Chapter 10 - Examiners Guide

1 Chapter 10 LOANS TABLE OF CONTENTS PART PART I LOANS . GENERAL LOAN review .. 10/1-1 Examination Objectives .. 10/1-1 Associated Risks .. 11 O/ 1. Examination Guidelines .. 10/1-3 Loan Documents .. 10/1-5 Loan Exceptions ..lo/ Impermissible Loans .. 10/1-6 Loan Programs and Policies .. 1 O/l -6 Lending Practices .. 10/1-9 Credit Report Analysis .. 10/1- 10 Capacity to Repay .. 10/1- 1 1 Credit Scoring .. 111 O/ 1. Paperless Lending .. 10/ 1. 1 3 Overview .. 1 0/1-3 .. Examiner Guidance ..lO/ 1-13 Risk-Based Lending ..lO/ 1-14 Large Loans and Concentrations .. 1 0/1- 1 5 AIRES .. 10/1-15 Workpapers and References .. 1 O/ 1- 16 2 LOANS - CREDIT RISK, DELINQUENCY, & CHARGE OFFS .. 10/2-1 Examination Objectives.

2 10/2-1 Evaluating Credit Risk .. 12-1 O/ Delinquency Control .. 10/2-3 Collection Procedures .. 10/2-5 Extension and Refinancing .. 12-7 O/ Credit Card Collection Program .. 1012-8 Bdptcy .. 10/2-8 Forms of Bankruptcy Relief .. 10/2-8 Automatic Stay .. 10/2- 10 Discharge - Objections and Exceptions .. 10/2-10 Reaffirmation .. 10/2- 12 Transfers Not Promptly Perfected or Recorded .. 1 O/ 2- 12 Loan Loss Ratio (Net Charge Offs to Average Loans) .. 1 O/ 2- 13 Associated Risks .. 1 0/2- 1 Overview 101 2-1 .. Statutory Lien ..lO/ 2-12 q c-9 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.

3 10/ 2. 16 Accounting for OREO .. 10/ 2. 1 7 Workpapers and References .. 117 O/ 2. Other Real Estate Owned (OREO) .. 10/2-16 APPENDIX 1 OA - LOAN TYPES .. 11 OA- Loans to Insiders .. 11 OA- Co-makers and Co-signers .. 10A-1 Policies and Procedures .. 1 0a-2 Lines of Credit .. 1 0a-3 Internal Controls for Plastic Cards .. 1 0a-4 Monitoring Lines of Credit .. 1 0a-5 Open-End Loans .. 1 0a-5 Variable Rate Loans .. 10a-5 Guaranteed Student Loans .. 10a-7 Due Diligence on Student Loans .. 1 0a-7 Real Estate Loans .. 10a-8 The Secondary Market .. 1 0a-9 Appraisals .. 110 OA- Evaluating Appraisers .. 111 OA- Holding versus Selling Loans .. 111 OA- Servicing Mortgage Loans .. 112 OA- Servicing Rights: Sell or Keep.

4 112 OA- Selling of Servicing Rights .. 112 OA- Escrow Accounts .. 10A-15 Foreclosures .. 1OA-15 Internal Controls, Segregation of Duties .. 1 0a-16 Independent Quality Control .. 116 OA- Asset/Liability Management .. 116 OA- Adjustable Real Estate Loans .. 117 OA- Home Equity Lines of Credit .. 118 OA- Loans Secured by Mobile Homes and Real Estate .. 1OA-20 Insured - Guaranteed Loans .. 1OA-20 Auto-Equity Loans .. 1 0a-2 1 Construction Loans .. 1 0a-2 1 Land Loans .. 1OA-23 Member Business Loans .. 1 0a-23 Policies and Procedures .. 1 0a-24 Underwriting .. 1 0a-24 Documentation .. 1 0a-26 Subordinate (Second) Mortgages .. 1OA-17 Environmental Protection Agency (EPA) Concerns .. 1 0a-27 Types of Member Business Loans.

5 1OA-28 LOANS APPENDIX 1 OA . LOAN TYPES Continued Rental Property Loans .. 1OA-28 Working Capital Loans .. 1 0a-28 Term Business Loans .. 1OA-30 Agricultural Loans .. 1 0a-30 Letters of Credit .. 1 0a-3 1 Floor Plan Loans .. 1OA-32 Examination Guidance .. 1 0a-33 SBA LOUIS .. 1 0a-34 Participation Loans .. 1 0a-34 Purchase, Sale and Pledge of Eligible Obligations .. 1 0a-35 Stock Secured Loans .. 1OA-35 Loan Policy and Procedure .. 1 0a-36 Required Documents .. 1 0a-37 NCUA Guaranteed Loans .. 1 0a-3 8 Indirect Dealer Financing Programs .. 1 0a-39 Policies and Procedures .. 1 0a-40 Potential Problems .. 1 0a-41 Warning Signs .. 1 0a-43 Regulatory Issues .. 1 0a-43 Direct vs . Indirect Point of Sale Programs.

6 1 0a-44 Leasing .. 1 0a-45 Residual Value Insurance .. 1 0a-46 Auto Insurance .. 1 0a-46 Regulation M .. 1 0a-46 Income on Leases .. 1 0a-48 Leasing Program Problems ..lO A-49 Balloon Notes .. 1 0a-5 1 Boat Loans .. 1 0a-5 1 APPENDIX 10B - Glossary of Loan Terms .. 10B-1 APPENDIX 1 OE - Real Estate Documentation Checklist .. 1 OE- 1 APPENDIX 1 OC - Member Business Loan Financial Ratios .. 1 OC- 1 APPENDIX 1 OD - Sample IDFP Agreements .. 1 OD- 1 Chapter I0 - Part 1 LOANS - GENERAL LOAN review Examination Objectives Associated Risks 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.

7 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 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.

8 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.

9 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.

10 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 interrelationships of interest rates, mortgage cash flows, prepayment risk, extension risk, and the effect on the fair value of its assets.