Over the past few years, credit unions and other financial institutions have been hit with a number of new regulations targeted at managing risk within the loan portfolio. Among them, the Consumer Financial Protection Bureau’s revamp of mortgage rules, including how the loans are serviced and disclosed, have led to additional compliance costs.
Being proactive with managing risk is a must so that lenders can ensure that policies and procedures in place now are in alignment with portfolio best practices for future success.
One of the first steps is to see compliance as a key factor for guiding where resources will be allocated to spot risks. It may seem like a given, but credit unions should have some sort of oversight governance structure modeled after supervisory, audit or asset/liability committees. An oversight committee can not only identify and address new compliance requirements, the individuals can pinpoint exactly which credit union departments will be impacted. Another of the committee’s responsibilities can be integrating regulatory compliance duties into a credit union’s daily operations.
Once the oversight committee is established, credit unions can get down to business with what proactive best practices are the most critical.
Fair lending compliance is just one area that regulators have upped the scrutiny on. A credit union should ensure that is has created policies and procedures that clearly spell out what compliance measures are in place. Those guidelines should also include any exceptions, additional training that might be needed and how often monitoring should take place.
Through a Letters to Credit Unions and webinars, the NCUA has advised credit unions to conduct periodic fair lending risk assessments to identify risks. Meaning, all credit products and services, marketing, organization structure and lending channels should be evaluated.
Another way credit unions can stay proactive with loan portfolio risk management is through the automation of the loan administration process. For example, in the case of exceptions or any deviations from the lender’s standard policies and procedures, a credit union can create a new standard for timeliness and completeness of records associated with outstanding loans. Senior managers can have the necessary resources to spot problem loans, who is responsible for tracking the loan, the time frame of a particular exception and its overall impact on the loan portfolio.
One additional benefit of having an automated system allows credit unions to update their risk ratings, especially in the case of exceptions, which, in turn, boosts stress test accuracy, concentration reporting and migration analysis. Not only will lenders be able to have a better grip on capital adequacy, lending strategy and risk appetite, real-time data can help identify and monitor members who tend to cause exceptions.
The use of credit scorecards and other scoring models can help to rate an applicant’s risk during the underwriting process. The key here is to validate the scorecards on a regular basis to ensure they are still effective, particularly in cases such as an economic downturn. Loans that score high on a scorecard may indeed perform better than credit transactions that ranked much lower but assessment may be needed if the applicant’s situation has changed. Credit unions should consider adjusting their score thresholds to compensate for new risk environments.
When it comes to being proactive with the management of credit union loans, determining how much should be earmarked for Allowances for Loan and Lease Losses is a daunting undertaking for some lenders. In a 2006 policy statement from the Office of the Comptroller of the Currency, which is among the latest directives on file, the regulator said credit unions were subject to provisions that address the ALLL calculation.
The OCC defined estimated credit losses as “an estimate of the current amount of loans that is probable the institution will be unable to collect given facts and circumstances of the evaluation date.”
Given that definition, credit unions should consider a credit migration model with a reporting system that identifies those loans that have seen a significant drop in credit scores. This type of model can provide the strongest concentration risk policies, the correct placements to ALLL and help to stem delinquent and charged-off loans.
Some lenders have begun to court subprime and nonprime borrowers more aggressively. Proactive risk management becomes even more of an issue but credit unions can still quell trouble by implementing a few, proactive measures. For one, lenders can establish lower loan-to-value requirements for nonprime borrowers. Secondly, with auto loans, a credit union has a better chance of mitigating risk with such insurance products as debt cancellation, credit life and disability, mechanical breakdown protection and guaranteed asset protection.
If credit unions are steering more loans to less-than-prime members, using a stochastically derived, risk-based loan pricing model can grow their lending base and improve profits. By being proactive, the model can provide pricing recommendations for loan types and borrowers as well as create and identify risk ranges according to certain pricing models.