Federal financial regulatory agencies issued a joint final statement on subprime mortgage lending late last week, to address issues relating to adjustable-rate mortgage (ARM) products that can cause payment shock. The agencies involved include the Federal Reserve System, the Office of the Comptroller of Currency, the Federal Deposit Insurance Corporation, the Department of Treasury and the National Credit Union Administration.
The statement has been issued in the wake of the subprime crisis – the effects of which mortgage lenders and some investment banks are still reeling from. It includes directives saying subprime ARM loans should be underwritten at fully indexed rates with fully amortising repayment schedules, and maintains that income verification is a crucial step in the lending process. It also encourages lenders to pursue prudent workout arrangements for subprime borrowers struggling with rate resets.
The statement also refers to the importance of lenders having strong control systems in place to monitor their operational policies and procedures. It reads: “Institutions should have procedures and systems in place to monitor compliance with applicable laws and regulations, third-party agreements and internal policies. An institution’s controls should also include appropriate corrective actions in the event of failure to comply… In addition, institutions should initiate procedures to review consumer complaints to identify potential compliance problems or other negative trends.” It goes on to state that the agencies will continue to review risk management and consumer compliance processes, policies and procedures, and that it will take action against those failing to do so.
The statement has been very well received by the industry, but some say it does not go far enough: “Even though the regulators say lenders have to be able to demonstrate they have control over their processes, right now the only way they can do that is by examiners physically checking the lenders have policies and procedures in place. What is missing is something to be able to demonstrate a long-term trend of control over risk management in the subprime sector,” says Rebecca Walzak, president and chief executive of Walzak Risk Analysis – a Florida-based firm that delivers standardised measurements that quantify mortgage product quality as well as offering risk management services. “What we have been lobbying the regulators for is that they have independent validation systems over policies and procedures for mortgage lenders, whether this is a technical or manual process.”
Nevertheless, the statement is a positive step forward for the industry: “Finally we [mortgage lenders] are getting to understand that processes, no matter what industry, can be a major risk if not managed correctly,” she adds.
See the July issue of OpRisk & Compliance for more about how op risk issues contributed to the subprime crisis.