Credit risk is Hilltop’s “strong suit” as we have significant depth of knowledge and experience with the extension of credit in all lending areas (Commercial, Multifamily, Residential mortgage, home equity loans/lines, consumer, SBA, education loans), servicing and monitoring credit risks, loss mitigation and assessing the recoverability of distressed loans. Our services incorporate every aspect of the credit risk cycle i.e. origination to payoff:
- Credit Policies, Credit Review and Controls
- Underwriting Policies and Procedures
- Quality Control (QC) and Compliance Efforts
- Loan Ratings Assessment
- Independent Loan Reviews
- Portfolio Credit Risk Analysis and Asset Management
- Loss Mitigation Efforts
- Fair Value Accounting for loans and securities
- ALLL Analysis and ALLL Calculations (New CECL rules coming in 2020/2021)
Our credit policy and review methodology includes:
- Understanding Management’s risk appetite and its expectations for the Company’s credit policy,
- Assessing credit policy design and effectiveness
- Assisting with the re-design and/or documentation of the credit policy, if needed,
- Designing and implementing loan procedures that adhere to the credit policies,
- Creating monitoring efforts to determine that credit risks are being managed in accordance with Management’s risk appetite,
- Performing credit reviews and controls testing,
- Analyzing the portfolio’s risk trends, delinquency performance, loss frequency and severities,
- Assessing the loan loss mitigation efforts that were executed,
- Reviewing the loan status, borrower financial position and collateral valuation to identify potential loan loss,
- Identifying the impact of projected loan losses on the ALLL and overall financial statements, and
Analyzing risks, deploying loss mitigation activities and understanding loss frequency and severity will help your company with understanding how to change credit and underwriting policies, loan origination and/or loan shipping/delivery (to investors) procedures, as well as, ongoing loan servicing techniques.
Hilltop’s focus on underwriting policies is to analyze and test whether underwriting is consistent with the Company’s overall credit policies, including investor requirements for sold or securitized loans. We often find that underwriters use processes and/or credit policy from their past employers. Our typical underwriting engagements include:
- testing loan decisions (approvals and denials) to assess adherence to credit policy,
- assessing early payment defaults (EPDs) and any trends of such EPDs,
- assessing prepayment experience and identifying underwriting factors that may identify potential early prepayment loans,
- determining that the credit approval decision is properly supported/documented,
- determining if “underwriting exceptions” have documented approval in the loan file,
- assessing whether all significant credit risks for the loan are appropriately identified, and
- assessing whether all tested loan underwriting decisions were made in compliance with the Company’s policies, investor requirements (where applicable) and regulatory requirements.
The Company’s underwriting policies and procedures are a “first line of defense” in the overall controls process to ensuring the its Credit Policy is begin adhered to.
The Company’s “second line of defense” for its overall credit controls is their QC and Compliance efforts. Hilltop has helped many lenders establish these functions and help maximize the effectiveness of such control efforts. A sample of our services are listed below:
- retest a sample of loans that QC and/or Compliance have reviewed to ensure the findings are accurate and complete,
- assess Management’s responses to either the QC or Compliance teams’ findings (were they supportive, pro-active or not),
- assess the completeness of the review performed by QC i.e. are the test procedures consistent with assessing compliance with the Company’s credit policies and/or investor requirements,
- assess the completeness of the review performed by Compliance i.e. are the test procedures consistent with assessing compliance with the Company’s policies and regulatory requirements,
- assess QC’s review of loans where “reps and warranties” have been granted by the Company,
assess whether QC or Compliance have consistently identified those loans where buyers have asked for the loan to be repurchased
Our “Independent Loan Review” for banks is well received by examiners due to the completeness and accuracy of the reviews and their independent nature. Such review is normally provided to the Board, Senior Management (specifically the Chief Credit Officer) and Internal Audit where applicable. Hilltop has designed its “Independent Loan Review” to meet or exceed the requirements of the bank regulatory agencies. The review can be “truly independent” (i.e. where Hilltop sets the scope, procedures and reports findings without any direction from the Company) or can be completed in conjunction with the Company’s Internal Audit or Loan Review groups. Our review can be completed on either an annual or other periodic basis. The scope of the review can include all of the components noted below or can be limited to specific/combination of components.
The “full scope” loan review will include the following components:
- Review the Credit Policy and establish the scope/procedures for a complete review of the Company’s compliance with its’ policies.
- Analyze the loan portfolio risk segments and trends (with particular focus on new types of loans or new credit trends).
- Select the loan sample using both random (for performing loans) and “biased” (for non-performing or high risk loans) sampling processes. The higher risk loans should be identified given the above portfolio risk analysis and the Company’s risk assessments.
- Assess the Company’s Loan Rating policy and process to determine whether it meets the typical standard used by regulatory examiners.
- Test the sample of loans for compliance with both the Company’s loan origination (underwriting, approvals, documentation, etc.) and loan servicing (collections, customer communications, loss mitigation, default activities, etc.) requirements.
- Test the sampled loans to determine if loans have been appropriately rated in compliance with the Company’s policy and/or regulatory requirements. Perform the loan rating review as of a point in time. The full scope Independent Loan Review includes, but is not limited to, the following steps:
- Reviewing/testing the payment status,
- Assessing Management’s risk evaluation and how risk is identified (loan type, portfolio trends, etc.),
- Test procedures to determine compliance with origination, approvals, sales/securitization/own portfolio requirements, loan servicing policies,
- Assess the value of the collateral using the Company’s information and comparing to Company’s assessment,
- Review the borrower and guarantor financial information and economic factors to assess credit risk status, ability to pay, etc.,
- Identifying any risks that may have not been identified at origination,
- Assessing the borrower’s compliance with loan covenant terms and conditions,
- Assessing the Company’s continuous review efforts and rating updates to ensure timely action if the borrower’s credit position changes,
- Assess the scale of ratings and their definitions (5, 8 or 10 point scales) and any instructions of how reviewers should apply such ratings,
- Perform the loan review and identify Hilltop’s independent loan rating.
- Assess the overall credit management activities to determine level of management oversight, actions taken, remediation steps taken for non-compliance issues, etc.
- Determining the potential loss related to such loan that accounting rules would require to be included in the ALLL.
Our report will indicate the procedures performed, the findings, Hilltop recommendations and loan ratings (for commercial/multifamily loan reviews). Where Hilltop’s rating may differ from the Company’s, our team will provide the rationale for its rating and indicate where possible information that the Company may want to consider. For non-commercial loan reviews – ratings are not typically provided but compliance with policy and regulations are the main focus.
Our credit risk professionals and financial modeling team work together to perform risk analyses of our clients’ loan portfolios. We assess the risk analyses and asset management policy/techniques used by our clients to determine if their risk identification efforts are complete and accurate. We assess the loan portfolio’s credit performance to determine if the Company has identified all of the relevant portfolio risks. Our loan portfolio credit risk analyses include, but are not limited to, the following:
- identifying all significant risk components of the loan portfolio and building a credit model to track such risks:
- loan type,
- loan characteristics,
- borrower strength,
- collateral type/strength,
- real estate value trends,
- economic cycles,
- waived credit exceptions vs. losses incurred,
- roll rate analysis,
- econometric factors,
- other specific risks to the type of loan or borrower.
- Identifying risks (such as defaults, early payment delinquency, fraud, etc.) by
- loan originator,
- loan process or underwriting tool used,
- vendors used,
- response rate of loan servicer to first delinquency,
- other processes or personnel consistently involved in high risk loans.
- identifying new and continuing trends in the loan portfolio performance and comparing such to National trends,
- assessing the data quality and integrity,
- assessing the Company’s loss frequency and severity calculations (accuracy, completeness, support for assumptions, etc.),
- reviewing the Company’s cost of restructuring/modification calculations,
- evaluating the personnel and tools used by the Company to perform the portfolio’s credit risk analysis and performance trends (including actual vs. expected performance),
- assessing whether the loss frequency and severity is measured the same for portfolio analytics and financial accounting calculations, including any loan loss risk related to repurchase and indemnification risks,
- assessing the risk of Regulatory or Investor penalties/fines related to regulatory non-compliance (especially for mortgages i.e. HAMP, HARP, State required workouts or modifications, Investor compensatory fees, violations of the loan sales, securitization or servicing agreements,
- assessing the impact of funding, reconciliation and recovery of all required mortgage advances – escrows, foreclosure, P&I, property preservation, etc.,
- assess the impact of recovery efforts for mortgage related anti-repurchase efforts, insurance claims and investor reimbursements.
Hilltop’s risk analytics uses our various modeling and data tools to identify delinquency trends, understand payment dynamics, calculate portfolio by vintage, calculate loss severity and loss frequency, etc. Our independent calculations are used to compare to the Company’s assumptions, assess the accuracy of the Company’s calculations and the probabilities of loss (frequency and severity) which are needed for the ALLL calculations. Our portfolio analytics modeling will also identify the portfolio components that are subject to higher credit risk, higher probability of delinquency, higher loss per loan, etc. The benefit of identifying higher risk loans in the portfolio is that it provides the Company with prioritization in its loss mitigation efforts and better information for its ALLL calculations.
In simple terms – synchronizing the assumptions used by Management for the ALLL calculation with the loan portfolio analytics, loss mitigation impact and NPV calculations is critical. We know that it also provides auditors with a significant “red flag” if there are significant differences between the credit risk analytics and the assumptions used in the ALLL calculations. Therefore, Hilltop has integrated elements of our independent loan review services (all loan types), our default servicing and loss mitigation services and our loan portfolio analytics and valuation services to be able to provide a strong analytical approach and supporting documentation for all ALLL and reserve calculations made by our team to support the Company’s calculations.
Our credit risk analyses go beyond the owned or serviced loan portfolios. We are also very focused on lenders who have sold loans with recourse, have representations and warranties on loan performance (repurchase risk), and/or have agreed to indemnify purchasers of such loans for losses incurred. This type of credit risk was a significant component of the “mortgage crisis”. Our approach to these types of credit risk is to analyze from many perspectives – risk management, accounting, regulatory net worth, and overall exposure to credit losses.
A lender may have excellent credit risk policy in place but without effective controls over compliance with such credit policy and/or appropriate loss mitigation techniques – credit losses will accumulate and likely attract the attention of the regulator. Our consultants with operational experience in the credit loss mitigation area have “hands on” knowledge of the credit loss mitigation efforts that are expected to be performed (whether dictated by bank policy, Federal or State regulators or the investors who own such loans).
Our loss mitigation efforts include assessing whether the lender/servicer is using proven techniques that will reduce credit losses as well as make your company compliant with the applicable regulations. Hilltop assesses all aspects of the Company’s loss mitigation and default servicing processes. We review the policies, walk through the operational processes, interview the key people executing such efforts, assess the technology in use, conduct testing, identify investor or regulator comments, analyze losses taken, etc. We will often suggest using a “triage” concept which “rates” the severity of the borrower’s credit issues and identifies whether more complex work-out efforts are needed. This allows the loan servicer to gain efficiency and effectiveness by having their more experienced credit employees involved in restructuring the serious delinquencies/defaults. Less complex work-outs are handled by less experienced default employees.
Given that many financial institutions carry some or all of their loans and other assets at fair market value, Hilltop has the accounting knowledge and the valuation skills to assist our clients with fair value accounting requirements. Our valuation accounting expertise is deepest for the following asset types:
- Residential mortgages
- Commercial mortgages
- Multifamily mortgages
- Commercial loans
- Home equity lines/loans
- Auto and other consumer loans
- Credit card portfolios
- Financial instruments
- REMICs, CMOs, other MBS or ABS structured finance assets
- CDO, CLO investments
- Mortgage Servicing Rights (MSRs)
- Other loans and intangibles.
The Allowance for Loan and Lease Losses (ALLL) is a critical requirement for regulated financial services companies. A typical finding by regulatory auditors is that the ALLL is not consistent in its assumptions with the credit risk management’s loan ratings and overall portfolio status assessment. Our credit risk consultants and accountants can evaluate the ALLL process to determine the following:
- Is the ALLL calculation performed in accordance with Credit Risk Management policy?
- Does the ALLL calculation consider all of the Credit Review team’s findings i.e. portfolio risk level, trends, new risks, etc.
- Is the ALLL calculation performed accurately and are significant changes tracked as to why such may have occurred?
- Does Management need to document the rationale for any “portfolio risk” adjustments (i.e. “portfolio-wide” reserves)?
- Does Management need to document its rationale for any differences between the ALLL calculation and the balance per the financial statements?
Valuation tools and databases are also an important component in quantifying credit risk. Our credit risk team has worked with and created many credit loss models (especially the NPV models and the modeling of financial alternatives related to loan restructuring). We understand how such models should work, how the results should be used and how the regulators will interpret such. Of course, our focus on the accounting impact of credit losses is never lost. Our credit risk management assessment will review the process from identifying potential credit losses through to the final entries for the ALLL. We have found examples where clients have established the right credit policy, completed the appropriate credit risk analysis and quantification, only to then misinterpret such results when calculating the ALLL and thereby misstating the allowance for loan losses or the reserves for repurchases, warranties, indemnifications. As former CFOs, bank examiners and auditors, we understand the financial and operational aspects of the credit risk function.
Loan loss accounting is also about to change dramatically in 2018 with the implementation of Current Expected Credit Losses (CECL) calculations being completed for the ALLL. Our accountants can help your Company plan for the appropriate loan loss accounting and assist in your transition to the CECL standards for loan losses. Transitioning from the current accounting guidance’s incurred loss approach to CECL will require a significant amount of thought and discussion with key stakeholders. Two key changes that may impact credit modeling include:
- Life-of-loan estimates – one of the most talked about aspects of CECL is the use of a life-of-loan concept, thus creating the potential that estimates need to cover a longer loss horizon.
- To determine the life of the loan time horizon, an institution could take the weighted average life of the loan (by portfolio) to estimate the time horizon over which to forecast losses.
- Banks can then begin developing life-of-loan loss estimates and justify adjustments from the historic average losses.
Reasonable and supportable forecasts will be key to implementing the CECL model. Management’s assessment of current conditions and forecasts about future conditions will become more important and will need to be justified. Forecasts may require:
- Significant reliance on Management’s judgment where detailed long-term forecasts are not available.
- Regulatory “stress scenarios” are not intended to be used for accounting purposes.
- Processes to support the macroeconomic scenarios used in ALLL estimates under CECL will need to be developed and documented. Such processes will need to be used consistently.
Hilltop’s senior management members have been involved in one or more of the aspects of loan review throughout their careers. However, the differentiator for Hilltop is that our professionals conduct such reviews from a number of different perspectives – credit policy backgrounds, risk management, accountant, auditor, bank examiner, etc. We are not just “underwriters” or “due diligence document reviewers”. We understand the various idiosyncrasies of credit risk that impact how regulators, auditors and investors think. We also understand the loan underwriting and monitoring processes that are required to maintain the appropriate credit reserves.