| 1.4.1 | Large commercial loans to corporates, governments, private banking customers and others are often reviewed and assessed on an individual basis. Systematic measurement of impairment of individual loans must include the use of a classification system for assigning loans to risk categories. Such a system should segregate loans by the probability of risks associated with individual loans. Over time, banks should monitor and evaluate the levels and trends of risk in their commercial loan portfolios through an analysis of the classification categories. Banks should also target troubled loans for more frequent reviews and higher levels of scrutiny.
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| 1.4.2 | The assessment of each loan should be based upon its fundamentals, including as a minimum the following evaluation factors:
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| | • | The obligor’s character and integrity.
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| | • | The purpose of the loan and the sources of repayment.
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| | • | The overall financial condition and resources of the obligor, including the current and future cash flows.
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| | • | The credit and delinquency history of the obligor.
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| | • | The probability of default on existing loan and any new Ioan being extended.
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| | • | The types of secondary sources of repayment available, such as guarantor’s support and collateral values when they are not a primary sources of repayment. (Undue reliance on secondary sources of repayment should be questioned and the bank’s policy on such practice should be reviewed.)
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| 1.4.3 | While assessing a loan, banks should consider the extent of the shortfall in the operating results and cash flows of the obligor, the support provided by any pledged collateral, and/or the support provided by any third party.
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| 1.4.4 | In order to promote uniformity in the criteria used by Saudi Banks for assigning quality rating to loans, SAMA proposes the system of credit classifications described in the following paragraphs. It should be noted that banks may use classification systems that have more grades than those noted below, as long as they can demonstrate that their systems comply with and their data can be summarized in a manner consistent with the system proposed in these regulations.
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| 1.4.5 | Standard Category
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| | Loans in this category are performing and have sound fundamental characteristics such as borrower’s overall financial conditions, resources and cash flows, credit history and primary or secondary sources of repayment.
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| | A classification of standard should be given to all loans that exhibit neither actual nor potential weaknesses. Loans that exhibit potential weaknesses should be categorized as Special Mention. Standard and Special Mention loans are considered as “performing” credits.
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| 1.4.6 | Special Mention Category
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| | A ‘Special Mention’ loan is defined as having potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may, at some future date, result in the deterioration of the repayment prospects for the loan. These loans are normally current and up-to-date in terms of principal and commission/income payments but deserve management’s close attention. These potential weaknesses may include:
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| | • | Declining profitability
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| | • | Tightening liquidity or cash flow
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| | • | Increasing leverage and/or weakening net worth
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| | • | Weakened marketability and/or value of collateral
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| | • | Industry-specific problems
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| | • | Economic and/or other problems affecting the obligor’s performance
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| | • | Concerns about the obligor’s management competence or depth
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| | • | Material documentation problems
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| | • | Inability to obtain current financial information
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| 1.4.7 | ‘Special Mention’ loans would not expose an institution to sufficient risk to warrant a non-performing classification and would continue to accrue commission. ‘Special Mention’ loans would have characteristics, which corrective management actions could remedy. The ‘Special Mention’ category should also not be used to list loans that contain risks usually associated with that particular type of lending. Any lending involves certain risks, regardless of the collateral or the obligor’s capacity and willingness to repay the debt. But only where the risk has increased beyond that which existed at origination, should the loans be categorized as ‘Special Mention’. However, loans to businesses in certain industries (for example, those with declining revenues or reducing margins or which are subject to specific competitive issues) may be included.
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| 1.4.8 | Loans, which exhibit well-defined weaknesses and a distinct possibility of loss, should be assigned the following categories from less to most severe:
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| | • | “Substandard”
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| | • | “Doubtful”
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| | • | “Loss”
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| | Loans in the ‘Substandard’, ‘Doubtful’ and ‘Loss’ categories would be collectively termed as “non-performing” credits.
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| 1.4.9 | ‘Substandard’ Category
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| | Loans in this category have well-defined weaknesses, where the current financial soundness and paying capacity of the obligor is not assured. Orderly repayment of debt may be in jeopardy. A ‘Substandard’ loan is inadequately protected by future cash flows, the obligor’s current net worth or by the collateral pledge, if any. An important indicator is that any portion of commission/income or principal or both are more than 90 days past due or where there is insufficient credits for an overdraft. For corporate, government and private banking loans and other individually reviewed loans, the 90 days past due rule will also generally apply, unless a bank has strong documentary evidence to support a different classification.
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| 1.4.10 | ‘Doubtful’ Category
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| | A loan classified as ‘Doubtful’ has all the weaknesses inherent in one classified ‘Substandard’ with the added characteristic that the weaknesses make collection or liquidation of the principal and contractual commission/income in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Classification as ‘loss’ is not warranted because of specific factors that generate additional cash flows other than from realization of existing collateral. Such factors include business cash flows, potential merger, acquisition, capital injection or additional collateral. In general a loan where the principal and commission are more than 180 days past due should be included in this classification, except where a bank has strong documentary evidence to support a different categorization such as ‘Sub-standard’ or ‘Special Mention’.
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| 1.4.11 | ‘Loss’ Category
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| | A loan classified as ‘Loss’ is considered uncollectible in the normal course of business and recourse will have to be made to collateral. Loss category does not mean that the asset has absolutely no recovery or salvage value but rather that it is prudent to establish a provision for the entire loan not covered by collateral. For private banking loans and other individually reviewed loans where principal or commission/income are past due for more than 360 days should be included in this classification except where a bank has strong documentary evidence to support a different categorization.
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