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FDIC Federal Register Citations

Bank of  American Fork

Robert E. Feldman
Executive Secretary
Attention : Comments
Federal Deposit Insurance Corporation
550 17th Street, NW
Washington, DC 20429

RE: Classification of Commercial Credit Exposures

Dear Mr. Feldman:


It has been my observation that for the past 60 years or so the number of bank failures has been, for the most part, relatively stable. There have been times when the number of bank failures has spiked, however, the system of review of loans has proven to be successful in identifying potential problem loans for banks. Why try to fix a wheel that is not broken. It is not like we have a huge spike in bank failures and the system of review is failing, quite the contrary. For our bank, the classification system is simple to understand and is reliable in identifying problem loans. It is our recommendation that the current risk classification system remain in place.


As I see it, the proposed change involves eliminating the “special mention”, “substandard”, and “doubtful” classifications with a two-dimensional based framework. The proposed framework would be used by institutions and supervisors for the uniform classification of commercial and industrial loans; leases; receivables; mortgages; and other extensions of credit made for business purposes by federally insured depository institutions and their subsidiaries (institutions), based on an assessment of borrower creditworthiness and estimated loss severity. The proposed framework would modify Part I of the “Revised Uniform Agreement on the Classification of Assets and Appraisal of Securities Held by Banks and Thrifts” issued in June 2004. The proposal is intended to enhance the methodology used to systematically assess the level of credit risk posed by individual commercial extensions of credit and the level of an institution’s aggregate commercial credit risk.

As I mentioned earlier, the system of classification has worked for some 60 years and is still effective in identifying problem loans for our institution. For our bank, once the loan has been identified as special mention, substandard or doubtful specific action to correct deficiencies. We take this approach very seriously, as I am sure other banks do. None of the banks want to take losses and/or be criticized by the regulators for allowing non performing loans to continue on the books. Furthermore, it is important for the banks to quickly identify problem loans early to minimize loss to the bank.

Under the present system of loan classification it is fairly simple to understand and apply. Under the proposal it would be more time intensive, complicated, and costly to the bank to follow and track. Every bank knows their customers and they know how to identify problem loans, you cannot effectively place a quantifiable system, as proposed, to accomplish a more precise identification of problem loans by category.

For example, when a loan is identified as special mention by either the internal auditors, regulatory examiners or the independent auditors a process is in place to correct the deficiencies as stated in the FDIC guidelines. We identify the potential weaknesses and our loan officer’s work the loan until the loan is either ready for reclassification to a higher grade or is down graded to substandard of doubtful. The current system is easy to understand and follow.

For substandard loans the current guidelines state “A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any. Assets so classified must have a well – defined weakness, or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. It behooves an institution to properly identify defined weaknesses or weaknesses that jeopardize the liquidation of the debt and not wait for an examiner to identify the problem. Bankers are going to initiate steps to correct problems in loans as soon as the red flags begin to occur, they are in the business of making a profit for their shareholders and identifying problem loans is paramount for avoiding shareholder lawsuits for being negligent in indentifying problem loans. Every loan has either a credit weakness or a collateral weakness when the borrower fails to live up to his or her contractual responsibilities and the banks are going to shore up those weaknesses accordingly. Every bank has unique circumstances with handling their customers, we must have the flexibility to handle work out problems as we know best for our customers. The current system allows flexibility, to a certain degree, to the banks in identifying substandard loans.

Finally, a doubtful loan, as defined in the guidelines, is a loan with the added characteristic that the weakness makes collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable and improbable. I have never seen an examination team hesitant to criticize a bank because the examiner sees the weaknesses differently than the bank. If the bank management is smart they will error on the side of caution and do what is necessary in properly classifying the loan as doubtful rather than wait for an examiner to classify the loan. Furthermore, it behooves the bank to act on doubtful loans inasmuch as Sarbanes Oxley has raised the bar on the banks to properly and accurately disclose weaknesses in controls particularly in risk grading loans. The personal liability from Sarbanes Oxley and FIDICIA Part 363 will force the banks to act even more carefully in identifying assets as substandard, doubtful and loss than before.

A loss is so classified when it is considered uncollectible and of such little value that its continuance on the books is not warranted. This classification, according to the guidelines, states that it does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset event though partial recovery may be affected in the future. How simple is that to follow?

When we have been criticized for not following the regulatory examination guidelines for classifying a loan as substandard, doubtful or loss we have placed the loan in the proper classification once a healthy discussion has occurred with the examiner on all aspects of the loan. We respect the views of the examiners and in most cases we end up agreeing with the wisdom of the examination team as to how to correct the deficiencies.


You state “The current classification system focuses primarily on borrower weaknesses and the possibility of loss without specifying how factors that mitigate the loss, such as collateral and guarantees, should be considered in the rating assignment. This has led to differing applications of the current classification system by institutions and the agencies. The question I have is has it resulted in a spike in losses? Don’t banks work with the agency examiners in the end to correct the noted deficiencies? You simply cannot completely quantify every loan into a perfect rating system because all loans are different and the borrower’s circumstances are different. So what if you have disagreements in the classification of the loan, we end up working through the issues and in 99%, if not more, of the cases we end up either agreeing to upgrade or downgrade the loan. We end up agreeing on the strengths and weaknesses of each loan in determining the final classification. There will always be some degree of disagreement as to the proper classification of the loan, however, we end up working toward the same goal when all is said and done.

Under your proposal, you are requiring more intensive resources to be placed on identifying the “potential” loss severity of the particular facility. Why do we need to spend additional time and money on analyzing and reconciling risk of the borrower’s default with the estimated loss severity of the particular facility? We know our customers and we know our potential loss when a loan starts going south. We should be placing our time on correcting noted deficiencies, we already know the risk of loss. Why do we need to add another layer of loss severity? You further state that the current system dictates that transactions with significantly different levels of expected loss receive the same rating, so what? A potential loss does not need to be placed into several different levels of risk, that sounds to me to be an imposition of administrative overload. We don’t need administrative micromanaging of several levels of risk of severity of loss, sometimes we analyze things to death when the solution is to identify the loss as either partial or full and figuring out how to reduce the loss to the bank. Furthermore, you state that this limits the effectiveness of the current classification system in measuring an institution’s credit risk exposure, yet you offer no evidence that the current system is showing a pattern of failures.

You also state “to address these limitations, the agencies are proposing a two-dimensional rating framework that considers a borrower’s capacity to meet its debt obligations separately from the facility characteristics that influence loss severity”. You further say “by differentiating between these two factors, a more precise measure of an institution’s level of credit risk is achieved.” How is this? You offer no support that the current system is failing in any way. By offering a more complicated system of analyzing different levels of credit risk you are placing the banks in a position of examiner criticism rather than helping the bank identify problems and offering solutions, if necessary, to get the loan back on track. Again, there are no signs that the bank failure rate is increasing and that if it was the problem is with the credit risk rating system.

You state that the proposal includes three borrower rating categories, “marginal”, “weak”, and “default” (i.e., borrowers with a facility placed on nonaccrural or fully or partially charged off). How much more complicated can you make this? What is the need for dissecting the weaknesses? You fail to identify what gain is there for the bank to have these added categories of risk classification. How is going to help the bank and is it going to offset the potential loss by the added cost of analyzing and documenting the analysis? Furthermore, this is going to open up all kinds of opportunities for examiner criticism for what benefit to the bank?

You say “In this proposed framework, the agencies have sought to minimize complexity and supervisory burden.” How? Furthermore, “The agencies believe that the proposed framework attains these goals and that institutions of all sizes will be able to apply the approach”. You have not proven a thing, all you have done is increased the complexity of classifying loans, period. This is not simpler, it is more complex and costly to the banks.

You say “The agencies believe that this flexibility will allow institutions with both one-dimensional and two-dimensional internal risk rating systems to adopt the proposed framework. Under the current classification system, institutions with two-dimensional internal credit rating systems have encountered problems translating their internal ratings into the supervisory categories”. If that is true, wouldn’t training correct that problem. We have never experienced that problem with our regulators.


This proposal will not help the banks identify and classify problem loans any better than the current system. The proposal only adds documentation requirements. The proposal adds cost to the banks. The wheel is not broken, banks aren’t failing at an alarming rate, the system has worked for the last 60 years, so why tinker with a successfully system?

I urge you not to change the current risk rating system.


Robert F. Chatfield
Senior Vice President
Chief Credit Officer
Bank of American Fork
33 East Main
American Fork, Utah 84003

Last Updated 06/30/2005

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