Prudent Commercial Real Estate Loan Accommodations and Workouts
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Federal Reserve SR/CA Letters › Prudent Commercial Real Estate Loan Accommodations and Workouts
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BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
WASHINGTON, D.C. 20551
DIVISION OF SUPERVISION
AND REGULATION
SR 23-5
June 30, 2023
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECT: Prudent Commercial Real Estate Loan Accommodations and Workouts
Applicability: This guidance applies to all institutions supervised by the Federal Reserve,
including those with $10 billion or less in consolidated assets.
The Federal Reserve, along with the other financial regulators,1 has adopted the attached
policy statement on Prudent Commercial Real Estate Loan Accommodations and Workouts. The
Federal Reserve and the other financial regulators issued this policy statement to update previous
guidance, reinforce the message that financial institutions should work prudently and
constructively with creditworthy commercial borrowers experiencing financial difficulties, and
clarify that such message applies in all stages of the economic cycle. This policy statement is
intended to promote supervisory consistency among examiners and ensure that supervisory
policies and actions do not inadvertently curtail the availability of credit to sound borrowers.
This policy statement provides a broad set of principles relevant to all commercial loan
accommodations and workouts. The policy statement also includes guidance applicable to the
specific risks and structures of commercial real estate (CRE) loans
tency among examiners and ensure that supervisory
policies and actions do not inadvertently curtail the availability of credit to sound borrowers.
This policy statement provides a broad set of principles relevant to all commercial loan
accommodations and workouts. The policy statement also includes guidance applicable to the
specific risks and structures of commercial real estate (CRE) loans. Consistent with the safety
and soundness standards, this policy statement updates and supersedes existing supervisory
guidance to assist financial institutions’ efforts to modify CRE and other commercial loans to
borrowers who are, or may be, unable to meet a loan’s current contractual payment obligations.2
The policy statement also includes: a section on short-term loan accommodations; a discussion
of recent accounting changes on estimating loan losses; and updated examples that clarify how to
classify and account for loans modified or affected by loan accommodations or loan workout
activity.
1 The other financial regulators are the Federal Deposit Insurance Corporation, National Credit Union
Administration, and Office of the Comptroller of the Currency.
2 This policy statement replaces the interagency Policy Statement on Prudent Commercial Real Estate Loan
Workouts (October 2009).
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Reserve Banks are asked to distribute this letter to the supervised institutions in their
districts and to appropriate supervisory staff. Questions may be sent via the Board’s public
website.3
Michael S. Gibson
Director
Division of Supervision and Regulation
Attachments:
• Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts
• Federal Register Notice
Supersedes:
• SR letter 09-7, “Prudent Commercial Real Estate Loan Workouts”
3 See http://www.federalreserve.gov/apps/contactus/feedback.aspx.
e sent via the Board’s public
website.3
Michael S. Gibson
Director
Division of Supervision and Regulation
Attachments:
• Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts
• Federal Register Notice
Supersedes:
• SR letter 09-7, “Prudent Commercial Real Estate Loan Workouts”
3 See http://www.federalreserve.gov/apps/contactus/feedback.aspx.
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_________________________________________________________________________________
Board of Governors of the Federal Reserve System
Federal Deposit Insurance Corporation
National Credit Union Administration
Office of the Comptroller of the Currency
_________________________________________________________________________________
June 30, 2023
Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts
The agencies1 recognize that financial institutions2 face significant challenges when
working with commercial real estate (CRE)3 borrowers who are experiencing diminished operating
cash flows, depreciated collateral values, prolonged sales and rental absorption periods, or other
issues that may hinder repayment. While such borrowers may experience deterioration in their
financial condition, many borrowers will continue to be creditworthy and have the willingness and
ability to repay their debts. In such cases, financial institutions may find it beneficial to work
constructively with borrowers. Such constructive efforts may involve loan accommodations4 or
more extensive loan workout arrangements.5
This statement provides a broad set of risk management principles relevant to CRE loan
accommodations and workouts in all business cycles, particularly in challenging economic
environments. A wide variety of factors can negatively affect CRE portfolios, including economic
downturns, natural disasters, and local, national, and international events
more extensive loan workout arrangements.5
This statement provides a broad set of risk management principles relevant to CRE loan
accommodations and workouts in all business cycles, particularly in challenging economic
environments. A wide variety of factors can negatively affect CRE portfolios, including economic
downturns, natural disasters, and local, national, and international events. This statement also
describes the approach examiners will use to review CRE loan accommodation and workout
arrangements and provides examples of CRE loan workout arrangements as well as useful references
in the appendices.
The agencies have found that prudent CRE loan accommodations and workouts are often in
the best interest of the financial institution and the borrower. The agencies expect their examiners to
1 The Board of Governors of the Federal Reserve System (Board), the Federal Deposit Insurance Corporation (FDIC),
the National Credit Union Administration (NCUA), and the Office of the Comptroller of the Currency (OCC)
(collectively, the agencies). This Policy Statement was developed in consultation with state bank and credit union
regulators.
2 For the purposes of this statement, financial institutions are those supervised by the Board, FDIC, NCUA, or OCC.
3 Consistent with the Board, FDIC, and OCC joint guidance on Concentrations in Commercial Real Estate Lending,
Sound Risk Management Practices (December 2006), CRE loans include loans secured by multifamily property, and
nonfarm nonresidential property where the primary source of repayment is derived from rental income associated with
the property (that is, loans for which 50 percent or more of the source of repayment comes from third party,
nonaffiliated, rental income) or the proceeds of the sale, refinancing, or permanent financing of the property
CRE loans include loans secured by multifamily property, and
nonfarm nonresidential property where the primary source of repayment is derived from rental income associated with
the property (that is, loans for which 50 percent or more of the source of repayment comes from third party,
nonaffiliated, rental income) or the proceeds of the sale, refinancing, or permanent financing of the property. CRE loans
also include land development and construction loans (including 1-4 family residential and commercial construction
loans), other land loans, loans to real estate investment trusts (REITs), and unsecured loans to developers. For credit
unions, “commercial real estate loans” refers to “commercial loans,” as defined in Section 723.2 of the NCUA Rules and
Regulations, secured by real estate.
4 For the purposes of this statement, an accommodation includes any agreement to defer one or more payments, make a
partial payment, forbear any delinquent amounts, modify a loan or contract, or provide other assistance or relief to a
borrower who is experiencing a financial challenge.
5 Workouts can take many forms, including a renewal or extension of loan terms, extension of additional credit, or a
restructuring with or without concessions.
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take a balanced approach in assessing the adequacy of a financial institution’s risk management
practices for loan accommodation and workout activities. Consistent with the Interagency
Guidelines Establishing Standards for Safety and Soundness,6 financial institutions that implement
prudent CRE loan accommodation and workout arrangements after performing a comprehensive
review of a borrower’s financial condition will not be subject to criticism for engaging in these
efforts, even if these arrangements result in modified loans that have weaknesses that result in
adverse classification
s Establishing Standards for Safety and Soundness,6 financial institutions that implement
prudent CRE loan accommodation and workout arrangements after performing a comprehensive
review of a borrower’s financial condition will not be subject to criticism for engaging in these
efforts, even if these arrangements result in modified loans that have weaknesses that result in
adverse classification. In addition, modified loans to borrowers who have the ability to repay their
debts according to reasonable terms will not be subject to adverse classification solely because the
value of the underlying collateral has declined to an amount that is less than the outstanding loan
balance.
I. Purpose
Consistent with the safety and soundness standards, this statement updates and supersedes
previous supervisory guidance to assist financial institutions’ efforts to modify CRE loans to
borrowers who are, or may be, unable to meet a loan’s current contractual payment obligations or
fully repay the debt.7 This statement is intended to promote supervisory consistency among
examiners, enhance the transparency of CRE loan accommodation and workout arrangements, and
support supervisory policies and actions that do not inadvertently curtail the availability of credit to
sound borrowers.
This statement addresses prudent risk management practices regarding short-term loan
accommodations, risk management for loan workout programs, long-term loan workout
arrangements, classification of loans, and regulatory reporting and accounting requirements and
considerations. The statement also includes selected references and materials related to regulatory
reporting.8 The statement does not, however, affect existing regulatory reporting requirements or
supervisory guidance provided in relevant interagency statements issued by the agencies or
accounting requirements under U.S. generally accepted accounting principles (GAAP)
nting requirements and
considerations. The statement also includes selected references and materials related to regulatory
reporting.8 The statement does not, however, affect existing regulatory reporting requirements or
supervisory guidance provided in relevant interagency statements issued by the agencies or
accounting requirements under U.S. generally accepted accounting principles (GAAP). Certain
principles in this statement are also generally applicable to commercial loans that are secured by
either real property or other business assets of a commercial borrower.
Five appendices are incorporated into this statement:
• Appendix 1 contains examples of CRE loan workout arrangements illustrating the
application of this statement to classification of loans and determination of nonaccrual
treatment.
• Appendix 2 lists selected relevant rules as well as supervisory and accounting guidance for
6 12 CFR part 30, appendix A (OCC); 12 CFR part 208 Appendix D-1 (Board); and 12 CFR part 364 appendix A
(FDIC). For the NCUA, refer to 12 CFR part 741.3(b)(2), 12 CFR part 741 appendix B, 12 CFR part 723, and letter to
credit unions 10-CU-02 “Current Risks in Business Lending and Sound Risk Management Practices” issued January
2010. Credit unions should also refer to the Commercial and Member Business Loans section of the NCUA Examiner’s
Guide.
7 This statement replaces the interagency Policy Statement on Prudent Commercial Real Estate Loan Workouts (October
2009). See FFIEC Press Release, October 30, 2009, available at: https://www.ffiec.gov/press/pr103009.htm.
8 For banks, the FFIEC Consolidated Reports of Condition and Income (FFIEC Call Report), and for credit unions, the
NCUA 5300 Call Report (NCUA Call Report).
ner’s
Guide.
7 This statement replaces the interagency Policy Statement on Prudent Commercial Real Estate Loan Workouts (October
2009). See FFIEC Press Release, October 30, 2009, available at: https://www.ffiec.gov/press/pr103009.htm.
8 For banks, the FFIEC Consolidated Reports of Condition and Income (FFIEC Call Report), and for credit unions, the
NCUA 5300 Call Report (NCUA Call Report).
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real estate lending, appraisals, allowance methodologies,9 restructured loans, fair value
measurement, and regulatory reporting matters such as nonaccrual status. The agencies
intend this statement to be used in conjunction with materials identified in Appendix 2 to
reach appropriate conclusions regarding loan classification and regulatory reporting.
• Appendix 3 discusses valuation concepts for income-producing real property.10
• Appendix 4 provides the special mention and adverse classification definitions used by the
Board, FDIC, and OCC.11
• Appendix 5 addresses the relevant accounting and supervisory guidance on estimating loan
losses for financial institutions that use the current expected credit losses (CECL)
methodology.
II. Short-Term Loan Accommodations
The agencies encourage financial institutions to work proactively and prudently with
borrowers who are, or may be, unable to meet their contractual payment obligations during periods
of financial stress. Such actions may entail loan accommodations that are generally short-term or
temporary in nature and occur before a loan reaches a workout scenario. These actions can mitigate
long-term adverse effects on borrowers by allowing them to address the issues affecting repayment
ability and are often in the best interest of financial institutions and their borrowers.
When entering into an accommodation with a borrower, it is prudent for a financial
institution to provide clear, accurate, and timely information about the arrangement to the borrower
and any guarantor
ate
long-term adverse effects on borrowers by allowing them to address the issues affecting repayment
ability and are often in the best interest of financial institutions and their borrowers.
When entering into an accommodation with a borrower, it is prudent for a financial
institution to provide clear, accurate, and timely information about the arrangement to the borrower
and any guarantor. Any such accommodation must be consistent with applicable laws and
regulations. Further, a financial institution should employ prudent risk management practices and
appropriate internal controls over such accommodations. Weak or imprudent risk management
practices and internal controls can adversely affect borrowers and expose a financial institution to
increases in credit, compliance, operational, or other risks. Imprudent practices that are widespread
at a financial institution may also pose a risk to its capital adequacy.
Prudent risk management practices and internal controls will enable financial institutions to
identify, measure, monitor, and manage the credit risk of accommodated loans. Prudent risk
management practices include developing and maintaining appropriate policies and procedures,
updating and assessing financial and collateral information, maintaining an appropriate risk rating
(or grading) framework, and ensuring proper tracking and accounting for loan accommodations.
Prudent internal controls related to loan accommodations include comprehensive policies12 and
practices, proper management approvals, an ongoing credit risk review function, and timely and
9 The allowance methodology refers to the allowance for credit losses (ACL) under Financial Accounting Standards
Board (FASB) Accounting Standards Codification (ASC) Topic 326, Financial Instruments – Credit Losses.
10 Valuation concepts applied to regulatory reporting processes also should be consistent with ASC Topic 820, Fair
Value Measurement
g credit risk review function, and timely and
9 The allowance methodology refers to the allowance for credit losses (ACL) under Financial Accounting Standards
Board (FASB) Accounting Standards Codification (ASC) Topic 326, Financial Instruments – Credit Losses.
10 Valuation concepts applied to regulatory reporting processes also should be consistent with ASC Topic 820, Fair
Value Measurement.
11 Credit unions must apply a relative credit risk score (i.e., credit risk rating) to each commercial loan as required by 12
CFR part 723 Member Business Loans; Commercial Lending (see Section 723.4(g)(3)) or the equivalent state regulation
as applicable.
12 See 12 CFR 34.62(a) and 160.101(a) (OCC); 12 CFR 208.51(a) (Board); and 12 CFR 365.2(a) (FDIC) regarding real
estate lending policies at financial institutions. For NCUA, refer to 12 CFR part 723 for commercial real estate lending
and 12 CFR part 741, appendix B, which addresses loan workouts, nonaccrual policy, and regulatory reporting of
workout loans.
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accurate reporting and communication.
III. Loan Workout Programs
When short-term accommodation measures are not sufficient or have not been successful in
addressing credit problems, financial institutions could proceed into longer-term or more complex
loan arrangements with borrowers under a formal workout program. Loan workout arrangements
can take many forms, including, but not limited to:
• Renewing or extending loan terms;
• Granting additional credit to improve prospects for overall repayment; or
• Restructuring13 the loan with or without concessions.
A financial institution’s risk management practices for implementing workout arrangements
should be appropriate for the scope, complexity, and nature of the financial institution’s lending
activity. Further, these practices should be consistent with safe and sound lending policies and
supervisory guidance, real estate lending standards and requirements,14 and relevant regulatory
reporting requirements
al institution’s risk management practices for implementing workout arrangements
should be appropriate for the scope, complexity, and nature of the financial institution’s lending
activity. Further, these practices should be consistent with safe and sound lending policies and
supervisory guidance, real estate lending standards and requirements,14 and relevant regulatory
reporting requirements. Examiners will evaluate the effectiveness of a financial institution’s
practices, which typically include:
• A prudent loan workout policy that establishes appropriate loan terms and amortization
schedules and that permits the financial institution to reasonably adjust the loan workout plan
if sustained repayment performance is not demonstrated or if collateral values do not
stabilize;15
• Management infrastructure to identify, measure, and monitor the volume and complexity of
the loan workout activity;
• Documentation standards to verify a borrower’s creditworthiness, including financial
condition, repayment ability, and collateral values;
• Management information systems and internal controls to identify and track loan
performance and risk, including impact on concentration risk and the allowance;
• Processes designed to ensure that the financial institution’s regulatory reports are consistent
with regulatory reporting requirements;
• Loan collection procedures;
• Adherence to statutory, regulatory, and internal lending limits;
• Collateral administration to ensure proper lien perfection of the financial institution’s
collateral interests for both real and personal property; and
13 A restructuring involves a formal, legally enforceable modification in the loan’s terms.
14 12 CFR part 34, subpart D, and Appendix to 160.101 (OCC); 12 CFR section 208.51 (Board); and 12 CFR part 365
(FDIC)
and internal lending limits;
• Collateral administration to ensure proper lien perfection of the financial institution’s
collateral interests for both real and personal property; and
13 A restructuring involves a formal, legally enforceable modification in the loan’s terms.
14 12 CFR part 34, subpart D, and Appendix to 160.101 (OCC); 12 CFR section 208.51 (Board); and 12 CFR part 365
(FDIC). For NCUA requirements, refer to 12 CFR part 723 for member business loan and commercial loan regulations,
which addresses CRE lending, and 12 CFR part 741, Appendix B, which addresses loan workouts, nonaccrual policy,
and regulatory reporting of workout loans.
15 Federal credit unions are reminded that in making decisions related to loan workout arrangements, they must take into
consideration any applicable maturity limits (12 CFR 701.21(c)(4)).
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• An ongoing credit risk review function.16
IV. Long-Term Loan Workout Arrangements
An effective loan workout arrangement should improve the lender’s prospects for repayment
of principal and interest, be consistent with sound banking and accounting practices, and comply
with applicable laws and regulations. Typically, financial institutions consider loan workout
arrangements after analyzing a borrower’s repayment ability, evaluating the support provided by
guarantors, and assessing the value of any collateral pledged. Proactive engagement by the financial
institution with the borrower often plays a key role in the success of the workout
ractices, and comply
with applicable laws and regulations. Typically, financial institutions consider loan workout
arrangements after analyzing a borrower’s repayment ability, evaluating the support provided by
guarantors, and assessing the value of any collateral pledged. Proactive engagement by the financial
institution with the borrower often plays a key role in the success of the workout.
Consistent with safety and soundness standards, examiners will not criticize a financial
institution for engaging in loan workout arrangements, even though such loans may be adversely
classified, so long as management has:
• For each loan, developed a well-conceived and prudent workout plan that supports the
ultimate collection of principal and interest and that is based on key elements such as:
Updated and comprehensive financial information on the borrower, real estate project,
and all guarantors and sponsors;
Current valuations of the collateral supporting the loan and the workout plan;
Appropriate loan structure (e.g., term and amortization schedule), covenants, and
requirements for curtailment or re-margining; and
Appropriate legal analyses and agreements, including those for changes to original or
subsequent loan terms;
• Analyzed the borrower’s global debt17 service coverage, including realistic projections of the
borrower’s cash flow, as well as the availability, continuity, and accessibility of repayment
sources;
• Analyzed the available cash flow of guarantors;
• Demonstrated the willingness and ability to monitor the ongoing performance of the
borrower and guarantor under the terms of the workout arrangement;
• Maintained an internal risk rating or loan grading system that accurately and consistently
reflects the risk in the workout arrangement; and
• Maintained an allowance methodology that calculates (or measures) an allowance, in
accordance with GAAP, for loans that have undergone a workout arrangement and
recognizes loan losses in a timely manner through provision expe
the workout arrangement;
• Maintained an internal risk rating or loan grading system that accurately and consistently
reflects the risk in the workout arrangement; and
• Maintained an allowance methodology that calculates (or measures) an allowance, in
accordance with GAAP, for loans that have undergone a workout arrangement and
recognizes loan losses in a timely manner through provision expense and recording
appropriate charge-offs.18
A. Supervisory Assessment of Repayment Ability of Commercial Borrowers
16 See Interagency Guidance on Credit Risk Review Systems. OCC Bulletin 2020-50 (May 8, 2020); FDIC Financial
Institution Letter FIL-55-2020 (May 8, 2020); Federal Reserve Supervision and Regulation (SR) letter 20-13 (May 8,
2020); and NCUA press release (May 8, 2020).
17 Global debt service coverage is inclusive of the cash flows generated by both the borrower(s) and guarantor(s), as well
as the combined financial obligations (including contingent obligations) of the borrower(s) and guarantor(s).
18 Additionally, if applicable, financial institutions should recognize in a separate liability account an allowance for
expected credit losses on off-balance sheet credit exposures related to restructured loans (e.g., loan commitments) and
should reverse interest accruals on loans that are deemed uncollectible.
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The primary focus of an examiner’s review of a CRE loan, including binding commitments, is an
assessment of the borrower’s ability to repay the loan. The major factors that influence this analysis
are the borrower’s willingness and ability to repay the loan under reasonable terms and the cash flow
potential of the underlying collateral or business
are deemed uncollectible.
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The primary focus of an examiner’s review of a CRE loan, including binding commitments, is an
assessment of the borrower’s ability to repay the loan. The major factors that influence this analysis
are the borrower’s willingness and ability to repay the loan under reasonable terms and the cash flow
potential of the underlying collateral or business. When analyzing a commercial borrower’s
repayment ability, examiners should consider the following factors:
• The borrower’s character, overall financial condition, resources, and payment history;
• The nature and degree of protection provided by the cash flow from business operations or
the underlying collateral on a global basis that considers the borrower’s and guarantor’s total
debt obligations;
• Relevant market conditions,19 particularly those on a state and local level, that may influence
repayment prospects and the cash flow potential of the business operations or the underlying
collateral; and
• The prospects for repayment support from guarantors.
B. Supervisory Assessment of Guarantees and Sponsorships
Examiners should review the financial attributes of guarantees and sponsorships in
considering the loan classification. The presence of a legally enforceable guarantee from a
financially responsible guarantor may improve the prospects for repayment of the debt obligation
and may be sufficient to preclude adverse loan classification or reduce the severity of the loan
classification. A financially responsible guarantor possesses the financial ability, the demonstrated
willingness, and the incentive to provide support for the loan through ongoing payments,
curtailments, or re-margining.
Examiners also review the financial attributes and economic incentives of sponsors that
support a loan
lude adverse loan classification or reduce the severity of the loan
classification. A financially responsible guarantor possesses the financial ability, the demonstrated
willingness, and the incentive to provide support for the loan through ongoing payments,
curtailments, or re-margining.
Examiners also review the financial attributes and economic incentives of sponsors that
support a loan. Even if not legally obligated, financially responsible sponsors are similar to
guarantors in that they may also possess the financial ability, the demonstrated willingness, and may
have an incentive to provide support for the loan through ongoing payments, curtailments, or re-
margining.
Financial institutions that have sufficient information on the guarantor’s global financial
condition, income, liquidity, cash flow, contingent liabilities, and other relevant factors (including
credit ratings, when available) are better able to determine the guarantor’s financial ability to fulfill
its obligation. An effective assessment includes consideration of whether the guarantor has the
financial ability to fulfill the total number and amount of guarantees currently extended by the
guarantor. A similar analysis should be made for any material sponsors that support the loan.
Examiners should consider whether a guarantor has demonstrated the willingness to fulfill all
current and previous obligations, has sufficient economic incentive, and has a significant investment
19 See 12 CFR 34.62(c) and 160.101(c)(OCC); 12 CFR 208.51(a) (Board); and 12 CFR 365.2(c) (FDIC) regarding the
need for financial institutions to monitor conditions in the real estate market in its lending area to ensure that its real
estate lending policies continue to be appropriate for current market conditions
bligations, has sufficient economic incentive, and has a significant investment
19 See 12 CFR 34.62(c) and 160.101(c)(OCC); 12 CFR 208.51(a) (Board); and 12 CFR 365.2(c) (FDIC) regarding the
need for financial institutions to monitor conditions in the real estate market in its lending area to ensure that its real
estate lending policies continue to be appropriate for current market conditions. For the NCUA, refer to 12 CFR
723.4(f)(6) requiring that a federally insured credit union’s commercial loan policy have underwriting standards that
include an analysis of the impact of current market conditions on the borrower and associated borrowers.
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in the project. An important consideration is whether any previous performance under its
guarantee(s) was voluntary or the result of legal or other actions by the lender to enforce the
guarantee(s).
C. Supervisory Assessment of Collateral Values
As the primary sources of loan repayment decline, information on the underlying collateral’s
estimated value becomes more important in analyzing the source of repayment, assessing credit risk,
and developing an appropriate loan workout plan. Examiners will analyze real estate collateral
values based on the financial institution’s original appraisal or evaluation, any subsequent updates,
additional pertinent information (e.g., recent inspection results), and relevant market conditions.
Examiners will assess the major facts, assumptions, and valuation approaches in the collateral
valuation and their influence in the financial institution’s credit and allowance analyses.
The agencies’ appraisal regulations require financial institutions to review appraisals for
compliance with the Uniform Standards of Professional Appraisal Practice.20 As part of that
process, and when reviewing collateral valuations, financial institutions should ensure that
assumptions and conclusions used are reasonable
luence in the financial institution’s credit and allowance analyses.
The agencies’ appraisal regulations require financial institutions to review appraisals for
compliance with the Uniform Standards of Professional Appraisal Practice.20 As part of that
process, and when reviewing collateral valuations, financial institutions should ensure that
assumptions and conclusions used are reasonable. Further, financial institutions typically have
policies21 and procedures that dictate when collateral valuations should be updated as part of
financial institutions’ ongoing credit risk reviews and monitoring processes, as relevant market
conditions change, or as a borrower’s financial condition deteriorates.22
For a CRE loan in a workout arrangement, a financial institution should consider the current
project plans and market conditions in a new or updated appraisal or evaluation, as appropriate. In
determining whether to obtain a new appraisal or evaluation, a prudent financial institution considers
whether there has been material deterioration in the following factors:
• The performance of the project;
• Conditions for the geographic market and property type;
• Variances between actual conditions and original appraisal assumptions;
• Changes in project specifications (e.g., changing a planned condominium project to an
apartment building);
• Loss of a significant lease or a take-out commitment; or
• Increases in pre-sale fallout.
A new appraisal may not be necessary when an evaluation prepared by the financial institution
appropriately updates the original appraisal assumptions to reflect current market conditions and
provides a reasonable estimate of the underlying collateral’s fair value.23 If new money is being
advanced, financial institutions should refer to the agencies’ appraisal regulations to determine
20 See 12 CFR part 34, subpart C (OCC); 12 CFR part 208, subpart E, and 12 CFR part 225, subpart G (Board); 12 CFR
part 323 (FDIC); and 12 CFR part 722 (NCUA)
reflect current market conditions and
provides a reasonable estimate of the underlying collateral’s fair value.23 If new money is being
advanced, financial institutions should refer to the agencies’ appraisal regulations to determine
20 See 12 CFR part 34, subpart C (OCC); 12 CFR part 208, subpart E, and 12 CFR part 225, subpart G (Board); 12 CFR
part 323 (FDIC); and 12 CFR part 722 (NCUA).
21 See Footnote 12.
22 For further reference, see Interagency Appraisal and Evaluation Guidelines, 75 FR 77450 (December 10, 2010).
23 According to the FASB ASC Master Glossary, “fair value” is “the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants at the measurement date.”
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whether a new appraisal is required.24
The market value provided by an appraisal and the fair value for accounting purposes are based
on similar valuation concepts.25 The analysis of the underlying collateral’s market value reflects the
financial institution’s understanding of the property’s current “as is” condition (considering the
property’s highest and best use) and other relevant risk factors affecting the property’s value.
Valuations of commercial properties may contain more than one value conclusion and could include
an “as is” market value, a prospective “as complete” market value, and a prospective “as stabilized”
market value.
Financial institutions typically use the market value conclusion (and not the fair value) that
corresponds to the workout plan objective and the loan commitment. For example, if the financial
institution intends to work with the borrower so that a project will achieve stabilized occupancy, then
the financial institution can consider the “as stabilized” market value in its collateral assessment for
credit risk grading after confirming that the appraisal’s assumptions and conclusions are reasonable
s to the workout plan objective and the loan commitment. For example, if the financial
institution intends to work with the borrower so that a project will achieve stabilized occupancy, then
the financial institution can consider the “as stabilized” market value in its collateral assessment for
credit risk grading after confirming that the appraisal’s assumptions and conclusions are reasonable.
Conversely, if the financial institution intends to foreclose, then it is required for financial reporting
purposes that the financial institution use the fair value (less costs to sell)26 of the property in its
current “as is” condition in its collateral assessment.
If weaknesses exist in the financial institution’s supporting loan documentation or appraisal or
evaluation review process, examiners should direct the financial institution to address the
weaknesses, which may require the financial institution to obtain additional information or a new
collateral valuation.27 However, in the rare instance when a financial institution is unable or
unwilling to address weaknesses in a timely manner, examiners will assess the property’s operating
cash flow and the degree of protection provided by a sale of the underlying collateral as part of
determining the loan’s classification. In performing their credit analysis, examiners will consider
expected cash flow from the property, current or implied value, relevant market conditions, and the
relevance of the facts and the reasonableness of assumptions used by the financial institution. For an
income-producing property, examiners evaluate:
• Net operating income of the property as compared with budget projections, reflecting
reasonable operating and maintenance costs;
24 See footnote 20.
25 The term “market value” as used in an appraisal is based on similar valuation concepts as “fair value” for accounting
purposes under GAAP
mptions used by the financial institution. For an
income-producing property, examiners evaluate:
• Net operating income of the property as compared with budget projections, reflecting
reasonable operating and maintenance costs;
24 See footnote 20.
25 The term “market value” as used in an appraisal is based on similar valuation concepts as “fair value” for accounting
purposes under GAAP. For both terms, these valuation concepts about the real property and the real estate transaction
contemplate that the property has been exposed to the market before the valuation date, the buyer and seller are well
informed and acting in their own best interest (that is, the transaction is not a forced liquidation or distressed sale), and
marketing activities are usual and customary (that is, the value of the property is unaffected by special financing or sales
concessions). The market value in an appraisal may differ from the collateral’s fair value if the values are determined as
of different dates or the fair value estimate reflects different assumptions from those in the appraisal. This may occur as
a result of changes in market conditions and property use since the “as of” date of the appraisal.
26 Costs to sell may be used in determining any allowance for collateral-dependent loans. Under ASC Topic 326, a loan
is collateral dependent when the repayment is expected to be provided substantially through the operation or sale of the
collateral when the borrower is experiencing financial difficulty based on the entity’s assessment as of the reporting date.
Costs to sell are used when the loan is dependent on the sale of the collateral. Costs to sell are not used when the
collateral-dependent loan is dependent on the operation of the collateral.
27 See 12 CFR 34.43(c) (OCC); 12 CFR 225.63(c) (Board); 12 CFR 323.3(c) (FDIC); and 12 CFR 722.3(e) (NCUA).
is experiencing financial difficulty based on the entity’s assessment as of the reporting date.
Costs to sell are used when the loan is dependent on the sale of the collateral. Costs to sell are not used when the
collateral-dependent loan is dependent on the operation of the collateral.
27 See 12 CFR 34.43(c) (OCC); 12 CFR 225.63(c) (Board); 12 CFR 323.3(c) (FDIC); and 12 CFR 722.3(e) (NCUA).
Page 9 of 39
• Current and projected vacancy and absorption rates;
• Lease renewal trends and anticipated rents;
• Effective rental rates or sale prices, considering sales and financing concessions;
• Time frame for achieving stabilized occupancy or sellout;
• Volume and trends in past due leases; and
• Discount rates and direct capitalization rates (refer to Appendix 3 for more information).
Assumptions, when recently made by qualified appraisers (and, as appropriate, by qualified,
independent parties within the financial institution) and when consistent with the discussion above,
should be given reasonable deference by examiners. Examiners should also use the appropriate
market value conclusion in their collateral assessments. For example, when the financial institution
plans to provide the resources to complete a project, examiners can consider the project’s
prospective market value and the committed loan amount in their analyses.
Examiners generally are not expected to challenge the underlying assumptions, including
discount rates and capitalization rates, used in appraisals or evaluations when these assumptions
differ only marginally from norms generally associated with the collateral under review. The
examiner may adjust the estimated value of the collateral for credit analysis and classification
purposes when the examiner can establish that underlying facts or assumptions presented by the
financial institution are irrelevant or inappropriate or can support alternative assumptions based on
available information
arginally from norms generally associated with the collateral under review. The
examiner may adjust the estimated value of the collateral for credit analysis and classification
purposes when the examiner can establish that underlying facts or assumptions presented by the
financial institution are irrelevant or inappropriate or can support alternative assumptions based on
available information.
CRE borrowers may have commercial loans secured by owner occupied real estate or other
business assets, such as inventory and accounts receivable, or may have CRE loans also secured by
furniture, fixtures, and equipment. For these loans, examiners should assess the adequacy of the
financial institution’s policies and practices for quantifying the value of such collateral, determining
the acceptability of the assets as collateral, and perfecting its security interests. Examiners should
also determine whether the financial institution has appropriate procedures for ongoing monitoring
of this type of collateral.
V. Classification of Loans
Loans that are adequately protected by the current sound worth and debt service ability of the
borrower, guarantor, or the underlying collateral generally are not adversely classified. Similarly,
loans to sound borrowers that are modified in accordance with prudent underwriting standards
should not be adversely classified by examiners unless well-defined weaknesses exist that jeopardize
repayment. However, such loans could be flagged for management’s attention or for inclusion in
designated “watch lists” of loans that management is more closely monitoring.
Further, examiners should not adversely classify loans solely because the borrower is
associated with a particular industry that is experiencing financial difficulties
unless well-defined weaknesses exist that jeopardize
repayment. However, such loans could be flagged for management’s attention or for inclusion in
designated “watch lists” of loans that management is more closely monitoring.
Further, examiners should not adversely classify loans solely because the borrower is
associated with a particular industry that is experiencing financial difficulties. When a financial
institution’s loan modifications are not supported by adequate analysis and documentation,
examiners are expected to exercise reasonable judgment in reviewing and determining loan
classifications until such time as the financial institution is able to provide information to support
management’s conclusions and internal loan grades. Refer to Appendix 4 for the classification
Page 10 of 39
definitions.28
A. Loan Performance Assessment for Classification Purposes
The loan’s record of performance to date should be one of several considerations when
determining whether a loan should be adversely classified. As a general principle, examiners should
not adversely classify or require the recognition of a partial charge-off on a performing commercial
loan solely because the value of the underlying collateral has declined to an amount that is less than
the loan balance. However, it is appropriate to classify a performing loan when well-defined
weaknesses exist that jeopardize repayment.
One perspective on loan performance is based upon an assessment as to whether the
borrower is contractually current on principal or interest payments. For many loans, the assessment
of payment status is sufficient to arrive at a loan’s classification. In other cases, being contractually
current on payments can be misleading as to the credit risk embedded in the loan. This may occur
when the loan’s underwriting structure or the liberal use of extensions and renewals masks credit
weaknesses and obscures a borrower’s inability to meet reasonable repayment terms
assessment
of payment status is sufficient to arrive at a loan’s classification. In other cases, being contractually
current on payments can be misleading as to the credit risk embedded in the loan. This may occur
when the loan’s underwriting structure or the liberal use of extensions and renewals masks credit
weaknesses and obscures a borrower’s inability to meet reasonable repayment terms.
For example, for many acquisition, development, and construction projects, the loan is
structured with an “interest reserve” for the construction phase of the project. At the time the loan is
originated, the lender establishes the interest reserve as a portion of the initial loan commitment.
During the construction phase, the lender recognizes interest income from the interest reserve and
capitalizes the interest into the loan balance. After completion of the construction, the lender
recognizes the proceeds from the sale of lots, homes, or buildings for the repayment of principal,
including any of the capitalized interest. For a commercial construction loan where the property has
achieved stabilized occupancy, the lender uses the proceeds from permanent financing for repayment
of the construction loan or converts the construction loan to an amortizing loan.
However, if the development project stalls and management fails to evaluate the
collectability of the loan, interest income could continue to be recognized from the interest reserve
and capitalized into the loan balance, even though the project is not generating sufficient cash flows
to repay the loan. In this case, the loan will be contractually current due to the interest payments
being funded from the reserve, but the repayment of principal may be in jeopardy. This repayment
uncertainty is especially true when leases or sales have not occurred as projected and property values
have dropped below the market value reported in the original collateral valuation. In this situation,
adverse classification of the loan may be appropriate
y current due to the interest payments
being funded from the reserve, but the repayment of principal may be in jeopardy. This repayment
uncertainty is especially true when leases or sales have not occurred as projected and property values
have dropped below the market value reported in the original collateral valuation. In this situation,
adverse classification of the loan may be appropriate.
A second perspective for assessing a loan’s classification is to consider the borrower’s expected
performance and ability to meet its obligations in accordance with the modified terms over the
remaining life of the loan. Therefore, the loan classification is meant to measure risk over the term
28 The NCUA does not require credit unions to adopt a uniform regulatory classification schematic of loss, doubtful, or
substandard. A credit union must apply a relative credit risk score (i.e., credit risk rating) to each commercial loan as
required by 12 CFR part 723, Member Business Loans; Commercial Lending, or the equivalent state regulation as
applicable (see Section 723.4(g)(3)). Adversely classified refers to loans more severely graded under the credit union’s
credit risk rating system. Adversely classified loans generally require enhanced monitoring and present a higher risk of
loss. Refer to the NCUA’s Examiner’s Guide for further information on credit risk rating systems.
Page 11 of 39
of the loan rather than just reflecting the loan’s payment history. As a borrower’s expected
performance is dependent upon future events, examiners’ credit analyses should focus on:
• The borrower’s financial strength as reflected by its historical and projected balance sheet
and income statement outcomes; and
• The prospects for the CRE property considering events and market conditions that reasonably
may occur during the term of the loan.
B
t history. As a borrower’s expected
performance is dependent upon future events, examiners’ credit analyses should focus on:
• The borrower’s financial strength as reflected by its historical and projected balance sheet
and income statement outcomes; and
• The prospects for the CRE property considering events and market conditions that reasonably
may occur during the term of the loan.
B. Classification of Renewals or Restructurings of Maturing Loans
Loans to commercial borrowers can have short maturities, including short-term working
capital loans to businesses, financing for CRE construction projects, or bridge loans to finance
recently completed CRE projects for a period to achieve stabilized occupancy before obtaining
permanent financing or selling the property. When there has been deterioration in collateral values,
a borrower with a maturing loan amid an economic downturn may have difficulty obtaining short-
term financing or adequate sources of long-term credit, despite the borrower’s demonstrated and
continued ability to service the debt. In such cases, financial institutions may determine that the
most appropriate course is to restructure or renew the loan. Such actions, when done prudently, are
often in the best interest of both the financial institution and the borrower.
A restructured loan typically reflects an elevated level of credit risk, as the borrower may not
be, or has not been, able to perform according to the original contractual terms. The assessment of
each loan should be based upon the fundamental characteristics affecting the collectability of that
loan. In general, renewals or restructurings of maturing loans to commercial borrowers who have
the ability to repay on reasonable terms will not automatically be subject to adverse classification by
examiners. However, consistent with safety and soundness standards, such loans should be
identified in the financial institution’s internal credit grading system and may warrant close
monitoring
loan. In general, renewals or restructurings of maturing loans to commercial borrowers who have
the ability to repay on reasonable terms will not automatically be subject to adverse classification by
examiners. However, consistent with safety and soundness standards, such loans should be
identified in the financial institution’s internal credit grading system and may warrant close
monitoring. Adverse classification of a renewed or restructured loan would be appropriate if, despite
the renewal or restructuring, well-defined weaknesses exist that jeopardize the orderly repayment of
the loan pursuant to reasonable modified terms.
C. Classification of Problem CRE Loans Dependent on the Sale of Collateral for Repayment
As a general classification principle for a problem CRE loan that is dependent on the sale of
the collateral for repayment, any portion of the loan balance that exceeds the amount that is
adequately secured by the fair value of the real estate collateral less the costs to sell should be
classified “loss.” This principle applies to loans that are collateral dependent based on the sale of the
collateral in accordance with GAAP and for which there are no other available reliable sources of
repayment such as a financially capable guarantor.29
The portion of the loan balance that is adequately secured by the fair value of the real estate
collateral less the costs to sell generally should be adversely classified no worse than “substandard.”
The amount of the loan balance in excess of the fair value of the real estate collateral, or portions
thereof, should be adversely classified “doubtful” when the potential for full loss may be mitigated
by the outcomes of certain pending events, or when loss is expected but the amount of the loss
cannot be reasonably determined. If warranted by the underlying circumstances, an examiner may
29 See footnote 26.
an balance in excess of the fair value of the real estate collateral, or portions
thereof, should be adversely classified “doubtful” when the potential for full loss may be mitigated
by the outcomes of certain pending events, or when loss is expected but the amount of the loss
cannot be reasonably determined. If warranted by the underlying circumstances, an examiner may
29 See footnote 26.
Page 12 of 39
use a “doubtful” classification on the entire loan balance. However, examiners should use a
“doubtful” classification infrequently, as such a designation is temporary and subject to a financial
institution’s timely reassessment of the loan once the outcomes of pending events have occurred or
the amount of loss can be reasonably determined.
D. Classification and Accrual Treatment of Restructured Loans with a Partial Charge-off
Based on consideration of all relevant factors, an assessment may indicate that a loan has
well-defined weaknesses that jeopardize collection in full of all amounts contractually due and may
result in a partial charge-off as part of a restructuring. When well-defined weaknesses exist and a
partial charge-off has been taken, the remaining recorded balance for the restructured loan generally
should be classified no more severely than “substandard.” A more severe classification than
“substandard” for the remaining recorded balance would be appropriate if the loss exposure cannot
be reasonably determined. Such situations may occur when significant remaining risk exposures are
identified but are not quantified, such as bankruptcy or a loan collateralized by a property with
potential environmental concerns.
A restructuring may involve a multiple note structure in which, for example, a loan is
restructured into two notes (referred to as Note A and Note B). Lenders may separate a portion of
the current outstanding debt into a new, legally enforceable note (Note A) that is reasonably assured
of repayment and performance according to prudently modified terms
with
potential environmental concerns.
A restructuring may involve a multiple note structure in which, for example, a loan is
restructured into two notes (referred to as Note A and Note B). Lenders may separate a portion of
the current outstanding debt into a new, legally enforceable note (Note A) that is reasonably assured
of repayment and performance according to prudently modified terms. When restructuring a
collateral-dependent loan using a multiple note structure, the amount of Note A should be
determined using the fair value of the collateral. This note may be placed back in accrual status in
certain situations. In returning the loan to accrual status, sustained historical payment performance
for a reasonable time prior to the restructuring may be taken into account. Additionally, a properly
structured and performing Note A generally would not be adversely classified by examiners. The
portion of the debt that is unlikely to be repaid or collected and therefore is deemed uncollectible
(Note B) would be adversely classified “loss” and must be charged off.
In contrast, the loan should remain on, or be placed in, nonaccrual status if the financial
institution does not split the loan into separate notes, but internally recognizes a partial charge-off.
A partial charge-off would indicate that the financial institution does not expect full repayment of
the amounts contractually due. If facts change after the charge-off is taken such that the full
amounts contractually due, including the amount charged off, are expected to be collected and the
loan has been brought contractually current, the remaining balance of the loan may be returned to
accrual status without having to first receive payment of the charged-off amount.30 In these cases,
examiners should assess whether the financial institution has well-documented support for its credit
assessment of the borrower’s financial condition and the prospects for full repayment.
VI
e
loan has been brought contractually current, the remaining balance of the loan may be returned to
accrual status without having to first receive payment of the charged-off amount.30 In these cases,
examiners should assess whether the financial institution has well-documented support for its credit
assessment of the borrower’s financial condition and the prospects for full repayment.
VI. Regulatory Reporting and Accounting Considerations
30 The charged-off amount should not be reversed or re-booked, under any condition, to increase the recorded investment
in the loan or its amortized cost, as applicable, when the loan is returned to accrual status. However, expected
recoveries, prior to collection, are a component of management’s estimate of the net amount expected to be collected for
a loan under ASC Topic 326. Refer to relevant regulatory reporting instructions for supervisory guidance on returning a
loan to accrual status.
Page 13 of 39
Financial institution management is responsible for preparing regulatory reports in
accordance with GAAP and regulatory reporting requirements. Management also is responsible for
establishing and maintaining an appropriate governance and internal control structure over the
preparation of regulatory reports. The agencies have observed this governance and control structure
commonly includes policies and procedures that provide clear guidance on accounting matters.
Accurate regulatory reports are critical to the transparency of a financial institution’s financial
position and risk profile and are imperative for effective supervision. Decisions related to loan
workout arrangements may affect regulatory reporting, particularly interest accruals and loan loss
estimates
nly includes policies and procedures that provide clear guidance on accounting matters.
Accurate regulatory reports are critical to the transparency of a financial institution’s financial
position and risk profile and are imperative for effective supervision. Decisions related to loan
workout arrangements may affect regulatory reporting, particularly interest accruals and loan loss
estimates. Therefore, it is important that loan workout staff appropriately communicate with the
accounting and regulatory reporting staff concerning the financial institution’s loan restructurings
and that the consequences of restructurings are presented accurately in regulatory reports.
In addition to evaluating credit risk management processes and validating the accuracy of
internal loan grades, examiners are responsible for reviewing management’s processes related to
accounting and regulatory reporting. While similar data are used for loan risk monitoring,
accounting, and reporting systems, this information does not necessarily produce identical outcomes.
For example, loss classifications may not be equivalent to the associated allowance measurements.
A. Allowance for Credit Losses
Examiners need to have a clear understanding of the differences between credit risk
management and accounting and regulatory reporting concepts (such as accrual status and the
allowance) when assessing the adequacy of the financial institution’s reporting practices for on- and
off-balance sheet credit exposures. Refer to Appendix 5 for a summary of the allowance standard
under ASC Topic 326, Financial Instruments – Credit Losses. Examiners should also refer to
regulatory reporting instructions in the FFIEC Call Report and the NCUA 5300 Call Report
guidance as well as applicable accounting standards for further information.
B
on’s reporting practices for on- and
off-balance sheet credit exposures. Refer to Appendix 5 for a summary of the allowance standard
under ASC Topic 326, Financial Instruments – Credit Losses. Examiners should also refer to
regulatory reporting instructions in the FFIEC Call Report and the NCUA 5300 Call Report
guidance as well as applicable accounting standards for further information.
B. Implications for Interest Accrual
A financial institution needs to consider whether a loan that was accruing interest prior to the
loan restructuring should be placed in nonaccrual status at the time of modification to ensure that
income is not materially overstated. Consistent with FFIEC and NCUA Call Report instructions, a
loan that has been restructured so as to be reasonably assured of repayment and performance
according to prudent modified terms need not be placed in nonaccrual status. Therefore, for a loan
to remain in accrual status, the restructuring and any charge-off taken on the loan must be supported
by a current, well-documented credit assessment of the borrower’s financial condition and prospects
for repayment under the revised terms. Otherwise, the restructured loan must be placed in
nonaccrual status.
A restructured loan placed in nonaccrual status should not be returned to accrual status until
the borrower demonstrates sustained repayment performance for a reasonable period prior to the date
on which the loan is returned to accrual status. A sustained period of repayment performance
generally would be a minimum of six months and would involve payments of cash or cash
equivalents. It may also include historical periods prior to the date of the loan restructuring. While
an appropriately designed restructuring should improve the collectability of the loan in accordance
o the date
on which the loan is returned to accrual status. A sustained period of repayment performance
generally would be a minimum of six months and would involve payments of cash or cash
equivalents. It may also include historical periods prior to the date of the loan restructuring. While
an appropriately designed restructuring should improve the collectability of the loan in accordance
Page 14 of 39
with a reasonable repayment schedule, it does not relieve the financial institution from the
responsibility to promptly charge off all identified losses. For more detailed instructions about
placing a loan in nonaccrual status and returning a nonaccrual loan to accrual status, refer to the
instructions for the FFIEC Call Report and the NCUA 5300 Call Report.
Page 15 of 39
Appendix 1
Examples of CRE Loan Workout Arrangements
The examples in this appendix are provided for illustrative purposes only and are designed to
demonstrate an examiner’s analytical thought process to derive an appropriate classification and
evaluate implications for interest accrual.31 Although not discussed in the examples below,
examiners consider the adequacy of a financial institution’s supporting documentation, internal
analysis, and business decision to enter into a loan workout arrangement. The examples also do not
address the effect of the loan workout arrangement on the allowance and subsequent reporting
requirements. Financial institutions should refer to the appropriate regulatory reporting instructions
for supervisory guidance on the recognition, measurement, and regulatory reporting of loan
modifications.
Examiners should use caution when applying these examples to “real-life” situations,
consider all facts and circumstances of the loan being evaluated, and exercise judgment before
reaching conclusions related to loan classification and nonaccrual treatment.32
A
porting instructions
for supervisory guidance on the recognition, measurement, and regulatory reporting of loan
modifications.
Examiners should use caution when applying these examples to “real-life” situations,
consider all facts and circumstances of the loan being evaluated, and exercise judgment before
reaching conclusions related to loan classification and nonaccrual treatment.32
A. Income Producing Property – Office Building
BASE CASE: A lender originated a $15 million loan for the purchase of an office building with
monthly payments based on an amortization of 20 years and a balloon payment of $13.6 million at
the end of year five. At origination, the loan had a 75 percent loan-to-value (LTV) based on an
appraisal reflecting a $20 million market value on an “as stabilized” basis, a debt service coverage
(DSC) ratio of 1.30x, and a market interest rate. The lender expected to renew the loan when the
balloon payment became due at the end of year five. Due to technological advancements and a
workplace culture change since the inception of the loan, many businesses switched to hybrid work-
from-home arrangements to reduce longer-term costs and improve employee retention. As a result,
the property’s cash flow declined as the borrower has had to grant rental concessions to either retain
its existing tenants or attract new tenants, since the demand for office space has decreased.
SCENARIO 1: At maturity, the lender renewed the $13.6 million loan for one year at a market
interest rate that provides for the incremental risk and payments based on amortizing the principal
over the remaining 15 years. The borrower had not been delinquent on prior payments and has
sufficient cash flow to service the loan at the market interest rate terms with a DSC ratio of 1.12x,
based on updated financial information.
A review of the leases reflects that most tenants are stable occupants, with long-term leases and
sufficient cash flow to pay their rent
mortizing the principal
over the remaining 15 years. The borrower had not been delinquent on prior payments and has
sufficient cash flow to service the loan at the market interest rate terms with a DSC ratio of 1.12x,
based on updated financial information.
A review of the leases reflects that most tenants are stable occupants, with long-term leases and
sufficient cash flow to pay their rent. The major tenants have not adopted hybrid work-from-home
arrangements for their employees given the nature of the businesses. A recent appraisal reported an
“as stabilized” market value of $13.3 million for the property for an LTV of 102 percent. This
reflects current market conditions and the resulting decline in cash flow.
Classification: The lender internally graded the loan pass and is monitoring the credit. The
31 The agencies view that the accrual treatments in these examples as falling within the range of acceptable practices
under regulatory reporting instructions.
32 In addition, estimates of the fair value of collateral use assumptions based on judgment and should be consistent with
measurement of fair value in ASC Topic 820, Fair Value Measurement; see Appendix 2.
Page 16 of 39
examiner agreed, because the borrower has the ability to continue making loan payments based
on reasonable terms, despite a decline in cash flow and in the market value of the collateral.
Nonaccrual Treatment: The lender maintained the loan in accrual status. The borrower has
demonstrated the ability to make the regularly scheduled payments and, even with the decline in
the borrower’s creditworthiness, cash flow appears sufficient to make these payments, and full
repayment of principal and interest is expected. The examiner concurred with the lender’s
accrual treatment.
SCENARIO 2: At maturity, the lender renewed the $13.6 million loan at a market interest rate that
provides for the incremental risk and payments based on amortizing the principal over the remaining
15 years
itworthiness, cash flow appears sufficient to make these payments, and full
repayment of principal and interest is expected. The examiner concurred with the lender’s
accrual treatment.
SCENARIO 2: At maturity, the lender renewed the $13.6 million loan at a market interest rate that
provides for the incremental risk and payments based on amortizing the principal over the remaining
15 years. The borrower had not been delinquent on prior payments. Current projections indicate the
DSC ratio will not drop below 1.12x based on leases in place and letters of intent for vacant space.
However, some leases are coming up for renewal, and additional rental concessions may be
necessary to either retain those existing tenants or attract new tenants. The lender estimates the
property’s current “as stabilized” market value is $14.5 million, which results in a 94 percent LTV,
but a current valuation has not been ordered. In addition, the lender has not asked the borrower or
guarantors to provide current financial statements to assess their ability to support any cash flow
shortfall.
Classification: The lender internally graded the loan pass and is monitoring the credit. The
examiner disagreed with the internal grade and listed the credit as special mention. While the
borrower has the ability to continue to make payments based on leases currently in place and
letters of intent for vacant space, there has been a declining trend in the property’s revenue
stream, and there is most likely a reduced collateral margin. In addition, there is potential for
further deterioration in the cash flow as more leases will expire in the upcoming months, while
absorption for office space in this market has slowed. Lastly, the examiner noted that the lender
failed to request current financial information and to obtain an updated collateral valuation,33
representing administrative weaknesses.
Nonaccrual Treatment: The lender maintained the loan in accrual status
erioration in the cash flow as more leases will expire in the upcoming months, while
absorption for office space in this market has slowed. Lastly, the examiner noted that the lender
failed to request current financial information and to obtain an updated collateral valuation,33
representing administrative weaknesses.
Nonaccrual Treatment: The lender maintained the loan in accrual status. The borrower has
demonstrated the ability to make regularly scheduled payments and, even with the decline in the
borrower’s creditworthiness, cash flow is sufficient at this time to make payments, and full
repayment of principal and interest is expected. The examiner concurred with the lender’s
accrual treatment.
SCENARIO 3: At maturity, the lender restructured the $13.6 million loan on a 12-month interest-
only basis at a below market interest rate. The borrower has been sporadically delinquent on prior
principal and interest payments. The borrower projects a DSC ratio of 1.10x based on the
restructured interest-only terms. A review of the rent roll, which was available to the lender at the
time of the restructuring, reflects the majority of tenants have short-term leases, with three leases
expected to expire within the next three months. According to the lender, leasing has not improved
since the restructuring as market conditions remain soft. Further, the borrower does not have an
33 In relation to comments on valuations within these examples, refer to the appraisal regulations applicable to the
financial institution to determine whether there is a regulatory requirement for either an evaluation or appraisal. See
footnote 20.
ding to the lender, leasing has not improved
since the restructuring as market conditions remain soft. Further, the borrower does not have an
33 In relation to comments on valuations within these examples, refer to the appraisal regulations applicable to the
financial institution to determine whether there is a regulatory requirement for either an evaluation or appraisal. See
footnote 20.
Page 17 of 39
update as to whether the three expiring leases will renew at maturity; two of the tenants have moved
to hybrid work-from-home arrangements. A recent appraisal provided a $14.5 million “as
stabilized” market value for the property, resulting in a 94 percent LTV.
Classification: The lender internally graded the loan pass and is monitoring the credit. The
examiner disagreed with the internal grade and classified the loan substandard due to the
borrower’s limited ability to service a below market interest rate loan on an interest-only basis,
sporadic delinquencies, and an increase in the LTV based on an updated appraisal. In addition,
there is lease rollover risk because three of the leases are expiring soon, which could further limit
cash flow.
Nonaccrual Treatment: The lender maintained the loan in accrual status due to the positive
cash flow and collateral margin. The examiner did not concur with this treatment as the loan was
not restructured with reasonable repayment terms, and the borrower has not demonstrated the
ability to amortize the loan and has limited ability to service a below market interest rate on an
interest-only basis. After a discussion with the examiner on regulatory reporting requirements,
the lender placed the loan on nonaccrual.
B. Income Producing Property – Retail Properties
BASE CASE: A lender originated a 36-month, $10 million loan for the construction of a shopping
mall. The construction period was 24 months with a 12-month lease-up period to allow the borrower
time to achieve stabilized occupancy before obtaining permanent financing
tory reporting requirements,
the lender placed the loan on nonaccrual.
B. Income Producing Property – Retail Properties
BASE CASE: A lender originated a 36-month, $10 million loan for the construction of a shopping
mall. The construction period was 24 months with a 12-month lease-up period to allow the borrower
time to achieve stabilized occupancy before obtaining permanent financing. The loan had an interest
reserve to cover interest payments over the three-year term. At the end of the third year, there is $10
million outstanding on the loan, as the shopping mall has been built and the interest reserve, which
has been covering interest payments, has been fully drawn.
At the time of origination, the appraisal reported an “as stabilized” market value of $13.5 million for
the property. In addition, the borrower had a take-out commitment that would provide permanent
financing at maturity. A condition of the take-out lender was that the shopping mall had to achieve a
75 percent occupancy level.
Due to weak economic conditions and a shift in consumer behavior to a greater reliance on e-
commerce, the property only reached a 55 percent occupancy level at the end of the 12-month lease
up period. As a result, the original takeout commitment became void. In addition, there has been a
considerable tightening of credit for these types of loans, and the borrower has been unable to obtain
permanent financing elsewhere since the loan matured. To date, the few interested lenders are
demanding significant equity contributions and much higher pricing.
SCENARIO 1: The lender renewed the loan for an additional 12 months to provide the borrower
time for higher lease-up and to obtain permanent financing. The extension was made at a market
interest rate that provides for the incremental risk and is on an interest-only basis
n matured. To date, the few interested lenders are
demanding significant equity contributions and much higher pricing.
SCENARIO 1: The lender renewed the loan for an additional 12 months to provide the borrower
time for higher lease-up and to obtain permanent financing. The extension was made at a market
interest rate that provides for the incremental risk and is on an interest-only basis. While the
property’s historical cash flow was insufficient at a 0.92x debt service ratio, recent improvements in
the occupancy level now provide adequate coverage based on the interest-only payments. Recent
events include the signing of several new leases with additional leases under negotiation; however,
takeout financing continues to be tight in the market.
In addition, current financial statements reflect that the builder, who personally guarantees the debt,
has cash on deposit at the lender plus other unencumbered liquid assets. These assets provide
Page 18 of 39
sufficient cash flow to service the borrower’s global debt service requirements on a principal and
interest basis, if necessary, for the next 12 months. The guarantor covered the initial cash flow
shortfalls from the project and provided a good faith principal curtailment of $200,000 at renewal,
reducing the loan balance to $9.8 million. A recent appraisal on the shopping mall reports an “as is”
market value of $10 million and an “as stabilized” market value of $11 million, resulting in LTVs of
98 percent and 89 percent, respectively.
Classification: The lender internally graded the loan as a pass and is monitoring the credit. The
examiner disagreed with the lender’s internal loan grade and listed it as special mention. While
the project continues to lease up, cash flows cover only the interest payments. The guarantor has
the ability, and has demonstrated the willingness, to cover cash flow shortfalls; however, there
remains considerable uncertainty surrounding the takeout financing for this loan
ring the credit. The
examiner disagreed with the lender’s internal loan grade and listed it as special mention. While
the project continues to lease up, cash flows cover only the interest payments. The guarantor has
the ability, and has demonstrated the willingness, to cover cash flow shortfalls; however, there
remains considerable uncertainty surrounding the takeout financing for this loan.
Nonaccrual Treatment: The lender maintained the loan in accrual status as the guarantor has
sufficient funds to cover the borrower’s global debt service requirements over the one-year
period of the renewed loan. Full repayment of principal and interest is reasonably assured from
the project’s and guarantor’s cash resources, despite a decline in the collateral margin. The
examiner concurred with the lender’s accrual treatment.
SCENARIO 2: The lender restructured the loan on an interest-only basis at a below market interest
rate for one year to provide additional time to increase the occupancy level and, thereby, enable the
borrower to arrange permanent financing. The level of lease-up remains relatively unchanged at 55
percent, and the shopping mall projects a DSC ratio of 1.02x based on the preferential loan terms.
At the time of the restructuring, the lender used outdated financial information, which resulted in a
positive cash flow projection. However, other file documentation available at the time of the
restructuring reflected that the borrower anticipates the shopping mall’s revenue stream will further
decline due to rent concessions, the loss of a tenant, and limited prospects for finding new tenants.
Current financial statements indicate the builder, who personally guarantees the debt, cannot cover
any cash flow shortfall. The builder is highly leveraged, has limited cash or unencumbered liquid
assets, and has other projects with delinquent payments. A recent appraisal on the shopping mall
reports an “as is” market value of $9 million, which results in an LTV ratio of 111 percent
enants.
Current financial statements indicate the builder, who personally guarantees the debt, cannot cover
any cash flow shortfall. The builder is highly leveraged, has limited cash or unencumbered liquid
assets, and has other projects with delinquent payments. A recent appraisal on the shopping mall
reports an “as is” market value of $9 million, which results in an LTV ratio of 111 percent.
Classification: The lender internally classified the loan as substandard. The examiner disagreed
with the internal grade and classified the amount not protected by the collateral value, $1 million,
as loss and required the lender to charge-off this amount. The examiner did not factor costs to
sell into the loss classification analysis, as the current source of repayment is not reliant on the
sale of the collateral. The examiner classified the remaining loan balance, based on the
property’s “as is” market value of $9 million, as substandard given the borrower’s uncertain
repayment ability and weak financial support.
Nonaccrual Treatment: The lender determined the loan did not warrant being placed in
nonaccrual status. The examiner did not concur with this treatment because the partial charge-
off is indicative that full collection of principal is not anticipated, and the lender has continued
exposure to additional loss due to the project’s insufficient cash flow and reduced collateral
margin and the guarantor’s inability to provide further support. After a discussion with the
examiner on regulatory reporting requirements, the lender placed the loan on nonaccrual.
partial charge-
off is indicative that full collection of principal is not anticipated, and the lender has continued
exposure to additional loss due to the project’s insufficient cash flow and reduced collateral
margin and the guarantor’s inability to provide further support. After a discussion with the
examiner on regulatory reporting requirements, the lender placed the loan on nonaccrual.
Page 19 of 39
SCENARIO 3: The loan has become delinquent. Recent financial statements indicate the borrower
and the guarantor have minimal other resources available to support this loan. The lender chose not
to restructure the $10 million loan into a new single amortizing note of $10 million at a market
interest rate because the project’s projected cash flow would only provide a 0.88x DSC ratio as the
borrower has been unable to lease space. A recent appraisal which reasonably estimates the fair
value on the shopping mall reported an “as is” market value of $7 million, resulting in an LTV of
143 percent. At the original loan’s maturity, the lender restructured the $10 million debt, which is a
collateral-dependent loan, into two notes. The lender placed the first note of $7 million (Note A) on
monthly payments that amortize the debt over 20 years at a market interest rate that provides for the
incremental risk. The project’s DSC ratio equals 1.20x for the $7 million loan based on the
shopping mall’s projected net operating income. For the second note (Note B), the lender placed the
remaining $3 million, which represents the excess of the $10 million debt over the $7 million market
value of the shopping mall, into a 2 percent interest-only loan that resets in five years into an
amortizing payment. The lender then charged-off the $3 million note due to the project’s lack of
repayment ability and to provide reasonable collateral protection for the remaining on-book loan of
$7 million. The lender also reversed accrued but unpaid interest
on debt over the $7 million market
value of the shopping mall, into a 2 percent interest-only loan that resets in five years into an
amortizing payment. The lender then charged-off the $3 million note due to the project’s lack of
repayment ability and to provide reasonable collateral protection for the remaining on-book loan of
$7 million. The lender also reversed accrued but unpaid interest. Since the restructuring, the
borrower has made payments on both loans for more than six consecutive months and an updated
financial analysis shows continued ability to repay under the new terms.
Classification: The lender internally graded the on-book loan of $7 million as a pass loan due to
the borrower’s demonstrated ability to perform under the modified terms. The examiner agreed
with the lender’s grade as the lender restructured the original obligation into Notes A and B, the
lender charged off Note B, and the borrower has demonstrated the ability to repay Note A.
Using this multiple note structure with charge-off of the Note B enables the lender to recognize
interest income.
Nonaccrual Treatment: The lender placed the on-book loan (Note A) of $7 million loan in
nonaccrual status at the time of the restructure. The lender later restored the $7 million to
accrual status as the borrower has the ability to repay the loan, has a record of performing at the
revised terms for more than six months, and full repayment of principal and interest is expected.
The examiner concurred with the lender’s accrual treatment. Interest payments received on the
off-book loan have been recorded as recoveries because full recovery of principal and interest on
this loan (Note B) was not reasonably assured.
SCENARIO 4: Current financial statements indicate the borrower and the guarantor have minimal
other resources available to support this loan
expected.
The examiner concurred with the lender’s accrual treatment. Interest payments received on the
off-book loan have been recorded as recoveries because full recovery of principal and interest on
this loan (Note B) was not reasonably assured.
SCENARIO 4: Current financial statements indicate the borrower and the guarantor have minimal
other resources available to support this loan. The lender restructured the $10 million loan into a
new single note of $10 million at a market interest rate that provides for the incremental risk and is
on an amortizing basis. The project’s projected cash flow reflects a 0.88x DSC ratio as the borrower
has been unable to lease space. A recent appraisal on the shopping mall reports an “as is” market
value of $9 million, which results in an LTV of 111 percent. Based on the property’s current market
value of $9 million, the lender charged-off $1 million immediately after the renewal.
Classification: The lender internally graded the remaining $9 million on-book portion of the
loan as a pass loan because the lender’s analysis of the project’s cash flow indicated a 1.05x DSC
ratio when just considering the on-book balance. The examiner disagreed with the internal grade
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and classified the $9 million on-book balance as substandard due to the borrower’s marginal
financial condition, lack of guarantor support, and uncertainty over the source of repayment.
The DSC ratio remains at 0.88x due to the single note restructure, and other resources are scant.
Nonaccrual Treatment: The lender maintained the remaining $9 million on-book portion of the
loan on accrual, as the borrower has the ability to repay the principal and interest on this balance.
The examiner did not concur with this treatment
port, and uncertainty over the source of repayment.
The DSC ratio remains at 0.88x due to the single note restructure, and other resources are scant.
Nonaccrual Treatment: The lender maintained the remaining $9 million on-book portion of the
loan on accrual, as the borrower has the ability to repay the principal and interest on this balance.
The examiner did not concur with this treatment. Because the lender restructured the debt into a
single note and had charged-off a portion of the restructured loan, the repayment of the principal
and interest contractually due on the entire debt is not reasonably assured given the DSC ratio of
0.88x and nominal other resources. After a discussion with the examiner on regulatory reporting
requirements, the lender placed the loan on nonaccrual. The loan can be returned to accrual
status34 if the lender can document that subsequent improvement in the borrower’s financial
condition has enabled the loan to be brought fully current with respect to principal and interest
and the lender expects the contractual balance of the loan (including the partial charge-off) will
be fully collected. In addition, interest income may be recognized on a cash basis for the
partially charged-off portion of the loan when the remaining recorded balance is considered fully
collectible. However, the partial charge-off would not be reversed.
C. Income Producing Property – Hotel
BASE CASE: A lender originated a $7.9 million loan to provide permanent financing for the
acquisition of a stabilized 3-star hotel property. The borrower is a limited liability company with
underlying ownership by two families who guarantee the loan. The loan term is five years, with
payments based on a 25-year amortization and with a market interest rate. The LTV was 79 percent
based on the hotel’s appraised value of $10 million.
At the end of the five-year term, the borrower’s annualized DSC ratio was 0.95x
ar hotel property. The borrower is a limited liability company with
underlying ownership by two families who guarantee the loan. The loan term is five years, with
payments based on a 25-year amortization and with a market interest rate. The LTV was 79 percent
based on the hotel’s appraised value of $10 million.
At the end of the five-year term, the borrower’s annualized DSC ratio was 0.95x. Due to
competition from a well-known 4-star hotel that recently opened within one mile of the property,
occupancy rates have declined. The borrower progressively reduced room rates to maintain
occupancy rates, but continued to lose daily bookings. Both occupancy and Revenue per Available
Room (RevPAR)35 declined significantly over the past year. The borrower then began working on
an initiative to make improvements to the property (i.e., automated key cards, carpeting, bedding,
and lobby renovations) to increase competitiveness, and a marketing campaign is planned to
announce the improvements and new price structure.
The borrower had paid principal and interest as agreed throughout the first five years, and the
principal balance had reduced to $7 million at the end of the five-year term.
SCENARIO 1: At maturity, the lender renewed the loan for 12 months on an interest-only basis at
a market interest rate that provides for the incremental risk. The extension was granted to enable the
borrower to complete the planned renovations, launch the marketing campaign, and achieve the
borrower’s updated projections for sufficient cash flow to service the debt once the improvements
are completed. (If the initiative is successful, the loan officer expects the loan to either be renewed
on an amortizing basis or refinanced through another lending entity.) The borrower has a verified,
pledged reserve account to cover the improvement expenses. Additionally, the guarantors’ updated
34 Refer to the supervisory guidance on “nonaccrual status” in the FFIEC Call Report and NCUA 5300 Call Report
instructions
ve is successful, the loan officer expects the loan to either be renewed
on an amortizing basis or refinanced through another lending entity.) The borrower has a verified,
pledged reserve account to cover the improvement expenses. Additionally, the guarantors’ updated
34 Refer to the supervisory guidance on “nonaccrual status” in the FFIEC Call Report and NCUA 5300 Call Report
instructions.
35 Total guest room revenue divided by room count and number of days in the period.
Page 21 of 39
financial statements indicate that they have sufficient unencumbered liquid assets. Further, the
guarantors expressed the willingness to cover any estimated cash flow shortfall through maturity.
Based on this information, the lender’s analysis indicates that, after deductions for personal
obligations and realistic living expenses and verification that there are no contingent liabilities, the
guarantors should be able to make interest payments. To date, interest payments have been timely.
The lender estimates the property’s current “as stabilized” market value at $9 million, which results
in a 78 percent LTV.
Classification: The lender internally graded the loan as a pass and is monitoring the credit. The
examiner agreed with the lender’s internal loan grade. The examiner concluded that the
borrower and guarantors have sufficient resources to support the interest payments; additionally,
the borrower’s reserve account is sufficient to complete the renovations as planned.
Nonaccrual Treatment: The lender maintained the loan in accrual status as full repayment of
principal and interest is reasonably assured from the hotel’s and guarantors’ cash flows, despite a
decline in the borrower’s cash flow due to competition. The examiner concurred with the
lender’s accrual treatment
the borrower’s reserve account is sufficient to complete the renovations as planned.
Nonaccrual Treatment: The lender maintained the loan in accrual status as full repayment of
principal and interest is reasonably assured from the hotel’s and guarantors’ cash flows, despite a
decline in the borrower’s cash flow due to competition. The examiner concurred with the
lender’s accrual treatment.
SCENARIO 2: At maturity of the original loan, the lender restructured the loan on an interest-only
basis at a below market interest rate for 12 months to provide the borrower time to complete its
renovation and marketing efforts and increase occupancy levels. At the end of the 12-month period,
the hotel’s renovation and marketing efforts were completed but unsuccessful. The hotel continued
to experience a decline in occupancy levels, resulting in a DSC ratio of 0.60x. The borrower does
not have ability to offer additional incentives to lure customers from the competition. RevPAR has
also declined. Current financial information indicates the borrower has limited ability to continue to
make interest payments, and updated projections indicate that the borrower will be below break-even
performance for the next 12 months. The borrower has been sporadically delinquent on prior
interest payments. The guarantors are unable to support the loan as they have limited unencumbered
liquid assets and are highly leveraged. The lender is in the process of renewing the loan again.
The most recent hotel appraisal, dated as of the time of the first restructuring, reports an “as
stabilized” appraised value of $7.2 million ($6.7 million for the real estate and $500,000 for the
tangible personal property of furniture, fixtures, and equipment), resulting in an LTV of 97 percent.
The appraisal does not account for the diminished occupancy, and its assumptions significantly
differ from current projections. A new valuation is needed to ascertain the current value of the
property
zed” appraised value of $7.2 million ($6.7 million for the real estate and $500,000 for the
tangible personal property of furniture, fixtures, and equipment), resulting in an LTV of 97 percent.
The appraisal does not account for the diminished occupancy, and its assumptions significantly
differ from current projections. A new valuation is needed to ascertain the current value of the
property.
Classification: The lender internally classified the loan as substandard and is monitoring the
credit. The examiner agreed with the lender’s treatment due to the borrower’s diminished
ongoing ability to make payments, the guarantors’ limited ability to support the loan, and the
reduced collateral position. The lender is obtaining a new valuation and will adjust the internal
classification, if necessary, based on the updated value.
Nonaccrual Treatment: The lender maintained the loan on an accrual basis because the
borrower demonstrated an ability to make interest payments. The examiner did not concur with
this treatment as the loan was not restructured on reasonable repayment terms, the borrower has
insufficient cash resources to service the below market interest rate on an interest-only basis, and
Page 22 of 39
the collateral margin has narrowed and may be narrowed further with a new valuation, which
collectively indicates that full repayment of principal and interest is in doubt. After a discussion
with the examiner on regulatory reporting requirements, the lender placed the loan on
nonaccrual.
SCENARIO 3: At maturity of the original loan, the lender restructured the debt for one year on an
interest-only basis at a below market interest rate to give the borrower additional time to complete
renovations and increase marketing efforts. While the combined borrower/guarantors’ liquidity
indicated they could cover any cash flow shortfall until maturity of the restructured note, the
borrower only had 50 percent of the funds to complete its renovations in reserve
debt for one year on an
interest-only basis at a below market interest rate to give the borrower additional time to complete
renovations and increase marketing efforts. While the combined borrower/guarantors’ liquidity
indicated they could cover any cash flow shortfall until maturity of the restructured note, the
borrower only had 50 percent of the funds to complete its renovations in reserve. Subsequently, the
borrower attracted a sponsor to obtain the remaining funds necessary to complete the renovation plan
and marketing campaign. Eight months later, the hotel experienced an increase in its occupancy and
achieved a DSC ratio of 1.20x on an amortizing basis. Updated projections indicated the borrower
would be at or above the 1.20x DSC ratio for the next 12 months, based on market terms and rate.
The borrower and the lender then agreed to restructure the loan again with monthly payments that
amortize the debt over 20 years, consistent with the current market terms and rates. Since the date of
the second restructuring, the borrower has made all principal and interest payments as agreed for six
consecutive months.
Classification: The lender internally classified the most recent restructured loan substandard.
The examiner agreed with the lender’s initial substandard grade at the time of the subject
restructuring, but now considers the loan as a pass as the borrower was no longer having
financial difficulty and has demonstrated the ability to make payments according to the modified
principal and interest terms for more than six consecutive months.
Nonaccrual Treatment: The original restructured loan was placed in nonaccrual status. The
lender initially maintained the most recent restructured loan in nonaccrual status as well, but
returned it to an accruing status after the borrower made six consecutive monthly principal and
interest payments. The lender expects full repayment of principal and interest. The examiner
concurred with the lender’s accrual treatment
riginal restructured loan was placed in nonaccrual status. The
lender initially maintained the most recent restructured loan in nonaccrual status as well, but
returned it to an accruing status after the borrower made six consecutive monthly principal and
interest payments. The lender expects full repayment of principal and interest. The examiner
concurred with the lender’s accrual treatment.
SCENARIO 4: The lender extended the original amortizing loan for 12 months at a market interest
rate. The borrower is now experiencing a six-month delay in completing the renovations due to a
conflict with the contractor hired to complete the renovation work, and the current DSC ratio is
0.85x. A current valuation has not been ordered. The lender estimates the property’s current “as
stabilized” market value is $7.8 million, which results in an estimated 90 percent LTV. The lender
did receive updated projections, but the borrower is now unlikely to achieve break-even cash flow
within the 12-month extension timeframe due to the renovation delays. At the time of the extension,
the borrower and guarantors had sufficient liquidity to cover the debt service during the twelve-
month period. The guarantors also demonstrated a willingness to support the loan by making
payments when necessary, and the loan has not gone delinquent. With the guarantors’ support, there
is sufficient liquidity to make payments to maturity, though such resources are declining rapidly.
Classification: The lender internally graded the loan as pass and is monitoring the credit. The
examiner disagreed with the lender’s grading and listed the loan as special mention. While the
borrower and guarantor can cover the debt service shortfall in the near-term, the duration of their
is sufficient liquidity to make payments to maturity, though such resources are declining rapidly.
Classification: The lender internally graded the loan as pass and is monitoring the credit. The
examiner disagreed with the lender’s grading and listed the loan as special mention. While the
borrower and guarantor can cover the debt service shortfall in the near-term, the duration of their
Page 23 of 39
support may not extend long enough to replace lost cash flow from operations due to delays in
the renovation work. The primary source of repayment does not fully cover the loan as
evidenced by a DSC ratio of 0.85x. It appears that competition from the new hotel will continue
to adversely affect the borrower's cash flow until the renovations are complete, and if cash flow
deteriorates further, the borrower and guarantors may be required to use more liquidity to
support loan payments and ongoing business operations. The examiner also recommended the
lender obtain a new valuation.
Nonaccrual Treatment: The lender maintained the loan in accrual status. The borrower and
guarantors have demonstrated the ability and willingness to make the regularly scheduled
payments and, even with the decline in the borrower’s creditworthiness, global cash resources
appear sufficient to make these payments, and the ultimate full repayment of principal and
interest is expected. The examiner concurred with the lender’s accrual treatment.
D. Acquisition, Development and Construction – Residential
BASE CASE: The lender originated a $4.8 million acquisition and development (A&D) loan and a
$2.4 million construction revolving line of credit (revolver) for the development and construction of
a 48-lot single-family project. The maturity for both loans is three years, and both are priced at a
market interest rate; both loans also have an interest reserve. The LTV on the A&D loan is 75
percent based on an “as complete” value of $6.4 million
uisition and development (A&D) loan and a
$2.4 million construction revolving line of credit (revolver) for the development and construction of
a 48-lot single-family project. The maturity for both loans is three years, and both are priced at a
market interest rate; both loans also have an interest reserve. The LTV on the A&D loan is 75
percent based on an “as complete” value of $6.4 million. Up to 12 units at a time will be funded
under the construction revolver at the lesser of 80 percent LTV or 100 percent of costs. The builder
is allowed two speculative (“spec”) units (including one model). The remaining units must be pre-
sold with an acceptable deposit and a pre-qualified mortgage. As units are settled, the construction
revolver will be repaid at 100 percent (or par); the A&D loan will be repaid at 120 percent, or
$120,000 ($4.8 million/48 units x 120 percent). The average sales price is projected to be $500,000,
and total construction cost to build each unit is estimated to be $200,000. Assuming total cost is
lower than value, the average release price will be $320,000 ($120,000 A&D release price plus
$200,000 construction costs). Estimated time for development is 12 months; the appraiser estimated
absorption of two lots per month for total sell-out to occur within three years (thus, the loan would
be repaid upon settlement of the 40th unit, or the 32nd month of the loan term). The borrower is
required to curtail the A&D loan by six lots, or $720,000, at the 24th month, and another six lots, or
$720,000, by the 30th month.
SCENARIO 1: Due to issues with the permitting and approval process by the county, the
borrower’s development was delayed by 18 months. Further delays occurred because the borrower
was unable to pave the necessary roadways due to excessive snow and freezing temperatures. The
lender waived both $720,000 curtailment requirements due to the delays. Demand for the housing
remains unchanged
.
SCENARIO 1: Due to issues with the permitting and approval process by the county, the
borrower’s development was delayed by 18 months. Further delays occurred because the borrower
was unable to pave the necessary roadways due to excessive snow and freezing temperatures. The
lender waived both $720,000 curtailment requirements due to the delays. Demand for the housing
remains unchanged. At maturity, the lender renewed the $4.8 million outstanding A&D loan
balance and the $2.4 million construction revolver for 24 months at a market interest rate that
provides for the incremental risk. The interest reserve for the A&D loan has been depleted as the
lender had continued to advance funds to pay the interest charges despite the delays in development.
Since depletion of the interest reserve, the borrower has made the last several payments out-of-
pocket. Development is now complete, and construction has commenced on eight units (two “spec”
units and six pre-sold units). Combined borrower and guarantor liquidity show they can cover any
debt service shortfall until the units begin to settle and the project is cash flowing. The lender
Page 24 of 39
estimates that the property’s current “as complete” value is $6 million, resulting in an 80 percent
LTV. The curtailment schedule was re-set to eight lots, or $960,000, by month 12, and another eight
lots, or $960,000, by month 18. A new appraisal has not been ordered; however, the lender noted in
the file that, if the borrower does not meet the absorption projections of six lots/quarter within six
months of booking the renewed loan, the lender will obtain a new appraisal.
Classification: The lender internally graded the restructured loans as pass and is monitoring the
credits. The examiner agreed, as the borrower and guarantor can continue making payments on
reasonable terms and the project is moving forward supported by housing demand and is
consistent with the builder’s development plans
of booking the renewed loan, the lender will obtain a new appraisal.
Classification: The lender internally graded the restructured loans as pass and is monitoring the
credits. The examiner agreed, as the borrower and guarantor can continue making payments on
reasonable terms and the project is moving forward supported by housing demand and is
consistent with the builder’s development plans. However, the examiner noted weaknesses in
the lender’s loan administrative practices as the financial institution did not (1) suspend the
interest reserve during the development delay and (2) obtain an updated collateral valuation.
Nonaccrual Treatment: The lender maintained the loans in accrual status. The project is
moving forward, the borrower has demonstrated the ability to make the regularly scheduled
payments after depletion of the interest reserve, global cash resources from the borrower and
guarantor appears sufficient to make these payments, and full repayment of principal and interest
is expected. The examiner concurred with the lender’s accrual treatment.
SCENARIO 2: Due to weather and contractor issues, development was not completed until month
24, a year behind the original schedule. The borrower began pre-marketing, but sales have been
slow due to deteriorating market conditions in the region. The borrower has achieved only eight pre-
sales during the past six months. The borrower recently commenced construction on the pre-sold
units.
At maturity, the lender renewed the $4.8 million A&D loan balance and $2.4 million construction
revolver on a 12-month interest-only basis at a market interest rate, with another 12-month option
predicated upon $1 million in curtailments having occurred during the first renewal term (the lender
had waived the initial term curtailment requirements). The lender also renewed the construction
revolver for a one-year term and reduced the number of “spec” units to just one, which also will
serve as the model
-month interest-only basis at a market interest rate, with another 12-month option
predicated upon $1 million in curtailments having occurred during the first renewal term (the lender
had waived the initial term curtailment requirements). The lender also renewed the construction
revolver for a one-year term and reduced the number of “spec” units to just one, which also will
serve as the model. A recent appraisal estimates that absorption has dropped to four lots per quarter
for the first two years and assigns an “as complete” value of $5.3 million, for an LTV of 91 percent.
The interest reserve is depleted, and the borrower has been paying interest out-of-pocket for the past
few months. Updated borrower and guarantor financial statements indicate the continued ability to
cover interest-only payments for the next 12 to 18 months.
Classification: The lender internally classified the loan as substandard and is monitoring the
credit. The examiner agreed with the lender’s treatment due to the deterioration and uncertainty
surrounding the market (as evidenced by slower than anticipated sales on the project), the lack of
principal reduction, and the reduced collateral margin.
Nonaccrual Treatment: The lender maintained the loan on an accrual basis because the
development is complete, the borrower has pre-sales and construction has commenced, and the
borrower and guarantor have sufficient means to make interest payments at a market interest rate
until the earlier of maturity or the project begins to cash flow. The examiner concurred with the
lender’s accrual treatment.
al Treatment: The lender maintained the loan on an accrual basis because the
development is complete, the borrower has pre-sales and construction has commenced, and the
borrower and guarantor have sufficient means to make interest payments at a market interest rate
until the earlier of maturity or the project begins to cash flow. The examiner concurred with the
lender’s accrual treatment.
Page 25 of 39
SCENARIO 3: Lot development was completed on schedule, and the borrower quickly sold and
settled the first 10 units. At maturity, the lender renewed the $3.6 million A&D loan balance ($4.8
million reduced by the sale and settlement of the 10 units ($120,000 release price x 10) to arrive at
$3.6 million) and $2.4 million construction revolver on a 12-month interest-only basis at a below
market interest rate.
The borrower then sold an additional 10 units to an investor; the loan officer (new to the financial
institution) mistakenly marked these units as pre-sold and allowed construction to commence on all
10 units. Market conditions then deteriorated quickly, and the investor defaulted under the terms of
the bulk contract. The units were completed, but the builder has been unable to re-sell any of the
units, recently dropping the sales price by 10 percent and engaging a new marketing firm, which is
working with several potential buyers.
A recent appraisal estimates that absorption has dropped to three lots per quarter and assigns an “as
complete” value of $2.3 million for the remaining 28 lots, resulting in an LTV of 156 percent. A
bulk appraisal of the 10 units assigns an “as-is” value of the units of $4.0 million ($400,000/unit).
The loans are cross-defaulted and cross-collateralized; the LTV on a combined basis is 95 percent
($6 million outstanding debt (A&D plus revolver) divided by $6.3 million in combined collateral
value)
ete” value of $2.3 million for the remaining 28 lots, resulting in an LTV of 156 percent. A
bulk appraisal of the 10 units assigns an “as-is” value of the units of $4.0 million ($400,000/unit).
The loans are cross-defaulted and cross-collateralized; the LTV on a combined basis is 95 percent
($6 million outstanding debt (A&D plus revolver) divided by $6.3 million in combined collateral
value). Updated borrower and guarantor financial statements indicate a continued ability to cover
interest-only payments for the next 12 months at the reduced rate; however, this may be limited in
the future given other troubled projects in the borrower’s portfolio that have been affected by market
conditions.
The lender modified the release price for each unit to net proceeds; any additional proceeds as units
are sold will go towards repayment of the A&D loan. Assuming the units sell at a 10 percent
reduction, the lender calculates the average sales price would be $450,000. The financial
institution’s prior release price was $320,000 ($120,000 for the A&D loan and $200,000 for the
construction revolver). As such (by requiring net proceeds), the financial institution will be
receiving an additional $130,000 per lot, or $1.3 million for the completed units, to repay the A&D
loan ($450,000 average sales price less $320,000 bank’s release price equals $130,000). Assuming
the borrower will have to pay $30,000 in related sales/settlement costs leaves approximately
$100,000 remaining per unit to apply towards the A&D loan, or $1 million total for the remaining 10
units ($100,000 times 10).
Classification: The lender internally classified the loan as substandard and is monitoring the
credit. The examiner agreed with the lender’s treatment due to the borrower and guarantor’s
diminished ability to make interest payments (even at the reduced rate), the stalled status of the
project, and the reduced collateral protection
lion total for the remaining 10
units ($100,000 times 10).
Classification: The lender internally classified the loan as substandard and is monitoring the
credit. The examiner agreed with the lender’s treatment due to the borrower and guarantor’s
diminished ability to make interest payments (even at the reduced rate), the stalled status of the
project, and the reduced collateral protection.
Nonaccrual Treatment: The lender maintained the loan on an accrual basis because the
borrower had previously demonstrated an ability to make interest payments. The examiner
disagreed as the loan was not restructured on reasonable repayment terms. While the borrower
and guarantor may be able to service the debt at a below market interest rate in the near term
using other unencumbered liquid assets, other projects in their portfolio are also affected by poor
market conditions and may require significant liquidity contributions, which could affect their
ability to support the loan. After a discussion with the examiner on regulatory reporting
requirements, the lender placed the loan on nonaccrual.
E. Construction Loan – Single Family Residence
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BASE CASE: The lender originated a $1.2 million construction loan on a single-family “spec”
residence with a 15-month maturity to allow for completion and sale of the property. The loan
required monthly interest-only payments at a market interest rate and was based on an “as
completed” LTV of 70 percent at origination. During the original loan construction phase, the
borrower was able to make all interest payments from personal funds. At maturity, the home had
been completed, but not sold, and the borrower was unable to find another lender willing to finance
this property under similar terms.
SCENARIO 1: At maturity, the lender restructured the loan for one year on an interest-only basis at
a below market interest rate to give the borrower more time to sell the “spec” home
ake all interest payments from personal funds. At maturity, the home had
been completed, but not sold, and the borrower was unable to find another lender willing to finance
this property under similar terms.
SCENARIO 1: At maturity, the lender restructured the loan for one year on an interest-only basis at
a below market interest rate to give the borrower more time to sell the “spec” home. Current
financial information indicates the borrower has limited ability to continue to make interest-only
payments from personal funds. If the residence does not sell by the revised maturity date, the
borrower plans to rent the home. In this event, the lender will consider modifying the debt into an
amortizing loan with a 20-year maturity, which would be consistent with this type of income-
producing investment property. Any shortfall between the net rental income and loan payments
would be paid by the borrower. Due to declining home values, the LTV at the renewal date was 90
percent.
Classification: The lender internally classified the loan substandard and is monitoring the credit.
The examiner agreed with the lender’s treatment due to the borrower’s diminished ongoing
ability to make payments and the reduced collateral position.
Nonaccrual Treatment: The lender maintained the loan on an accrual basis because the
borrower demonstrated an ability to make interest payments during the construction phase. The
examiner did not concur with this treatment because the loan was not restructured on reasonable
repayment terms. The borrower had limited ability to continue to service the debt, even on an
interest-only basis at a below market interest rate, and the deteriorating collateral margin
indicated that full repayment of principal and interest was not reasonably assured. The examiner
instructed the lender to place the loan in nonaccrual status
cause the loan was not restructured on reasonable
repayment terms. The borrower had limited ability to continue to service the debt, even on an
interest-only basis at a below market interest rate, and the deteriorating collateral margin
indicated that full repayment of principal and interest was not reasonably assured. The examiner
instructed the lender to place the loan in nonaccrual status.
SCENARIO 2: At maturity of the original loan, the lender restructured the debt for one year on an
interest-only basis at a below market interest rate to give the borrower more time to sell the “spec”
home. Eight months later, the borrower rented the property. At that time, the borrower and the
lender agreed to restructure the loan again with monthly payments that amortize the debt over 20
years at a market interest rate for a residential investment property. Since the date of the second
restructuring, the borrower had made all payments for over six consecutive months.
Classification: The lender internally classified the restructured loan substandard. The examiner
agreed with the lender’s initial substandard grade at the time of the restructuring, but now
considered the loan as a pass due to the borrower’s demonstrated ability to make payments
according to the reasonably modified terms for more than six consecutive months.
Nonaccrual Treatment: The lender initially placed the restructured loan in nonaccrual status but
returned it to accrual after the borrower made six consecutive monthly payments. The lender
expects full repayment of principal and interest from the rental income. The examiner concurred
ability to make payments
according to the reasonably modified terms for more than six consecutive months.
Nonaccrual Treatment: The lender initially placed the restructured loan in nonaccrual status but
returned it to accrual after the borrower made six consecutive monthly payments. The lender
expects full repayment of principal and interest from the rental income. The examiner concurred
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with the lender’s accrual treatment.
SCENARIO 3: The lender restructured the loan for one year on an interest-only basis at a below
market interest rate to give the borrower more time to sell the “spec” home. The restructured loan
has become more than 90 days past due, and the borrower has not been able to rent the property.
Based on current financial information, the borrower does not have the ability to service the debt.
The lender considers repayment to be contingent upon the sale of the property. Current market data
reflects few sales, and similar new homes in this property’s neighborhood are selling within a range
of $750,000 to $900,000 with selling costs equaling 10 percent, resulting in anticipated net sales
proceeds between $675,000 and $810,000.
Classification: The lender graded $390,000 loss ($1.2 million loan balance less the maximum
estimated net sales proceeds of $810,000), $135,000 doubtful based on the range in the
anticipated net sales proceeds, and the remaining balance of $675,000 substandard. The
examiner agreed, as this classification treatment results in the recognition of the credit risk in the
collateral-dependent loan based on the property’s value less costs to sell. The examiner
instructed management to obtain information on the current valuation on the property.
Nonaccrual Treatment: The lender placed the loan in nonaccrual status when it became 60 days
past due (reversing all accrued but unpaid interest) because the lender determined that full
repayment of principal and interest was not reasonably assured
on the property’s value less costs to sell. The examiner
instructed management to obtain information on the current valuation on the property.
Nonaccrual Treatment: The lender placed the loan in nonaccrual status when it became 60 days
past due (reversing all accrued but unpaid interest) because the lender determined that full
repayment of principal and interest was not reasonably assured. The examiner concurred with
the lender’s nonaccrual treatment.
SCENARIO 4: The lender committed an additional $48,000 for an interest reserve and extended
the $1.2 million loan for 12 months at a below market interest rate with monthly interest-only
payments. At the time of the examination, $18,000 of the interest reserve had been added to the loan
balance. Current financial information obtained during the examination reflects the borrower has no
other repayment sources and has not been able to sell or rent the property. An updated appraisal
supports an “as is” value of $952,950. Selling costs are estimated at 15 percent, resulting in
anticipated net sales proceeds of $810,000.
Classification: The lender internally graded the loan as pass and is monitoring the credit. The
examiner disagreed with the internal grade. The examiner concluded that the loan was not
restructured on reasonable repayment terms because the borrower has limited ability to service
the debt, and the reduced collateral margin indicated that full repayment of principal and interest
was not assured. After discussing regulatory reporting requirements with the examiner, the
lender reversed the $18,000 interest capitalized out of the loan balance and interest income.
Further, the examiner classified $390,000 loss based on the adjusted $1.2 million loan balance
less estimated net sales proceeds of $810,000, which was classified substandard. This
classification treatment recognizes the credit risk in the collateral-dependent loan based on the
property’s market value less costs to sell
18,000 interest capitalized out of the loan balance and interest income.
Further, the examiner classified $390,000 loss based on the adjusted $1.2 million loan balance
less estimated net sales proceeds of $810,000, which was classified substandard. This
classification treatment recognizes the credit risk in the collateral-dependent loan based on the
property’s market value less costs to sell. The examiner also provided supervisory feedback to
management for the inappropriate use of interest reserves and lack of current financial
information in making that decision. The remaining interest reserve of $30,000 is not subject to
adverse classification because the loan should be placed in nonaccrual status.
Nonaccrual Treatment: The lender maintained the loan in accrual status. The examiner did not
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concur with this treatment. The loan was not restructured on reasonable repayment terms, the
borrower has limited ability to service a below market interest rate on an interest-only basis, and
the reduced collateral margin indicates that full repayment of principal and interest is not
assured. The lender’s decision to provide a $48,000 interest reserve was not supported, given the
borrower’s inability to repay it. After a discussion with the examiner on regulatory reporting
requirements, the lender placed the loan on nonaccrual, and reversed the capitalized interest to be
consistent with regulatory reporting instructions. The lender also agreed to not recognize any
further interest income from the interest reserve.
F. Construction Loan – Land Acquisition, Condominium Construction and Conversion
BASE CASE: The lender originally extended a $50 million loan for the purchase of vacant land
and the construction of a luxury condominium project. The loan was interest-only and included an
interest reserve to cover the monthly payments until construction was complete
erest income from the interest reserve.
F. Construction Loan – Land Acquisition, Condominium Construction and Conversion
BASE CASE: The lender originally extended a $50 million loan for the purchase of vacant land
and the construction of a luxury condominium project. The loan was interest-only and included an
interest reserve to cover the monthly payments until construction was complete. The developer
bought the land and began construction after obtaining purchase commitments for 1/3 of the 120
planned units, or 40 units. Many of these pending sales were speculative with buyers committing to
buy multiple units with minimal down payments. The demand for luxury condominiums in general
has declined since the borrower launched the project, and sales have slowed significantly over the
past year. The lack of demand is attributed to a slowdown in the economy. As a result, most of the
speculative buyers failed to perform on their purchase contracts and only a limited number of the
other planned units have been pre-sold.
The developer experienced cost overruns on the project and subsequently determined it was in the
best interest to halt construction with the property 80 percent completed. The outstanding loan
balance is $44 million with funds used to pay construction costs, including cost overruns and
interest. The borrower estimates an additional $10 million is needed to complete construction.
Current financial information reflects that the developer does not have sufficient cash flow to pay
interest (the interest reserve has been depleted); and, while the developer does have equity in other
assets, there is doubt about the borrower’s ability to complete the project.
SCENARIO 1: The borrower agreed to grant the lender a second lien on an apartment project in its
portfolio, which provides $5 million in additional collateral support. In return, the lender advanced
the borrower $10 million to finish construction. The condominium project was completed shortly
thereafter
in other
assets, there is doubt about the borrower’s ability to complete the project.
SCENARIO 1: The borrower agreed to grant the lender a second lien on an apartment project in its
portfolio, which provides $5 million in additional collateral support. In return, the lender advanced
the borrower $10 million to finish construction. The condominium project was completed shortly
thereafter. The lender also agreed to extend the $54 million loan ($44 million outstanding balance
plus $10 million in new money) for 12 months at a market interest rate that provides for the
incremental risk, to give the borrower additional time to market the property. The borrower agreed
to pay interest whenever a unit was sold, with any outstanding balance due at maturity.
The lender obtained a recent appraisal on the condominium building that reported a prospective “as
complete” market value of $65 million, reflecting a 24-month sell-out period and projected selling
costs of 15 percent of the sales price. Comparing the $54 million loan amount against the $65
million “as complete” market value plus the $5 million pledged in additional collateral (totaling $70
million) results in an LTV of 77 percent. The lender used the prospective “as complete” market
value in its analysis and decision to fund the completion and sale of the units and to maximize its
recovery on the loan.
Classification: The lender internally classified the $54 million loan as substandard due to the
units not selling as planned and the project’s limited ability to service the debt despite the 1.3x
LTV of 77 percent. The lender used the prospective “as complete” market
value in its analysis and decision to fund the completion and sale of the units and to maximize its
recovery on the loan.
Classification: The lender internally classified the $54 million loan as substandard due to the
units not selling as planned and the project’s limited ability to service the debt despite the 1.3x
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gross collateral margin. The examiner agreed with the lender’s internal grade.
Nonaccrual Treatment: The lender maintained the loan in accrual status due to the protection
afforded by the collateral margin. The examiner did not concur with this treatment due to the
uncertainty about the borrower’s ability to sell the units and service the debt, raising doubts as to
the full repayment of principal and interest. After a discussion with the examiner on regulatory
reporting requirements, the lender placed the loan on nonaccrual.
SCENARIO 2: A recent appraisal of the property reflects that the highest and best use would be
conversion to an apartment building. The appraisal reports a prospective “as complete” market
value of $60 million upon conversion to an apartment building and a $67 million prospective “as
stabilized” market value upon the property reaching stabilized occupancy. The borrower agreed to
grant the lender a second lien on an apartment building in its portfolio, which provides $5 million in
additional collateral support. In return, the lender advanced the borrower $10 million, which is
needed to finish construction and convert the project to an apartment complex. The lender also
agreed to extend the $54 million loan for 12 months at a market interest rate that provides for the
incremental risk, to give the borrower time to lease the apartments. Interest payments are deferred.
The $60 million “as complete” market value plus the $5 million in other collateral results in an LTV
of 83 percent
construction and convert the project to an apartment complex. The lender also
agreed to extend the $54 million loan for 12 months at a market interest rate that provides for the
incremental risk, to give the borrower time to lease the apartments. Interest payments are deferred.
The $60 million “as complete” market value plus the $5 million in other collateral results in an LTV
of 83 percent. The prospective “as complete” market value is primarily relied on as the loan is
funding the conversion of the condominium to apartment building.
Classification: The lender internally classified the $54 million loan as substandard due to the
units not selling as planned and the project’s limited ability to service the debt. The collateral
coverage provides adequate support to the loan with a 1.2x gross collateral margin. The
examiner agreed with the lender’s internal grade.
Nonaccrual Treatment: The lender determined the loan should be placed in nonaccrual status
due to an oversupply of units in the project’s submarket, and the borrower’s untested ability to
lease the units and service the debt, raising concerns as to the full repayment of principal and
interest. The examiner concurred with the lender’s nonaccrual treatment.
G. Commercial Operating Line of Credit in Connection with Owner Occupied Real Estate
BASE CASE: Two years ago, the lender originated a CRE loan at a market interest rate to a
borrower whose business occupies the property. The loan was based on a 20-year amortization
period with a balloon payment due in three years. The LTV equaled 70 percent at origination. A
year ago, the lender financed a $5 million operating line of credit for seasonal business operations at
market terms. The operating line of credit had a one-year maturity with monthly interest payments
and was secured with a blanket lien on all business assets
n was based on a 20-year amortization
period with a balloon payment due in three years. The LTV equaled 70 percent at origination. A
year ago, the lender financed a $5 million operating line of credit for seasonal business operations at
market terms. The operating line of credit had a one-year maturity with monthly interest payments
and was secured with a blanket lien on all business assets. Borrowings under the operating line of
credit are based on accounts receivable that are reported monthly in borrowing base reports, with a
75 percent advance rate against eligible accounts receivable that are aged less than 90 days old.
Collections of accounts receivable are used to pay down the operating line of credit. At maturity of
the operating line of credit, the borrower’s accounts receivable aging report reflected a growing
trend of delinquency, causing the borrower temporary cash flow difficulties. The borrower has
recently initiated more aggressive collection efforts.
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SCENARIO 1: The lender renewed the $5 million operating line of credit for another year,
requiring monthly interest payments at a market interest rate, and principal to be paid down by
accounts receivable collections. The borrower’s liquidity position has tightened but remains
satisfactory, cash flow available to service all debt is 1.20x, and both loans have been paid according
to the contractual terms. The primary repayment source for the operating line of credit is conversion
of accounts receivable to cash. Although payments have slowed for some customers, most
customers are paying within 90 days of invoice. The primary repayment source for the real estate
loan is from business operations, which remain satisfactory, and an updated appraisal is not
considered necessary.
Classification: The lender internally graded both loans as pass and is monitoring the credits.
The examiner agreed with the lender’s analysis and the internal grades
omers, most
customers are paying within 90 days of invoice. The primary repayment source for the real estate
loan is from business operations, which remain satisfactory, and an updated appraisal is not
considered necessary.
Classification: The lender internally graded both loans as pass and is monitoring the credits.
The examiner agreed with the lender’s analysis and the internal grades. The lender is monitoring
the trend in the accounts receivable aging report and the borrower’s ongoing collection efforts.
Nonaccrual Treatment: The lender determined that both the real estate loan and the renewed
operating line of credit may remain in accrual status as the borrower has demonstrated an
ongoing ability to perform, has the financial ability to pay a market interest rate, and full
repayment of principal and interest is reasonably assured. The examiner concurred with the
lender’s accrual treatment.
SCENARIO 2: The lender restructured the operating line of credit by reducing the line amount to
$4 million, at a below market interest rate. This action is expected to alleviate the borrower’s cash
flow problem. The borrower is still considered to be a viable business even though its financial
performance has continued to deteriorate, with sales and profitability declining. The trend in
accounts receivable delinquencies is worsening, resulting in reduced liquidity for the borrower.
Cash flow problems have resulted in sporadic over advances on the $4 million operating line of
credit, where the loan balance exceeds eligible collateral in the borrowing base. The borrower’s net
operating income has declined but reflects the ability to generate a 1.08x DSC ratio for both loans,
based on the reduced rate of interest for the operating line of credit. The terms on the real estate loan
remained unchanged. The lender estimated the LTV on the real estate loan to be 90 percent
dit, where the loan balance exceeds eligible collateral in the borrowing base. The borrower’s net
operating income has declined but reflects the ability to generate a 1.08x DSC ratio for both loans,
based on the reduced rate of interest for the operating line of credit. The terms on the real estate loan
remained unchanged. The lender estimated the LTV on the real estate loan to be 90 percent. The
operating line of credit currently has sufficient eligible collateral to cover the outstanding line
balance, but customer delinquencies have been increasing.
Classification: The lender internally classified both loans substandard due to deterioration in the
borrower’s business operations and insufficient cash flow to repay the debt at market terms. The
examiner agreed with the lender’s analysis and the internal grades. The lender will monitor the
trend in the business operations, accounts receivable, profitability, and cash flow. The lender
may need to order a new appraisal if the DSC ratio continues to fall and the overall collateral
margin further declines.
Nonaccrual Treatment: The lender reported both the restructured operating line of credit and
the real estate loan on a nonaccrual basis. The operating line of credit was not renewed on
market interest rate repayment terms, the borrower has an increasingly limited ability to service
the below market interest rate debt, and there is insufficient support to demonstrate an ability to
meet the new payment requirements. The borrower’s ability to continue to perform on the
operating line of credit and real estate loan is not assured due to deteriorating business
as not renewed on
market interest rate repayment terms, the borrower has an increasingly limited ability to service
the below market interest rate debt, and there is insufficient support to demonstrate an ability to
meet the new payment requirements. The borrower’s ability to continue to perform on the
operating line of credit and real estate loan is not assured due to deteriorating business
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performance caused by lower sales and profitability and higher customer delinquencies. In
addition, the collateral margin indicates that full repayment of all of the borrower’s indebtedness
is questionable, particularly if the borrower fails to continue as a going concern. The examiner
concurred with the lender’s nonaccrual treatment.
H. Land Loan
BASE CASE: Three years ago, the lender originated a $3.25 million loan to a borrower for the
purchase of raw land that the borrower was seeking to have zoned for residential use. The loan
terms were three years interest-only at a market interest rate; the borrower had sufficient funds to
pay interest from cash flow. The appraisal at origination assigned an “as is” market value of $5
million, which resulted in a 65 percent LTV. The zoning process took longer than anticipated, and
the borrower did not obtain full approvals until close to the maturity date. Now that the borrower
successfully obtained the residential zoning, the borrower has been seeking construction financing to
repay the land loan. At maturity, the borrower requested a 12-month extension to provide additional
time to secure construction financing which would include repayment of the subject loan.
SCENARIO 1: The borrower provided the lender with current financial information, demonstrating
the continued ability to make monthly interest payments and principal curtailments of $150,000 per
quarter. Further, the borrower made a principal payment of $250,000 in exchange for a 12-month
extension of the loan
secure construction financing which would include repayment of the subject loan.
SCENARIO 1: The borrower provided the lender with current financial information, demonstrating
the continued ability to make monthly interest payments and principal curtailments of $150,000 per
quarter. Further, the borrower made a principal payment of $250,000 in exchange for a 12-month
extension of the loan. The borrower also owned an office building with an “as stabilized” market
value of $1 million and pledged the property as additional unencumbered collateral, granting the
lender a first lien. The borrower’s personal financial information also demonstrates that cash flow
from personal assets and the rental income generated by the newly pledged office building are
sufficient to fully amortize the land loan over a reasonable period. A decline in market value since
origination was due to a change in density; the project was originally intended as 60 lots but was
subsequently zoned as 25 single-family lots because of a change in the county’s approval process. A
recent appraisal of the raw land reflects an “as is” market value of $3 million, which results in a 75
percent LTV when combined with the additional collateral and after the principal reduction. The
lender restructured the loan into a $3 million loan with quarterly curtailments for another year at a
market interest rate that provides for the incremental risk.
Classification: The lender internally graded the loan as pass due to adequate cash flow from the
borrower’s personal assets and rental income generated by the office building to make principal
and interest payments. Also, the borrower provided a principal curtailment and additional
collateral to maintain a reasonable LTV. The examiner agreed with the lender’s internal grade.
Nonaccrual Treatment: The lender maintained the loan in accrual status, as the borrower has
sufficient funds to cover the debt service requirements for the next year
by the office building to make principal
and interest payments. Also, the borrower provided a principal curtailment and additional
collateral to maintain a reasonable LTV. The examiner agreed with the lender’s internal grade.
Nonaccrual Treatment: The lender maintained the loan in accrual status, as the borrower has
sufficient funds to cover the debt service requirements for the next year. Full repayment of
principal and interest is reasonably assured from the collateral and the borrower’s financial
resources. The examiner concurred with the lender’s accrual treatment.
SCENARIO 2: The borrower provided the lender with current financial information that indicated
the borrower is unable to continue to make interest-only payments. The borrower has been
sporadically delinquent up to 60 days on payments. The borrower is still seeking a loan to finance
construction of the project and has not been able to obtain a takeout commitment; it is unlikely the
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borrower will be able to obtain financing, since the borrower does not have the equity contribution
most lenders require as a condition of closing a construction loan. A decline in value since
origination was due to a change in local zoning density; the project was originally intended as 60 lots
but was subsequently zoned as 25 single-family lots. A recent appraisal of the property reflects an
“as is” market value of $3 million, which results in a 108 percent LTV. The lender extended the
$3.25 million loan at a market interest rate for one year with principal and interest due at maturity.
Classification: The lender internally graded the loan as pass because the loan is currently not
past due and is at a market interest rate. Also, the borrower is trying to obtain takeout
construction financing. The examiner disagreed with the internal grade and adversely classified
the loan
.25 million loan at a market interest rate for one year with principal and interest due at maturity.
Classification: The lender internally graded the loan as pass because the loan is currently not
past due and is at a market interest rate. Also, the borrower is trying to obtain takeout
construction financing. The examiner disagreed with the internal grade and adversely classified
the loan. The examiner concluded that the loan was not restructured on reasonable repayment
terms because the borrower does not have the ability to service the debt and full repayment of
principal and interest is not assured. The examiner classified $550,000 loss ($3.25 million loan
balance less $2.7 million, based on the current appraisal of $3 million less estimated cost to sell
of 10 percent or $300,000). The examiner classified the remaining $2.7 million balance
substandard. This classification treatment recognizes the credit risk in this collateral-dependent
loan based on the property’s market value less costs to sell.
Nonaccrual Treatment: The lender maintained the loan in accrual status. The examiner did not
concur with this treatment and instructed the lender to place the loan in nonaccrual status
because the borrower does not have the ability to service the debt, value of the collateral is
permanently impaired, and full repayment of principal and interest is not assured.
I. Multi-Family Property
BASE CASE: The lender originated a $6.4 million loan for the purchase of a 25-unit apartment
building. The loan maturity is five years, and principal and interest payments are based on a 30-year
amortization at a market interest rate. The LTV was 75 percent (based on an $8.5 million value),
and the DSC ratio was 1.50x at origination (based on a 30-year principal and interest amortization).
Leases are typically 12-month terms with an additional 12-month renewal option. The property is 88
percent leased (22 of 25 units rented)
and principal and interest payments are based on a 30-year
amortization at a market interest rate. The LTV was 75 percent (based on an $8.5 million value),
and the DSC ratio was 1.50x at origination (based on a 30-year principal and interest amortization).
Leases are typically 12-month terms with an additional 12-month renewal option. The property is 88
percent leased (22 of 25 units rented). Due to poor economic conditions, delinquencies have risen
from two units to eight units, as tenants have struggled to make ends meet. Six of the eight units are
90 days past due, and these tenants are facing eviction.
SCENARIO 1: At maturity, the lender renewed the $5.9 million loan balance on principal and
interest payments for 12 months at a market interest rate that provides for the incremental risk. The
borrower had not been delinquent on prior payments. Current financial information indicates that
the DSC ratio dropped to 0.80x because of the rent payment delinquencies. Combining borrower
and guarantor liquidity shows they can cover cash flow shortfall until maturity (including reasonable
capital expenditures since the building was recently renovated). Borrower projections show a return
to break-even within six months since the borrower plans to decrease rents to be more competitive
and attract new tenants. The lender estimates that the property’s current “as stabilized” market value
is $7 million, resulting in an 84 percent LTV. A new appraisal has not been ordered; however, the
lender noted in the file that, if the borrower does not meet current projections within six months of
booking the renewed loan, the lender will obtain a new appraisal.
to be more competitive
and attract new tenants. The lender estimates that the property’s current “as stabilized” market value
is $7 million, resulting in an 84 percent LTV. A new appraisal has not been ordered; however, the
lender noted in the file that, if the borrower does not meet current projections within six months of
booking the renewed loan, the lender will obtain a new appraisal.
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Classification: The lender internally graded the renewed loan as pass and is monitoring the
credit. The examiner disagreed with the lender’s analysis and classified the loan as substandard.
While the borrower and guarantor can cover the debt service shortfall in the near-term using
additional guarantor liquidity, the duration of the support may be less than the lender anticipates
if the leasing fails to materialize as projected. Economic conditions are poor, and the rent
reduction may not be enough to improve the property’s performance. Lastly, the lender failed to
obtain an updated collateral valuation, which represents an administrative weakness.
Nonaccrual Treatment: The lender maintained the loan in accrual status. The borrower has
demonstrated the ability to make the regularly scheduled payments and, even with the decline in
the borrower’s creditworthiness, the borrower and guarantor appear to have sufficient cash
resources to make these payments if projections are met, and full repayment of principal and
interest is expected. The examiner concurred with the lender’s accrual treatment.
SCENARIO 2: At maturity, the lender renewed the $5.9 million loan balance on a 12-month
interest-only basis at a below market interest rate. In response to an event that caused severe
economic conditions, the federal and state governments enacted moratoriums on all evictions. The
borrower has been paying as agreed; however, cash flow has been severely impacted by the rent
moratoriums
t.
SCENARIO 2: At maturity, the lender renewed the $5.9 million loan balance on a 12-month
interest-only basis at a below market interest rate. In response to an event that caused severe
economic conditions, the federal and state governments enacted moratoriums on all evictions. The
borrower has been paying as agreed; however, cash flow has been severely impacted by the rent
moratoriums. While the moratoriums do not forgive the rent (or unpaid fees), they do prevent
evictions for unpaid rent and have been in effect for the past six months. As a result, the borrower’s
cash flow is severely stressed, and the borrower has asked for temporary relief of the interest
payments. In addition, a review of the current rent roll indicates that five of the 25 units are now
vacant. A recent appraisal values the property at $6 million (98 percent LTV). Updated borrower
and guarantor financial statements indicate the continued ability to cover interest-only payments for
the next 12 to 18 months at the reduced rate of interest. Updated projections that indicate below
break-even performance over the next 12 months remain uncertain given that the end of the
moratorium (previously extended) is a “soft” date and that tenant behaviors may not follow historical
norms.
Classification: The lender internally classified the loan as substandard and is monitoring the
credit. The examiner agreed with the lender’s treatment due to the borrower’s diminished ability
to make interest payments (even at the reduced rate) and lack of principal reduction, the
uncertainty surrounding the rent moratoriums, and the reduced and tight collateral position.
Nonaccrual Treatment: The lender maintained the loan on an accrual basis because the
borrower demonstrated an ability to make principal and interest payments and has some ability to
make payments on the interest-only terms at a below market interest rate
d rate) and lack of principal reduction, the
uncertainty surrounding the rent moratoriums, and the reduced and tight collateral position.
Nonaccrual Treatment: The lender maintained the loan on an accrual basis because the
borrower demonstrated an ability to make principal and interest payments and has some ability to
make payments on the interest-only terms at a below market interest rate. The examiner did not
concur with this treatment as the loan was not restructured on reasonable repayment terms, the
borrower has insufficient cash flow to amortize the debt, and the slim collateral margin indicates
that full repayment of principal and interest may be in doubt. After a discussion with the
examiner on regulatory reporting requirements, the lender placed the loan on nonaccrual.
SCENARIO 3: At maturity, the lender renewed the $5.9 million loan balance on a 12-month
interest-only basis at a below market interest rate. The borrower has been sporadically delinquent on
prior principal and interest payments. A review of the current rent roll indicates that 10 of the 25
units are vacant after tenant evictions. The vacated units were previously in an advanced state of
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disrepair, and the borrower and guarantors have exhausted their liquidity after repairing the units.
The repaired units are expected to be rented at a lower rental rate. A post-renovation appraisal
values the property at $5.5 million (107 percent LTV). Updated projections indicate the borrower
will be below break-even performance for the next 12 months.
Classification: The lender internally classified the loan as substandard and is monitoring the
credit. The examiner agreed with the lender’s concerns due to the borrower’s diminished ability
to make principal or interest payments, the guarantor’s limited ability to support the loan, and
insufficient collateral protection
orrower
will be below break-even performance for the next 12 months.
Classification: The lender internally classified the loan as substandard and is monitoring the
credit. The examiner agreed with the lender’s concerns due to the borrower’s diminished ability
to make principal or interest payments, the guarantor’s limited ability to support the loan, and
insufficient collateral protection. However, the examiner classified $900,000 loss ($5.9 million
loan balance less $5 million (based on the current appraisal of $5.5 million less estimated cost to
sell of 10 percent, or $500,000)). The examiner classified the remaining $5 million balance
substandard. This classification treatment recognizes the collateral dependency.
Nonaccrual Treatment: The lender maintained the loan on accrual basis because the borrower
demonstrated a previous ability to make principal and interest payments. The examiner did not
concur with the lender’s treatment as the loan was not restructured on reasonable repayment
terms, the borrower has insufficient cash flow to service the debt at a below market interest rate
on an interest-only basis, and the impairment of value indicates that full repayment of principal
and interest is in doubt. After a discussion with the examiner on regulatory reporting
requirements, the lender placed the loan on nonaccrual.
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Appendix 2
Selected Rules, Supervisory Guidance, and Authoritative Accounting Guidance
Rules
• Federal regulations on real estate lending standards and the Interagency Guidelines for Real
Estate Lending Policies: 12 CFR part 34, subpart D, and appendix A to subpart D (OCC),
160.100, 160.101, and Appendix to 160.101 (OCC); 12 CFR part 208, subpart E and appendix
C (Board); and 12 CFR part 365 and appendix A (FDIC)
, Supervisory Guidance, and Authoritative Accounting Guidance
Rules
• Federal regulations on real estate lending standards and the Interagency Guidelines for Real
Estate Lending Policies: 12 CFR part 34, subpart D, and appendix A to subpart D (OCC),
160.100, 160.101, and Appendix to 160.101 (OCC); 12 CFR part 208, subpart E and appendix
C (Board); and 12 CFR part 365 and appendix A (FDIC). For NCUA, refer to 12 CFR part
723 for member business loan and commercial loan regulation which addresses commercial
real estate lending and 12 CFR part 741, appendix B, which addresses loan workouts,
nonaccrual policy, and regulatory reporting of workout loans.
• Federal regulations on the Interagency Guidelines Establishing Standards for Safety and
Soundness: 12 CFR part 30, appendix A (OCC); 12 CFR part 208 Appendix D-1 (Board); and
12 CFR part 364 appendix A (FDIC). For NCUA safety and soundness regulations and
supervisory guidance, see 12 CFR 741.3(b)(2); 12 CFR part 741, appendix B; 12 CFR part
723; and NCUA letters to credit unions 10-CU-02 “Current Risks in Business Lending and
Sound Risk Management Practices” issued January 2010 (NCUA). Credit unions should also
refer to the Commercial and Member Business Loans section of the NCUA Examiner’s Guide.
• Federal appraisal regulations: 12 CFR part 34, subpart C (OCC); 12 CFR part 208, subpart E
and 12 CFR part 225, subpart G (Board); 12 CFR part 323 (FDIC); and 12 CFR part 722
(NCUA).
Supervisory Guidance
• FFIEC Instructions for Preparation of Consolidated Reports of Condition and Income (FFIEC
031, FFIEC 041, and FFIEC 051 Instructions) and NCUA 5300 Call Report Instructions.
• Interagency Policy Statement on Allowances for Credit Losses (Revised April 2023), issued
April 2023.
• Interagency Guidance on Credit Risk Review Systems, issued May 2020.
• Interagency Supervisory Examiner Guidance for Institutions Affected by a Major Disaster,
issued December 2017
ition and Income (FFIEC
031, FFIEC 041, and FFIEC 051 Instructions) and NCUA 5300 Call Report Instructions.
• Interagency Policy Statement on Allowances for Credit Losses (Revised April 2023), issued
April 2023.
• Interagency Guidance on Credit Risk Review Systems, issued May 2020.
• Interagency Supervisory Examiner Guidance for Institutions Affected by a Major Disaster,
issued December 2017.
• Board, FDIC, and OCC joint guidance entitled Statement on Prudent Risk Management for
Commercial Real Estate Lending, issued December 2015.
• Interagency Appraisal and Evaluation Guidelines, issued October 2010.
• Board, FDIC, and OCC joint guidance on Concentrations in Commercial Real Estate Lending,
Sound Risk Management Practices, issued December 2006.
• Interagency FAQs on Residential Tract Development Lending, issued September 2005.
Authoritative Accounting Standards
• ASC Topic 310, Receivables
• ASC Topic 326, Financial Instruments – Credit losses
• ASC Topic 820, Fair Value Measurement
• ASC Subtopic 825-10, Financial Instruments – Overall
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Appendix 3
Valuation Concepts for Income Producing Real Estate
Several conceptual issues arise during the process of reviewing a real estate loan and in using
the present value calculation to determine the value of collateral. The following discussion sets forth
the meaning and use of those key concepts.
The Discount Rate and the Present Value: The discount rate used to calculate the present value is
the rate of return that market participants require for the specific type of real estate investment. The
discount rate will vary over time with changes in overall interest rates and in the risk
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