The Federal Reserve estimates that just short of 60% of the outstanding HELOCs originated between 2004 and 2008, at the peak of the real estate run-up, will hit end-of-draw between 2014 and 2017. Many of these lines may now be underwater. Michael Webb, Managing Examiner, The Federal Reserve Bank of Richmond, Martin Gallagher, EVP & CCO, Beneficial Bank, and Meg Mueller, EVP/Chief Credit Officer, Fulton Financial Corp, provided HELOC risk management considerations and recommendations for community banks during an informative session on Day One of RMA’s Annual Risk Management Conference in Washington D.C.
For community banks, ensuring that they have identified the hidden risks in their HELOC portfolios does not have to be an expensive proposition. Most of the data can be mined from their existing credit risk management portfolio systems. Refreshing credit scores once a year or semi-annually (quarterly for high risk accounts) is highly recommended. Segmenting utilization rates by credit scores can help with loan loss reserves. It is also prudent to review payment history, draws, and curtailment, and consider combined loan-to-values. Freezing the line is one action banks can take to mitigate loss, however, specific analysis must be available to warrant freezing.
Presenters acknowledged that dedicating people and resources could be a challenge for community banks. There isn’t a one-size-fits-all solution to how many resources are enough. Each bank needs to determine what is appropriate for them.
Providing insight into model validation for community banks, Stephen D. Phillips, EVP/Chief Credit & Risk Officer, First United Bank, Michael G. Nassy, Executive Vice President & Chief Credit Officer, First Virginia Community Bank, and Joel J. Pruis, Senior Business Consultant, Experian Information Solutions, Inc., directed participants to the Supervisory Guidance on Model Risk Management OCC Bulletin 2011–12. Jointly developed by the Office of the Comptroller of Currency (OCC) and the Board of Governors of the Federal Reserve System, this bulletin provides guidance on model risk management policies, practices, and standards for:
- model development;
- model implementation and use;
- model validation;
- and model governance and controls.
Nassy proceeded to identify keys to an effective validation framework: 1) review of models to ensure they meet the bank’s needs and an evaluation of conceptual soundness; 2) ongoing monitoring; and 3) outcome analysis/backtesting on a semi-annual basis.
Lessons learned from Phillips’ bank’s model validation efforts include benefiting from third-party expertise, leveraging software providers, testing assumptions/outcomes against experience, documenting the process, and using internal independent assessment.
Recent guidance on leveraged lending is causing confusion among banks as they interpret definitions. Thomas Guenther, National Bank Examiner, OCC Shared National Credit Program Manager, Daniel J. Neumeyer, Chief Credit Officer, Huntington National Bank, and Darrin Benhart, Director/Commercial Credit Policy, Office of the Comptroller of the Currency Central Dist., offered both the policy and supervisory sides of this issue.
Nuemeyer identified several challenges for banks. First, there is compliance with at least two definitions — FDIC High Risk and Joint Agency Guidance on Leveraged Lending along with internal reporting requirements that may differ. Data capture, tracking, and reporting is often manual and, therefore, time-consuming.
Second, there is an “evolving” interpretation of the guidance issued in March, 2013. The purpose test is now being debated and is inconsistently communicated among banks (validated through a recent RMA survey). Although the guidance stated that “financial institutions should do their own analysis to define leveraged lending,” recent conversations have implied a more prescriptive approach.
Adding to these challenges is the difficulty of using the Joint Agency Guidance as a risk management tool if it does not align with a particular bank’s size, business model, risk appetite, and portfolio characteristics; as well as a lack of consistency among, and within, the various agencies in their interpretation and application of the guidance.
Guenther and Benhart indicated that the scope of the leveraged lending guidance applies to all supervised financial institutions including loans originated and held in portfolio, loans originated and held in a distribution pipeline, and loans purchased via participations or as traded assets. Community banks are largely unaffected. They indicated that banks’ risk management framework should include:
- a definition of leveraged lending consistent across all business lines;
- acceptable leverage levels and amortization expectations for senior and subordinated debt; and
- credit and concentration limits consistent with the bank’s risk appetite.
Leveraged lending based on the historical definition has higher risk elements and, therefore, should be defined, monitored, and controlled. The leveraged lending market has gotten overly aggressive with many deals underpriced and under-structured in terms of covenants, amortization, and permitted EBITDA add-backs. Ultimately, management should have policies, tracking, and reporting in place to control the amount of risk being taken in the leveraged lending arena. It should be incorporated into the bank’s overall risk appetite. Although a risky business, leveraged lending can be done prudently if consistent policies are in place to manage the risks.
A panel of community bank chief credit risk officers discussed the risk issues facing community banks today. Bob Rose, Chief Credit Officer, Brookline Bank, Nancy Foster, EVP/Chief Risk Officer, Park Sterling Bank, and Terrie McQuillen, SVP/Chief Credit Officer, Community National Bank emphasized the importance of establishing an enterprise risk management program along with a risk appetite statement for community banks. By a show of hands, many attendees in the room have implemented both at their institutions.
All three panelists have incorporated cyber security risk as an element of the ERM framework, and more importantly, have recently been building it into their risk culture by educating employees at every level to raise recognition of the risks if/when they occur. Strategic risks associated with new products and services is also an area of focus for the panelists.
As the economy emerges from the recession and loan opportunities are returning, panelists are being mindful of competitive pressures, analyzing the strength of deals, evaluating the risk rating, and simply walking away from low-rated deals.
Please check the blog in the coming days for Day Two conference highlights.
