After months of warnings from federal regulators about loosening home-loan underwriting standards, many observers and industry executives say most lenders have not significantly changed their practices.
By most accounts, fierce competition, coupled with banks' general comfort with the practices, has kept the industry from changing its product offerings or lending criteria much.
That comfort may not last much longer because there are signs that the regulatory heat is about to increase.
Agency heads' speeches have grown more ominous, and bank executives report a recent uptick in questions from examiners and written warnings of coming scrutiny.
Interagency guidelines on home equity were released in May, and guidance on first mortgages is expected this year.
Whether those steps will be any more effective than previous ones is an open question. The perception that jawboning from Washington has had little effect on business was reinforced by the response to a special question in an October survey by the Federal Reserve Board.
According to the survey, whose results were released Nov. 7, only five of about 60 banks reported tightening pricing in response to the interagency guidance on home equity lending. Even fewer reported tightening other terms and credit standards, a main source of regulators' concerns.
The survey response seems out of step with the tone of the guidance, which was issued by the Fed, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the National Credit Union Administration. "The agencies have found that, in many cases, institutions' credit risk management practices for home equity lending have not kept pace with the product's rapid growth and easing of underwriting standards," the guidance said.
But Barbara Grunkemeyer, the OCC's deputy chief comptroller for credit risk, cautioned against reading too much into the survey. There is typically a "lag" between the issuance of guidance and any tangible effects, she said, and the OCC will follow up in supervisory activities to make sure banks make necessary changes.
Another possible mitigating factor to lenders' response is that last quarter's growth in home equity portfolios was generally down from the brisk pace of recent years. Many companies reported portfolio growth in the high single digits or low double digits from a year earlier.
Ms. Grunkemeyer acknowledged that regulators have been concerned about things like interest-only first mortgages since last year, and she defended the use of verbal warnings on first-mortgage issues. She also cited the vigorous work now under way to put out formal interagency guidance on first mortgages by yearend.
"I think we've been responding in a very appropriate manner," she said. "I've heard back from certain institutions that just the fact that we're speaking out and expressing concerns is tempering some of the loosening of underwriting" and even affecting decisions about whether to offer risky products.
An FDIC spokesman said that the home equity guidance largely "reinforced tried and true credit standards and underwriting practices that banks have been following for years." His agency has not "had an issue, at least at this point, of noncompliance with the guidance."
Fed and OTS spokespeople had no comment.
Officials with several sizable banking companies, some of which asked not to be identified, said they made no changes in response to the home equity guidance, because they felt their practices were already in line with what the regulators wanted.
Doreen Woo Ho, the president of Wells Fargo & Co.'s consumer credit group, said that her banking company - and other large ones - had regular discussions about ensuring safe home equity practices with the OCC for more than a year before the guidance came out. "By the time the guidelines came out, they weren't in essence any news to us."
The guidance is somewhat nonspecific, she said, so for institutions that have not had such dialogue, it is "not like something where you could look at the guidelines and know what your policy is the next day." Still, "I think we agree it's a good idea to have a level playing field" by having all institutions adhere to the guidelines.
Regulators said in the guidance that, along with rising interest rates, there were several other issues that warrant extra caution: interest-only features; loosening documentation standards; weaker loan-to-value ratios, debt-to-income ratios, and credit scores; and the increased use of brokers and automated appraisals.
Underwriting was only one set of home equity matters regulators said should get more attention, but it topped the list. The agencies particularly wanted lenders to give more consideration to a borrower's income and debt, not just credit scores, and to take into account the potential for rates to rise.
Josh Silver, the vice president of research and policy at the National Community Reinvestment Coalition, called the Fed survey's results "an indication that the examinations haven't been as rigorous and persuasive as they need to be."
However, as Ms. Grunkemeyer noted, many examiners have not had the chance to take up the issue with many small and midsize OCC institutions, which do not have on-site examiners and get reviewed only every 12 to 18 months.
The survey raised questions about oversight on first mortgages, as well as the potential effectiveness of the forthcoming guidance on them. Despite regulators' appeals and the generally rising worries among bankers and investors, the survey also showed a return to a net loosening in residential mortgage standards in the previous three months, after banks pulled even in a July survey. (The net effect was not dramatic; five banks loosened somewhat, according to the October survey, while three tightened somewhat, and 46 did not change.)
Several secondary marketing executives who sell loans to banks said in recent interviews that they have seen no tightening of standards. Still, there are signs lenders are beginning to reflect on regulators' input - including what Ms. Grunkemeyer and others have indicated about the coming guidance.
This month several mortgage executives, at banks and thrifts of various sizes, said increased questions from examiners, written warnings about coming scrutiny from the agencies, and the coming guidance have caused at least internal discussion about what regulators will want to see.
"I think it has caused a great deal of people … to relook at their underwriting policies," said one executive, who asked to remain anonymous and expects a crackdown on disclosures and portfolio concentrations.
Several bank-owned lenders say some issues are already getting more attention from regulators. For example, they say concentrations of loans to real estate investors appear to be a big bugbear in examinations. Meanwhile, a March list of frequently asked questions on appraisal independence from regulators that clarified a 2003 interagency statement has also pressured some lenders to rework policies and processes.
Some consumer advocates say guidance for first mortgages is long overdue, though regulators say they are making progress. During a speech last month in which he urged examiners to keep a close eye on practices even before the guidance comes out, Comptroller of the Currency John Dugan said the goal is "to ready the guidance for release by year's end, although serious interagency discussions about the initial draft have only just begun."
Observers say regulators may be moving slowly for several reasons. One is a fear of pushing bankers too far in the opposite direction and causing a credit crunch like the one in the early 1990s - or even simply curtailing access to equity, which has been a boon to the economy in recent years.
"I think that the ability to tap into home equity is a major source of financing and flexibility to a lot of consumers," said Brent Ambrose, the director of the University of Kentucky Center for Real Estate Studies. "We don't want to prevent that from happening."
Another possible reason for regulatory restraint is that reining in lending practices could put banks at a severe disadvantage against unregulated lenders.
It's also difficult to pass firm judgments on exactly how to use the complex, untested innovations in mortgage products and risk-layering, since most of the practices in question are generally believed to be appropriate for certain borrowers.
Mr. Dugan implicitly acknowledged the point in his speech, which was otherwise highly critical of mortgages that could deliver severe payment shocks, such as the increasingly popular brand of adjustable-rate mortgages whose low minimum payments can create negative amortization.
"Some have suggested that payment option ARMs are inherently unsafe and unsound, and that regulators should banish them from reputable banking practice. I would characterize them differently, in this way: They have a legitimate use in the right hands, but they need to be handled with extreme care," he said.
Another issue is that as long as banks are selling most of their riskiest loans, safety-and-soundness worries are muted. And while underwriting has apparently either stayed the same or loosened this year, many banks and thrifts have been selling even more of their riskier loans recently.
Fed Governor Susan Schmidt Bies gave some other reasons why regulators have not taken drastic measures.
"From the point of view of bank supervisors, affordability products do not necessarily pose solvency concerns. Despite the apparent decline in underwriting standards, less than 5% of outstanding mortgages have a loan-to-value ratio greater than 90%, which means that the vast majority of homeowners have a significant equity cushion; in the event prices fall, only a very small percentage of owners are likely to see their debts exceed the value of their homes," Ms. Bies said in a speech last month.
"Moreover, depository institutions are generally well capitalized and well diversified, which means that prices could fall significantly without leading to a significant number of bank failures," she said.
However, Bert Ely, a bank consultant in Alexandria, Va., cautioned that by focusing only on portfolios, regulators may miss the fact that even the bad loans that banks sell can "hurt the paper on their books, to the extent there is any collapse in prices."
Representations and warranties on sold loans could lead to repurchases, he said. "Reps and warranties are in effect credit residuals."
Others say possible litigation or penalties for abusive practices may lurk as a safety-and-soundness issue. Consumer advocates say federal regulators have also handed themselves a bigger role in consumer protection through the increased preemption of state oversight.
In February the OCC established guidelines on avoiding predatory real estate lending to go with an expansion of its preemption powers the previous year. The guidelines reiterated that predatory lending is synonymous with making loans "without regard to the borrower's ability to repay the loan according to its terms."
Ms. Grunkemeyer said the OCC is attuned to the risks of sold loans: potential repurchase obligations and reputation issues. It is also sensitive to "consumer fairness issues," she said.
"We've looked at some institutions that have had negative press over the last couple of years, and it's taken a toll," Ms. Grunkemeyer said. Asked if protecting banks' good name is part of a regulator's job, she said, "I do think reputation risk is a safety-and-soundness concern."
Anecdotally, at least, some national banking and thrift companies and lending units appear to be feeling more pressure already than others.
One thrift executive recently complained to American Banker that Washington Mutual Inc. has been allowed to write option ARMs without qualifying borrowers at fully indexed rates - a practice his thrift's own examiner basically insists on following. (A spokeswoman for Wamu said that it raised qualifying rates last month, so only "small discrepancies" now exist in certain cases between qualifying and fully indexed rates.)
Meanwhile, some executives at OCC-regulated lenders suggest that OTS-regulated ones generally have been given looser rein, particularly when it comes to option ARMs (though several thrifts have extensive experience with such loans). And of course, any regulated lenders insist that unregulated ones are playing faster and looser.
Bob Gnaizda, the policy director and general counsel of the Greenlining Institute of Berkeley, Calif., says more needs to be done immediately.
He said he has met with Alan Greenspan three times in the past year and a half and has gotten a strong sense that the Fed chairman is aware of the dangers of the situations for many consumers.
In recent months Mr. Greenspan has started to make public "statements that are commendable on the matter," but the time for "strong leadership" has come, Mr. Gnaizda said. In his contacts with other regulators, he said, the response has also been one of "sympathy, but no sign of action."
