Last November, the Federal Deposit Insurance Company issued a warning to
banks about the hazards of secondary market participation with third-party
lenders. Their report, titled
Advisory on Effective Risk Management Practices for Purchased Loan Participations (FIL-49-2015), advises banking institutions on several safe-lending practices.
The advisory stresses the need for banks to employ stringent underwriting
standards and to exercise proper due diligence when dealing with non-institutional
lenders. With the expansive growth in the origination of third-party loans,
there is an increase in risk exposure associated with the purchase of
those loans by federally insured banks. Third-party lenders often do not
utilize the same underwriting standards as big banks; as such, these loans
may have defects that are not uncovered until after a purchase and could
expose banks to future losses.
While banks are unable or unwilling to participate in small business or
neighborhood consumer lending, they have been quick to snap up loans originated
by independent and non-institutional lenders. The FDIC has indicated that
many banks have been participating in the purchase of loans that rely
on proprietary or non-bank standards when being underwritten. The agency
has expressed fear that exposure to poor underwriting and qualification
guidelines could lead to losses for the bank or its investors.
In the advisory, the FDIC indicates an interest in seeing that banks can
participate in, and even expand their commitment to third-party small
business and consumer lending, but advises them to take a more involved
approach to originating and purchasing those loans. The agency believes
it to be in the best interest of the banks to become more involved at
a local level, understanding how originating lenders are qualifying borrowers,
and ensuring that they maintain proper risk assessment and oversight.
The government is advising banks to do the following before purchasing
any third-party non-bank mortgage debt:
- Ensure the loans that are considered for purchase adhere to stringent bank
- Proactively analyze credit and collateral; use due diligence and manage
possible risks as if it were a direct customer. Complete extensive examination
of out-of-state loans to evaluate and consider risks involved.
- Ensure the loan sale or participation agreement fully outlines the roles
of all parties to the loan.
- Ensure extensive board oversight into the practices of and exposure to
third-party relationships. Conduct thorough reporting that specifies to
the board the level of performance and risk associated with each purchase.
The agency believes that these actions, while they may seem overly aggressive,
may help banks avoid future losses from over-exposure. The recommendations
come as a way for the FDIC to provide guidance, rather than regulations
for the bank to follow. The hope is that the banks will voluntarily improve
their risk assessment to better protect the institution, the government,
and the taxpayer from another round of devastating losses.
Contact Geraci Law Firm at (949) 298-8050 today, or contact
for more information.