Risk Management Manual of Examination Policies - FDIC

LOANS Section 3.2
generally should not require a new appraisal. (These
technical violations should not be relisted in subsequent
examinations.) Since the point of an appraisal is to help
make sound loan underwriting decisions, getting an
appraisal on a loan already made simply to fulfill the
requirements of the appraisal regulation, would be of little
benefit. However, an institution should be expected to
obtain a new appraisal on a loan in violation of the
appraisal regulation when there is a safety and soundness
reason for such action. For example, construction loans
and lines of credit need to have the value of the real estate
reviewed frequently in order for the institution to properly
manage the credit relationship. A new appraisal might also
be needed to determine the proper classification for
examination purposes of a collateral dependent loan.
Loan Participations
A loan participation is a sharing or selling of ownership
interests in a loan between two or more financial
institutions. Normally, a lead bank originates the loan and
sells ownership interests to one or more participating banks
at the time the loan is closed. The lead (originating) bank
retains a partial interest in the loan, holds all loan
documentation in its own name, services the loan, and
deals directly with the customer for the benefit of all
participants. Properly structured, loan participations allow
selling banks to accommodate large loan requests which
would otherwise exceed lending limits, diversify risk, and
improve liquidity. Participating banks are able to
compensate for low local loan demand or invest in large
loans without servicing burdens and origination costs. If
not appropriately structured and documented, a
participation loan can present unwarranted risks to both the
seller and purchaser of the loan. Examiners should
determine the nature and adequacy of the participation
arrangement as well as analyze the credit quality of the
loan.
Accounting and Capital Treatment - The proper
accounting treatment for loan participations is governed by
FAS 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities. FAS
applies to both the transferor (seller) of assets and the
transferee (purchaser).
Loan participations are accounted for as sales provided the
sales criteria in FAS 140 are met. If the sales criteria are
not met, participations are accounted for as secured
borrowings. The sales criteria focus on whether or not
control is effectively transferred to the purchaser. To
qualify for sales treatment three criteria must be met:
• The purchaser's interest in the loan must be isolated
from the seller, meaning that the purchaser's interest in
the loan is presumptively beyond the reach of the
seller and its creditors, even in bankruptcy or other
receivership;
• Each purchaser has the right to pledge or exchange its
interest in the loan, and there are no conditions that
both constrain the purchaser from taking advantage of
that right and provide more than a trivial benefit to the
seller; and
• The agreement does not both entitle and obligate the
seller to repurchase or redeem the purchaser's interest
in the loan prior to the loan's maturity, and it does not
provide the seller with the ability to unilaterally cause
the purchaser to return its interest in the loan to the
seller (other than through a cleanup call).
Right to Repurchase - Some loan participation
agreements may give the seller a contractual right to
repurchase the participated interest in the loan at any time.
In this case, the seller's right to repurchase the participation
effectively provides the seller with a call option on a
specific asset and precludes sale accounting. If a loan
participation agreement contains such a provision, the
participation should be accounted for as a secured
borrowing.
Recourse Arrangements - Recourse arrangements may, or
may not, preclude loan participations from being accounted
for as sales for financial reporting purposes. The date of
the participation and the formality of the recourse
provision affect the accounting for the transaction. Formal
recourse provisions may affect the accounting treatment of
a participation depending upon the date that the
participation is transferred to another institution. Implicit
recourse provisions would not affect the financial reporting
treatment of a participation because the accounting
standards look to the contractual terms of asset transfers in
determining whether or not the criteria necessary for sales
accounting treatment have been met. Although implicit
recourse provisions would not affect the accounting
treatment of a loan participation, they may affect the riskbased
capital treatment of a participation.
Loan participations transferred prior to April 1, 2001, are
accounted for based on FAS 125, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of
Liabilities. The sales criteria contained in FAS 125 are
very similar to those contained in FAS 140, which are
summarized above. However, for FDIC-insured
institutions, the first of the sales criteria in FAS 140,
known as the isolation test, applies to transfers occurring
after December 31, 2001. As a result, loan participations
transferred from April 1 through December 31, 2001, are
DSC Risk Management Manual of Examination Policies 3.2-33 Loans (12-04)
Federal Deposit Insurance Corporation