TO THE OFFICER IN CHARGE OF SUPERVISION AT EACH FEDERAL RESERVE BANK
In some cases, institutions with loans to financially
troubled borrowers have charged off substantial portions of these
credits. Questions have been raised regarding the appropriate
supervisory treatment of the remaining recorded balance of these
loans. This examination guidance is intended to clarify existing
supervisory practices regarding the classification of partially
charged-off loans.
Consistent with long standing supervisory practice, the
evaluation of each extension of credit should be based upon the
fundamentals of the particular credit. That is, the evaluation
of each credit should be based upon the borrower's (or the
collateral's) current and stabilized cash flow, earning and debt
service capacity, financial performance, net worth, guarantees,
future prospects, and other factors relevant to the borrower's
ability to service and retire its debt.
Based upon consideration of all of the above relevant
financial factors, this evaluation may indicate that a credit has
well-defined weaknesses which jeopardize repayment in full, but
that a portion of the loan may be reasonably assured of
repayment. When an institution has taken a charge-off in a
sufficient amount so that the remaining recorded balance of the
loan is being serviced (based upon reliable sources of cash flow)
and is reasonably assured of repayment, this remaining recorded
balance would generally be classified no more severely than
substandard.1 Consistent with long standing classification
guidelines, a substandard classification of the remaining
recorded balance would only be appropriate when well-defined
weaknesses continue to be present in the credit. For example,
when the remaining recorded balance of an asset is secured by
readily marketable collateral, the portion that is secured by
this collateral would generally not be classified.
This approach would generally be appropriate when an
institution maintains sufficient controls over its lending
function and maintains adequate current documentation to support
the credit analysis of the loan. This classification approach
could not be utilized for loans for which the loss exposure
cannot be reasonably determined, e.g., loans collateralized by
properties subject to environmental hazards. This approach would
also not be justified when sources of repayment are considered
unreliable.
Extensions of credit that have not been subject to
partial charge-offs should continue to be classified in
accordance with existing supervisory guidelines.
Deputy Associate Director
Footnotes 1. The accrual/nonaccrual status of the loan must continue to be determined in accordance with the glossary to the current Call Report instructions. Thus, while these partially charged-off loans may qualify for nonaccrual treatment, cash basis recognition of income will be appropriate when the criteria specified in the Call Report guidance are met. Return to text |
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