Sunday, October 22, 2017

New OCC Guidance Released on Investor Owned Properties

Posted by Tom October 2, 2012 11:07am

Photo Credit: phanlop88

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.
  • Multiple 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.”   
Loan Identification and Portfolio Monitoring Expectations - This one is pretty straight forward. These types of properties should (if not already) be identified and segregated from the traditional one to four family loans in the portfolio. This way they can be tracked and effectively monitored for risk and concentration purposes as they are distinctly different.  The loans can probably be easily coded at set up and monitored in a similar fashion as multi family or mixed use units.

Allowance for Loan and Lease Losses Considerations - Somehow, it always comes back to the ALLL.  The guidance  suggests that the IORR loans be segregated on the  calculation as its own group, akin to separate groups for CRE, C&I etc., and be evaluated for ASC-450 under that heading.  The rest of the ALLL guidelines are straight forward (Qualitative factors, ASC-310 impairment analysis, etc.) Or at least, they aren’t any more complicated than they were before this document was issued.

Internal Risk Assessment and Rating Systems - Here the guidance suggests that for loan classification purposes, the loans should be evaluated for risk based more on the CRE model than the 1-4 Family model.   It again emphasizes that, “The complexity of the ongoing analysis and risk rating should be commensurate with the number of properties financed globally by the borrower.” The guidance goes on to state that  a bank that is heavily involved in these loans may even want to develop its own risk  rating system specifically for this type of lending, but I  don’t see that becoming a rampant requirement. Bottom line – don’t risk rate like a one to four, and you’re on the right track.
 
Regulatory Reporting, HOLA, and Risk-Based Capital Treatment - Finally, the guidance states that:  “…Banks should continue to report IORR loans that meet the call report definition of one- to four-family residential lending in that category. IORR loans continue to qualify as residential real property loans under HOLA. IORR loans will qualify for the 50% risk-based capital category if certain regulatory requirements are met. IORR loans that do not meet the criteria will fall into a higher risk-based capital category”

So bear that in mind when putting together the Call Report on a quarterly basis.

Overall, I think this is a very well thought out and beneficial set of guidelines for Banks, especially those who may have more than a few of these loan types. The OCC is absolutely correct in stating that these loans do come with a different and higher set of risks, and just because it looks like 1-4 family unit, and acts like a 1-4 family unit, does not mean it’s going to make its payments the same as a 1-4 family unit.

To read the official release, please click here.

 

 

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