Off-Balance Sheet Activities:

2 primary risks of SBLC:

1. Credit risk - default of account party 2. Funding risk - inability to fund a large draw

SBLC can be either:

1. Financial 2. Performance

Off-balance sheet activities include:

1. Loan commitments 2. Certain letters of credit 3. Revolving underwriting facilities 4. Notional values on swaps, futures, forwards, and option contracts.

4 Types of Commitment:

1. Travelers 2. Those sold for cash 3. Commercial 4. Standby

Policies and Procedures for Off-balance sheet lending activities should be developed and include:

1. Underwriting standards 2. Documentation and file maintenance 3. Collection and review procedures 4. Borrowing and lending limits 5. Exposures requiring Board approva 6. Periodic reports to the Board

Off-balance sheet contingent liabilities:

1. Asset backed commercial paper programs 2. Revolving underwiring facilities.

20% conversion factor for the following off-balance sheet items

- Commercial LOC < 1 year - Unfunded loan commitments < 1 year

50% conversion factor for the following off-balance sheet items

- Commercial LOC > 1 year - Unfunded loan commitments > 1 year - Performance SBLOC

100% conversion factor for the following off-balance sheet items

- Financial SBLOC - Repo transactions (includes reverse) - Guarantees or credit enhancing representations

Part 337.2 of the FDIC Rules and Regs requires banks to:

- Maintain adequate controls and subsidiary records (comparable to records maintained on direct loans) - Reflect all SBLCs on FS - Keep credit files current - Report to the Board regularly

Loan commitments:

- can be irrevocable - Line of credit: less detailed than a formal loan commitment. Can be cancellable if financial condition deteriorates. Line of credit is generally referred to as advised on confirmed lines.

Assets accounted for as a sale under FAS 140 if seller surrenders control. Controls is defined as:

1) legal isolation of assets from seller 2) ability of the purchaser to pledge or sell the asset; or 3) absence of right of seller to repurchase the financial assets.

-Classification of Category I •Substandard

1.Chance is at least reasonably possible 2.Considered no better than "Substandard" quality -Example: undisbursed loan funds in a speculative real estate venture where the disbursed portion is classified "Substandard

-Classification of Category I •Special Mention

1.Chance is at least reasonably possible 2.Considered worthy of "Special Mention" -Example: »undrawn portion of a poorly supervised accounts receivable line where the drawn portion is listed for "Special Mention"

-Classification of Category I Doubtful

1.Chance is probable 2.Considered "Doubtful" quality -Example: »undisbursed loan funds in an incomplete construction project where cost overruns will likely result in the bank sustaining significant loss from disposing the underlying property

- Classification of Category I Loss:

1.Chance is probable 2.NOT considered bankable quality -Example: »Letter of credit which the bank will probably be forced to honor draws that are considered uncollectible -Specific reserve should be established to cover the estimated loss

Classification of Category 1 is dependent on 2 categories:

1.The likelihood of the liability becoming direct 2.The credit risk of the potential acquired asset

RW of Financials SBLC:

100

RW of Performance SBLC

50

Travelers Letter of Credit

Addressed to the bank's correspondent authorizing drafts by the person names. Generally sold for cash

Sold for Cash Letter of Credit

Bank receives funds from the account party at the time of issuance NOT reported as a contingent liability. Reported as a demand deposit.

What is the difference between a SBLC and Commercial letter of credit?

Commercial letters of credit are expected to be draft upon by the beneficiary in the normal course of business SBLC is NOT expected to be drawn upon

Letters of credit:

Document authorizing a third party to draw drafts on the bank - up to stipulated amount with specified terms and conditions.

Derivatives are reported at ____ ON the balance sheet

Fair Value

Standby Letter of Credit

IRREOCABLE commitment to make payment to a designated beneficiary. Obligates the bank to guarantee or stand as surety for the benefit of a third party

___ nature of SBLCs cause significant risks.

Irrevocable

Commercial Letter of Credit

Issued specifically to facilitate trade or commerce. Drafts are drawn when the underlying transaction is consummated Represents a contingent liability.

Adverse Classification of Category 2 Contingent Liabilities

NOT adversely classified.

Guarantors are required to recognize a liability at FV at the inception of the guarantee. This only applies to ____. Commercial letters of credit are not considered guaranteed.

SBLC

0% conversion factor for the following off-balance sheet items

Unconditionally cancellable unfunded commitments

Can SBLCs be participated?

Yes; however, the sale of participations doe NOT diminish the total contingent liability of the originating bank. The originating bank must honor all drafts if the participants do NOT disburse their share.

Can SBLCs be syndicated?

Yes; if one of the bank's fails to fulfill its obligation, the remaining banks are not liable.

Loan commitments that are HFS (interest rate locks) must be accounted for as ___ by issuers. If the loan is held for investment, then it is NOT a ___.

derivatives

Off-balance sheet allowances should be made to ___

other liabilities

Loan Commitments are:

written agreement detailing terms and conditions of a loan that will be made

Revolving underwriting facilities

•A commitment by a group of banks to purchase short-term notes that the issuer is unable to sell in the Euromarket •A lead bank arranges the facility and receives a one-time fee •RUF banks receive an annual commitment or underwriting fee •Standby RUFs = commitments which Euronotes are NOT expected to be sold in the normal course of the borrower's business •Inability to sell notes in the Euromarket = -Financial deterioration of the borrower -Volatile short-term market conditions

Material Adverse Change Clause is usually contained in Loan Commitments and:

•Allows the bank to terminate the commitment or line of credit if the customer's financial condition deteriorates •Enforceable if a legally binding relationship continues to exist when financial covenants are violated

Category 2 Contingent Liabilities:

•NO increase in assets if a contingency becomes a direct liability

Adverse Classification of Category 1 Contingent Liabilities:

•Should be evaluated for credit risk •Listed for "Special Mention" or adverse classification, if appropriate

Category 1 Contingent Liabilities:

•Will increase bank assets if the contingencies convert into actual liabilities