elizabeth a duke : restoring credit to communities speech by ms elizabeth a duke, member of the board of governors of the federal reserve system, at the fifty - third annual western independent bankers conference, scottsdale, arizona, 31 march 2010. the original speech, which contains various links to the documents mentioned, can be found on the us federal reserve system ’ s website. * * * good morning. i am pleased to be here today to address the western independent bankers annual conference. as many of you know, i spent most of my career as a community banker. what you may not know is that i first became ceo of a community bank under an unusual set of circumstances. i found myself in the ceo ’ s seat unexpectedly, after the sudden death of my mentor, the man who had taught me banking and with whom i had started and built that bank carefully over the years. in addition, it was august 1991, which i ’ m sure you will recognize as the peak of the last credit crisis. it was a typical community bank. we loaned inside our market to customers who had been with us for many years. as the economy weakened in the early 1990s, those customers struggled and the value of their collateral dropped. neither we nor our customers had caused the crisis, but we still had to face it and deal with it. throughout those challenging years, we had some successful workouts and some that were not so successful. sound familiar? so, i have experienced banking crises from different perspectives throughout my career. having dealt with the last banking crisis as a banker, i understand the stress many of you and many of your customers feel today. i also know firsthand the importance of recognizing problems early and tackling them head on. having experienced the more recent crisis at the fed, i can assure you that this environment is every bit as stressful for your regulators. even in the best of times, lending involves judgment. so does bank supervision. during times of stress, the judgment calls get more difficult and more critical. an economy and its financial system are inextricably intertwined and bank supervisors are charged with maintaining the safety and soundness of the system without impeding the flow of loans to creditworthy borrowers. the linkages that connect community banks, the communities they serve, and their bank supervisors, are especially interwoven and essential. now i am happy to report that our bank and, for the most part, our customers pulled through that crisis in the early 1990s. and i continued

in perception is through welldocumented facts. for example, to support the value of a construction project, the bank would need current information on the project status, including an estimate of the cost to complete. it would also need documentation of the method of realizing value for the completed project. for instance, if the borrower has a take - out permanent loan commitment, the file should include an update on the status of the commitment including any conditions to closing. if the property is under a sales contract, the bank should document the buyers ’ continued willingness and ability to close. if the bank is relying on other resources of borrowers or guarantors for repayment, it should have global cash flow information to be able to assess their ability to continue to carry the loan until conditions improve. the fact that the loan has a good payment history and is performing is important, but not sufficient to make the case that resources are available to keep it current in the future. finally, the bank should have either a current appraisal or sufficient current market information to credibly update the assumptions in the most recent appraisal. if market conditions are changing rapidly, “ current information ” may need to be more up - to - date than is usually the case. examiners generally are not expected to challenge the underlying valuation assumptions, including discount rates and capitalization rates, used in appraisals or evaluations when these assumptions differ only in a limited way from norms that would generally be associated with the collateral under review. loans will be classified and valued on the basis of cash flow first, and collateral value second. assessments of cash flow and valuation will be much more reliable if based on solid documentation. in the absence of documentation, examiners will have to make assumptions. most loans should fall into one of three categories : first, if available cash flow, including the willingness and ability of any guarantors to provide cash support, is sufficient to carry a construction project to completion or to amortize a completed project on reasonable terms at a market rate of interest, the loan should not be classified ; if, on the other hand, there is no available cash flow to carry the loan and repayment can only come from the sale of the collateral, an amount equal to the value of the collateral less selling expenses will be classified and any remaining amount charged off ; and finally, if cash flow is sufficient to partially amortize the loan, the bank may be able to restructure the loan into