Compliance: What to consider as 2020 comes to an end
NCUA encourages credit unions to prudently work with borrowers.
Ten months ago, who would have thought there would be pandemic-related mask ordinances, splash guards at teller windows, and social distance decals on the floors of branch lobbies?
The only constant has been credit unions’ commitment to doing what they do best: assisting and serving their members.
In addition, regulators have issued a seeming onslaught of agency guidance and regulatory changes since the beginning of the coronavirus (COVID-19) pandemic. Although we can’t predict what may be in store in the coming months, here’s a snapshot of issues to consider as we try to get through the end of 2020.
NCUA’s exam posture remains as it was since the start of the pandemic, with most exams occurring off-site and materials shared electronically and securely.
At the beginning of 2020, NCUA announced one of its priorities would be the review of credit union loan programs and underwriting standards and procedures. As a result of the pandemic, NCUA instead shifted the emphasis to reviewing actions credit unions have taken to assist members facing financial difficulties.
Credit unions may be experiencing an uptick in examiner requests for policy reviews and the use of loan workout strategies. Of interest are credit unions’ risk management controls and how credit unions are assisting those experiencing financial hardships due to the pandemic.
Based on NCUA exam guidance and interagency statements, the agency is encouraging credit unions to prudently work with borrowers. From the onset of the pandemic, guidance stated that well-structured loan accommodations in this environment are to be viewed as positive actions to mitigate the adverse effects COVID-19 is having on borrowers and facilitate a credit union’s ability to collect on its loans.
These agency issuances offer prudent risk management and consumer protection practices and guidance on meeting accounting and regulatory reporting requirements. They also stress the importance of sound internal controls in this current environment.
So, let’s talk additional accommodations. Now that we’re approximately 10 months into the pandemic, many of the accommodations provided to members are nearing or at their end.
While some member borrowers are in a reasonable capacity to repay and can resume payments, others, unfortunately, cannot. They’re likely feeling the pressure of looming payments and realizing they’ll likely face continued financial hardship for the foreseeable future.
A Federal Financial Institutions Examination Council (FFIEC) joint statement issued in August addressed additional loan accommodations for borrowers. Following are some issues to consider.
NEXT: Communications to the borrower
Communications to the borrower
Think clarity and timing. Be clear and accurate in communications and disclosures regarding additional accommodations/options available to the borrower that are affordable and sustainable (a reasonable capacity to repay).
Communications should provide ample time for both the borrower and credit union to consider next steps, and should occur well in advance of the prior accommodation terminating.
Based on NCUA’s COVID-19 exam specific resources, when granting loan modifications, credit unions should clearly explain to the borrower how the payments will be handled going forward. Providing clear and accurate disclosures can assist in preventing and avoiding misunderstandings relevant any change in terms, especially during this turbulent time.
Policies and procedures
Make sure that any exceptions to policies or procedures reflect the accommodations and/or options the credit union offers. The exceptions should be consistent with applicable laws and regulations.
Recent updates to NCUA’s Exam Manual online, specifically relating to COVID-19, acknowledge that credit unions may need to make exceptions to their policies, and that the board of directors should approve any policy exceptions.
NCUA’s Regulation Part 741 applies to all federally insured credit unions, with 741.3(b)(2) and Appendix B to Part 741 providing the regulatory framework for loan modification programs.
Elements of a loan workout policy
The COVID-19 section in NCUA’s exam manual provides that credit unions should address these elements in a loan workout policy:
- Eligibility requirements. What conditions will the credit union consider to do a workout?
- Types of loans that may be modified.
- Aggregate program limits as a percentage of net worth.
- The number of times a loan may be modified.
- Documentation that shows the ability to repay the loan, as well as requirements supporting the borrower’s renewed willingness to repay the loan.
- Internal controls that promote appropriately structured loan workouts.
- The prohibition of financing additional advances for unpaid interest and fees. However, credit unions may make advances to cover third-party fees, excluding credit union commissions, such as force-placed insurance or property taxes.
- The frequency and responsibility for reporting requirements, including aggregate program limits that will trigger enhanced reporting to the board of directors. This reporting should include information regarding multiple restructurings.
Underwriting standards should include:
- Allowable loan modification options (extended amortization period, interest rate reduction, principal forbearance, etc.).
- Updated collateral information (condition, value, title search, etc.).
- Verified monthly income and updated credit reports.
- Affordable debt ratio.
- Documented analysis of modification options. For example, if reducing the interest rate will not achieve the target debt ratio, consider extending the amortization period.
- Demonstrated ability and willingness to repay under the new terms for a period of time before completion of a permanent modification.
- A financial impact analysis for long term mortgages. Estimate the cost of the credit union concession as measured by a net present value (NPV) test against the estimated cost of foreclosure or other alternative (see NCUA Letter to Credit Unions 09-CU-19, Evaluating Residential Real Estate Mortgage Loan Modification Programs).
In the many letters to credit unions, alerts, and interagency guidance, one of the key takeaways is that loan modifications and workouts should be well documented as to the reasoning behind the accommodations.
Any new or changed policies should address the use of loan workout strategies and the practices and strategies in place to provide funds to borrowers impacted by COVID-19.
Examiners are focusing on any adjustments to address borrowers facing financial hardship as a result of the pandemic.
Accounting and regulatory reporting
Accuracy is crucial when following applicable accounting and regulatory reporting requirements for all loan modifications, regardless of whether the modification is an initial modification or any additional modifications after the initial accommodation period.
Call Report instructions, interagency statements on troubled debt restructurings, section 4013 of the CARES Act, and ALLL account requirements in accordance with FASB accounting standards all provide insight and clarity as to how to report the information.
In addition to assessing loan workout programs, examiners will review credit unions for potential safety and soundness concerns.
Delinquencies and loan losses
NCUA has indicated in guidance that credit unions experiencing increases in delinquencies and loan losses could use qualitative and environmental factors (Q&E) to adjust historical loss factors.
Keep in mind, though, that credit unions must document the adjustments with supporting evidence and explain why they used the information (i.e., the local unemployment rate) in the loss measurements. Allowances for loan and lease loss calculations are specific to each institution, so credit unions should consult their CPA regarding ALLL funding.
Don’t circumvent internal controls. The credit union’s risk management framework (and its monitoring and reporting framework) enable the board of directors to evaluate the effectiveness of the program, any implications the framework has on the credit union’s financial condition, and whether the credit union adjusted its business strategy.
Agency letters to credit unions, alerts, and interagency guidance issued since the beginning of the pandemic highlight the need to document and substantiate the reasons behind loan accommodations and workouts.
Examiners will assess the various workout programs credit unions put in place (such as modifications, refinances, due date adjustments) and whether these programs ultimately improve the collectability of the debt.
Communications with the member borrower and corresponding legal documentation must be clear, accurate, and timely, and in accordance with contractual terms, policy guidelines, federal and state laws, and regulatory requirements.
Examiners will assess safety and soundness, and whether the credit union has put in place risk management strategies that consider this unprecedented time.
What to expect
Examiners will be interested in how credit unions have handled the COVID-19 pandemic, the type of processes and programs they’ve put in place, and whether those processes and programs have been able to assist, evolve, mitigate, and manage the risks in this challenging time.