Fed Warns Lenders to be More Strict

Lenders must disclose more information about products like adjustable- rate mortgages to people with poor credit histories and make sure that borrowers are able to repay the loans, according to guidelines issued in Washington Friday by the Fed as well as the Federal Deposit Insurance Corporation, and other U.S. regulators.

The guidelines reflect regulators’ growing concern about an increase in mortgage defaults by homeowners with weak credit, after late payments last quarter rose to their highest level in four years.

Fremont General, a lender in California, announced the planned sale of its subprime unit; another California lender, New Century Financial, said that it faced a criminal investigation.

Today in Marketplace by Bloomberg

 HSBC, facing U.S. losses, plans a comeback in Asia Fed warns lenders to be stricter Chinese entrepreneurs poised to leap on North Korean border

The intention is “to limit risks to both the borrower and the lending institution,” a Fed governor, Randall Kroszner, said. Borrowers, he added, need “clear and balanced information on the risks associated with these loans.”

Senator Christopher Dodd, the Democrat who is chairman of the Banking Committee, told Ben Bernanke, the chairman of the Federal Reserve, at a hearing last month that regulators were not doing enough to protect consumers from deceptive mortgage practices. Lawmakers are concerned that aggressive lending, rising interest rates and falling home prices have put more borrowers at risk of losing their homes.

The new guidelines update standards released by the regulators in September directing lenders to strengthen loan underwriting requirements. Banks were instructed to scrutinize a borrower’s ability to repay a mortgage and ensure that home buyers understand loan terms.

During the housing boom of the past few years, banks provided new mortgage services that offered an initial fixed-rate period before shifting to a higher adjustable rate. Lawmakers and consumer groups complained that the September guidelines failed to address so-called 2/28 mortgages, those with a fixed interest rate for 2 years and an adjustable rate for 28 years.

About 75 percent of subprime borrowers use a 3/27 mortgage, which has a fixed rate for three years, or a 2/28, according to Freddie Mac, the U.S. mortgage finance agency.

Bank regulators expressed concern that lenders were approving the loans without “appropriate documentation” of the borrower’s income, according to the guidelines released by the Fed, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the National Credit Union Administration.

The agencies advised banks to do a better job analyzing the borrower’s ability to repay the entire loan, giving consideration to annual changes in interest rates.

Lenders should also disclose risks, including the likelihood of monthly payments rising, in advertisements, oral statements and promotional materials. Such communications should not be used to steer subprime borrowers to adjustable-rate mortgages, the regulators said.

“The agencies will carefully scrutinize risk-management and consumer- compliance processes” through regularly scheduled examinations, the regulators said. “Institutions that do not adequately manage these functions will be asked to take remedial action.”

The Mortgage Bankers Association, a trade group based in Washington, said that the recommendations go too far and that lender closings show that the market is fixing itself.

“A number of firms, which made weaker loans, have been forced out of business simply because the loans didn’t perform as they proposed,” Doug Duncan, the group’s chief economist, said. “The guidance has the potential of overreaching and constraining credit availability to people who need it.”

Banks should also develop “strong control systems” to monitor employee lending practices and scrutinize relationships with mortgage brokers. The regulators will seek public comment on their recommendations for 60 days after publication in the Federal Register.

“I hope everyone in the market will quickly embrace these new guidelines, so we can move forward and work together to address the looming foreclosure problems that may lie ahead,” Dodd said.

Representative Barney Frank, the Democratic chairman of the Financial Services Committee, said he appreciated “federal regulators working together and taking this important step.” A House subcommittee will hold hearings on predatory lending March 6.

About 2 percent of subprime mortgages made last year were more then 60 days past due after five months, nearly twice the rate for ones made in 2005, according to a Feb. 22 report from Barclays Capital.

Delinquencies and loan defaults are at the highest levels in at least seven years, the report said.