|July 15, 2014|
Previously published on July 10, 2014
In anticipation of some home equity lines of credit ("HELOC") borrowers having difficulty meeting higher payments resulting from principal amortization or interest rate reset or renewing existing loans due to changes in financial circumstances or property values, the federal financial institutions regulatory agencies issued guidance on HELOCs nearing their end-of-draw periods. The guidance describes core operating principles to govern management's oversight of HELOCs nearing end-of-draw periods and the components of a risk management approach that promotes an understanding of potential exposures.
Five end-of-draw risk management principles should be included in a financial institution's end-of-draw risk management program: (1) use of prudent underwriting and loss mitigation strategies whenever existing loan terms are modified; (2) 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 Policy; (3) use of well-structured and sustainable modification terms; (4) use of appropriate accounting, reporting and disclosure of troubled debt restructurings; and, (5) segmentation and analysis of end-of-draw exposure in allowance for loan and lease losses ("ALLL") estimation processes.
Prudent risk management expectations generally include: (1) quantification of scheduled end-of-draw period exposure, showing maturity schedules in the aggregate and by significant segments of performing and non-performing borrowers; (2) understanding of end-of-draw contract provisions which can be challenging when existing portfolios are the result of numerous mergers, acquisition, or origination channels over the years and may require a detailed inventory of contracts and contract provisions to ensure an understanding of all parties' rights and obligations; (3) evaluation of near term risks in cases where line availability has already been suspended due to collateral value declines or repayment performance problems; (4) contact of borrower through an outreach program at least six to nine months or more before end-of-draw dates with simple direct messaging; (5) ensuring that refinancing, renewal, workout and modification programs are consistent with regulatory guidance and expectations, including consumer protection laws and regulations, and are supported by a thorough analysis of the borrower's financial condition and reasonable ability to repay with payment terms that are sustainable and avoid unnecessary payment shock; (6) ensuring regulatory reports and financial statements are prepared in accordance with generally accepted accounting principles and regulatory reporting instructions; (7) development of clear internal guidelines, criteria and processes for end-of-draw actions and alternatives (renewals, extensions and modifications) to be handled by trained customer account representatives familiar with the characteristics of the products, the borrower and property information needed and the range of alternatives available; (8) provision of practical information to high risk borrowers that explains basic options available, general eligibility criteria and the process for requesting a modification, if loan modifications or other options are offered; (9) development of end-of-draw reporting to allow quantification of exposures, activities and performance results in the aggregate and separately by response type; (10) consideration of potential HELOC default risk from payment shock, loss of line availability, and home value changes in ALLL methodology; and (11) provision of control systems with adequate scope and coverage of the full end-of-draw period exposure with appropriate target testing of the full process by quality assurance, internal audit and operational risk management.