UNSOUND BANKING PRACTICES—Excessive Premiums on Government-Guaranteed Loans; Policy Statement

Examiners should review the extent and nature of activities in connection with the sale of government-guaranteed loans. Lax or improper management of the selling institution’s servicing responsibilities should be criticized. Out-of-trade-area lending for the purpose of resale of any portion of U.S. government-guaranteed loans should be carefully reviewed to ensure that the practice is conducted in a safe and sound manner.

All income, including servicing fees and premiums charged in lieu of servicing fees, associated with the sale of U.S. government-guaranteed loans, should be recognized only as earned and amortized to appropriate income accounts over the life of the loan.

Purchasers of U.S. government-guaranteed loans should be aware that the purchase premiums are not guaranteed and are not paid by the guaranteeing federal agency when the loans are prepaid. Because payment of premiums which do not reasonably relate to the yield on the loan can distort published financial reports by overstating the value of a financial institution’s assets, it will generally be viewed as an unsafe and unsound banking practice for a financial institution to pay purchase premiums which result in a significant overstatement in the value of bank assets.

Many government-guaranteed loans currently being originated and sold are variable rate. These variable-rate loans normally should not trade at anything more than a modest premium or discount from par. Examiners will be directed to carefully review any loans being sold or purchased at significant premiums and will criticize any involvement with excessive premiums as an unsafe and unsound business practice. Excessive purchase premiums will be classified loss. The loans will be required to be revalued to the market value at the time of the acquisition, and the excessive premiums will be charged against current earnings.

In addition, any unamortized loan premium on a government-guaranteed loan must be immediately charged against income if the loan is prepaid, regardless of whether payment is received from the borrower or the guaranteeing agency.

Institutions supervised by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency are advised that guaranteed portions of U.S. government-guaranteed loans should not be recorded or carried as U.S. government or federal-agency securities. They should be carried and reported as U.S. government-guaranteed loans. STATEMENT issued by the Federal Financial Institutions Examination Council April 10, 1985.