At an April 17 hearing to explore possible responses to the rising home mortgage foreclosure rates, Rep. Barney Frank, D-Mass., Chairman of the House Financial Services Committee, heard testimony from Fannie Mae, Freddie Mac, the Federal Housing Administration, the mortgage industry and consumer

organizations. The hearing was held to "determine the scope of the problems and the implications on homeowners and the economy; the causes of the problem; what regulators, industry and community organizations are doing about it; and what additional steps regulators and Congress can take to improve the situation to ensure that we do not end up here again," according to Frank.

Frank said resulting legislation will be drafted with a variety of goals in mind, including protecting all Americans against predatory lending; keeping access to credit open during "troubled" markets; not allowing lenders to make loans they perceive the consumer cannot repay; eliminating incentives for loan originators to make bad loans; and requiring a simple, meaningful full disclosure of the terms of the loan.

Appraisal Industry Weighs in

In an April 11 letter to the federal bank regulators, the four largest professional appraisal organizations stressed the need for an independent appraisal process in the mortgage lending process.

The letter from the Appraisal Institute, American Society of Appraisers, American Society of Farm Managers and Rural Appraisers and National Association of Independent Fee Appraisers came in response to a proposed "Statement on Subprime Mortgage Lending," issued by the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of Thrift Supervision and National Credit Union Administration. The proposed statement was sent to industry leaders in the lending, mortgage and real estate fields.

"In their effort to safeguard consumers from shoddy subprime mortgages, the agencies have overlooked the importance of selecting ethical, professional and independent appraisers," said Don Kelly, chief external relations officer for the Appraisal Institute. "Specific guidance on appraisal management and appraiser independence cannot be emphasized enough, particularly when fraud in residential mortgage lending has grown to new heights. The agencies need to revise their statement to stress this point," Kelly stated.

The full comment letter is available on the Appraisal Institute Web site at www.appraisalinstitute.org/govtaffairs/letrs/tstimny.asp. The proposed guidance is available at www.federalreserve.gov/BoardDocs/press/bcreg/2007/20070302/attachment.pdf.

Subprime Casualty: New Century

New Century Financial Corp., overwhelmed by rising defaults from borrowers with poor credit records, became the largest subprime mortgage lender ever to fail as it filed for Chapter 11 bankruptcy April 2. After the filing was announced, the company's shares fell 13 cents, or 12 percent, to 93 cents. They've fallen 97 percent this year.

The company rode the U.S. housing boom to become the largest independent mortgage lender to subprime borrowers, only to collapse as interest rates rose and home prices fell. New Century's market value soared to more than $3.5 billion in December 2004, and last year it made about $60 billion in loans.

Analyst Matthew Howlett at the investment firm Fox-Pitt, Kelton, told the Fort Worth Star-Telegram that New Century's operational safeguards, from guarding against inaccurate appraisals to accounting for losses, appear to have been inadequate.

"Suitability" of Loans Questioned

The issue of a lender's need to ensure that the loan is "suitable" is a hot topic in light of the rising number of foreclosures. For example, in Hennessy v. Dawson, dozens of New York plaintiffs filed a $100 million lawsuit on November 21, 2006, against a group of defendants that include several large mortgage lenders and brokers accused of working together to misappropriate the plaintiffs' money through fraud and misrepresentation. The plaintiffs argue that the mortgage companies aided and abetted lead defendant Peter J. Dawson by failing to properly examine the suitability of the borrowers with regard to income, financial situation and the ability to make mortgage payments. The plaintiffs also claim they never received proper disclosures or closing documents related to their loans. The plaintiffs seek to have their mortgages voided and to prevent further foreclosure proceedings or collection activities on their mortgages.

Foreclosure Reprieve Requested

National civil rights groups, including the Leadership Conference on Civil Rights, the NAACP, the National Fair Housing Alliance, the National Council of La Raza and the Center for Responsible Lending, have called on mortgage lenders, loan servicers and loan investors to institute an immediate six-month moratorium on subprime home foreclosures resulting from reckless and unaffordable loans in the subprime market.

The groups want to stop home losses for families that received unaffordable subprime mortgages with "payment shock." The predominant loan type marketed by subprime lenders in recent years is a hybrid subprime mortgage, which begins with a temporary fixed interest rate that changes to a much more costly adjustable-rate mortgage. These "exploding" ARMs, as well as other types of nontraditional mortgages, have been a driving force in massive foreclosures occurring today. Recent lending data shows that subprime mortgages--which make up only 13 percent of the overall mortgage market--account for more than 60 percent of new foreclosure filings.

The groups also called on Congress to pass anti-predatory legislation, including a private right of action, to ensure protection for minority and other communities and to see that this situation does not happen again.

Fitch: Increase in CMBS Defaults

After a 3.7 percent cumulative default rate over the past 10 years (1995-2005), commercial mortgage-backed securities loan defaults could jump 15 percent over the next decade to 4.2 percent, Fitch Ratings has warned. Aggressive underwriting on loans originated in 2007 as well as the practice of basing loans on projected--rather than current--property values, has led to the conclusion. Agency researchers reportedly are pointing to the subprime mortgage market meltdown as a warning to investors not to mix aggressive underwriting with a reliance on property price appreciation that may or may not materialize. In the current environment, Fitch said, some borrowers are taking on total debt in excess of 100 percent of asset values, with debt service at the outset exceeding existing cash flow.

"Real estate professionals are structuring loans today with the expectation that cash flow will continue to rise in a commercial real estate market that has already experienced dramatic upward trends," Fitch Senior Director Eric Rothfeld said.

Approximately 70 percent of new CMBS loans are interest only (IO) or include an interest-only period. As a result, the bulk of defaults likely to result from CMBS loans originated this year may not occur until the loans are up for refinancing in 2017, said RBS Greenwich Capital's Lisa Pendergast. "The irony is that while IO loans will keep term defaults lower, they will work in unison with the very real potential that rates will be higher and property valuations lower (in 2017) to create a higher balloon default rate," she explained.

By Adam Webster, Managing Editor