Regulators Prepare Lenders for HELOC Transition

Federal and state regulatoryrnagencies have issued final guidance to financial institutions under theirrnjurisdiction regarding home equity lines of credit (HELOCs) that are nearingrntheir “end-of-draw” periods. A HELOCrnis a dwelling-secured line of credit thatrngenerally provides a drawrnperiod for a borrower to access a revolving line of credit and typicallyrnmakes only interest payments.  When thisrnperiod ends, borrowers can no longer draw on thernline of credit and the outstanding principal is either due immediately in a balloon paymentrnor repaid over thernremaining loan term through higher monthly payments.rn</p

The Federal Reserve, Office, of Comptroller of thernCurrency (OCC), the Federal Deposit Insurance Corporation (FDIC), NationalrnCredit Union Administration (NCUA) along with the Conference of State BankrnSupervisors acknowledged that both financial institutions and borrowers mayrnface challenges brought about by the HELOC transition with some borrowersrnexperiencing difficulties with higher amortizing payments or a balloonrnmaturity.  Many HELOCs were originated beforernthe housing crash and recession so homeowners may have seen changes in theirrnfinancial circumstances or declines in property values.</p

The guidance issued today describes core operatingrnprincipals governing management oversight of HELOCs during this period andrndescribes components of risk management. rnIt also highlights concepts related to financial reporting for HELOCs.</p

Regulatory agency examiners will review financial institutionsrnend-of-draw risk management programs for provisions addressing five riskrnmanagement principles:</prn

1.  rn   Prudent underwriting for renewals, extensions,rnand rewrites.</p

2.     rnCompliancernwith pertinent existing guidance, including that in current regulatoryrnpublications.</p

3.     rnUsernof well-structured and sustainable modification terms.</p

4.     rnAppropriaternaccounting, reporting, and disclosure of troubled debt restructurings.</p

5.     rnAppropriaternsegmentation and analysis of exposure in allowance for loan and lease losses (ALLL)rnestimation processes.</p

Financialrninstitutions should implement policies and procedures for managing HELOCS asrnthe draw period ends that are commensurate with the size and complexity ofrntheir portfolio.  </p

Regulators expect risk managementrnprocedures to include:</prn

1.  rnArnclear understanding of scheduled end-of-draw exposures and identification ofrnhigher-risk segments.  They should also profilerndraw period transition dates for all HELOCS showing aggregate maturity schedulesrnand those of significant segments of performing and non-performing borrowersrnincluding product types, post-draw payment characteristics, borrowerrncharacteristics, and other segments where performance may vary.</p

2.  rnArnfull understanding of end-of-draw contract provisions.  Transitions issues such as payment changes,rnamortization options, debt consolidation options, and payment processing shouldrnbe controlled and programmed correctly into servicing systems</p

3.  rnEvaluationrnof near-term risks.  Accounts that havernalready had draws suspended because of borrower performance or collateral valuernissues warrant attention.  Managementrnshould also evaluate borrowers making only the contractual minimum interestrnpayments to assess their ability to make the larger payments that will bernrequired.</p

4.     rnProvisionsrnfor contacting borrowers though outreach programs well before the schedulernend-of-draw, periodic follow-ups and effective response to issues.</p

5.     rnEnsuringrnthe refinancing, renewal, workout, and modification programs are consistentrnwith regulatory guidance and expectations including consumer protection lawsrnand regulations.</p

Financial institutions mustrninsure that their regulatory reports and financial statements are prepared inrnaccordance with accepted standards and regulatory reporting instructions andrnshould fairly represent their condition and performance.  Institutions must also comply with applicablernconsumer protection laws such as the Equal Credit Opportunity Act, Truth inrnLending Act, and others relevant to HELOC lending.</p

The guidance says that even financial institutionsrnwith moderate volumes of HELOCs nearing end-of-draw should direct borrowers torntrained consumer account representatives familiar with the products and the rangernof alternatives available.  Managementrnshould establish and define clear loss mitigation steps so that well-trainedrnaccount representatives can quickly process requests. </p

Borrowers having financial difficulties should bernoffered practical information explaining their options, general eligibility criteria,rnand the process for applying for a modification.  Such information should be clear, complete, andrneasily accessible.</p

Management should structure and distribute to allrninvolved personnel periodic reports to track end-of-draw actions and subsequentrnaccount performance aggregate and by response type.  Information should be sufficient to providerntimely feedback to management.</p

ALLL methodologies should considerrnpotential HELOC default riskrnfrom payment shock, loss of line availability,rnand home value changes. Higher-riskrnborrowers who’s HELOCs are nearing their end-of-drawrnperiods generally pose greater repayment risk for ALLL purposes, andrnmanagement should monitor them separately for appropriate considerationrnin the ALLL estimation process.</p

Commensurate with the volume of the institutions HELOCrnexposure, management should have quality assurance, internal audit, andrnoperational risk management functions that perform appropriate targeted testingrnof the full process for managing end-of-draw transactions to confirmrninformation such as that draw terms and interest-only periods are not exceededrnwithout credit approval, staffing and resources are able to handle expectedrnvolume, servicing systems are able to accurately calculate and process paymentsrnand generate billing statements, borrower notifications are timely and inrncompliance with contract terms and management guidelines, and reports provide reliablernand timely information.</p

While financial institutions with significant volumes ofrnHELOCS or higher risk exposure characteristics should have comprehensive systemsrnand procedures in place to monitor and assess their portfolios, regulators sayrnthat institutions with small portfolios of HELOCs or lower exposures may bernable to use existing, less sophisticated processes.

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