Collateral Values for Classified Assets
Community Banks are constantly managing their growth versus the risk associated with their portfolio. One of the Risk Management areas that banks continually evaluate is the loans contained within their Classified Assets since they represent one of the most significant potential risks of loss to the bank.
For a bank to fully evaluate the potential risk of loss, they have to determine the collateral value securing the loans as well as taking into consideration discounts associated with liquidation costs while comparing that to the outstanding balance. The different types of collateral, as well as the date of the last value, will determine the discount percentage applied. Real Estate collateral is discounted significantly less when compared to other types of collateral.
Maintaining a current value (one year or less) for all of the Classified Assets is imperative for banks to actively manage the risk within their portfolio. By not having a current value for the collateral, the bank would have a difficult time determining whether or not a specific impairment was necessary for that relationship, which could affect the ALLL reserve.
Continually maintaining a current value for real estate secured loans could get expensive if the banks were to utilize a full appraisal for the collateral valuation, especially for a non-performing credit. Obtaining a full appraisal or even a broker’s price opinion isn’t necessary for determining the value of the real estate collateral or any other type of collateral. An internal valuation is sufficient enough, as long as there is supporting evidence documenting how the value was calculated. By doing an internal valuation, the bank would not incur the normal appraisal expenses. Still, they would have a current value for all of the collateral to determine if a specific impairment is needed. Maintaining a current value for all Classified Assets is essential for all banks to determine the potential risk of loss.