the

[[Page 17812]]

subprime market is growing, we would like to have a thorough 
understanding of it before thrifts have significant exposure in that 
market, so our regulations and supervisory strategies address the 
issues adequately.
    Our lending regulations are intended to serve several purposes. As 
OTS considers whether changes in the lending market should cause the 
agency to make changes in its regulations, we must balance several 
goals.
    First and foremost, we want our lending regulations to encourage 
safe and sound lending. Whatever type of mortgage lending or market on 
which a thrift may focus, the loans it makes must be prudently 
underwritten. In evaluating mortgage loan applications, institutions 
must carefully evaluate the capacity of the borrower to make payments 
on the debt, the level of equity in the property, and the overall 
credit worthiness of the borrower. The ability of the lender to acquire 
the borrower?s collateral in order to pay off a loan is no substitute 
for ensuring that the borrower has the ability to make loan payments in 
accordance with the terms of the loan contract.
    Second, we want to encourage innovation in identifying potential 
customers and meeting customers' needs. Nontraditional markets may 
present new opportunities that require novel underwriting approaches 
but that can still be pursued safely and soundly. Overly detailed 
regulatory restrictions may quickly prove obsolete as technology 
advances and potential customers change.
    Third, we want to discourage lending practices that prey upon 
customers' lack of knowledge or options. Such practices may seem like 
an easy avenue to profitability in the short run, but they are 
inconsistent with long-term safety and soundness and are contrary to 
the purposes for which thrifts were created.
    Fourth, we want to enable thrifts to compete with other lenders. 
Except where regulatory restrictions unique to savings associations are 
statutorily mandated, the agency believes that thrift regulations 
should be carefully crafted to keep thrifts competitive, consistent 
with safety and soundness, especially in the area of mortgage lending. 
Approaches that rely entirely upon OTS's examination, supervision, and 
enforcement, without addressing OTS regulations that apply both to 
thrifts and other housing creditors with whom they compete, could have 
inadvertent negative effects on thrifts' competitiveness without 
effectively addressing the underlying problems.
    Fifth, federal savings associations operate under a uniform system 
of regulation. Section 5(a) of the Home Owners' Loan Act (HOLA) 
authorizes OTS ``to provide for the organization, incorporation, 
examination, operation, and regulation'' of federal savings 
associations. 12 U.S.C. 1464(a)(1). Uniformity in regulation, 
examination, and supervision, regardless of geographic location, is a 
key component of the federal thrift charter. Federal thrifts know they 
are subject to one set of federal laws and regulations in all of the 
key areas of their operations, which enables them to conduct those 
operations consistently and efficiently.
    Finally, but by no means of the least importance, we want to 
minimize regulatory burden on savings associations. Generally, the 
market should drive the products offered and terms and conditions in 
loan contracts should be the result of negotiation between well-
informed borrowers and lenders. In some instances, where some level of 
regulation is required, regulatory burden may be minimized by 
differentiating among different types of institutions based upon their 
condition, characteristics, activities, or size.
    As we evaluate input on potential approaches to modify our mortgage 
lending regulations, OTS will be keeping each of these goals in mind. 
We hope that commenters on this ANPR will provide us with a wide 
variety of useful insights on how potential changes may further--or 
impair--any of these goals. While every regulatory change cannot 
further each of these goals, the agency is particularly interested in 
hearing from commenters about how any proposed approach that advances 
one goal might have an inadvertent side effect of impairing another 
goal.
    This ANPR and any subsequent rulemaking affecting OTS's mortgage 
lending regulations could affect not only federal savings associations, 
but, through the operation of the Alternative Mortgage Transactions 
Parity Act (``Parity Act''), may also apply to certain mortgage 
transactions of state-licensed and regulated housing creditors. As 
discussed more fully in section II.B below, that statute was enacted to 
enable those state housing creditors to enter into alternative mortgage 
transactions, such as variable rate loans, notwithstanding state law, 
so long as they complied with the regulations on alternative rate 
mortgage transactions that applied to federally chartered depository 
institutions. OTS does not have licensing, supervision, examination, or 
enforcement authority over these housing creditors. Those 
responsibilities rest with the states, even when the housing creditors 
choose to provide alternative mortgages under the Parity Act. OTS's 
statutorily assigned role is solely to designate which OTS lending 
regulations affecting alternative mortgage transactions are appropriate 
and applicable to housing creditors when they make such loans under the 
Parity Act. OTS does not collect information about how many housing 
creditors choose to take advantage of the Parity Act's preemption of 
state laws affecting alternative mortgage transactions. Today, as OTS 
considers whether our mortgage lending regulations continue to meet the 
purposes for which they were intended, we also solicit comments about 
how the application of these regulations in the context of the Parity 
Act may affect housing creditors and their borrowers.
    This ANPR first discusses the background of changes and 
developments in statutes, regulations, and the market that have given 
rise to questions about how best to encourage responsible, and 
discourage predatory, lending in the market for alternative mortgages. 
The ANPR then discusses various regulatory approaches the agency may 
consider in any rulemaking that may follow this ANPR. Non-regulatory 
approaches such as education, examination, enforcement of existing 
statutes and regulations, interagency regulations or supervisory 
guidance, or industry best practices, may also be appropriate to 
address some identified issues. The agency is committed to considering 
all viewpoints presented before determining what approaches to pursue.

II. Background

A. Evolution of OTS's Lending Regulations and the Changing Financial 
Climate

    Mortgage lending--both purchase money mortgages and home equity 
lending--has always been, and remains, a key area of thrift operations. 
OTS has periodically conducted comprehensive reviews of its lending and 
investment regulations to ensure that they enhance safe and sound 
lending, implement statutory requirements, protect consumers, minimize 
regulatory burden, and are clearly written and consistent with the 
regulations of other banking agencies. OTS lending regulations have 
been considerably modified over time as savings associations, their 
markets, their competition, and the economy have changed.
    Historically, mortgage lending regulations for savings associations 
were extremely detailed, limiting the loan terms such as permissible 
length, location of collateral, loan-to-value

[[Page 17813]]

ratios, and amortization schedules. Over the last two decades, the 
regulatory approach of OTS and its predecessor agency, the Federal Home 
Loan Bank Board (Bank Board), has been to gradually move away from 
detailed authorization of lending products and specific restrictions on 
their structure. For the most part, OTS has taken a market-based 
approach to provide flexibility for thrifts and encourage innovations 
in lending to stimulate credit. To protect consumers, OTS has required 
thrifts to disclose terms and conditions to consumers on the assumption 
that, with this knowledge, the parties would be free to negotiate the 
lending terms. Ideally such negotiation would result in lenders making 
competitive safe and sound loans that meet borrowers' needs 
responsibly--a win-win situation for all involved. One of the reasons 
OTS is publishing this ANPR, however, is evidence indicating that some 
provisions in our lending regulations may have a different effect in 
subprime or high-cost loan markets, where borrowers may not have access 
to the same information or options, as compared with more traditional 
markets.
    For example, in 1993, as part of a regulatory burden reduction 
effort, the agency removed a requirement that no institution could 
impose a prepayment penalty on an ARM borrower within 90 days of a 
notice of a rate adjustment. This permitted prepayment penalties to be 
imposed on adjustable rate mortgages under the same conditions as apply 
for fixed-rate mortgages: prepayments must first be applied to loan 
principal, but the loan contract governs the terms of any prepayment 
penalty. In the fixed-rate market, and indeed, in ARMs made by thrifts, 
prepayment penalties generally have not been abused, and have been a 
means by which some borrowers can negotiate a lower interest rate on 
their loans. In the subprime market, however, some studies and news 
reports indicate that prepayment penalties have been particularly 
subject to abuse by predatory lenders.\1\
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    \1\ Prepayment penalties arise in the case of subprime lending 
with much greater frequency than in the conventional market. Rich 
Connell, ``Safeguards Sought for Inner City Borrowers,'' Los Angeles 
Times, March 12, 2000, at B6. For example, in 1998 Merrill Lynch 
estimated that 50-75% of home equity loans (primarily subprime) that 
they securitized included some kind of prepayment penalty. ``Lenders 
Test Whether Mortgage Prepayment Penalties Insulate Against 
Portfolio Runoff,'' Inside Mortgage Finance, January 16, 1998. In 
contrast, in the case of home loan purchases by Fannie Mae, the 
overwhelming majority of which are conventional, less than 2% carry 
prepayment penalties. ``Fannie Revamps Prepayment Penalty Bonds,'' 
American Banker, July 20, 1999.
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    We have been told that some nonfederally chartered housing 
creditors active in the subprime home equity market often structure 
their loans as alternative mortgage transactions in order to rely on 
these federal regulations under the Parity Act, because it gives them 
more flexibility than state law in charging prepayment penalties and 
late charges.\2\ We solicit comment on the accuracy of these 
observations and the role the Parity Act plays in today's mortgage 
markets.
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    \2\ For example, the National Home Equity Mortgage Association 
(NHEMA), the largest national trade association focusing primarily 
on the home equity lending market, sued to enjoin Virginia from 
enforcing its statutes limiting prepayment penalties for alternative 
mortgage transactions. NHEMA's members include mortgage lending 
corporations and secured equity lenders. The federal district court 
found that the Virginia statutes were preempted by the Parity Act 
and that NHEMA had standing to bring the suit. ``NHEMA's members are 
state housing creditors subject to the Parity Act who are suffering 
or will suffer injury from the enforcement of penalties announced by 
the state.'' National Home Equity Mortgage Association v. Face, 64 
F. Supp. 2d 584, 591 (E.D. Va. 1999), appeal docketed, No. 99-2331 
(4th Cir. Oct. 21, 1999).
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B. The Alternative Mortgage Transactions Parity Act

    Congress enacted the Parity Act in 1982, a time of high interest 
rates, to encourage variable rate mortgages and other creative 
financing to stimulate credit. In hearings before the Senate in 1981, 
mortgage bankers testified that statutes in 26 states barred mortgage 
bankers or state-chartered lending institutions from originating 
alternative mortgage loans or imposed significantly higher restrictions 
on such loans than applied to federally chartered lenders operating 
under federal regulations. Congress wanted to give those state-
chartered housing creditors parity with federally chartered 
institutions by authorizing those creditors to make, purchase and 
enforce alternative mortgage loans.\3\
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    \3\ 12 U.S.C.A. 3801(b) (West 1989). See also NHEMA v. Face, 64 
F. Supp. 2d at 587.
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    The Parity Act applies to loans with any ``alternative'' payment 
features, such as variable rates, balloon payments, or call features. 
It allows state licensed housing creditors \4\ to engage in 
``alternative mortgage transactions'' notwithstanding ``any State 
constitution, law, or regulation,'' provided the transactions are in 
conformity with certain federal lending regulations.\5\
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    \4\ A ``housing creditor'' is a depository institution, a lender 
approved by the Secretary of Housing and Urban Development for 
participation in certain mortgage insurance programs, ``any person 
who regularly makes loans, credit sales or advances secured by 
interests in properties referred to in [the Parity Act]; or * * * 
any transferee of any of them.'' 12 U.S.C.A. 3802(2).
    \5\ Id.; 12 U.S.C.A. 3803 (West 1989).
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    The Parity Act does not place state housing creditors under the 
supervision of federal agencies, but instead merely enables those 
creditors to make alternative mortgage transactions that comply with 
designated federal regulations, as an alternative to state law.\6\ The 
Parity Act specifically provides that in order to qualify as a housing 
creditor and take advantage of the Parity Act's preemption, the 
creditor must be ``licensed under applicable State law and [remain or 
become] subject to the applicable regulatory requirements and 
enforcement mechanisms provided by State law''.\7\ Housing creditors, 
other than state-chartered banks and state-chartered credit unions,\8\ 
that wish to make an alternative mortgage transaction under the 
authority of the Parity Act must abide by designated OTS regulations.
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    \6\ OTS Op Chief Counsel (May 3, 1996) at 8, fn. 16 citing 
Report of the Committee on Banking, Housing, and Urban Affairs, 
Senate Report No. 97-463 at p. 55 (May 28, 1982), 97th Cong., 2d 
Sess. 55 and 48 FR 23,032, 23,053 (May 1983).
    \7\ 12 U.S.C. 3802(2).
    \8\ 12 U.S.C.A. 3803(a) (West 1989). State-chartered banks and 
state-chartered credit unions must comply respectively with 
regulations of the Office of the Comptroller of the Currency and the 
National Credit Union Administration.
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    The Parity Act directed the Bank Board, OTS's predecessor agency, 
to identify, describe, and publish those portions of its regulations 
that were inappropriate for, and thus inapplicable to, nonfederally 
chartered housing creditors.\9\ In 1982, the Bank Board published a 
``Notice to Housing Creditors'' (1982 Notice) with a request for 
comments.\10\ The 1982 Notice provided that state housing creditors, 
other than commercial banks, credit unions or federal associations, may 
make alternative mortgage loans subject to the Bank Board's 
requirements on adjustments to rate, payment, balance or term of 
maturity and disclosure. The agency premised this approach on the 
statement of Congressional intent that Title VIII ``does not place 
state housing creditors under the supervision of the federal agencies, 
but instead merely enables them to follow a federal program as an 
alternative to state law.'' \11\ The 1982 Notice identified as 
appropriate and applicable those regulations that ``describe and 
define'' alternative mortgage transactions and not those regulations 
intended for the

[[Page 17814]]

general supervision of federal associations.
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    \9\ Section 807 of Pub. L. 97-320 (1982).
    \10\ 47 FR 51733 (November 17, 1982).
    \11\ U.S. Senate Report No. 97-463 at p. 55 (May 28, 1982), 97th 
Cong., 2d Sess. 55 and 48 FR 23032, 23053 (May 23, 1983).
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    In 1983, the Bank Board published a final rule incorporating a 
revised Notice to Housing Creditors (1983 Notice). The 1983 Notice 
identified as applicable three provisions that the Bank Board described 
as an integral part of, and particular to, alternative mortgage 
transactions, namely Sec. 545.33(c) (authority to make partially 
amortized or non-amortized loans and to adjust the interest rate 
payment, balance or term of maturity); (e) (limitations on adjustments 
on loans secured by borrower-occupied property); and (f)(4)-(11) 
(requirements for disclosures on loans secured by borrower-occupied 
property that are not fixed-rated and fully amortized).\12\
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    \12\ 48 FR 23032, 23053 (May 23, 1983).
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    In 1996, after reexamining the purposes of the Parity Act, OTS 
reevaluated which regulations should be deemed appropriate and 
applicable to alternative mortgage transactions. OTS concluded that 
variable rate loans made by Wisconsin-chartered savings and loan 
associations in conformity with the Parity Act are not subject to a 
Wisconsin statute restricting prepayment penalties on variable rate 
loans.\13\ The opinion stated that because OTS regulations permitted 
federal thrifts, through terms in their loan contracts, to impose 
prepayment penalties on variable rate loans (as well as other loans), 
state housing creditors lending under the Parity Act could impose those 
penalties. Otherwise state housing creditors would be disadvantaged 
vis-a-vis federal thrifts--the very result Congress intended to 
prevent. Using this analysis, the agency did not limit potentially 
appropriate and applicable regulations for state housing creditors to 
those regulations applying only to alternative mortgage transactions 
and not other mortgage loans.
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    \13\ OTS Op. Chief Counsel (April 30, 1996).
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    Later that year, OTS modified its Parity Act regulations, now 
codified at 12 CFR 560.220.\14\ The list of OTS regulations applicable 
to state housing creditors now includes regulations on late charges 
(Sec. 560.33), prepayments (Sec. 560.34), adjustments to home loans 
(Sec. 560.35), and disclosure (Sec. 560.210).\15\ Housing creditors 
must comply with the requirements contained in these regulations in 
order to obtain the benefit of the Parity Act's preemption of state 
laws.
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    \14\ As a federal court recently recognized, OTS may revise, on 
a continuing basis, the list of provisions that apply to housing 
creditors lending under the authority of the Parity Act. The Parity 
Act ``implies no temporal limit on [OTS] rulemaking as it applies to 
state chartered housing creditors.'' NHEMA v. Face, 64 F. Supp. 2d 
at 589. As the court noted, the legislative history of the Parity 
Act shows that Congress contemplated future revisions to federal 
agency regulations and expected conforming agency actions so that 
the regulatory list would continue to provide parity to state 
housing creditors. Id., quoting S. Rep. 97-463, at 55 
(1982)(Congressional expectation that ``any future amendments that 
the agencies make to regulations that are within the scope of this 
title will conform to the objectives of this title.'')
    \15\ 12 CFR 560.220 (1999).
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C. Subprime Lending and Potentially Predatory Practices

    The flow of responsibly delivered credit to underserved markets is 
critical to their survival. Thrifts and other lenders that provide 
credit and other financial services in ways that actually reach and 
fairly serve underserved borrowers fill an important community need. 
OTS believes it is important for thrifts to reach out to underserved 
markets and to make safe and sound loans--both prime and subprime--in 
such markets.
    The 1990's have seen an explosive growth in subprime lending: i.e., 
extending credit to borrowers whose past credit problems make them a 
higher risk. Subprime lenders use risk-based pricing to serve borrowers 
with troubled credit histories who cannot obtain credit in the prime 
market. Subprime loans pose higher risks to an institution and require 
a lender to have or develop particularized loan underwriting and 
management skills.\16\ The higher degree of risk associated with 
subprime borrowers often necessitates a higher cost or other non-
traditional terms for a subprime loan.
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    \16\ On March 1, 1999, the four federal banking agencies--OTS, 
the Board of Governors of the Federal Reserve System, the Federal 
Deposit Insurance Corporation, and the Office of the Comptroller of 
the Currency--issued ``Interagency Guidance on Subprime Lending.'' 
That guidance discussed a variety of controls that an insured 
depository institution engaging in subprime lending should have in 
place to ensure that it is properly controlling the risks the 
activity can present.
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    Subprime lending helps provide borrowers with a bridge to 
conventional financing once the borrower resolves temporary credit 
problems. However, subprime lending can become predatory if it makes it 
difficult for borrowers to get out of debt once their credit improves. 
Unfortunately, some segments of the subprime lending market use 
unscrupulous practices, more fully described below, to pressure a 
borrower into a commitment for a high-cost loan. It is important that 
our mortgage lending regulations actively discourage, rather than 
inadvertently allow, predatory practices by those who rely upon our 
regulations--whether they be thrifts, their subsidiaries or affiliates, 
or non-depository institution housing creditors relying upon the Parity 
Act.
    Predatory practices that unfairly disadvantage borrowers can take a 
variety of forms. For example, an unscrupulous lender may use pressure 
tactics to convince the borrower to consolidate mortgage and consumer 
debt into a loan that is in fact less advantageous to the borrower; 
refinance a low interest rate mortgage loan to one with higher rates 
and fees but a longer term that lowers the borrower's current mortgage 
costs while vastly increasing the total cost of financing; undertake 
unnecessarily expensive home improvements; or finance unnecessary fees 
for products like credit insurance.\17\
    Predatory lenders may also include loan terms in mortgage documents 
that make it difficult for the borrower to pay off the loan. Some 
examples of such loan terms include negative amortization repayment 
terms where monthly payments fail to pay off accrued interest and 
increase the principal loan balance; high balloon payments at the end 
of the loan; high loan-to-value (LTV) loans that lock the borrower into 
additional debt; mandatory arbitration partially paid for by the 
borrower; and high prepayment penalties that prevent borrowers from 
refinancing or selling their home. While these terms may be reasonable 
when fully understood by a sophisticated borrower with the ability and 
motivation to shop for a loan, they can be grossly unfair when 
misunderstood by an unsophisticated borrower pressured into accepting 
them.
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    \17\ For example, a recent New York Times/ABC News article 
reported examples of a variety of such practices. ``Profiting From 
Fine Print With Wall Street's Help,'' New York Times (March 15, 
2000).
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D. Interagency Implications

    OTS recognizes that its regulations can only go so far to address 
predatory practices. Some practices may raise issues involving the 
Truth in Lending Act, the Home Ownership and Equity Protection Act, the 
Equal Credit Opportunity Act, the Real Estate Settlement Procedures 
Act, the Home Mortgage Disclosure Act, and other statutes and 
regulations generally affecting depository institutions or creditors. 
These laws are implemented through regulations imposed by agencies 
other than OTS, including the Federal Reserve Board and the Department 
of Housing and Urban Development. Like other insured depository 
institutions, thrifts are subject to regular examination and 
supervision for their compliance with this comprehensive federal 
network of

[[Page 17815]]

laws and their implementing regulations. Most non-depository 
institution creditors may be equally subject to such laws, but their 
regulators do not use the same examination and supervision process to 
regularly monitor their compliance. OTS will share with other 
regulators any issues that commenters raise that implicate any of these 
statutes or their implementing regulations.
    OTS participates in a number of interagency efforts to address 
responsible subprime lending and limit predatory practices. An 
interagency working group has been established to examine predatory 
lending issues. This group, which includes the Federal Reserve Board, 
the Federal Deposit Insurance Corporation, the Office of the 
Comptroller of the Currency, the Department of Justice, the Federal 
Trade Commission, the Department of Housing and Urban Development, the 
Federal Housing Finance Board, and the Office of Federal Housing 
Enterprise Oversight, is considering a variety of policy, regulatory, 
and legislative options as well as consumer education initiatives.

E. State Initiatives to Address Predatory Lending

    OTS is aware that several states have undertaken statutory or 
regulatory initiatives to protect their citizens from some of the 
abuses of predatory lending. OTS believes that such initiatives are 
worth studying as it considers the scope and direction of any potential 
regulatory actions. We are interested in learning more about these 
initiatives and other states' proposed statutory or regulatory 
initiatives in these areas. Commenters are therefore urged to address 
the advantages and disadvantages of these initiatives, especially in 
connection with state-regulated housing creditors.
    North Carolina, for example, has recently enacted legislation that 
addresses predatory lending and covers all consumer home loans 
including first and junior liens and manufactured housing. The 
legislation limits prepayment penalties, financing credit insurance, 
flipping (repeated unjustified refinancing of loans), and default 
incentives. The act also establishes a class of ``high-cost home 
loans'' (e.g., loans with total points and fees in excess of 5-8% of 
the loan amount or an annual percentage rate more than 10 percentage 
points higher than the yield on Treasury securities of comparable 
maturities). The act applies additional consumer protections to these 
high-cost loans including required consumer counseling, prohibitions on 
financing fees and points in the loans, and other safeguards. 
Violations of the act may result in a determination that the loan is 
usurious or that an unfair trade practice has occurred. Additionally, 
the borrower may be permitted to recover attorney's fees.
    New York has proposed regulations to impose certain limitations on 
the making of high-cost home loans to consumers. The proposed 
regulations define high-cost home loans as loans that are made either 
at a rate exceeding eight percentage points over U.S. Treasury 
securities of comparable maturities or, in the case of junior 
mortgages, nine percentage points above such securities. High-cost home 
loans also include any mortgage loan with total points and fees (other 
than bona fide discount points) exceeding five percent of the principal 
amount of the loan. The proposed regulations prohibit high-cost home 
loans from including terms such as balloon payments within seven years 
of origination, negative amortization, elevated rates of interest after 
default, certain mandatory arbitration clauses, modification or 
deferral fees, and accelerated payment schedules at the discretion of 
the lender. The proposed regulations also prohibit high-cost home 
lending without a disclosure at the time of application concerning home 
ownership counseling and without due regard to the obligor's ability to 
repay the loan.

F. Other Regulatory Incentives to Encourage Responsible Lending

    OTS invites public comment on potential federal regulatory 
incentives to encourage financial institutions to seek out responsible 
ways to meet the lending and other financial services needs of 
underserved borrowers consistent with safety and soundness. We are 
interested in innovative approaches to facilitate responsible lending 
in underserved markets--whether prime or subprime--and to limit 
predatory practices that subject borrowers to improper pressures, 
unduly limited options, and unnecessary costs.

III. Potential Regulatory Approaches

    This ANPR solicits public input from any interested parties, 
including savings associations, consumers, housing creditors, and state 
and local regulators, on a wide variety of potential regulatory 
approaches that would encourage responsible lending and discourage 
predatory practices. OTS is particularly interested in learning from 
the states' experience with recent statutory and regulatory actions 
dealing with subprime lending and predatory lending practices, such as 
the North Carolina statute and New York proposed regulation discussed 
above.
    The approaches discussed below focus on mortgage lending, with an 
emphasis on the high-cost loan arena that has proven particularly 
vulnerable to potential abuses. We would like input about other 
potential approaches, consistent with OTS's overall goals for its 
lending regulations, to address these issues. We recognize that changes 
in regulations may not ultimately turn out to be the best way to 
address some of these issues. In some cases supervisory guidance or 
industry best practices may be more effective and less burdensome.
    We encourage commenters to identify potential regulatory or 
paperwork burdens that some approaches might impose and ways to 
minimize such burdens. We are also interested in identifying approaches 
that might impose a disproportionate burden upon small savings 
associations and alternatives that might minimize such burdens.

Should OTS Modify Its Regulations Implementing the Alternative Mortgage 
Transactions Parity Act?

    As discussed above, the Bank Board and OTS have identified various 
regulations over time as appropriate and applicable to alternative 
mortgage transactions under the Parity Act. We solicit comment on 
whether all of the regulations that are currently designated as 
appropriate and applicable should continue to be so designated. Should 
only those OTS regulations that apply exclusively to alternative 
mortgage transactions be designated appropriate and applicable (the 
approach taken by the Bank Board in 1982)? Should every regulation that 
imposes conditions or restrictions on a federal savings association's 
ability to make an alternative mortgage transaction be designated 
appropriate and applicable, even if the regulation applies to a broader 
category of loans (the approach taken by OTS in 1996)? Is another 
standard appropriate?
    The Parity Act, as discussed above, authorizes housing creditors to 
make alternative mortgage loans as long as the transactions are ``in 
accordance with'' appropriate and applicable OTS regulations. The Act 
does not grant housing creditors the same powers as federal savings 
associations outside of the context of alternative mortgage 
transactions. Even within that context, state law governs those aspects 
of a housing creditor's operations not covered by regulations 
designated as applicable to alternative mortgage transactions under the 
Parity Act. The limited role the Parity Act plays in the

[[Page 17816]]

overall regulation of housing creditors has not always been clearly 
understood. OTS solicits comments on how best to clarify the 
interaction between federal and state regulatory schemes affecting 
housing creditors. OTS is also interested in information about how 
state laws and regulations on alternative mortgage transactions have 
changed since the Parity Act was enacted in 1982.
    If commenters believe OTS should revise the scope of applicable 
regulations designated under the Parity Act, we are interested in 
recommendations about what factors and standards the agency should 
consider in determining appropriate and applicable regulations. The 
agency has a continuing responsibility to implement congressional 
intent as expressed in the 1982 Parity Act consistent with the 
realities of the current market in which federal savings associations 
and state housing creditors make alternative mortgage transactions. 
Therefore, we also are interested in whether additional regulations, 
including any that may result from a rulemaking following this ANPR, 
should be added to the list of appropriate regulations.
    In determining appropriate and applicable regulations, OTS must 
keep the overall congressional goal of parity in mind.\18\ Like other 
insured depository institutions, savings associations are subject to a 
comprehensive regime of regular examination, supervision, and 
enforcement to determine their compliance with applicable laws and 
regulations. Non-depository institution state housing creditors are 
not. How should these significant differences in examination, 
supervision and enforcement be taken into account so that alternative 
mortgage transactions by non-depository institution state housing 
creditors under the Parity Act are treated neither more harshly nor 
more leniently than similar transactions by savings associations?
---------------------------------------------------------------------------

    \18\ See discussion in footnote 14, supra.
---------------------------------------------------------------------------

    In considering whether to alter the operation of OTS lending 
regulations with respect to institutions benefiting from the Parity 
Act, we wish to act on an informed basis. OTS is interested in 
receiving evidence of the extent to which housing creditors taking 
advantage of the Parity Act are engaged in predatory or abusive lending 
practices. We recognize that the actions of a few entities do not 
necessarily represent an entire industry. While a number of press 
reports have recounted instances of egregious practices in connection 
with mortgage credit, the degree of participation in such practices by 
housing creditors that have used the Parity Act and OTS's implementing 
regulations to avoid state law restrictions has not been studied in any 
focused manner. Accordingly, we raise the following questions:
     To what extent are housing creditors engaging in predatory 
or abusive mortgage lending practices that would be contrary to 
existing state law but for the provisions of the Parity Act and OTS's 
implementation thereof?
     To what extent are housing creditors engaging in predatory 
or abusive mortgage lending practices that are contrary to existing 
laws, but are not being prosecuted by state authorities whose power is 
specifically reserved by the Parity Act for that purpose?

As previously noted, OTS has curtailed its lending regulations to 
permit savings associations to respond more efficiently to competitive 
market forces. Some have argued that the ability of housing creditors 
to rely on these limited regulations through the Parity Act may have 
resulted in abuses in markets where there are fewer competitive 
pressures and no regular governmental oversight. To explore this 
possibility, we solicit comment on the following questions:
     To what extent do housing creditors lending under the 
Parity Act use different practices and impose more onerous loan terms 
in under-served or financially unsophisticated markets than they (or 
their affiliates) use in other more mainstream markets?
     To what extent do housing creditors lending under the 
Parity Act provide mortgage credit at rates and with terms 
significantly above those of conventional prime mortgages to persons 
with good or excellent credit records?
     To what extent does the use or terms of prepayment 
penalties, the financing of prepaid credit life insurance or loan fees, 
or the frequency of partial amortizing, non-amortizing or negative 
amortizing loans vary among housing creditors or between housing 
creditors and insured depository institutions? Do variations relate to 
characteristics of the borrower (such as race or age) or the 
neighborhood in which the borrower resides or to quantifiable 
differences in the creditworthiness of the borrower? Do variations 
result in returns that compensate lenders in excess of risk-adjusted 
prices or loan terms?
     Do housing creditors refinance their own (or an 
affiliate's) borrowers' mortgage loans (including the financing of loan 
fees) at rates at or above those on the existing loan? Does this 
practice exist at insured depository institutions?
     How, if at all, do the answers to any of the above 
questions differ for housing creditors who do not make alternative 
mortgage transactions under the Parity Act but rely instead upon state 
law?

Should OTS Adopt Regulations on High-Cost Mortgage Loans?

    The explosive growth in subprime lending has occurred, and many of 
the predatory practices in the mortgage market discussed above have 
developed, since OTS last modified its lending regulations. Where 
borrowers are less knowledgeable or more in need of credit than has 
been the case in the past, a market-based approach to regulation that 
relies on disclosures to equalize the negotiation postures of the 
lender and borrower may not be effective. As a result, some states have 
gone beyond the loans covered and disclosures required by the Home 
Ownership and Equity Protection Act of 1994, Pub. L. 103-325, Title I, 
Subtitle B (Sept. 23, 1994) (HOEPA), to impose more substantive 
restrictions and limitations to protect such borrowers. OTS could 
similarly choose to enact regulations that would apply to high-cost 
loans originated by some or all savings associations. Depending on the 
scope of the OTS's Parity Act regulations and whether a state with its 
own statutes or regulations on high-cost loans had opted out from the 
Parity Act, these regulations could also apply to high-cost loans made 
by state housing creditors, as such loans are nearly always structured 
as alternative mortgage transactions.\19\ Such regulations would raise 
a variety of issues, including:
---------------------------------------------------------------------------

    \19\ Of course, Parity Act lenders could, if their home state 
regulations were more lenient than revised OTS regulations, simply 
follow state law rather than the OTS regulations.
---------------------------------------------------------------------------

    What loans should be covered? HOEPA applies to certain mortgages 
where either the annual percentage rate at consummation of the 
transaction exceeds by more than 10 percentage points the yield on 
Treasury securities of comparable maturities or the total points or 
fees the borrower must pay exceed the greater of 8% of the loan amount 
or $400 (as adjusted annually based on changes in the Consumer Price 
Index). The North Carolina and New York provisions discussed above 
apply to a broader range of loans, but similarly use the annual 
percentage rate and the ratio of total points and fees to loan amount 
to define the scope of loans covered. Some criteria differ depending on 
whether senior or junior mortgage liens were involved. What are the 
advantages or disadvantages of these approaches? Are there other 
factors that

[[Page 17817]]

should be considered in defining high-cost loans? How should high-cost 
loans be defined to reach areas where the potential for abuse is 
highest without having an unnecessarily chilling effect on non-
traditional, but non-abusive, loan structures?
    Should OTS impose limits on financing of certain fees or charges? 
Predatory loans are often dependent on the financing of points and fees 
in the loan, including charges to third parties. Financing these fees 
may hide their magnitude and impact from the borrower and enable 
unethical lenders to pile on unwarranted fees. Should OTS, in 
connection with high-cost loans, limit an institution's ability to 
finance fees and points above a certain amount, credit life insurance, 
and/or brokerage commissions?
    Are limits on refinancing appropriate? Should any OTS regulation on 
high-cost loans limit rollovers and refinancings on such loans within a 
specified time frame or where a refinancing would actually increase the 
cost of funds previously loaned? Should we limit or prohibit 
refinancing an institution's own (or an affiliate's) mortgage unless 
the annual percentage rate for the new loan is less than the rate 
reflected on the existing note and no fees are financed?
    Are prepayment penalties appropriate for high-cost loans? Do high-
cost loans present such potential for the abusive use of prepayment 
penalties that OTS should limit such penalties on such loans, either 
with respect to amount or when they can be imposed (e.g., not within a 
certain number of days after a change in interest rate)? Should 
prepayment penalty terms in such loans be prohibited except where 
initial mortgage rates are set at less than market rate?
    What limits on balloon payments, negative amortization, post-
default interest rates and mandatory arbitration clauses would be 
appropriate for high-cost loans? Should OTS limit the inclusion of such 
terms as balloon payments (at least prior to seven years), negative 
amortization, higher interest penalties after default, and mandatory 
arbitration clauses for high-cost loans?
    Should OTS require lenders to determine the suitability of a 
mortgage loan product for a particular borrower? As discussed above, an 
important component of safe and sound lending is determining the 
borrower's ability to repay the loan. Should OTS require institutions 
to document the suitability of a particular high-cost loan product for 
a particular customer/borrower, including an analysis of the customer's 
ability to repay the loan without relying on the collateral? This 
approach would be similar to the ``sophisticated investor'' or 
suitability analysis standard used in the securities industry in 
determining whether a particular investment product should be sold to a 
potential investor. Suitability standards as applied to the residential 
mortgage industry might include a relatively straight-forward analysis 
of factors such as comparing projected monthly payments against the 
applicant's income or determining the propriety of add-on features that 
the consumer may not need, such as credit life insurance where the 
individual does not have any dependents. If ``suitability'' is not 
established, then the institution would be subject to additional limits 
and higher requirements in making a loan. Such standards could impose 
regulatory burdens on thrifts if they required thrifts to go beyond the 
factors normally considered in underwriting a loan. Would such a burden 
be outweighed by the benefits of the potential deterrent effect of such 
a requirement?
    Should OTS require institutions to notify applicants for high cost 
loans of the availability of home loan counseling programs before 
closing? For borrowers that do not fully understand the credit process 
and the choices available to them, a disclosure of the availability of 
counseling programs may prompt them to more fully explore their options 
before closing on a high cost loan. The New York provisions, for 
example, prohibit the making of a high cost loan without first 
notifying applicants that they should consider counseling and providing 
them with a list of approved counselors. Should OTS consider imposing 
some similar type of requirement for institutions that provide high 
cost loans? How could such a list be generated and by whom? How could 
we minimize any associated paperwork burden?

Is Differential Regulation Appropriate?

    For the past decade, OTS has differentiated among thrifts in 
determining whether they must file a notice or application with the 
agency before engaging in certain activities. This differentiation 
looks at, among other things, a thrift's capital, safety and soundness 
rating, and compliance ratings. See 12 CFR part 516. Such 
differentiation may be appropriate in the context of subprime or high-
cost loan programs. As discussed in the interagency guidance on 
subprime lending cited above, subprime and high-cost lending can pose 
potential safety and soundness risks. Before an institution with a 
lower safety and soundness or compliance rating undertakes a 
significant level of subprime or high-cost lending, it may be 
appropriate for the agency to review that thrift's management and 
internal controls. Thrifts with stronger ratings and management that 
are eligible for expedited treatment could be subject to different, 
less onerous restrictions.
    If OTS were to take the examination ratings, among other 
characteristics, of federal savings associations making certain types 
of alternative mortgage loans, into account in determining whether the 
agency should receive advance notice of certain lending activities, how 
could a differential approach apply to housing creditors making similar 
loans? State-regulated housing creditors are not subject to the same 
level of regular comprehensive examination as federally insured 
depository institutions. They are unlikely to have capital, safety and 
soundness, or compliance ratings. Under these circumstances, enabling 
such housing creditors to offer certain alternative mortgage loans in 
parity with federal savings associations--under neither harsher nor 
more lenient conditions--will require careful agency consideration. 
Thus, if OTS were to require some federal savings associations to 
notify OTS before making alternative mortgage transactions as part of a 
high-cost loan program, how would a comparable requirement be 
implemented for housing creditors? How, if at all, do states 
differentiate among the conditions and characteristics of housing 
creditors they license and regulate?
    The Parity Act contemplates situations where a housing creditor may 
not be able to comply with the letter of an applicable OTS regulation 
in making an alternative mortgage transaction. In such circumstances, 
the Parity Act considers the alternative mortgage transaction to be in 
accordance with the regulation if the transaction is in ``substantial 
compliance'' with the regulation and any error is corrected within 60 
days.\20\ OTS solicits comments from housing creditors and their state 
regulators about how to determine ``substantial compliance'' with OTS 
regulations using different standards for federal savings associations 
in different conditions. We seek input from housing creditors and their 
state regulators about any other practical implications of a 
differential regulatory approach.
---------------------------------------------------------------------------

    \20\ 12 U.S.C. 3803(b).

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[[Page 17818]]

How Should OTS Deal With Potential Lending Issues Raised by Thrift 
Subsidiaries or Affiliates?

    Some believe that subsidiaries and affiliates of insured depository 
institutions engage in lending practices that may disadvantage 
potentially vulnerable customers. OTS is interested in any evidence on 
this issue. Subsidiaries of savings associations are subject to OTS 
examination and supervision. If, however, they pose different or higher 
risks than their parent thrifts in this area, OTS could consider 
modifying its subordinate organizations regulations, 12 CFR Part 559, 
to address these risks. Should OTS impose limits on subsidiaries 
engaged in a significant amount of subprime lending on behalf of their 
parent federal thrifts? Should OTS restrict institutions' efforts to 
steer customers who are labeled high risk to one particular 
organizational unit of a thrift? Should thrifts and their subsidiaries 
that offer a variety of loans be required to inform customers of all 
available lending alternatives regardless of the location at which the 
customer initially seeks assistance? Should OTS consider restricting a 
thrift's interactions with affiliates that engage primarily in subprime 
lending? Would any such limits or restrictions affect a thrift's 
ability to develop expertise in different components of its 
organization or its ability to manage the risks associated with 
different types of lending?

Should OTS Impose Certain Due Diligence Requirements?

    It has been argued that the secondary market has had a 
disproportionate impact in facilitating some potentially predatory 
practices in the high-cost loan market.\21\ In addition to their role 
in originating mortgage loans, thrifts form an important part of the 
secondary market through their purchase of whole loans or investments 
in mortgage-backed securities. Given that the secondary market both 
plays a role in the high-cost loan market and is a vital part of 
housing credit liquidity, potential solutions to some of the problems 
in the high-cost mortgage loan market may be found in the secondary 
market. Accordingly, should OTS require federal thrifts to conduct a 
due diligence review of potential loan purchases to determine whether 
the loans meet applicable federal or state rules relating to predatory 
practices? For example, an institution might sample loan files to 
ensure that the originating lender has appropriately priced the 
product, looking for evidence of excessive fees. This review may be 
merely an adjunct to any other due diligence analysis that prudent 
institutions would undertake to ensure that purchased loans are 
properly secured and have been authenticated. How could any burden of 
such a requirement be minimized consistent with achieving the goal of 
ensuring that purchased loans meet applicable laws and regulations?
---------------------------------------------------------------------------

    \21\ See, for example, the New York Times/ABC News article cited 
in footnote 17, supra.
---------------------------------------------------------------------------

    Similarly, should OTS encourage thrifts to inquire whether 
securitizers from whom they purchase interests in loan pools have 
conducted their own due diligence efforts with regard to the underlying 
loans? The institution could, for example, make inquiries to the 
securitizers concerning their efforts to minimize the inclusion of 
predatory loans in their securitized pools. Would the concerted efforts 
by institutions to conduct such inquiries help to deter predatory 
practices?
    We are also interested in understanding the extent of due diligence 
conducted by secondary market mortgage investors to determine whether 
housing creditors benefiting from the Parity Act comply with applicable 
federal consumer protection and fair lending laws. Does due diligence 
vary depending on whether the selling institution is an insured 
depository institution undergoing regular federal compliance 
examinations or an unsupervised housing creditor?

IV. Conclusion and Request for Comments

    The flow of responsibly delivered credit to underserved markets is 
critical to their survival, and any regulatory or enforcement solutions 
that might be crafted to deal with predatory lenders must proceed with 
this caution in mind. With this ANPR, OTS seeks input from all 
interested parties to assist in determining how best to address some of 
the issues that have arisen in the alternative mortgage market. OTS is 
interested in hearing from any and all potentially affected persons, 
including representatives of the thrift industry, housing creditors, 
consumers, and state governments. Hearing from commenters with diverse 
viewpoints will help the agency to develop strategies to identify the 
lending risks and opportunities in underserved communities and to help 
thrifts develop and institute responsible lending programs in low-
income and minority communities. We are interested in data that will 
help identify where problems exist and whether and how OTS regulations 
could be modified to help address those problems. We encourage 
commenters to suggest other approaches not discussed above that could 
meet our overall goal of encouraging the safe and sound, efficient 
delivery of low-cost credit to the public free from undue regulatory 
duplication and burden.

    Dated: March 24, 2000.

    By the Office of Thrift Supervision.
Ellen Seidman,
Director.
[FR Doc. 00-8375 Filed 4-4-00; 8:45 am]
BILLING CODE 6720-01-P