Large Bank Supervision Forum eBook

Internal Use Only Loans to sound borrowers that are modified in accordance with prudent underwriting standards should not be adversely classified by examiners unless well-defined weaknesses exist that jeopardize repayment . . . Loan Performance:  One perspective on loan performance is based upon an assessment as to whether the borrower is contractually current on principal or interest payments (recognizing that being contractually current on payments can be misleading as to the credit risk embedded in the loan)  A second perspective for assessing a loan’s classification is to consider the borrower’s expected performance and ability to meet its obligations in accordance with the modified terms over the remaining life of the loan − The borrower’s financial strength as reflected by its historical and projected balance sheet and income statement outcomes; and − The prospects for the CRE property considering events and market conditions that reasonably may occur during the term of the loan Renewals or Restructuring of Maturing Loans:  When there has been deterioration in collateral values, a borrower with a maturing loan amid an economic downturn may have difficulty obtaining short-term financing or adequate sources of long-term credit, despite the borrower’s demonstrated and continued ability to service the debt. In such cases, financial institutions may determine that the most appropriate course is to restructure or renew the loan. Such actions, when done prudently, are often in the best interest of both the financial institution and the borrower  Renewals or restructurings of maturing loans to commercial borrowers who have the ability to repay on reasonable terms will not automatically be subject to adverse classification by examiners. However, consistent with safety and soundness standards, such loans should be identified in the financial institution’s internal credit grading system and may warrant close monitoring. Adverse classification of a renewed or restructured loan would be appropriate if, despite the renewal or restructuring, well-defined weaknesses exist that jeopardize the orderly repayment of the loan pursuant to reasonable modified terms

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Internal Use Only

Classification of Problem CRE Loans Dependent on the Sale of Collateral for Repayment . . .

 Substandard: The portion of the loan balance that is adequately secured by the fair value of the real estate collateral less the costs to sell generally should be adversely classified no worse than “substandard.”

 Doubtful: The amount of the loan balance in excess of the fair value of the real estate collateral, or portions thereof, should be adversely classified “doubtful” when the potential for full loss may be mitigated by the outcomes of certain pending events, or when loss is expected but the amount of the loss cannot be reasonably determined. If warranted by the underlying circumstances, an examiner may use a “doubtful” classification on the entire loan balance. However, examiners should use a “doubtful” classification infrequently, as such a designation is temporary and subject to a financial institution’s timely reassessment of the loan once the outcomes of pending events have occurred or the amount of loss can be reasonably determined.  Loss: Any portion of the loan balance that exceeds the amount that is adequately secured by the fair value of the real estate collateral less the costs to sell should be classified “loss.” This principle applies to loans that are collateral dependent based on the sale of the collateral in accordance with GAAP and for which there are no other available reliable sources of repayment such as a financially capable guarantor

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