Bankruptcy Strategy for Federal Credit Unions

Bankruptcy filings have become all too commonplace and are a major source of loss to Federal Credit Unions. The following outline suggests approaches for dealing with bankruptcy losses and controlling them in the future.

LEARNING FROM OUR MISTAKES: INFORMATION TO GATHER FROM BANKRUPT LOAN FILES

  • A determination of whether the loan was secured or unsecured;
  • What was your member's debt-to-payment ratio at the time credit was extended?
  • What percentage of the member's total indebtedness was unsecured?
  • Was the member's credit profile properly reviewed and investigated prior to loan approval?
  • Was the member's income and employment properly verified?
  • Was offered collateral properly appraised?
  • Were general credit guidelines and lending policies observed?
  • Upon re-review would your credit union have granted the credit requested under the same terms?
  • Would alternative forms of credit more fully protect your credit union's loan account against bankruptcy loss?
  • Based upon your loan review, is there a need to modify existing lending policies? If so, what changes should be recommended?

PROCEDURES TO PREVENT BANKRUPTCY LOSSES

Credit unions must adopt internal policies and procedures to prevent bankruptcy filings from damaging its loan portfolio. In adopting these policies and procedures the credit union should consider:

  • Establishing sound lending policies;
  • Developing sound loan review procedures to prevent or minimize bankruptcy loss;
  • Developing a written policy in response to bankruptcy filings, and;
  • Developing strong and aggressive bankruptcy procedures.

ESTABLISH A BANKRUPTCY POLICY

Develop a written policy in response to the filing of bankruptcies by members. Your credit union should establish a policy prohibiting new loans to members whose bankruptcies have resulted in a loss to the credit union, and requiring that each debtor member's loan file be reviewed and analyzed in order to prevent future losses. Such a bankruptcy policy might read as follows:

"It is the policy of Credit Union to deny future credit-related services to a member who has an existing credit obligation in default which causes this Credit Union to suffer a pecuniary loss. If, however, the credit obligation is reaffirmed or otherwise voluntarily repaid in such a manner that this Credit Union sustains no loss or expense with respect to the obligation, then the member will remain eligible for such credit-related services as though the default or bankruptcy had not occurred."

LENDING POLICIES AND PROCEDURES

Consider these factors in the development of lending policies:

  • What extensions of credit should be secured?
  • What extensions of credit may be unsecured?
  • What credit limits should be established for each type of credit?
  • Procedures to insure perfection of security interests;
  • Should the extension of credit be under a closed or open-end plan?
  • Will your credit union be granting credit to members who previously filed bankruptcy? If so, under what circumstances?

Establish sound lending review procedures to insure that bankruptcy losses are minimized. For example:

  • Obtain a written loan application signed by your member verifying that the information contained is true and complete, and that the member intends for the credit union to rely on the information;
  • Leave enough room on loan applications to list all debts;
  • Obtain a credit report to review debt load and payment history;
  • Compare loan application to credit report;
  • Review facts of all debts disclosed by sources other than member;
  • Determine whether credit report discloses excessive use of unsecured credit;
  • On collateralized obligations, your credit union should verify values by obtaining, wherever practical, appraisals or visual inspections of the collateral offered;
  • Verify all sources of income and employment, particularly in those cases where additional income is relied upon in making the loan.

COMMON SIGNS OF BANKRUPTCY

  • Many credit cards;
  • A high level of unsecured debts;
  • History of pyramiding debts;
  • Large-dollar signature loans;
  • Dealings with finance companies;
  • Lifestyle changes (job, spending, residence, divorce);
  • Many credit bureau inquiries;
  • Few, if any, real assets;
  • Nothing to lose in bankruptcy.

COMMON MYTHS MEMBERS HAVE ABOUT BANKRUPTCY

  • That the debtor can keep secured collateral without having to pay for it;
  • That all debts will be discharged;
  • That he can remain in his home indefinitely without making payments;
  • That after discharge he can easily reestablish his credit;
  • That credit unions do not suffer bankruptcy losses, because they are reimbursed by a government agency;
  • That by filing bankruptcy you are not harming your fellow credit union members.