Credit Evaluation School eBook

Credit Evaluation School March 3-7, 2025 Washington, DC

@ www.csbs.org ♦ @csbsnews

CONFERENCE OF STATE BANK SUPERVISORS 1300 I Street NW / Suite 700 / Washington, DC 20005 / (202) 296-2840

Credit Evaluation School Washington, DC March 3-7, 2025

Monday, March 3, 2025 7:30 – 8:30 am

Registration and Breakfast

Introduction and Goals for the Week

8:30 – 9:00 am 9:00 – 9:30 am 9:30 – 10:15 am 10:15 – 10:30 am 10:30 – 12:00 pm 12:00 – 1:15 pm 1:15 – 2:00 pm 2:00 – 2:45 pm 2:45 – 3:00 pm 3:00 – 3:30 pm 3:30 – 4:30 pm 5:00 – 7:00 pm 8:30 – 8:45 am 8:45 – 9:30 am 9:30 – 10:00 am 10:00 – 10:15 am 10:15 – 10:45 am 10:45 – 12:00 pm 12:00 – 1:15 pm 1:15 – 4:00 pm 4:00 – 4:30 pm

Pre-Course Recap

Examiner Roles – Asset Manager & Loan Scoping

Break

Primary Loan Documents

Lunch on your own

Defining the 6 P’s & Loan Classification Case Study: 19 th Hole – Identifying the 6 P’s

Break

Nonaccrual

Hand Out Line Deck #1 Networking Reception

Tuesday, March 4, 2025 7:30 – 8:30 am

Breakfast

Monday Recap

Reviewing & Classifying Loans

Mock Discussions

Break

Quick Hitters

Loan Discussion Prep Lunch on your own

Loan Discussions

Loan Discussion #1 Materials Due Students must turn in classification grid and bullet-point writeup on a classified line.

Wednesday, March 5, 2025 ; 7:30 – 8:30 am

Breakfast

Tuesday Recap Quick Hitters

8:30 – 9:00 am 9:00 – 10:00 am 10:00 – 10:30 am 10:30 – 10:45 am 10:45 – 11:15 am 11:15 – 12:00 pm 12:00 – 1:15 pm 1:15 – 4:30 pm 8:30 – 8:45 am 8:45 – 9:15 am 9:15 – 10:15 am 10:15 – 10:30 am 10:30 – 12:00 pm 12:00 – 1:15 pm 1:15 – 4:00 pm 4:00 – 4:30 pm

Red Flags

Break

Loan Writeups

Hand Out Line Deck #2 Lunch on your own Loan Discussion Prep

Thursday, March 6, 2025 7:30 - 8:30 am

Breakfast

Wednesday Recap

Quick Hitters

Loan Discussion Prep

Break

Loan Discussions Lunch on your own Loan Discussions

Loan Discussion #2 Materials Due Students must turn in classification grid, self-evaluation and full writeup on a classified line.

Friday, March 7, 2025 7:30 – 8:30 am

Breakfast

Thursday Recap

8:30 – 8:45 am 8:45 – 9:15 am 9:15 – 9:45 am 9:45 – 10:00 am 10:00 – 10:15 am 10:15 – 11:00 am

Asset Quality: Analyzing and Rating

AQ Quick Hitters

Review & Discuss Line Decks

Break

Learning Assessment & Wrap Up

11:00 am

Adjourn

March 3-7, 2025 Credit Evaluation School Washington, DC

ATTENDEES Colorado Department of Regulatory Agencies Division of Banking Chagolla, Jared

jared.chagolla@state.co.us

Iowa Division of Banking Baltimore, Danielle Wardell, Christopher

danielle.baltimore@idob.state.ia.us chris.wardell@idob.state.ia.us

Kansas Office of the State Bank Commissioner Butler, Dylan

dylan.butler@osbckansas.org eddie.deltoro@osbckansas.org hanna.ediger@osbckansas.org carly.walter@osbckansas.org

Del Toro, Eddie Edgier, Hanna Walter, Carly

Mississippi Department of Banking and Consumer Finance Selman, Jonathan

jonathan.selman@dbcf.ms.gov

Missouri Division of Finance Hamilton, Hannah

hannah.hamilton@dof.mo.gov

New York State Department of Financial Services Huang, Weiwen

weiwen.huang@dfs.ny.gov zaza.zhvania@dfs.ny.gov

Zhvania, Zaza

North Carolina Office of the Commissioner of Banks Duguid, Stephie

sduguid@nccob.gov

Ohio Division of Financial Institutions Corder, Timothy

timothy.corder@com.ohio.gov marie.currier@com.ohio.gov

Currier, Marie

Oregon Division of Financial Regulation Smith, Holland

holland.d.smith@dcbs.oregon.gov

West Virginia Division of Financial Institutions Freeman, Caleb

cfreeman@wvdob.org

Wisconsin Department of Financial Institutions Eisenschink, April

april.eisenschink@dfi.wisconsin.gov

INSTRUCTORS Alabama State Banking Department Andrews, Marcus

marcus.andrews@banking.alabama.gov

California Department of Financial Protection and Innovation Chavez, Roberto

roberto.chavez@dfpi.ca.gov

Iowa Division of Banking Smith, Zachary

zac.smith@idob.state.ia.us

CSBS STAFF Hoyle, Katie

khoyle@csbs.org

Richardson, Amy

arichardson@csbs.org

Credit Evaluation School March 3-7, 2025

Schedule Monday: • Registration/Breakfast – 7:30 AM - 8:30 AM

• School – 8:30 AM - 4:30 PM • Reception – 5:00 – 7:00 PM Tuesday – Thursday: • Breakfast – 7:30 AM - 8:30 AM • School – 8:30 AM - 4:30 PM Friday: • Breakfast – 7:30 AM - 8:30 AM • School – 8:30 AM – 11:00 AM

Attendance Policy In order to receive a certificate of completion for a CSBS in-person training, an attendee may not miss more than 1 hour throughout the duration of the training. Attendees must also participate in all training activities including exercises, presentations, and assessments to receive the credit hours (CEHs) and certificate. If a certificate of completion is not important to you, you may continue in the training even if you no longer meet the attendance requirement.

Instructors

Roberto Chavez

Mark Andrews

Senior Financial Institutions Examiner California Department of Financial Protection & Innovation

Bank Examinations Coordinator Alabama State Banking Department

Zac Smith

Senior Bank Examiner Iowa Division of Banking

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

4 Series1

1

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2

1

2

2

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4

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© GeoNames, Microsoft, TomTom Powered by Bing

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?

Examiner Roles & Loan Scoping

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

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

Loan Scoping

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?

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

• Real Estate • Consumer

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

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

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

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.

Primary Loan Documents

Primary Loan Documents for Commercial, Real Estate, Consumer & Ag Credits

Overview • Ability to collect on a loan can depend on the accuracy & completeness of the loan documents. • Ability to understand the purpose & effect of each loan document is crucial.

Questions to Ask • What are the appropriate documents? • Are the documents properly executed? • Have they been properly filed?

• Are there any pertinent documents omitted? • Have the authorized signer(s) correctly signed?

Things to Consider • Different types of loan transactions • Primary & supporting loan documents • Documents necessary to attach, perfect, protect, & gain access to collateral in secured transactions • Who is authorized to sign on behalf of various types of businesses?

In this session we will: • Identify documents required for various types of commercial, real estate, consumer, & agricultural loans • Identify the purpose & effect of common loan documents, including promissory notes, credit reports, borrowing resolutions, articles of incorporation, appraisals/inspections, collateral filings, financial documents, & insurance • Security agreements, security interest in collateral, financing statements/UCCs, title commitment & title insurance • Review primary documents including documents within basic line sheets

Primary Documents Application: States the requested amount, purpose, borrower, and security.

Primary Documents Promissory Note: Is a document that contains a written promise by the borrower to pay the bank. It is enforceable against the borrower. Review of each section for content, purpose, rights of all parties and terms.

Primary Documents Security Agreement: A document that provides a lender a security interest in a specified asset or property that is pledged as collateral (may be included within the promissory note).

Primary Documents Borrowing Resolution: A corporate resolution that authorizes borrowing is often referred to a borrowing resolution. This resolution indicates that the members (LLC) or Board of Directors (Corporation) have held a meeting and conducted a vote allowing the company to borrow a specific loan amount.

Primary Documents Articles of Incorporation: A set of formal documents filed with a government body to legally document the creation of a corporation.

Primary Documents Credit Report: Has information about a borrower/principal/guarantor's credit activity and current credit situation such as loan paying history and score.

Primary Documents Appraisal: A fair market valuation of real estate property (or other collateral) conducted by an authorized person.

Primary Documents Appraisal Review: An evaluation of a real estate appraisal that comments on the completeness and apparent accuracy and compliance of an appraisal report.

Primary Documents Title Commitment & Title Policy: Commitment for Title Insurance is issued once the title search is complete, describing everything that was uncovered during the search. It is also a binder promising to issue a title policy once the requirements laid out in the commitment are met. Title insurance will provide the bank for defending against any lawsuit against the bank’s insured title & will either clear up the title problems or pay the insured’s (bank’s) loss.

Primary Documents Mortgage (Deed of Trust): The mortgage conveys the security interest from the borrower to the bank. Also called a Deed of Trust, gives the lender the right to foreclose on the property being used to secure the loan. The mortgage document must be recorded at the county records office to ensure that the bank’s security interest is protected.

Primary Documents Assignment of Leases & Rents: Is a document that gives a mortgage lender (bank) the right to any future profits that may come from leases and rents when a property owner defaults on their loan. This document can be attached to a mortgage loan agreement or separate.

Primary Documents Commercial Lease Agreement: Outlines a landlord's and tenant's rights and obligations when the landlord rents out commercial property to a tenant. (look for sections: “title” and “subordination”) .

Primary Documents Agreement to Provide Insurance: A legal document that requires the borrower to maintain insurance coverage on the collateral securing the loan and to show evidence of the coverage (list bank as lien holder, forced place).

Uniform Commercial Code (UCC)

UCC Set of rules that help govern U.S. business laws on commercial transactions •Start with UCC search for previous lienholders UCC – 1 filings typically happen when loan is originated •Includes creditor’s name & address, debtor’s name & address, and collateral description

UCC UCC liens against specific collateral or blanket lien – 5-year terms •After, lender must renew the lien if loan is still active

UCC – 1: UCC is filed with the state & the county where property is located

Types of Guarantees

Unlimited • Full-recourse guarantees - aka unconditional guarantee • Guarantors pay all amounts due until note paid • Guarantor liable for any debt owed

Limited • Simple form • Puts a limit on amount guarantor responsible for • Usually, an agreed upon dollar amount or percentage of total debt

Joint & Several

• If multiple

guarantors, lenders have few options to distribute risk guarantor is fully responsible for entire loan

• Each individual

Types of Guarantees

Performance • Guaranty that may not be based on payment • Based on certain conditions or milestones • In CRE, based on specific actions

Carve Out • Aka “bad boy” guaranty • Ties liability to bad acts

• Usually found on non-recourse loans & includes borrower’s promise to abstain from certain acts • Gives lenders control to recoup payment quickly during legal process

Financial Information

Paystubs

PFS

Credit Reports

Financial Statements

Tax Returns

Examples of Loan Documents (redacted)

Promissory Note

Resolution

Mortgage

Appraisal

Title Commitment & Policy

Agreement to Provide Insurance

Commercial Lease Agreement

Internal Evaluation

Assignment of Leases and Rents

Business Loan Agreement C&I

Business Loan Agreement

Click on each to view the example document

Loan Types & Primary Documents Required Consumer Loans •Motor Vehicles • Residential Home • Residential Construction Commercial Loans •Working Capital & Equipment •Commercial Real Estate (CRE) Agricultural Loans •Working Capital & Equipment •Real Estate

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.

Consumer Loans – Motor Vehicles

Primary Documents Required: • Signed Consumer Credit Application • Promissory Note

• Credit Report • Security Agreement • Certificate of Title or Certificate of Origin • Income Information

• Financing Statement • Evidence of Insurance

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.

Consumer Loans – Residential Home Primary Documents Required: • Signed Residential Mortgage Credit Application (Form 1003) • Promissory Note • Appraisal or Evaluation • Title Insurance Commitment/ Preliminary Lien Search • Agreement to Provide Homeowner’s Insurance/Flood Insurance • Credit Report • Mortgage or Deed of Trust • Appraisal Review • Title Insurance Policy/Title Opinion • Income Information

Consumer Loans – Residential Construction

What is it: A consumer loan to an individual for personal reasons. Typically, to purchase and construct a residential home.

Consumer Loans – Residential Construction

Primary Documents Required: • Signed Residential Mortgage Credit Application (Form 1003) • Promissory Note/Construction Draw Note • Appraisal or Evaluation • Title Insurance Commitment/ Preliminary Lien Search • Agreement to Furnish Homeowner’s Insurance

• Credit Report • Warranty Deed/ Mortgage Deed of Trust • Appraisal Review • Builder’s Risk Hazard Insurance • Income Information • Master Construction Inspection Draw Report

Commercial Loans – Working Capital & 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.

Commercial Loans – Working Capital & Equipment

Primary Documents Required: • Promissory Note • Articles of Incorporation • UCC Lien Search/UCC-1 Financing Statement • Guarantees

• Borrowing Resolution • Security Agreement • Agreement to Provide Insurance • Financial Statements • Business Loan Agmt.

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.

Commercial Loans – Commercial Real Estate

Primary Documents Required: • Promissory Note • Articles of Incorporation • Assignment of Leases & Rents • Appraisal & Appraisal Review • Title Insurance Commitment/ Preliminary Lien Search • Agreement to Provide Insurance

• Borrowing Resolution • Mortgage/Deed of Trust • Commercial Lease Agmt. • Title Insurance Policy/ Title Opinion • Guarantees • Financial Statements

Agricultural Loans – Working Capital & 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, forestry's, and commercial fishermen, and purchase or maintenance of farm machinery, equipment, and implements.

Agricultural Loans – Working Capital & Equipment

Primary Documents Required: • Promissory Note • UCC Lien Search/UCC-1 Financing Statement • Farm/Livestock Inspection • Appraisal/Valuation of Collateral/Bill of Sale

• Security Agreement • Agreement to Provide Insurance • Financial Statements

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 pastureland, whether tillable or note and whether wooded or not.

Agricultural Loans – Real Estate

Primary Documents Required: • Promissory Note • Appraisal • Title Insurance Commitment/ Preliminary Lien Search • Title Insurance Policy/Title Opinion

• Mortgage/Deed of Trust • Appraisal Review • Agreement to Provide Insurance • Farm/Livestock Inspection • Financial Statements

Examples of Documents Within Basic Line Sheets

Sample Ag credit

Sample quipment Loan File

Questions?

Credit Evaluation School Defining the 6 P's & Loan Classification

6 P Format

Person / People • Who is the borrower? • Borrower’s primary business? • Owners of the business? • Borrower’s background & experience? • Guarantors? • Any related businesses?

Purpose • How are loan proceeds being used? • Structure of financing appropriate for loan purpose? • Repayment terms appropriate - frequency & source of repayment?

Protection • What is the collateral? • Condition & value of the collateral? • How is lender’s interest secured?

Payment

• Primary source of repayment? • Repayment source adequate? • Secondary source of repayment? • Adequate to repay the loan? • Tertiary source of repayment? • Adequate to repay the loan?

Problem • Do any weaknesses exist which are jeopardizing repayment? • Any potential weaknesses which have emerged?

Prospects • What actions are being taken to address weaknesses?

Criticized & 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.

Special Mention

Key characteristics can include: • Improper loan structure

• Inadequate loan agreements or covenants • Incomplete or inadequate documentation • Lack of control over collateral • Management can usually fix the issue • Typically not a long-term rating

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.

Substandard Key characteristics can include: • Negative trends • Significant deviation from original repayment source • Numerous extensions and/or renewals • Diversion of repayment funds • Delinquency • Failure to clean up 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. Loans classified Loss are uncollectible and of such highly questionable and improbable.

Doubtful

Key characteristics: • Weaknesses noted for loans classified Substandard & not readily identified Loss • Undetermined value of collateral and amount of loss • Typically not a long term rating

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 be effected in the future.

Loss Key characteristics can include:

• No readily identifiable source of repayment • Not well secured & not in process of collection • Severe delinquency

Questions?

Let’s take a swing at Case Study: 19th Hole: Identifying the 6 P’s in a sample write-up

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

Payment

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?

Line Deck and Loan Discussion Instructions

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.

Objectives 4. Rate loans properly based on discussion and evaluation of loan quality. 5. Evaluate communication skills. * The accuracy of your ratings decisions and communication skills will be evaluated by the instructors .

Introduction and Overview • Line Deck #1 consists of 9 lines and Line Deck #2 consists of 18 lines. • Students will individually review the line decks then meet with their group to prepare for the loan officer discussions. • Instructors will act as the loan officer responsible for the credit. • Students will assign a classification to each line. • Students will write a 6 P’s write up for one classified line. • Students will complete a self-evaluation of their loan discussion

Schedule • Monday, March 3: Hand out Line Deck # 1 • Tuesday, March 4: Loan Discussion Prep & Loan Discussions • Materials due: Students must turn in loan ratings grid and 6 P’s write-up on a classified line for Line Deck #1 by end of day. • Wednesday, March 5: Hand out Line Deck #2 & Loan Discussion Prep • Thursday, March 6: Loan Discussions • Materials due: Students must turn in loan ratings grid, 6 P’s write-up on a classified line for Line Deck #2, and self evaluation for both loan discussions by end of day.

Preparation 1. Look through all lines individually and identify the 6 P’s for each line 2. Review the lines together with your group and determine which lines need to be discussed with the loan officers 3. As a group, formulate questions for those lines which need clarification and discussion with the loan officers 4. Students should be prepared to discuss any of the loans in the line deck

Discussion Guidelines • Instructors will act as loan officers, responsible for specific lines • Students should be prepared to discuss any of the loans in the line deck • Each group member must discuss at least one loan before any member can discuss a second loan • The group must agree on the loans to be discussed

Discussion & Loan Rating Process • The group has 20 minutes with each loan officer to discuss their lines • The discussion is followed by a 10 minute debrief with your group to finalize notes • This is repeated for three rounds, allowing each group time with each instructor/loan officer

Loan Rating Decisions • Immediately following your group’s completion of all three rounds of discussion, each student will complete the Loan Classifications form. • Assign a rating to each line in the deck (Pass, Special Mention, Substandard, Doubtful, or Loss). • Support each rating decision with 2-3 bullet points.

• The loan rating decisions are made individually • Each group may hear different explanations/ comments regarding the lines discussed • Discussion with other groups should be avoided when making a final rating decision

• Each student will complete a 6 P’s write-up for one classified line in each Line Deck. • Only classified lines are to be written up • Substandard, Doubtful, or Loss • Examiners do not write up Pass or Special Mention lines 6 P’s Loan Write-ups

• Each student will complete a Loan Discussion Self-Evaluation Self-Evaluation

Linesheet Abbreviations

Unfunded

Charge-off

Current Balance Accrued Interest

Participation Sold

Specific Reserve

Restricted - FR

LOAN LINE SHEET

BORROWER(S):

ABC Company, Inc.

EXAMINATION DATE: 02/05/20XX

BORROWER ID: 123456

BORROWER ADDRESS: Anytown, USA

LAST EXAM DATE:

Origination Amount

GTYS OR END: None

BUSINESS TYPE: Commercial

Origination Date

EXAMINER: John Doe

REASON LINED: Size (1, 2)

RELATIONSHIP: (ABC Company, Inc.: $2,153,292.43)

PURPOSE / REPAYMENT CAPACITY / COLLATERAL / CLASSIFICATIONS

12/08/2023

GENERAL

NOTE # RATE

ORIG. AMT ORIG DATE

TERMS / MATURITY

SCOPING BALANCE

INFO

6 622200093

$26,000 P: Line of Credit - Construction

$1,950,000 BR: $1,950,000 OFF:

$3,000,000

8 @

CDV

CB:

05/02/2024

05/02/2022 MAT DATE:

$26,000 NA:

N N N N

02/02/2024 R:

AI:

X EXT: X REN:

0 NEXT DUE: 0 DAYS PD:

$1,050,000 RTD:

15

PS: UF: CO: SR:

$0 WL:

N 8.0000%

0 C: REAL ESTATE MORTGAGE DATED 5/1/23

0 /

0 /

X30/60/90: LN TYPE: PAY TYPE:

$0 INTCL:

Commercial

Previously Classified (Y/N)

QUARTERLY

DOE:

PRVCL: N AMT PRVCL: NOTE RISK RATING:

Notes:

Amount Previously Classified

Times Renewed

Maturity Date

Times Extended

Next Due Date

Days Past Due

6 622200453

$1,762 P: Line of Credit – Construction overage

$203,292 BR: $203,292 OFF:

$500,000

6 @

CDV

CB:

05/02/2024

09/28/2022 MAT DATE:

$1,762 NA:

N N N N

02/02/2024 R:

AI:

0 NEXT DUE: 0 DAYS PD:

X EXT: X REN:

$0 RTD:

0

PS: UF: CO: SR:

1 C: REAL ESTATE MORTGAGE DATED 5/1/23

N 8.0000%

4 /

2 /

$296,708 WL:

X30/60/90: LN TYPE: PAY TYPE:

$0 INTCL:

Commercial

QUARTERLY

DOE:

PRVCL: N AMT PRVCL: NOTE RISK RATING:

Notes:

Times Days Past Due

Loan Type

Payment Type/Frequency

$0 Subtotal Continuing Pages

REASONS FOR CLASSIFICATION

TECHNICAL EXCEPTIONS

$2,153,292 Total Line

$27,762 Total Accrued Interest

INSTITUTION: State Bank USA, Anytown, USA EXAM #:

Director or Officer (Y/N)

Internally Classified (Y/N)

Watchlist (Y/N)

Bank Branch (number or name)

Nonaccrual (Y/N)

Loan Officer (Initials)

Restructured (Y/N)

Linesheet Walkthrough LOAN LINE SHEET

Restricted - FR

BORROWER(S):

Good Company, Inc.

EXAMINATION DATE: 02/05/20X4

BORROWER ID: Good Company, Inc.

BORROWER ADDRESS: Anywhere, USA

LAST EXAM DATE:

GTYS OR END: None

BUSINESS TYPE:

EXAMINER: John Doe

REASON LINED: Examiner Discretion

RELATIONSHIP: (Good Company, Inc.: $122,013)

12/08/2023 SCOPING BALANCE

GENERAL INFO

NOTE # RATE

ORIG. AMT ORIG DATE

TERMS / MATURITY

PURPOSE / REPAYMENT CAPACITY / COLLATERAL / CLASSIFICATIONS

$0 P: DEBT CONSOLIDATION

$84,212 BR: $84,212 OFF: $1,000 NA:

1 ABCD1234

$655,466

101 @

CB:

06/20/20X5

DPO

07/14/20X1 MAT DATE:

0 NEXT DUE: 0 DAYS PD:

AI:

N N N N

X EXT: X REN:

03/20/20X4 R:

0

$0 RTD: $0 WL: $0 INTCL:

PS: UF: CO: SR:

1 /

0 /

0 C: REM 7/1/20X1

N 8.0000%

X30/60/90: LN TYPE: PAY TYPE:

Comm'l RE

MONTHLY

DOE:

PRVCL: N AMT PRVCL: NOTE RISK RATING:

Notes:

$385 P: Line of Credit – Construction on 140 15 th Ave, Anywhere USA

$37,801 BR: $37,801 OFF:

1 EFGH5678

$43,750

144 @

CB:

03/20/20X9

DPO

05/05/20X1 MAT DATE:

$500 NA:

0 NEXT DUE: 0 DAYS PD:

03/20/20X4 R:

AI:

N N N N

X EXT: X REN:

0

$0 RTD: $0 WL: $0 INTCL:

PS: UF: CO: SR:

0 /

0 /

0 C: REM 5/1/20X1 (140 15 th Ave. Anywhere, USA)

N 8.0000%

X30/60/90: LN TYPE: PAY TYPE:

Fixed Rate RE

MONTHLY

DOE:

PRVCL: N AMT PRVCL: NOTE RISK RATING:

Notes:

$0 Subtotal Continuing Pages

REASONS FOR CLASSIFICATION

TECHNICAL EXCEPTIONS

$122,013 Total Line $38,445 Total Accrued Interest

INSTITUTION: State Bank of Anywhere, USA EXAM #:

Linesheet Walkthrough LOAN LINE SHEET

Restricted - FR

BORROWER(S):

Bad Company, Inc.

EXAMINATION DATE: 02/05/20X4

BORROWER ID: Bad Company, Inc.

BORROWER ADDRESS: Anytown, USA

LAST EXAM DATE:

GTYS OR END: None

BUSINESS TYPE:

EXAMINER: John Doe

REASON LINED: Nonaccrual (1, 2), Previously Classified or Criticized (1, 2), Watch List (1, 2)

RELATIONSHIP: (Bad Company, Inc.: $122,013)

12/08/2023 SCOPING BALANCE

GENERAL INFO

NOTE # RATE

ORIG. AMT ORIG DATE

TERMS / MATURITY

PURPOSE / REPAYMENT CAPACITY / COLLATERAL / CLASSIFICATIONS

$0 P: DEBT CONSOLIDATION

$650,212 BR: $650,212 OFF: $27,475 NA:

1 1234ABCD

$655,466

101 @

CB:

06/20/20X5

DPO

07/14/20X1 MAT DATE:

4 NEXT DUE: 0 DAYS PD:

10/20/20X1 R:

AI:

Y N Y N

X EXT: X REN:

700

$0 RTD: $0 WL:

PS: UF: CO: SR:

4 /

4 /

4 C: REM 7/1/20X1

Y 15.0000%

X30/60/90: LN TYPE: PAY TYPE:

$0 INTCL:

Comm'l RE

MONTHLY

DOE:

PRVCL: Y AMT PRVCL: NOTE RISK RATING:

Notes:

$385 P: Line of Credit – Construction on 140 15 th Ave. Anytown, USA

$37,801 BR: $37,801 OFF: $10,970 NA:

1 5678EFGH

$43,750

144 @

CB:

03/20/20X9

DPO

05/05/20X1 MAT DATE:

2 NEXT DUE: 0 DAYS PD:

01/20/20X2 R:

AI:

Y N Y N

X EXT: X REN:

600

$0 RTD: $0 WL:

PS: UF: CO: SR:

6 /

5 /

4 C: REM 5/1/20X1 (140 15 th Ave, Anytown, USA)

Y 15.0000%

X30/60/90: LN TYPE: PAY TYPE:

$0 INTCL:

Fixed Rate RE

MONTHLY

DOE:

PRVCL: Y AMT PRVCL: NOTE RISK RATING:

Notes:

$0 Subtotal Continuing Pages

REASONS FOR CLASSIFICATION

TECHNICAL EXCEPTIONS

$122,013 Total Line $38,445 Total Accrued Interest

INSTITUTION: State Bank of Anytown, USA EXAM #:

Line Deck Review Exercise

Line Deck Review Exercise

Line Deck Review Exercise

Line Deck Review Exercise

Abbreviations Used in Line Cards Or Loan Committee Memorandums: AL Acres of Land LS Livestock FS Financial Statement AR Accounts Receivable M&E Machinery & Equipment GTY Guaranty ARM Adjustable-Rate Mortgage M/M Mr. and Mrs. Int Interest Assign Assignment MI Monthly Interest INS Insurance AV Appraised Value Mo. Monthly Inv Inventory Brand Brand Filing Mtg Mortgage JM Joint Maker CD Certificate of Deposit P Prime Rate LC Letter of Credit CFD Contract for Deed P&L Profit & Loss Statement LOC Line of Credit CRP Crop Reduction Program PATL T/C Title Certificate

Pledged against totalliability (collateral listed is pledged

Deed of Trust (similar to Security Deed)

D/T

RE Real Estate

TI Title Insurance

End Endorser

Rec. Recorded date

UCC Uniform Commercial Code

F&F Furniture & Fixtures

S/S Shares of Stock

W/C Working Capital

Farmers Home Administration

F&G Feed & Grain

FmHA

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.

Special Mention Rating 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.

Special Mention Rating: Key Characteristics • Special Mention are loans of questionable quality, but involving insufficient risk to warrant Classification • Weak underwriting, administration, and/or imprudent lending practices (improper loan structure, inadequate loan agreements or covenants, incomplete or inadequate documentation to adequately monitor the loan) • Borrowers with adverse operating trends (declining revenues or margins) • Borrowers with ill-proportioned balance sheet (e.g., increasing inventory without an increase in sales, high leverage, tight liquidity) • Collateral concerns • *(Special Mention assets may or may not have characteristics that management action would remedy)

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?

Mock Discussions

Introductions

Introductions

Organization

Organization

Asking Questions

Asking Questions

Listening

Listening

Concluding the Discussion

Concluding the Discussion

Bad Habits

Eye Contact

Disinterested

Banker Admits to Fraud

Examiner classifies loan over something small

Banker doesn’t take examiner comments seriously

Credit Evaluation School

RED FLAGS

What is a…

RED

FLAG

Red Flag: Definition for the Purposes of the Presentation

A signal indicating there may be a more serious: •Problem •Trend •Regulatory Concern

Red Flag: Kahoot Exercise

Description of an occurrence, scenario,

Match the best Red Flag choice to the description

Red Flag options

or examiner observation

QUESTIONS?

Credit Evaluation School Loan Writeups

Criticized Vs. Classified Loans • All four categories are considered - Criticized • All but Special Mention are considered - Classified •Special Mention • Substandard •Doubtful •Loss

Loan Writeups Rules for including a loan writeup in an examination report vary among regulators, states and agencies: •Management disagrees with examiner •Dollar amount represents a significant percentage of assets or capital •EIC discretion •Others (concentrations, economic impact - COVID)

Loan Writeups The writeup format should cover the 6 Ps: •Person

•Purpose •Payment • Protection •Problem • Prospects

Types of Writeups • Agencies have different formats for loan writeups • May vary depending on the examination • Full: detail of the credit relationship & 6 Ps • Abbreviated: summary (usually one paragraph) • Bullet points: highlight each area

Contents of a Writeup All write-ups should include the following: • Identification of Borrower • Description of Debt • Description of Collateral • Borrower’s Financial Status • Classification • Management’s comments, plan, and/or prospects

Identification of Borrower • Name and/or title of borrower – note insiders • Nature of borrower • Nature of business or employment • Capacity • Identify Cosigners, Endorsers & 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.

Description of Debt

• Original Amount Borrowed • Original Date • 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

Description of Debt

Example: 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

Example: 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.

Description of Collateral

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

Description of Collateral •Note if estimates of the value higher or lower than appraised value •Note if internal or external appraisal & date of valuation if pertinent to classification •Specialized collateral or work in progress may need special consideration •Appraisal violations should be noted only

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.

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

Financial Exhibits

Abbreviations:

FS – Financial Statement PFS – Personal Financial Statement TA – Total Assets TL – Total Liabilities

NW – Net Worth GP – Gross Profit NI – Net Income

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.

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

Classification

Example: Previously Classified

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

Classification

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