Lending:

Policies and procedures

Chapter 16
Contents
Types of Loans
Factors Affecting the Mix of Loans Made
Credit analysis
Steps in the Lending Process
Loan Review and Loan Workouts
Optional readings
Regulation of Lending
Creating a Written Loan Policy
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Introduction
Banks main job is to make loans
Loans support the growth of new businesses and jobs within
the lenders market area
Loans frequently convey information to the marketplace
about a borrowers credit quality
The lending process should be carefully monitored
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Types of Loans
Real Estate Loans (including mortgage)
Financial Institution Loans
Agriculture Loans
Commercial and Industrial Loans
Loans to Individuals
Miscellaneous Loans
Lease Financing Receivables
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TABLE 161 Loans Outstanding for All FDIC-Insured Banks as of
December 31, 2010 (consolidated domestic and foreign offices)
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E.g: ACB
Types of Loans (continued)
Factors Determining the Growth and Mix of Loans
Characteristics of the market area
Lender size
Wholesale lenders vs. retail credit
Experience and expertise of management
Loan policy
Expected yield of each type of loan
Regulation
General rule: A lending institution should make the types of
loans for which it is the most efficient producer
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Regulation of Lending
The mix, quality, and yield of the loan portfolio are heavily
influenced by regulation
Examples of lending regulations:
Total loan to a single customer normally cannot exceed 15
percent of a single banks equity (legal lending limit)
Any loans made are subject to examination and review
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Regulation of Lending (continued)
Uniform Financial Institutions Rating System
Each banking firm is assigned a numerical rating based on the
quality of its asset portfolio
The federal examiner may assign one of these ratings:
1 = strong performance
2 = satisfactory performance
3 = fair performance
4 = marginal performance
5 = unsatisfactory performance
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Regulation of Lending (continued)
Asset Quality
Criticized loans: good but not in full compliance with the
banks loan policy
Scheduled loans: significant weaknesses (credit
concentration in a borrower or an industry)
Adversely classified loans
Substandard loans: problems with repayment abilities &
collateral
Doubtful loans: high probability of uncollectible loss
Loss loans: uncollectible
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Regulation of Lending (continued)
CAMELS Rating
Capital adequacy
Asset quality
Management quality
Earnings record
Liquidity position
Sensitivity to market risk exposure
All six dimensions of performance are combined into one overall
numerical rating, referred to as the CAMELS rating
Depository institutions whose overall rating is low tend to be
examined more frequently than the highest-rated institutions
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Establishing a Good Written Loan Policy
Important in order to meet regulatory standards
What should a written loan policy contain?
A goal statement for the entire loan portfolio
Specification of lending authority of each loan officer and
loan committee
Lines of responsibility in making assignments and
reporting information
Operating procedures for soliciting, evaluating and
making loan decisions
Required documentation for all loans
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Establishing a Good Written Loan Policy (cont)
Lines of authority for maintaining and reviewing credit files
Guidelines for taking, evaluating, and perfecting loan
collateral.
Procedures for setting loan rates and fees and the terms for
repayment of loans
A statement of quality standards applicable to all loans
A statement of the preferred upper limit for total loans
outstanding
A description of the lending institutions principal trade area
Procedures for detecting and working out problem loan
situations.
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Steps in lending process 6 steps
1. Find prospective customers
Individuals: normally come to the bank
Business loans: through salespeople contacts
2. Evaluate customers character and sincerity of
purpose
Interview: customer explains his credit needs
Loan officer to assess customers sincerity
3. Make site visit & evaluate credit records of customer
Location and condition of property
Records of customers previous loans
Steps in lending process
4. Evaluate customers financial condition
Does customer have sufficient cash flow and backup assets to
repay the loan?
5. Assess collateral & sign the loan agreement
6. Monitor customers compliance with the agreement
Ensure terms are being followed, principal and interest are
paid in time
Visit customers & explore new opportunities
Credit analysis
Is the borrower creditworthy?
How to structure the loan so that lender is protected and
borrower is able to repay
Can lender secure its claim on the collateral in the event of
loan default
Credit Analysis: What Makes a Good Loan?
1. Is the Borrower Creditworthy? The Cs of Credit
Character
Specific purpose of loan and serious intent to repay the loan
Capacity
Legal authority to sign binding contract
Cash
Ability to generate enough cash to repay loan
Collateral
Adequate assets to support the loan
Conditions
Economic conditions faced by borrower
Control
Does loan meet written loan policy and how would loan be affected
by changing laws and regulations
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Credit Analysis: What Makes a Good Loan?
(continued)
2. Can the Loan Agreement Be Properly Structured
and Documented?
Draft a loan agreement that meets the borrowers need for
funds with a comfortable repayment schedule
Proper accommodation of a customer may involve lending
more or less money than requested over a longer or shorter
period
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Credit Analysis: What Makes a Good Loan?
(continued)
3. Can lender secure its claim on the collateral in the event of
loan default?
Reasons for Taking Collateral
If the borrower cannot pay, the pledge of collateral gives the lender
the right to seize and sell those assets
It gives the lender a psychological advantage over the borrower
Types of Collateral
Accounts Receivables
Factoring
Inventory
Real Property
Personal Property
Personal Guarantees
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EXHIBIT 161 Safety Zones Surrounding Funds Loaned in
Order to Protect a Lender
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TABLE 164 Sources of Information Frequently Used in Loan
Analysis and Evaluation by Lenders and Loan Committees
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Parts of a Typical Loan Agreement
The Note: principal, interest, terms of repayment
Collateral
Covenants
Affirmative
Negative
Borrower Guaranties
Events of Default
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Loan Review
1. Carrying out reviews of all types of loans on a periodic basis
2. Structuring the loan review process: check
Record of borrower payments
Quality and condition of collateral
Completeness of loan documentation
Evaluation of borrowers financial condition
Assessment as to whether the loan fits with the lenders loan policies
3. Reviewing Largest Loans Most Frequently
4. Conducting More Frequent Reviews of Troubled Loans
5. Accelerating the Loan Review Schedule if Economy or Industry
Experiences Problems
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Loan Workouts
Loan workout the process of recovering funds from a problem
loan situation
Warning Signs of Problem Loans
1. Unusual or unexpected delays in receiving financial statements
2. Any sudden changes in accounting methods
3. Restructuring debt or eliminating dividend payments or changes in
credit rating
4. Adverse changes in the price of stock
5. Losses in one or more years
6. Adverse changes in capital structure
7. Deviations in actual sales from projections
8. Unexpected or unexplained changes in deposits
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Loan Workouts (continued)
What steps should a lender take when a loan is in trouble?
1. Do not forget the goal: Maximize full recovery of funds
2. Rapid detection and reporting of problems is essential
3. Loan workout should be separate from lending function
4. Should consult with customer quickly regarding possible options
5. Estimate resources available to collect on loan
6. Conduct tax and litigation search
7. Evaluate quality and competence of management
8. Consider all reasonable alternatives
Preferred option: Seek a revised loan agreement
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