Risk Management Manual of Examination Policies - FDIC

LOANS Section 3.2
Other loans of questionable quality, but involving
insufficient risk to warrant classification, are designated as
Special Mention loans. Loans lacking technical or legal
support, whether or not adversely classified, should be
brought to the attention of the bank's management. If the
deficiencies in documentation are severe in scope or
volume, a schedule of such loans should be included in the
Report of Examination.
Loan classifications are expressions of different degrees of
a common factor, risk of nonpayment. All loans involve
some risk, but the degree varies greatly. It is incumbent
upon examiners to avoid classification of sound loans. The
practice of lending to sound businesses or individuals for
reasonable periods is a legitimate banking function.
Adverse classifications should be confined to those loans
which are unsafe for the investment of depositors' funds.
If the internal grading system is determined to be accurate
and reliable, examiners can use the institution’s data for
preparing the applicable examination report pages and
schedules, for determining the overall level of
classifications, and for providing supporting comments
regarding the quality of the loan portfolio. If the internal
classifications are overly conservative, examiners should
make appropriate adjustments and include explanations in
the report’s comments.
A uniform agreement on the classification of assets and
appraisal of securities in bank examinations was issued
jointly on June 15, 2004, by the Office of the Comptroller
of the Currency, the FDIC, the Federal Reserve Board, and
the Office of Thrift Supervision. This interagency
statement provides definitions of Substandard, Doubtful,
and Loss categories used for adversely classifying bank
assets. Amounts classified Loss should be promptly
eliminated from the bank's books.
Uniform guidelines have been established by the FDIC
regarding the Report of Exam treatment of assets classified
Doubtful. The general policy is not to require charge-off
or similar action for Doubtful classifications. Examiners
should make a statement calling for a bank to charge-off a
portion of loans classified Doubtful only when State law or
policy requires. Further, any such statement should be
clear as to the intended purpose of bringing the bank into
conformity with those State requirements. An exception is
made for formal actions under Section 8 of the FDI Act.
A statement addressing the chargeoff of loans classified
Loss is a required comment Report of Examination when
the amount is material. Amounts classified Loss should be
promptly eliminated from the bank's books.
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.
• 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.
• 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.
There is a close relationship between classifications, and
no classification category should be viewed as more
important than the other. The uncollectibility aspect of
Doubtful and Loss classifications makes their segregation
of obvious importance. The function of the Substandard
classification is to indicate those loans which are unduly
risky and, if unimproved, may be a future hazard.
A complete list of adversely classified loans is to be
provided to management, either during or at the close of an
examination.
Special Mention Assets
Definition - 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 an institution to sufficient risk to warrant adverse
classification.
Use of Special Mention - The Special Mention category is
not to be used as a means of avoiding a clear decision to
classify a loan or pass it without criticism. Neither should
it include loans listed merely "for the record" when
uncertainties and complexities, perhaps coupled with large
size, create some reservations about the loan. If
DSC Risk Management Manual of Examination Policies 3.2-41 Loans (12-04)
Federal Deposit Insurance Corporation