Risk Management Manual of Examination Policies - FDIC

LOANS Section 3.2
controls over its process for estimating its FAS 114
allowance.
Other Considerations - Examiners may encounter
situations where impaired loans and restructured debts are
identified, but the bank has not properly accounted for the
transactions. Where incorrect accounting treatment
resulted in an overstatement of earnings, capital and assets,
it will be necessary to determine the proper carrying values
for these assets, utilizing the best available information
developed by the examiner after consultation with bank
management. Nonetheless, proper accounting for impaired
and restructured loans is the responsibility of bank
management. Examiners should not spend a
disproportionate amount of time developing the
appropriate accounting entries, but instead discuss with and
require corrective action by bank management when the
bank’s treatment is not in accordance with accepted
accounting guidelines. It must also be emphasized that
collectability and proper accounting and reporting are
separate matters; restructuring a borrower’s debt does not
ensure collection of the loan or security. As with all other
assets, adverse classification should be assigned if analysis
indicates there is risk of loss present. Examiners should
take care, however, not to discourage or be critical of bank
management’s legitimate and reasonable attempts to
achieve debt settlements through concessionary terms. In
many cases, restructurings offer the only realistic means for
a bank to bring about collection of weak or nonearning
assets. Finally, the volume of impaired loans and
restructured debts having concessionary interest rates
should be considered when evaluating the bank’s earnings
performance and assigning the earnings performance
rating.
Examination procedures for reviewing TDRs are included
in the ED Modules.
Report of Examination Treatment of
Classified Loans
The Items Subject to Adverse Classification page allows an
examiner to present pertinent and readily understandable
comments related to loans which are adversely classified.
In addition, the Analysis of Loans Subject to Adverse
Classification page permits analysis of present and
previous classifications from the standpoint of source and
disposition. These loan schedules should be prepared in
accordance with the Report of Examination Instructions.
An examiner must present, in writing, relevant and readily
understandable comments related to criticized loans.
Therefore, a thorough understanding of all factors
surrounding the loan is required and only those germane to
description, collectability, and management plans should
be included in the comments. Comments should be
concise, but brevity is not to be accomplished by omission
of adequate information. Comments should be informative
and factual data emphasized. The important weaknesses of
the loan should not be overshadowed by extraneous
information which might well have been omitted. An
ineffective presentation of a classified loan weakens the
value of a Report of Examination and frequently casts
doubt on the accuracy of the classifications. The essential
test of loan comments is whether they justify the
classification.
Careful organization is an important ingredient of good
loan comments. Generally, loan comments should include
the following items:
• Identification - Indicate the name and occupation or
type of business of the borrower. Cosigners, endorsers
and guarantors should be identified and in the case of
business loans, it should be clear whether the borrower
is a corporation, partnership, or sole proprietorship.
• Description - The make-up of the debt should be
concisely described as to type of loan, amount, origin
and terms. The history, purpose, and source of
repayment should also be indicated.
• Collateral - Describe and evaluate any collateral,
indicating the marketability and/or condition thereof.
If values are estimated, note the source.
• Financial Data - Current balance sheet information
along with operating figures should be presented, if
such data are considered necessary. The examiner
must exercise judgment as to whether a statement
should be detailed in its entirety. When the statement
is relevant to the classification, it is generally more
effective to summarize weaknesses with the entire
statement presented. On the other hand, if the
statement does not significantly support or detract
from the loan, a very brief summarization of the
statement is in order.
• Summarize the Problem - The examiner's comments
should explicitly point out reasons for the
classification. Where portions of the line are accorded
different classifications or are not subject to
classification, comments should clearly set forth the
reasoning for the split treatment.
• Management's Intentions - Comments should
include any corrective program contemplated by
management.
Examiners should avoid arbitrary or penalty classifications,
nor should "conceded" or "agreed" be given as the
principal reason for adverse classifications. Management's
DSC Risk Management Manual of Examination Policies 3.2-49 Loans (12-04)
Federal Deposit Insurance Corporation