The Office of the Comptroller of Currency (“OCC”) has released new guidelines on credit risk management practices for investor-owned, 1-4 family residential real estate lending where the primary repayment source for the loan is the rental income generated by that property.
Sighting the recent increase in this type of lending, the OCC is prompting Lenders to manage this property as it does its CRE portfolio, rather than treating it as a traditional 1-4 family owner occupied loan. This makes a great deal of sense as it is an income generating venture, regardless of its outer appearance.
The OCC breaks down its guidance into six specific bullet points:
Credit Risk Management Expectations - The OCC explains that Investor Owned Residential Real Estate (“IORR”) has distinct and very different risks involved from traditional 1-4 family lending. The loan is generally repaid by rent and perhaps a bit of the investor’s personal income. The investor may own multiple properties that give this type of loan even higher risk as one unoccupied property greatly lowers revenue and can cascade onto other products. To mitigate this risk, the OCC is suggesting that banks develop policies and procedures , “…suitable for the risks specific to IORR lending. These policies and processes should cover loan underwriting standards; loan identification and portfolio monitoring expectations; allowance for loan and lease losses (“ALLL”) methodologies; and internal risk assessment and rating systems.”
Loan Underwriting Standards - Now that you have your policies and procedures in place, the OCC expect you to use them. Basically, they are recommending your underwriting standards be prudent. The normal standards apply, LTV, financials, etc. But they do point out two interesting things that I do believe are relevant:
- Amortization - the guidance suggests that the Bank consider “both the property’s useful life and the predictability of its future value” when setting up the amortization on this loan type. 1-4 family properties can be fragile and rental properties even more so, given that an owner/occupier will typically take much better care of a house than a renter, because that’s their home. This, again, makes sense. Amortization on these loan types should absolutely take into account the physical deterioration of the property over the course of time, as that would certainly lead to its marketability for potential renters, and by proxy, rental income.
properties - If a borrower is financing multiple rental properties, the guidance
calls for a Global Cash Flow analysis. In addition, it states “Underwriting
standards and the complexity of risk analysis should increase as the number of
properties financed for a borrower and related parties increase.”