NCUA RLS Jerry Bonk 11/01/2016 3/10/ Lending Hot Topics. Key Lending Issues from an Examiner Perspective

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Muriel Ethel Ellis
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1 NCUA RLS Jerry Bonk 11/01/2016 3/10/ Lending Hot Topics Key Lending Issues from an Examiner Perspective

2 Lending Hot Topics Credit Risk Related Items Concentration Risks & Trends Residential Real Estate Consumer Lending Indirect Auto Lending Business Lending Participation Lending Problem Loans 2

3 FICU Loan Type Concentrations 3

4 FICU Specific Program Trends 4

5 Residential Real Estate Lending Establish limits, tracking and monitoring of LTV s at origination. Limits to net worth for: Overall RE concentrations and by type 1 st REM over 80% LTV (if allowed) and separate for those with or without PMI (if allowed) 2 nd REM s by LTV categories If material residential RE concentrations exist should perform analysis to estimate current LTV and obtain current credit score. Assess concentration of higher risk types (such as those with combined poorer credit score and higher LTV) 5

6 Real Estate Valuations Appraisal issues seen with LTCU 10-CU-23 guidance: Lack of independent ordering and review of appraisals Lack of documented appraisal review Expertise/qualification of appraisal reviewers Appraisal review quality and content Purchase transaction LTV - use lesser of actual purchase cost or value estimate for value 6

7 Real Estate Valuations Evaluations Issues LTCU 10-CU-23 Use of broker price opinion prohibited for value by Dodd-Frank for purchase of consumer s principal dwelling Rely solely for evaluation (cannot do) using: AVM s. If use need policies and procedures for AVM selection; when it can be used; and validation of results Tax assessed valuations (TAV). If use determine how calculated; analyze relationship between TAV and market values; test and document how closely TAV s correlate to market value 7

8 Consumer Lending Issues Lack of limits for skip payments and modifications Resulting extended amortization and repayment time affects secondary source of repayment (collateral value erosion) Vehicle financing structural concerns Extended terms (example increase in 72 and 84 month financing Trade in issues (upside-down on trade in value to existing loan balance rolled into new vehicle financing) 8

9 Consumer Lending Issues Risk based pricing validation Documented support for the tiers, pricing and servicing spreads Ensure tier structures appropriately price for risk Lack of obtaining updated credit reports or scores for open lines of credit (credit cards and HELOCs) If material deterioration seen in credit reports or scores, can be proactive and reduce or terminate the line to limit exposure 9

10 Indirect Lending (IDL) Two Types Point of Sale: Credit union contracts with a merchant, such as an auto dealer, to originate loans at the point of sale. Outsourced Lending Relationship: Credit union contracts with a third party, such as a CUSO, to originate loans Point of sale accounts for 69.3% of indirect lending nationally based on 6/30/16 Call Report Data thus focus on issues here 10

11 IDL Issues Lack of controls or monitoring Loan documentation problems Missing loan files Titles Interesting credit reports Suspicious income verification Powerbooking Funding date precedes approval date Incentive programs tied to loan volume 11

12 IDL Issues Frequent 1 st payment defaults, deferments Poor dealer management: Reliance on the dealer to obtain credit reports Loan payments from dealers Dealer-created down payments via dealer incentives Inflated or fraudulent trade-in or purchase price Continuous overdrafts in dealer reserve accounts 12

13 IDL Program Improvements Strategic Plan & Business Model LTCU 10-CU- 15 Set goals considering program cost/benefits Set limits to % net worth, % of loans, specific dealer paper amounts, and paper grade limits Staffing needs Impact on ALM & Liquidity Adequate Resources and Staffing Dealer Due Diligence and Portfolio Performance Tracking Documentation Tracking and Quality Control Reviews 13

14 IDL Program Improvements Detailed Policies and Procedures Underwriting, Documentation, Monitoring Standards Internal Approval Authorities Pricing Models such as Risk Based Pricing Collateral, Collections, and ALLL Standards Concentration Limits Proper Contracts Legal Review Effective Dealer Due Diligence Background/Credit Checks BBB, D&B report Financial Statements Dealer Site Visits 14

15 IDL Program Improvements Portfolio Tracking and Monitoring By Dealer Delinquency, Charge offs, Credit Grade, LTV, Gross/Net Yield, Denial Rate By Loan Officer Delinquency, Charge offs, Credit Grade, Approval/Denial, Dealer Concentrations Ongoing Performance Analysis Portfolio level (total portfolio performance) Static Pool Loans originated with the same underwriting criteria during same month, quarter, or year 15

16 IDL Program Concerns Is the program profitable? If an IDL or inhouse program is mostly A or B paper, while the credit quality is good, the net return may be lower than an equivalent term US Treasury or other lower risk investment product. Indirect recreational vehicle lending risks. Involve larger dollar amounts, longer terms (15 years). May experience large collateral price fluctuations based on external factors (state of economy, gas prices, etc.) 16

17 Commercial/MBL Lending Issues Strategic Plan Policies and Procedures Staffing & Internal Controls Credit Presentations Loan Structure and Conditions Underwriting Monitoring 17

18 Commercial/MBL Lending Issues Strategic Planning Often not documented or only addresses one-year budget general volume goals Policies and Procedures May lack sufficient detail regarding underwriting and monitoring standards (for example, minimum debt service coverage for loan types or industries). New regulation will require additional clarity in a number of areas Staffing (Experience) & Internal Controls Should segregate loan officer sales function from credit analysis and credit administration functions. 18

19 Credit Presentations Provides sufficient documentation and analysis to allow approvers to make fully informed decision. Best practice key items include: Explain borrower and business background; principals involved, nature of business, industry and market conditions List all loans in associated borrower group Document loan purpose and source and use of funds Full financial analysis of borrower and principals or guarantors; identify financial quality obtained. Sources of repayment and ability to service debt 19

20 Credit Presentations Best practice key items (continued): Collateral details as applicable Appropriate analysis as applicable. CRE may involve tenant & lease analysis if the cash flow source. C&I involves UCA cash flow analysis and ratio analysis with comparison to industry averages Projections as needed with clearly stated and supported assumptions Risk rating and how it was derived Conditions/covenants requirements Strengths and weaknesses Policy exceptions with supporting rationale 20

21 Commercial/MBL Lending Issues Loan Structure and Conditions Extended Amortizations or Terms Significant cash-out refinancing for appropriate reason Lack financial performance covenants or risk mitigation conditions; is there any recourse for noncompliance? Underwriting Global cash flow methodology used sufficient? Do related interests affect ours? Appropriate cash flow analysis-traditional or UCA? Risk rating Proper criteria based on loan industry or type? Is cash flow appropriately weighted? 21

22 Commercial/MBL Lending Issues Monitoring Documented site inspections as part of annual review process lacking in many instances (often also for preloan underwriting) Tickler systems not always adequate to track and report outstanding and overdue financial or other information or loan conditions/covenants Program lacks independent periodic third party review by qualified parties to assess adequacy of policies and processes, risk rating accuracy, credit quality related issues 22

23 Participation Issues Lack of documented due diligence of the participation originator and/or servicer s experience/track record with similar types. Also assess their financial ability to continue to service the loan Lack of documentation of internal analysis and risk rating for participation purchases; cannot rely solely on seller s due diligence on the loan Lack of complete origination loan file and/or ongoing financial or other monitoring items 23

24 Participation Issues Lack of monitoring process to obtain seller/servicers annual reviews and supporting data Lack of completing internal annual review summaries to document the credit union s monitoring and updated risk rating for each participation loan Lack of timely and complete assessment of ALLL needs for participation loans 24

25 Problem Loan Causes Poor initial loan decisions or underwriting Lack understanding of business or industry Higher risk industries or types not mitigated Inaccurate or incomplete cash flow measurement Appropriate conditions not formulated Weak credit administration Loan documentation flaws Lack appropriate monitoring Economic (environmental) changes Address through concentration limits and monitoring market conditions 25

26 Problem Loan Issues Lack timely recognition (monitor unpaid property taxes, adverse account activity, guarantor credit declines, lack timely submitted financials, google) Troubled debt restructure recognition and reporting Capitalization of accrued interest, late fees, etc. on workout loans Inadequate limits on the number of workouts a loan can receive Workout granted without adequate documentation of financial ability to repay 26

27 Problem Loan Issues Lack of Watch lists or Problem Loan Reports completed timely (monthly or quarterly depending on circumstances) on collection problem commercial loans ALLL funding for impaired loans based on collateral dependent method for non-collateral dependent loans Lack of timely charge off of loans in accordance with industry guidance 27

28 Summary Thoughts Formulate and document strategic plans, policies and rationale for what you do and plan to do Ensure you have sufficient staffing levels with the expertise to administer successful programs Seek periodic timely feedback from quality control reviews using qualified parties Document your due diligence efforts and monitoring efforts over the various programs Focus on what you know and can understand Document, document, document! 28

29 Resources NCUA Letters to Credit Unions: 07-CU-13 (Evaluating Third Party Relationships) 08-CU-20 ( Mortgage Risks) 08-CU-26 (Loan Participations) 10-CU-02 (Business Lending Risks) 10-CU-03 (Concentration Risks) 10-CU-07 (CRE Workouts) 10-CU-15 (Indirect Lending & Due Diligence) 10-CU-23 (Appraisal & Evaluation Guidelines) 13-CU-03 (Guidance Loan Workouts & TDRs) Ag Lending Topics 29

30 References NCUA Rules and Regulations (h) Third party servicing of indirect vehicle loans NCUA Rules and Regulations (c)(8)(i) Incentive Compensation Ag Lending Topics 30

31 Questions? Ag Lending Topics 31

CREDIT RISK MANAGEMENT GUIDANCE FOR HOME EQUITY LENDING

CREDIT RISK MANAGEMENT GUIDANCE FOR HOME EQUITY LENDING Office of the Comptroller of the Currency Board of Governors of the Federal Reserve System Federal Deposit Insurance Corporation Office of Thrift Supervision National Credit Union Administration CREDIT