Credit Risk Management Policy and Procedures Manual



Credit Risk Management Policy and Procedures ManualEffective: July 17, 2019C Peters and G Leachright251898Table of Contents(Note: hold the control key & click on the section name to follow the link to the section) TOC \o "1-5" \h \z CREDIT RISK PHILOSOPHY PAGEREF _Toc396932927 \h 2Asset Liability Management Committee (ALCO) Responsibilities PAGEREF _Toc396932928 \h 3Board of Directors Responsibilities PAGEREF _Toc396932929 \h 3BOARD TRAINING PAGEREF _Toc396932930 \h 4ELEVATED CREDIT RISK PAGEREF _Toc396932931 \h 4PORTFOLIO GUIDELINES PAGEREF _Toc396932932 \h 4GENERAL LOAN CONCENTRATION PAGEREF _Toc396932933 \h 4CONCENTRATION BY LOAN TYPE – IDEAL PORTFOLIO GUIDELINES PAGEREF _Toc396932934 \h 4CONCENTRATION BY CREDIT SCORE – IDEAL PORTFOLIO GUIDELINES PAGEREF _Toc396932939 \h 5CONCENTRATION BY CREDIT GRADE – IDEAL PORTFOLIO GUIDELINES PAGEREF _Toc396932940 \h 6INDIRECT CONCENTRATION BY CREDIT SCORE - IDEAL PORTFOLIO GUIDELINES PAGEREF _Toc396932941 \h 6CONCENTRATION BY INDIRECT LOAN TYPE – IDEAL PORTFOLIO GUIDELINES PAGEREF _Toc396932942 \h 7CONCENTRATION BY PARTICIPATION TYPE – IDEAL PORTFOLIO GUIDELINES PAGEREF _Toc396932943 \h 7CONCENTRATION BY LOAN TO VALUE AT ORIGINATION– IDEAL PORTFOLIO GUIDELINES PAGEREF _Toc396932945 \h 8GEOGRAPHIC ANALYSIS PAGEREF _Toc396932946 \h 9DELINQUENCY AND CHARGEOFF REVIEW AND ANALYSIS PAGEREF _Toc396932947 \h 9NET MARGIN ANALYSIS PAGEREF _Toc396932948 \h 9CREDIT RISK PHILOSOPHYCredit risk is affected by many factors, including underwriting criteria, portfolio diversification, pricing structures, portfolio monitoring, economic or political events, and management practices. During times of economic stress, credit risk becomes increasingly important and may impact loan losses, earnings and net worth. Credit union officials and management have a fiduciary responsibility to identify, measure, monitor, and control credit risk. Risk must be managed in conjunction with credit, interest rate, and liquidity risks, as a negative event in any category may have significant consequences on the other areas. The Board of Directors of Michigan Legacy Credit Union thereby establishes this Credit Risk Policy to: Address the credit union’s philosophy on credit risk,Monitor and establish limits on concentrations in loans, commensurate with risk within the loan portfolio levels and market knowledge, and Provide rationale as to how the limits fit into the overall strategic plan of the credit union. This policy shall be reviewed and approved by the Board of Directors on an annual basis.Credit Risk: PhilosophyCredit risk is defined as a single exposure or group of exposures that have the potential to produce losses large enough to threaten the health of this credit union or the ability of this credit union to maintain its core operations. Thus, credit risk is a combined outcome of Default Risk and Exposure Risk. Portfolio analysis helps in identifying concentration of credit risk, default/migration statistics, recovery data, etc.Certain credit concentration risks may be unavoidable; the credit union recognizes that, for example, operating in a well-defined market or geographic area creates concentrations. We accept that risk and believe that by staying close to our markets we benefit from information advantage in that we are much more familiar with local conditions than those that are not similarly situated. MICHIGAN LEGACY CREDIT UNION’s local geographic area includes southeastern Michigan (including the following counties: Macomb, Monroe, Wayne, Livingston and Oakland). The Board and Management will monitor portfolios correlating to various pertinent geographic areas to identify, manage, and mitigate the risks associated with that area (i.e. Southeast Michigan, the entire State of Michigan, outside the State of Michigan). Concentration risk activities necessarily include measurement of exposure within the loan portfolio by geographic region or zip code, but nothing in this policy will conflict with the Fair Housing Act or any other regulation.Forces outside of the influence or control of the credit union may significantly influence risk. Employment levels, collateral values, local and national economic conditions may well influence risk that could impact the credit union. These factors should all be considered when identifying risk factors, monitoring those factors and establishing limits. Regardless of the perceived safety of a specific loan or third party provider, every concentration should be subject to review and rationalized. Dependency on a very limited number of borrowers, loan types, geographies, third party providers and the like can create havoc when the “unthinkable” happens. Credit concentration risk must be managed in conjunction with credit, interest rate and liquidity risks to assure the health and wellbeing of the credit union. Credit risk management underscores the fact that the survival and health of the credit union depends heavily on its capabilities to anticipate and prepare for the change rather than just waiting for the change and reacting to it. The objective of credit risk management is not to prohibit or prevent risk taking activity, but to ensure that the risks are consciously taken with full knowledge, clear purpose and understanding so that it can be measured and mitigated. It also prevents the credit union from suffering unacceptable loss causing the credit union to fail or materially damage its competitive position. Asset Liability Management Committee (ALCO) ResponsibilitiesQuarterly, ALCO should provide a report on credit risk to the Board of Directors. The report should provide the following:A member of the ALCO will act as Credit Risk Management Officer and will have the responsibility to provide all appropriate data required by this policy.A detailed report of all loan categories and types, providing quarter end actual data and relating each category to portfolio percentage.A trend analysis by all major loan categories over a period of two years by quarter, tracking changes in the portfolio mix. The trend analysis should include actual dollar amounts and percentages of the total loan portfolio by category.Report on the impact on earnings and net worth of a deteriorating loan portfolio, considering the potential for the risk of an event or impact of uncontrolled outside forces.Board of Directors ResponsibilitiesPeriodically, but no less than semi-annually, the Board of Directors should establish/review risk benchmarks specific to the loan portfolio and appropriate credit risk management. The benchmarks established by the board should include limits on loan types, credit grade, loan-to-value and other identifiable credit risk areas that can be adequately measured and reported. The benchmarks should be consistent with the overall objectives, financial targets and net worth plan for the credit union; further, the credit risk policy should be viewed within the context of other policies, including loan policies, the asset/liability management policy, liquidity policy, and the investment policy. The quarterly report to the Board of Directors, prepared by ALCO, should include reporting on the benchmarks established, compared to actual results.The board should identify “events” and/or outside forces (scenario analysis) that may affect the ability to manage credit risk. These events or outside forces should include an analysis of the impact of unemployment levels, home values and the like on the credit union. An attempt should be made to determine which factors have the most impact.Quarterly, the board should review the report on credit risk. The review should include the following:A review of concentrations in loans. Established benchmarks should be compared to actual results; any variance should be noted. Any exceptions that continue for two or more quarters should be specifically addressed by the board.The board should document adequate rationale for undertaking that level of risk. The documentation for the rationale may take the form of approval of a business or strategic plan that includes such undertakings.The risk of an “event” or the impact of outside, uncontrolled forces that potentially harm credit quality should be considered and reviewed. The impact on earnings and net worth should be considered. The intent of the analysis is to create a scenario analysis model to predict future changes in asset quality, income, and loan portfolio concentrations given an event or series of events. BOARD TRAININGManagement and the Board will receive, at a minimum, annual training on credit risk analysis and reporting.ELEVATED CREDIT RISKIf ALCO determines credit risk is elevated, steps shall be implemented to mitigate such risk. Corrective action may include but is not limited to: 1) reducing limits or thresholds on risk concentrations, 2) reducing exposure to new business lines to address undue concentrations, 3) transferring risk to other parties by either selling directly or as part of securitization transactions and/or 4) ceasing the product or service line. The Board of Directors shall be notified of the elevated risk level and corresponding corrective action plan at the first meeting following such determination. It shall not be standard practice to arbitrarily raise risk limits once reached; however, the Board of Directors reserves its right to adjust such limits if good cause determines the increase justifiable and appropriate to the credit union’s strategic plan. The Board of Directors shall document any such action to include adequate rationale in the minutes of its meeting. PORTFOLIO GUIDELINESAt times the portfolio mix may face large swings; this can be caused by a number of varying factors including merger or loan portfolio purchase. The Management and Board will carefully monitor these ranges to ensure the safety and soundness of the loan portfolio. GENERAL LOAN CONCENTRATIONGeneral Loan Concentration ReviewAcceptable Limit of Loan to Share PortfolioCaution Area of Loan to Share PortfolioMaximum Limit of Loan to Share PortfolioLoan to Share Portfolio65-80%80-90%Look at Liquidity Risk90%Enact Liquidity Risk ActionsCONCENTRATION BY LOAN TYPE – IDEAL PORTFOLIO GUIDELINESLoan TypesAcceptable Limit of Loan Portfolio Acceptable Limit to Net WorthCaution Area of Loan Portfolio Maximum Limit of Loan Portfolio Consumer Vehicle New & Used75%250%140-149%150%Unsecured Consumer25%100%26-34%35%All Other Secured15%100%16-19%20%Credit Card25%100%26-34%35%Member Business Loans Real Estate7%30%8-9%10%Member Business Loans Non-Real Estate secured5%25%6-9%10%Indirect Loans25%250%80-89%90%Real Estate 30%400%40-49%50%Home Equity30%200%40-44%45%All Other Types20%50%21-25%26%For each loan type MICHIGAN LEGACY CREDIT UNION will identify the largest 25 loans or 5%, whichever is greater, and individual membership balances representing significant credit risk to the credit union (individual loan greater than $200,000). These loans will be reviewed at the ALCO meeting each quarter; any changes in performance or risk will be documented and presented to the Board in the ALCO minutes. CONCENTRATION BY INDIVIDUAL MEMBER LOAN POLICY LIMITK:\Approved Protocol\Approved Policies\Consumer Lending Policies and Procedures Manual 6-2013.docxIndividual loan maximum limits are established in the Consumer Lending Policy and will be reviewed for concentration risk by member to validate internal controls and risk management at the membership level.CONCENTRATION BY CREDIT SCORE – IDEAL PORTFOLIO GUIDELINESBelow is the ideal range(s) of credit scores for the loan portfolio, Management and the Board will monitor the portfolio on a quarterly basis. Management and the Board will make recommended adjustments as history, delinquency, credit grade migration and net income reports dictate. The below is an “ideal mix of credit score concentration” the Board and Management recognize that exceeding “ideal” mixes of A+, A and B ranges will not cause increased risk due to the relative low credit default risk. The Board and Management will work on strategy to diversify the portfolio while minimizing risk and increasing profitability with net yield on loans with lower credit scores of C, D and E always keeping the increased default risk in mind with any strategy.Loan TypesA+ABCDEConsumer Vehicle New & Used≤35%≤25%≤20%≤20%≤105-10%Unsecured Consumer≤25%≤25%≤20%≤20%≤10%5-10%All Other Secured≤20%≤25%≤30%≤20%≤10%1-5%Credit Card≤25%≤20%≤30%≤15%≤10%1-5%Member Business Loans- R/ESee Member Business Loan Policy and Procedure Manual for Risk Rating system applicable to MBLsMember Business Loans-Non R/EFirst Mortgage Real Estate≤35%≤35%≤30%≤30%≤7%≤5%Home Equity≤30%≤25%≤15%≤10%≤3%≤1%All Other Types≤25%≤25%≤25%≤10%≤3%≤2%CONCENTRATION BY CREDIT GRADE – IDEAL PORTFOLIO GUIDELINESCredit Grade takes into account many factors creating a grade encompassing many factors and updated monthly. Below is the acceptable limits of credit grade for the loan portfolio, Management and the Board will monitor the portfolio on a quarterly basis. Management and the Board will make recommended adjustments as history, delinquency, credit grade migration and net income reports dictate. The below is an “acceptable limits of credit grade concentration” the Board and Management recognize that exceeding “acceptable limits” in the specific mixes of A+, A and B ranges will not cause increased risk due to the relative low credit default risk. The Board and Management will work on strategy to diversify the portfolio while minimizing risk and increasing profitability with net yield on loans with lower credit grades of C, D and E always keeping the increased default risk in mind with any strategy.Loan TypesA+ABCDEConsumer Vehicle New & Used15-20%20-30%20-30%20%5-10%5-10%Unsecured Consumer25-35%20-30%20-30%20%5-10%5-10%All Other Secured15-20%20-30%30-45%25-35%10-15%5-7%Credit Card20-35%20-35%30-35%10-15%5-10%5-7%Member Business Loans-R/ESee Member Business Loan Policy and Procedure Manual for Risk Rating system applicable to MBLsMember Business Loans-Non R/EFirst Mortgage Real Estate30-40%20-30%35-45%30-35%<10%<7%Home Equity30-40%25-35%15-30%<10-15%<7%<3%All Other Types10-25%25-30%20-30%10-15%5-10%<5%INDIRECT CONCENTRATION BY CREDIT SCORE - IDEAL PORTFOLIO GUIDELINESBelow is the ideal range(s) of credit scores for the indirect loan portfolio, Management will monitor the portfolio on a quarterly basis. Management and the Board will make recommended adjustments as history, delinquency, credit grade migration and net income reports dictate. The below is an “ideal mix of credit score concentration” the Board and Management recognize that exceeding “ideal” mixes of A+, A and B ranges will not cause increased risk due to the relative low credit default risk. The Board and Management will work on strategy to diversify the portfolio while minimizing risk and increasing profitability with net yield on loans with lower credit scores of C, D and E always keeping the increased default risk in mind with any strategy.Loan TypesA+ABCDEIndirect New & UsedAutos≤35%≤25%≤20%25%50%20%CONCENTRATION BY INDIRECT LOAN TYPE – IDEAL PORTFOLIO GUIDELINESBelow is the acceptable limits and caution range(s) of credit grade for the loan portfolio, Management and the Board will monitor on a quarterly basis the ideal guidelines and make recommended adjustments as history, delinquency and net income reports dictate.Indirect Loan TypesAcceptable Limit of Loan Portfolio Caution Area of the Loan PortfolioMaximum Limit of the Loan PortfolioAuto Loans13%41-50%51%Recreation Vehicle35%40-45%50%Powersports15%15-25%30%Individual Dealer 60%60-85%85%Management and the Board will closely monitor the performance by individual loan types and dealers to determine further action including but not limited to increased collection efforts, restricting new loans by dealer, additional reserves based on reported risk and limiting additional loan growth by type or dealer. These reports, discussions and actions will be recorded in the official Board minutes for permanent records.CONCENTRATION BY PARTICIPATION TYPE – IDEAL PORTFOLIO GUIDELINESBelow is the acceptable limit for the participation loan portfolio, Management and the Board will monitor on a quarterly basis the ideal guidelines and make recommended adjustments as risk areas, history, delinquency and net income reports dictate. Management and the Board will closely monitor the performance by participation loan types and further determine necessary action based on reported risk and limiting additional loan growth by type.Participation Loan TypesAcceptable Limit of Net WorthCaution Area of Net WorthMaximum Limit of Net WorthConstruction, MBL and Consumer Mortgage ≤ 1%≤ 1.5%≤ 2%Secured by Farmland, MBL and Consumer Mortgage≤ 1%≤ 1.5%≤ 2%Secured by Non Farm Residential – MBL and Consumer Mortgage≤ 40%≤ 41%≤ 42%Secured by Owner Occupied, Non-Farm, Non-Residential – MBL and Consumer Mortgage≤ 5%≤ 5.5%≤ 6%Secured by Non-Owner Occupied, Non-Farm, Non Residential – MBL and Consumer Mortgage≤ 30%≤ 31%≤ 32%Commercial & Industrial – MBL≤ 5%≤ 5.5%≤ 6%Unsecured Business Loans≤ 3%≤ 3.5%≤ 4%Agricultural Production – MBL and Consumer Mortgage≤ 3%≤ 3.5%≤ 4%Revolving - MBL≤ 1%≤ 1.5%≤ 2%CONCENTRATION BY LOAN TO VALUE AT ORIGINATION– IDEAL PORTFOLIO GUIDELINESThese guidelines are a percentage of the loan portfolio. Management will review, and provide to the Board, the origination reports to evaluate and analyze the risk to the credit union based on loan-to-value at origination. Significant increases in any one particular loan-to-value migration may cause the Board and Management to review and adjust the amount reserved in the allowance for loan loss related to this segment of the portfolio.Loans by Type<80%80-100%100-120%>120%Vehicle Loans including Motorcycles≤ 65%≤ 80%≤25%≤5%Recreational Vehicles≤35%≤45%≤10%≤7%Member Business Loans- Real Estate≤7.5%2%0%0%Member Business Loans-Non R/E<2%0%0%0%Indirect Loans Vehicle 80%≤5 20%25%10%Indirect Recreational Vehicle≤20%≤30%≤5%≤1%First Mortgage Real Estate≤50%≤100%≤7%≤5%Home Equity50%≤75%≤70%≤10%All Other Secured25%35%≤1 5%≤1%Indirect Secured≤1%≤3%≤2%≤1%GEOGRAPHIC ANALYSIS Management will review and provide to the Board the appropriate geographic loan reports to evaluate and analyze the risk to the credit union in the geographic areas the credit union lends. Significant increases in any one particular geographic location may cause the Board and Management to review and adjust the amount reserved in the allowance for loan losses related to this segment of the portfolio.DELINQUENCY AND CHARGEOFF REVIEW AND ANALYSIS Management will provide appropriate reports to review areas of concentrated high risk (i.e. such as low credit scores, high LTV and or any other combination of high risk factors). If the combined delinquency and charge-off ratios fall into the categories listed below for two consecutive quarters the action below will be implemented. The Board is provided a 10 year historical view, which shows the known fact of the membership base at Michigan Legacy CU, has lower than average credit scores and the ability of the credit union to withstand higher than peer delinquencies. Combined Delinquency and Charge-off RatioAction RequiredLow Risk Average Peer Combined, over the previous calendar year+.70 BPConsistent Collection action to continued reducing delinquencyElevated Risk RangeAverage Peer Combined + .95 BP to 1.20 BPCollection Manager will review high risk loans and increase collection efforts to reduce delinquency and charge offsModerate Risk RangeAverage Peer Combined +1.21 BP to 1.45 BPExecutive Management and the Vice President in charge of Collections will review with the Collection Manager the appropriate action as outlined above and allocate additional resources for collection activity to reduce delinquency and charge-offsHigh RiskAverage Peer Combined +1.46 BPBoard will review all previous activities and strategies to reduce delinquency and charge-off and may at this time include appropriate actions such as curtailing new loan origination in high risk categories or combination of categories.CUSTOMIZED INTERNAL CONTROLS Michigan Legacy Credit Union utilizes internal reports and through vendor software to track delinquency and charge offs, in the event the combined delinquency and charge off ratio enters into the high risk category the ALCO Committee will review delinquencies and make adjustments based on recognized deficiencies. Those recommended adjustments could include actions such as stricter underwriting guidelines for combinations causing delinquency and charge off issues or environmental adjustments to the ALLL as recommended by ALCO and approved by the Board of MARGIN ANALYSISThe credit union will perform a Net Margin analysis, on a semi-annual basis, to monitor the cost/ benefit relationship by loan type, particularly for subprime loans. This will allow the credit union to adjust its pricing structure accordingly.DateDescriptionCreatorInitialsManagementInitialsBoard Approved DateReview Date9/2013New Policy CSPCSP10/201311/2013Policy Revision CSPCSP11/19/201310/20148/2014Add indirect loan concentration limitsCSPCSP8/19/20147/1/2015Changed from net worth to loan portfolio limitsCSPCSP7/17/201511/2017Modification of Concentration RiskCSP/GLCSP/GL11/21/20177/2018Exam finding updateCSPCSP/GL8/21/20188/20197/2019Exam finding and review updateCSPCSP7/16/20197/2020 ................
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