nt>
CONFERENCE OF STATE BANK SUPERVISORS CONFERENCE OF STATE BANK SUPERVISORS

AMERICAN ASSOCIATION OF RESIDENTIAL MORTGAGE REGULATORS

NATIONAL ASSOCIATION OF CONSUMER CREDIT ADMINISTRATORS


STATEMENT ON SUBPRIME MORTGAGE LENDING

I.

INTRODUCTION AND BACKGROUND

On June 29, 2007, the Federal Deposit Insurance Corporation (FDIC), the Board of
Governors of the Federal Reserve System (Board), the Office of the Comptroller of the
Currency (OCC), the Office of Thrift Supervision (OTS), and the National Credit Union
Administration (NCUA) (collectively, the Agencies) publicly released the Statement on
Subprime Mortgage Lending (Subprime Statement).

The Agencies developed the Subprime Statement to address emerging risks associated with
certain subprime mortgage products and lending practices. In particular, the Agencies are
concerned about the growing use of adjustable rate mortgage (ARM) products
1
that
provide low initial payments based on a fixed introductory rate that expires after a short
period, and then adjusts to a variable rate plus a margin for the remaining term of the loan.
These products could result in payment shock to the borrower. The Agencies are
concerned that these products, typically offered to subprime borrowers, present heightened
risks to lenders and borrowers. Often, these products have additional characteristics that
increase risk. These include qualifying borrowers based on limited or no documentation of
income or imposing substantial prepayment penalties or prepayment penalty periods that
extend beyond the initial fixed interest rate period. In addition, borrowers may not be
adequately informed of product features and risks, including their responsibility to pay
taxes and insurance, which might be separate from their mortgage payments.

These products originally were extended to customers primarily as a temporary credit
accommodation in anticipation of early sale of the property or in expectation of future
earnings growth. However, these loans have more recently been offered to subprime
borrowers as credit repair or affordability products. The Agencies are concerned that
many subprime borrowers may not have sufficient financial capacity to service a higher
debt load, especially if they were qualified based on a low introductory payment. The
Agencies are also concerned that subprime borrowers may not fully understand the risks
and consequences of obtaining this type of ARM loan. Borrowers who obtain these loans
may face unaffordable monthly payments after the initial rate adjustment, difficulty in

1
For example, ARMs known as 2/28 loans feature a fixed rate for two years and then adjust to a variable
rate for the remaining 28 years. The spread between the initial fixed interest rate and the fully indexed
interest rate in effect at loan origination typically ranges from 300 to 600 basis points. paying real estate taxes and insurance that were not escrowed, or expensive refinancing
fees, any of which could cause borrowers to default and potentially lose their homes.

Like the interagency Guidance on Nontraditional Mortgage Product Risks that was
published in the Federal Register on October 4, 2006 (Volume 71, Number 192, Page
58609-58618), the interagency Subprime Statement applies to all banks and their
subsidiaries, bank holding companies and their nonbank subsidiaries, savings associations
and their subsidiaries, savings and loan holding companies and their subsidiaries, and
credit unions.

Recognizing that the interagency Subprime Statement does not apply to subprime loan
originations of independent mortgage lenders and mortgage brokers, on June 29, 2007 the
Conference of State Bank Supervisors (CSBS), the American Association of Residential
Mortgage Regulators (AARMR), and the National Association of Consumer Credit
Administrators (NACCA) announced their intent to develop a parallel statement. CSBS,
AARMR and NACCA strongly support the purpose of the Subprime Statement and are
committed to promoting uniform application of the Statements origination and
underwriting standards for all mortgage brokers and lenders (herein referred to as
providers).

The Subprime Statement identifies many important standards for subprime lending, and
CSBS, AARMR, and NACCA support additional efforts to enhance subprime lending
oversight. For instance, the Subprime Statement encourages depository institutions to
consider a borrowers housing-related expenses in the course of determining a borrowers
ability to repay the subprime mortgage loan. However, the Agencies did not explicitly
encourage the consideration of total monthly debt obligations. Rather than create
confusion or adopt a higher standard, CSBS, AARMR, and NACCA have determined to
mirror the interagency statement. We will continue to work with the Agencies and our
state members to improve industry-wide mortgage lending practices.

In order to promote consistent application across the states, AARMR and CSBS are
developing Model Examination Guidelines (MEGs) to implement the 2006 Guidance on
Nontraditional Mortgage Product Risks (NTM Guidance) and the following Statement on
Subprime Mortgage Lending. These guidelines are being developed as examination
standards to assist state regulators in determining proper compliance with the NTM
Guidance and the Subprime Statement. The MEGs will also be published as a public
document to guide mortgage providers and their auditors in reviewing transactions covered
by the NTM Guidance and the Subprime Statement.

The following statement will assist state regulators of mortgage providers not affiliated
with a bank holding company or an insured financial institution in promoting consistent
regulation in the mortgage market and clarify how providers can offer subprime loans in a
safe and sound manner that clearly discloses the risks that borrowers may assume.


2 In order to maintain regulatory consistency, this statement substantially mirrors the
interagency Subprime Statement, except for the removal of sections not applicable to non-
depository institutions.

II.

STATEMENT ON SUBPRIME MORTGAGE LENDING

CSBS, AARMR and NACCA developed this Statement on Subprime Mortgage Lending
(Subprime Statement) to address emerging issues and questions relating to subprime
mortgage lending practices. The term subprime refers to the credit characteristics of
individual borrowers. Subprime borrowers typically have weakened credit histories that
include payment delinquencies, and possibly more severe problems such as charge-offs,
judgments, and bankruptcies. They may also display reduced repayment capacity as
measured by credit scores, debt-to-income (DTI) ratios, or other criteria that may
encompass borrowers with incomplete credit histories. Subprime loans are loans to
borrowers displaying one or more of these characteristics at the time of origination or
purchase. Such loans have a higher risk of default than loans to prime borrowers.
Generally subprime borrowers will display a range of credit risk characteristics that may
include one or more of the following:

Two or more 30-day delinquencies in the last 12 months, or one or more 60-day
delinquencies in the last 24 months;

Judgment, foreclosure, repossession, or charge-off in the prior 24 months;

Bankruptcy in the last 5 years;

Relatively high default probability as evidenced by, for example, a credit bureau risk
score (FICO) of 660 or below (depending on the product/collateral), or other bureau or
proprietary scores with an equivalent default probability likelihood; and/or

Debt service-to-income ratio of 50% or greater, or otherwise limited ability to cover
family living expenses after deducting total monthly debt-service requirements from
monthly income.

This list is illustrative rather than exhaustive and is not meant to define specific parameters
for all subprime borrowers. Additionally, this definition may not match all market or
institution specific subprime definitions, but should be viewed as a starting point from
which the Michigan Office of Financial and Insurance Services will expand examination
efforts.
2


2
Subprime and subprime loans are defined by the 2001 Interagency Expanded Guidance for Subprime
Lending Programs. To promote consistency and uniformity, CSBS, AARMR and NACCA support these
definitions for the purposes of this statement.

3 CSBS, AARMR and NACCA are concerned borrowers may not fully understand the risks
and consequences of obtaining products that can cause payment shock.
3
In particular,
CSBS, AARMR and NACCA are concerned with certain adjustable-rate mortgage (ARM)
products typically
4
offered to subprime borrowers that have one or more of the following
characteristics:

Low initial payments based on a fixed introductory rate that expires after a short period
and then adjusts to a variable index rate plus a margin for the remaining term of the
loan;
5


Very high or no limits on how much the payment amount or the interest rate may
increase (payment or rate caps) on reset dates;

Limited or no documentation of borrowers income;

Product features likely to result in frequent refinancing to m