Call it Christmas in July, because we all just received the gift of an additional ALLL consideration. On July 1, 2014 Interagency Guidance on Home Equity Lines of Credit Nearing Their End-of-Draw Periods was released.
Members will undergo a payment shock at the end of their draw periods. Whether there is a balloon payment involved or the line simply converts from interest only to principal and interest payments, the member’s payment is presumably going up. On a fully funded $50,000 HELOC with a 4% interest rate and a 10-year amortization period, payments would go up from ~$167 to ~$506.
That means risk and presumably default rates will also go up. Practically speaking, this means:
- Communicating with your borrowers nearing the end of their draw periods and understanding their financial situation.
- If the borrower is looking to extend or renew their line, you should be carefully evaluating the borrower’s ability to repay prior to extension as opposed to relying on initial underwriting documentation.
- If the borrower communicates financial difficulty, management should participate in or establish workout and modification programs where feasible. Terms should be consistent with the borrower’s hardship meaning payments should correspond with the member’s unique financial situation.
The way I picture this being effectively built into your allowance is segmenting your HELOCs between those far from their draw period (e.g. 12 months or greater) and those nearing or after their draw period. You will also need to evaluate your historical charge offs to ensure you are breaking them out between segments.
I do think this is easier said than done because hypothetically you’ll need to not only break out your current portfolio, but break out the historical portfolio as well as charge offs.
When considering how much attention you want to give to the guidance, I would consider the size of your HELOC portfolio and the historical risk. If the portfolio has three charge offs over the past year, it might be overkill to segment these out, unless your goal is to apply some sort of qualitative and environmental factor for the change in balances of HELOCS nearing their end-of-draw period.
Credit unions have a tendency to over think their allowance calculation; spending more time on it than necessary. This is absolutely driven by an overwhelming pool of guidance and scrutiny examiners and auditors. Keep in mind that (a) it’s your calculation and (b) no one is ever right! Do your best, continue to evaluate your methodology’s historical accuracy in forecasting losses, and move on.