Federal and state regulatory agencies have issued final guidance to financial institutions under their jurisdiction regarding home equity lines of credit (HELOCs) that are nearing their "end-of-draw" periods. A HELOC is a dwelling-secured line of credit that generally provides a draw period for a borrower to access a revolving line of credit and typically makes only interest payments. When this period ends, borrowers can no longer draw on the line of credit and the outstanding principal is either due immediately in a balloon payment or repaid over the remaining loan term through higher monthly payments.
The Federal Reserve, Office, of Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), National Credit Union Administration (NCUA) along with the Conference of State Bank Supervisors acknowledged that both financial institutions and borrowers may face challenges brought about by the HELOC transition with some borrowers experiencing difficulties with higher amortizing payments or a balloon maturity. Many HELOCs were originated before the housing crash and recession so homeowners may have seen changes in their financial circumstances or declines in property values.
The guidance issued today describes core operating principals governing management oversight of HELOCs during this period and describes components of risk management. It also highlights concepts related to financial reporting for HELOCs.
Regulatory agency examiners will review financial institutions end-of-draw risk management programs for provisions addressing five risk management principles:
1. Prudent underwriting for renewals, extensions, and rewrites.
2. Compliance with pertinent existing guidance, including that in current regulatory publications.
3. Use of well-structured and sustainable modification terms.
4. Appropriate accounting, reporting, and disclosure of troubled debt restructurings.
5. Appropriate segmentation and analysis of exposure in allowance for loan and lease losses (ALLL) estimation processes.
Financial institutions should implement policies and procedures for managing HELOCS as the draw period ends that are commensurate with the size and complexity of their portfolio.
Regulators expect risk management procedures to include:
1. A clear understanding of scheduled end-of-draw exposures and identification of higher-risk segments. They should also profile draw period transition dates for all HELOCS showing aggregate maturity schedules and those of significant segments of performing and non-performing borrowers including product types, post-draw payment characteristics, borrower characteristics, and other segments where performance may vary.
2. A full understanding of end-of-draw contract provisions. Transitions issues such as payment changes, amortization options, debt consolidation options, and payment processing should be controlled and programmed correctly into servicing systems
3. Evaluation of near-term risks. Accounts that have already had draws suspended because of borrower performance or collateral value issues warrant attention. Management should also evaluate borrowers making only the contractual minimum interest payments to assess their ability to make the larger payments that will be required.
4. Provisions for contacting borrowers though outreach programs well before the schedule end-of-draw, periodic follow-ups and effective response to issues.
5. Ensuring the refinancing, renewal, workout, and modification programs are consistent with regulatory guidance and expectations including consumer protection laws and regulations.
Financial institutions must insure that their regulatory reports and financial statements are prepared in accordance with accepted standards and regulatory reporting instructions and should fairly represent their condition and performance. Institutions must also comply with applicable consumer protection laws such as the Equal Credit Opportunity Act, Truth in Lending Act, and others relevant to HELOC lending.
The guidance says that even financial institutions with moderate volumes of HELOCs nearing end-of-draw should direct borrowers to trained consumer account representatives familiar with the products and the range of alternatives available. Management should establish and define clear loss mitigation steps so that well-trained account representatives can quickly process requests.
Borrowers having financial difficulties should be offered practical information explaining their options, general eligibility criteria, and the process for applying for a modification. Such information should be clear, complete, and easily accessible.
Management should structure and distribute to all involved personnel periodic reports to track end-of-draw actions and subsequent account performance aggregate and by response type. Information should be sufficient to provide timely feedback to management.
ALLL methodologies should consider potential HELOC default risk from payment shock, loss of line availability, and home value changes. Higher-risk borrowers who's HELOCs are nearing their end-of-draw periods generally pose greater repayment risk for ALLL purposes, and management should monitor them separately for appropriate consideration in the ALLL estimation process.
Commensurate with the volume of the institutions HELOC exposure, management should have quality assurance, internal audit, and operational risk management functions that perform appropriate targeted testing of the full process for managing end-of-draw transactions to confirm information such as that draw terms and interest-only periods are not exceeded without credit approval, staffing and resources are able to handle expected volume, servicing systems are able to accurately calculate and process payments and generate billing statements, borrower notifications are timely and in compliance with contract terms and management guidelines, and reports provide reliable and timely information.
While financial institutions with significant volumes of HELOCS or higher risk exposure characteristics should have comprehensive systems and procedures in place to monitor and assess their portfolios, regulators say that institutions with small portfolios of HELOCs or lower exposures may be able to use existing, less sophisticated processes.
