Legal basis and governing standards
- Section 1 sets the general policy that banks must observe Section 76 of R.A. No. 337, as amended.
- Section 76 of R.A. No. 337 requires that before granting a loan, banks must exercise proper caution to ascertain that the debtor is capable of fulfilling his commitments to the bank.
Core classification framework
- Section 2 requires loans to be classified not only as current or past due, but also qualitatively grouped as Unclassified or Classified.
- Section 2(A) defines Unclassified Loans as loans that have no greater-than-normal risk and do not possess the characteristics of classified loans.
- Section 2(B) defines Classified Loans as loans that possess the characteristics outlined in the circular.
- Section 2(B) further subdivides classified loans into: (1) loans especially mentioned; (2) substandard; (3) doubtful; and (4) loss.
Unclassified loans and mandatory exclusions
- Section 2(A) declares Unclassified Loans where the borrower has the apparent ability to satisfy obligations in full, and no loss in ultimate collection is anticipated.
- Section 2(A) provides loans (among others) that shall not be subject to classification, including:
- Loans or portions secured by hold-outs on deposits/deposit substitutes maintained in the lending institution, and margin deposits, or government-supported securities.
- Loans with technical defects and/or deficiencies in documentation and/or collateral requirements that are isolated, not material, and do not undermine the bank’s chance of repayment or the borrower’s ability to liquidate in an orderly manner.
- Section 2(A) requires that technical defects/deficiencies isolated as exceptions be brought to Management’s attention for corrective action during the examination.
- Section 2(A) requires classification as “Loans Especially Mentioned” for deficiencies that remain uncorrected in the following examination.
- Section 2(A) requires citation under “Miscellaneous Exceptions” for loans with the following examples of exceptions:
- Unregistered mortgage instrument not complying with loan approval.
- Improperly executed supporting deed of assignment/pledge agreement/chattel mortgage/real estate mortgage.
- Unnotarized mortgage instruments/agreements.
- Collaterals not covered by appraisal reports, or appraisal reports not updated.
- Loan availments against expired credit line; availments in excess of credit line; availments against credit line without prior approval by the appropriate authority.
- Collaterals not insured or with inadequate/expired insurance or insurance not endorsed in favor of the bank.
- Loans granted beyond the limits of approving authority.
- Loans granted without compliance with conditions stated in the approval.
- Loans secured by property whose title bears an uncancelled annotation or lien or encumbrance.
Classified loans by risk category
- Section 2(B) requires Classified Loans to be subdivided as (1) loans especially mentioned; (2) substandard; (3) doubtful; (4) loss.
- Loans Especially Mentioned are those with potential weaknesses needing Management’s close attention, where uncorrected weaknesses may increase credit risk and affect repayment, including:
- Unlocated collateral folders and documents (including title papers, mortgage instruments, and promissory notes).
- Loans to firms not supported by board resolutions authorizing borrowings.
- Loans without credit investigation report.
- Loans without the latest income tax returns and/or the latest audited financial statements.
- Loans whose repayment may be endangered by economic/market conditions evidenced by declining operations, illiquidity, or increasing leverage.
- Loans to borrowers whose securing properties have declined in value or with other adverse information.
- Past due for more than thirty (30) days up to ninety (90) days.
- Loans previously cited as “Miscellaneous Exceptions” that remain uncorrected in the current BSP examination.
- Substandard loans are loans or portions with a substantial and unreasonable degree of risk with a possibility of future loss unless closely supervised; they must have well-defined weaknesses jeopardizing liquidation, including:
- Secured Loans:
- Past due loans with an imminent possibility of foreclosure or acquisition of collateral due to failure of all collection efforts.
- Past due loans where securing properties declined materially in value or have defects as to ownership or other adverse information.
- Current loans whose audited financial statements show impaired/negative net worth, except start-up firms, to be evaluated case-to-case.
- Unsecured Loans:
- Renewed/extended loans where there is a declining operations trend, illiquidity, or increasing leverage without at least twenty percent (20%) repayment of principal before renewal or extension.
- Current loans with unfavorable operations for two (2) consecutive years or with impaired/negative net worth, except start-up firms evaluated case-to-case.
- Loans under litigation.
- Past due for more than ninety (90) days.
- Loans granted without requiring submission of the latest AFS/income tax returns and/or statements of assets and liabilities to determine paying capacity.
- Loans with unsigned promissory notes or signed by unauthorized officers of the borrowing firm.
- Loans classified as “Loans Especially Mentioned” in the last BSP examination that remain uncorrected in the current examination.
- Secured Loans:
- Doubtful loans are loans/portions with weaknesses inherent in Substandard, but with facts making collection or liquidation in full highly improbable, where substantial loss is probable, including:
- Past due clean loans classified as Substandard in the last BSP examination without at least twenty percent (20%) repayment of principal during the succeeding twelve (12) months, or with current unfavorable credit information.
- Past due loans secured by collaterals (inventories, receivables, equipment, other chattels) that declined materially without additional collateral and previously classified as Substandard in the last BSP examination.
- Past due loans secured by real estate mortgage whose title is subject to an adverse claim making settlement through foreclosure doubtful.
- Cases where loss possibility is extremely high but delayed classification away from estimated loss is justified by certain important and reasonably specific pending factors that may work to the advantage and strengthen the asset.
- Loss loans are loans/portions considered uncollectible or worthless, with their continuance as bankable assets not warranted though partial recovery or salvage may exist; they include:
- Past due clean loans where the interest is unpaid for six (6) months.
- Installment loans where amortization applicable to interest is past due for six (6) months, unless the loan is well secured.
- When the borrower’s whereabouts is unknown, or the borrower is insolvent, or the borrower’s earning power is permanently impaired, and co-makers/guarantors are insolvent or their guaranty is not financially supported.
- Where the collaterals securing the loans are worthless and the borrower and/or co-makers are insolvent.
- Loans considered absolutely uncollectible.
- Loans classified as Doubtful in the last BSP examination with no payment of interest or substantial reduction of principals during the succeeding twelve (12) months, or with current unfavorable credit information rendering collection highly improbable.
Allowance for probable losses schedule
- Section 3 requires banks to set up an allowance for probable losses on loan accounts.
- Section 3(a) establishes the allowance percentage schedule:
- Unclassified — 0%
- Loans Especially Mentioned — 5%
- Substandard (Secured) — 6% to 25%
- Substandard (Unsecured) — 25%
- Doubtful — 50%
- Loss — 100%
- Section 3(a) requires the percentage within 6% to 25% for Substandard (Secured) to be based on sound judgment considering, among others:
- nature of collateral,
- location of property (for real estate collateral),
- assessment of borrower’s current capacity to pay shown by updated cash flow projections,
- credit rating from credit rating agencies,
- expectations on the industry of the borrower.
- Section 3(a) requires that the allowance for probable losses be adjusted accordingly for additional allowance required by the BSP.
- Section 3(a) encourages Management to provide additional allowance as it deems prudent and to formulate additional specific guidelines within the described system.
Administrative implementation posture
- Section 2(A) requires Management’s involvement in correcting technical defects/deficiencies during the BSP examination process.
- Section 2(A) requires continuing classification consequences when deficiencies remain uncorrected in subsequent examinations (classification as Loans Especially Mentioned).
- Section 3(a) requires adjustments in allowances when BSP determines additional allowances are required.