84083, TB 3, Internal Loan Review, 101788 by wvm21293



                                          Office of Regulatory Activities

                                   TB 3 rescinded 10/21/91. Incorporated into Thrift Activities 210

    Handbook:       Thrift Activities                                                                               Section: 210
    Subjects:       lending Risk Assessment                                                                                  TB3
                                                                                                              October 17,1988

                                             Internal Loan Review

       Summmy: This Bulletin
       loan review systems.
                                discusses the common objectives and major elements which comprise effective internal

For Further lnfonnution Contact:                  To help minimize loss to the              l   Frequency of reviews.
The appropriate FHLBank or the                    institution    by    the early            l   Scope of the review.
Thrift Activities Division of the                 identification and classification         l   Depth of the review.
Office of Regulatory Activities,                  of loans possessing potential             l   Review and follow-up.
Washington, DC.                                   and well defined credit weak-             l   Workpaper and report distribu-
                                                  nesses so that timely action can              tion
Supplementury Infomkrtionz                        be taken.
This Bulletin provides guidance to                                                         Independence of Loan Review Personnel
assist individual institutions in eval-           To provide essential information
uating or establishing their respec-              for determining the adequacy of          An effective system of internal loan
tive internal loan review program                 valuation allowances.                    review incorporates both a high
which is an essential part of their                                                        degree of independence       (by the
asset classification system.                      To assess the adequacy and               credit review staff) and also uses
                                                  adherence to internal policies           loan officers (who may be more
                                                  and procedures and to monitor            knowledgeable but less indepen-
                                                  compliance with laws and regu-           dent) to serve as the first line of
The Competitive Equality Banking                  la tions.                                defense in identifying emerging
Act of 1987 resulted in revised regu-                                                      problem loans. An important ele-
lations being promulgated by the                  To provide senior management             ment of an effective system is to
Federal Home Loan Bank Board. The                 and the board of directors with          place responsibility on loan officers
revised “Classification of Certain                an objective assessment of the           for continuous portfolio analysis
Assets” regulation (12 CFR 561.16~)               overall quality of the loan port-        and identification of problem loans.
requires each insured institution to              folio, and                               Because of their frequent contact
classify its own assets on a regular                                                       with borrowers, loan officers can
b&S.                                              To ensure the integrity of finan-        usually identify potential problems
                                                  cial reports.                            before they become apparent to oth-
Unlike the regulation which applies                                                        ers.
to all assets held by an insured insti-      As a visible sign of the*directorate’s
tution, this Bulletin addresses only         full support of and commitment to             While larger institutions typically
the systems implemented by institu-          the program, the internal loan                establish an independent depart-
tions to monitor lending portfolio           review program should be in writ-             ment staffed with credit analysts,
risk.                                        ing and be approved initially and             cost and volume considerations may
                                             annually by the board of directors.           not justify such a system in smaller
While an internal loan review sys-                                                         institutions. Nevertheless, indepen-
tem may take many forms (reliance            An internal loan review program               dence can be maintained provided
on loan officers to identify problem         should address the following ele-             loan evaluators do not have control
loans; review of junior officers’ loans      ments:                                        over the loans they review, and are
by a senior lending officer; use of a                                                      not a art of, or influenced or con-
qualified, part-time person; or an           l   Independence of loan review               troll J by anyone associated with
independent     department     staffed           persom4                                   the loan approval process. In many
with credit analysts), effective sys-        l   Description of classification rat-        smaller institutions an independent
tems have the following common                   ing system.                               committee of outside directors may
objjves:                                     .   Qualifications, and reporting             fill this role.
                                                 lines of loan review personnel.

Federal Home Loan Bank System                                                                                           Page 1 of 2
I   I                                                                                                                                 1
m                                                                                                                              TB3

    Description of Classification Rating       on a regular basis for all lending           Reviewand Follow-up
    system                                     areas. Classified loans should be
                                               reviewed on at least a quarterly             Findings are usually reviewed with
    Classifications   should     accurately    basis to ensure that aggregate totals        appropriate     loan officers and
    r@ect the risk of nonpayment. If an        of each classification category and          department managers and present
    institution’s classification rating sys-   that valuation allowances are accu-          or planned corrective action is elic-
    tem differs from those categories          rately reported on the Thrift Finan-         ited for all noted deficiencies and
    (substandard, doubtful, loss and           cial Report.                                 identified weaknesses, including the
    special mention) outlined in the                                                        time frames for correction.
    “Classification of certain assets” reg-
    ulation (12 CFR 561.16c and 571.laL                                                     Workpaperand Report Distribution
    the definitional aiteria of the ratings    The review typically includes, in
    or categories used should closely          addition to all loans over a predeter-       A list of loans reviewed, the date of
    parallel those contained in the regu-      mined size, a sample of smaller              the review, and credit rating sum-
    lation to both facilitate accuracy in      loans; past due, non-accrual,                mations to substantiate assigned
    filing quarterly reports and to enable     renewed and restructured loans;              classifications,   including    “pass”
    examiners to test the accuracy of the      loans previously classified; insider         loans, should be prepared on all
    ratings.                                   loans; and inter-related or common           loans reviewed. The results of the
                                               interest loans. The percentage of the        loan review would then be submit-
    Qualification and Reporting Lines of       portfolio selected for review should         ted to the board of directors on at
    herna1 Loan Review Personnel               provide reasonable assurance that            least a quarterly basis. In addition to
                                               the results of the review have               reporting current credit quality
    Loan review personnel should be            identified the major problems in the         findings, comparative trends can be
    qualified based on level of educa-         portfolio and reflect its quality as a       presented to enable the directorate
    tion, experience, and extent of for-       whole.                                       to spot significant changes in the
    mal credit training, should be                                                          overall quality of the portfolio. Find-
    knowledgeable in sound lending             Depth of
                                                      Reviews                               ings should also address the ade-
    practices for the types of loans                                                        quacy and adherence to internal pol-
    offered by the institution,      and       Reviews should usually       analyze         icies, practices and procedures and
    should report directly to the board        selected loans for:                          compliance with laws and regula-
    of directors or a committee thereof.                                                    tions so that any noted deficiencies
                                                  credit quality,                           can be remedied in a timely manner.
    Frequency of Revitws                          concentrations,
                                                  sufficiency of credit and collat-
    Optimally, the internal loan review           eraI documentation,
    function would impact the loan pro            proper lien perfection,
    cess during three stages - before the         proper approval by the loan
    loan is made, shortly after the loan is       officer and/or loan
    committed or disbursed, and peri-             committee(s),        .
    odically thereafter until the loan is         adherence to any loan agree-
    paid in full. While each institution          ment covenants,
    should consider adopting a program            compliance with internal poli-
    that encompasses all three stages,            cies and procedures and laws
    stage three or periodic reviews               and regulations.
    should be conducted, at a minimum,

                                                                                        -     Darrel Dochow, Executive Director
    Federal Home Loan Bank System                                                                                         Page 2 of 2

To top