Risk Management Manual of Examination Policies - FDIC

LOANS Section 3.2
also take into account any governmental support programs
or Federal crop insurance benefits from which the
borrower may benefit. If cash flow from ongoing
operations appears insufficient to repay production loans,
adverse classification may be in order, depending upon the
secondary repayment sources and collateral, and the
borrower’s overall financial condition and trends.
Breeder Stock Loans - These loans are generally not
adversely classified if they are adequately secured by the
livestock and if the term debt payments are being met
through the sale of offspring (or milk and eggs in the case
of dairy and poultry operations). If one or both of these
conditions is not met, adverse classification may be in
order, depending upon the support of secondary repayment
sources and collateral, and the borrower’s overall financial
condition and trends.
Machinery and Equipment Loans - Loans for the
acquisition of machinery and equipment will generally not
be subject to adverse classification if they are adequately
secured, structured on an appropriate amortization program
(see above), and are paying as agreed. Farm machinery
and equipment is often the second largest class of
agricultural collateral, hence its existence, general state of
repair, and valuation should be verified and documented
during the bank’s periodic on-site inspections of the
borrower’s operation. Funding for the payments on
machinery and equipment loans sometimes comes, at least
in part, from other loans provided by the bank, especially
production loans. When this is the case, the question arises
whether the payments are truly being “made as agreed.”
For examination purposes, such loans will be considered to
be paying as agreed if cash flow projections, payment
history, or other available information, suggests there is
sufficient capacity to fully repay the production loans when
they mature at the end of the current production cycle. If
the machinery and equipment loan is not adequately
secured, or if the payments are not being made as agreed,
adverse classification should be considered.
Carryover Debt - Carryover debt results from the debtor’s
inability to generate sufficient cash flow to service the
obligation as it is currently structured. It therefore tends to
contain a greater degree of credit risk and must receive
close analysis by the examiner. When carryover debt
arises, the bank should determine the basic viability of the
borrower’s operation, so that an informed decision can be
made on whether debt restructuring is appropriate. It will
thus be useful for bank management to know how the
carryover debt came about: Did it result from the obligor’s
financial, operational or other managerial weaknesses;
from inappropriate credit administration on the bank’s part,
such as over lending or improper debt structuring; from
external events such as adverse weather conditions that
affected crop yields; or from other causes? In many
instances, it will be in the long-term best interests of both
the bank and the debtor to restructure the obligations. The
restructured obligation should generally be rescheduled on
a term basis and require clearly identified collateral,
amortization period, and payment amounts. The
amortization period may be intermediate or long term
depending upon the useful economic life of the available
collateral, and on realistic projections of the operation’s
payment capacity.
There are no hard and fast rules on whether carryover debt
should be adversely classified, but the decision should
generally consider the following: borrower’s overall
financial condition and trends, especially financial leverage
(often measured in farm debtors with the debt-to-assets
ratio); profitability levels, trends, and prospects; historical
repayment performance; the amount of carryover debt
relative to the operation’s size; realistic projections of debt
service capacity; and the support provided by secondary
collateral. Accordingly, carryover loans to borrowers who
are moderately to highly leveraged, who have a history of
weak or no profitability and barely sufficient cash flow
projections, as well as an adequate but slim collateral
margin, will generally be adversely classified, at least until
it is demonstrated through actual repayment performance
that there is adequate capacity to service the rescheduled
obligation. The classification severity will normally
depend upon the collateral position. At the other extreme
are cases where the customer remains fundamentally
healthy financially, generates good profitability and ample
cash flow, and who provides a comfortable margin in the
security pledged. Carryover loans to this group of
borrowers will not ordinarily be adversely classified.
Installment Loans
An installment loan portfolio is usually comprised of a
large number of small loans scheduled to be amortized
over a specific period. Most installment loans are made
directly for consumer purchases, but business loans granted
for the purchase of heavy equipment or industrial vehicles
may also be included. In addition, the department may
grant indirect loans for the purchase of consumer goods.
The examiner's emphasis in reviewing the installment loan
department should be on the overall procedures, policies
and credit qualities. The goal should not be limited to
identifying current portfolio problems, but should include
potential future problems that may result from ineffective
policies, unfavorable trends, potentially dangerous
concentrations, or nonadherence to established policies. At
a minimum, the direct installment lending policies should
address the following factors: loan applications and credit
Loans (12-04) 3.2-22 DSC Risk Management Manual of Examination Policies
Federal Deposit Insurance Corporation