WASHINGTON — A debate over how regulators should treat refinancings and stated-income loans is delaying the release of final guidelines on subprime hybrid mortgages, sources said.
Though John Reich, the director of the Office of Thrift Supervision, said May 23 that he expected the guidelines to be completed in the next few weeks, most observers said they now expect the guidelines to be released in late June at the earliest.
"There remain a few issues to be resolved," said Erick Gustafson, a lobbyist for the Mortgage Bankers Association.
The delay was caused by last-minute issues raised by agency officials. Comptroller of the Currency John Dugan warned last week about the dangers of accepting stated-income loans for subprime borrowers and said the guidance should be stronger in reining in the practice.
"Stated income is too great a temptation for misrepresentation and, in its most extreme form, outright fraud," Mr. Dugan said, noting that 50% of subprime loans made in 2006 used stated income.
"We are seeing the consequences of stated-income loans in a market where house prices are declining or failing to increase," he said. "These consequences have been increased delinquencies and foreclosures."
Several industry observers said those statements caught them off guard, because they had believed regulators were close to finalizing the guidelines. Regulators had not previously appeared very interested in stated-income loans, a topic that was mentioned only briefly in the proposed guidelines issued in March. The guidelines said that the loans should only be accepted if mitigating factors clearly minimize the need for direct verification of repayment capacity.
"We did not see that coming, and also the tone of the comments … [was] very direct and very strong," said James Ballentine, the director of housing and economic development for the American Bankers Association.
Mr. Dugan's comments also won attention from lawmakers. Reps. Spencer Bachus, R-Ala., the ranking member of the House Financial Services Committee; Paul Gilmor, R-Ohio; and Judy Biggert, R-Ill., responded to Mr. Dugan's speech with a letter dated May 23 requesting an update on his intentions to rein in stated-income loans.
"As the comptroller points out, the market conditions of two years ago may have led both homebuyers and mortgage originators to believe that no-doc loans would be less risky, as borrowers could grow their way to a different product. When home values are increasing rapidly, a lot of bad loans are hidden," the members wrote. "Current circumstances in the housing market have exposed these poorly underwritten loans, and we would ask the regulators to closely examine the role an expanded use of 'liar loans' may have played in the subprime market defaults we are experiencing."
In addition to Mr. Dugan, Mr. Reich also appears to be seeking alterations to the proposed guidelines. In a speech the same day, Mr. Reich noted that there was significant concern in the industry about the flexibility of the guidance with regard to refinancings. Under the proposed guidelines, banks would have to underwrite all loans — including originations and refinancings — to the fully indexed rate, not a teaser one.
In comment letters about the guidance, bankers argued that the standard would be too rigid for refinancings and might prevent lenders from being able to offer them to struggling borrowers.
Mr. Reich said regulators would need to look at providing more flexibility before the guidelines could be finalized. "There is a concern among institutions that they need to have some flexibility in rewriting these loans when they reset, that if they have to rewrite in accordance with the original guidance, that their borrowers may not be able to afford those payments," he said. "So I think we're going to have to consider in the guidance what flexibility … should we give to lenders to redo loans currently on their books."
Industry representatives said they hope the final product will be changed.
"We've seen a lot of the problems reside in the refinancing area," Mr. Ballentine said. "I think they will make an effort to make that stronger. We are not sure how they will do that."
But taking too much time could further anger Capitol Hill, where lawmakers, including Chris Dodd, D-Conn., the chairman of the Senate Banking Committee, have been pushing regulators to finalize the guidelines as fast as possible. Industry observers said they expect hearings on the issue soon.
"We are going to see some more hearings on this in the coming weeks, and I don't think the regulators want to go back to the Hill empty handed," said Howard Glaser, a mortgage industry consultant. He said he believes regulators will work out any differences quickly and put the guidelines out in the next few weeks.
Consumer groups are also pushing for final guidelines soon.
"These are issues of critical importance for homeowners, and it is critical for homeowners to get them right," said Evan Fuguet, policy counsel for the Center for Responsible Lending. "However, the time to act is now, with millions of homeowners at risk. So I would hope they would issue the guidance in the coming weeks, as the OTS director suggested."
But regulators may also fear moving too quickly and leaving an issue unaddressed. That happened last year, after regulators finalized guidelines for alternative mortgages but left it unclear whether subprime hybrid adjustable-rate mortgages were covered under the new rules. After prodding from Sen. Dodd and Barney Frank, D-Mass., the chairman of the House Financial Services Committee, the regulators released new proposed guidelines March 2.
If regulators leave an issue unaddressed this time, it could prompt new legislation, observers said.
"There's also a sense here of wanting to address things as fully as possible, because if regulatory agencies don't fix this, Congress will want to fill in the gaps as much as possible. So it makes sense to fill in the gaps before Congress acts," Mr. Ballentine said.
But observers agree that by the time regulators act, the guidelines will likely have little impact on the market.
"It's clear the market has moved to correct faster than the regulators have moved," Mr. Glaser said. "Investors have already made changes on the underwriting. The immediate impact of the guidance won't be substantial. The horse is not only out of the barn, it's off the cliff."
Gil Schwartz, a partner at Schwartz & Ballen LLP, agreed that the changes in the market make the guidelines less critical.
"Unless something occurs in the marketplace … I don't see … [the guidance] regarded as a major, major issue as it was a few months ago," Mr. Schwartz said. It "seems an issue people have gotten their arms around. It's not going to shake things up. The world has moved on."
