Mortgage Lending Compliance

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Mortgage Lending Compliance Exam Considerations
Matthew Biliouris, Program Officer Division of
Supervision National Credit Union Administration
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Overview

• Mortgage Lending Trends
• Risks
• Appraisal Considerations
• Flood Hazard Insurance
• Loan Participations
• MBLs
• 3rd Party Due Diligence
• Industry Evolution
• Question Answer Session

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Mortgage Lending Trends
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FICU Share of U.S. Mortgage Originations
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Residential RE to Total Assets All FICUs
(compared to all banks)
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Residential RE Growth Rate All FICUs (compared
to all banks)
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Real Estate Comparison FICUs and All FDIC
Institutions
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Loans All FICUs
December 31, 2007
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RE Loan Growth RatesAll FICUs
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First Mortgage Loans to Total Assets All FICUs
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First Mortgage Loans / Net Worth (All FICUs)
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Fixed Rate First Mortgages
Percentage of FICUs with Fixed Rate First
Mortgage Loans Greater than 25 Percent of Assets
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ALLL to Loans
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Delinquency Charge-Offs
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Delinquency by Type
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Concerns About Real Estate Loans
of residential mortgage debt, Source Moodys
Economy.com
Delinquencies (L)
Losses (R)
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Increasing Credit Risk with Real Estate Loans
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Real Estate Delinquency Type
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Interest Rate Risk
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Interest Rate Risk Defined

• Interest Rate Risk Risk that changes in market
  rates will negatively impact the income statement
  and balance sheet

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Historical Mortgage Rates
1972 2007 (Freddie Mac)
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Interest Rate Risk

• Impact of Market Changes
• Identifying Current Exposure
• Measuring Interest Rate Risk
• Reasonable Assumptions in ALM Models
• Realistic Viable Marketing Strategies
• Models to Shock Income Statement / Balance Sheet

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Adjustable Rate Mortgages
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Adjustable Rate Mortgages

• Regulation Z Requirements
• Information about Interest Rates
• Index Values
• Effects of Adjustments
• Payment Due after Adjustments

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Adjustable Rate Mortgages

• Common Regulation Z Errors/Issues
• Wrong Index
• Wrong Date for Index Adjustment
• Inaccurate Rounding Method
• Incorrect Application of Adjustment Caps
• Incorrect Payments
• Index
• Principal BalanceDP Errors

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Liquidity Risk
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Liquidity Risk Defined

• Liquidity Risk Risk of an inability to Fund
  Obligations as they Come Due

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Loan Share Growth
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Liquidity
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Liquidity
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Liquidity Trends
Unused Commitments 2001 June 2007
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Liquidity Risk

• Identify Main Sources of Liquidity
• Impact of Investments
• Establish Alternative Sources
• Updating Marketing Plans
• Establish Loan Participation Agreements
• Liquidity Forecast Models

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Credit Risk
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Credit Risk Defined

• Credit Risk Risk of Default on Expected
  Repayments of Loans or Investments

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Credit Risk Considerations

• Strategic Fit
• Written Lending Policies
• Types of Loans Offered
• Loan Limits (By Type)
• Loan Limits (Aggregate)
• Debt Ratios
• Trade Area
• Maximum LTV

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Credit Risk Considerations

• Pricing Policy
• Quality Control Policies
• Monitoring Policies
• Secondary Market
• Staffing
• Documentation
• Hazard Insurance

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Credit Risk Considerations

• Title Search
• Title Insurance
• Credit Report
• Appraisals

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Non-Traditional / Subprime Lending Guidance
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Real Estate Lending Guidance

• NCUA Letter to Credit Unions 05-CU-07
• Interagency Statement on Managing Risks with Home
  Equity Lending
• NCUA Letter to Credit Unions 05-CU-15
• Increasing Risks in Mortgage Lending
• NCUA Letter to Credit Unions 06-CU-16
• Nontraditional Mortgage Guidance

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More Recent Guidance

• NCUA Letter to Credit Unions 07-CU-06
• Interagency Statement on Working with Mortgage
  Borrowers
• NCUA Letter to Credit Unions 07-CU-07
• Final Interagency Illustrations for Consumer
  Information with Nontraditional Mortgage Products
• NCUA Letter to Credit Unions 07-CU-09
• Final Interagency Guidance on Subprime Mortgage
  Lending

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What are Nontraditional Mortgage Products?

• AKA Exotic or Alternative
• Interest Only or Payment Option
• Allows Deferral of Principle or Interest
  (Non-fully Amortizing)

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Understanding Nontraditional Risks

• Payment Shock
• Negative Amortization
• Collateral Devaluation
• Risk Layering
• Reputation

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Mitigating Nontraditional Risks

• Capacity to Repay
• Collateral In-Dependent
• Loan to Value Requirements
• Mitigating Factors
• Full Disclosure

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What are Subprime Mortgage Products?

• Definition of subprime is vague
• Sub-prime lending is the practice of extending
  credit to borrowers who have weak credit
  histories (e.g., delinquent payments,
  charge-offs, judgments, bankruptcies), or reduced
  payment capacity (e.g., high debt ratios or low
  credit scores).
• Troublesome types are generally 2/28 or 3/27 ARMS

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Which are the Troublesome Subprime Loans?

• Underwritten to Teaser Rates
• Low Doc/No Doc
• Limited Payment or Rate Caps
• Prepayment Penalties
• Inadequate Information

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Subprime Risk Mitigation

• Ensure Non-Predatory Lending-
• Not Collateral Based
• No Loan Flipping
• No Unfair of Deceptive Practices
• Underwriting Standards-
• Fully Indexed, Fully Amortizing
• Have some PITI

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FFIEC- Illustrations of Consumer Information for
Nontraditional Mortgage Products

• Issued by the FFIEC and NCUA in May 2007
• Illustration 1- Narrative on IOs and POs
• Illustration 2- Sample Payment IOs and POs
• Illustration 3- Impact of Payment Options

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FFIEC- Proposed Illustrations of Consumer
Information for Subprime Mortgage Products

• Issued by the FFIEC August 2007
• Illustration 1- Narrative on Subprime ARMs
• Illustration 2- Sample Payment Subprime ARMs
• Expect Final Illustrations in Next Few Months

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Nontraditional Subprime Mortgage Underwriting
Terms

• Initial Interest Rate Period
• Payment Recast
• Caps (LTV, Interest Rate, Payment)
• Teaser Rate
• Fully Indexed Rate
• Fully Amortizing
• PITI

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Appraisal Considerations
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Appraisal Considerations

• Part 722 of RRs
• Definitions
• Requirements
• Minimum Standards
• Independence

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Flood Hazard Insurance
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Flood Hazard Insurance

• History Part 760 of RRs
• Requirements
• Flood Hazard Determination
• Fees Charges
• Notice to Borrowers
• Purchase Requirements
• Escrowing Premiums
• Forced Placement of Insurance

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Loan Participations
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Loan Participations

• What is a loan participation?
• Why sell participations?
• Why buy participations?

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Participations Purchased vs. Sold
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Participation LoansDelinquency and Charge-off
Trend
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Mitigating Participation Loan Risks

• The risk might not fit your credit union.
• You might not understand the risks.
• The participant has limited control.

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Successful Programs

• Adequate due diligence
• Ongoing risk monitoring
• Limit concentration risk

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Member Business Loans
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Member Business Loans

• NCUA Board encourages MBLs
• Attractive yields
• Serving a broader membership base

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MBL Trends
Member Business Loan Activity All
FICUs 2001-June 2007
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MBL Trends
Member Business Loan Activity by Asset Range
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MBL Trends
Member Business Loans Outstanding by Asset
Range 2005-June 2007
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MBL and MBL Delinquency
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MBL Delinquency Charge Offs
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2 Year Comparison - FICUs
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Safety Soundness

• Due diligence
• Controlled growth
• Adequate resources
• Strong internal controls

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Other MBL Concerns

• Inadequate cash flow analysis
• Incomplete loan write-ups
• Lack of understanding business risk
• Lack of understanding concentration risk

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Evaluating Third Party Relationships
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Discussion Items

• Letter to Credit Unions 07-CU-13, Supervisory
  Letter 07-01
• Elements of An Effective Program

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Vendor Relationships

• CUs Use Vendors For
• Lending Services
• BSA and OFAC
• Data Processing/Web Based Services

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Benefits/Risks

• Benefits
• Expand Products
• Cost Effective
• Risks
• Inadequately Managed/Controlled
• Outsourcing Relationship

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First Element of an Effective Program

• Risk Assessment and Planning
• Expectations for Outsourced Functions
• Criticality of Relationship
• Cost-Benefit Relationship
• Exit Strategy

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Second Element of an Effective Program

• Due Diligence Consideration
• Background Checks
• Business Model/Cash Flows
• Financial Condition
• Contract and Legal

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Third Element of an Effective Program

• Measuring, Monitoring, Controlling Risk
• Policies and Procedures
• Internal Controls and Audit Function
• Measure Compliance with Contract
• Evaluation of the Program

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Summary

• Outsourcing Increases Risk
• Officials Responsible for Oversight
• Elements of Effective Program

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Industry Evolution
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11 Year Comparison - FICUs
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11 Year Comparison - FICUs
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11 Year Comparison - FICUs
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Loan Distribution 11 Year Comparison
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Share Distribution 11 Year Comparison
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Credit Card Use Increasing?
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Questions??
Contact Information Matthew Biliouris 703-518-639
4 matthewb_at_ncua.gov