CHAPTER FIFTEENLending Policies And

Procedures

The purpose of this chapter is to learn why sound lending policies are important to banks and other lenders and the public they serve and how to spot and deal with problem loans when they appear in an institution’s portfolio.

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Types of Loans Made By Banks

Real Estate LoansFinancial Institution LoansAgriculture LoansCommercial and Industrial LoansLoans to IndividualsMiscellaneous LoansLease Financing Receivables

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Loans Outstanding for U.S. Banks

Loans By Purpose 1998

All Banks $

< $100 Mill.

$100 Mill. To $1 Bill. > $1 Bill.

Real Estate Loans 2068.00 49.70 60.10 46.20Loans to Fin. Inst. 133.50 3.20 0.10 3.80Agriculture Loans 46.80 1.10 10.30 0.50

C & I Loans 912.00 21.90 16.80 22.90Loans to Indiv. 703.60 16.90 11.40 18.30

Misc. Loans 137.00 3.30 1.00 3.70Lease Fin. Rec. 162.50 3.90 0.30 4.60

Total 4163.40 100.00 100.00 100.00

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Factors Determining the Mix of Bank Loans

Characteristics of Market Area

Bank Size

Experience and Expertise of Management

Expected Yield of Each Type of Loan

Regulations

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CAMELS Rating System

Capital Adequacy

Asset Quality

Management Quality

Earnings Record

Liquidity Position

Sensitivity to Market Risk

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Asset Quality

Criticized Loans

Scheduled Loans

Adversely Classified LoansSubstandard Loans

Doubtful Loans

Loss Loans

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Regulators’ Use of Market Forces

Because the Quality of Examination Information Decays Very Quickly Regulators are Starting to Use Market Forces and Private Market Discipline to Monitor Bank Behavior

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Bank’s Written Loan Policy

Goal Statement for Bank’s Loan PortfolioSpecification of Lending Authority of Each Loan Officer and Committee Lines of Responsibility in Making Assignments and Reporting InformationOperating Procedures for Reviewing, Evaluating and Making Loan DecisionsRequired Documentation for All LoansLines of Authority for Maintaining and Reviewing Credit Files

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Bank’s Written Loan Policy (cont.)

Guidelines for Taking and Perfecting Collateral

Policies and Procedures for Setting Loan Interest Rate

Statement of Quality Standards for All Loans

Statement of Upper Limit for Total Loans Outstanding

Description of the Bank’s Principal Trade Area

Discussion of the Preferred Procedures for Detecting, Analyzing and Working Out Problem Loans

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The Six Basic C’s of Lending

Character – Specific Purpose of Loan and Serious Intent to Repay LoanCapacity – Legal Authority to Sign Binding ContractCash – Ability to Generate Enough Cash to Repay LoanCollateral – Adequate Assets to Support the LoanConditions – Economic Conditions Faced By BorrowerControl – Does Loan Meet Written Loan Policy and How Would Loan Be Affected By Changing Laws and Regulations

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Common Types of Loan Collateral

Accounts Receivables

Factoring

Inventory

Real Property

Personal Property

Personal Guarantees

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Parts of a Typical Loan Agreement

The NoteLoan Commitment AgreementCollateralCovenants

AffirmativeNegative

Borrower Guaranties and WarrantiesEvents of Default

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Loan Review

Examination of Outstanding Loans to Make Sure Borrowers are Adhering to Their Credit Agreements and the Bank is Following Its Own Loan Policies

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Warning Signs of Problem Loans

Unusual or Unexpected Delays in Receiving Financial StatementsAny Sudden Changes in Accounting MethodsRestructuring Debt or Eliminating Dividend Payments or Changes in Credit RatingAdverse Changes in the Price of StockNet Earnings Losses in One or More YearsAdverse Changes in Capital StructureDeviations in Actual Sales from PredictionsUnexpected and Unexplained Changes in Deposits

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Loan Workouts

The Process of Resolving a Troubled Loan So the Bank Can Recover Its Funds

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Loan Workout Process

Goal is to Maximize Full Recovery of FundsRapid Detection and Reporting of Problems is EssentialLoan Workout Should Be Separate From Lending FunctionShould Consult With Customer Quickly on Possible OptionsEstimate Resources Available to Collect on LoanConduct Tax and Litigation SearchEvaluate Quality and Competence of ManagementConsider All Reasonable Alternatives