loan Classification, Provisioning and Credit Review

Loans, which exhibit well-defined weaknesses and a distinct possibility of loss, should be assigned the following categories from less to most severe: • “Substandard” • “Doubtful” • “Loss” Loans in the ‘Substandard’, ‘Doubtful’ and ‘Loss’ categories would be collectively termed as “non-performing” credits. 1.4.9 ‘Substandard’ Category Loans in this category have well-defined weaknesses, where the current financial soundness and paying capacity of the obligor is not assured. Orderly repayment of debt may be in jeopardy. A ‘Substandard’ loan is inadequately protected by future cash flows, the obligor’s current net worth or by the collateral pledge, if any. An important indicator is that any portion of commission/income or principal or both are more than 90 days past due or where there is insufficient credits for an overdraft. For corporate, government and private banking loans and other individually reviewed loans, the 90 days past due rule will also generally apply, unless a bank has strong documentary evidence to support a different classification. 1.4.10 ‘Doubtful’ Category A loan classified as ‘Doubtful’ has all the weaknesses inherent in one classified ‘Substandard’ with the added characteristic that the weaknesses make collection or liquidation of the principal and contractual commission/income in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Classification as ‘loss’ is not warranted because of specific factors that generate additional cash flows other than from realization of existing collateral. Such factors include business cash flows, potential merger, acquisition, capital injection or additional collateral. In general a loan where the principal and commission are more than 180 days past due should be included in this classification, except where a bank has strong documentary evidence to support a different categorization such as ‘Sub-standard’ or ‘Special Mention’. 1.4.11 ‘Loss’ Category A loan classified as ‘Loss’ is considered uncollectible in the normal course of business and recourse will have to be made to collateral. Loss category does not mean that the asset has absolutely no recovery or salvage value but rather that it is prudent to establish a provision for the entire loan not covered by collateral. For private banking loans and other individually reviewed loans where principal or commission/income are past due for more than 360 days should be included in this classification except where a bank has strong documentary evidence to support a different categorization. 1.5 Split Classifications 1.5.1 Split classifications refer to the practice of assigning different classifications to different entities within the same group relationship, or to different loans extended to the same obligor, or to different portions of a single loan. 1.5.2 Split within a relationship. Loans extended to subsidiaries of a parent company on the basis of direct or implied support from the parent should generally not be classified at the higher level than the parent. On the other hand, loans extended to subsidiaries without direct or implied parent support may be classified at a lower level than the parent. An exception may be where there is tangible collateral or independent cash flow. 1.5.3 Split to same obligor. All loans extended to one borrower should generally be classified at the same level. However, certain loans to an obligor may be classified at a different level than other loans if they are secured by collateral or guarantees of unquestionable value. For example, a loan secured by properly hypothecated cash collateral would be less severely classified than other less well-secured loans to the same borrower. 1.6 Assessing Classification and Impairment of a Group of Loans