Risk Based Lending

NCUA's Tough Love - The Final Nail in Many Credit Unions' Coffins?

Examiners will assess whether a credit union involved in specialized higher-risk lending activities has adequately planned for, and is monitoring and controlling those activities. Management will be adversely rated for failure to manage and control such programs. 

When a credit union engages in any higher risk activity, it should be compatible with a credit union’s risk tolerance, administrative capabilities, and strategic goals. The projected and realized impact on a credit union’s financial performance should be analyzed regularly. Reasonable program limits should be established as well as on-going program monitoring and analysis.

This letter focuses on three higher risk lending activities – sub-prime lending, indirect lending, and outsourced lending relationships. Each of these lending activities can make good strategic business sense for credit unions when done with proper care. However, engaging in any of these lending activities exposes a credit union to a range of risks including credit, interest rate, liquidity, transaction, compliance, strategic, and reputation.

Due to the complexity and specialization associated with risk-based lending, examiners must carefully evaluate this activity during regular examinations and, if necessary, during supervision contacts. In reviewing risk-based lending programs, examiners will:

Risk-based lending benefits borrowers with strong credit histories by providing them lower interest rates. A properly planned risk-based lending program rewards borrowers based on how they manage their credit histories. As a member’s credit history improves, risk-based lending should recognize and reward the borrower’s financial improvement. To work properly, risk-based lending requires:

• specialized expertise,
• sound planning, and
• reliable monitoring and control systems.

Risk-based lending is a means by which a credit union may be able to more effectively meet the credit needs of all its members. It involves setting a tiered pricing structure that assigns loan rates based upon an individual’s credit risk.

Risk-based lending generally has the most significant benefit for two broad categories of borrowers:

Home equity lending is an attractive product for many homeowners and lenders. The quality of these portfolios, however, is subject to increased risk if interest rates rise and home values decline. Sound underwriting practices and effective risk management systems are essential to mitigate this risk.

This guidance describes sound credit risk management systems for:

• Product Development and Marketing
• Origination and Underwriting
• Third-Party Originations
• Collateral Valuation Management
• Account Management
• Portfolio Management
• Operations, Servicing, and Collections
• Secondary Market Activities
• Portfolio Classifications, Allowance for Loan and Lease Losses (ALLL), and Capital