Lending: assessment and management

Loan Documentation

Standard loan documentation

All loans required documentation to determine who is empowered to sign for the
borrower. For partnership, lender should require a bank partnership authorization form
besides a copy of partnership agreement. If a limited partnership, the lender should obtain
certificate and a certified copy of the articles of limited partnership recorded with the
state’s central governing office. All limited partnerships should confirm to their
respective states’ Limited Partnership Acts. Separate operating agreements pertaining to
the partnership should be requested when applicable.

For corporation lenders should obtain a current corporate borrowing resolution

supplemented by the corporation’s charter, articles of incorporation, and bylaws. Based
on recently enacted changes in federal and state bank legal lending limits calculations as
they relate to combining directly and indirectly related entities and partnership, obtaining
the supplemental corporate documentation may become imperative to verify ownership,
relationship and percentages that have a bearing on legal lending limits. The articles of
incorporation, charter and bylaws validate the corporation’s existence, ownership, the
purpose for which it was organized, and the individual names on the board of directors.
Lenders need an assumed name certificate if an individual, proprietorship, corporation or
joint venture is operating under an assumed name or trade style.

Regarding collateral documentation, attachment of personal property must be

accomplished. Thus, lender must identify collateral ownership and right to pledge it
versus other claims against the collateral. Always determine if the collateral is own in
joined names. It is not possible to obtain collateral interests in certain assets, such as IRA
accounts, Veteran Benefit and various types of pension benefits. Relatives to certain
collateral that may be located on the real property, lender must examine the ownership of
the real property. This may include obtaining surveys that help determine boundaries,
water and mineral rights owned by others besides the real property surface owner.

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Loan Documentation

A critical feature of executing any loan involves perfecting the bank’s security
interests in collateral. A security interests is the legal claim on property that secures
payment on a debt or performance of an obligation. When the bank’s claim is superior to
that of other creditors and the borrower, its security interest s is said to be perfected. The
Uniform Commercial Code (UCC) establishes that documentation is required to obtain a
security interests in commercial lending. The UCC applies in every state, although
various states have revised certain condition. Each lending officer must understand what
conditions apply wherever the bank conduct business.

Because there are many different types of borrowers and collateral, there are
different methods in perfecting a security interests. In most cases, the bank requires
borrowers to sign a security agreement that assigns qualifying collateral to the bank. This
agreement describes the collateral and relevant covenants or warranties.

Formal closure may involve getting the signature of the third party guarantor on
the loan agreement or having a key individual assigns the cash value of the life insurance
policy to the bank. In other cases, a bank may need to obtain title to equipment or
vehicles. Whenever the security agreement is signed by all parties and the bank hold the
collateral, the security interests is perfected. When the borrower holds the collateral, the
bank must file a financing statement with the state that describes the collateral and the
right of the bank and the borrower. To establish the bank’s superior interests, this
statement must be signed.

Legal Aspects of Loan Documentation

A loan agreement represents the bank’s legal relationship with the borrower and
also with third parties involved in the loan. When a loan is classified as non performing
loan (NPL), legal action will be taken against the borrower in accordance with the loan
agreement and documentation made before disbursing the loan. Therefore in preparing

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loan documentation, a banker must take duty of care in preparing it because the
borrower’s attorney, other creditors, bankruptcy trustees and the borrower’s guarantors
can challenge it.

If those mentioned can prove the deficiencies of a legal adequacy of the loan
agreement, the bank may lose it right over the collateral and will be unable to collect its
money from the borrowers or guarantors.

In preparing the loan documentation the bank must observe the following aspects
of legal aspects of loan documentations:

1. To use the proper legal name of the borrower exactly as it appears in the National
Identity card in all loan documentation. For a corporation, the banker needs to
verify the mane by obtaining a copy of its charter from the registrar of companies.
For partnership, a partner agreement is required.

2. Ascertain that if the owner of the collateral is not the borrower himself that the
owner must execute all security documentation.

3. Make sure that there are signatures of the borrowers and guarantors on the loan
documentation. For a corporation, it must clearly indicate the number of
signatories required and the capacity of the individuals signing the
documentation.

4. To have a complete and accurate collateral description. For example, where land
is given as collateral information such as location, size, owner and users of the
land should be accurate.

5. Loans that are secured with real property, a banker must make a title search prior
to file in the land office or other offices for a first priority position for the banks.

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6. To have adequate information and valuation of the collateral charged to the bank.
A banker need to inspect the collateral and is required to make formal appraisals
regarding the liquidation values of the collateral.

7. To reduce default risk, a banker will require the borrower to buy insurance
coverage for the loan and the bank shall be named as the beneficiary on the
insurance policy.

8. The banker must inform the guarantor about his duty as a guarantor to the
borrower. A banker must not misrepresent the financial strength of the borrower
or the value the collateral to the guarantor.

9. The guarantor must notify about the status of the loan especially where a problem
might arise from the loan.

10. Before making payment for the loan the banker must make sure that perfection of
security interests is done and having the bank as the first priority.

Tools for loan documentation

Documentation does not need to be fancy. The information can be concise. A

simple form will do the trick - as long as the lenders fill out the form.

Loan officer worksheets are familiar to all lenders. Most institutions have some
form of lender worksheet. Most of the worksheets have the information needed for
compliance documentation. The problem is that lenders don't use them. If you use
worksheets to document loan underwriting, be sure to maintain the clear expectation that
a "good loan" is one with proper documentation.

More advanced techniques include use of software such as Excel. These can be
developed in a shell form and provided to lenders. Using a software form can have the

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advantage of doubling as a loan committee memo. Serving this double purpose is a way
of minimizing what is perceived as "extra" work for compliance while providing the
institution with consistent documentation. Automated underwriting systems may create
the documentation. As underwriters enter the information into the system, the
documentation system is created. However, this system is dependent on collecting the
information first. And there are also situations when a "notes" box should contain
information.

Whatever system you use, lenders should not be allowed to skip steps or make
assumptions. When that happens, you have documentation deficiencies that will haunt
you. The compliance bottom line should be the loan officer's bottom line. Poorly
documented loans should count against the loan officer's performance evaluation.

Loan Documentation Deficiencies

Loan documentation deficiencies is usually occur when the a banker is careless in doing
the evaluation on the borrower or the lender is skip steps or make assumption in loan
documentation whilst they are not allowed to do it.

The loan documentation that usually faced by the bankers are:

Obsessed in Loan Term and Conditions

With regard to the preparation of the loan and security documents, good rafting
requires at every assay for these documents to encapsulate the term and conditions on
which the loan is granted and secured. It had been noticed, however, the draftsmen of
loan documents can sometimes be so obsessed in ensuring that all the term and conditions
are set out in the documents that many a time they end up repeating the term and
conditions in the loan and the security documents, whilst paying scant regard to the
important legal procedures to perfect the securities in favour of the lender. As a result,
problems are bound when the time comes to enforce these securities.

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If this situation happened the borrower can challenge the documents. Therefore
the lender should be very careful in perfecting the loan documentation before released the
loan to the borrower. The term and conditions stated in the documents must be accurate
and easy to understand by the borrower. This can reduce the risk of loan documentation
deficiencies to the bank that will lead to the loss to the bank itself.

The related case to this can be best illustrated in the case of Indian Bank vs.
Ramachandran & Ors. In this case, the seven defendants were directors of Wesmapack
(Singapore) Pte Ltd which applied in January for the banking facilities from the Indian
bank (plaintiff). The plaintiff agreed to extent the banking facilities to the company
provided the seven defendants execute the plaintiffs’ standard form guarantee for the
facilities. The guarantee (the first guarantee) was prepared and signed by the first to sixth
defendants because, all material time, the seventh defendant was away in England. The
seventh defendant however signed a separate standard form guarantee (the second
Guarantee) which was identical to the first guarantee except that the first guarantee had
all the name of seven defendants as co-sureties and the second guarantee had only the
name of the seventh defendant as surety.

The company then defaulted on the loan and was subsequently wound up. The
plaintiffs then demanded payment from the seventh defendants on the basis that all seven
defendants were jointly and severally liable under the first to sixth defendant and the
second guarantee was only signed by the seventh defendant, the plaintiff counsel
submitted the essential issue , in the circumstances of the case , was that were the parties
had an agreements for guarantees to be furnished by the directors of the company, that
agreement need not be evidenced on a single document in order that all the seven
defendants can be held jointly and severally liable for the banking facilities.

The high court of Singapore dismissed the plaintiffs’ claim on the ground that as
the first guarantee had a recital which stated that it was to be signed by the seven
defendants who were to be jointly and severally liable for overdraft facilities granted by
the plaintiffs’ to the company, it was therefore the condition precedent that the first

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guarantee was to be executed by all persons named as co-sureties. Where a promise was
intended to be made by several persons jointly but if any one of those persons failed to
execute the instruments of the agreement, there was no contract and no liability was
incurred by such of them as have entered into the agreement. The plaintiffs were not able
to show that the first to sixth defendants had consented to dispense with the execution of
the first guarantee by the seventh defendant.

Consequently, they were not entitled to enforce it. The second guarantee could not
also in law be regarded as an addendum to the first guarantee. This case was later
affirmed upon appeal.

Failure to Assess of Documents risk or Fraud

Failure to assess of documents risk or fraud may cause deficiencies to the loan
documentation. Forged of documents may be done by the irresponsible borrower to get
the money from the bank. This is another deficiencies face by the loan documentations
because it is lack of sufficient system that can trace the forge document from entering the
process of giving out loan by the bank.

The document that usually being forged by the borrower is the document of title if
the collateral gives to the bank is the real property. This situation also tests the efficiency
of the banker itself in handling the loan documentation and evaluating the borrower
before the loan is being approved. Inspection on the property charged as collateral must
be done by the banker to make sure the existence of the collateral and the exact value of
the collateral.

If the forged document is being accepted by the banker in loan documentation it

would invite problems in the future where the bank cannot enforce its right over the
collateral charged. It may cause losses to the bank where they cannot collect any money
from the borrower and the collateral charged that’s why the loan documentation must be
done carefully.

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Failure to Register the Charge

Another common mistake in perfecting the lender’s securities is the failure to

register the charges as required by law, and also the giving of advice to the lender to
release the loan upon presentations of transfers and charges simultaneously with the
lender’s withdrawal of private caveat only to find out subsequently that the charges
presented for registration at the land office has been rejected.

Section 108 CA provides that where a charged where is required to be registered

under this section, the charged shall be registered with the Registry of Companies within
30 days after its creation. Hence, if the charge is over land, then the charge is required to
be registered within 30 days after it have been registered with the land office. If the
charge is not registered within a specified period, then it can only be registered with prior
leave of the court. If the court gives the extension of time and the charge is registered,
then it becomes valid ab initio as if registered within the specified period.

However, if the application for extension is made after the commencement of

winding up the company, then the court will most likely refuse to grant the extension of
time. Non-registration of a charge which is required to be registered will make the
company and every officer of the company acting in default guilty of an offence and the
charge will be void against the liquidator and creditors of the company. In other words,
the lender will be unsecured creditor vis-à-vis the liquidator and the other creditors of the
company albeit section 108(2) CA states that the debt is still revocable by the lender.

The charges which are required to be registered under section 108 CA are:
 Debentures
 A charge on its uncalled share capital
 A charge on share of its subsidiary owned by the company

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 An instrument which is remittable as a bill of sale if executed by an individual to

charge a property to secure payment of money.
 A charge of assignment over land or any interest therein
 A charge over the company’s book debts
 A floating charge of the company’s undertaking or property
 A charge on calls made but not paid
 A charge on a ship or an aircraft or any share therein
 A charge on goodwill, on a patent or license under a patent, on a trade mark,
copyright or a license under a copyright.
 A charge on a credit balance of the company in any deposit account

Despite clear word being used in section 108 CA, doubt still arise sometimes as to
whether a particular security is required to be registered. The best approach when one is
in doubt is that one should still, nevertheless, always submit the charge of registration and
let the Registry of Companies reject it if it is unnecessary for registration under the CA.

The Documents of Income is a Must

In addition to the borrower's name and the loan type, the most important
information to document in a loan file is the borrower's income. The file should show the
amount of income and include some indication of how income was verified. If the
income documentation is not being issued in applying the loan, it would cause the
problem to the borrower when the banker wants to evaluate the performance of the
borrower. It also becomes one of the loan documentation deficiencies.

Income documentation is critical for a variety of purposes. The basic, of course, is

safety and soundness. Without evaluating how a loan will be repaid, how can the lender
assure the institution that the loan is safe and sound?

Income evaluation is also significant in fair lending. The borrower's income and
other core credit qualifications is what the lender should be considering. Documentation

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of income is one way to demonstrate that the evaluation was fair and non-discriminatory.
It can also demonstrate technical compliance with Regulation B's income treatment rules.
When a loan file shows consideration of pertinent credit qualifications, an investigator or
examiner has a comfort level that the lender looked at and considered pertinent elements
of creditworthiness rather than prohibited bases.

Similar concerns arise from predatory lending allegations. The single definition of
predatory lending on which everyone agrees is that if the borrower lacks the income to
repay the loan, it is a predatory loan. The very documentation that enables a lender to
survive a fair lending examination also provides the lender with the information needed
to respond to a charge of predatory lending.

Closely related to predatory lending are the concerns of examiners when an

institution makes sub-prime loans. Loans to sub-prime borrowers are, by their very
nature, riskier than loans to prime borrowers. Examiners want to see that the lending
decisions were made carefully and based on solid information.

Next, the file should indicate an analysis of the borrower's obligations. The key to
non-predatory lending is making loans within the ability of the borrower to repay. Income
and obligations are both essential to evaluate the ability to repay. Other information used
to evaluate the application, including credit reports and follow-up on any questions rose
in the report or the application, should be present and explained in the file.

Finally, there should be a statement, however brief, of the loan purpose. This
means that the file should contain a statement of what the borrower intends to do with the
loan proceeds. This information is relevant to safety and soundness considerations, but it
is essential information for compliance with the Bank Secrecy Act. Lenders should have
knowledge of where money is going and how it will be used when it leaves the
institution.

Value of Collateral

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Even though there is enough and perfect documentation of loan, there are one
circumstance that cannot be secured by the loan documentation. It is the value of the
collateral itself. The value of collateral can be fluctuate depends on the economic
condition, location and it s environment. For example the value of collateral of it is in
form of real property, the value will be fluctuate depends on the demand and also location
of the land itself. Therefore of the land is in remote area the value will be a bit lower
contrast with the land located in a develop area.

An acceptable appraisal reflecting the value of the land and improvements,

prepared by one of your real estate officers on an officer’s certificate or standard real
estate appraisals certificate, should be a normal requirement on small loans. Loan officers
need to be familiar with the appraisals process. They must also realize that, no matter the
professional the appraiser, in the final analysis this is only one’s party estimate of the
value of the real estate. Of course the appraiser usually bases the appraisal on valid data
obtained from marketplace comparisons. The selection and interpretation of data is
significant factor in determining the true value of the property.

Conclusion

The loan documentation is very important factors that need to be include in the
procedure to giving out loan by the finance companies or banks. Without loan
documentation the bank cannot get the security or collateral to secure the loan given out
to the borrower. It would expose the banks to the bigger risk. In cooperate with the
collateral given by the borrower too secure their loan the bank officer need to make sure
that certain term and conditions have been fulfilled by the borrower. It is to make sure
that the banks get the right on the collateral charge if there is any circumstances occur.

The bank must be very careful in documenting the loan to avoid any type of risk
in the future that will cause losses to the bank. Any loan documentation deficiencies that
occur would reduce the bank power to enforce its right and also reduce the bank

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efficiency. So, the bank need to make sure that all term and conditions is fulfilled to
protect the bank own interests.

References

Peter s. Clarke, 1992, A Banker’s Guide to Secured Lending and Documentation, BAI
Toppan.

Timothy W. Koch, 1995, Bank Management, Dryden

Wan Zakiah Wan Abdullah, Noordin Ali, 1999, Lending: Assessment and Management,
Pusat Pendidikan Lanjutan.

“Dokumen untuk Nilai Prestasi Jamin Pinjaman Lulus”, Usahawan Suksess, July-August
1999.

www.bankersonline.com, March 17, 2006.

www.bnm.gov.my, March 21, 2006

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