2. overview of lending controls 2016• the “bread and butter” loans for credit unions •...

Overview of Lending Controls

CARRIE KENNEDY, PARTNERARAN LOFTUS, SENIOR MANAGER

Disclaimer

The material appearing in this presentation is for informationalpurposes only and should not be construed as advice of anykind, including, without limitation, legal, accounting, orinvestment advice. This information is not intended to create,and receipt does not constitute, a legal relationship, including,but not limited to, an accountant‐client relationship. Althoughthis information may have been prepared by professionals, itshould not be used as a substitute for professional services. Iflegal, accounting, investment, or other professional advice isrequired, the services of a professional should be sought.

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Presentation Objectives

• Overview of credit union lending• Identify key controls in the lending function• Distinguish differences between major lending programs

• Review common audit and exam findings

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Credit Union Lending Overview

It’s a great time to be a credit union!

• Net income at highest point in 7 years• CUNA compiled loan growth rates were 10.5% for 2015; best year since 20005

• Memberships up 3.5%; best year since 1984• Net charge offs steady at 48bps• Reportable delinquencies inching up slightly to around 0.84% of loans

• Net worth remains strong at 10.9% for the industry4


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Internal Control Considerations

• What is the tone?• Ethical tenor starts at top management and trickles down• Code of conduct• Lending Committees

• Credit Union can control “opportunities” for fraud

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• Internalcontrolobjectivesaredesiredgoalsorconditionsforaspecificeventcyclewhich,ifachieved,minimizethepotentialthatwaste,loss,unauthorizeduseormisappropriatewilloccur.Theyareconditionswhichwewantthesystemofinternalcontroltosatisfy.

• Foracontrolobjectivetobeeffective,compliancewithitmustbemeasurableandobservable.

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• Internal controls can be preventative or detective in nature.

• Preventative controls are designed to keep errors or irregularities from occurring in the first place.

• Detective controls are designed to detect errors or irregularities that may have occurred.

• Are processes in place to correct errors or irregularities that have been detected?

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• Lending function can be broadly divided into the following categories:

• Program development and sales• Origination and disbursement• Ongoing maintenance and reporting• Credit supervision and monitoring

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Policies

Sets the tone and communicates strategy! • Drafted by management and approved by the Board• Common items addressed in policy:

• Basic elements of strategy including desirable loan types• Underwriting guidelines by loan type• Loan approval guidelines• Concentration limits• Loan workout scenarios, modifications, and impairments• Consideration of risk ratings and reference to related allowance policy

• Collateral review and monitoring including appraiser qualifications

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Loans – Originating and Disbursement

• Origination Process

• Includes initial documentation gathering

• Member and management time intensive

• Involves valuation and perfection of collateral

• The overall underwriting process

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• Origination• Approval levels are appropriate – extends to exceptions! • Collateral liens

• UCC searches and filings• Filing deed of trust• Title policies• Freezing shares

• Quality control review to ensure all collateral liens have been perfected

• Tickler system for outstanding documents not yet received

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Loans – Originating and Disbursement • Appraisal reviews ‐How are you comfortable the appraisal can be

relied upon?

• Approved appraiser

• Appraisal review conducted by independent qualified 3rd party,

either internal or external party

• Usually a “desk review” and includes:

• Description of the property and conclusion on appraisers value

• Discussion of key assumptions used by the appraiser

• Summary of the appraisers findings

• Ultimate conclusion on value compared to appraisers findings

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• Disbursement• Performed by individual separate from the origination/underwriting process

• Ensure proceeds are used for the borrower’s stated loan purpose

• Unable to segregate disbursement function???

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Loans – Loan Review

• Boarding review

• Detects common errors such as interest rate and maturity

date errors

• Quality control review

• Determine whether loans adhere to the loan policy

• Conducted by personnel independent of credit functions

• Don’t rely on your external auditors!

• Review of bancontrol and escrow accounts

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Loans – Loan Review

• Credit Quality Review

• Increasing in frequency at Credit Unions with the increase

in member business lending and indirect loans.

• Usually performed by external 3rd party. Who manages

the process at your institution?

• Can be tied in with QC loan reviews, but ultimate purpose

is to validate the credit evaluation/monitoring by the

Credit Union.

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Loans – Credit Supervision/Monitoring• Common Key Credit Risk Indicators

• Delinquency (60+ days past due)

• Early stage delinquency (1 – 59 days past due)

• Charge‐off history

• FICO/LTV/loan grade migration

• Concentrations

• Multiple modifications/extensions and renewals

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Loans – Credit Supervision/Monitoring

• Questions to ask regarding monitoring:

• Is the loan review function independent of the credit administration and loan approval processes?

• Are any loan findings reported directly to the board of directors or board level committee?

• Does the board receive necessary and reliable information on a regular basis to assess potential risks within the lending portfolio?

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Loans – Credit Supervision/Monitoring• Questions to ask regarding monitoring:

• Are procedures in place to ensure the prompt identification of loans with well‐defined weaknesses and relevant lending patterns that may potentially be indicative of fictitious or fraudulent activity?

• Do loan review personnel have the knowledge and confidence to challenge transactions that look suspicious?

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Loans – Fraud Controls

• Common detective controls to identify errors and/or fraud• Review “high/low” rate reports• Multiple loans to similar address• File maintenance reports should be reviewed for:

• Advancing payment due dates• Changes in interest rates• Changes of the payment amount• Several address changes to the same address• Changing the payment frequency

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Loans – Fraud Controls

• Other fraud and error detection

• Overdraft reports reviewed for:• Overdrafts created for purpose of “paying” loan

• Large amount of interest is due, but the loan is current

• Original loan amount and current loan amount are the same, but the loan is not delinquent

• Review of employee and official loans

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Loans – General Controls

• Additional controls to consider

• Reconciling loan subsidiaries to the general ledger

• Global rate change review

• Loan exception reporting

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Loans – Reporting to Members

• Member statements are the final detection controls

• Proper controls over no‐mail and print suppressed

statements

• Reconciling total statements processed to members

• Timely response to member inquiries

• Closed account review

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Internal Reporting and Monitoring

We have all this data – now what?

• Common monitoring reports:• Loans by risk rating• Loans by type and collateral• Loans by branch and/or officer• Delinquency reporting• Charge off and recovery reporting• Watch list – this is a key report!

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Who should be reviewing what?

• Management – the aforementioned reports

• Board – Totals, new loan originations, charge offs, delinquency, exceptions, a summarized watch report, 5300 call report and audited financial statements

• Supervisory Committee – audited financials, control exceptions, internal auditor reports

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What role does the internal auditor play?

• Periodic audits of loan terms, file completeness and compliance

• Periodic audits of key member lending controls• Report audit findings to the supervisory committee• Coordinate independent loan file review engagement• Coordinate independent allowance for loan losses validation

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Consumer Loans

• The “bread and butter” loans for credit unions

• Personal lines of credit• Credit cards• Auto, recreational vehicle, and misc. consumer goods• Indirect• HELOC

The ability to efficiently fund these loans is key to credit union success!

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Consumer Loans – Key Considerations

• Where is approval occurring?• Is an automated system in place? • How is QC performed on these loans?• Can they be self‐funded? • Are exceptions tracked, monitored, analyzed?

• Additional considerations for indirect loans:• Dealership due diligence – don’t rely on others! • Specific monitoring reports based on dealer performance

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Mortgages

• An essential part of the member experience

• First mortgages• Second mortgages• Specialized lending programs:

• HUD• GNMA• FNMA

These loans bring increased compliance risk!

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Mortgages – Key Considerations

• Where is approval occurring?• Is an automated system in place? • How is QC performed on these loans?• Are exceptions tracked, monitored, analyzed?• Are loans retained or sold?

• Compliance considerations – TRID, Flood, RESPA, TILA, qualified mortgages, etc.

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Member Business Lending

• What is member business lending?• In short, these are loans to businesses! • Proceeds from the loan are used to purchase business related assets or for investment purposes

• Common member business loans are for:• Purchase of commercial real estate for use by the business or for investment purposes

• Construction • Purchase of equipment for use by the business• Purchase of residential rental property• Lines of credit to fund short term cash flow needs

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• Common definitions:• CRE – Commercial Real Estate• C&I – Commercial and Industrial• Owner occupied – the purchaser occupies the property and uses it for

their business. Ex: Auto repair shop• Non‐owner occupied – the owner rents to third parties. Ex: Shopping

center• SBA Loans ‐ loans guaranteed by the Small Business Administration

and subject to the specific requirements as defined by the SBA. • Revolving lines of credit – loans used for short term cash flow needs

and require periodic repayment. Ex. Credit cards

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• Common definitions (continued):• Participations and loan pools – loans funded with other credit unions.

• Participation sold – the credit union sells a portion of the loan to another credit union

• Participation purchased – the credit union purchases a portion of a loan from another credit union

• Loan pools – A grouping of similar loans purchased from, or sold to, another credit union. Commonly used for auto loans.

• TAKE AWAY – If your Credit Union is involved in these activities or considering these transactions, we recommend having a conversation with your auditor and management regarding accounting requirements.

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Member Business Lending – Key Considerations

• How is QC performed on these loans?• Are exceptions tracked, monitored, analyzed?• Are loans retained or sold? • How are risk ratings considered in the allowance?• Timeliness of tickler items cleared • Timeliness of annual reviews

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Common Findings

• Overarching: • Lack of a clearly defined strategy• Lack of comprehensive governing policies• Management team not qualified

• Controls:• Loan boarding controls deficient or do not exist• Lack of file maintenance controls• Impairments are not recognized in a timely manner• Risk ratings are not accurately input to the allowance for loan losses

• Physical security controls

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Common Findings

• Additional findings: • Policy exceptions not approved• Appraisal reviews not completed or not subject to segregation of duties

• Lack of covenant monitoring (tickler systems)• Adding lines of business or loan types without accompanying policy

• Purchasing loans outside the credit union’s operating region

• Monitoring a borrower’s global financial picture• Lack of well defined workout strategies

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Common Findings

• Implications of findings:• Regulatory documents of resolution and higher CAMELS ratings

• Inability to fund new member business loans• Excessive risk levels in the portfolio• Reputational and economic costs due to errors in the funding and servicing process

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Thank you! Carrie KennedyAssurance Services Partner – Financial Institutions(509) 777‐[email protected]

Aran Loftus, CPAAssurance Services Senior Manager – Financial Institutions(503) 478‐[email protected]

2. overview of lending controls 2016• the “bread and butter” loans for credit unions •...

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