Lending Policies

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Lending Policies Procedures

• Presented by Kayce M. Bell, Chief Operating
  Officer, Alabama Credit Union

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Lending policies procedures

• A guide to growing and protecting a financial
  institutions largest asset
• Compliance
• Consumer vs. commercial (Member Biz Lending)
• Lending systems
• Pricing various risks
• Monitoring the portfolios balance
• Unforeseen risks
• Subprime lending (mortgages)
• Differences between credit unions and banks

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Policy includes

• Statements of compliance
• Authorized decision makers and persons who can
  make documented exceptions
• Approved forms of lending (closed end, open end,
  products, consumer, commercial)
• Approved underwriting procedures
• Approved forms of valuation of collateral
• Limits on rates, amount of portfolio invested in
  various types of loan products
• Targets for lending portfolio performance
• Usually approved by board of directors

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Compliance

• Truth In Lending Act (TILA Reg Z) -- promotes
  the informed use of consumer credit by requiring
  disclosures about its terms and costs in clear
  and conspicuous disclosures.  The Act has
  involved into an extremely complex set of rules. 

Equal Credit Opportunity Act (ECOA Reg B) --
prevents discrimination on the basis of sex or
marital status in any aspect of a credit
transaction. Subsequent amendments extended the
Act's prohibition of discrimination in credit
transactions on the basis of race, color,
religion, national origin, age (provided the
applicant has the capacity to contract), receipt
of part or all of one's income from a public
assistance program, and good faith exercise of
rights under the Consumer Protection Act of 1968.
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Compliance

• Fair Credit Reporting Act (FCRA) -- ensures fair
  and accurate reporting of consumer credit
  information.  It regulates "consumer reporting
  agencies," including credit bureaus restricts
  the use of consumer reports to their legitimate
  purposes prohibits the dissemination of outdated
  credit information and requires disclosure to
  consumers and employees when adverse action is
  taken as the result of credit reports or other
  consumer information.
• FACT (Fair Accurate Credit Transactions Act)
  in 2003, permanently reauthorized the seven
  existing preemption provisions which were
  scheduled to sunset on January 1, 2004, and
  extended preemption to certain areas related to
  identity theft prevention and mitigation. In
  addition, the new law provided consumers with a
  free credit report every year, new identity theft
  protections, medical privacy rights, and an
  ability to opt-out of information sharing between
  affiliated companies for marketing purposes. The
  Act also established a financial literacy
  commission and mandated a national financial
  literacy campaign to educate consumers on
  personal financial matters, including creating
  household budgets, managing spending more
  effectively, investment and wealth building,
  buying a home, and preparing for retirement.

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Compliance

• Fair Housing Act -- establishes a national policy
  of fair housing by forbidding discrimination in
  the sale, rental, or financing of residential
  housing or in the provision of real estate
  brokerage services on the basis of race, color,
  religion, sex, handicap, familial status (having
  one or more children under the age of 18), or
  national origin. These are known as the
  "prohibited bases." 
• Home Mortgage Disclosure Act Home Ownership
  Equity Protection Act -- eliminates redlining and
  other illegal practices by lenders that sometimes
  contributed to the decline of certain geographic
  areas by failing to provide adequate home
  financing to qualified applicants on reasonable
  terms and conditions.

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Compliance

• Anti-Redlining Requirements -- prohibits certain
  mortgage lending practices (typically,
  discrimination by geographic area) by a
  credit-granting institution
• Secured Transactions/UCC Article 9 -- applies to
  any transaction intended to create a security
  interest in personal property or fixtures
• Servicemembers Civil Relief Act -- provides
  protection to individuals who are on full-time
  active military service of the United States.
  Active duty personnel includes individuals
  appointed, enlisted, or inducted into regular
  branches of the U.S. military service, that is
  the Army, Air Force, Navy, Marines, and Coast
  Guard, as well as personnel mobilized in National
  Guard and Reserve Units and certain public health
  officers. Active duty also includes full-time
  training such as boot camp

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Compliance

• Allowance for Loan Lease Losses -- credit
  unions use their ALLL accounts to try to predict
  their overall loan and lease losses. They take
  periodic charges to earnings to better match
  losses to periods when they occurred.  They use
  current income, through the provision for loan
  and lease losses, to create and build a reserve
  to absorb losses

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Consumer vs. commercial

• Credit unions specialize in consumer lending
  (autos, primary residences, collateralized,
  unsecured loans, credit cards) and small Member
  Business Loans
• Limit for MBLs 12.25 of assets
• Participation loans
• Banks focus on commercial lending development
  of residential subdivisions commercial
  construction lines of credit for manufacturers,
  builders, etc. brokerage of bond issuance for
  municipalities, etc. mortgages

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Real estate lending

• Aggressive strategies over past 7,8 years have
  resulted in current subprime lending crisis for
  many lenders
• First mortgages purchase and refinance loans
• FNMA FHLMC (secondary market)
• Portfolio loans
• Fixed vs. ARMs
• Second mortgages home equity line of credit
  (HELOC)
• Typically not salable
• Closed- or open-end plans

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Lending systems types of credit

• Closed end
• Installment or single-pay loans
• Maturity date
• Pre-disclosed finance charge
• No subsequent advances to increase balance
• For credit unions, simple interest lending
• Open end
• Line of credit
• No maturity date
• APR/DPR, payment amount due date disclosed
• Convenient source of credit with subsequent
  advances
• One signature/lifetime lending
• Permanent security agreement
• Addendum disclosures range of rates available to
  borrowers

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Lending systems credit cards

• Open end lending
• Subject to additional disclosure requirements
  (i.e., Fed box or Schumer Box, prohibition
  against pre-approved hot card mailings, etc.)
• Some state-level requirements result in lenders
  reluctant to accept applications from residents
  (California)
• Banks now decline to provide small loans that
  could be advanced by credit cards, but credit
  unions still provide

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Lending procedures

• Underwriting procedures may require proof of
  income, inspection of collateral, proof of
  collateral insurance
• Application for credit regulated standard
• Stricter controls for self-employment and riskier
  borrowers
• Perfection of lien
• Declining credit requests, rescinding credit
  lines, and making counter-offers (Adverse Action
  Notice)
• Internal (inspection or quality-control) audit
  and independent audit vs. regulatory exam
• Usually written by Lending VP approved by CEO

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Types of risk to financial institutions

• Borrowers default
• Interest rate risk
• Reputation risk
• Devaluation of collateral
• Unperfected liens

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Pricing the risk

• Risk-Based Pricing (not Risk-Based Lending)
• Determining acceptable risk
• Credit scoring Beacon, Bankruptcy Navigator
  (BNI) measures credit history and predicts
  performance
• Statistically sound, empirically derived scoring
  system
• Data provided by credit bureaus (consumer
  reporting agencies)
• Debt ratio
• Amount of income
• Collateralized vs. unsecured

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Lending portfolio yield monitoring the balance

• Investing in higher-yielding loans
• Life cycle of loan
• Asset-liability management (ALM)

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Unforeseen risks

• Federal Reserve rate adjustments
• Narrowing margins
• Natural disasters (hurricanes!)
• Other lenders too aggressive
• Borrower declares bankruptcy
• Consumers unable to absorb rate/payment increases
  (excessively high Loan-To-Value)
• Regulatory changes
• Vendor failure (leasing or balloon-note programs,
  insurers of excessive Loan-To-Value programs)
• Sponsor group failure

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Subprime lending

• also known as B-paper, near-prime, or second
  chance lending) is lending at a higher rate than
  the prime rate
• refers to the credit status of the borrower
  (being less than ideal), not the interest rate on
  the loan itself
• often defined or defended as lending to borrowers
  with compromised credit histories, but the Wall
  Street Journal reported that in 2006, 61 of all
  borrowers receiving subprime loans had credit
  scores high enough to qualify for prime
  conventional loans

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Subprime lending

• According to U.S. Department Of Housing Urban
  Development (HUD)
• Many have questioned why minorities appear to be
  over-represented in the subprime lending market.
• Studies reveal that even in upper-income
  African-American neighborhoods one is
  one-and-a-half times as likely to have a subprime
  loan than persons in low-income white
  neighborhoods.
• In neighborhoods where Hispanics comprise at
  least 80 percent of the population, they were 1.5
  times as likely than the nation as a whole to
  have a subprime mortgage loan.
• Some allege this disparity to be attributed to
  subprime lenders purposefully marketing to
  African-American communities-what some have
  called reverse redlining.
• They allege lenders will provide loans to these
  communities, but at a higher cost and with less
  favorable conditions.

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Subprime lending

• controversy surrounding subprime lending has
  expanded as the result of an ongoing lending and
  credit crisis (1) in the subprime industry and
  (2) in the greater financial markets which began
  in the United States
• phenomenon has been described as a financial
  contagion which has led to a restriction on the
  availability of credit in world financial markets
• hundreds of thousands of borrowers have been
  forced to default several major American
  subprime lenders have filed for bankruptcy
• financial institutions investments in pools of
  mortgages once considered stable may be
  affected by widespread default

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Your handouts include these samples

• Risk-Based Pricing Matrix
• Credit Card Applicationhttp//www.alabamacu.com/
  pdf_files/acuvisa.pdf
• Open-End Lending Plan Addendum
• Open-End Lending Plan
• Closed-End Loan Agreement
• CHARM booklet http//www.federalreserve.gov/pubs
  /arms/armsbrochure.pdf
• Adverse Action Notice

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Questions?
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Kayce M. Bell

• Chief Operating Officer
• Alabama Credit Union
• kbell_at_AlabamaCU.com or [phone]