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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.
15-3
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Types of Loans Made By Banks
Real Estate LoansFinancial Institution LoansAgriculture LoansCommercial and Industrial LoansLoans to IndividualsMiscellaneous LoansLease Financing Receivables
15-4
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
15-5
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
15-6
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© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
CAMELS Rating System
Capital Adequacy
Asset Quality
Management Quality
Earnings Record
Liquidity Position
Sensitivity to Market Risk
15-7
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© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Asset Quality
Criticized Loans
Scheduled Loans
Adversely Classified LoansSubstandard Loans
Doubtful Loans
Loss Loans
15-8
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© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
15-9
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
15-10
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
15-11
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
15-12
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Common Types of Loan Collateral
Accounts Receivables
Factoring
Inventory
Real Property
Personal Property
Personal Guarantees
15-13
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© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Parts of a Typical Loan Agreement
The NoteLoan Commitment AgreementCollateralCovenants
AffirmativeNegative
Borrower Guaranties and WarrantiesEvents of Default
15-14
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© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
15-15
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© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
15-16
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© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Loan Workouts
The Process of Resolving a Troubled Loan So the Bank Can Recover Its Funds
15-17
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
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