One Employer, Hundreds of Auto Loans: The Fed Warns About Concentrated Credit Risk

New Federal Reserve guidance expands the discussion from individual borrower risk to portfolio concentration, while ECOA still limits how lenders may respond.

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Last month, federal regulators warned that uncertainty surrounding a borrower’s employment authorization could affect repayment ability and even make collateral harder to recover. Sadly, this requires looking deep into membership segments that many credit unions have come to lean on as their prime sources for membership and loans.

CURepossession covered that issue in July, focusing on the possibility that borrowers and financed vehicles could become more difficult to locate after employment disruption.

Now the Federal Reserve has taken the issue a step further.

In supervisory guidance issued August 13, the Fed warned banks to consider not only the risk posed by individual borrowers, but also the possibility of concentrated exposure by geography, employer or industry.

Read The Guidance Here!

The concern is that one major workforce disruption could trigger problems across hundreds of loans at once.

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From One Borrower to an Entire Portfolio

The Fed specifically warns that employment disruptions could result in what it describes as correlated credit deterioration.

That could occur when a lender has a significant number of borrowers tied to the same employer, industry or local economy.

For example, a bank or credit union may have hundreds of auto loans made to employees of one large manufacturer, agricultural operation, warehouse complex or regional employer.

Each loan may have looked acceptable individually.

But if that employer experiences a major disruption, the lender could suddenly see a concentration of missed payments, hardship requests, delinquencies and repossessions from the same segment of its portfolio.

The Fed also specifically notes that lenders could have difficulty contacting borrowers or locating and repossessing movable collateral such as automobiles, recreational vehicles and boats.

That makes the new guidance broader than the July warning.

The earlier guidance identified the potential repayment and recovery problem.

The Fed is now telling lenders to consider whether that risk may already be concentrated across an entire portfolio.

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Where ECOA Enters the Picture

The guidance also creates an important compliance issue.

The Equal Credit Opportunity Act and Regulation B prohibit discrimination based on protected characteristics such as race, national origin, sex, age and other protected factors.

At the same time, Regulation B permits creditors to consider immigration status when necessary to evaluate repayment risk and the creditor’s ability to enforce its rights.

Those are not the same thing.

A lender can legitimately ask: How much of our portfolio depends on one employer or industry?

That is concentration-risk management.

But a lender cannot simply use an employer, neighborhood or other neutral factor as a substitute for a protected characteristic when making individual credit decisions.

For example:

“We have too much exposure to Employer X.”

is fundamentally different from:

“We do not want to lend to the type of people who work for Employer X.”

The first is portfolio management.

The second can move quickly into fair-lending territory.

The Fed itself notes that its guidance does not change existing fair-lending laws or regulations.

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The ECOA Rules Have Changed, But Not Disappeared

The CFPB revised Regulation B this year to eliminate the agency’s previous disparate-impact interpretation of ECOA.

That reduces one area of fair-lending exposure.

But intentional disparate treatment remains prohibited.

Lenders therefore may have more room to analyze legitimate concentration risks, but underwriting policies still need to be applied consistently and without using geography, employment or other factors as disguised proxies for protected characteristics.

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Collections May Be Where the Risk Finally Appears

For collections departments, the concentration may not become obvious until months or years after origination.

A lender might eventually notice that:

• delinquencies are clustered around one employer;
• hardship requests are concentrated geographically;
• skips are rising in one market;
• repossessions are coming disproportionately from one industry; or
• losses are increasing within a particular segment of the portfolio.

Those trends may indicate more than a collections problem.

They may reveal a concentration that underwriting never fully identified.

That is the most important difference between the earlier regulatory guidance and the Fed’s new warning.

The original concern was whether one borrower might lose income and become harder to collect from.

The new question is whether lenders have unknowingly created portfolios in which one economic disruption could affect hundreds of borrowers at the same time.

For banks and credit unions, that is a legitimate risk to measure.

The challenge will be measuring it without crossing the thin line between prudent concentration management and prohibited discrimination.

One Employer, Hundreds of Auto Loans: The Fed Warns About Concentrated Credit Risk – One Employer, Hundreds of Auto Loans: The Fed Warns About Concentrated Credit Risk – One Employer, Hundreds of Auto Loans: The Fed Warns About Concentrated Credit Risk

Kevin Armstrong

Publisher

One Employer, Hundreds of Auto Loans: The Fed Warns About Concentrated Credit Risk – Credit Union Collections – Credit Union Collectors – Lending – Auto Loan – Skip – Skip – Delinquency – NCUA – NCUA – Repossession –  Repossession