Pools of Subprime Loans - Not Classified The ALLL required for subprime loans should be sufficient to absorb at least all estimated credit losses on outstanding balances over the current operating cycle, typically 12 months. The board of directors and management are expected to ensure that the institution's process for determining an adequate level for the ALLL is based on a comprehensive and adequately documented analysis of all significant factors.
The consideration factors should include historical loss experience, ratio analysis, peer group analysis, and other quantitative analysis, as a basis for the reasonableness of the ALLL. To the extent that the historical net charge-off rate is used to estimate expected credit losses, it should be adjusted for changes in trends, conditions, and other relevant factors, including business volume, underwriting, risk selection, account management practices, and current economic or business conditions that may alter such experience.
The allowance should represent a prudent, conservative estimate of losses that allows a reasonable margin for imprecision. Institutions should clearly document loss estimates and the allowance methodology in writing.
This documentation should describe the analytical process used, including: Portfolio segmentation methods applied; Loss forecasting techniques and assumptions employed; Definitions of terms used in ratios and model computations; Relevance of the baseline loss information used; Rationale for adjustments to historical experience; and A reconciliation of forecasted loss rates to actual loss rates, with significant variances explained. New Entrants to the Business In some instances an institution for example, a newly chartered institution or an existing institution entering the subprime lending business may not have sufficient previous loss experience to estimate an allowance for subprime lending activities.
In such cases, industry statistics or another institution's loss data for similar loans may be a better starting point than the institution's own data for developing loss rates to determine the ALLL. When an institution uses loss rates developed from industry statistics or from other institutions to determine its ALLL, it should demonstrate and document that the attributes of the loans in its portfolio or portfolio segment are similar to those in the other institution's or industry's portfolio.
Capital Adequacy The Agencies' minimum capital requirements generally apply to portfolios that exhibit substantially lower risk profiles than exist in subprime loan programs.
Therefore, these requirements may not be sufficient to reflect the risks associated with subprime portfolios. Each subprime lender is responsible for quantifying the amount of capital needed to offset the additional risk in subprime lending activities, and for fully documenting the methodology and analysis supporting the amount specified.
Examiners will evaluate the capital adequacy of subprime lenders on a case-by-case basis, considering, among other factors, the institution's own documented analysis of the capital needed to support its subprime lending activities. Examiners should expect capital levels to be risk sensitive, that is, allocated capital should reflect the level and variability of loss estimates within reasonably conservative parameters.
Examiners should also expect institutions to specify a direct link between the expected loss rates used to determine the required ALLL, and the unexpected loss estimates used to determine capital. Given the higher risk inherent in subprime lending programs, examiners should reasonably expect, as a starting point, that an institution would hold capital against such portfolios in an amount that is one and one half to three times greater than what is appropriate for non-subprime assets of a similar type.
Refinements should depend on the factors analyzed above, with particular emphasis on the trends in the level and volatility of loss rates, and the amount, quality, and liquidity of collateral securing the loans. Institutions with subprime programs affected by this guidance should have capital ratios that are well above the averages for their traditional peer groups or other similarly situated institutions that are not engaged in subprime lending.
Some subprime asset pools warrant increased supervisory scrutiny and monitoring, but not necessarily additional capital.
For example, well-secured loans to borrowers who are slightly below what is considered prime quality may entail minimal additional risks compared to prime loans, and may not require additional capital if adequate controls are in place to address the additional risks.
Because of the higher inherent risk levels and the increased impact that subprime portfolios may have on an institution's overall capital, examiners should document and reference each institution's subprime capital evaluation in their comments and conclusions regarding capital adequacy. Stress Testing An institution's capital adequacy analysis should include stress testing as a tool for estimating unexpected losses in its subprime lending pools. Institutions should project the performance of their subprime loan pools under conservative "stress test" scenarios, including an estimation of the portfolio's susceptibility to deteriorating economic, market, and business conditions.
Portfolio stress testing should include "shock" testing of basic assumptions such as delinquency rates, loss rates, and recovery rates on collateral. It should also consider other potentially adverse scenarios, such as: changing attrition or prepayment rates; changing utilization rates for revolving products; changes in credit score distribution; and changes in the capital markets demand for whole loans, or asset-backed securities supported by subprime loans.
These are representative examples; actual factors will vary by product, market segment, and the size and complexity of the portfolio relative to the institution's overall operations. Whether stress tests are performed manually, or through automated modeling techniques, the Agencies will expect that: The process is clearly documented, rational, and easily understood by the institution's board and senior management; The inputs are reliable and relate directly to the subject portfolios for example, baseline loss history or default probabilities should reflect each segment of the institution's portfolio and not just a blend of prime and subprime borrowers ; Assumptions are well documented and conservative; and Any models are subject to a comprehensive validation process.
About About Overview. Topics Overview. Share This Page:. The guidance attached to this bulletin continues to apply to federal savings associations. The guidance principally applies to institutions with subprime lending programs that equal or exceed 25 percent of an institution's Tier 1 regulatory capital.
For purposes of this guidance, "subprime lending" refers to programs that target borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, or bankruptcies. Office of the Comptroller of the Currency. About About Overview. Topics Overview. Share This Page:.
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