Loan Performance

Collateral value, although generally viewed as a secondary source of debt repayment, may lend strenght to the relationship. Essential elements of this component include an objective appraisal of the value of the asset and evidence that the institution's security interest has been properly perfected. Value of real estate collateral is best established by an independent appraisal. The internal auditor may wish to review these appraisals to determine that assumptions are based on comparables and the appraisers' qualifications are all reasonable. Value of business assets offered as collateral are established from the firm's balance sheet. Reliance on these figures is dependent on the review or audit work performed by the borrowing firm's independent public accountants. If the audit tests that established asset levels appear inadequate, a site visitation may be helpful in correctly stating these quantities. Perfection of the institution's security interest is generally tested in a documentation review. The inspection of notes, deeds, title options, UCC filings, and the like are required during this process. An attorney must represent the institution at the loan closing, and the internal auditor should review a subsequent document checklist. Such controls are essential. Loan review is a specialized area of banking requiring expertise not generally considered part of the body of common knowledge of internal auditors. Testing the loan review controls and reasonability of credit quality grading is a procedure the internal auditor may wish to undertake prior to utilizing the findings in a loan loss adequacy review. Section A of the workpaper shows any recognized identifiable loss in the loan portfolio which was classified as a valid asset on the review date. This amount is used to reduce the reserve book balance. Nonidentifiable commercial loan loss is assessed in Section B of the workpaper. The proposed technique shows segmentation of the commercial loan portfolio by collateral type and the assignment of an anticipated loss factor based on the institution's experience and perception of future changes in underwriting or the lending area. As shown on the workpaper, simple commercial portfolios may be segregated by real estate, secured, and other secured and nonsecured credits. Institutions with more complex structures may wish to divide their commercial credits into more classifications. Prior to the application of a unique anticipated loss factor, each category is further reduced by the volume of loans reviewed and accorded a prime risk factor by the loan review department. Institutions will use a variety of methods to determine credit risk grades. The internal auditor may exercise judgment on those loan grades that exhibit enough credit risk to warrant exclusion from consideration in the nonidentified loss pool. Loans participated without recourse or those insured by federal agencies are also likely candidates for exclusion from the pool. :