WASHINGTON Federal Deposit Insurance Corp. Chairman Donna Tanoue warned that banks are inadvertently helping predatory lenders by buying their loans or providing them credit.
To effectively combat predatory lending, we must sever the money chain that replenishes the capital of predatory lenders and allows them to remain in business, she said Friday at the annual conference of the National Congress for Community Economic Development in New Orleans.
If banks are not careful, they could find themselves embroiled in lawsuits against those lenders or forced to pay back securitized loans to borrowers, she said.
The last several years have seen an increase in both class-action lawsuits and state and federal enforcement activity against finance companies based upon fraud and other deceptive acts and practices in connection with real estate-related loans, Ms. Tanoue said. This increased and increasing risk of litigation is a cause for concern.
She said the agency will release guidelines by the end of the month to combat the problem. In her speech, Ms. Tanoue outlined steps that banks could take to detect securities that are backed by predatory loans.
First, banks should assess the reputation of the originator. That process would include obtaining prospectuses that identify the sellers and master servicers of the loans backing the securities and investigating whether originators have been sued over their lending practices, she said.
Second, banks should watch for tell-tale signs of predatory lending, such as frequent prepayments, high delinquencies, or high loss rates from earlier securitizations, Ms. Tanoue said.
Banks could spot potential predators by looking for low loan-to-value ratios combined with unusually high interest rates, she said. Other red flags include high prepayment penalties, odd methods of calculating adjustable rates on mortgages, and a high percentage of loans that have been subject to negative amortization.
Finally, banks should scrutinize any credit enhancements being used to market the securities, Ms. Tanoue said. FDIC officials said that a seller offering a high number of enhancements such as assurance of limited exposure in case of default could indicate a risky underlying portfolio.
But Ms. Tanoue acknowledged the difficulty of combating predatory lending without hurting legitimate subprime lenders. Wall Street firms have injected more than $300 billion over the past decade into the subprime market, which has expanded access to credit, she noted.
The FDIC plans to publish questions for banks on its antipredatory ideas this month on its Web site. The agency wants to know how costly it will be for banks to carry out its recommendations, or whether they would have unintended consequences, Ms. Tanoue said.
Curbing predatory lending will not be easy, she said. Therefore, I have decided that it would be best to get input to ensure that we get things right, to ensure that our efforts to combat predators do not inadvertently choke off other sources of credit to low- and moderate-income, elderly, and minority borrowers.
Lawmakers have been debating whether new laws or better enforcement of existing rules would stop abusive practices without hurting legitimate activities.
Eleven federal agencies, including the Federal Reserve Board and the Justice Department, are expected to issue a policy statement this year or early next year on how to use existing laws to crack down on predators.
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