Installment Lending, Comptroller's Handbook - United States Secretary ...

Comptroller's Handbook

A-IL

Safety and Soundness

Capital Adequacy

(C)

Asset Quality

(A)

Management Earnings

(M)

(E)

Liquidity

(L)

Sensitivity to Market Risk

(S)

Other Activities

(O)

Installment Lending

Version 1.0, February 2016

Version 1.1, June 16, 2016 Version 1.2, January 6, 2017 Version 1.3, May 23, 2018

Office of the Comptroller of the Currency

Washington, DC 20219

Version 1.3

Contents

Introduction ..............................................................................................................................1 Overview....................................................................................................................... 1 Direct Loans............................................................................................................ 2 Indirect Loans ......................................................................................................... 2 Indirect Leases ........................................................................................................ 3 Manufactured Housing Loans................................................................................. 3 Student Loans.......................................................................................................... 4 Small Dollar Loans ................................................................................................. 4 Regulatory Considerations for FSAs ...................................................................... 4 Fundamentals of Installment Lending .................................................................... 5 Risks Associated With Installment Lending................................................................. 5 Credit Risk .............................................................................................................. 6 Operational Risk ..................................................................................................... 6 Compliance Risk ..................................................................................................... 6 Strategic Risk .......................................................................................................... 7 Reputation Risk....................................................................................................... 7 Risk Management ......................................................................................................... 7 Management............................................................................................................ 9 Underwriting, Credit Scoring/Modeling, and Product Marketing ........................ 10 Account Management ........................................................................................... 23 Collections ............................................................................................................ 26 Secured Loans Discharged in Chapter 7 Bankruptcy ........................................... 33 Allowance for Loan and Lease Losses ................................................................. 36 Profitability ........................................................................................................... 37 Third-Party Management ...................................................................................... 39 Asset Securitization .............................................................................................. 40 Stress Testing ........................................................................................................ 41 Debt Suspension and Cancellation........................................................................ 42 Product Profiles..................................................................................................... 43 Control Functions.................................................................................................. 47

Examination Procedures .......................................................................................................50 Scope........................................................................................................................... 50 Primary Examination Procedures ............................................................................... 52 Supplemental Examination Procedures ...................................................................... 62 Management and Management Planning.............................................................. 62 Underwriting, Credit Scoring/Modeling, and Product Marketing ........................ 65 Account Management ........................................................................................... 75 Collections ............................................................................................................ 78 Secured Loans Discharged in Chapter 7 Bankruptcy ........................................... 88 ALLL .................................................................................................................... 90 Profitability ........................................................................................................... 91 Third-Party Management ...................................................................................... 92 Asset Securitization .............................................................................................. 96

Version 1.3

Contents

Stress Testing ........................................................................................................ 97 Debt Suspension and Cancellation........................................................................ 97 Control Functions................................................................................................ 102 Conclusions............................................................................................................... 120 Internal Control Questionnaire ................................................................................. 122 Verification Procedures ............................................................................................ 125

Appendixes............................................................................................................................127 Appendix A: Transaction Testing ............................................................................. 127 Appendix B: Sample Request Letter......................................................................... 131 Appendix C: Uniform Retail Credit Classification and Account Management Policy Checklist (RCCP Checklist)................................ 136 Appendix D: Debt Suspension Agreement and Debt Cancellation Contract Forms and Disclosure Worksheet (National Banks) ............................ 139 Appendix E: Debt Suspension and Debt Cancellation Product Information Questionnaire and Worksheet ............................................................................. 142 Appendix F: Loss Forecasting Tools ........................................................................ 145 Appendix G: Credit Scoring and Development of Scoring Models ......................... 149 Appendix H: Glossary............................................................................................... 155 Appendix I: Abbreviations........................................................................................ 161

References .............................................................................................................................163

Table of Updates Since Publication....................................................................................168

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Installment Lending

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Introduction > Overview

Introduction

The Office of the Comptroller of the Currency's (OCC) Comptroller's Handbook booklet, "Installment Lending," is prepared for use by OCC examiners in connection with their examination and supervision of national banks and federal savings associations (collectively, banks). Each bank is different and may present specific issues. Accordingly, examiners should apply the information in this booklet consistent with each bank's individual circumstances. When it is necessary to distinguish between them, national banks and federal savings associations (FSA) are referred to separately.

This booklet is one of several specialized lending booklets and supplements guidance contained in the "Loan Portfolio Management," "Large Bank Supervision," and "Community Bank Supervision" booklets of the Comptroller's Handbook. This booklet addresses only closed-end consumer credit. For information related to open-end credit, refer to the "Credit Card Lending" and the "Residential Real Estate Lending" booklets of the Comptroller's Handbook.

Overview

A bank's installment lending portfolio is usually comprised of secured or unsecured small loans, each scheduled to be repaid in equal installments at fixed intervals over a specific period (closed-end loans). Installment loans are made directly to customers for activities such as buying automobiles, boats, or recreational vehicles. Other installment loans are made indirectly, that is, customers purchase these types of items by accepting loans from thirdparty brokers or dealers. Although automobile leases are not the same as loans, the installment lending industry typically manages leases in the same manner as loans.

The vast majority of the installment lending industry is highly automated and technologyintensive. Banks' analytical and monitoring capabilities continually improve because of technological advances, allowing banks to better identify and differentiate risk and to accept increased credit risk on a calculated basis. Many banks rely on technology and their loan officers' experience to expand installment lending activities and target higher-risk loans.

Banks offer numerous installment lending products with term and pricing variations tailored to meet customer circumstances. Banks can be successful in the installment lending industry if they have a sound understanding of the markets they serve, well-developed risk management processes, efficient economies of scale, a board of directors-approved risk appetite, and strong customer relationships.

Because a well-managed installment lending portfolio can be lucrative for a bank and provide an avenue for cross-selling opportunities, competition can be fierce. The installment lending industry has expanded to include several nontraditional market participants, including investment brokerage firms and insurance companies. Market share lines have blurred among traditional niche players (banks, finance companies, captive finance companies, and credit unions) as they increasingly compete across markets. Moreover, larger

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Introduction > Overview

banks compete nationally and tend to view their markets regionally. Technological advances, including Web-based solutions, fuel expansion of product marketing and delivery channels.

Banks and other financial services providers continually broaden their strategic decisions for product offerings, such as automobile loans, particularly when they offer installment loans nationwide. The number of mergers and acquisitions between banks and other financial services providers is predicated, in part, on the need to achieve greater economies of scale to compete effectively and efficiently.

Direct Loans

Banks originate direct loans with customers without intervention from third-party brokers or dealers. Customers typically use direct loans to finance purchases of automobiles, boats, recreational vehicles, pools, or spas and to obtain small-dollar loans. The loans are typically written with monthly amortizations of various durations.

Bank branches and call centers generate the majority of the direct loan business, although online lending has gained prominence as a delivery channel. Underwriting may be automated or manual and often includes using credit scores and other rules-based criteria. Competition puts pressure on direct loan underwriting and frequently results in lower credit standards, competitive interest rates, increased advance rates, and extended repayment periods.

Indirect Loans

Customers apply for indirect loans with third-party dealers to finance customer purchases that typically include automobiles, boats, or recreational vehicles. Third-party dealers subsequently sell the indirect loans to banks with which the dealers have established relationships. Written agreements spell out the terms of the relationships between dealers and banks. Banks work with dealers that meet the banks' business criteria. Some banks work with dealers who are in their local or regional markets, while other banks work with dealers nationwide. Dealers generally have relationships with multiple banks to obtain the best possible rates for their customers' loan applications. Each bank competes for the dealers' indirect loans by providing optimal service including quick responses and favorable pricing.

Banks regularly provide updated rate sheets to their dealers. The rate sheets include the bank's buy rate (the interest rate the bank charges for the loan), the maximum customer rate (interest rate the dealer can charge the customer), and term limits based on the age of the collateral (new and used, model year). The rate sheets may also provide other information, such as down payment requirements. Rate sheets may be standardized or vary, for example, by geographic region, manufacturer, or dealer. In some cases, banks may run short-term "loan sales" to generate volume or diversify some aspect of the banks' loan portfolios. In the past, direct loans carried lower interest rates than indirect loans, but pricing differentials are no longer a significant consideration because of competition in the indirect market and the customer's desire for one-stop shopping (i.e., simultaneous purchase and financing).

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