Credit Evaluation School - June 2022

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Credit Evaluation School

June 14-23, 2022

@ www.csbs.org � @csbsnews

CONFERENCE OF STATE BANK SUPERVISORS 1129 20th Street NW / 9th Floor / Washington, DC 20036 / (202) 296-2840

Credit Evaluation School Live Virtual June 14-23, 2022

Week 1 Tuesday, June 14, 2022 1:00 pm – 1:30 pm

Introduction & Goals for the Week

1:30 pm – 1:45 pm

Pre-Course Recap

1:45 pm – 2:00 pm

Break

2:00 pm – 2:45 pm

Credit Evaluation Examiner Roles & Responsibilities: Asset Manager and Loan Reviewer

2:45 pm – 3:30 pm

Identifying the 6Ps & Their Documents

3:30 pm – 4:00 pm

Hand Out Line Decks & Review

Wednesday, June 15, 2022 1:00 pm – 1:15 pm

What I Learned Yesterday

1:15 pm – 2:15 pm

Decision Strategies & Loan Classification

2:15 pm – 2:30 pm

Break

2:30 pm – 2:45 pm

Quick Hitters

2:45 pm – 3:15 pm

Loan Writeups

3:15 pm – 3:45 pm

Quick Hitters

3:45 pm – 4:00 pm

End of Day Q&A

Thursday, June 16, 2022 1:00 pm – 1:20 pm

What I Learned Yesterday

1:20 pm – 1:45 pm

Quick Hitters

1:45 pm – 2:15 pm

Red Flags

2:15 pm – 2:30 pm

Break

2:30 pm – 2:45 pm

Quick Hitters

2:45 pm – 3:20 pm

Mock Discussions

3:20 pm – 4:00 pm

Instructor Q&A

Internal Use Only

Week 2 Tuesday, June 21, 2022 1:00 pm – 1:20 pm

Best Thing I Learned Last Week

1:20 pm – 1:45 pm

Week 1 Recap

1:45 pm – 2:00 pm

Instructor Q&A

2:00 pm – 2:15 pm

Break

2:15 pm – 3:00 pm

Red Flags

3:00 pm – 4:00 pm

Small Group Loan Discussion Planning

Wednesday, June 22, 2022 1:00 pm – 1:10 pm

What I Learned Yesterday

1:10 pm – 1:25 pm

Instructor Q&A

1:25 pm – 4:00 pm

Small Group Loan Discussions

Thursday, June 23, 2022 1:00 pm – 1:15 pm

Best Thing I Learned

1:15 pm – 1:45 pm

Review & Discuss Line Decks

1:45 pm – 2:15 pm

Asset Quality Discussion

2:15 pm – 2:30 pm

Break

2:30 pm – 2:50 pm

AQ Quick Hitters

2:50 pm – 3:30 pm

Instructor Q&A

3:30 pm – 4:00 pm

Final Quiz & End of Class

Credit Evaluation School June 14-23, 2022

Instructors

Roberto Chavez

Marcus Andrews

Bank Examinations Coordinator Alabama State Banking Department

Senior Financial Institutions Examiner California Department of Financial Protection and Innovation

Curtis Larsen

Senior Bank Examiner Iowa Division of Banking Paula Peters

Bank Examinations Specialist, Sr. Alabama State Banking Department

Introductions

SOMETHING YOU HOPE TO LEARN DURING THIS CLASS

NAME AGENCY AND STATE

YEARS OF EXPERIENCE AS EXAMINER AND LENGTH OF TIME WORKING CREDIT FILES

FUN FACT ABOUT YOURSELF

Class Demographics - States

Goals for the Week

Discuss with you the 6 Ps method of credit evaluation 1

Give you the tools and tips to assist you in arriving at the appropriate classification decision 2

Improve your comfort level in the discussion setting 3

Provide guidance for clear and concise writeups 4

Questions?

Internal Use Only

Credit Evaluation Examiner Roles & Responsibilities Asset Manager vs Loan Reviewer

Internal Use Only

Asset Manager and/or Examiner-In-Charge

Obtains the loan download and various reports from management. • Watch List • Past Due report • Concentration reports • Other miscellaneous reports Uses the ETS program to generate the loan scope, identifying loans to review based on items such as:

• Previously Classified Loans • Large Lending Relationships

• New Loans • Loan Type • Insider Loans

Internal Use Only

Asset Manager (Examiner-In-Charge in ETS)

Manages the loan review process between bank and examiners

Tracks noted trends, violations, policy and technical exceptions, etc.

Generates portfolio classification data, compares to bank identified information, etc.

Collects completed linesheets from examiners

Internal Use Only

Loan Selection

Loan Scoping

Internal Use Only

Loan Selection • Which loans do we look at and why? • Which loans generally have more risk? • Which loans tend to have less risk? • Why is it important to look at insider loans?

Internal Use Only

Loan Selection Condition of the bank • Previous Examination Reports • Uniform Bank Performance Report • Correspondence Risk Focus • Commercial loans

• Real Estate • Consumer

Internal Use Only

Loan Selection Coverage • Loan volume or particular area of the loan trial • History can dictate how much to review • Confidence in management also lends to coverage Resources • Number of employees assigned to examination • Length of time allowed on site/scheduling

Internal Use Only

Standard Review Items  Previously Classified  Internal Watch List  External Loan Review  Past Dues • Delinquency Threshold • Files worked or discussed only  Nonaccrual  Restructured  Insider and Related-Interest  Participations

 Loans above the “cut”  Letters of credit

 Unfunded Loan Commitments  Financed Sales of Other Real Estate  Unusual Loans • Capitalized Interest • Out-of-Territory • Long-term Unsecured • Evergreen  New Loan Sampling  New Loan Officer Sample

Internal Use Only

Additional Line Sheets Info • Charge Off Amounts • Overdrafts • Rejects/ Insufficient Items • Unadvanced funds to which bank is committed

Internal Use Only

Individual Loan Reviewer • Obtains the ETS Distribution package from the Asset Manager (or EIC).

• Gains familiarity with loan products, policies and procedures.

• Reviews assigned files. • Examine loan and credit files for necessary documents • Completes 6 P and Financial Analysis • Completes a writeup on sizable downgrades or when management does not agree • Discusses lines with loan officer and/or management designee as needed.

• Communicates findings with Asset Manager.

Let’s take a swing at Identifying the 6 P’s

What are the 6 P’s?

Method of evaluating the asset quality of a loan.

Take a moment and review the Sample Writeup included in your eBook.

The 6 P’s Are…. 1. Person (People) • Borrower • Co-Borrower • Guarantor • Related Entity 2. Purpose • What, why, and how? 3. Payment

4. Protection

• Collateral

5. Problem

• What went wrong?

6. Prospects

• Potential remedies?

• Primary, Secondary, Tertiary

Person

The 19 TH Hole, INC. • By: Tiger Woods, President • Gty: Tiger Woods Business operates as a local bar/restaurant/indoor golf simulation.

Person

Indebtedness is the balance of a 1,100M note originated 10-5-16 with principal and interest payable at $7,567 per month for 20 years. Purpose of the loan was to purchase an existing restaurant and add an indoor golf simulation bay. Source of repayment is from the operation of the bar. Loan was 78 days past due and payments have been extended five times since origination. A payment was made during the examination bringing the note current.

Purpose

Paym ent

The business continues to struggle financially. CPA-compiled financials as of 12-31-18 indicate a highly leveraged operation and reflect TA of 1,490M, TL of 1,610M, for a deficit NW of 120M. Assets are concentrated in net FA of 1,395M including various F&F and M&E. Liquidity is tight and was (14M). Operating income for 2018 shows a net loss of 100M on gross sales of 750M. Cash flow from operations available to service debt totals (35M). An unsigned and stale personal statement on the guarantor dated 11-15-17 adds minimal support and little liquidity with TA of 542M and NW of 145M. Cash was only 2M.

Payment

Protection

Collateral consists of a first REM on the commercial building located in Iowa City, Iowa along with a blanket security agreement covering general business assets. An appraisal performed on 9-2-16 indicates an “as is” value of 950M and an “as completed” value of 1,350M.

Protection

78 Days PD

The business was a new venture for Mr. Woods, who previously worked as a semi-professional golfer. The golf simulation bay closed last winter as Mr. Woods lost his contract with operator/servicer of the golf simulator. The entity struggles with employee turnover, unreliable suppliers, and pressure from existing competition. The operation continues to be unprofitable on a monthly basis and some suppliers are demanding cash upon delivery further limiting liquidity. President Mickelson now estimates the value of the property at 1,200M based on sales of similar properties. Due the to the apparent cash flow and liquidity issues, unprofitable operations, leveraged position, and marginal collateral coverage, the loan is classified Substandard. This is a downgrade from management’s internal Pass rating.

Problem

Questions?

Reviewing and Classifying Loans

INDIVIDUAL LOAN FILE REVIEW As we work through the files and identify the 6 P’s of credit, we are looking for:

• Problem credits (may not yet be identified) • Past due loans (is management manipulating) •Credit documentation exceptions • Violations of laws/regulations/policies •Concentrations of credit • Evidence of self-dealing loan transactions

ASSET MANAGER DUTIES • Collect data from examiners working files to aid in identifying trends • Compare examiner classification to internal classification • Determine if adequate risk controls exist • Adequacy of policies, practices, controls, procedures, servicing, etc. • Nonaccrual guidelines • Risk rating system-early identification of risk

LOAN CLASSIFICATION DEFINITIONS Substandard Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.

LOAN CLASSIFICATION DEFINITIONS Doubtful Loans classified Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.

LOAN CLASSIFICATION DEFINITIONS Loss Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future.

LOAN CLASSIFICATION DEFINITIONS Listed for Special Mention A asset listed for Special Mention has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution's credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

UNACCEPTABLE OR HIGH RISK LOANS • Illegal or illegal purpose • Speculative • Finance changing business ownership • Construction loans without firm takeout • Loans for new business ventures/venture capital loans • Nonamortizing term loans • Loan where source of repayment is not firmly committed • Loans on unmarketable securities • Unsecured loans for real estate purposes

UNACCEPTABLE OR HIGH RISK LOANS Other Considerations • Loans where management has no expertise • Loans that require special handling or controls • Abnormal amount of loans involving out of territory borrowers • Loans involving brokered deposits or link financing

ITEMS NEEDED TO REVIEW FILE

• Credit File Information • Financial Analysis

• Review and consideration of six “Ps” • Historical financial data and trends • Nature and degree of collateral • Capacity to retire debt in accordance with specified terms • Financial responsibility • Credit reports

ITEMS NEEDED TO REVIEW PORTFOLIO • External Credit File Information • Aware of bank’s service area and regional economy • Trend in the business’ industry • Bank management • Previous reports of examination • Prior examination loan decks • Loan committee minutes • Board reports and management information systems

COMMON RISKS IN LOAN PORTFOLIO • Self dealing loans • Anxiety for income or growth • Weak servicing • Incomplete credit information • Poor supervision • Complacency • Poor risk evaluation • Concentrations of credit • Subprime Lending

SOURCES OF REPAYMENT

• Conversion of current assets to cash • Sale of non-current assets • Replacing debt with debt - refinancing • Equity injection

SOURCES OF REPAYMENT

CASH IS KING!

QUESTIONS?

Loan Write-ups

CRITICIZED VS. CLASSIFIED LOANS: • All four categories are considered as Criticized • All but Special Mention are considered as Classified • Special Mention • Substandard • Doubtful • Loss

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LOAN WRITEUPS Rules for including a loan writeup in an examination report vary amongst regulators: • Management disagrees with examiner • Dollar amount represents a significant percentage of assets or capital • EIC discretion • Others

LOAN WRITEUPS The writeup format should cover the 6 Ps: • Person

• Purpose • Payment • Protection • Problem • Prospects

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IDENTIFICATION OF BORROWER • Name and/or title of borrower - Note if the borrower is an insider or related interest of an insider as defined by Regulation O, or state code if appropriate • Nature of borrower (Individual, partnership, corporation, etc.)

• Nature of business or employment • Capacity in which individuals sign • Identify Cosigners, Endorsers, and Guarantors

• Note: The identification of the obligor can be in the heading of the write- up or in the written comments. It is also standard procedure to include the total balance of the debt above the heading, in thousands of dollars.

IDENTIFICATION OF BORROWER EXAMPLES:

1,200 ABC Corporation End: Alfred B. Cook, President/Owner Textile Manufacturer

1,200 ABC Corporation

• The corporation is in manufacturing and operated by the owner. All notes are signed and endorsed by Mr. Alfred B. Cook, president and owner.

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DESCRIPTION OF DEBT • Original amount borrowed (per note or with notation of total original if renewals with reductions or combination of various notes) • Original Date (of note or line if renewals involved) • Original Due date/terms • Purpose of loan • Repayment source • Present balance

DESCRIPTION OF DEBT • Note: If any portion of the debt was previously charged-off or paid from liquidation of the collateral, this should be noted. • Past due status is applicable • Tie-ins - Related debt/related interests • Note any specific reserve balances, if applicable

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DESCRIPTION OF DEBT EXAMPLES:

Debt consists of a $150,000 note originating 1-20-x8 at the same amount due 1-20-x9. The purpose of the loan was to purchase the collateral to be repaid from maker’s income.

DESCRIPTION OF DEBT

Debt consists of two installment notes totaling $100M, due $500 each monthly, past due two payments each. The notes originated at $50M and $75M respectively. The purpose of both loans was for working capital and repayment was to come from income. The secondary source of repayment was from the guarantor, Mr. Johnson who has a NW of $1,300M as reflected in 6-30-x8 financial statement.

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DESCRIPTION OF COLLATERAL • Type of Collateral • Examples: Real Estate, Inventory, Accounts Receivable, Automobiles, etc. • Location of Collateral if applicable (especially if out of trade area) • Appraised value or estimated value

DESCRIPTION OF COLLATERAL • Note if loan officer estimates the value higher or lower than the appraised value • Note if internal or external appraisal and date of valuation if it is pertinent to the classification • Specialized collateral or work in progress may need special consideration • Appraisal violations should be noted only, not restated

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DESCRIPTION OF COLLATERAL EXAMPLE – APPRAISAL VIOLATION NOTED WITHIN WRITEUP The appraisal does not meet the requirements for a Certified Appraisal. Refer to Schedule of Violations of Laws and Regulations elsewhere in this report of examination.

DESCRIPTION OF COLLATERAL EXAMPLE – COLLATERAL DESCRIPTION Collateral consists of 2 AL valued at $100M (internal evaluation). The property is unimproved and zoned commercial.

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DESCRIPTION OF COLLATERAL EXAMPLE - COLLATERAL DESCRIPTION

Collateral is listed as inventory and AR valued at $125M on the makers audited 12-31-x8 financial statement. Management indicated that the liquidation value would probably be $100M.

FINANCIAL EXHIBITS Preparer - Internal, CPA (type), Other Term • Annual (Fiscal Year) • Interim List major categories only • Note: Depreciation and Amortization should be footnoted on the operating statement

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FINANCIAL EXHIBITS 12-31-x9 ABC Corporation (CPAAudited) Cash 100 AP

300 GP 4,000

1,000 CPLTD 200 COGS 3,000

Inventory 90 CL

500 NP 1,000

CA FA NR TA RE

1,190 LTD 1,700 TL

1,000 Op Exp

500 500 190 310

2,000 NI

290 Capital 3,180 Surplus 980 Op Exp

100 Taxes 100 NIAT

NW 1,180 includes TL & NW 3,180 50 M in depreciation

FINANCIAL EXHIBITS Note Abbreviations: (CHECK INSIDE OF REPORT COVER)

BALANCE SHEET

AR - Accounts Receivable

AP - Accounts Payable

CA - Current Assets

CPLTD - Current Portion of Long-Term Debt

FA - Fixed Assets

CL - Current Liabilities

NR - Notes Receivable CSVLI-Cash surrender value life insurance

LTD - Long-term debt TL - Total Liabilities UP/RE- Undivided Profits NW - Net Worth

INCOME STATEMENT

GP - Gross Profit NP – Net Profit

COGS - Cost of Goods Sold

NI - Net Income

NIAT - Net Income After Taxes

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CLASSIFICATION Point out all the reasons for classification • Marginal or Insufficient collateral • Poor or weak financial condition • Lack of a repayment plan • Past due status • Others?

CLASSIFICATION EXAMPLE – POOR OR WEAK FINANCIAL CONDITION ABC Corporation’s 12-31-x9 audited financial statements reflected TA of $1,200M, TL of $2,000M, and negative NW of $800M. Also reflected was GP of $2,000M, COGS of $1,000M, Operating Expenses of $1,200M, and Net Loss of $200M.

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CLASSIFICATION • Clear and concise reasons for classification • Accurate • Include management's response including any commitments • If the debt was classified at the previous examination, include the information - how classified, and at what amount

CLASSIFICATION EXAMPLE – PREVIOUSLY CLASSIFIED

Debt classified Substandard at the previous examination in the amount of $150,000. Collateral remains the same.

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CLASSIFICATION Amounts secured by cash collateral not classified IF completely documented: • Assigned Certificates of Deposit • Assigned savings accounts with holds on the account • Listed securities with adequate documentation

CLASSIFICATION EXAMPLE – CASH COLLATERAL EXCLUDED

The $10,000 CD (certificate of deposit) assigned as collateral is deleted from classification, with the remaining balance classified Substandard.

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CLASSIFICATION Government guaranties are also removed from classification • Small Business Administration (SBA) • Farm Service Agency (FSA) • Others?

CLASSIFICATION EXAMPLE – GOVERNMENT GUARNATYS EXCLUDED The $200M note is 90% guaranteed by the Small Business Administration. The guaranty is deleted from classification and the remaining $20M is classified Loss.

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CLASSIFICATION Add a notation if any violations are noted and refer to that section of the report of examination.

CLASSIFICATION EXAMPLE – VIOLATION CITED ELSEWHERE

This line is in excess of the bank’s legal lending limit. Refer to Violations of Law and Regulations section of this report.

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GENERAL WRITEUP TIPS • Use the 6 P’s as a guide • Detailed vs. short form • Outline key points – keep it simple • Break up paragraphs (not one huge one) • Include management’s comments and any commitments made • See Guide Sheet handout

Questions??

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AssetQuality Analyzing and Rating Asset Quality

C A M E L S Asset quality (AQ) is one of the most critical areas in determining the overall condition of a bank. • The primary factor affecting overall asset quality is the quality of the loan portfolio and the credit administration program. • Loans typically comprise a majority of a bank’s assets and carry the greatest amount of risk to capital. • Securities, OREO, and other earning (or non) assets the institution may have on their books can also greatly affect AQ. Examiners should be diligent and focused when reviewing a bank’s assets, as they can significantly impact most other facts of bank operations.

*FDIC RMS Manual of Examination Policies

Why is AQ important? • Core earnings are reliant on the quality and earning ability of assets (i.e. accrual vs. nonaccrual; classifications’ impact on the loan loss provisions; impairment of securities). • Strong capital levels are excellent; however, quality assets are needed to ensure retained earnings are augmenting capital and that capital is being used as intended. • Poor asset quality continues to be a primary contributor in bank failures.

Analyze AQ • What are the loan reviewers' findings? • Was credit risk identification practices appropriate (examiner downgrades of credits)? • Were credit underwriting and administration weaknesses noted? • Amount and severity of technical exceptions. • Are the issues isolated or do they indicate a systemic issue? • What are the reasons for the issues? • Weak policies/procedures • Inadequate loan officer or credit administration staff training • Weak underwriting

Analyze AQ - Credit Administration • Level and severity of weaknesses identified. • Promptness of identification, correction, and taking measures for future prevention. • Accuracy of internal risk ratings. • Identifying and taking losses in a timely manner. • Accurate and timely reporting to senior management and Board.

Analyze AQ – Key UBPR Ratios and Pages • Average Total Assets – Summary Ratios Page

• Net Loans & Leases to Assets – Summary Ratios Page • LN&LS Allowance to Total LN&LS – Summary Ratios Page

• Total LN&LS-90+ Days Past Due and Nonaccrual – Summary Ratios Page • Problems Assets – Analysis of Past Due, Nonaccrual, and RTD Pages • Loan portfolio composition – Balance Sheet and Loan Mix Pages • Concentrations – Concentrations of Credit Page

Analyze AQ – Other areas to consider • Portfolio composition • Strategic and succession plans

• Policies and procedures • Overall bank credit culture • ALLL • Concentrations • OREO/OA • Securities portfolio

Considerations for AQ Rating – FDIC Manual • The adequacy of underwriting standards, soundness of credit administration practices, and appropriateness of risk identification practices. • The level, distribution, severity, and trend of problem, classified, nonaccrual, restructured, delinquent, and nonperforming assets for both on- and off-balance sheet transactions. • The adequacy of the ALLL and other asset valuation reserves. • The credit risk arising from or reduced by off-balance sheet transactions, such as unfunded commitments, credit derivatives, commercial and standby letters of credit, and lines of credit.

Considerations for AQ Rating cont. • The diversification and quality of the loan and investment portfolios. • The extent of securities underwriting activities and exposure to counter- parties in trading activities. • The existence of asset concentrations. • The adequacy of loan and investment policies, procedures, and practices. • The ability of management to properly administer its assets, including the timely identification and collection of problem assets. • The adequacy of internal controls and management information systems. • The volume and nature of credit documentation exceptions.

*FDIC RMS Manual of Examination Policies

Rating the asset quality factor • Like other components, the AQ rating is based on a 1 through 5 scale. • The asset quality rating definitions are applied following a thorough evaluation of existing and potential risks and the mitigation of those risks. The definition of each rating is as follows:

Asset Quality Rating - 1 A rating of 1 indicates strong asset quality and credit administration practices. Identified weaknesses are minor in nature and risk exposure is modest in relation to capital protection and management’s abilities. Asset quality in such institutions is of minimal supervisory concern.

Asset Quality Rating - 2 A rating of 2 indicates satisfactory asset quality and credit administration practices. The level and severity of classifications and other weaknesses warrant a limited level of supervisory attention. Risk exposure is commensurate with capital protection and management’s abilities.

Asset Quality Rating - 3 A rating of 3 is assigned when asset quality or credit administration practices are less than satisfactory. Trends may be stable or indicate deterioration in asset quality or an increase in risk exposure. The level and severity of classified assets, other weaknesses, and risks require an elevated level of supervisory concern. There is generally a need to improve credit administration and risk management practices.

Asset Quality Rating - 4 A rating of 4 is assigned to financial institutions with deficient asset quality or credit administration practices. The levels of risk and problem assets are significant, inadequately controlled, and subject the financial institution to potential losses that, if left unchecked, may threaten its viability.

Asset Quality Rating - 5 A rating of 5 represents critically deficient asset quality or credit administration practices that present an imminent threat to the institution’s viability.

Suggested AQ Comment This is a sample format and can be utilized as framework for an AQ comment. However, each examination is different and therefore, each AQ comment should be different. Utilize your state’s guidelines when writing AQ comments.

First Paragraph: • Translate the numerical rating to a qualitative statement of AQ (i.e. Asset quality is strong). • Adversely classified items ratio, comparisons to prior periods or exams as appropriate. • Narrate the major findings (underwriting weaknesses). • Composition of classified/criticized assets (loans, securities, OREO, etc.) and the

respective classifications (Substandard, Doubtful, etc.) • Internal classification/Watch List numbers, if necessary. • Level and trend of nonaccrual and past dues, if necessary.

Second Paragraph (Risk Rating Accuracy/Risk Identification Practices):

• Level and amount of examiner downgrades • Adequacy of internal loan grading system • Adequacy of independent loan review

Third Paragraph Address major findings. If none identified, then address acceptability of credit and loan administration practices.

Fourth Paragraph The level and trend of the ALLL as well as the methodology associated with it. • This will likely change to ACL in the near future.

Subsequent Items to Consider • Concentrations • OREO • Investment portfolio • Off-balance sheet items

• Internal controls and management information systems • Adequacy of loan and investment policies, procedures, and practices

AM Duties – Quick Overview • Scope loans/OREO for examiner review • Follow-up on prior examination findings/recommendations/violations. • Review Loan Committee Minutes • Review Loan/Lending Policy and other lending policies, if needed. • Review UBPR/Call Report information in regards to AQ • Review completed linesheets from credit examiners. • Compile and review AQ related findings/recommendations/violations.

• Participate in individual loan discussions, if necessary. • Update management on exam related AQ findings. • Prepare AQ comment and report pages.

Loan Classifications – Discussion STUDENT INSTRUCTIONS

INTRODUCTION AND OVERVIEW OF EXERCISE The Line Deck consists of 20 lines. Students should plan on spending up to 8 hours outside of class time between now and the beginning of next Tuesday’s session in reviewing these lines. On Tuesday, 6/21, we will break into your groups for review as a group. On Wednesday, 6/22, students, in the group setting, will be discussing the lines with instructors. The instructors will be playing the part of the loan officer responsible for the credit. 1. A rating (Pass, Special Mention, Substandard, Doubtful, or Loss) will be assigned to each line on the Loan Classifications link. 2. Each student will then write a bullet points writeup using the Loan Write-Up Bullet Points link for one classified line. 3. Lastly, students will complete the Self-Evaluation link. 4. All three of the above links are to be completed no later than 10 AM Eastern on Thursday, 6/23. OBJECTIVES 1. Determine which loans should/should not be discussed with the loan officer. 2. Choose pertinent questions (based on 6Ps) to ask the loan officer regarding each loan to be discussed. 3. Rate loans properly based on discussion and evaluation of loan quality. 4. Evaluate communication skills. * The accuracy of your ratings decisions and communication skills will be evaluated by the instructors. PREPARATION Students will first look through all 20 lines individually and identify the 6Ps for each line. Once students are placed into groups on Tuesday 6/21, the group should use the time to briefly review the lines together and determine which lines need to be discussed with the loan officers. The students will then, as a group, formulate questions for those lines which need clarification and discussion with the loan officers. Students should be prepared to discuss any of the loans in the line deck. GUIDELINES FOR DISCUSSION • Each instructor will act as a loan officer, responsible for specific lines in the deck. The instructors will inform the students which loans are handled by each of the loan officers. • Students should be prepared to discuss any of the loans in the deck. • Each group member must discuss at least one loan before any group member can discuss a second loan. • The group must agree on the loans to be discussed. If a group member wants to discuss a loan that the rest of the group does not want to discuss, that loan may be discussed only if time allows. DISCUSSION AND LOAN RATING MECHANICS The group will have 20 minutes with each loan officer to discuss that loan officer’s lines, followed by a 10-minute break, part of which should be used to finalize any notes taken during the discussion. This will be repeated for four rounds (each group with each loan officer).

Loan Classifications – Discussion STUDENT INSTRUCTIONS

LOAN RATING DECISIONS Immediately following your group’s completion of all four rounds of discussion, you as an individual should complete the Loan Classifications link. Assign a rating (Pass, Special Mention, Substandard, Doubtful, or Loss) to each line in the deck. Justify/support each decision made using 2-3 bullet points. Remember, these are individual rating decisions. Each group may also hear different explanations/comments regarding the lines discussed, so discussion with other groups should be avoided when making a final rating decision. BULLET POINT WRITEUP FOR A CRITICIZED LINE Each student should choose one loan to complete a bullet point writeup on using the Loan Write- Up Bullet Points link. Remember that only classified lines (Substandard, Doubtful, Loss) are to be written up (examiners do not write up Pass lines). LOAN DISCUSSION SELF-EVALUATION Each student should complete the Loan Discussion Self-Evaluation link.

CRITICIZED AND CLASSIFIED LOAN RATING DEFINITIONS

SPECIAL MENTION A Special Mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special Mention assets are not adversely classified and do not expose the institution sufficient risk to warrant adverse classification. Key Characteristics: • Improper loan structure • Inadequate loan agreements or covenants • Incomplete or inadequate documentation to adequately monitor the loan • Lack of control over collateral SUBSTANDARD Loans classified Substandard are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected. Key Characteristics: • Negative trends in – Cash Flow; Profitability; Net Worth; Liquidity; Leverage • Significant deviation from the original repayment source • Numerous extensions and/or renewals • Diversion of repayment funds • Delinquency • Failure to clean up a short-term operating line • Whenever debt is carried over without sufficient reason

DOUBTFUL Loans classified Doubtful have all of the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable. Key Characteristics: • Weaknesses noted for loans classified Substandard and not readily identified Loss • Undetermined value of collateral LOSS Loans classified Loss are uncollectible and of such little value that their continuance as a bankable asset is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value but rather that it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may occur in the future. Key Characteristics: • No readily identifiable source of repayment (cash flow or liquidation of collateral) • Not well secured and not in process of collection • Severe delinquency

6 P Format

Person/People Who is the borrower? What is the borrower’s primary business? Who are the owners of the business? What is the borrower’s background and experience? Are there guarantors? Are there any related businesses which need to be discussed? Purpose How are the loan proceeds being used? Is the structure of the financing appropriate for the loan purpose? Are the repayment terms appropriate considering the frequency and source of repayment? Protection What is the collateral? What is condition and value of the collateral? How is the lender’s interest in the collateral secured? Payment What is the primary source of repayment? Is this repayment source adequate to repay the loan? What is the secondary source of repayment? Is this repayment source adequate to repay the loan? Is there a tertiary source of repayment? Is this repayment source adequate to repay the loan? Problem Do any weaknesses exist which are jeopardizing repayment of the loan? Are there any potential weaknesses which have emerged? Prospects What actions are being taken by the borrower or the bank to address the weaknesses related to the loan?

Items Subject to Adverse Classification SAMPLE WRITEUP Includes assets and off-balance sheet items which are detailed in the following categories: Substandard Assets - A Substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Doubtful Assets - An asset classified Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Loss Assets - An asset classified Loss is considered uncollectable and of such little value that continuance as a bankable asset is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future. CATEGORY AMOUNT, DESCRIPTION AND COMMENTS Substandard Doubtful Loss 1,045 78 Days PD 1,045 THE 19 TH HOLE, INC. By: Tiger Woods, President Gty: Tiger Woods Business operates as a local bar/restaurant/indoor golf simulation. Indebtedness is the balance of a 1,100M note originated 10-5-16 with principal and interest payable at $7,567 per month for 20 years. Purpose of the loan was to purchase an existing restaurant and add an indoor golf simulation bay. Source of repayment is from the operation of the bar. Loan was 78 days past due and payments have been extended five times since origination. A payment was made during the examination bringing the note current. The business continues to struggle financially. CPA-compiled financials as of 12-31-18 indicate a highly leveraged operation and reflect TA of 1,490M, TL of 1,610M, for a deficit NW of 120M. Assets are concentrated in net FA of 1,395M including various F&F and M&E. Liquidity is tight and was (14M). Operating income for 2018 shows a net loss of 100M on gross sales of 750M. Cash flow from operations available to service debt totals (35M). An unsigned and stale personal statement on the guarantor dated 11-15-17 adds minimal support and little liquidity with TA of 542M and NW of 145M. Cash was only 2M. Collateral consists of a first REM on the commercial building located in Iowa City, Iowa along with a blanket security agreement covering general business assets. An appraisal performed on 9-2-16 indicates an “as is” value of 950M and an “as completed” value of 1,350M. The business was a new venture for Mr. Woods, who previously worked as a semi-professional golfer. The golf simulation bay closed last winter as Mr. Woods lost his contract with operator/servicer of the golf simulator. The entity struggles with employee turnover, unreliable suppliers, and pressure from existing competition. The operation continues to be unprofitable on a monthly basis and some suppliers are demanding cash upon delivery further limiting liquidity. President Mickelson now estimates the value of the property at 1,200M based on sales of similar properties. Due the to the apparent cash flow and liquidity issues, unprofitable operations, leveraged position, and marginal collateral position, the loan is classified Substandard. This is a downgrade from management’s internal Pass rating. President Mickelson disagrees with the assigned classification. He stated the operation is gradually gaining in popularity among the younger clientele, and he believes the operation can return to profitability in the next three to five years. President Mickelson believes that Mr. Woods’ relatives are providing funds for working capital in the daily operation and will continue to do so for the foreseeable future. Originating/Servicing Officer: President Phil Mickelson 12345

Internal Classification: Pass Examiner: Dustin Johnson

ABBREVIATIONS USED IN LINECARDS OR LOAN COMMITTEE MEMORANDUMS:

Acres of Land

LS Livestock M&E Machinery & Equipment M/M Mr. and Mrs. MI Monthly Interest Mo. Monthly Mtg Mortgage P Prime Rate P&L Profit & Loss Statement PATL Pledged against total liability (collateral listed is pledged against all debt) RE Real Estate Rec. Recorded date S/S Shares of Stock SA Security Agreement SBA Small Business Administration T/C Title Certificate TI Title Insurance UCC Uniform Commercial Code W/C Working Capital

AR Accounts Receivable ARM Adjustable Rate Mortgage Assign Assignment AV Appraised Value Brand Brand Filing CD Certificate of Deposit CFD Contract for Deed CRP Crop Reduction Program D/T Deed of Trust (similar to Security Deed) End Endorser F&F Furniture & Fixtures F&G Feed & Grain FmHA Farmers Home Administration FS Financial Statement GTY Guaranty Int Interest INS Insurance Inv Inventory JM Joint Maker LC Letter of Credit LOC Line of Credit

CONSUMER LOANS MOTOR VEHICLES

What is it: A consumer loan to an individual for personal reasons, typically to purchase automobiles, boats, trucks, truck tractors, trailers, semi-trailers, motorcycles, motor scooters, buses, or recreational vehicles.

1. PRIMARY DOCUMENTS REQUIRED:

☐ Signed Consumer Credit Application ☐ Credit Report ☐ Promissory Note

☐ Security Agreement (may be included within promissory note) ☐ Certificate of Title or Certificate of Origin (properly filed). ☐ If Applicable, Financing Statement (properly filed) ☐ Evidence of Insurance ☐ Income Information (Tax Returns, Payroll Stubs, etc.)

CONSUMER LOANS RESIDENTIAL (HOME)

What is it: A consumer loan to an individual for personal reasons, typically to purchase real property such as a residential home, undeveloped land, lots, free-standing dwellings, duplexes, fourplexes, apartments, or condominiums.

2. PRIMARY DOCUMENTS REQUIRED:

☐ Signed Residential Mortgage Credit Application (Form 1003-Fannie Mae) ☐ Credit Report ☐ Promissory Note ☐ Mortgage or Deed of Trust (properly filed) ☐ Appraisal or Evaluation ☐ Independent Review of Appraisal or Evaluation ☐ Title Insurance Commitment or Preliminary Lien Search

☐ Title Insurance Policy or Title Opinion ☐ Evidence of Home Owner’s Insurance ☐ Income Information (Tax Returns, Payroll Stubs, etc.)

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COMMERCIAL LOANS WORKING CAPITAL AND EQUIPMENT

What is it: A loan to a commercial business for business purposes typically for operating purposes (working capital line of credit) or for the purchase of equipment to be used in the business.

3. PRIMARY DOCUMENTS REQUIRED: ☐ Promissory Note ☐ Borrowing Resolution ☐ Articles of Incorporation ☐ Security Agreement ☐ Lien Search ☐ Financing Statement (properly filed) ☐ Evidence of Insurance ☐ Tax Returns ☐ Balance Sheet and Profit and Loss Statement ☐ Guarantees (if applicable) ☐ Financial Statement for Guarantors (if applicable) ☐ Tax Returns for Guarantors (if applicable)

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COMMERCIAL LOANS COMMERCIAL REAL ESTATE

What is it: A loan to a commercial business for business purposes secured by real estate for the purpose of purchasing, acquiring, developing, or constructing an income producing property. Typical loans within this category are: business and industrial properties, apartment or condominium buildings, hotels, hospitals, golf courses, nursing homes, mini-storage warehouses, etc.

4. PRIMARY DOCUMENTS REQUIRED:

☐ Promissory Note ☐ Borrowing Resolution ☐ Article of Incorporation ☐ Mortgage or Deed of Trust (properly filed) ☐ Appraisal or Evaluation ☐ Independent Review of Appraisal or Evaluation ☐ Title Insurance Commitment or Preliminary Lien Search ☐ Title Insurance Policy or Title Opinion ☐ Evidence of Property Insurance ☐ Tax Returns ☐ Balance Sheet and Profit and Loss Statement ☐ Lease or Rental Agreements (depending on property type) ☐ Assignment of Rents (depending on property type) ☐ Guarantees (if applicable) ☐ Personal Financial Statement for Guarantors (if applicable) ☐ Tax Returns for Guarantors (if applicable)

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AGRICULTURAL LOANS WORKING CAPITAL AND EQUIPMENT

What is it: Loans for the purpose of financing agricultural production and equipment. Typical loans within this category are for: growing, storing, or marketing of crops, breeding, raising, fattening, or marketing of livestock, financing fisheries, forestries, and commercial fishermen, and purchase or maintenance of farm machinery, equipment, and implements.

5. PRIMARY DOCUMENTS REQUIRED:

☐ Promissory Note ☐ Security Agreement ☐ Lien Search ☐ Financing Statement (properly filed) ☐ Evidence of Insurance ☐ Farm or Livestock Inspection ☐ Financial Statement ☐ Tax Returns

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AGRICULTURAL LOANS REAL ESTATE

What is it: A loan which is secured by farmland and known to be used or usable for agriculture purposes, such as crop and livestock production. Farmland includes grazing or pasture land, whether tillable or note and whether wooded or not.

6. PRIMARY DOCUMENTS REQUIRED:

☐ Promissory Note ☐ Mortgage or Deed of Trust (properly filed) ☐ Appraisal or Evaluation ☐ Independent Review of Appraisal or Evaluation ☐ Title Insurance Commitment or Preliminary Lien Search ☐ Title Insurance Policy or Title Opinion ☐ Evidence of Insurance ☐ Farm or Livestock Inspection ☐ Financial Statement ☐ Tax Returns

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