3.2 - Loans I

Front 1

What should lending policy have

Back 1

• General fields of lending, kinds, types of loans w/in ea field
• Lending authority - each loan officer, loan/exec committee
• Board responsibility for approving/reviewing loans
• Guidelines for unsecured loans
• Guidelines for rates & terms for secured/unsecured loans
• Loan to value limits
• Collateral documentation requirements
• RE appraisal guidelines
• Borrower credit file requirements
• Collection procedures
• Loans to total assets limit
• Limits on extensions of credit thru overdrafts
• Bank's trade area, circumstances for lending outside
• Portfolio mix/diversification goals, concentration monitoring
• Guidelines for loan review and grading system (watch list)
• ALLL guidelines
• Environmental liability guidelines

Front 2

Loan review system elements

Back 2

• Qualifications of loan review personnel
• Independence of loan review personnel
• Frequency of reviews
• Scope of reviews
• Depth of reviews
• Review of findings and follow-up
• Workpaper and report distribution

Front 3

Effective loan review system should address:

Back 3

• Identify loans with well-defined weaknesses
• Provide info essential for ALLL
• Identify relevant trends affecting collectibility of loan portfolio
• Evaluate activities of lending personnel
• Adherence to policies, compliance with laws
• Assessment of overall quality
• A formal credit grading system
• Mechanism for reporting identified loans
• Documentation of credit loss experience

Front 4

What loans should be reviewed by internal loan review

Back 4

Significant credits generally annually, upon renewal, or more frequently if potential for deterioration.

Loans over a predetermined size

Smaller loans w/ elevated risk (delinquent, nonaccrual, restructured, previously classified, Special Mention)

Summary report submitted to Board quarterly. Important for quarterly ALLL evaluation

Front 5

Commercial Loans - characteristics

Back 5

• Loans to businesses for commercial or industrial purposes (proprietorships, partnerships, or corporations)
• Secured or unsecured
• Short term or long term
• Includes: working capital advances, term loans, loans to individuals for business purposes

Front 6

Term business loans

Back 6

• For acquiring capital assets (e.g. plant & equipment)
• Greater risk cause longer term
• Usually secured and regular amortization

Front 7

What should commercial lending policy have?

Back 7

• Acquisition of credit info (cash flow statements)
• Factors to determine need for collateral acquisition
• Acceptable collateral margins
• Perfecting liens
• Lending terms
• Charge offs

Front 8

Accounts receivable financing

Back 8

• Type of commercial loan
• Accounts receivable as collateral
• For rapidly growing business that need year round financing in amounts too large to justify unsecured credit, cannot borrow unsecured anymore, or nonseasonal need due to insufficient working capital

Front 9

A/R financing - advantages for businesses

Back 9

• Efficient way to finance expansion
• Take advantage of purchase discounts
• Insures revolving, expanding LOC
• Interest may be no more than fixed unsecured loan

Front 10

A/R financing - advantages for bank

Back 10

• Relatively high-yield loan
• New business, depository relationship
• Continue banking w borrower who can no longer get unsecured credit
• Minimize potential loss

Front 11

Two basic methods to make A/R advances

Back 11

1. Blanket Assignment - bank advances percentage of outstanding receivables. borrower receives A/R payments and remits to bank
2. Ledgering - bank receives duplicate copies of invoices, shipping & delivery docs, advance on that. Receivables usually pledged on a notification basis. Borrower's customer remits payment directly to bank

Front 12

Leveraged financing

Back 12

Financing vehicle for mergers & acquisitions, business re-capitalizations & refinancings, equity buyouts, and business line build-outs & expansions

Highly leveraged, high risk

Front 13

Mezzanine financing

Back 13

Parts of a leveraged financing package that are neither equity nor senior debt

Front 14

Assessing creditworthiness in an Oil & Gas Reserve Loan - first step

Back 14

Analysis of engineering function. Engineering report must be independent, and address:

1. Pricing

2. Discount factors

3. Timing

Front 15

How do you classify oil/gas reserve loans if total support provided solely by pledged collateral?

Back 15

65% of discounted present worth of future net income (PWFNI) should be substandard

Balance, but not more than 100% should be doubtful

Any remaining deficiency should be loss

Front 16

Part 365 - Real Estate Lending Standards

Requires policies that include:

Back 16

• Portfolio diversification standards
• Prudent underwriting standards, LTV limits
• Loan administration procedures
• Documentation, approval, and reporting requirements
• Monitoring procedures

Front 17

Part 365 - Real Estate Lending Standards (Appendix A)

Maximum supervisory LTV limits

Back 17

65% - Raw land

75% - Land development

80% - Construction: commercial, multifamily, other non-residential

85% - Residential construction; Improved property

Owner-occupied 1-4 family residential - no limit. However if LTV exceeds 90%, credit enhancement (mortgage insurance or marketable collateral) required

Front 18

Part 365 - Real Estate Lending Standards (Appendix A)

Loans that exceed supervisory LTV limits:

Back 18

Identified, aggregate amount reported to Board at least quarterly

Aggregate amount should not exceed 100% total capital

Within limit, commercial, agri, & multifamily should not exceed 30% total capital

Front 19

Signs of troubled CRE markets

Back 19

• Rent concessions, sales discounts, resulting in less CF than original appraisal
• Changes in concept or plan (e.g. condo converting to apt project)
• Construction delays, cost overruns
• Slow leasing, lack of sustained sales
• Lack of sound feasibility study
• Periodic construction draws which exceed amount needed
• Identified problem credits

Front 20

Construction loans

Major challenge and what should policies address?

Back 20

Necessity to complete project within specified cost and time limits. Full value of collateral does not exist at the time loan is granted. Bank must ensure funds properly used or be able to complete project.

Policies - specify type & extent of bank involvement, procedures for controlling disbursements, collateral margins, assuring timely completion

Front 21

Construction loans

Two types of disbursement plans

Back 21

Standard payment - residential and smaller commercial construction. Preestablished schedule for fixed payments and end of each stage of construction

Progress payment - larger more complex projects. Monthly disbursements totaling 90% of value with 10% held back until project completed.

Front 22

Construction loans

Four basic types

Back 22

1. Unsecured Front Money

2. Land Development

3. Commercial Construction

4. Residential Construction

Front 23

Construction Loans

1. Unsecured Front Money

Back 23

New, unproven venture; Builder planning to start project before permanent construction funding obtained. Acquire/develop site, pay architect, fees, meet min working capital requirements by construction lenders, etc. Repayment often comes from first draw against construction financing. Symptomatic of inexperienced or inept builder

Front 24

Construction Loans

2. Land Development

Back 24

Purchase of land development in anticipation of further construction or sale.

• Should be based on appraisals on "as is" and "as completed" basis
• Proper title search or mortgage insurance
• Repayment structured to follow sales or development program
• If unsecured or spec, analyze PFS for other sources of repayment

Front 25

Construction Loans

3. Commercial Construction

Back 25

• Generally collateralized just like CRE loans
• Recorded mortgage or deed of trust, title insurance, liability insurance, land appraisals, evidence taxes have been paid
• Loan agreements, takeout commitments, completion bonds, and inspection or progress reports

Front 26

Construction Loans

4. Residential Construction

Back 26

• Spec basis or prearranged permanent financing
• Recorded first mortgage, appraisal, construction agreement, draws based on progress payment plans, and inspection reports
• Spec contractors: control procedures, predetermined limit on number of unsold units to be financed at one time, prearranged permanent financing, payment depends on sale of finished homes

Front 27

Home Equity Loans

Characteristics and considerations

Back 27

• Can be structured as traditional second mortgage or LOC
• Relatively low interest, low risk
• Generally junior lien
• Acceptable LTV, debt to income ratios, credit & collateral documentation, borrowers financial condition

Front 28

Agricultural Loans

Two main risk factors

Back 28

• Commodity prices
• Weather conditions

Front 29

Agricultural Loans

Five main types of ag loans

Back 29

1. Production or operating loans (ST) - seed, fuel, chemicals, rent, labor, living expenses, paid at end of season

2. Feeder Livestock Loans (ST) - production expenses for livestock, paid when sold for slaughter

3. Breeder Stock Loans (intermediate term) - purchase breeding stock, repaid through sales of offspring/produce

4. Machinery & Equipment Loans (intermediate term) - equipment, repaid from CF from farm earnings

5. Farm RE Acquisition Loans (LT) - acquire/improve farm RE, repaid from CF farm earnings

Front 30

Agricultural Loans

Carryover Loans

Back 30

1. Production or feeder livestock loans that are unable to be paid at maturity

2. Already-existing term debt whose repayment terms or maturities need to be rescheduled because of inadequate CF to intermediate or LT amortization. Possible acquisition of Federal guarantees

Due to weather, commodity prices, or high production costs

Front 31

Agricultural Loans

Classification guidelines

Back 31

Feeder, Production, Breeder, and Machinery Loans - Generally not classified if adequately secured. If needed, classify depending on secondary repayment sources, borrower's financials and trends.

Front 32

Installment Loans

Characteristics

Back 32

• Small, amortizing loans
• Mostly consumer purchases; also to businesses for equipment & vehicles

Front 33

Installment Loans

Policies should include what

Back 33

• Loan apps & credit checks
• Terms in relation to collateral
• Collateral margins
• Perfection of liens
• Extensions, renewals & rewrites
• Delinquency notification & follow-up
• Charge-offs & collections

Indirect lending:

• Pmt to bank vs pmt to dealer
• Acquisition of dealer financials
• Possible upper limits for any one dealer's paper
• Dealer reserves and chargebacks

Front 34

Direct Lease Financing

What is it?

Back 34

• Form of term debt financing for fixed assets
• Similar to loans from a credit viewpoint
• Same basic considerations (CF, repayment, credit history, projections of future operations)
• Usually written requesting bank to purchase property & arrange for installation

Front 35

Direct Lease Financing

Four common types of terms

Back 35

1. Net Lease - bank is not obligated to assume expenses of maintaining equpment

2. Full Payout Lease - bank expects to realzie both the return of its full investment and cost of financing property over the term of the lease

3. Leveraged Lease - bank purchases equipment by providing relatively small percentage (20-40%) of capital needed. Balance of funds is borrowed by lessor from long term lenders who hold first lien on equipment and lease rental payments. Specialized and complex. Lending standards should be similar to unsecured credit.

4. Rentals - include only those payments reasonable anticipated by the bank at the time lease is executed

Front 36

Floor Plan Lending

Characteristics

Back 36

• Retail goods inventory financing
• Ea loan made against specific piece of collateral
• Loan against ea collateral repaid as that piece gets sold by dealer
• i.e. cars, home appliances, furniture, boats, etc.
• Higher risk - lack of control over items
• Collateral value is of prime importance
• Control requires bank to determine collateral value at time loan is made, frequently inspect collateral, impose curtailment requirement

Front 37

Check Credit

Back 37

Typically through overdrafts. Preestablished LOC to a DDA when check causes an overdraft

Cash reserve system, customers must request funds transfer from preestablished LOC to DDA

Special draft system, customer negotiates a special check drawn directly against a preestablished LOC

Front 38

Credit Card Loans

Types of CC banks

Back 38

Agent Bank - receives CC apps from customers, sales drafts from merchants forwards to sublicensee and licensee banks. accountable for docs during receiving and forwarding

Sublicensee Bank - maintains accountability for CC loans and merchant accounts; may maintain own pmt processing center; may emboss CCs

Licensee Bank - same as sublicensee, in addition may perform transaction processing and CC embossing, and acts as regional or national clearinghouse

Front 39

Credit Card Loans

What is re-aging and what are guidelines?

Back 39

Bringing a delinquent account current

• Renewed willingness to repay
• Acct should exist 9 mo before re-aging
• Three consecutive monthly pmts required before re-aging
• No loan should be re-aged more than once in 12 months, more than twice in 5 years

Front 40

Merchant Credit-Card activity

What is it and what are safety and soundness standards?

Back 40

Acceptance of CC sales drafts for clearing by a bank. Thin profit margin, high transaction volume.

• Should scrutinize prospective merchants like would a borrower
• Closely monitor merchants, early warning signs so problem merchants can be removed
• Acct admin program if large dollar volumes, periodic reviews of merchants financials
• Internal periodic reporting system of merchant acct activities, review for irregularities
• Follow guidelines established by card issuing networks

Front 41

Loan participations

Back 41

Lead bank originates and sells ownership interests to one or more banks.

Lead bank retains a partial interest, holds loan docs, services loan, deals directly with customer

Used to accommodate large loans, meet legal lending limit requirements, diversify risk, and improve liquidity.

Participants can cheaply invest in large loans and compensate for low local demand

Front 42

Loan participations

Accounting treatment

Back 42

FAS 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liablities

Loan participations are sales, and is removed from books if:

• Purchaser's interest is beyond reach of seller and its creditors
• Purchaser has right to pledge or exchange interest in the loan
• Agreement does not let or obligate seller to repurchase the participation; and purchaser cannot unilaterally return participation

Otherwise, participation is a secured borrowing, stays on books as Loans and 'Other Borrowed Money'

Front 43

Loan problems

Back 43

1. Poor selection of risks
2. Overlending
3. Failure to establish or enforce liquidation agreements
4. Incomplete credit info
5. Overemphasis on loan income
6. Self dealing
7. Technical incompetence
8. Lack of supervision
9. Lack of attn to changing econ conditions
10. Competition

Front 44

1. Poor selection of risks

Back 44

Absence of sound lending policies, poor credit judgement.

e.g. finance new/untried businesses, spec purchase of goods/securities, inadequate collateral margins, loans not based on sound worth or collateral, questionable collateral

Front 45

2. Overlending

Back 45

Too much loans to one borrower, can't repay

Front 46

3. Failure to Establish or Enforce Liquidiation Agreements

Back 46

No well defined repayment program or not enforced

Front 47

4. Incomplete credit info

Back 47

Failure to obtain and properly evaluate credit info (PFS, cash flow, income statements, purpose, etc)

Front 48

5. Overemphasis on loan income

Back 48

Misplaced emphasis on income instead of soundness

Front 49

6. Self dealing

Back 49

Overextensions of unsound credit to insiders or their interests

Front 50

7. Technical incompetence

Back 50

Management's inability to obtain and evaluate credit info and put together well conceived loan package

Front 51

8. Lack of supervision

Back 51

Lack of keeping up with borrower, lack of knowledge of borrower's affairs over life of the loan

Failure of mgmt to oversee loan officers to ensure they are on top of borrowers and following policies

Front 52

9. Lack of attn to changing econ conditions

Back 52

Don't evaluate lending policies and individual borrowers in light of changing conditions. CF and collateral value can decline in econ downturn

Front 53

10. Competition

Back 53

Competitive pressures to make unsound loans. Not worth short term gain.