Chapter 10 - Examiners Guide - National Credit Union ...
Chapter 10
LOANS
TABLE OF CONTENTS
PART ILOANS .GENERAL LOAN REVIEW ........................................................... 10/1-1 Examination Objectives....................................................................................... 10/1-1 Associated Risks .................................................................................................. 1O/1. 1
OExvaemrvi.ineawt.i.o..n...G...u..i..d...e.l..i..n..e..s..............................................................................................................................................................................
10/1-3 10/1-3
Loan Documents .................................................................................................. 10/1-5
Loan Exceptions.................................................................................................. .lo/1.5
Impermissible Loans ............................................................................................ 10/1-6
Loan Programs and Policies................................................................................. 1O/l -6
Lending Practices................................................................................................. 10/1-9
Credit Report Analysis............................................................................. 10/1-10
Capacity to Repay .................................................................................... 10/1-11
Credit Scoring.......................................................................................... 1O/1. 1
Paperless Lending ................................................................................................ 10/1. 13
Examiner Guidance..................................................................................lO/
1-13
Risk-Based Lending.............................................................................................lO/
1-14
Large Loans and Concentrations.......................................................................... 10/1-15 AIRES .................................................................................................................. 10/1-15
Workpapers and References................................................................................. 1O/1-16
PART 2 LOANS - CREDIT RISK, DELINQUENCY, & CHARGE OFFS...................10/2-1
Examination Objectives ....................................................................................... 10/2-1
Associated Risks .................................................................................................. 10/2-1 Overview.............................................................................................................. 1012-1 Evaluating Credit Risk ......................................................................................... 1O2/ - 1
Delinquency Control ............................................................................................ 10/2-3
Collection Procedures .......................................................................................... 10/2-5
Extension and Refinancing ...................................................................... 1O2/ - 7
Credit Card Collection Program .............................................................. 1012-8
B d p t c y ........................................................................................................... Forms of Bankruptcy Relief.....................................................................
Automatic Stay.........................................................................................
Discharge - Objections and Exceptions ................................................... Reaffirmation ........................................................................................... Transfers Not Promptly Perfected or Recorded ...................................................
10/2-8 10/2-8 10/2-10
10/2-10 10/2-12
1O/2- 12
Statutory Lien.......................................................................................................lO/
2-12
Loan Loss Ratio (Net Charge Offs to Average Loans) ............................ 1O/ 2-13
EXAMINER'S GUIDE
PART 2 LOANS .CREDIT RISK. DELINQUENCY. & CHARGE OFFS
Continued
Charge Off of Problem Credits ............................................................................ 10/2. 14 Collateral in Process of Liquidation......................................................... 10/2. 16 Other Real Estate Owned (OREO) .......................................................... 10/2-16 Accounting for OREO ............................................................................. 10/2. 17
Workpapers and References................................................................................. 1O/21. 7 APPENDIX 1OA - LOAN TYPES.................................................................................. 1OA-1
Loans to Insiders.................................................................................................. 1OA-1 Co-makers and Co-signers................................................................................... 10A-1
Policies and Procedures ........................................................................... 10a-2 Lines of Credit ..................................................................................................... 10a-3
Internal Controls for Plastic Cards........................................................... 10a-4 Monitoring Lines of Credit ...................................................................... 10a-5 Open-End Loans .................................................................................................. 10a-5 Variable Rate Loans............................................................................................. 10a-5 Guaranteed Student Loans ................................................................................... 10a-7 Due Diligence on Student Loans ............................................................. 10a-7 Real Estate Loans................................................................................................. 10a-8 The Secondary Market ............................................................................. 10a-9
Appraisals ................................................................................................ 1OA1- 0 Evaluating Appraisers .............................................................................. 1OA1- 1 Holding versus Selling Loans .................................................................. 1OA1- 1 Servicing Mortgage Loans ....................................................................... 1OA1- 2 ServicingRights: Sell or Keep................................................................. 1OA1- 2 Selling of Servicing Rights ...................................................................... 1OA1- 2 Escrow Accounts ..................................................................................... 10A-15 Foreclosures............................................................................................. 1OA-15 Internal Controls, Segregationof Duties.................................................. 10a-16 Independent Quality Control.................................................................... 1OA1- 6 Asset/Liability Management .................................................................... 1OA1- 6 Adjustable Real Estate Loans .................................................................. 1OA1- 7 Subordinate(Second) Mortgages............................................................. 1OA-17 Home Equity Lines of Credit ................................................................... 1OA1- 8 Loans Secured by Mobile Homes and Real Estate .................................. 1OA-20 Insured - Guaranteed Loans..................................................................... 1OA-20 Auto-Equity Loans ................................................................................... 10a-21 Construction Loans .............................................................................................. 10a-21 Land Loans........................................................................................................... 1OA-23 Member Business Loans ...................................................................................... 10a-23 Policies and Procedures ........................................................................... 10a-24 Underwriting............................................................................................ 10a-24 Documentation......................................................................................... 10a-26 Environmental Protection Agency (EPA) Concerns................................ 10a-27 Types of Member Business Loans ........................................................... 1OA-28
LOANS
APPENDIX 1OA . LOAN TYPES Continued
Rental Property Loans.............................................................................. 1OA-28
Working Capital Loans ............................................................................ 10a-28
Term Business Loans ............................................................................... 1OA-30
Agricultural Loans ................................................................................... 10a-30
Letters of Credit ....................................................................................... 10a-31
Floor Plan Loans ...................................................................................... 1OA-32
Examination Guidance............................................................................. 10a-33
SBA LOUIS........................................................................................................... 10a-34
Participation Loans .............................................................................................. 10a-34
Purchase, Sale and Pledge of Eligible Obligations.............................................. 10a-35 Stock Secured Loans ............................................................................................ 1OA-35
Loan Policy and Procedure ...................................................................... 10a-36 Required Documents................................................................................ 10a-37
NCUA Guaranteed Loans .................................................................................... 10a-38 Indirect Dealer Financing Programs .................................................................... 10a-39
Policies and Procedures ........................................................................... 10a-40
Potential Problems................................................................................... 10a-41
Warning Signs.......................................................................................... 10a-43
Regulatory Issues ..................................................................................... 10a-43
Direct vs. Indirect Point of Sale Programs............................................... 10a-44
Leasing................................................................................................................. 10a-45
Residual Value Insurance......................................................................... 10a-46
Auto Insurance ......................................................................................... 10a-46
Regulation "M'........................................................................................ 10a-46
Income on Leases..................................................................................... 10a-48
Leasing Program Problems ......................................................................lO
A-49
Balloon Notes....................................................................................................... 10a-51
Boat Loans ........................................................................................................... 10a-51
APPENDIX 10B- Glossary of Loan Terms ................................................................... 10B-1
APPENDIX 1OC - Member Business Loan Financial Ratios ......................................... 1OC-1
APPENDIX 1OD - Sample IDFP Agreements................................................................ 1OD-1 APPENDIX 1OE - Real Estate Documentation Checklist............................................... 1OE-1
Chapter I 0 - Part 1
LOANS - GENERAL LOAN REVIEW
Examination Objectives
Evaluate management's ability to identify and manage risk Evaluate the quality of the loan portfolio and the extent of related risks in lending activities Evaluate whether management has established adequate lending standards and maintains proper controls over the program Determine whether management adequately plans for all lending programs, committing the necessary resources in terms of technology and skilled personnel Assess whether the credit union has the financial capacity to conduct lending safely, without undue concentration of credit and without overextending capital resources Analyze the loan portfolio's performance, including profitability, delinquency, and losses Consider management's response to adverse performance trends, such as higher than expected delinquencies, charge-offs, and expenses Determine if the credit union's compliance program effectively manages the fair lending and consumer protection compliance risks Determine whether management has implemented an effective internal loan grading system (if applicable) to identify credit risk
Associated Risks
Credit risk. Credit risk, which involves the ability of the member to repay the obligation, affects all types of loans. Loans with a guarantee (student, VA, SBA, FHA, NCUA purchase) contain a lesser degree of credit risk.
Compliance risk. Each loan type has various degrees of compliance risk. Various NCUA regulations, state laws, and federal consumer compliance laws apply to both consumer loans and real estate loans. Failure to comply with these laws and regulations exposes the credit union to fines, civil money penalties, and diminished reputation.
Page 1011-1
EXAMINER'S GUIDE
0 Interest rate risk. Interest rate risk increases as the terms of the loans extend. Monitoring this risk involves a large segment of a credit union's asset-liability management (ALM) program. Credit unions engaging in real estate lending should recognize that changes in interest rates affect the fair value of their balance sheet. Variable-rate loans also can experience interest rate risk since they may contain lifetime and periodic "caps" that limit the credit union's ability to increase (reprice) loan rates.
0 Strategic risk. Strategic risk appears in the diversification of loans offered to members. Management's due diligence in the planning effort before implementing new loan programs will greatly affect the amount of this risk. A well-established program should have less risk than a proposed or newly instituted program.
0 Transaction risk. Numerous transaction risks accompany lending. The strength of the credit union's internal controls will determine the extent of the risk. Management may demonstrate their control of transaction risk through reviewing internal reports such as Paid Ahead Loans, Non-Amortizing Loans, File Maintenance, Supervisory Override, Accrued Interest Greater than Payment, etc. Appendix 4B to the Internal Controls chapter of this Guide discusses other specific loan-related reports.
0 Liquidity risk. The success of any lending program determines the level and type of liquidity risk involved. Credit unions engaging in real estate lending should evaluate and understand the variability of mortgage cash flows and the corresponding effect on its balance sheet. When interest rates fall, mortgage cash flows increase; conversely, when interest rates rise, mortgage cash flows decrease. This could result in a credit union having either too much or too little liquidity. To control liquidity risk, management must understand the interrelationshipsof interest rates, mortgage cash flows, prepayment risk, extension risk, and the effect on the fair value of its assets.
0 Reputation risk. Lending and the types of loan programs offered greatly affect reputation risk. Collection efforts, or lack of them, influence the members' perception of the credit union, as do lending personnel and how they deal with the public. If the credit
Page 1011-2
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