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Credit Memorandums - Write or Wrong

by Regional Examiner K. Paul Qualls, Oklahoma State Banking Department

In this age of transient loan officers, expanding loan portfolios and increasing sophistication of borrower needs and underwriting, the demand and need for timely, informative credit memorandums has never been greater. Lifetime institutional loan officers appear to be an aberration of the past with retirement pending for many seasoned bankers, coupled with the allure of hiring bonuses and higher salaries for producing and capable younger officers from banks seeking larger market share. These two elements have combined to reduce stability and institutional loyalty within the lending staff ranks. Loan growth for Oklahoma banks has increased $4,312MM,or 20%, over the past two years; however, this growth has been tempered over the same time period by a contracting of the net interest margin. This contracting has resulted in growth focus to merely maintain current income levels, perhaps, to the detriment of credit underwriting, servicing and quality. These factors contribute to a declared admonishment that loan files be organized, contemporary and contain a current credit memorandum in order to transform them from static, bulky repositories of loan documents to viable, dynamic sources of credit information.

Loan files without credit memorandums are generally considered a "bulky maze" that an individual, not familiar with the credit or creditor, musters the desire and analytical capacity to read through. These same files are generally not as up-to-date, contain non-pertinent information and render quality more of a subjective opinion rather than an objective decision. Should the originating officer leave and another loan officer assume the credit relationship, how much time will be required by said officer to acclimate themselves with, not only the extensions of credit, but with the borrowers also. And if this loan officer, who has to service this relationship, requires a significant amount of time to accomplish the aforementioned, how much greater a disadvantage must the external reviewer or examiner overcome in the short time allotted to determine the quality of the relationship and extensions of credit between borrower and bank.

Credit memorandums should be viewed as a " Table of Contents" or a " Road Map" to the loan file(s) that contains all the information relating to a lending relationship. This "Table of Contents" will instruct the reviewer or loan officer on what they will or will not find in the loan file. With this view in mind, a credit memorandum should contain the basic elements of all extensions of credit to an individual including the person, purpose, payment, protection and plan of each extension.

The basic elements can be summarized as follows:

Person - who the borrower(s) is/are and what authority do they have to borrow if other than a sole proprietorship. Have all related entities co-signed or has management exempted their personal obligation.

Purpose - what are the monies to be used for? Do the borrower's have experience coinciding with the stated purpose or is this a new venture. In other words, does the purpose match the person? The purpose of each extension should be clearly identified in the memorandum.

Payment - how and when are the monies to be paid back? Does the repayment plan match the purpose of the extension and the cashflow of the borrower? The terms of each extension should be listed.

Protection - what does the bank have as secondary and tertiary sources of repayment/collateral should the borrower default on their credit extension? How is this collateral attached to our extension of credit? How and when were these sources valued? Collateral and any guarantees should be listed per each extension of credit.

Plan - how is each credit extension to be serviced? What are the reporting requirements for the borrower concerning financial information, nonpossessory collateral agings and listings? When are inspections to be performed and by whom?

By planning for and completing these memorandums on at least an annual basis, loan officers, loan reviewers and examiners alike are afforded a timely, condensed synopsis of the credit file that lies before them, and lends tremendously to the examination and understanding thereof. Credit memorandums, write them or your wrong!

K. Paul Qualls is a 16 year veteran of the Oklahoma State Banking Department. His career began at the height of the oil field bust and, for the first several years of employ, dealt with the inherent effects said bust effected upon the local banking industry; chiefly, severe underwriting weakness and deficient collateral support. Currently, he holds the position of Regional Examiner and is responsible for the oversight and conduct of fourteen junior examiners, and is a Department representative. He is a graduate of and former instructor at the Graduate School of Banking of Colorado. He is now a course instructor for the Conference of State Bank Supervisors' Credit Risk Analysis and Director's Training Courses taught in various locations throughout the United States of America.

First published on 10/28/02

First published on 10/28/2002

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