This is the second installment of the summary of the Interagency Guidance for Home Equity Lines of Credit (HELOCs) that near the end-of-draw period.[1]Part one, listed a summary of the risk management principles Federal Financial Regulatory Agencies require as the foundation of the drafting, development and implementation of our policies. Part two, this post, summarizes guidance on reasonable expectations from which we may develop and implement HELOCs end-of-draw period management programs.

The risk management principles called for by this guidance are a reminder of common sense management of change of terms of a loan; in this case possible higher payments for the borrower, or a balloon final payment. But for me, the MORE INTERESTING PART of the guidance, are the implications of the use of existing data to draw expectations and refine our management process

According to Federal FInancial Regulating Agencies, prudent risk management expectation generally include:[2]

• Developing a clear picture of scheduled end-of-draw period exposures
  • our portfolios should clearly identify and segment higher risk borrowers
  • identify end-of-draw periods, and segments based on maturity dates
  • segment examples may include:
    • product type
    • post-draw payment characteristics
    • origination channels
    • borrower characteristics
    • expected pay offs
    • attrition
    • utilization rates
    • delinquency/modification status of first lien
    • change risk levels before contractual end-of-draw periods
    • pre-end-of-draw payment history
• Ensuring a full understanding of end-of-draw contract provisions
  • portfolios may turn complex after several mergers, acquisitions, or change in the origination channels. Institutions should keep monitoring systems that allow them to keep track of payment changes, interest rate options, amortization terms, lockouts, and relevant loan term information to ensure management understands and is aware of all partiess rights and obligations, and to comply with all required notifications to borrowers
• Evaluating near-term risks
  • some HELOCs may already have suspended the draw period due to a decline in the propertys value or non-performing repayment. In these cases, the creditor should consider a workout arrangement and/or modification
  • for borrowers who submit only their minimum interest-only payments, creditors should start to consider whether these borrowers will meet current underwriting standards and/or qualify for renewal/modification programs
• Contacting borrowers through outreach programs
  • management should exercise proactive communication with borrowers before the end-of-draw period, and engage in periodic follow-ups to identify issues
  • many lenders have found that successful outreach efforts start 6 to 9 months before the end-of-draw period
  • many lenders have found that direct messaging is the most effective way of communication
• Ensuring that refinancing, renewal, workout, and modification programs are consistent with regulatory guidance and expectations, including consumer protection laws and regulations
  • the agencies have observed that well designed and consistently applied workout and modification programs minimize losses and help troubled borrowers resume structured repayment. In the long run, prudent refinancing, renewal, workout, and modification programs are in the best interest of the creditor and the borrower.
  • workout programs should include sustainable payment schedules that promote the orderly and systematic repayment of principal
• Establishing clear internal guidelines, criteria, and processes for end-of-draw actions and alternatives (renewals, extensions, and modifications)
  • refer nearing end-of-draw period borrowers to customer representatives that can explain the terms of the loan and the range of alternatives available to the borrower given his/her characteristics and his/her property. The representative should be equipped to present/process targeted refinancing options/requests for which the borrower qualifies
• Providing practical information to higher-risk borrowers
  • creditors should provide practical information that presents basic options available, eligibility criteria, and application process. This information and request process should be easy to understand and access
• Establishing end-of-draw reporting that tracks actions taken and subsequent performance
  • management should structure reports that allow all involved personnel to understand and respond to risk exposures, activity, and performance results. Reporting should track end-of-draw period actions and subsequent performance. This reporting should be frequent and contain enough information to provide a timely snapshot to management, which will enable it to consider additional necessary analysis or actions
• Documenting the link between ALLL methodologies and end-of-draw performance
  • Allowance for Loans and Lease Losses, ALLL, methodologies should consider all types of potential HELOC default risks.
  • higher-risk borrowers nearing the end-of-draw period should be monitored separately through the ALLL estimation process
• Ensuring that control systems provide adequate scope and coverage of the full end-of-draw period exposure
  • the creditor should have quality assurance, internal audit, and operational risk management functions perform testing of the full process for managing the end-of-draw transactions
  • organizations are responsible for test results even when they outsource the process

I find business process discovery, optimization, and tuning extremely interesting, and the second part of this guidance, subtitled End-of-draw Risk Management Expectations is a great tool for our organizations to develop policies and processes that deal with HELOCs. Even better, this part of the guidance may be a good starting template for the optimization of management and monitoring processes of other types of property based lending. As I write this, I am thinking that as the Government begins to allure private capital to finance our housing market, mortgage bankers will need become ever more sophisticated in the management and monitoring of the purchases they fund. I have not researched it, but I would not be surprised there is already software that embodies what this guide calls for. I think this is an interesting topic I will pursue in a future post, mortgage banking software or the like...

Here I have summarized the second part of the guidance; however, the guidance is loaded with important details, additional references to other official guidelines and rules, and the testing results expected by the agencies. You can access the guideline here: http://www.fdic.gov/news/news/press/2014/pr14052a.pdf

GO TO PART 1

1) http://content.govdelivery.com/accounts/USFDIC/bulletins/c14aec

2) http://www.fdic.gov/news/news/press/2014/pr14052a.pdf#page=3

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