Classified loans are bank loans that have been issued according to the terms and regulations of the bank, but later become somewhat suspect by the bank examiners. Often, this takes place when information that was not available at the time of issue is uncovered, or circumstances with the borrower undergo some sort of change. A classified loan is not understood to be a bad risk, but may be considered worth watching more closely than other classifications of loans.
In some cases, a bank examiner may come across a loan that was made to a borrower who appears to be somewhat marginal in the ability to repay the loan balance. It is not unusual for some bankers to extend loans to long time clients who are temporarily undergoing a financial downturn, based on past payment records with the banks. The examiner, however, may also consider the current credit rating of the individual to be questionable and feel that the bank is at additional risk. When this evaluation is made, the transaction is listed as a classified loan, and it is likely that the repayment activity will be watched a little more closely.
Another reason for a loan to be flagged as classified is when changes in bank policies and procedures take place. This is especially true within a merger situation. While all banking institutions follow the same basic regulations regarding banking and financing, it is not unusual for individual banks to vary somewhat in how the interact with customers. When a merger takes place, the new entity may adopt more stringent standards for issuing loans. This may lead to an existing loan inherited from one of the former separate banking entities to be considered of a higher risk, and be marked as a classified loan.
Last, changes in the financial outlook of a borrower may lead to viewing an existing loan as a classified loan. For example, the borrower may have possessed an excellent credit rating at the time the loan was approved, but has since lost his or her high paying job and is now working at a job that pays significantly less. Even if the borrower is managing to make the installment payments on time, the bank may consider the loan to be classified until the loan is repaid in full, or the borrower experiences an upswing in his or her financial outlook.
It is important to note that the designation of classified loan does not mean that the debtor is not credit worthy, or that he or she is necessarily demonstrating behavior that indicate an impending default on the loan. Rather, the categorization of a loan as classified simply means the bank may wish to watch for further developments that may or may not place the assets of the bank at greater risk.
