WASHINGTON
Comptroller of the Currency John C. Dugan expressed strong concern in a speech
today about negative amortization in consumer loan products, particularly in
the areas of credit cards and mortgages.
Mr. Dugan also took
issue with the notion that national bank preemption has created a regulatory
gap in consumer protection, citing the strong protections in federal law and
the OCC's extensive enforcement powers and strong supervisory oversight, along
with differences in state and federal regulation that result from federalism
and the dual banking system.
In a speech to the
Consumer Federation of America, Mr. Dugan said that negative amortization of
consumer loans raise substantial and intertwined consumer protection and
safety and soundness issues.
Too many consumers
have been attracted to products by the seductive prospect of low minimum
payments that delay the day of reckoning, but often make ultimate repayment of
growing principal far more difficult, he added. At the same time, too many lenders have been attracted to the
product by the prospect of booking immediate revenue without receiving cash in
hand, a process that often masks underlying credit problems that could
ultimately produce substantial losses.
In a payment option
mortgage, which allows the borrower to select from a menu of payment
possibilities, the initial lower monthly payment means that less principal is
being paid. As a result, the loan balance grows, or amortizes negatively until
the sixth year when payments are adjusted to ensure the principal is paid off
over the remaining 25 years of the loan.
In the case of a
typical $360,000 payment option mortgage that starts at 6 percent interest,
monthly payments could increase by 50 percent in the sixth year if interest
rates do not change. If rates jump two
percentage points, to 8 percent, monthly payments could double.
Is this an appropriate
product to mass market to customers who may be looking at the less than fully
amortizing minimum payment as the only way to afford a larger mortgage at
least for the five years before the onset of payment shock? Mr. Dugan
asked. And are lenders really prepared
to deal with the consequences including litigation risk of providing such
products in markets where real estate prices soften or decline, or where
interest rates substantially increase?
The Comptroller said
the federal bank and thrift regulatory agencies are working on guidance that
will deal with negative amortization, among other issues. The guidance, which could be issued by the
end of the year should draw clear lines about appropriate standards for
qualifying borrowers for payment option ARMs that explicitly take into account
potential payment shock.
Put another way,
lenders should not encourage or accept applications from borrowers who clearly
cannot afford the dramatically increased payments that are likely to result at
the end of the five-year, low minimum payment period, he added. Disclosures should also be clear, timely,
and meaningful. And lenders should have
very substantial controls in place to manage the potential risk of such loans.
The Comptroller noted
that the issue of negative amortization in mortgages is similar to an issue
that arose in the credit card industry, where monthly payment requirements had
been set so low that borrowers who paid the minimum might see their balances
increase, even if they made no new charges.
Regulators responded by
requiring that minimum payments be sufficiently large to amortize credit card
loans over a reasonable period of time.
Most banks are expected to be in compliance by the end of the year.
We recognize that the
change in required minimum payments will make it more difficult for some
existing credit card borrowers to pay the full amount of the increased minimum
payments due, the Comptroller said.
We have encouraged lenders to work with these borrowers to the maximum
extent possible to avoid writing down the loan and cutting off the customers
credit.
Mr. Dugan said lenders
have a variety of tools to do this, including restructuring or deferring
payments and, in appropriate circumstances, re-aging accounts.
In addition, lenders
always have the option of reducing high interest rates charged to delinquent
borrowers sometimes exceeding 30 percent of the outstanding loan balance
and/or waiving fees in order to reduce a minimum payment while still amortizing
a modest amount of the outstanding principal, he added.
In
discussing the OCCs approach to consumer protection, Mr. Dugan noted that
recently released data collected under the Home Mortgage Disclosure Act (HMDA)
show that national banks and their operating subsidiaries made far fewer high
cost loans than state-chartered lenders. That demonstrates that the OCCs
history of rigorous supervisory oversight has deterred lenders from using the
national bank charter as the primary vehicle for higher-cost loans.
We recognize our
responsibility to enforce federal and applicable state laws for the national
banking system, and we expect to be held accountable for how well we do that
job, Mr. Dugan said. The same should
be true at the state level.
Mr. Dugan noted that
there are thousands of non-bank lenders and brokers that are not subject to
bank-like examination and supervision, and these institutions are commonly
cited as a significant source of abusive lending practices. Consequently, the argument that states also
should be allowed to enforce non-preempted state consumer protection laws
applicable to national banks is wrong, Mr. Dugan said.
Enforcement resources
are not infinite. It makes no sense for
both federal and state officials to focus their limited supervisory
resources on redundant enforcement actions against nationally chartered banks
or their subsidiaries, especially when those institutions are already
extensively examined and supervised by the OCC, he added.
Indeed, I worry that,
if there is a gap, it is created when state resources are diverted from
areas where problems are known to exist, and where state authorities clearly
have jurisdiction to achieve corrective measures.
# # #
The Office of the
Comptroller of the Currency was created by Congress to charter national banks,
to oversee a nationwide system of banking institutions, and to assure that
national banks are safe and sound, competitive and profitable, and capable of
serving in the best possible manner the banking needs of their customers.