On July 1, 2014, the federal financial institutions regulatory agencies, in conjunction with the Conference of State Bank Supervisors, issued guidance describing the core principles that should govern management’s oversight of home equity lines of credit (HELOC) nearing their end-of-draw periods. The guidance also describes components of a risk management approach that promotes an understanding of potential exposures and consistent, effective responses to HELOC borrowers who may be unable to meet contractual obligations. The agencies suggest this guidance should be applied in a manner commensurate with the size and risk characteristics of a financial institution’s HELOC portfolio.
For some time now, the bank regulatory agencies have been expressing concern regarding the challenges that financial institutions and residential borrowers may face as HELOCs near their end-of-draw periods. As HELOCs transition to full repayment, many borrowers may have difficulty meeting higher payments resulting from principal amortization or interest rate reset, or renewing existing loans due to changes in their financial circumstances or declines in property values. The OCC in particular, in comments contained in its last several Semiannual Risk Perspective publications, has been warning bankers of the looming risk related to HELOCs approaching their end-of-draw periods and has been urging a proactive approach, including a more comprehensive ALLL analysis to ensure an appropriate reflection of the risk of loss in these portfolios.
This new guidance explains that examiners will be reviewing financial institutions’ end-of-draw risk management programs for provisions that address five risk management principles:
- Prudent underwriting for renewals, extensions, and rewrites
- Compliance with pertinent existing guidance, including but not limited to the Credit Risk Management Guidance for Home Equity Lending and the Interagency Guidelines for Real Estate Lending Policies. (This new guidance lists all the relevant regulations and guidance that convey supervisory expectations for appropriate HELOC underwriting, account management, accounting and reporting, and loss mitigation activities.)
- Use of well-structured and sustainable modification term
- Appropriate accounting, reporting, and disclosure of troubled debt restructurings
- Appropriate segmentation and analysis of end-of-draw exposure in ALLL estimation processes.
The guidance suggests that prudent risk management expectations generally include:
- Developing a clear picture of scheduled end-of-draw period exposures. Management reports should identify contractual draw period transition dates for all HELOCs, showing maturity schedules in the aggregate and by significant segments of performing and non-performing borrowers.
- Ensuring a full understanding of end-of-draw contract provisions. Institutions should monitor options available to lenders and borrowers such as draw period extensions or interest rate locks, and institutions should be aware of the timing of any required notifications to borrowers.
- Evaluating near-term risks. Management should evaluate borrowers making only the contractual minimum interest-only payments to consider whether those borrowers will meet current underwriting standards or qualify for renewal or rewrite programs.
- Contacting borrowers through outreach programs. Management should begin reaching out to borrowers well before their scheduled end-of-draw dates to establish contact, engage in periodic follow-up with borrowers, and respond effectively to issues.
- Ensuring that refinancing, renewal, workout, and modification programs are consistent with regulatory guidance and expectations, including consumer protection laws and regulations.
- Establishing clear internal guidelines, criteria, and processes for end-of-draw actions and alternatives. Management should establish and define clear loss mitigation steps so that well-trained account representatives can quickly and efficiently process requests.
- Providing practical information to higher-risk borrowers.
- Establishing end-of-draw reporting that tracks actions taken and subsequent performance. Reporting should be frequent and contain a sufficient amount of detailed information to provide timely feedback to management.
- Documenting the link between ALLL methodologies and end-of-draw performance.
- Ensuring that control systems provide adequate scope and coverage of the full end-of-draw period exposure. Management should have quality assurance, internal audit, and operational risk management functions perform targeted testing of the full process for managing the end-of-draw transactions.
The complete guidance can be found at the following link: http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20140701a1.pdf
