Rating Credit Risk - OCC

Assets Comptroller of the Currency Administrator of National Banks Rating Credit Risk Comptroller’s Handbook April 2001 A-RCR A As of May 17, 2012, this guidance applies to federal savings associations in addition to national banks.* Comptroller's Handbook Rating Credit Risk i Rating Credit Risk Table of Contents Introduction Functions of a Credit Risk Rating System 1 Expectations of Bank Credit Risk Rating Systems 3 Developments in Bank Risk Rating Systems 4 Risk Rating Process Controls 8 Examining the Risk Rating Process 11 Rating Credit Risk 13 The Credit Risk Evaluation Process 21 Financial Statement Analysis 22 Other Repayment Sources 24 Qualitative Considerations 24 Credit Risk Mitigation 25 Accounting Issues 31 Appendices A. Nationally Recognized Rating Agencies Definitions 35 B. Write-Up

Standards, Guidelines, and Examples 41 C. Rating Terminology 51 D. Guarantees 53 E. Classification of Foreign Assets 54 F. Structural Weakness Elements 62 References 67 As of May 17, 2012, this guidance applies to federal savings associations in addition to national banks.* Comptroller's Handbook Rating Credit Risk 1 Introduction Credit risk is the primary financial risk in the banking system and exists in virtually all income-producing activities. How a bank selects and manages its credit risk is critically important to its performance over time; indeed, capital depletion through loan losses has been the proximate cause of most institution failures. Identifying and rating credit risk is the essential first step in managing it effectively. The OCC expects national banks to have credit risk management systems that produce accurate and timely risk ratings. Likewise, the OCC considers accurate classification of credit among its top supervisory priorities. This booklet describes the elements of an effective internal process for rating credit risk. It also provides guidance on regulatory classifications supplemental to that found in other OCC credit-related booklets, and should be consulted whenever a credit-related examination is conducted. This handbook provides a comprehensive, but generic, discussion of the objectives and general characteristics of effective credit risk rating systems. In practice, a bank’s risk rating system should reflect the complexity of its lending activities and the overall level of risk involved. No single credit risk rating system is ideal for every bank. Large banks typically require sophisticated rating systems involving multiple rating grades. On the other hand, community banks that lend primarily within their geographic area will typically be able to adhere to this guidance in a less formal and systematic manner because of the simplicity of their credit exposures and management’s direct knowledge of customers’ credit needs and financial conditions. Functions of a Credit Risk Rating System Well-managed credit risk rating systems promote bank safety and soundness by facilitating informed decision making. Rating systems measure credit risk and differentiate individual credits and groups of credits by the risk they pose. This allows bank management and examiners to monitor changes and trends in risk levels. The process also allows bank management to manage risk to optimize returns. As of May 17, 2012, this guidance applies to federal savings associations in addition to national banks.* Rating Credit Risk Comptroller's Handbook 2 Credit risk ratings are also essential to other important functions, such as: • Credit approval...

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