Section 3-2 Loans

LOANSSection 3.2INTRODUCTION.3LOAN ADMINISTRATION .3Lending Policies .3Loan Review Systems .4Credit Risk Rating or Grading Systems .4Loan Review System Elements .5Current Expected Credit Losses (CECL) .6Allowance for Loan and Lease Losses (ALLL) .6Responsibility of the Board and Management .7Factors to Consider in Estimating Credit Losses.7Examiner Responsibilities .8Regulatory Reporting of the ALLL .8Accounting and Reporting Treatment .8PORTFOLIO COMPOSITION.9Commercial Loans .9General .9Accounts Receivable Financing . 10Leveraged Lending. 11Applicability . 11General . 11Risk Management Framework . 12General Policies . 12Participations Purchased . 12Underwriting Standards. 12Credit Analysis . 13Valuation Standards . 13Risk Rating Leveraged Loans . 14Problem Credit Management. 14Reporting and Analytics . 15Deal Sponsors. 15Independent Credit Review . 16Stress Testing . 16Conflicts of Interest . 16Oil and Gas Lending . 16Industry Overview . 16Reserve-Based Lending. 17Real Estate Loans . 22General . 22Real Estate Lending Standards . 22Commercial Real Estate Loans . 23Real Estate Construction Loans . 23Home Equity Loans . 25Agricultural Loans . 26Introduction . 26Agricultural Loan Types and Maturities . 26Agricultural Loan Underwriting Guidelines . 27Administration of Agricultural Loans . 28Classification Guidelines for Agricultural Credit . 29Installment Loans . 30Lease Accounting . 31Direct Lease Financing. 31Lessor Accounting under ASC Topic 840. 31Lessor Accounting under ASC Topic 842. 31Examiner Consideration . 32Floor Plan Loans . 32Check Credit and Credit Card Loans . 32RMS Manual of Examination PoliciesFederal Deposit Insurance CorporationCredit Card-related Merchant Activities . 33OTHER CREDIT ISSUES . 34Appraisals . 34Valuation of Troubled Income-Producing Properties. 35Appraisal Regulation . 35Interagency Appraisal and Evaluation Guidelines . 37Examination Treatment . 41Loan Participations . 41Accounting . 41Right to Repurchase . 42Recourse Arrangements . 42Call Report Treatment . 42Independent Credit Analysis. 43Participation Agreements. 43Participations Between Affiliated Institutions . 43Sales of 100 Percent Loan Participations. 43Environmental Risk Program . 44Elements of an Effective Environmental RiskProgram . 44Examination Procedures . 46LOAN PROBLEMS . 46Poor Selection of Risks . 47Overlending . 47Failure to Establish or Enforce Liquidation Agreements. 47Incomplete Credit Information . 47Overemphasis on Loan Income . 47Self-Dealing . 47Technical Incompetence . 48Lack of Supervision . 48Lack of Attention to Changing Economic Conditions . 48Competition . 48Potential Problem Indicators by Document . 48SELECTING A LOAN REVIEW SAMPLE IN A RISKFOCUSED EXAMINATION . 49Assessing the Risk Profile . 49Selecting the Sample . 49Nonhomogeneous Loan Sample . 50Homogeneous Pool Sample . 50Determining the Depth of the Review . 50Adjusting Loan Review . 51Accepting an Institution’s Internal Ratings . 51Loan Penetration Ratio . 51Large Bank Loan Review . 51LOAN EVALUATION AND CLASSIFICATION . 52Loan Evaluation . 52Review of Files and Records . 52Additional Transaction Testing . 52Loan Discussion . 52Loan Analysis . 53Loan Classification . 53Definitions . 53Special Mention Assets. 54Troubled Commercial Real Estate Loan ClassificationGuidelines . 543.2-1Loans (11-20)

LOANSSection 3.2Technical Exceptions . 55Past Due and Nonaccrual . 55Nonaccrual Loans That Have Demonstrated SustainedContractual Performance . 56Troubled Debt Restructuring - Multiple Note Structure. 56Interagency Retail Credit Classification Policy. 56Re-aging, Extensions, Deferrals, Renewals, orRewrites . 57Partial Payments on Open-End and Closed-EndCredit . 58Examination Considerations . 58Examination Treatment . 58Impaired Loans, Troubled Debt Restructurings,Foreclosures, and Repossessions . 59Report of Examination Treatment of Classified Loans 61Issuance of "Express Determination" Letters toInstitutions for Federal Income Tax Purposes . 62CONCENTRATIONS. 63FEDERAL FUNDS SOLD AND REPURCHASEAGREEMENTS . 64Assessing Bank-to-Bank Credit . 65FUNDAMENTAL LEGAL CONCEPTS ANDDEFINITIONS . 65Uniform Commercial Code – Secured Transactions . 66General Provisions . 66Grant of Security Interest . 66Collateral . 66Perfecting the Security Interest . 66Right to Possess and Dispose of Collateral . 66Agricultural Liens . 67Borrowing Authorization . 68Bond and Stock Powers. 68Co-maker . 68Loan Guarantee . 69Subordination Agreement . 69Hypothecation Agreement. 69Real Estate Mortgage . 69Collateral Assignment . 70CONSIDERATION OF BANKRUPTCY LAW AS ITRELATES TO COLLECTIBILITY OF A DEBT . 70Introduction . 70Forms of Bankruptcy Relief . 70Functions of Bankruptcy Trustees . 71Voluntary and Involuntary Bankruptcy . 71Automatic Stay . 71Property of the Estate . 71Discharge and Objections to Discharge . 71Reaffirmation . 72Classes of Creditors. 72Preferences . 72Setoffs . 73Transfers Not Timely Perfected or Recorded . 73SYNDICATED LENDING. 73Overview . 73Syndication Process . 73Loans (11-20)Loan Covenants . 74Credit Rating Agencies . 74Overview of the Shared National Credit (SNC) Program. 75Definition of a SNC . 75SNC Review and Rating Process . 75SNC Rating Communication and Distribution Process. 75Appeals Process . 76Additional Risks Associated with Syndicated LoanParticipations . 76CREDIT SCORING . 76SUBPRIME LENDING . 77Introduction . 77Capitalization . 78Stress Testing . 79Risk Management . 80Classification . 82ALLL Analysis . 82Subprime Auto Lending . 83Subprime Residential Real Estate Lending. 83Subprime Credit Card Lending . 83Payday Lending . 84General . 84Underwriting . 84Payday Lending Through Third Parties . 85Concentrations . 85Capital Adequacy . 85Allowance for Loan and Lease Losses . 85Classifications . 86Renewals/Rewrites . 86Accrued Fees and Finance Charges . 86Recovery Practices . 873.2-2RMS Manual of Examination PoliciesFederal Deposit Insurance Corporation

LOANSSection 3.2maintenance of written, up-to-date lending policies whichhave been approved by the board of directors. A lendingpolicy should not be a static document, but must bereviewed periodically and revised in light of changingcircumstances surrounding the borrowing needs of theinstitution's customers as well as changes that may occurwithin the institution itself. To a large extent, the economyof the community served by the institution dictates thecomposition of the loan portfolio. The widely divergentcircumstances of regional economies and the considerablevariance in characteristics of individual loans precludeestablishment of standard or universal lending policies.There are, however, certain broad areas of consideration andconcern that are typically addressed in the lending policiesof all banks regardless of size or location. These include thefollowing:INTRODUCTIONSection 39 of the Federal Deposit Insurance Act, Standardsfor Safety and Soundness, requires each federal bankingagency to establish safety and soundness standards for allinsured depository institutions. Appendix A to Part 364 ofthe FDIC Rules and Regulations, Interagency GuidelinesEstablishing Standards for Safety and Soundness, sets outthe safety and soundness standards that the agencies use toidentify and address problems at insured depositoryinstitutions before capital becomes impaired. Operationaland managerial safety and soundness standards pertainingto an institution’s loan portfolio address areas such as assetquality, internal controls, credit underwriting, and loandocumentation.The examiner’s evaluation of an institution’s lendingpolicies, credit administration, and the quality of the loanportfolio is among the most important aspects of theexamination process. To a great extent, the quality of aninstitution's loan portfolio determines the risk to depositorsand to the FDIC's insurance fund. Conclusions regardingthe institution’s condition and the quality of its managementare weighted heavily by the examiner's findings with regardto lending practices. Emphasis on review and evaluation ofthe loan portfolio and its administration by institutionmanagement during examinations recognizes that loanscomprise a major portion of most institutions’ assets; and,that it is the asset category which ordinarily presents thegreatest credit risk and potential loss exposure to banks.Moreover, pressure for increased profitability, liquidityconsiderations, and a more complex society produce greatinnovations in credit instruments and approaches to lending.Loans have consequently become more complex.Examiners therefore find it necessary to devote a largeportion of time and attention to loan portfolio examination. LOAN ADMINISTRATIONLending Policies The examiner's evaluation of the loan portfolio involvesmuch more than merely appraising individual loans.Prudent management and administration of the overall loanaccount, including establishment of sound lending andcollection policies, are of vital importance if the institutionis to be continuously operated in an acceptable manner. Lending policies should be clearly defined and set forth insuch a manner as to provide effective supervision by thedirectors and senior officers. The board of directors ofevery institution is responsible for formulating lendingpolicies and to supervise their implementation. Thereforeexaminersshould encourage establishment andRMS Manual of Examination PoliciesFederal Deposit Insurance Corporation 3.2-3General fields of lending in which the institution willengage and the kinds or types of loans within eachgeneral field;Lending authority of each loan officer;Lending authority of a loan or executive committee, ifany;Responsibility of the board of directors in reviewing,ratifying, or approving loans;Guidelines under which unsecured loans will begranted;Guidelines for rates of interest and the terms ofrepayment for secured and unsecured loans;Limitations on the amount advanced in relation to thevalue of the collateral and the documentation requiredby the institution for each type of secured loan;Guidelines for obtaining and reviewing real estateappraisals as well as for ordering reappraisals, whenneeded;Maintenance and review of complete and currentcredit files on each borrower;Appropriate collection procedures including, but notlimited to, actions to be taken against borrowers whofail to make timely payments;Limitations on the maximum volume of loans inrelation to total assets;Limitations on the extension of credit throughoverdrafts;Description of the institution's normal trade area andcircumstances under which the institution may extendcredit outside of such area;Guidelines that address the goals for portfolio mix andrisk diversification and cover the institution's plans formonitoring and taking appropriate corrective action, ifdeemed necessary, on any concentrations that mayexist;Guidelines addressing the institution's loan review andgrading system ("Watch list");Loans (11-20)

LOANS Section 3.2 Guidelines addressing the institution's review of theAllowance for Loan and Lease Losses (ALLL) orACL for loans and leases, as appropriate; andGuidelines for adequate safeguards to minimizepotential environmental liability. Note: The allowance for credit losses on loans and leasesor ACL for loans and leases is the term used for those banksthat adopted ASU 2016-13, which implements ASC Topic326, Financial Instruments – Credit Losses replacing theallowance for loan losses used under the incurred lossmethodology. The above are only guidelines for areas that should beconsidered during the loan policy evaluation. Examinersshould also encourage management to develop specificguidelines for each lending department or function. As withoverall lending policies, it is not the FDIC's intent to suggestuniversal or standard loan policies for specific types ofcredit.The establishment of these policies is theresponsi

LOANS Section 3.2 RMS Manual of Examination Policies 3.2-3 Loans (11-20) Federal Deposit Insurance Corporation INTRODUCTION Section 39 of the Federal Deposit Insurance Act, Standards for Safety and Soundness, requires each federal banking agency to establish safety and soundness standards for all