Submitted by sevans on Thu, 11/13/2014 - 10:49am

The foundation for any loan review system is accurate and timely loan classification or credit grading, which involves an assessment of credit quality and leads to the identification of problem loans. An effective loan classification or credit grading system provides important information on the collectibility of the portfolio for use in the determination of an appropriate level for the ALLL.

Regardless of the type of loan review system employed, an effective loan classification or credit grading framework generally places primary reliance on the institution’s lending staff to identify emerging loan problems. However, given the importance and subjective nature of loan classification or credit grading, the judgment of an institution’s lending staff regarding the assignment of particular classification or grades to loans should be subject to review by: (i) peers, superiors, or loan committee(s); (ii) an independent, qualified part-time or full-time employee(s); (iii) an internal department staffed with credit review specialists; or (iv) qualified outside credit review consultants. A loan classification or credit grading review that is independent of the lending function is preferred because it typically provides a more objective assessment of credit quality. Because accurate and timely loan classification or credit grading is a critical component of an effective loan review system, each institution should ensure that its loan review system includes the following attributes:

  • A formal loan classification or credit grading system in which loan classifications or credit grades reflect the risk of default and credit losses and for which a written description is maintained, including a discussion of the factors used to assign appropriate classifications or credit grades to loans.
  • Identification or grouping of loans that warrant the special attention of management or other designated “watch lists” of loans that management is more closely monitoring.
  • Documentation supporting the reasons why particular loans merit special attention or received a specific adverse classification or credit grade and management’s adherence to approved work out plans.
  • A mechanism for direct, periodic, and timely reporting to senior management and the board of directors on the status of loans identified as meriting special attention or adversely classified or graded and the actions taken by management.
  • Appropriate documentation of the institution’s historical loss experience for each of the groups of loans with similar risk characteristics into which it has segmented its loan portfolio.
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