Lending Hot Topics - CUNA Councils - NCUA...merchant, such as an auto dealer, to originate loans at the point of sale. Outsourced Lending Relationship: Credit union contracts with

Lending Hot TopicsKey Lending Issues from an Examiner

Perspective

NCUA RLS Jerry Bonk 11/01/20163/10/

Lending Hot Topics

CUNA Lending Conference 10/01/16 2

Credit Risk Related ItemsConcentration Risks & TrendsResidential Real EstateConsumer LendingIndirect Auto LendingBusiness LendingParticipation LendingProblem Loans

FICU Loan Type Concentrations


FICU Specific Program Trends


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• 1st REM over 80% LTV (if allowed) and separate

for those with or without PMI (if allowed)• 2nd 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)

Real Estate Valuations


Appraisal issues seen with LTCU 10-CU-23 guidance:Lack of independent ordering and review of

appraisalsLack of documented appraisal reviewExpertise/qualification of appraisal

reviewersAppraisal review quality and contentPurchase transaction LTV - use lesser of

actual purchase cost or value estimate for value

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

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)

Consumer Lending Issues


Risk based pricing validationDocumented support for the tiers, pricing and

servicing spreadsEnsure 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

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

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

IDL – Issues


Frequent 1st 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

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



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



Portfolio Tracking and Monitoring • By DealerDelinquency, Charge offs, Credit Grade, LTV,

Gross/Net Yield, Denial Rate• By Loan OfficerDelinquency, 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

IDL Program Concerns


Is the program profitable? If an IDL or in-house 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.)

Commercial/MBL Lending Issues


Strategic Plan Policies and Procedures Staffing & Internal Controls Credit Presentations Loan Structure and Conditions Underwriting Monitoring



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 723.4 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.

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

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



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 non-compliance?

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?



Monitoring• Documented site inspections as part of annual review

process lacking in many instances (often also for pre-loan 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

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

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

Problem Loan Causes


Poor initial loan decisions or underwritingLack understanding of business or industryHigher risk industries or types not mitigatedInaccurate or incomplete cash flow measurementAppropriate conditions not formulated

Weak credit administrationLoan documentation flawsLack appropriate monitoring

Economic (environmental) changesAddress through concentration limits and monitoring

market conditions

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

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

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!

Resources

Ag Lending Topics 29

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)

References


NCUA Rules and Regulations §701.21(h) – Third party servicing of indirect vehicle loans

NCUA Rules and Regulations §701.21(c)(8)(i) –Incentive Compensation

Questions?


Documents

Lending Hot Topics - CUNA Councils - NCUA...merchant, such as an auto dealer, to originate loans at the point of sale. Outsourced Lending Relationship: Credit union contracts with