Douglas Wagler

The policy statement stresses performing loans made to creditworthy borrowers—including loans that have been renewed or restructured on reasonable modified terms —will not be subject to adverse classification solely because the value of the underlying collateral has declined.

Another key point of the guidance, which should be considered regardless of whether a CRE loan is in a workout scenario, is the expectation that the institution will analyze the global cash flow of the borrower and guarantors. This analysis can be helpful in documenting the support of guarantors on what have become guarantor-reliant loans.

Highlights of the guidance are:

• Purpose
• Promote supervisory consistency
• Enhance transparency of CRE workouts
• Ensure supervisory policies do not curtail availability of credit to sound borrowers
• Risk management elements for loan workout programs
• Management infrastructure to identify, control and manage the volume and complexity of the workout activity
• Documentation standards to verify the borrower’s financial condition and collateral values
• Adequacy of management information systems and internal controls to identify and track loan performance and risk, including concentration risk
• Management’s responsibility to ensure an institution’s regulatory reports are consistent with regulatory requirements (including GAAP) as well as supervisory guidance
• Effectiveness of loan collection procedures
• Adherence to statutory, regulatory and internal lending limits
• Collateral administration to ensure proper lien perfection of the institution’s collateral interests for both real and personal property
• An ongoing credit review function
• Loan workout arrangements
• Bank will not be criticized for engaging in loan workout arrangements as long as management has:
• A prudent workout policy that establishes appropriate loan terms and amortization schedules and permits the institution to modify the workout plan if sustained repayment performance is not demonstrated or if collateral values do not stabilize
• A well-conceived and prudent workout plan for an individual credit that analyzes the borrower’s or guarantor’s current financial information and supports the ultimate collection of principal and interest. Key elements of a workout plan include:
• Updated and comprehensive financial information on the borrower, real estate project and any guarantor
• Current valuations of the collateral supporting the loan and workout plan
• Analysis and determination of appropriate loan structure, i.e., term and amortization schedule, curtailment, covenants or remargining requirements
• Appropriate legal documentation for any changes to loan terms
• An analysis of the borrower’s global debt service that reflects a realistic projection of borrower and guarantor expenses
• The ability to monitor ongoing performance of the borrower and guarantor under the terms of the workout
• An internal loan grading system that accurately and consistently reflects the risk in the workout arrangement
• An allowance for loan and lease losses methodology that covers estimated credit losses in the restructured loan, measured in accordance with GAAP, and recognizes credit losses in a timely manner through provisions and charge-offs, as appropriate
• When analyzing a borrower’s repayment capacity, lenders should consider:
• The character, overall financial condition, resources and payment record of the borrower
• The nature and degree of protection provided by the cash flow from business operations or the collateral on a global basis that considers the borrower’s total debt obligations
• Market conditions that may influence repayment prospects and the cash flow potential of business operations or underlying collateral
• The prospects for repayment support from any financially responsible guarantors
• Evaluating guarantees
• Bank should have sufficient information (global) on all guarantors to determine repayment capacity. Metrics should include:
• Financial condition
• Income
• Liquidity
• Cash flow
• Contingent liabilities
• Other relevant factors, such as credit ratings
• Attributes of a financially responsible guarantor
• The guarantor has both the financial capacity and willingness to provide support for the credit through ongoing payments, curtailments or remargining.
• The guarantee is adequate to provide support for repayment of the indebtedness, in whole or in part, during the remaining loan term.
• The guarantee is written and legally enforceable.
• Assessing collateral values
• A bank should have policies and procedures that determine when collateral evaluations are updated based on:
• Part of its ongoing credit review
• Changes in market conditions
• Deterioration of borrower’s financial condition
• As-is values
• Use if bank intends to foreclose
• Less selling costs
• As-completed or stabilized values
• Use if bank plans to work with borrower to complete project or reach stabilization
• Loans should generally NOT be adversely classified:
• When a loan is adequately protected by the current sound worth and debt service capacity of the borrower, guarantor or underlying collateral
• When the borrower is sound and renewed or restructured in accordance with prudent underwriting standards, unless well-defined weaknesses exist that jeopardize repayment
• Solely because the borrower is associated with a particular industry that is experiencing financial difficulties
• Solely because the value of the underlying collateral has declined to an amount that is less than the loan balance
• It is appropriate to classify a performing loan when:
• Well-defined weaknesses exist that will jeopardize repayment.
• Interest payments are being funded from the interest reserve, but the repayment of principal may be in jeopardy, especially when expected leases or sales have not occurred as projected and property values have dropped below the market value reported in the original collateral valuation.

Click here to view the guidance. For more information, please contact your BKD advisor.