[Federal Register Volume 63, Number 128 (Monday, July 6, 1998)]
[Notices]
[Pages 36403-36408]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-17782]



[[Page 36403]]

=======================================================================
-----------------------------------------------------------------------

FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL


Uniform Retail Credit Classification Policy

AGENCY: Federal Financial Institutions Examination Council.

ACTION: Notice and request for comment.

-----------------------------------------------------------------------

SUMMARY: The Federal Financial Institutions Examination Council 
(FFIEC), on behalf of the Board of Governors of the Federal Reserve 
System (FRB), the Federal Deposit Insurance Corporation (FDIC), the 
Office of the Comptroller of the Currency (OCC), and the Office of 
Thrift Supervision (OTS), collectively referred to as the Agencies, 
requests comment on proposed changes to the Uniform Policy for 
Classification of Consumer Installment Credit Based on Delinquency 
Status (Uniform Retail Credit Classification Policy). The National 
Credit Union Administration (NCUA), also a member of FFIEC, is 
reviewing the applicability and appropriateness of the FFIEC proposal 
for institutions supervised by the NCUA; however, the NCUA does not 
plan to adopt the proposed policy at this time.
    The Uniform Retail Credit Classification Policy is a supervisory 
policy used by the federal regulatory agencies for the uniform 
classification of retail credit loans of financial institutions. At the 
time the initial Uniform Retail Credit Classification Policy was issued 
in 1980, open-end credit generally consisted of credit card accounts 
with small credit lines to the most creditworthy borrowers. Today, 
open-end credit generally includes accounts with much larger lines of 
credit to diverse borrowers with a variety of risk levels. The change 
in the nature of those accounts and the inconsistencies in the 
reporting and charging off of accounts has raised concerns with the 
FFIEC. This proposed policy statement is intended to help the FFIEC 
develop a revised classification policy to more accurately reflect the 
changing nature of risk in today's retail credit environment. The FFIEC 
is proposing to revise the charge-off policy for closed-end and open-
end credit and address other significant issues in retail credit 
lending by the financial services industry. The FFIEC is requesting 
comment on the proposed revision and the listed issues.

DATES: Comments must be received by September 4, 1998.

ADDRESSES: Comments should be sent to Keith Todd, Acting Executive 
Secretary, Federal Financial Institutions Examination Council, 2100 
Pennsylvania Avenue NW., Suite 200, Washington, DC 20037, or by 
facsimile transmission to (202) 634-6556.

FOR FURTHER INFORMATION CONTACT:
    FRB: William Coen, Supervisory Financial Analyst, (202) 452-5219, 
Division of Banking Supervision and Regulation, Board of Governors of 
the Federal Reserve System. For the hearing impaired only, 
Telecommunication Device for the Deaf (TDD), Dorothea Thompson, (202) 
452-3544, Board of Governors of the Federal Reserve System, 20th and C 
Streets NW., Washington, DC 20551.
    FDIC: James Leitner, Examination Specialist, (202) 898-6790, 
Division of Supervision. For legal issues, Michael Phillips, Counsel, 
(202) 898-3581, Supervision and Legislation Branch, Federal Deposit 
Insurance Corporation, 550 17th Street NW., Washington, DC 20429.
    OCC: Cathy Young, National Bank Examiner, Credit Risk Division, 
(202) 874-4474, or Ron Shimabukuro, Senior Attorney, Legislative and 
Regulatory Activities Division (202) 874-5090, Office of the 
Comptroller of the Currency, 250 E Street SW., Washington, DC 20219.
    OTS: William J. Magrini, Senior Project Manager, (202) 906-5744, 
Supervision Policy; or Vern McKinley, Attorney, (202) 906-6241, 
Regulations and Legislation Division, Chief Counsel's Office, Office of 
Thrift Supervision, 1700 G Street NW, Washington, DC 20552.

SUPPLEMENTARY INFORMATION:

Background Information

    On June 30, 1980, the FRB, FDIC, and OCC adopted the FFIEC uniform 
policy for classification of open-end and closed-end credit (1980 
policy). The Federal Home Loan Bank Board, the predecessor of the OTS, 
adopted the 1980 policy in 1987. The 1980 policy established uniform 
guidelines for the classification of installment credit based on 
delinquency status and provided different charge-off time frames for 
open-end and closed-end credit. The 1980 policy recognized the 
statistical validity of determining losses based on past due status. At 
that time, open-end credit generally consisted of credit card accounts 
with small credit lines to the most creditworthy borrowers. Today, 
open-end credit generally includes accounts with much larger lines of 
credit to diverse borrowers with a variety of credit risk levels. The 
change in the nature of those accounts and the inconsistencies in the 
reporting and charging off of accounts by financial institutions, has 
prompted the federal regulatory agencies to propose several revisions 
to the 1980 policy.

Comments Received

    The FFIEC requested comment on September 12, 1997 at 62 FR 48089 
(September Notice) on a series of questions designed to help the FFIEC 
develop a revised classification policy. A total of 61 comments were 
received representing the views of 22 banks and thrifts, nine bank 
holding companies, eight regulatory agencies, seven trade groups, and 
15 other companies and individuals. The following is a summary of the 
questions and responses.

1. Charge-off Policy for Open-End and Closed-End Credit

    The September Notice requested comment on whether a uniform time 
frame should be used to charge off both open-end and closed-end 
accounts, and if a change in policy is made, a reasonable time frame to 
allow institutions to comply with such a change. Comments were also 
sought on whether to continue the current regulatory practice of 
classifying open-end and closed-end credit Substandard when the account 
is 90 days or more delinquent; whether a standard for the Doubtful 
classification or guidance for placing loans on a nonaccrual status 
should be adopted; and whether a specific reserve account should be 
established.
    Charge off policy: Commenters were divided on whether to maintain 
the current policy of charging off open-end (credit card) loans at 180 
days delinquent and closed-end installment loans at 120 days or to 
change the policy to a uniform time frame for both types of loans. 
Almost half of the commenters suggested a uniform charge-off time frame 
for both types of loans. Recommendations for the charge-off time frame 
varied from 90 days to 180 days; the majority who favored uniformity 
believed the time frame should be less than 180 days. Of 51 comments to 
this question, 22 commenters preferred a stricter open-end standard 
than what is contained in the 1980 policy and remaining respondents 
supported no change or a less strict open-end standard.
    Commenters in favor of a uniform time frame cited three main 
reasons: (1) inconsistency in the 1980 policy guidelines; (2) recovery 
data supports a lengthening of the charge-off policy for closed-end 
installment loans; and (3) the level of credit risk in open-end and 
closed-end loans has changed since the 1980 policy was adopted.

[[Page 36404]]

    Commenters supporting a uniform time frame cited the inconsistency 
between the level of risk associated with credit card loans and closed-
end credit and the inconsistency in the 1980 policy for charging-off 
delinquent accounts. Under the 1980 policy, credit card loans, which 
generally are unsecured, are charged off when an account is 180 days 
delinquent. Conversely, closed-end credits generally amortize according 
to a payment schedule, are better protected via a security interest in 
collateral, and experience much higher recovery rates after being 
charged off, but are subject to a more stringent charge-off policy at 
120 days delinquency. Over the years, the inconsistency in the time 
frames has become more apparent as the market for credit cards evolved. 
Several commenters stated that the risk associated with open-end credit 
has increased significantly since 1980. This is due to competition in 
solicitations, less stringent underwriting criteria, lower minimum 
payment requirements, lack of a security interest, and lower recovery 
rates after charge-off. Commenters contended that these factors provide 
support for shortening the current 180 day charge-off time frame for 
open-end credit.
    A uniform time frame would eliminate the inconsistent treatment for 
closed-end and open-end credit. On a volume basis, the change would 
actually lengthen the charge-off time frame for more loans than it 
would shorten. As of year end 1997, institutions supervised by the FRB, 
FDIC, and OCC had closed-end installment loans of $338 billion and 
open-end credit card loans of $237 billion. At that time, institutions 
supervised by the OTS had closed-end installment loans of $29 billion 
and open-end loans totaling $23 billion. Under a uniform time frame, 
institutions would have an additional month to work with borrowers 
before recognizing a loss for lower risk closed-end credit. Credit card 
issuers would have this same 150-day charge-off time frame, although it 
would be 30 days less than the current requirement.
    The most direct measure of credit risk is the ratio of net losses 
to loans. In every year since 1984, the credit card loss ratio has been 
much higher than the closed-end installment loss ratio. During the 
fourteen-year period, the average net loss for credit cards was 3.2 
percent while the average net loss for installment loans was 0.8 
percent. The percentage of current recoveries to prior year charge-offs 
is a ratio that indicates how timely loans are charged-off. A loss 
classification does not mean that the asset has absolutely no recovery 
or salvage value; rather, it means that it is not practical or 
desirable to defer writing off an essentially worthless asset even 
though partial recovery may occur in the future. A high rate of 
recoveries may illustrate a conservative charge-off policy, whereas a 
low rate may indicate an unwarranted delay in the recognition of 
losses. Since 1985, recoveries for credit card loans have averaged 19 
percent, while recoveries for installment loans have averaged 34 
percent.
    Commenters opposed to any change of the charge-off standards cited 
four principal reasons: (1) the impact on the industry's earnings and 
capital; (2) the effect on credit card securitization transactions; (3) 
the limitation of programming resources because of Year 2000 issues; 
and (4) impact on consumers.
    Some commenters believed that changing the charge-off guidelines 
for open-end credit may make it more difficult for lenders to collect 
from borrowers. They stated that a change in the guidelines will result 
in more expense for institutions, because of the need to revise their 
existing collection policies and procedures. This can negatively affect 
an institution's earnings and capital.
    Others stated that a change in the charge-off time frames would 
affect credit card securitization transactions. One commenter mentioned 
that as of September 1997, $213 billion, or 40.6 percent of outstanding 
credit card receivables, were securitized. Some commenters believed 
that any change in the charge-off policy could trigger contractual 
provisions, such as early amortization or collateral substitution 
requirements. This would increase costs to credit card issuers and 
limit their ability to sell securitizations, thus potentially 
restricting credit card lending. Some commenters indicated that such a 
change may cause them to exit the securitization market for years.
    Some commenters expressed concern about the re-programming efforts 
needed for a change in the charge-off policy. This comes at a time when 
computer programmer resources are limited due to Year 2000 efforts.
    Finally, some commenters contended that requiring earlier charge 
offs will have an impact on consumers. The incentives for borrowers to 
pay and for banks to invest in collection efforts are greatest before 
the charge off has occurred. One industry association reported that 34 
percent of accounts that are 120 days delinquent will be made current 
before charge off under the 1980 policy. A shorter charge-off time 
frame reduces the borrower's time to cure a debt. Once charge off 
occurs, the customer's charged-off account is reported to the credit 
bureau, further damaging the customer's credit rating and future 
ability to obtain credit. Commenters stated that the customer loses the 
incentive to pay, further impacting an institution's recoveries.
    Given the division in comments as to the appropriate charge-off 
policy guidelines, the FFIEC is requesting comment on two alternative 
charge-off standards (only one of these will be implemented):
     A uniform charge-off time frame for both open-end and 
closed-end credit at 150 days delinquency with a proposed 
implementation date of January 1, 2001; or
     Retaining the existing policy of charging off delinquent 
closed-end loans at 120 days and delinquent open-end loans at 180 days. 
If this option is selected, any changes affected by the final policy 
statement would have a January 1, 1999 implementation date.
    Substandard classification policy: Thirty-six of 41 commenters 
supported the practice of classifying open-end and closed-end loans 
Substandard at 90 days delinquency. The majority of commenters opposed 
a uniform policy of classifying loans Doubtful, placing them on 
nonaccrual, or setting up separate reserves in lieu of charging off a 
loan. The FFIEC has long felt that when an account is 90 days past due, 
it displays weaknesses warranting classification and proposes to 
continue the policy of classifying open-end and closed-end loans 
Substandard at 90 days delinquency. The FFIEC has decided not to add 
guidance for classifying retail credit Doubtful or placing those loans 
on nonaccrual.

2. Bankruptcy, Fraud, and Deceased Accounts

    The September Notice requested comment on whether there should be 
separate guidance for determining: (i) when an account should be 
charged off for bankruptcies under Chapter 7 or 13 of the Federal 
Bankruptcy Code; (ii) the event in the bankruptcy process that should 
trigger loss recognition; (iii) the amount of time needed by an 
institution to charge off an account after the bankruptcy event; and 
(iv) whether, as an alternative to an immediate charge off, it would be 
beneficial to set up a specific reserve account. Comments also were 
sought on the amount of time needed by an institution to charge off 
losses due to fraud or losses on loans to deceased borrowers.
    Bankruptcy: The majority of commenters, 26 of 40, stated that 
separate guidance should not be developed for bankruptcies under 
Chapter 7 or Chapter 13. Many

[[Page 36405]]

commenters stated that charge-off guidance recognizing bankruptcies 
arising from defaults on secured loans versus bankruptcies arising from 
defaults on unsecured is more realistic. The majority indicated that 
the notification date to the creditor from the bankruptcy court should 
constitute the event triggering loss recognition. The majority also did 
not believe it should be necessary to set up a separate allowance 
reserve at the time of the bankruptcy filing.
    The FFIEC proposes to add guidance specifying that unsecured loans 
for which the borrower declared bankruptcy should be charged off by the 
end of the month that the creditor receives notification of filing from 
the bankruptcy court. In addition, secured loans in bankruptcy should 
be evaluated for repayment potential and classified appropriately, 
within 30 days of notification of filing from the bankruptcy court, or 
within the charge-off time frames in the classification policy, 
whichever is shorter.
    The FFIEC is aware that Congress is in the process of addressing 
bankruptcy reform legislation. If legislation is passed, the FFIEC will 
review its proposed bankruptcy guidelines for any changes that may be 
necessary as a result of changes to the bankruptcy code.
    Fraud: Commenters were divided equally with respect to the time 
required to charge off fraudulent loans, either 30 days or 90 days. The 
FFIEC recognized that a fraud investigation may last more than 30 days. 
For that reason, the FFIEC is proposing that fraudulent retail credit 
should be charged off within 90 days of discovery or within the charge-
off time frames adopted in this classification policy, whichever is 
shorter.
    Deceased Accounts: The majority of commenters reported that they 
needed 150 days to work with the trustee of an estate to determine the 
repayment potential of loans of deceased persons. The FFIEC recognizes 
that working with the trustee or the deceased family may take months to 
determine repayment potential. The FFIEC proposes that retail credit 
loans of deceased persons should be evaluated and charged off when the 
loss is determined, or within the charge-off time frames adopted in 
this classification policy, whichever is shorter.

3. Partial Payments

    The September notice requested comment on whether borrowers should 
receive credit for partial payments in determining delinquency by 
giving credit for any payment received and if this would require 
significant computer programming changes. Comments were sought on other 
reasonable alternatives and how payments should be applied. Comments 
also were requested about the need for guidance on fixed payment 
programs.
    The commenters were divided evenly between supporting the proposal 
versus keeping the existing policy whereby 90 percent of a payment 
qualifies as a full payment. Many commented about the significant 
programming costs that a change to the existing policy would cause. For 
that reason, the FFIEC is proposing that institutions be permitted to 
choose one of two methods. The first method retains the current policy 
of considering a payment equivalent to 90 percent or more of the 
contractual payment to be a full payment in computing delinquency. The 
second method would allow an institution to aggregate payments and give 
credit for any partial payment received; however, the account should be 
considered delinquent until all contractual payments are received. 
Whichever method is chosen, the same method should be used consistently 
within the entire portfolio.
    Most commenters did not advocate additional guidance for fixed 
payment programs. Although no specific language is included in this 
policy, when an institution grants interest rate or principal 
concessions under a fixed payment program, and those concessions are 
material, the institution should follow generally accepted accounting 
principles (GAAP) guidelines presented in Financial Accounting 
Standards Board (FASB) 15 (Accounting by Debtors and Creditors for 
Troubled Debt Restructuring) and FASB 114 (Accounting by Creditors for 
Impairment of a Loan).

4. Re-aging, Extension, Renewal, Deferral, or Rewrite Policy

    The September notice proposed and requested comment on supervisory 
standards for re-aging accounts.
    Re-aging is the practice of bringing a delinquent account current 
after the borrower has demonstrated a renewed willingness and ability 
to repay the loan by making some, but not all, past due payments. A 
liberal re-aging policy on credit card accounts, or an extension, 
deferral, or rewrite policy on closed-end credit, can cloud the true 
performance and delinquency status of the accounts. The majority of 
commenters agreed that the borrower should show a renewed willingness 
and ability to repay, re-aging should occur after receipt of three 
months consecutive or equivalent lump sum payments, the account should 
be opened for a minimum period of time before it can be re-aged, and 
the account should not be re-aged more than once per year.
    The FFIEC concurred with those criteria, but decided that 
additional guidance on the amount that could be re-aged, and the number 
of times the account could be re-aged in its lifetime were also needed. 
The FFIEC proposes to allow re-aging of delinquent loans, when it is 
based on recent, satisfactory performance by the borrowers and when it 
is structured in accordance with the institution's prudent internal 
policies. Institutions that re-age open-end accounts or extend, defer, 
or rewrite closed-end accounts should establish a written policy, 
ensure its reasonableness, and adhere to it. An account eligible for 
re-aging, extension, deferral, or re-write exhibits the following:
     The borrower should show a renewed willingness and ability 
to repay the loan.
     The borrower should make at least three consecutive 
contractual payments or the equivalent lump sum payment (funds may not 
be advanced by the institution for this purpose).
     No more than one re-age, extension, deferral, or rewrite 
should occur during any 12 month period.
     The account should exist for at least 12 months before a 
re-aging, extension, deferral, or rewrite is allowed.
     No more than two re-agings, extensions, deferrals, or 
rewrites should occur in the lifetime of the account.
     The re-aged balance in the account should not exceed the 
predelinquency credit limit.
     A re-aged, extended, deferred, or rewritten loan should be 
documented adequately.

5. Residential and Home Equity Loans

    The September notice requested comment on whether residential and 
home equity loans should be classified Substandard at a certain 
delinquency and whether a collateral evaluation should be required at a 
certain delinquency.
    Twenty-eight of 37 commenters agreed with classifying residential 
and home equity loans Substandard when they are 90 days delinquent. The 
proposed policy statement classifies certain residential and home 
equity loans Substandard at 90 days delinquent. However, the FFIEC 
recognizes that delinquent, low loan-to-value loans (i.e., those loans 
less than or equal to 60 percent of the real estate's value based on 
the most current appraisal or evaluation) possess little likelihood for 
loss as they are protected

[[Page 36406]]

adequately by the real estate. Those loans will be exempted from the 
proposed classification policy. The FFIEC proposes that, if an 
institution holds a first-lien residential real estate loan and a home 
equity loan to the same borrower, and if the combined loan-to-value 
ratio exceeds 60 percent, the loans should be classified as substandard 
when both are delinquent more than 90 days. If only the residential 
real estate loan is delinquent or if only the home equity loan is 
delinquent, only the delinquent loan is classified substandard. If the 
institution only holds the home equity loan and does not hold other 
prior residential mortgages to the same borrower, and the loan is 
delinquent 90 days or more, it should be classified Substandard.
    The majority of commenters supported a collateral evaluation by the 
time the loan is 180 days delinquent. The proposed policy statement 
calls for a current evaluation of the collateral to be made by the time 
a residential or home equity loan is: (1) 150 days past due, if option 
one under the charge off time frames is selected, or (2) 120 days past 
due for closed-end credit and 180 days past due for open-end credit, if 
option 2 is selected. The outstanding balance in the loan in excess of 
fair value of the collateral, less the cost to sell, should be 
classified Loss and the balance classified Substandard.

6. Need for Additional Retail Credit Guidance

    The September notice requested comment as to whether additional 
supervisory guidance is needed or would be beneficial. Comments were 
also sought as to whether additional supervisory guidance is needed on 
the loan loss reserve for retail credit.
    The majority of commenters did not support any other regulatory 
guidance. Any additional guidance on the allowance for loan and lease 
loss will be addressed in other policy statements.

Proposed Revision

    The FFIEC drafted a revised policy statement in consideration of 
the comments. The proposed policy statement will:
     Establish a charge-off policy for open-end and closed-end 
credit based on delinquency under one of two possible time frames;
     Provide guidance for loans affected by bankruptcy, 
fraudulent activity, and death;
     Establish standards for re-aging, extending, deferring, or 
rewriting of past due accounts;
     Classify certain delinquent residential mortgage and home 
equity loans; and
     Broaden the recognition of partial payments that qualify 
as a full payment.
    The FFIEC considered the effect of GAAP on this guidance. GAAP 
requires that a loss be recognized promptly for assets or portions of 
assets deemed uncollectible. The FFIEC believes that this guidance 
requires prompt recognition of losses, and therefore, is consistent 
with GAAP.
    This proposed policy statement, if adopted, will apply to all 
regulated financial institutions and their operating subsidiaries 
supervised by the FRB, FDIC, OCC, and OTS.
    The proposed text of the statement is as follows:

Uniform Retail Credit Classification Policy 1
---------------------------------------------------------------------------

    \1\ The regulatory classifications used for retail credit are 
Substandard, Doubtful, and Loss. These are defined as follows: 
Substandard: An asset classified Substandard is protected 
inadequately by the current net 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. Doubtful: An asset classified 
Doubtful has all the weaknesses inherent in one classified 
Substandard with the added characteristic that the weaknesses make 
collection or liquidation in full, on the basis of currently 
existing facts, conditions, and values, highly questionable and 
improbable. Loss: An asset, or portion thereof, classified Loss is 
considered uncollectible, and of such little value that its 
continuance on the books is not warranted. This classification does 
not mean that the asset has absolutely no recovery or salvage value; 
rather, it is not practical or desirable to defer writing off an 
essentially worthless asset (or portion thereof), even though 
partial recovery may occur in the future.
    Although the Board of Governors of the Federal Reserve System, 
Federal Deposit Insurance Corporation, Office of the Comptroller of 
the Currency, and Office of Thrift Supervision do not require 
institutions to adopt the identical classification definitions, 
institutions should classify their assets using a system that can be 
easily reconciled with the regulatory classification system.
---------------------------------------------------------------------------

    Evidence of the quality of consumer credit soundness is indicated 
best by the repayment performance demonstrated by the borrower. When 
loans become seriously delinquent (90 days or more contractually past 
due), they display weaknesses that, if left uncorrected, may result in 
a loss. Because retail credit generally is comprised of a large number 
of relatively small balance loans, evaluating the quality of the retail 
credit portfolio on a loan-by-loan basis is inefficient and burdensome 
to the institution being examined and to examiners. Therefore, in 
general, retail credit should be classified based on the following 
criteria:
     [Option 1]: Open-end and closed-end retail loans that 
become past due 150 cumulative days or more from the contractual due 
date should be charged off. The charge off should be effected by the 
end of the month in which the requirement is triggered. Open-end and 
closed-end retail loans that are past due 90 days or more, but less 
than 150 cumulative days, should be classified Substandard or
     [Option 2]: Closed-end retail loans that become past due 
120 cumulative days and open-end retail loans that become past due 180 
cumulative days from the contractual due date should be charged off. 
The charge off should be effected by the end of the month in which the 
requirement is triggered. Open-end and closed-end retail loans that are 
past due 90 days or more should be classified Substandard.2
---------------------------------------------------------------------------

    \2\ The final policy will adopt only one of these options.
---------------------------------------------------------------------------

     Unsecured loans for which the borrower declared bankruptcy 
should be charged off by the end of the month in which the creditor 
receives notification of filing from the bankruptcy court, or within 
the charge-off time frames adopted in this classification policy, 
whichever is shorter.
     For secured and partially secured loans in bankruptcy, the 
collateral and the institution's security position in the bankruptcy 
court should be evaluated. Any outstanding investment in the loan in 
excess of the fair value of the collateral, less the cost to sell, 
should be charged off within 30 days of notification of filing from the 
bankruptcy court, or within the time frames in this classification 
policy, whichever is shorter. The remainder of the loan should be 
classified Substandard until the borrower re-establishes the ability 
and willingness to repay.
     Fraudulent loans should be charged off within 90 days of 
discovery, or within the time frames in this classification policy, 
whichever is shorter.
     Loans of deceased persons should be charged off when the 
loss is determined, or within the time frames adopted in this 
classification policy, whichever is shorter.
     One- to four-family residential real estate loans and home 
equity loans that are delinquent 90 days or more, and with loan-to-
value ratios greater than 60%, should be classified Substandard.
     A current evaluation of the loan's collateral should be 
made by the time a residential or home equity loan is: (1) 150 days 
past due if option one under the charge off time frames is selected or

[[Page 36407]]

(2) 120 days past due for closed-end credit and 180 days past due for 
open-end credit if option 2 is selected. Any investment in excess of 
fair value of the collateral, less cost to sell, should be classified 
Loss and the balance classified Substandard.
    Certain residential real estate loans with low loan-to-value ratios 
are exempt from classification based on delinquency, although these 
loans may be reviewed and classified individually. Residential real 
estate loans with a loan-to-value ratio equal to, or less than, 60 
percent should not be classified based solely on delinquency status. In 
addition, home equity loans to the same borrower at the same 
institution as the senior mortgage loan with a combined loan-to-value 
ratio equal to, or less than, 60 percent, should not be classified. 
However, home equity loans where the institution does not hold the 
senior mortgage that are delinquent 90 days or more should be 
classified Substandard, even if the loan-to-value ratio is reportedly 
equal to, or less than, 60 percent.
    The use of delinquency to classify retail credit is based on the 
presumption that delinquent loans display a serious weakness or 
weaknesses that, if uncorrected, demonstrate the distinct possibility 
that the institution will suffer a loss of either principal or 
interest. However, if an institution can clearly document that the 
delinquent loan is well secured and in the process of collection, such 
that collection will occur regardless of delinquency status, then the 
loan need not be classified. A well secured loan is collateralized by a 
perfected security interest on, or pledges of, real or personal 
property, including securities, with an estimated fair value, less cost 
to sell, sufficient to recover the recorded investment in the loan, as 
well as a reasonable return on that amount. In the process of 
collection means that either collection efforts or legal action is 
proceeding, and is reasonably expected to result in recovery of the 
recorded investment in the loan or its restoration to a current status, 
generally within the next 90 days.
    This policy does not preclude an institution from adopting an 
internal classification policy more conservative than the one detailed 
above. It also does not preclude a regulatory agency from using the 
Doubtful classification in certain situations if a rating more severe 
than Substandard is justified. Nor does it preclude a charge-off sooner 
when accounts are recognized as Loss.

Partial Payments on Open-End and Closed-End Credit

    Institutions should use one of two methods to recognize partial 
payments. A payment equivalent to 90 percent or more of the contractual 
payment may be considered a full payment in computing delinquency. 
Alternatively, the institution may aggregate payments and give credit 
for any partial payment received. However, the account should be 
considered delinquent until all contractual payments are received. For 
example, if a regular installment payment is $300 and the borrower 
makes payments of only $150 per month for a six-month period, the loan 
would be $900 ($150 shortage times six payments), or three full months 
delinquent. Whichever method is chosen, the same method should be used 
consistently within the entire portfolio.

Re-agings, Extensions, Deferrals, or Rewrites

    Re-aging is the practice of bringing a delinquent account current 
after the borrower has demonstrated a renewed willingness and ability 
to repay the loan by making some, but not all, past due payments. A 
permissive re-aging policy on credit card accounts, or an extension, 
deferral, or re-write policy on closed-end credit, can cloud the true 
performance and delinquency status of the accounts. However, prudent 
use of the re-aging policy is acceptable when it is based on recent, 
satisfactory performance and the borrower's other positive credit 
factors and when it is structured in accordance with the institution's 
internal policies. Institutions that re-age open-end accounts, or 
extend, defer, or re-write closed-end accounts, should establish a 
written policy, ensure its reasonableness, and adhere to it. An account 
eligible for re-aging, extension, deferral, or rewrite exhibits the 
following:
     The borrower should show a renewed willingness and ability 
to repay the loan.
     The borrower should make at least three consecutive 
contractual payments or the equivalent lump sum payment (funds may not 
be advanced by the institution for this purpose).
     No loan should be re-aged, extended, deferred, or 
rewritten more than once within the preceding 12 months.
     The account should exist for at least 12 months before a 
re-aging, extension, deferral, or re-write is allowed.
     No more than two re-agings, extensions, deferrals, or re-
writes should occur in the lifetime of the account.
     The re-aged balance in the account should not exceed the 
predelinquency credit limit.
     An institution should ensure that a re-aged, extended, 
deferred, or re-written loan meets the agencies' and institution's 
standards. The institution should adequately identify, discuss, and 
document any account that is re-aged, extended, deferred, or re-
written.

Examination Considerations

    Examiners should ensure that institutions adhere to this policy. 
Nevertheless, there may be instances that warrant exceptions to the 
general classification policy. Loans need not be classified if the 
institution can document clearly that repayment will occur irrespective 
of delinquency status. Examples might include loans well secured by 
marketable collateral and in the process of collection, loans for which 
claims are filed against solvent estates, and loans supported by 
insurance.
    The uniform classification policy does not preclude examiners from 
reviewing and classifying individual large dollar retail credit loans, 
which may or may not be delinquent, but exhibit signs of credit 
weakness.
    In addition to loan classification, the examination should focus on 
the institution's allowance for loan and lease loss and its risk and 
account management systems, including retail credit lending policy, 
adherence to stated policy, and operating procedures. Internal controls 
should be in place to assure that the policy is followed. Institutions 
lacking sound policies or failing to implement or effectively follow 
established policies will be subject to criticism.

Request for Comment

    The FFIEC is requesting comments on all aspects of the proposed 
policy statement. In addition, the FFIEC also is asking for comment on 
a number of issues affecting the charge-off policy and will consider 
the answers before developing the final policy statement:
    1. What would be the costs and benefits of the uniform 150 day 
charge-off time frame? What would be the costs and benefits of leaving 
the policy at the current 120/180 day charge-off time frames? The FFIEC 
welcomes historical statistical evidence showing the dollars and 
percentages of open-end accounts collected between 120 days delinquency 
and 150 days delinquency and between 150 days delinquency and 180 days 
delinquency.

[[Page 36408]]

    2. What will be the effect of the proposed two time frame charge-
off options on institutions? If possible, please quantify, in dollar 
amounts and percentages (of total operating expenses), the impact of 
the proposed options in the charge-off policy in the first year of 
implementation and in subsequent years for open-end and closed-end 
credits on:
    (a) gross and net charge-offs;
    (b) recoveries;
    (c) earnings; and
    (d) securitization transactions.
    3. What are the expected dollar costs of reprogramming to implement 
the first option (uniform charge-off policy at 150 days past due) and 
what percentage of total operating expenses do those programming 
dollars represent? Also, can the programming changes be completed by 
the proposed January 1, 2001 implementation date?
    4. Please provide any other information that the FFIEC should 
consider in determining the final policy statement including the 
optimal implementation date for the proposed changes.

    Dated: June 30, 1998.
Keith J. Todd,
Acting Executive Secretary, Federal Financial Institutions Examination 
Council.
[FR Doc. 98-17782 Filed 7-2-98; 8:45 am]
BILLING CODE 6210-01-P, 25% 6714-01-P, 25% 6720-01-P, 25% 4810-33-P 25%