In early July, federal bank regulators and the Conference of State Bank Supervisors issued guidance regarding home equity lines of credit (“HELOC”) that are nearing the end of their draw periods. Typically, a HELOC consists of two periods: a draw period during which the borrower has access to unused amounts under the line of credit and interest only payments are made, followed by a repayment period during which a balloon payment or increased monthly payments are made.
The regulatory guidance reminded banks of key risk management principles when the end of the draw period is approaching for HELOCs. For example, banks should:
- not extend draw periods, modify loans, or establish amortization terms without conducting thorough due diligence on the borrower;
- use loan workout programs when feasible, but only if tailored to the borrower’s financial situation, and identify appropriate troubled debt restructurings;
- in estimating their allowance for loan and lease losses, consider the risks associated with the end of the draw period, such as “payment shock” of the borrower resulting from the increased payments due during the repayment period.
In addition, the guidance delineated specific policies that banks should follow in implementing such principles, including:
- proper identification of the risks associated with the end of the draw period and of the higher risk segments of the portfolio;
- analysis of expected payoffs, delinquencies and other factors that change risk levels;
- complete understanding of the contractual provisions of the HELOCs (such as notifications, payment amounts, interest rates, and amortization terms) and ensuring that the payment processing and servicing systems are controlled and programmed correctly;
- communication by well-trained customer account representatives with the borrowers well in advance of the end of the draw periods, including descriptions of options available for modifications to high risk borrowers;
- tracking of actions taken by type at the end of the draw periods and subsequent account performance and the distribution of such reports to all involved personnel on a frequent basis;
- sufficient staffing and resources to handle all activities within the HELOC portfolio.
This guidance may be found at Interagency Guidance on Home Equity Lines of Credit Nearing Their End-of-Draw Periods.