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From: Harley Charlson
Sent: Tuesday, June 07, 2005 11:49 AM
Subject: FIL-22-05 on Proposed Classification of Commercial Credit Exposures
This is to comment on FIL-22-05 on Proposed Classification of
Commercial Credit Exposures. Comment will be provided on each proposed
1. "SPECIAL MENTION" PRESENTLY, AND PROPOSED CATEGORY IS "MARGINAL"
The proposed "MARGINAL" category is acceptable. The expanded
definition over the current special mention category is good.
Currently, Union Bank & Trust formally utilizes an 8 loan grade system
of excellent, good, satisfactory, acceptable, special mention,
substandard, doubtful, and loss. Additionally, as a loan reviewer where
at times there are borrowers that may have temporary shortfalls of
either working capital, temporary losses, or slightly higher leverage,
an informal category of acceptable-"minus" has been utilized. This is
an in-between category for those borrowers who are monitored to either
get better, possibly be moved, or are a candidate for a criticized or
classified rating if not improved.
Therefore, with the new proposed marginal rating, this looks to
possibly be a wider rating range than the previous special mention
classification, and may possibly obviate the use of the use of the
"acceptable-minus" rating in our case.
Historically, it has been my observation that very little use of
the special mention category by bank examiners has been made in bank
examinations, with rather the focus on classified assets (substandard
and doubtful). Are the plans to change the focus going forward to have
examiners rate some borrowers as marginal as well?
The proposed marginal definition also states: "The rating
should also be used for borrowers that have made significant progress in
resolving their financial weaknesses, but still exhibit characteristics
inconsistent with a "pass" rating." Does this mean either substandard
or doubtful classified borrowers can be upgraded to "marginal" versus
the previous expectation/standard of having to be able to upgrade
substandard and doubtful only to pass categories?
The previous "special mention" category reflected, "Special
mention assets are not adversely classified and do not expose an
institution to sufficient risk to warrant adverse classification." The
new marginal classification should also include this statement so
everyone is clear that the MARGINAL category is not a classified asset
2. "SUBSTANDARD" PRESENTLY AND PROPOSED NEW CATEGORY "WEAK"
After all the years of utilizing both the substandard and
doubtful categories for loan classification, it makes no sense to change
the titles of these categories at this time and particularly with the
proposed changes to WEAK and DEFAULT.
The new proposed definition of WEAK classified credits has
expanded language regarding stressed borrowers, but relative to the
current "substandard" category it is missing one very important element.
The current "substandard" definition includes a phrase "or by collateral
pledged." The proposed WEAK category make no reference to collateral
coverage at all!!
3. "DOUBTFUL" PRESENTLY AND PROPOSED NEW CATEGORY "DEFAULT"
As reflected above, a change in name of the classification from
DOUBTFUL to DEFAULT serves no meaningful purpose at this point.
The proposed new definition provides some additional defining
language which is likely good. However, the old definition also
provided more of a transition definition from substandard to doubtful
with its statement of, "An asset classified "doubtful" has all the
weaknesses inherent in one classified substandard with the added
In the new definition, it indicates that DEFAULT borrowers may
be upgraded if "... They have met their contractual debt service
requirements for six consecutive months and their financial condition
supports...they will recover their recorded book value(s) in full."
This implies that they will be put back on accrual as well, which should
likely be indicated as well.
The new proposed facility ratings for DEFAULT rated credits make
no sense at all as typically a presently rated DOUBTFUL borrower for
most banks has a reserve of 50%. In some cases, partial charge offs
relative to the potential collateral recovery value have already
occurred! Therefore, the facility ratings under the 30% level for
DEFAULT rate borrowers are not relevant.
What would make more sense would be to institute facility
ratings on SUBSTANDARD/WEAK borrowers that have a collateral or lack of
guarantor recovery with a gap of 10 to 30% of not covering the
borrower's loan balance. Therefore, facility ratings under 30% would
relate to SUBSTANDARD/WEAK borrowers and facility ratings over 30% would
relate to DOUBTFUL/DEFAULT borrowers.
4. "LOSS" PRESENTLY AND PROPOSED CONTINUED USE OF "LOSS"
The present loss definition is sufficient and needs no change.
The proposed classification expanded definitions have some merit
on select classifications as reflected to enhance understanding of
classification of borrowers. The proposed renaming of certain
classifications is not appropriate, to include the proposed name changes
of substandard to weak and doubtful to default. The proposed WEAK
definition lacks any reference at all to collateral coverage. The
facility rating proposed to rate the estimated loss on a facility is ill
conceived as it relates only to the DOUBTFUL/WEAK classification, which
historically has been reserved at 50%, and needs to be broadened to the
SUBSTANDARD/WEAK category if put in place.
Harley A. Charlson
Union Bank & Trust Company
Corporate Loan Review Officer
4243 Pioneer Woods Dr.
Lincoln, NE 68501
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