In July, the federal financial institution regulatory agencies issued guidance on home equity lines of credit (HELOC) nearing their end-of-draw periods. During the draw period, borrowers have access to further withdrawals or transactions up to an established limit, and they’re often required to make interest-only payments.
During the repayment period, borrowers can’t make withdrawals from the line of credit and must repay the outstanding balance. This can create a hardship and increase default risk.
Examiners will expect credit unions to have end-of-draw risk management programs addressing five principles:
1. Proper underwriting for renewals, extensions, and rewrites. Evaluate the borrower’s willingness and ability to repay the loan prior to extending draw periods, modifying notes, or establishing amortization terms for existing balances.
2. Compliance with regulatory guidance for prudent real estate lending.
3. Feasible modification programs. Workout arrangements should be consistent with the nature of the borrower’s hardship, have sustainable payment requirements, and promote orderly, systematic repayment of amounts owed.
4. Appropriate accounting, reporting, and disclosure of troubled debt restructurings.
5. End-of-draw exposure. HELOCs approaching their end-of-draw periods should, when volumes warrant, generally be a separate portfolio segment in the allowance for loan and lease loss (ALLL) estimation process. Before significant HELOC volumes reach their end-of draw periods, determine the nature and magnitude of exposures.
The interagency guidance also describes 10 components of a risk management program that promote an understanding of potential exposures and consistent, effective responses to HELOC borrowers who may be unable to meet their obligations:
1. Developing a clear understanding of scheduled end-of-draw period exposures and identifying higher-risk segments of the HELOC portfolio. Refer to the Interagency Junior Lien Allowance Guidance for information on account and portfolio management.
2. Ensuring a full understanding of end-of-draw contract provisions. Servicing systems should address transition issues such as payment changes, interest-rate options, amortization terms, lockout and debt consolidation options, and payment processing.
3. Evaluating near-term risks to determine whether the borrower will meet current underwriting standards or qualify for renewal programs.
4. Following up with borrowers through outreach programs six to nine months before the end-of-draw dates, and addressing any issues.
5. Ensuring that refinancing, renewal, workout, and modification programs are consistent with regulatory guidance, regulations, and consumer protection laws.
6. Directing borrowers to trained member account representatives who are familiar with the products, the borrower, and the range of available alternatives. Establish and define clear loss-mitigation steps.
7. Educating higher-risk borrowers about their options, general eligibility criteria, and the process for requesting a modification.
8. Structuring and distributing endof- draw period reports to help staff understand and respond to exposures, activity, and performance results.
9. Considering the potential HELOC default risk from payment shock, loss of credit line availability, and home value changes in ALLL methodologies.
10. Implementing quality assurance, internal audit, and operational risk management functions commensurate with the volume of the credit union’s HELOC exposure. Perform targeted testing of the full process for managing the end-ofdraw transactions.
Credit unions outsourcing HELOC management must ensure the service provider complies with applicable laws and supervisory guidance.
Credit unions with small HELOC portfolios, few portfolio acquisitions, or low-risk exposures may be able to use existing, less-sophisticated processes.
MICHAEL McLAIN is CUNA’s assistant general counsel for compliance.