1. Lending Policies and Procedures: Managing Credit Risk
Chapter Sixteen
Lending Policies and Procedures: Managing Credit Risk
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Key Topics Types of Loans Banks Make
16-2
Key Topics
Types of Loans Banks Make
Factors Affecting the Mix of Loans Made
Regulation of Lending
Creating a Written Loan Policy
Steps in the Lending Process
Loan Review and Loan Workouts

3. Types of Loans Made By Banks
16-3
Types of Loans Made By Banks
Real Estate Loans
Financial Institution Loans
Agriculture Loans
Commercial and Industrial Loans
Loans to Individuals
Miscellaneous Loans
Lease Financing Receivables

4. Loans Outstanding for U.S. Banks (2007)
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Loans Outstanding for U.S. Banks (2007)

5. Factors Determining the Mix of Bank Loans
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Factors Determining the Mix of Bank Loans
Characteristics of Market Area
Lender Size
Experience and Expertise of Management
Expected Yield of Each Type of Loan
Regulations

6. Regulation of Lending: CAMELS Rating System
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Regulation of Lending: CAMELS Rating System
Capital Adequacy
Asset Quality
Management Quality
Earnings Record
Liquidity Position
Sensitivity to Market Risk

7. Asset Quality Criticized Loans Scheduled Loans
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Asset Quality
Criticized Loans
Scheduled Loans
Adversely Classified Loans
Substandard Loans
Doubtful Loans
Loss Loans

8. Regulators’ Use of Market Forces
16-8
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

9. Establishing a Good Written Loan Policy
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Establishing a Good Written Loan Policy
Goal Statement for Bank’s Loan Portfolio
Specification of Lending Authority of Each Loan Officer and Committee
Lines of Responsibility in Making Assignments and Reporting Information
Operating Procedures for Soliciting, Evaluating and Making Loan Decisions
Required Documentation for All Loans
Lines of Authority for Maintaining and Reviewing Credit Files

10. Bank’s Written Loan Policy (cont.)
16-10
Bank’s Written Loan Policy (cont.)
Guidelines for Taking and Perfecting Collateral
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
Procedures for Detecting, Analyzing and Working Out Problem Loans

11. 16-11
Quick Quiz
Why is lending so closely regulated by state and federal authorities?
What is the CAMELS rating, and how is it used?
List several elements of a good written loan policy.

12. Steps in the Lending Process
16-12
Steps in the Lending Process
Finding Prospective Loan Customers
Evaluating a Customer’s Character and Sincerity of Purpose
Making Site Visits and Evaluating a Customer’s Credit Record
Evaluating a Customer’s Financial Record
Assessing Possible Loan Collateral and Signing the Loan Agreement
Monitoring Compliance with the Loan Agreement and Other Customer Service Needs

13. The Six Basic C’s of Lending
16-13
The Six Basic C’s of Lending
Character – Specific Purpose of Loan and Serious Intent to Repay 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

14. 16-14

15. Common Types of Loan Collateral
16-15
Common Types of Loan Collateral
Reasons for Taking Collateral
Types of Collateral:
Accounts Receivables
Factoring
Inventory
Real Property
Personal Property
Personal Guarantees

16. Information About Consumers
16-16
Information About Consumers
Consumer-Supplied Financial Statements
Credit Bureau Reports
Experience of Other Lenders
Verification of Employment
Verification of Property Ownership
The Web

17. Information About Businesses
16-17
Information About Businesses
Financial Reports Supplied by the Borrowing Firm
Copies of Board of Director’s Resolutions or Partnership Agreements
Credit Ratings – Dun & Bradstreet, Moody’s, Standard & Poor’s
New York Times, Wall Street Journal, Other Business Publications
Risk Management Associates (RMA), Dun & Bradstreet Industry Averages
The World Wide Web

18. Information About Governments
16-18
Information About Governments
Government Budget Reports
Credit Ratings Assigned to Government Borrowers By Moody’s, Standard & Poor’s, Fitch
Web

19. Lending the Old Fashioned Way? (box)
16-19
Lending the Old Fashioned Way? (box)
Traditional Lending Model
Deregulation of the 1980s and 1990s
New Lending Model
Financial Innovations, Such as Securitization, and Their Effect on Lending Mix and Policies (“streamlined” loans)
Mortgage Market Problems, 2007
Newer Lending Paradigm or Back to the Basics?
An Increased Coordination Among Financial Regulators in Different Countries

20. Parts of a Typical Loan Agreement
16-20
Parts of a Typical Loan Agreement
The Promissory Note
Loan Commitment Agreement
Collateral
Covenants
Affirmative
Negative
Borrower Guaranties and Warranties
Events of Default

21. 16-21
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

22. Loan Review Procedures
16-22
Loan Review Procedures
Carrying Out Review of All Types of Loans on a Periodic Basis
Structuring the Loan Process
Record of Borrower Payments
Quality and Condition of Collateral
Completeness of Loan Documentation
Evaluation of Borrower’s Financial Condition
Assessment as to Whether Fits with Lender’s Loan Policies

23. Loan Review Procedures (cont.)
16-23
Loan Review Procedures (cont.)
Reviewing Largest Loans Most Frequently
Conducting More Frequent Reviews of Troubled Loans
Accelerating the Loan Review Schedule if Economy or Industry Experiences Problems

24. Warning Signs of Problem Loans
16-24
Warning Signs of Problem Loans
Unusual or Unexpected Delays in Receiving Financial Statements
Any Sudden Changes in Accounting Methods
Restructuring Debt or Eliminating Dividend Payments or Changes in Credit Rating
Adverse Changes in the Price of Stock
Losses in One or More Years
Adverse Changes in Capital Structure
Deviations in Actual Sales from Predictions
Unexpected and Unexplained Changes in Deposits

25. 16-25
Loan Workouts
The Process of Resolving a Troubled Loan So the Bank Can Recover Its Funds

26. Loan Workout Process Goal is to Maximize Full Recovery of Funds
16-26
Loan Workout Process
Goal is to Maximize Full Recovery of Funds
Rapid Detection and Reporting of Problems is Essential
Loan Workout Should Be Separate From Lending Function
Should Consult With Customer Quickly on Possible Options
Estimate Resources Available to Collect on Loan
Conduct Tax and Litigation Search
Evaluate Quality and Competence of Management
Consider All Reasonable Alternatives

27. 16-27
Quick Quiz
What are the typical steps followed in receiving a loan request from a customer?
What three major questions or issues must a lender consider in evaluating nearly all loan requests?
Explain the following terms: character, capacity, cash, conditions, and control.
What are the principal parts of a loan agreement? What is each part designed to do?
What are some warning signs to management that a problem loan may be developing?