American Association of Bank Directors - Agenda Item of the Month: March 2003

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Agenda Item of the Month

Does or will the current upheaval in the subprime residential mortgage market have a material impact on your bank? Your board should be asking questions of management.

The board should ascertain to what extent the bank has made loans that remain in its portfolio that are considered subprime or Alt-A credits. These loans may also include no-doc or lite-doc loans. The board should request management to stress test such credits and to provide updated information on the performance of those credits. It should also inquire as to granting of future such credits in light of the real estate market in the bank's market.

The board should inquire about the trends in residential real estate valuation in the market and the possible impact of foreclosures. Stress testing of the residential real estate loans in the bank's portfolio assuming a decline in real estate values should be conducted by management and the results should be reported to the board.

The board should ask management for an evaluation of the bank's investments in order to identify investments that may directly or indirectly be affected by the upheaval in the subprime market and changes in valuations in the residential real estate in the relevant market. Once the board has the requisite information, it should decide whether to amend investment policies and guidelines.

The board should direct that management undertake a review of the contracts used to sell subprime residential real estate into the secondary market to determine to what extent such loans were sold with recourse, and where the loans were sold without recourse, to what extent would the covenants that the bank entered into may trigger repurchase obligations.

The board should determine, once the relevant information and data are available, whether any changes in the loan and investment policies of the bank are warranted or whether any additional efforts to monitor or address subprime credits in the bank's portfolio or sold into the secondary market are appropriate.

The board should reevaluate the lending and other business relationships that the bank has with mortgage brokers and bankers. The financial condition of some mortgage brokers has deteriorated so significantly over the past several months that reliance on year-end 2006 financial statements may not be warranted.

Finally, the board and management should discuss the opportunities that the bank may have to increase its portfolio of sound residential loans in light of the unsettled real estate mortgage secondary market and the difficulties of many mortgage brokers, and how the bank may take advantage of such opportunities through marketing, outreach, hiring, and other measures.