The Monetary Board, in its Resolution No. 1093 dated December 22, 1989, approved the following amendments to Books I, II, III, IV of the Manual of Regulations for Banks and Other Financial Intermediaries:

SECTION 1. The following are hereby added to Part I of Books I, II, III and IV of the Manual of Regulations to read as follows:

œ___________ ^[1] Management of Risk Assets. It shall be the responsibility of the board of directors of a bank/NBQB to formulate written policies on the extension of credit and risk diversification and to set the guidelines for evaluation of risk assets. Well-defined lending policies and sound lending practices are essential if a bank/NBQB is to perform its credit-creation function effectively and minimize the risk inherent in any extension of credit. The responsibility should be approached in a way that will provide assurance to the public, thru stock holders and supervisory authorities that timely and adequate action will be taken to maintain the quality of the loan portfolio and other risk assets on the extension of credit and risk diversification and to set the guidelines for evaluation of risk assets. 

SECTION 2. The following are hereby added to Part III Books I, II, III and IV of the Manual of Regulations to read as follows:

œ___________ ^[2] Loan Portfolio and Other Risk Assets Review System - To ensure that timely and adequate management action is taken to maintain the quality of the loan portfolio and other risk assets and that adequate loss reserves are set up and maintained at a level sufficient to absorb the loss inherent in the loan portfolio and other risk assets, each bank/NBQB shall establish a system of identifying and monitoring existing or potential problem loans and other risk assets and of evaluating credit policies vis-a-vis prevailing circumstances and emerging portfolio trends. Management must also recognize that loss reserve is a stabilizing factor and that failure to account appropriately for losses or make adequate provisions for estimated future losses may result in misrepresentation of the bank ™s/NBQB ™s financial condition.

œThe system of identifying and monitoring problem loans and other risk assets and setting up of allowance for probable losses may include but is not limited to the following criteria:

œSubsec. _______ ^[3] Classification of loans - In addition to classifying loans as either current or past due the same should be qualitatively appraised and grouped as Unclassified or Classified.

œSubsec. _______ ^[4] Unclassified loans - These are loans that do not have a greater-than-normal risk and do not possess the characteristics of classified loans as defined in the succeeding subsection. The borrower has the apparent ability to satisfy his obligations in full and therefore no loss in ultimate collection is anticipated.

œSubsec. ________ ^[5] Classified Loans - These are loans which possess the characteristics outlined hereunder. Classified loans are subdivided into (a) Loans especially mentioned; (b) Substandard; (c) Doubtful; (d) Loss.

œa. Loans especially mentioned. These are loans or portions thereof which are superior in quality to those classified Substandard, but which are potentially weak e.g., where there is lack of collateral, credit information or documentation and thus require closer management supervision. These loans do not have sufficient adverse information to warrant Substandard classification.

œThis Category may include the following:

1. Loans with technical defects and collateral exceptions, such as:

1. Unlocated collateral folders and documents including but not limited to title papers, mortgage instruments and promissory notes;
   
   
2. Improper execution of the supporting deed of assignment/pledge agreement/chattel mortgage/real estate mortgage;
   
   
3. Unregistered and/or unnotarized mortgage instruments as required in the loan approval;
   
   
4. Collaterals not covered by appraisal reports or appraisal reports of which are unlocated;
   
   
5. Collaterals not insured or with inadequate/expired insurance policies; and
   
   
6. Loans to firms not covered by board resolutions authorizing the borrowings.

2. Loans not supported by up-to-date and adequate financial statements or adequate credit information. Regardless of the size of the financial intermediary, it is important that available credit information on its borrowers be complied in the credit folders/files for effective credit supervision. Included in this group are:

1. Loans - renewed without updated financial statements, income tax returns and/or statements of assets and liabilities; and
   
   
2. Loans without credit investigation reports or updated credit information.

3. Loans which need the attention of management for special and/or corrective action. Common to this group of loans are:

1. Loan accounts wherein effort to collect is not evident or is deemed inadequate;
   
   
2. Loans granted beyond the limits of approving authority;
   
   
3. Availments against expired credit line; availments in excess of credit line; or availments against credit line without prior approval by appropriate authority;
   
   
4. Demand loans outstanding for an unreasonable length of time;
   
   
5. Loans granted without compliance with conditions set forth in the approval;
   
   
6. Loans with promissory notes signed by unauthorized officers of the borrowing firm;
   
   
7. Loans secured by property the title to which bears an uncancelled annotation of lien or encumbrance; and
   
   
8. Loans to firms with profitable operations but belonging to a distressed industry.

4. Loans the repayment of which may be endangered by economic or market conditions that in the future may affect the borrower ™s ability to meet scheduled repayments such as declining or fluctuating operation, illiquidity, or increasing leverage trend in the borrower ™s financial statements.

œb. Substandard loans - These are loans or portions thereof which appear to involve a substantial and unreasonable degree of risk to the institution because of unfavorable record or unsatisfactory characteristics. There exists in such loans the possibility of future loss to the institution unless given closer supervision. No loan should be classified Substandard if repayment seems reasonably assured. Loans classified as Substandard must have a well-defined weakness or weaknesses that jeopardize their liquidation. Such well-defined weakness may include adverse trends or development of financial, managerial, economic or political nature, or a significant weakness in collateral.

œThe basic characteristics of loan accounts subject to Substandard classification are as follows:

1. Secured loans

a. Loans under litigation;

b. Past due and circumstances are such that there is an imminent possibility of foreclosure or acquisition of the collateral because of failure of all collection efforts;

c. Past due for more than six (6) months without reduction in principal but in process of collection; and

d. Current loans to borrowers with inadequate net worth, poor earnings, or whose properties securing the loan have declined in value materially or have been found with defects as to ownership or other adverse information.

œLoans possessing any of the above characteristics should be classified Substandard at the full amount except portions thereof secured by hold-outs on deposits, margin deposits or government-supported securities. The portions so secured are not subject to classification.

2. Unsecured Loans

a. Items under litigation;

b. Loans past due for more than ninety (90) days;

c. Renewed/extended loans without at least twenty per cent (20%) repayment of the principal before renewal or extension;

d. Unmatured loans which have become unsound due to unfavorable results of operations of the borrower, minimal capitalization of the borrower in relation to the loan and/or project financed, weaknesses inherent to conduit loans or loans availed of for the benefit of another party, or absence of favorable track record showing borrower ™s financial responsibility; and

e. Loans to distressed industries repayments of which are imperiled.

c. Doubtful loans - These are loans or portions thereof which have the weaknesses inherent in those classified as Substandard, with the added characteristics that existing facts, conditions, and values make collection or liquidation in full highly improbable and in which substantial loss is probable.

œThe basic characteristics of loan accounts subject to Doubtful classification are as follows:

1. All past due clean loans classified as Substandard in the last Central Bank examination without at least twenty per cent (20%) repayment of principal during the succeeding twelve (12) months or with current unfavorable credit information;

2. Past due loans secured by collaterals which have declined in value materially such as inventories, receivables, equipment, and other chattels without the borrower offering additional collateral for the loans coupled by the weakened financial condition of the borrower;

3. Past due loans secured by real estate mortgage title to which is subject to an adverse claim rendering settlement of the loan through foreclosure doubtful;

4. Loans the possibility of loss of which is extremely high but because of certain important and reasonably specific pending factors that may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until a more exact status may be determined.

d. Loss - These are loans or portions thereof which are considered uncollectible or worthless and of such little value that their continuance as bankable assets is not warranted although the loans may have some recovery or salvage value. The amount of loss is difficult to measure and it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be obtained in the future. Also included under this category are statutory bad debts as defined under Subsection ____ ^[6] .

œThe basic characteristics of loan accounts subject to Loss classification are as follows:

1. Past due clean loans and advances the interest of which is unpaid for a period of six (6) months;

2. Past due well secured loans and advances not in process of collection, interest of which is unpaid for a period of six (6) months;

3. Loans payable in installments where amortization applicable to interest is past due for a period of six (6)months, unless the loan is well secured and in process of collection;

4. When the borrower ™s whereabouts is unknown, or he is insolvent, or his earning power is permanently impaired and his co-makers or guarantors are insolvent or that their guaranty is not financially supported;

5. Where the collateral securing the loan is considered worthless and the borrower and/or his co-makers are insolvent;

6. Loans considered as absolutely uncollectible; and

7. Loans classified as Doubtful in the last Central Bank examination and without any payment of interest or substantial reduction of principal during the succeeding twelve (12) months or has current unfavorable credit information which renders collection of the loan highly improbable.

Subsec. _________ ^[7] Investments and other risk assets.

1. Temporary investments in stocks and bonds should be valued at lower of cost or market. The lower of cost or market should be applied to the portfolio in its entirety. A valuation reserve account should be set up to reflect a material or major market decline equivalent to at least ten per cent (10%) of the book value.

2. Equity investment in affiliates shall be booked at cost or book value whichever is lower on the date of acquisition. If cost is greater than book value, the excess shall be charged in full to operations or booked as deferred charges and amortized as expense over a period not exceeding five years. Subsequent to acquisition, if there is an impairment in the recorded value, the impairment should adequately be provided with allowance for probable losses.

3. Other Property Owned or Acquired.

a. The basic characteristics of real estate property acquired subject to Substandard classification are as follows:

1. Acquired for less than five (5) years unless worthless.

2. Converted into a Sales Contract Receivable.

3. Sold to subject to a firm purchase commitment from a third party before the close of the examination.

b. The basic characteristics of real estate property acquired subject to Loss classification are as follows:

1. The accrued interest, foreclosure expenses, and other charges included in the book value.

2. The excess of the book value over the appraised value.

3. Property whose title is definitely lost to a third party or is being contested in court.

4. Property wherein the exercise of the right of usufruct is not practicable or possible as when it is eroded by a river or is under any like circumstances.

Real estate property acquired are not sound bank assets. Because of their nature, that is , non-liquid and non-productive, their immediate disposal through sale is highly recommended. If such is not possible, they should be charged-off by annually providing a valuation reserve in accord and with the following schedule starting at the expiration of the statutory redemption period.

End of Year After Expiry of Redemption Period or Perfection of Contract	Annual Provision (1% to Cost of Acquisition)
		Accumulated Reserve
6th Year	10%	10%
7th Year	10%	20%
8th Year	10%	30%
9th Year	10%	40%
10th Year	10%	50%

4. Acquired or Repossessed Personal Property -

a. All personal property owned or acquired held for three (3) years or less from date of acquisition shall be classified as Substandard assets.

b. The basic characteristics of acquired or repossessed personal property classified as Loss are as follows:

1. Property not sold for more than three years from date of acquisition;

2. Property which is worthless or not saleable;

3. Property whose title is lost or is being contested in court;

4. The accrued interest, foreclosure expenses and other charges included in the book value of the property; and

5. The excess of the book value of the property over its appraised or realizable value.

Valuation reserves shall also be provided for foreclosed personal property in accordance with the following schedule, reckoned from the date of foreclosure or from the perfection of the contract, if acquired through dation in payment.

End of Year After Expiry of Redemption Period or Perfection of Contract	Annual Provision (1% to Cost of Acquisition)	Accumulated Reserve
1st year	50%	50%
2nd Year	30%	80%
3rd Year	20%	100%

5. Accounts Receivable -

a. Accounts receivable arising from loan and investment accounts should be classified similar to their respective loan and investment accounts.

b. All other accounts receivable should be classified in accordance with age as follows unless there is good reason for non-classification:

No. of days Outstanding Classification     61-180 Substandard 181-360 Doubtful 361 or more Loss
The classification according to age of accounts receivable should be used in classifying other risk assets not covered above. However, their classification should be tempered by favorable information gathered in the review.

6. Accrued Interest Receivable -

a. Accrued interest receivable on loans or loan installments still uncollected after six (6) months from the date such loans or loan installments have matured or have become past due shall be provided with a 100% allowance for uncollected interest on loans, in accordance with Subsections ____ ^[8] of the Manual of Regulations for Banks and Other Financial Intermediaries.

b. All other accrued interest receivable on loans or loan installments shall be classified similar to the classification of their respective loan accounts.

œSubsec. ______ ^[9] Allowance for probable losses. An allowance for probable losses on the loan accounts and other risk assets should be set up in accordance with the following:

Classification	Allowance
a. Unclassified	0%
b. Loans Especially Mentioned	0%
c. Substandard (Unsecured Portion)	25%
d. Doubtful	50%
e. Loss	100%

œThe allowance for probable losses shall be adjusted accordingly for additional allowance required by the Central Bank.

œManagement is encouraged to provide additional allowance as it deems prudent and to formulate additional specific guidelines within the context of the herein-described system.

œSubsec. ____ 10 Transitory provision. Compliance with the establishment of the Loan Portfolio and Other Risk Assets Review System shall not be later than December 31, 1989 and submit to the Central Bank on or before January 31, 1990 a copy of such system and submit thereafter any subsequent change within thirty (30) days from date of such change.

œAllowance for probable losses on the unsecured portion of loans and other risk assets classified Substandard shall be set up quarterly based on the result of the examination conducted by the Central Bank after (date of Circular) in accordance with the following schedule reckoned from the date of examination:

1. Expanded Commercial Banks, Commercial Banks and NBQBs - Two (2) years
   
   
2. Thrift Banks - Five (5) years
   
   
3. Rural Banks - Five (5) years: Provided, That where the total amount of allowance to be set up would impair a rural bank ™s net worth such as to constrict its lending operations, the period may be extended to a maximum of ten (10) years upon prior approval of the Central Bank.
   
   œAllowance for probable losses for loans and other risk assets classified as Doubtful and Loss as required by the Central Bank shall be set up immediately. 

œSubsec. ________ ^[11] Sanctions - Compliance with the requirements in Subsection ______ ^[10] shall be a condition for the processing and/or approval of any of the following requests:

œa. For authority to establish new banking offices, regardless of type or category;

œb. For permit to operate new banking offices, regardless of type or category; and

œc. For availment of Central Bank credit facilities and other special financing programs managed by the Central Bank, except as may be allowed under Section 90 of Republic Act No. 265, as amended. 

SECTION 3. Subsections 1304.8, 2304.8, 3304.4c, and 4304Q.7 of Books I, II, III, and IV, respectively, are hereby deleted.

This Circular shall take effect immediately.

Adopted: 19 Jan. 1990

(SGD.) GABRIEL C. SINGSON
Senior Deputy Governor

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^[1] Sec. 1138 (Book I), 2138 (Book II), 3138 (Book III) and 4138Q (Book IV).

^[2] Sec. 1306 (Book I), 2306 (Book II), 3306 (Book III) and 4306Q (Book IV)

^[3] Subsec. 1306.1 (Book I), 2306.1 (Book II), 3306.1 (Book III) and 4306Q.1 (Book IV)

^[4] Subsec. 1306.2 (Book I), 2306.2 (Book II), 3306.3 (Book III) and 4306Q.3 (Book IV)

^[5] Subsec. 1306.3 (Book I), 2306.3 (Book II), 3306.3 (Book III) and 4306Q.3 (Book IV).

^[6] Subsection 1136.1a (Book I), 2136.1 (Book II), 3136.1 (Book III) and 4306Q.1 (Book IV)

^[7] Subsec. 1306.4 (Book I), 2306.4 (Book II), 3306.4 (Book III) and 4306Q.4 (Book IV)

^[8] Subsec. 1303.5d (Book I), 2303.5d (Book II), 3304.4a (Book III) and 4303Q.7d (Book IV).

^[9] Subsec. 1306.5 (Book I), 2306.5 (Book II), 3306.5 (Book III) and 4306Q.5 (Book IV)

^[10] Subsec. 1306.6 (Book I), 2306. 6 (Book II, 3306.6 (Book III) and 4306Q.6 (Book IV)

^[11] Subsec. 1306.7 (Book I), 2306.7 (Book II), 3306.7 (Book III) and 4306Q.7 (Book IV).