The FRB, FDIC, OCC and NCUA (the “Agencies”) jointly released updated guidance (the “Guidance”) concerning allowance for loan and lease losses (“ALLL”) estimation practices associated with loans and lines of credit secured by junior liens (typically second mortgages and home equity lines of credit) on one- to four-family residential properties (“Junior Liens”). The Guidance incorporates and updates similar guidance provided in 2005 and 2006, but the updated Guidance stresses, and provides further direction with respect to, the Agencies’ policies and expectations with respect to treatment of Junior Liens.
The Guidance states that in estimating its ALLL, a financial institution (“FI”) should gather enough information to assess its probable losses from its Junior Lien portfolios. The FI should obtain information on the status of senior liens. In addition, the Guidance states that FIs with significant Junior Lien portfolios should segment those portfolios based on risk factors. Specifically, the Agencies suggest that FIs consider the following risk factors:
(1) the delinquency or modification status of both the senior and Junior Liens;
(2) credit scores;
(3) loan-to-value ratios;
(4) the type of property securing the loan;
(5) the location of the property; and
(6) for home equity lines of credit, whether the consumer is making only minimum payments or could be subject to future “payment shock.”
The Agencies further state that an FI “should adjust a loan group’s historical loss rate for the effect of qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the [loan] group’s historical loss experience.”
Finally, the Guidance discusses the responsibilities of examiners in reviewing the ALLL of an FI that has a Junior Lien portfolio and the supervisory options available to the examiner should he or she conclude that the FI’s ALLL is not appropriate or its ALLL evaluation process is deficient.