Many mortgage industry pundits have written about an impending home equity line of credit (HELOC) crisis resulting from a significant volume of HELOCs reaching the end of their interest-only draw periods. In fact, the Office of the Comptroller of the Currency (OCC) estimates that $23 billion in HELOCs will reset in 2014 at the largest national banks; $42 billion in 2015; $50 billion in 2016; and $56 billion in 2017. There is a legitimate question whether many of these borrowers will be able or willing to repay the much higher, fully amortizing payments required during the HELOCs’ repayment periods. It is obvious that federal banking regulators share these concerns and have given them a lot of thought.
Four federal banking agencies—the OCC, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the National Credit Union Administration—along with the Conference of State Bank Supervisors, recently released guidance (“Guidance”) encouraging financial institutions to work with borrowers as their HELOCs reach the end of their draw periods. The Guidance offers “core operating principles” to govern a financial institution’s oversight of these HELOCs. The bottom line (according to the agencies): “lenders should communicate clearly and effectively with borrowers and prudently manage exposures in a disciplined manner.” The Guidance seems to be a clear effort on the agencies’ part to thwart a new wave of regulatory and litigation problems and is premised on previously issued general supervisory guidelines and policies addressing appropriate HELOC underwriting, account management, accounting and reporting, and loss mitigation activities.
The agencies warn in the Guidance that bank and credit union examiners will review management programs for end-of-draw HELOCs to ensure those programs address the following risk management principles:
• Applying thorough and prudent underwriting and loss mitigation strategies for renewals, extensions, and rewrites;
• Utilizing existing regulatory guidance for HELOC underwriting and credit analysis, including underwriting criteria that considers debt service capacity standards, creditworthiness standards, equity and collateral requirements, maximum loan amounts, maturities, and amortization terms;
• Using well-structured, flexible, and sustainable modification terms for borrowers experiencing financial difficulties;
• Ensuring accurate accounting, reporting, and disclosure of troubled debt restructurings; and
• Segmenting and analyzing end-of-draw exposure in allowance for loan and lease losses (ALLL) estimation processes.
The agencies set forth in the Guidance 10 “expectations” for prudent risk management. Most, and perhaps all, of these “expectations” emanate from practices that federal and state agencies, as well as depository and non-depository servicers, developed following the mortgage meltdown to manage defaulted loans or loans where default is reasonably foreseeable. To summarize, those expectations are:
1. Understand the full portfolio of end-of-draw exposures, including higher-risk segments, by analyzing and categorizing HELOCs based on factors such as contractual draw period transition dates, product types, post-draw payment characteristics, origination channels, and borrower characteristics.
2. Conduct an inventory of end-of-draw contract provisions to ensure management understands all parties’ rights and obligations and that servicing systems are programmed correctly.
3. Identify obvious near-term risks to consider workout arrangements or modifications.
4. Begin a dialogue with borrowers at least six to nine months before end-of-draw dates.
5. Implement well-designed and consistently applied renewal, workout, and modification programs that base eligibility on a thorough analysis of a borrower’s finances and ability to pay, provide sustainable payment terms, and amortize principal in an orderly and timely fashion.
6. Develop clear internal guidelines, criteria, and processes for end-of-draw actions and provide thorough training to customer representatives on those guidelines.
7. Provide high-risk borrowers with clear, practical information about available options.
8. Institute frequent, dynamic reports tracking end-of-draw period actions and subsequent account performance.
9. Document the link between ALLL methodologies and end-of-draw performance.
10. Confirm that internal control systems are capable of fully analyzing and managing the scope and coverage of all end-of-period exposure.
While the Guidance does not have the same force and effect as statutes or regulations, they likely illustrate, at a minimum, federal and state banking agencies’ views of what constitutes safe and sound banking practices. Even if a servicer is not a depository institution subject to banking agency oversight, the banking agencies may expect servicers to apply the Guidance to loans serviced for depositories and their affiliates.