Retail Lending Examination Procedures
Procedures
Minimum Examination Procedures
Objective: Assess the level of credit risk, evaluate the quality of risk management, and determine the aggregate level and direction of risk of the bank’s retail credit activities.
The scope of retail lending supervisory activities, in aggregate or for a specific product or function, depends on the examiner’s knowledge of those activities, the amount of total and product exposure, and the amount of risk posed to the bank’s earnings and capital. The minimum procedures provide the steps necessary for a comprehensive retail lending examination in smaller or less complex operations, and serve as the base retail lending procedures for larger or more complex operations. The procedures include in-depth portfolio analysis and testing to promote examiners’ assessments of the quantity, aggregate level, and direction of credit risk.
Expanding the scope of the review may be necessary in cases in which the bank offers new or significantly changed products, a particular concern exists, or in larger, more complex operations. In these situations, examiners should select the appropriate “Supplemental Examination Procedures” to augment the minimum procedures. The supplemental procedures are grouped by functional and product-specific areas. Examiners are also encouraged to refer to other Comptroller’s Handbook sections, including Community and Large Bank Supervision, Allowance for Loan and Lease Losses, Concentration of Credits, Credit Card Lending, Internal and External Audits, Internal Control, Lease Financing, Loan Portfolio Management, Merchant Processing, Mortgage Banking, and Rating Credit Risk.
While reviewing retail credit activities, examiners should remain alert for lending practices and product terms that could indicate discriminatory, unfair, deceptive, abusive, or predatory issues.
If the National Credit Tool (NCT) is available, examiners are encouraged to use the standard retail reports and other NCT capabilities (i.e., custom reports and sampling) to assist in the retail credit review.
Review the scope, conclusions, and work papers from previous supervisory activities. Determine the adequacy and timeliness of management’s response to the issues identified, and any findings or issues requiring follow-up.
Review relevant reports issued by internal and external audit, quality assurance, loan review, risk management, and compliance management since the prior supervisory activity. Determine the adequacy and timeliness of management’s responses to the issues identified, and any findings or issues requiring follow-up. Request work papers, if warranted.
Review the minutes of retail credit-related committee meetings conducted since the prior supervisory activity.
Obtain copies of the OCC (complaints reported to the Customer Assistance Group) and bank consumer complaint logs and evaluate the information for significant issues and trends.
NOTE:Complaints serve as a valuable early warning indicator for compliance, credit, and operational issues, including discriminatory, unfair, deceptive, abusive, and predatory practices.
Determine whether there is any litigation, either filed or anticipated, associated with the bank’s retail credit activities and the expected cost or other implications.
Determine whether the bank offers debt suspension and/or cancellation (debt waiver) products. If so, ensure compliance with 12 CFR 37, Debt Cancellation Contracts and Debt Suspension Agreements, and complete the “Debt Suspension and Cancellation” section in the “Supplemental Examination Procedures,” if program volume is significant.
NOTE:It is important to identify debt waiver penetration and benefit activation rates early in the examination in order to fully assess retail credit portfolio performance. Accounts generally show as current while on benefits, yet portfolio analysis should recognize that these customers are not actually performing which may indicate a higher risk profile.
Develop an initial assessment of the quality and performance of the bank’s retail credit portfolio and product segments using portfolio reports, risk management analyses, and the UBPR. Consider:
Growth.
Portfolio mix and changes.
Significance of the portfolio and each of the products in terms of total loans, total assets, and capital.
Credit performance.
Contribution to earnings and income composition (e.g., interest, fees).
NOTE:If the bank securitizes assets, also analyze data on a managed basis. Coordinate findings and conclusions with the examiner(s) assigned to review securitizations throughout the examination.
Discuss with management changes made since the prior supervisory activity or planned for retail credit products and operations, including:
Growth overall and in individual products.
Portfolio product mix.
Off-balance-sheet retail credit activities (e.g., merchant processing, ACH payment programs, and securitization activities).
New products.
Terms on existing products.
Marketing or acquisition channels (e.g., direct, mail, telemarketing, Internet, and third-party originators).
Expansion into new market and trade areas.
New or expanded third-party loan generation or servicing arrangements.
Underwriting, risk selection criteria, and portfolio quality.
Monitoring and risk management processes.
Models used to underwrite or manage the portfolio, if any.
Retail loan systems, including underwriting, servicing, and collection platforms.
NOTE:It is important to understand how management assesses the effects of changes on profitability and the risk profile, and incorporates the effects of changes into the planning and risk management processes.
Also, discuss management’s perception of the competition and whether the bank can remain successful in its market without changes. Determine the extent to which the changes made or proposed were in response to the competitive environment, and the reasonableness of and analytical support for those changes.
Evaluate retail credit management and the planning process. Specifically:
Determine whether retail credit objectives are consistent with the bank’s strategic plan, and whether the objectives are reasonable in light of the bank’s resources, expertise, product offerings, and competitive environment.
Determine whether the retail-marketing plans and budgets are consistent with the retail credit objectives and the bank’s strategic plan.
Evaluate the adequacy of the retail credit planning process (growth, financial, and product-related), including the adequacy and timeliness of revisions when warranted by portfolio performance and new developments.
Determine management’s risk tolerance with respect to risk and return objectives (e.g., return on assets, return on equity, or return on investment) or credit performance hurdles (e.g., delinquency, credit loss, or risk score tolerances).
Assess the qualifications, expertise, and staffing levels of management and staff in view of existing and planned retail credit activities.
Review and assess the adequacy of the bank’s policies, procedures, and practices. Specifically:
Determine whether consumer loan policies are approved by the board of directors at inception, and included in annual policy reviews thereafter.
Identify significant changes in underwriting criteria and terms, how credit scoring models are used, account management activities (including re-pricing and credit line management programs for open-end accounts), and collection practices and policies. Specifically:
Determine the effect of those changes on the portfolio and its performance.
Determine whether underwriting policies provide appropriate guidance on assessing that the borrower’s capacity to repay the loan is based on a consideration of the borrower’s income, financial resources, and debt service obligations.
Determine whether the underwriting policies provide appropriate guidance on permissible collateral, and collateral valuation guidelines and methodologies.
If the bank uses credit scoring (e.g., bureau, pooled, or custom):
Determine how the bank ensures that the model is appropriate for the target population and product offering.
Assess the reasonableness of the process used to establish cut-offs, and determine whether management changed the cut-offs between examinations and the implications for portfolio quality and performance.
Determine whether the policy provides for model monitoring and validation.
Determine how policies and changes are communicated to staff, and assess the adequacy of the process.
Evaluate the bank’s process for establishing policy exception criteria and limits, and for monitoring and approving underwriting policy exceptions (e.g., underwriting standards, loan terms, score overrides, and collateral documentation).
Determine the control processes in place to track and monitor policy adherence (e.g., quality assurance, MIS reports, loan review, and audit), and assess the adequacy of those processes.
If the bank uses third-party vendors, including brokers and dealers, for services such as loan origination or collection, determine:
How policies are communicated to those entities.
Determine whether the bank’s policies and procedures, including those for third-party vendors, provide adequate guidance to avoid discriminatory, unfair, deceptive, predatory, and abusive lending practices [2] (e.g., lending predominantly on the value of collateral rather than the borrower’s ability to service the debt, high-cost loans, and misleading disclosures).
Evaluate the condition and risk profile of the portfolio and individual products by reviewing historical trends and current levels of key performance indicators. Such indicators include, but are not limited to, loan balances, utilization, delinquencies, losses, recoveries, and profitability. Focus primarily on dollar balance percentages, but also consider percentages of numbers of accounts. Review performance indicators for:
Major products, sub-products, portfolio segments, acquisition channels, and acquired portfolios.
Third-party originators, including brokers and dealers.
Internal performance indicator hurdles and metrics. Compare actual performance indicators with internally established objectives
The industry and peers, as available (e.g., American Banker’s Association, Consumer Banker’s Association, Risk Management Association, Visa’s “Issuer Risk Key Indicators” (IRKI), Mortgage Bankers Association, Mortgage Information Corp. (MIC), and rating agency and securitization research). Compare industry indicators with bank performance.
In addition to coincident analysis, [3] consider performing vintage analysis, [4] especially if underwriting criteria, loan terms, or economic conditions have changed, and lagged analysis [5] chronology log [6]
Review new account application volumes, and approval and booking rates to assess portfolio growth. In addition, review new account metrics to determine the composition and quality of accounts currently being booked. Compare the quality of recent account bookings with that of accounts booked in the past. Metrics evaluated should include credit score distributions (if used), price tiers, loan-to-value/advance rate ratios, debt-to-income ratios, geographic distribution, override volume, and credit policy exceptions.
Evaluate the expected performance of the portfolio and the individual products through analysis of management reports, portfolio segmentation, and discussions with management. Specifically, review:
Score distributions and trends for accounts over time, evaluating scores at application (e.g., application score and bureau score), refreshed bureau scores, and behavior scores.
Delinquencies and losses by credit score range for each major scoring model, and whether there has been any deterioration of the good-to-bad odds.
Trend in advance rates and the effect on performance and loss severity.
Loan growth sources (e.g., branch, region, loan officer, and product channel such as, direct, indirect, telemarketing, direct mail, or Internet), and differences in performance by source.
Levels and trends of policy and documentation exceptions, and the performance of accounts with exceptions versus the performance of the portfolio overall.
Levels and trends of repossessions, foreclosures, and other real estate owned (residential).
Volumes and trends of first and early payment defaults.
Volumes and trends of account and balance attrition (open-end) and prepayment (closed-end).
Management’s loss forecasts.
Review collection department reports and activities to determine the implications for credit quality.
NOTE:Several of the procedures already performed also reflect collections activities (e.g., review of delinquencies and losses).
Review roll rate [7] reports overall and by product; evaluate trends; and, if peer group performance is available, compare roll rates.
Review the criteria, volume, performance, and trends for forbearance programs (debt management plans and other fixed payment or workout programs), as well as for re-aged, extended, deferred, renewed, and rewritten accounts.
Determine the reasonableness of the bank’s collection strategies and the adequacy and timeliness of the processes for making revisions.
Review the loss forecasting process and determine whether it is reasonable and reliable.
Assess the adequacy of MIS and reports with respect to providing management with the necessary information to monitor and manage all aspects of retail credit. Determine whether:
Adequate processes exist to ensure data integrity and report accuracy, and that balances and trends included in management’s retail credit reports reconcile to the bank’s general ledger and to the call report.
Various department reports are consistent, i.e., the reports show the same numbers for the same categories and time periods regardless of the unit generating the report.
Descriptions of key management reports are maintained and updated.
Reports are produced to track volume and performance by product, channel, marketing initiative, and to support any test with implications for credit quality and/or performance (e.g., pricing, open-end line assignment/adjustment, advance rates). This reporting process should be fully operational before the bank offers new products or initiates tests in order to accurately monitor performance from inception.
MIS and reports are available to clearly track volumes, performance, and trends for all types of forbearance/workout programs as well as activities such as re-aging, extensions, deferrals, renewals, and rewrites.
Reports are clearly labeled and dated.
Determine whether the amount of the allowance for loan and lease losses (allowance) is adequate and whether the method of calculating the allowance is sound. Ensure that management routinely analyzes the portfolio to identify instances when the performance of a product or some other segment (e.g., workout programs) varies significantly from the performance of the portfolio overall, and that such differences are adequately incorporated into the allowance analysis. Refer to the ”Allowance for Loan and Lease Losses” booklet of the
Comptroller’s Handbook
for guidance, and specifically consider:
Whether estimates and assumptions are documented and supported consistent with FFIEC guidance (OCC Bulletin 2001-37, “Policy Statement on Allowance for Loan and Lease Losses Methodologies and Documentation for Banks and Savings Institutions”).
Credit quality, including any changes to underwriting, account management, or collections that could affect future performance and credit losses.
Historical credit performance and trends (e.g., delinquency roll rates and flow-to-loss), overall, by product, and by vintage within products.
Level, trends, and performance of subprime and other higher-risk populations (e.g., over-limit accounts).
Level, trends, and performance of cure or workout programs, including re-aging, extensions, deferrals, renewals, modifications, and rewrites.
Levels and trends of bankruptcies, and the performance of bankruptcy accounts that remain on the bank’s books (including both accounts that have been reaffirmed and those that have not).
Charge-off practices, and compliance with the OCC Bulletin 2000-20, “FFIEC Uniform Retail Credit Classification and Account Management Policy.”
Whether management provides for accrued interest and fees deemed uncollectible in the allowance or in a separate reserve.
The effects of securitization activities, if applicable.
Economic conditions and trends.
Validate the preliminary risk assessment conclusions by conducting on-site transaction testing. The purpose of working these samples includes verifying adherence to bank policies; determining whether the bank maintains adequate documentation of analysis and decisions; verifying whether MIS reports accurately capture exception information; and determining whether practices exist that are inconsistent with bank policy or are not adequately depicted in existing management reports. The sample selected should be sufficient in size to reach a supportable conclusion.
Examiners conducting testing should remain alert for potential discriminatory, unfair, deceptive, abusive, and predatory lending practices (e.g., lending predominantly on the value of collateral rather than the borrower’s ability to service the debt). If weaknesses or concerns are found, consult the bank’s EIC or compliance examiner.
For each product being reviewed:
Sample recently approved accounts to assess adherence to underwriting policy. If the bank uses credit scoring, select two samples, one sample from accounts not automatically approved (e.g., judgmental decision involved even if credit scoring is used as a tool) and one sample from accounts automatically approved.
Sample recent “override” loans, i.e., exceptions to normal underwriting standards, to evaluate the adequacy and consistency of the judgmental decision process.
Sample loans that were 60 days or more delinquent two months ago and are now current to determine whether the customer cured the delinquency through payments or if the account was extended or re-aged. If the latter, determine whether the action was consistent with existing bank policy, and that it complied with the FFIEC Uniform Retail Credit Classification and Account Management Policy.
Sample loans that were recently extended, deferred, renewed, or rewritten for compliance with bank policy and reasonableness. Compliance with bank policy should be judged against the bank’s normal underwriting guidelines with respect to loan-to-value, amortization period, debt or payment limitations, and pricing.
Sample recently charged-off loans and review the borrower, payment, and collection history to determine whether the actions taken pre-charge-off were reasonable or if the practices had the effect of deferring losses.
Based on the results of transactional testing and the severity of concerns identified, determine whether the sample should be expanded.
NOTE:Refer to appendix A, “Transaction Testing,” for additional testing suggestions.
Complete the “RCCP Checklist” in appendix C to determine the bank’s level of compliance with the OCC Bulletin 2000-20, “FFIEC Uniform Retail Credit Classification and Account Management Policy.”
If the bank is involved in higher-risk retail lending, regardless of whether formally designated as subprime, ensure that management realistically identifies the level of risk assumed and that the allowance and capital provide sufficient support for the activity.
If the bank is involved in higher-risk retail lending, regardless of whether formally designated as subprime, ensure that management realistically identifies the level of risk assumed and that the allowance and capital provide sufficient support for the activity.
If the bank is engaged in credit card lending, complete the “Account Management and Loss Allowance Guidance Checklist” in appendix D to determine the bank’s level of compliance with OCC Bulletin 2003-01, “Account Management and Loss Allowance Guidance.”
If the bank relies on third-party vendors for significant functions, review compliance with OCC Advisory Letter 2000-9, “Third-Party Risk,” and OCC Bulletin 2001-47, “Risk Management Principles for Third-Party Relationships.” If further review is warranted, refer to the “Third-Party Management” section in “Supplemental Examination Procedures.”
If the bank offers overdraft protection plans, complete the “Overdraft Programs” section in this booklet’s “Supplemental Examination Procedures.”
Determine the effectiveness of the loan review process for retail lending. Determine the scope and frequency of the reviews and whether loan review provides a risk assessment of the quality of risk management and quantity of risk for retail lending.
NOTE:Refer to the loan review section in this booklet’s “Supplemental Procedures — Risk Management and Control Functions” for additional detail.
Review copies of the materials provided to the board of directors and relevant senior management committees to ensure that the board and senior management are adequately apprised of the condition of the retail credit portfolio and of significant decisions with implications for the quality and performance of the portfolio.
Fully document findings, conclusions, and recommendations in a memorandum for review and approval by the LPM examiner or the EIC. Reach a conclusion with respect to the quality of risk management, the quantity of risk, and the aggregate level and direction of risk, and include all necessary support. To accomplish these ends, complete the following procedures:
Determine whether further work needs to be completed in the retail credit area to fully assess credit risk or other risks. If so, refer to the appropriate supplemental procedures.
Provide criticized and classified asset totals to the LPM examiner or the EIC. In addition to the delinquency-based classifications outlined in the FFIEC Uniform Retail Credit Classification and Account Management Policy, consider bankruptcies, workout programs, repossessed and foreclosed assets, overdrafts, and any other segments that meet the criticized and classified definitions.
Provide retail credit conclusions to the examiner responsible for assessing earnings and capital adequacy.
If the bank securitizes assets, provide conclusions and supporting information about credit quality to the examiner assigned to review securitizations.
If significant violations of laws, rulings, or regulations are noted, prepare write-ups for inclusion in the Report of Examination.
Prepare a recommended supervisory strategy for the retail credit area.
Document findings in OCC systems as appropriate.
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