3.2 - Loans Ii

Front 1

Loan Scoping

What types of loans should be scoped at each exam?

Back 1

• Classified or Spec Mention at last exam
• Bank's watchlist loans
• Significant overdue/delinquency list
• Other significant loans, higher risk
• Insider loans

Front 2

Classifications

Special Mention

Back 2

• Potential weaknesses, deserve mgmt's attn
• If not corrected, may deteriorate in future
• Insufficient risk to warrant classification
• Should not be a means of avoiding a classification

Not together w/ classifications, but total should be considered in AQ. Should have comments in Report, geared toward correction of weaknesses

Front 3

Classifications

Substandard

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• Inadequately protected by current sound worth and paying capacity of borrower or collateral.
• Must have well defined weakness(es) that jeopardizes liquidation of the debt
• Distinct possibility bank will sustain some loss if not corrected

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Classifications

Doubtful

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• All weaknesses inherent in Substandard AND
• Weaknesses make collection in full, on the basis of currently known facts, highly questionable and improbable

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Classifications

Loss

Back 5

• Uncollectible
• Such little value - no longer bankable asset
• Not practical to defer write-off

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When should a loan be on nonaccrual?

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90+ past due unless well secured and in process of collection

Reversal of previously accrued but uncollected interest required

Exemption: consumer & residential RE or more stringent State standard

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When can accrual resume?

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1. All principal & interest contractually due (incl arrearage) are reasonably assured of repayment
2. Sustained period of performance (generally at least 6 mo.)

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Express determination letter (so bank can write off 'Loss' loans on taxes) should be issued if:

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• Bank maintains 'Loss' classification standards consistent with FDIC's
• No material deviations from FDIC standards

New one must be requested/issued at each exam

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Express determination letter should not be issued if:

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• Significant criticism to loan review/charge-off process
• Charge-offs are consistently overstated/understated
• Pattern of unrecognized charge-offs

Front 10

What should concentration policies consider?

Back 10

• Business strategy
• Mgmt expertise
• Location
• Track & monitor econ/financial condition of geographies, industries, and groups of borrowers
• Report regularly to Board

Front 11

What should be used as basis to calculate concentrations?

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• Loan-related: percent of TC (if capital too low, use TA)
• Non-loan related: percent of Tier 1 (if capital too low, use TA)
• Funding source related: percent of TA

(undisbursed loan commitments should not be included in calculation, but address impact in written analysis)

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Concentration listing requirements:

25% of TC (or Tier 1 for non-loans)

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• Individual borrower
• Small, interrelated group of individuals
• Single repayment source
• Individual project

(less than 25% can be listed if elevated risk)

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Concentration listing requirements:

100% of TC (or Tier 1 for non-loans)

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• Industry
• Product line
• Type of collateral
• Short term obligations of one bank or affiliated group (Fed Funds Sold)

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Concentration listing requirements:

Funding source concentrations

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10% of TA: single funding source

25% of TA: aggregate potentially volatile funding sources (brokered, high-rate, uninsured, listing svc, FFP, borrowings, other)

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Concentration listing requirements:

Written analysis required

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• Individual borrower (25% TC)
• Industry, product line, or collateral type (300% TC)
• ADC loans (100% TC)
• Obligations of one or closely related group of municipalities (100% Tier 1)
• Non-agency securities (100% Tier 1)
• Single source funding (10% TA)
• Aggregate potentially volatile funding (25% TA)

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Three terms basic to secured transactions

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1. Attachment - borrower's property is free of legal encumbrance and now legally bound by creditors security interest
2. Security agreement - borrower authenticates & provides description of collateral
3. Security interest - can be possessory or nonpossessory

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UCC-1 good for how long?

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5 years

continuations can be filed during the final 6 months

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Procedure for foreclosing

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1. Repossession of collateral - with or without judicial process. e.g. sheriff seizes collateral under court order

2. Borrower's right to redeem collateral - must pay entire balance plus all repo & holding expenses

3. Bank retains collateral & releases borrower from further liability on the loan - borrower must agree

4. Resale of collateral - public or private. notice to borrower must be given

Front 19

Rule of priority

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General rule that the creditor with the earliest perfected security interest has priority over collateral

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Exceptions to the rule of priority

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1. Buyer in good faith purchases car from dealer's floor plan line, cutting off prior perfected security interest in car

2. Buyer in good faith purchases TV from another person who bought it on credit, cutting off security interest by doing nothing

3. A creditor who provides additions/improvements on collateral and has perfected security interest in the improvements

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Types of guarantees

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Payment guaranteed - guarantor will pay if borrower doesn't

Collection guaranteed - guarantor will pay only after holder has reduced to judgement a claim against

Limited guarantee - relates to a specific loan

Continuing guarantee- enforceable for future transactions btwn bank and borrower until revoked

Front 22

Types of bankrupcy

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Liquidation. trustee collects all of debtor's nonexempt property (Chapter 7)

Rehabilitation. debtors retain assets but obligations are restructured and payment plan is implemented. Chapter 11 - available to all debtors. Chapter 13 - individuals w/ regular incomes and unsecured debts under $100M, secured under $350M

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What is automatic stay?

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Creditors' must stop further actions to collect claims or enforce liens once bankruptcy petition is filed. Stay remains in effect until:

• Debtor's property is released from the estate
• Bankruptcy case is dismissed
• Debtor obtains or is denied discharge
• Bankruptcy court approves creditor's request for termination of stay

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Two of the most important grounds for termination of stay requests:

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1. debtor has no equity in encumbered property and property is not necessary to an effective rehab plan

2. creditor's interest in secured property is not adequately protected

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Reaffirmation

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Debtor promise to pay after a bankrupcy discharge. e.g. to avoid foreclosure on a home

• Agreement must be signed before discharge is granted
• Judge informs borrower reaffirmation is optional
• Debtor has right to recind within 30 days

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Classes of creditors

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1. Priority creditors - entitled to receive payment prior to any others

2. Secured creditors - secured up to the extent of the value of their collateral

3. Unsecured creditors - last in priority

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What is difference between syndicated lending and loan participations?

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Lenders in a syndication participate jointly in the origination process, as opposed to one originator selling undivided participation interests to third parties.

Avg syndicated credit is over $100 million

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Advantages of syndicated credit

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• Raises large amounts of money
• Enables geographic diversification
• Satisfies relationship banking
• Obtaining working capital quickly and efficiently
• Spread large credit risk amongst banks
• Attractive pricing

Front 29

Phases in a loan syndication

Back 29

1. Pre-Launch Process - borrower's needs, due diligence, info analyzed, credit write ups take shape, bids sent. Info memorandum prepared

2. Launch - banks receive info memo. negotiations take place btwn banks and borrower over terms

3. Post-Launch - two week period for potential participants to evaluate transaction

4. Post-Closing - ongoing dialogue with borrower and quarterly credit covenant checks. annual full credit analysis

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Shared National Credit (SNC) Program

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Interagency initiative administered jointly by FIDC, FRB, and OCC to ensure consistency among three regulators in classification of large syndicated credits

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Definition of a SNC

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Loan/loan commitment extended to borrower with original amount $20 million or more and shared by three or more unaffiliated banks; or, a portion of which is sold to two or more unaffiliated banks, with purchasing banks assuming pro-rata share of credit risk

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Subprime lending

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No universal definition. Generally characterized as a lending program that targets borrowers who pose a significantly higher risk of default than traditional retail banking customers.

Can be profitable if well-managed.

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Subprime lender

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Bank that has a subprime lending program with an aggregate credit exposure of 25% of Tier 1 Capital or more

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What should a bank that wants to engage in subprime lending have?

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• Clear understanding of business and risks
• Risk acceptable given staff, condition, and size
• Higher capital support, commensurate with additional risk
• Comprehensive program with strong risk management practices
• Stress testing

If not properly controlled, can be unsafe & unsound

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Payday lending

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• Subtype of subprime lending.
• Small dollar, short-term, unsecured
• Promise to pay out of next paycheck
• Usually priced at a fixed dollar fee
• Significant credit risk. Also legal reputation, transaction, & third-party risk

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Payday loan classifications

Back 36

• By definition, inherently generally should be 'Substandard'
• Outstanding for 60+ days should be 'Loss'

Front 37

ROE schedules for adversely classified loans

Back 37

Items Subject to Adverse Classification Page

Presents pertinent comments related to classified loans

Analysis of Loans Subject to Adverse Classification Page

Permints analysis from a source & disposition standpoint. Should be completed in banks with special supervisory problems, or volume/composition of classifications has changed significantly.

Front 38

The documents which allow a bank to sell a debtor's securities collateral are called:

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Stock and bond powers