Subprime Lending

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BOARD OF GOVERNORS

OF THE

FEDERAL RESERVE SYSTEM

WASHINGTON, D.C. 20551

DIVISION OF BANKING

SUPERVISION AND REGULATION

SR 01-4 (GEN)

January 31, 2001

Revised June 2, 2026

Revision History:

On June 2, 2026: This letter’s attachment, Expanded Guidance for Subprime Lending

Programs, was revised to remove references to reputational risk.

TO THE OFFICER IN CHARGE OF SUPERVISION

AT EACH FEDERAL RESERVE BANK

SUBJECT: Subprime Lending

The Board of Governors of the Federal Reserve System, along with the Office of the

Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Office of Thrift

Supervision (the Agencies), has developed expanded examination guidance on subprime lending.

(See the attached interagency statement.) The purpose of the expanded guidance is to strengthen

the Agencies’ supervision of institutions with subprime lending programs. The guidance is

directed primarily to those institutions that have subprime lending programs that equal or exceed

25 percent of tier 1 regulatory capital.

The Agencies continue to believe that responsible subprime lending can expand credit

access for consumers and offer attractive returns provided that institutions recognize and manage

the unique risks associated with this activity. This expanded guidance supplements the

supervisory statement, Interagency Guidance on Subprime Lending (See SR letter 99-06) issued

in March 1999.

The guidance discusses a number of issues including:

•

The characteristics of a subprime lending program.

•

A set of specific borrower characteristics that may indicate an institution is involved

in the subprime lending market.

•

Analysis and documentation standards for the allowance for loan and lease losses

(ALLL).

on Subprime Lending (See SR letter 99-06) issued

in March 1999.

The guidance discusses a number of issues including:

•

The characteristics of a subprime lending program.

•

A set of specific borrower characteristics that may indicate an institution is involved

in the subprime lending market.

•

Analysis and documentation standards for the allowance for loan and lease losses

(ALLL).

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•

Factors to be considered when determining the appropriate level of capital needed to

support subprime lending.

•

A discussion of examination procedures for assessing the quality of subprime loan

portfolios.

•

A list of potentially predatory or abusive lending practices that safety and soundness

examiners would criticize.

Reserve Banks are asked to distribute this SR letter and attached interagency guidance to

regulated institutions in their districts and to their supervisory staff. Any questions may be

addressed to Arleen Lustig, Supervisory Financial Analyst, at (202) 452-2987 or Norah Barger,

Deputy Assistant Director, at (202) 452-2402.

Richard Spillenkothen

Director

Attachment:

• Expanded Guidance for Subprime Lending Programs

Cross References:

• SR 99-6, “Subprime Lending”

In June 2026, this document was revised to remove references to reputational risk.

Office of the Comptroller of the Currency

Board of Governors of the Federal Reserve System

Federal Deposit Insurance Corporation

Office of Thrift Supervision

Subject: Subprime Lending

Description: Expanded Guidance for Subprime

Lending Programs

Purpose of Guidance

The Office of the Comptroller of the Currency, the Federal Reserve Board, the Federal

Deposit Insurance Corporation, and the Office of Thrift Supervision (the Agencies) are

expanding previously issued examination guidance for supervising subprime lending

activities.1 The Agencies continue to believe that responsible subprime lending can

expand credit access for consumers and

e of Guidance

The Office of the Comptroller of the Currency, the Federal Reserve Board, the Federal

Deposit Insurance Corporation, and the Office of Thrift Supervision (the Agencies) are

expanding previously issued examination guidance for supervising subprime lending

activities.1 The Agencies continue to believe that responsible subprime lending can

expand credit access for consumers and offer attractive returns. However, we expect

institutions to recognize that the elevated levels of credit and other risks arising from

these activities require more intensive risk management and, often, additional capital.

This expanded guidance discusses supervisory expectations for the Allowance for Loan

and Lease Losses (ALLL), regulatory capital, examination review of subprime activities,

classification of risk, and documentation for re-aging, renewing, or extending delinquent

accounts. This guidance also discusses regulatory expectations for the review and

treatment of certain potentially abusive lending practices.

Contents

Purpose of Guidance ........................................................................................................... 1

Applicability of Guidance ................................................................................................... 2

Risk Management Expectations .......................................................................................... 3

Allowance for Loan and Lease Losses (ALLL) and Capital Expectations ........................ 3

ALLL Adequacy ............................................................................................................. 4

Capital Adequacy ............................................................................................................ 5

Examination Review and Analysis ..................................................................................... 7

Transaction-Level Testing .............................................................................................

........................... 4

Capital Adequacy ............................................................................................................ 5

Examination Review and Analysis ..................................................................................... 7

Transaction-Level Testing .............................................................................................. 8

Classification Guidelines for Subprime Lending ................................................................ 9

Individual Loans ............................................................................................................. 9

Portfolios ......................................................................................................................... 9

Required Documentation for Cure Programs ................................................................... 10

Predatory or Abusive Lending Practices........................................................................... 10

Summary ........................................................................................................................... 11

1 Interagency Guidance on Subprime Lending, March 1, 1999.

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Applicability of Guidance

This expanded guidance applies specifically to those institutions that have subprime

lending programs with an aggregate credit exposure greater than or equal to 25% of tier 1

capital.2 Aggregate exposure includes principal outstanding and committed, accrued and

unpaid interest, and any retained residual assets3 relating to securitized subprime loans.

The Agencies may also apply these guidelines to certain smaller subprime portfolios,

such as those experiencing rapid growth or adverse performance trends, those

administered by inexperienced management, and those with inadequate or weak controls

includes principal outstanding and committed, accrued and

unpaid interest, and any retained residual assets3 relating to securitized subprime loans.

The Agencies may also apply these guidelines to certain smaller subprime portfolios,

such as those experiencing rapid growth or adverse performance trends, those

administered by inexperienced management, and those with inadequate or weak controls.

This guidance is meant to intensify examination scrutiny of institutions that

systematically target the subprime market through programs that employ tailored

marketing, underwriting standards, and risk selection. In accordance with previously

issued guidance, such lending should be conducted in a segregated program, portfolio,

and/or portfolio segment. The term “program” refers to the process of acquiring on a

regular or targeted basis, either through origination or purchase, subprime loans to be

held in the institution’s own portfolio or accumulated and packaged for sale. The average

credit risk profile of such programs or portfolios will likely display significantly higher

delinquency and/or loss rates than prime portfolios.

Exclusions - For purposes of this guidance, subprime lending does not refer to individual

subprime loans originated and managed, in the ordinary course of business, as exceptions

to prime risk selection standards. The Agencies recognize that many prime loan

portfolios will contain such accounts. Additionally, this guidance will generally not

apply to: prime loans that develop credit problems after acquisition; loans initially

extended in subprime programs that are later upgraded, as a result of their performance,

to programs targeted to prime borrowers; and community development loans as defined

in the CRA regulations that may have some higher risk characteristics, but are otherwise

mitigated by guarantees from government programs, private credit enhancements, or

other appropriate risk mitigation techniques

tially

extended in subprime programs that are later upgraded, as a result of their performance,

to programs targeted to prime borrowers; and community development loans as defined

in the CRA regulations that may have some higher risk characteristics, but are otherwise

mitigated by guarantees from government programs, private credit enhancements, or

other appropriate risk mitigation techniques.

The term “subprime” refers to the credit characteristics of individual borrowers.

Subprime borrowers typically have weakened credit histories that include payment

delinquencies, and possibly more severe problems such as charge-offs, judgments, and

bankruptcies. They may also display reduced repayment capacity as measured by credit

scores, debt-to-income ratios, or other criteria that may encompass borrowers with

incomplete credit histories. Subprime loans are loans to borrowers displaying one or

more of these characteristics at the time of origination or purchase. Such loans have a

higher risk of default than loans to prime borrowers. Generally, subprime borrowers will

2 Tier 1 capital as defined in the Agencies' risk-based capital standards: 12 CFR part 3, Appendix A (OCC); 12 CFR

part 208, Appendix A (Federal Reserve); Part 325, Appendix A (FDIC); 12 CFR 565.2(h) (OTS).

3 Residual interests are on-balance sheet assets that represent interests (including beneficial interests) in transferred

financial assets retained by a seller (or transferor) after a securitization or other transfer of financial assets; and are

structured to absorb more than a pro rata share of credit loss related to the transferred assets through subordination

provisions or other credit enhancement techniques.

s are on-balance sheet assets that represent interests (including beneficial interests) in transferred

financial assets retained by a seller (or transferor) after a securitization or other transfer of financial assets; and are

structured to absorb more than a pro rata share of credit loss related to the transferred assets through subordination

provisions or other credit enhancement techniques.

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display a range of credit risk characteristics that may include one or more of the

following:

▪ Two or more 30-day delinquencies in the last 12 months, or one or more 60-

day delinquencies in the last 24 months;

▪ Judgment, foreclosure, repossession, or charge-off in the prior 24 months;

▪ Bankruptcy in the last 5 years;

▪ Relatively high default probability as evidenced by, for example, a credit

bureau risk score (FICO) of 660 or below (depending on the

product/collateral), or other bureau or proprietary scores with an equivalent

default probability likelihood; and/or

▪ Debt service-to-income ratio of 50% or greater, or otherwise limited ability to

cover family living expenses after deducting total monthly debt-service

requirements from monthly income.

This list is illustrative rather than exhaustive and is not meant to define specific

parameters for all subprime borrowers. Additionally, this definition may not match all

market or institution specific subprime definitions, but should be viewed as a starting

point from which the Agencies will expand examination efforts.

Risk Management Expectations

The Agencies’ March 1999 guidance outlined the risks associated with subprime lending,

examination objectives for supervisory reviews, and the Agencies’ expectations for risk

management standards necessary to manage and control subprime lending activities

itions, but should be viewed as a starting

point from which the Agencies will expand examination efforts.

Risk Management Expectations

The Agencies’ March 1999 guidance outlined the risks associated with subprime lending,

examination objectives for supervisory reviews, and the Agencies’ expectations for risk

management standards necessary to manage and control subprime lending activities.

Examiners should continue to carefully assess management’s ability to administer the

higher risk in subprime portfolios using the March 1999 Interagency Guidance and any

supplemental Agency-specific guidelines issued in conjunction with that document. In

particular, management’s ability should be judged by the quality of the risk management

and control processes in place, and more importantly, the extent to which management is

adhering to those processes. When examiners determine that risk management practices

are deficient, they should criticize management and initiate corrective action. Such

actions may include formal or informal enforcement actions and/or a plan to achieve

adequate capitalization. When a primary supervisor determines that an institution’s

risk management practices are materially deficient, the primary supervisor may

instruct the institution to discontinue its subprime lending programs.

Allowance for Loan and Lease Losses (ALLL) and Capital Expectations

Examiners should perform specific evaluations of the ALLL and regulatory capital

allocated to support subprime lending programs. The total protection for subprime asset

programs should consist of adequate levels of each component. Expectations for sound

risk management programs include the ability to determine and quantify appropriate

levels for each component.

and Capital Expectations

Examiners should perform specific evaluations of the ALLL and regulatory capital

allocated to support subprime lending programs. The total protection for subprime asset

programs should consist of adequate levels of each component. Expectations for sound

risk management programs include the ability to determine and quantify appropriate

levels for each component.

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ALLL Adequacy

Examiners should assess the adequacy of the ALLL to ensure that the portion allocated to

the subprime portfolio is sufficient to absorb estimated credit losses for this portfolio.

Consistent with interagency policy,4 the term “estimated credit losses” means an estimate

of the amount that is not likely to be collected; that is, net charge-offs that are likely to be

realized given the facts and circumstances as of the evaluation date.5 These estimated

losses should meet the criteria for accrual of loss contingency set forth under generally

accepted accounting principles, consistent with supervisory ALLL policy.

Classified and Other Problem Loans

Examiners should classify subprime loans and portfolios in accordance with the

guidelines contained herein and other applicable Agency guidelines. Classified loans are

loans that are not protected adequately by the current sound worth and paying capacity of

the borrower or the collateral pledged. As such, full liquidation of the debt may be in

jeopardy. Pools of classified subprime loans (to include, at a minimum, all loans past due

90 days or more) should be reviewed for impairment, and an adequate allowance should

be established consistent with existing interagency policy.

Pools of Subprime Loans - Not Classified

The ALLL required for subprime loans should be sufficient to absorb at least all

estimated credit losses on outstanding balances over the current operating cycle, typically

12 months

all loans past due

90 days or more) should be reviewed for impairment, and an adequate allowance should

be established consistent with existing interagency policy.

Pools of Subprime Loans - Not Classified

The ALLL required for subprime loans should be sufficient to absorb at least all

estimated credit losses on outstanding balances over the current operating cycle, typically

12 months. The board of directors and management are expected to ensure that the

institution's process for determining an adequate level for the ALLL is based on a

comprehensive and adequately documented analysis of all significant factors. The

consideration factors should include historical loss experience, ratio analysis, peer group

analysis, and other quantitative analysis, as a basis for the reasonableness of the ALLL.

To the extent that the historical net charge-off rate is used to estimate expected credit

losses, it should be adjusted for changes in trends, conditions, and other relevant factors,

including business volume, underwriting, risk selection, account management practices,

and current economic or business conditions that may alter such experience. The

allowance should represent a prudent, conservative estimate of losses that allows a

reasonable margin for imprecision. Institutions should clearly document loss estimates

and the allowance methodology in writing. This documentation should describe the

analytical process used, including:

4 Interagency Policy Statement on the Allowance for Loan and Lease Losses, December 21, 1993.

5 Estimates of credit losses should include accrued interest and other accrued fees (e.g., uncollected credit card fees or

uncollected late fees) that have been added to the loan balances and, as a result, are reported as part of the institution’s

loans on the balance sheet

process used, including:

4 Interagency Policy Statement on the Allowance for Loan and Lease Losses, December 21, 1993.

5 Estimates of credit losses should include accrued interest and other accrued fees (e.g., uncollected credit card fees or

uncollected late fees) that have been added to the loan balances and, as a result, are reported as part of the institution’s

loans on the balance sheet. An institution may include these types of estimated losses in either the ALLL or a separate

valuation allowance, which would be netted against the aggregated loan balance for regulatory reporting purposes.

When accrued interest and other accrued fees are not added to the loan balances and are not reported as part of loans on

the balance sheet, the collectability of these accrued amounts should nevertheless be evaluated to assure that the

institution’s income is not overstated.

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▪ Portfolio segmentation methods applied;

▪ Loss forecasting techniques and assumptions employed;

▪ Definitions of terms used in ratios and model computations;

▪ Relevance of the baseline loss information used;

▪ Rationale for adjustments to historical experience; and

▪ A reconciliation of forecasted loss rates to actual loss rates, with significant

variances explained.

New Entrants to the Business

In some instances an institution (for example, a newly chartered institution or an existing

institution entering the subprime lending business) may not have sufficient previous loss

experience to estimate an allowance for subprime lending activities. In such cases,

industry statistics or another institution’s loss data for similar loans may be a better

starting point than the institution’s own data for developing loss rates to determine the

ALLL

chartered institution or an existing

institution entering the subprime lending business) may not have sufficient previous loss

experience to estimate an allowance for subprime lending activities. In such cases,

industry statistics or another institution’s loss data for similar loans may be a better

starting point than the institution’s own data for developing loss rates to determine the

ALLL. When an institution uses loss rates developed from industry statistics or from

other institutions to determine its ALLL, it should demonstrate and document that the

attributes of the loans in its portfolio or portfolio segment are similar to those in the other

institution’s (or industry’s) portfolio.

Capital Adequacy

The Agencies’ minimum capital requirements generally apply to portfolios that exhibit

substantially lower risk profiles than exist in subprime loan programs. Therefore, these

requirements may not be sufficient to reflect the risks associated with subprime

portfolios. Each subprime lender is responsible for quantifying the amount of capital

needed to offset the additional risk in subprime lending activities, and for fully

documenting the methodology and analysis supporting the amount specified.

Examiners will evaluate the capital adequacy of subprime lenders on a case-by-case

basis, considering, among other factors, the institution’s own documented analysis of the

capital needed to support its subprime lending activities. Examiners should expect

capital levels to be risk sensitive, that is, allocated capital should reflect the level and

variability of loss estimates within reasonably conservative parameters. Examiners

should also expect institutions to specify a direct link between the expected loss rates

used to determine the required ALLL, and the unexpected loss estimates used to

determine capital

vities. Examiners should expect

capital levels to be risk sensitive, that is, allocated capital should reflect the level and

variability of loss estimates within reasonably conservative parameters. Examiners

should also expect institutions to specify a direct link between the expected loss rates

used to determine the required ALLL, and the unexpected loss estimates used to

determine capital.

The sophistication of this analysis should be commensurate with the size, concentration

level, and relative risk of the institution’s subprime lending activities and should consider

the following elements:

▪ Portfolio growth rates;

▪ Trends in the level and volatility of expected losses;

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▪ The level of subprime loan losses incurred over one or more economic

downturns, if such data/analyses are available;

▪ The impact of planned underwriting or marketing changes on the credit

characteristics of the portfolio, including the relative levels of risk of default,

loss in the event of default, and the level of classified assets;

▪ Any deterioration in the average credit quality over time due to adverse

selection or retention;

▪ The amount, quality, and liquidity of collateral securing the individual loans;

▪ Any asset, income, or funding source concentrations;

▪ The degree of concentration of subprime credits;

▪ The extent to which current capitalization consists of residual assets or other

potentially volatile components;

▪ The degree of legal risk associated with the subprime business line(s) pursued;

and

▪ The amount of capital necessary to support the institution’s other risks and

activities.

Given the higher risk inherent in subprime lending programs, examiners should

reasonably expect, as a starting point, that an institution would hold capital against such

portfolios in an amount that is one and one half to three times greater than what is

appropriate for non-subprime assets of a similar type

amount of capital necessary to support the institution’s other risks and

activities.

Given the higher risk inherent in subprime lending programs, examiners should

reasonably expect, as a starting point, that an institution would hold capital against such

portfolios in an amount that is one and one half to three times greater than what is

appropriate for non-subprime assets of a similar type. Refinements should depend on the

factors analyzed above, with particular emphasis on the trends in the level and volatility

of loss rates, and the amount, quality, and liquidity of collateral securing the loans.

Institutions with subprime programs affected by this guidance should have capital ratios

that are well above the averages for their traditional peer groups or other similarly

situated institutions that are not engaged in subprime lending.

Some subprime asset pools warrant increased supervisory scrutiny and monitoring, but

not necessarily additional capital. For example, well-secured loans to borrowers who are

slightly below what is considered prime quality may entail minimal additional risks

compared to prime loans, and may not require additional capital if adequate controls are

in place to address the additional risks. On the other hand, institutions that underwrite

higher-risk subprime pools, such as unsecured loans or high loan-to-value second

mortgages, may need significantly higher levels of capital, perhaps as high as 100% of

the loans outstanding depending on the level and volatility of risk. Because of the higher

inherent risk levels and the increased impact that subprime portfolios may have on an

institution’s overall capital, examiners should document and reference each institution’s

subprime capital evaluation in their comments and conclusions regarding capital

adequacy.

Stress Testing

An institution’s capital adequacy analysis should include stress testing as a tool for

estimating unexpected losses in its subprime lending pools

d impact that subprime portfolios may have on an

institution’s overall capital, examiners should document and reference each institution’s

subprime capital evaluation in their comments and conclusions regarding capital

adequacy.

Stress Testing

An institution’s capital adequacy analysis should include stress testing as a tool for

estimating unexpected losses in its subprime lending pools. Institutions should project

the performance of their subprime loan pools under conservative “stress test” scenarios,

including an estimation of the portfolio’s susceptibility to deteriorating economic,

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market, and business conditions. Portfolio stress testing should include “shock” testing

of basic assumptions such as delinquency rates, loss rates, and recovery rates on

collateral. It should also consider other potentially adverse scenarios, such as: changing

attrition or prepayment rates; changing utilization rates for revolving products; changes in

credit score distribution; and changes in the capital markets demand for whole loans, or

asset-backed securities supported by subprime loans.

These are representative examples; actual factors will vary by product, market segment,

and the size and complexity of the portfolio relative to the institution’s overall operations.

Whether stress tests are performed manually, or through automated modeling techniques,

the Agencies will expect that:

▪ The process is clearly documented, rational, and easily understood by the

institution's board and senior management;

▪ The inputs are reliable and relate directly to the subject portfolios (for

example, baseline loss history or default probabilities should reflect each

segment of the institution's portfolio and not just a blend of prime and

subprime borrowers);

▪ Assumptions are well documented and conservative; and

▪ Any models are subject to a comprehensive validation process

ard and senior management;

▪ The inputs are reliable and relate directly to the subject portfolios (for

example, baseline loss history or default probabilities should reflect each

segment of the institution's portfolio and not just a blend of prime and

subprime borrowers);

▪ Assumptions are well documented and conservative; and

▪ Any models are subject to a comprehensive validation process.

The results of the stress test exercises should be a documented factor in the analysis and

determination of capital adequacy for the subprime portfolios.

Institutions that engage in subprime lending programs without adequate procedures to

estimate and document the level of capital necessary to support their activities should be

criticized. Where capital is deemed inadequate to support the risk in subprime lending

activities, examiners should consult with their supervisory office to determine the

appropriate course of action. Such actions may include requiring additional capital in

accordance with their Agency’s respective capital adequacy rules, or requiring the

institution to submit an acceptable capital plan in accordance with the Agency’s safety

and soundness guidelines.

Examination Review and Analysis

The heightened risk levels and potential volatility in delinquency and loss rates posed by

subprime lending programs warrant increased ongoing attention by examiners.

Consistent with each of the Agencies’ risk-based examination approach, the risks

inherent in subprime lending programs call for frequent reviews. There are generally two

levels of review appropriate for subprime activities:

Portfolio-level reviews – including assessments of underwriting standards,

marketing practices, pricing, management information and control systems

(quality control, audit and loan review, vendor management, compliance),

ination approach, the risks

inherent in subprime lending programs call for frequent reviews. There are generally two

levels of review appropriate for subprime activities:

Portfolio-level reviews – including assessments of underwriting standards,

marketing practices, pricing, management information and control systems

(quality control, audit and loan review, vendor management, compliance),

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portfolio performance, and the appropriate application of regulatory and internal

allowance and capital policies.

Transaction-level testing – including testing of individual loans for compliance

with underwriting and loan administration guidelines, appropriate treatment of

loans under delinquency, re-aging and cure programs, and the appropriate

application of regulatory and internal allowance and capital policies.

Examiners should incorporate the findings of both transaction-level testing and portfolio-

level reviews into their conclusions about overall asset quality, the adequacy of the ALLL

and capital, and the adequacy of portfolio risk management practices.

Examiners should perform a portfolio-level review and some transactional testing at each

institution engaged in subprime lending during each regularly scheduled examination

cycle. The Agencies will also perform regular offsite monitoring and may require

subprime lenders to supply supplementary information about their subprime portfolios

between examinations.

Transaction-Level Testing

Subprime loan portfolios contain elevated risks and actual subprime lending practices

often can deviate from stated policy and procedural guidance. Therefore, portfolio-level

examination procedures should be supplemented with transaction-level testing

ire

subprime lenders to supply supplementary information about their subprime portfolios

between examinations.

Transaction-Level Testing

Subprime loan portfolios contain elevated risks and actual subprime lending practices

often can deviate from stated policy and procedural guidance. Therefore, portfolio-level

examination procedures should be supplemented with transaction-level testing. This

testing should determine whether:

▪ Individual loans adhere to existing policy, underwriting, risk selection, and

pricing standards;

▪ Individual loans and portfolios are classified in accordance with the guidelines

contained herein, or in other Agency guidance;

▪ Management, board, and regulatory reporting is accurate and timely;

▪ Existing loans conform to specified account management standards (over-

limits, line increases, reductions, cancellations, re-scoring, collections, etc.);

▪ Key risk controls and control processes are adequate and functioning as

intended;

▪ Roll rates and other loss forecasting methods used to determine ALLL levels

are accurate and reliable; and

▪ Lending practices exist that may appear unsafe, unsound, or abusive and

unfair.

Examiners should follow their Agency’s guidance on statistical or judgmental sampling

when choosing loans for this transaction-level review.

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Classification Guidelines for Subprime Lending

The evaluation of consumer loans is governed by the Uniform Retail Credit Classification

and Account Management Policy (Retail Classification Policy) issued by the FFIEC on

June 12, 2000. This policy establishes general classification thresholds based on

delinquency, but also grants examiners the discretion to classify individual retail loans

that exhibit signs of credit weakness regardless of delinquency status. An examiner may

also classify retail portfolios, or segments thereof, where underwriting standards are weak

and present unreasonable credit risk, and may criticize account management practices

that are deficient

thresholds based on

delinquency, but also grants examiners the discretion to classify individual retail loans

that exhibit signs of credit weakness regardless of delinquency status. An examiner may

also classify retail portfolios, or segments thereof, where underwriting standards are weak

and present unreasonable credit risk, and may criticize account management practices

that are deficient. Well-managed subprime lenders should recognize the heightened loss

characteristics in their portfolios and internally classify their delinquent accounts well

before the timeframes outlined in the interagency policy.

Individual Loans

Examiners should not automatically classify or place loans in special mention merely

because they are subprime. Rather, classifications should reflect the borrower’s capacity

and willingness to repay and the adequacy of collateral pledged.

Loans to borrowers that do not have the capacity to service their loans generally will be

classified substandard. Where repayment capacity is insufficient to support orderly

liquidation of the debt, and the collateral pledged is insufficient to mitigate risk of loss,

then a more severe classification and non-accrual is warranted. Subprime loans that are

past due 90 days, or more, should be classified at least substandard based on a reasonable

presumption that their past due status is indicative of inadequate capacity and/or

unwillingness to repay. A more stringent classification approach may be appropriate

based on the historical loss experience of a particular institution. Classification of other

subprime loans as doubtful or loss will be based on examiners’ analysis of the borrower’s

capacity to repay, and the quality of institution underwriting and account management

practices as contained in the loan file or other documentation.

In some cases, the repayment of principal, interest, and fees on some subprime loans may

be overly dependent on collateral pledged

assification of other

subprime loans as doubtful or loss will be based on examiners’ analysis of the borrower’s

capacity to repay, and the quality of institution underwriting and account management

practices as contained in the loan file or other documentation.

In some cases, the repayment of principal, interest, and fees on some subprime loans may

be overly dependent on collateral pledged. This occurs when risk of default is so high

that an abundance of collateral is taken to mitigate risk of loss in the event of default.

From a safety and soundness perspective the Agencies discourage lending solely on the

basis of collateral pledged, and will generally classify such loans substandard. Further,

when the borrower does not demonstrate the capacity to service the loan from sources

other than collateral pledged, the loan may be placed on non-accrual.

Portfolios

When the portfolio review or loan sample indicate serious concerns with credit risk

selection practices, underwriting standards, or loan quality, examiners should consider

classifying or criticizing the entire portfolio or segments of the portfolio. Such a decision

may be appropriate in cases where risk is inordinately high or delinquency reports reflect

performance problems. Some subprime lending portfolios may pose very high risk.

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These may include portfolios of unsecured loans, or secured high loan-to-value loans to

borrowers who clearly exhibit inadequate capacity to repay the debt in a reasonable

timeframe. Most such portfolios should be classified at least substandard.

Required Documentation for Cure Programs

Cure programs, including such practices as re-aging, extensions, renewals, rewrites, or

other types of account restructuring are subject to the standards outlined in the Retail

Classification Policy. In accordance with that policy, cure programs should be used only

when the institution has substantiated the customer’s renewed willingness and ability to

repay

Documentation for Cure Programs

Cure programs, including such practices as re-aging, extensions, renewals, rewrites, or

other types of account restructuring are subject to the standards outlined in the Retail

Classification Policy. In accordance with that policy, cure programs should be used only

when the institution has substantiated the customer’s renewed willingness and ability to

repay. Examiners will expect institutions to maintain documentation supporting their

analysis of the customer’s renewed ability and willingness to repay the loan at the time it

is extended, renewed, or deferred. When the institution cannot demonstrate both the

willingness and ability of the customer to repay, the loan should not be renewed,

extended, deferred, or rewritten, and the loan should be moved back to its pre-cure

delinquency status. Documentation should include one or more of the following:

▪ A new verification of employment;

▪ A recomputed debt-to-income ratio indicating sufficient improvement in the

borrower’s financial condition to support orderly repayment;

▪ A refreshed credit score or updated bureau report;

▪ A file memo evidencing discussion with the customer;

Where documentation of the customer’s renewed willingness and ability to repay the loan

is absent or deficient, management practices should be criticized.

Predatory or Abusive Lending Practices

The term subprime is often misused to refer to certain “predatory” or “abusive” lending

practices. The Agencies have previously expressed their support for lending practices

designed to responsibly service customers and enhance credit access for borrowers with

special credit needs. Subprime lending that is appropriately underwritten, priced, and

administered can serve these goals. However, the Agencies also recognize that some

forms of subprime lending may be abusive or predatory

ctices. The Agencies have previously expressed their support for lending practices

designed to responsibly service customers and enhance credit access for borrowers with

special credit needs. Subprime lending that is appropriately underwritten, priced, and

administered can serve these goals. However, the Agencies also recognize that some

forms of subprime lending may be abusive or predatory. Some such lending practices

appear to have been designed to transfer wealth from the borrower to the lender/loan

originator without a commensurate exchange of value. This is sometimes accomplished

when the lender structures a loan to a borrower who has little or no ability to repay the

loan from sources other than the collateral pledged. When default occurs, the lender

forecloses or otherwise takes possession of the borrower’s property (generally the

borrower’s home or automobile). In other cases, the lender may use the threat of

foreclosure/repossession to induce duress upon the borrower for payment. Typically,

predatory lending involves at least one, and perhaps all three, of the following elements:

▪ Making unaffordable loans based on the assets of the borrower rather than on the

borrower’s ability to repay an obligation;

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▪ Inducing a borrower to refinance a loan repeatedly in order to charge high points

and fees each time the loan is refinanced (“loan flipping”); or

▪ Engaging in fraud or deception to conceal the true nature of the loan obligation, or

ancillary products, from an unsuspecting or unsophisticated borrower.

Loans to borrowers who do not demonstrate the capacity to repay the loan, as structured,

from sources other than the collateral pledged are generally considered unsafe and

unsound. Such lending practices should be criticized in the Report of Examination as

imprudent. Further, examiners should refer any loans with the aforementioned

characteristics to their Agency’s respective consumer compliance/fair lending specialists

for additional review

ty to repay the loan, as structured,

from sources other than the collateral pledged are generally considered unsafe and

unsound. Such lending practices should be criticized in the Report of Examination as

imprudent. Further, examiners should refer any loans with the aforementioned

characteristics to their Agency’s respective consumer compliance/fair lending specialists

for additional review.

Summary

Although subprime lending is generally associated with higher inherent risk levels,

properly managed this can be a sound and profitable business. Because of the elevated

risk levels, the quality of subprime loan pools may be prone to rapid deterioration,

especially in the early stages of an economic downturn. Sound underwriting practices

and effective control systems can provide the lead time necessary to react to deteriorating

conditions, while sufficient allowance and capital levels can reduce its impact.