FDIC Home - Federal Deposit Insurance Corporation
FDIC Home - Federal Deposit Insurance Corporation

 
Skip Site Summary Navigation   Home     Deposit Insurance     Consumer Protection     Industry Analysis     Regulations & Examinations     Asset Sales     News & Events     About FDIC  


Home > Regulation & Examinations > Bank Examinations > Risk Management Manual of Examination Policies



Risk Management Manual of Examination Policies

Section TOC | Manual Home | Manual Index

Section 3.1 - Asset Quality

Introduction
Asset quality is one of the most critical areas in determining the overall condition of a bank. The primary factor effecting overall asset quality is the quality of the loan portfolio and the credit administration program. Loans are usually the largest of the asset items and can also carry the greatest amount of potential risk to the bank's capital account. Securities can often be a large portion of the assets and also have identifiable risks. Other items which impact a comprehensive review of asset quality are other real estate, other assets, off-balance sheet items and, to a lesser extent, cash and due from accounts, and premises and fixed assets.

Management often expends significant time, energy, and resources on their asset portfolio, particularly the loan portfolio. Problems within this portfolio can detract from their ability to successfully and profitably manage other areas of the institution. Examiners need to be diligent and focused in their review of the various asset quality areas, as they have an important impact on all other facets of bank operations.

Evaluation of Asset Quality
The asset quality rating reflects the quantity of existing and potential credit risk associated with the loan and investment portfolios, other real estate owned, and other assets, as well as off-balance sheet transactions. The ability of management to identify, measure, monitor, and control credit risk is also reflected here. The evaluation of asset quality should consider the adequacy of the Allowance for Loan and Lease Losses (ALLL) and weigh the exposure to counter-party, issuer, or borrower default under actual or implied contractual agreements. All other risks that may affect the value or marketability of an institution's assets, including, but not limited to, operating, market, reputation, strategic, or compliance risks, should also be considered.

Prior to assigning an asset quality rating, several factors should be considered. The factors should be reviewed within the context of any local and regional conditions that might impact bank performance. Also, any systemic weaknesses, as opposed to isolated problems, should be given appropriate consideration. The following is not a complete list of all possible factors that may influence an examiner's assessment; however, all assessments should consider the following:
  • The adequacy of underwriting standards, soundness of credit administration practices, and appropriateness of risk identification practices.
  • The level, distribution, severity, and trend of problem, classified, nonaccrual, restructured, delinquent, and nonperforming assets for both on- and off-balance sheet transactions.
  • The adequacy of the allowance for loan and lease losses and other asset valuation reserves.
  • The credit risk arising from or reduced by off-balance sheet transactions, such as unfunded commitments, credit derivatives, commercial and standby letters of credit, and lines of credit.
  • The diversification and quality of the loan and investment portfolios.
  • The extent of securities underwriting activities and exposure to counter-parties in trading activities.
  • The existence of asset concentrations.
  • The adequacy of loan and investment policies, procedures, and practices.
  • The ability of management to properly administer its assets, including the timely identification and collection of problem assets.
  • The adequacy of internal controls and management information systems.
  • The volume and nature of credit documentation exceptions.
As with the evaluation of other component ratings, the above factors, among others, should be evaluated not only according to the current level but also considering any ongoing trends. The same level might be looked on more or less favorably depending on any improving or deteriorating trends in one or more factors. The examiner should never look at things in a vacuum, instead, noting how the current level or status of each factor relates to previous and expected future performance and the performance of other similar institutions.

Rating the Asset Quality Factor
The asset quality rating definitions are applied following a thorough evaluation of existing and potential risks and the mitigation of those risks. The definitions of each rating follow.

A rating of 1 indicates strong asset quality and credit administration practices. Identified weaknesses are minor in nature and risk exposure is modest in relation to capital protection and management's abilities. Asset quality in such institutions is of minimal supervisory concern.

A rating of 2 indicates satisfactory asset quality and credit administration practices. The level and severity of classifications and other weaknesses warrant a limited level of supervisory attention. Risk exposure is commensurate with capital protection and management's abilities.

A rating of 3 is assigned when asset quality or credit administration practices are less than satisfactory. Trends may be stable or indicate deterioration in asset quality or an increase in risk exposure. The level and severity of classified assets, other weaknesses, and risks require an elevated level of supervisory concern. There is generally a need to improve credit administration and risk management practices.

A rating of 4 is assigned to financial institutions with deficient asset quality or credit administration practices. The levels of risk and problem assets are significant, inadequately controlled, and subject the financial institution to potential losses that, if left unchecked, may threaten its viability.

A rating of 5 represents critically deficient asset quality or credit administration practices that present an imminent threat to the institution's viability.


Last Updated 02/02/2005 supervision@fdic.gov

Home    Contact Us    Search    Help    SiteMap    Forms
Freedom of Information Act (FOIA) Service Center    Website Policies    USA.gov
FDIC Office of Inspector General