APRIL THROUGH SEPTEMBER 1998

Purpose and Design of the Report

In early 1995, the FDIC introduced a supplementary examination questionnaire on current

underwriting practices at FDIC-supervised

banks. The questionnaire focuses on three topics:

material changes in underwriting practices for

new loans, the degree of risk in underwriting

practices, and underwriting practices for specific

categories of loans. These categories are business, consumer, commercial (nonresidential) real

estate, agricultural, construction, home equity,

and credit card loans. Excluded from the questionnaire are banks specializing in residential

real estate loans that do not pose more than normal risk to the bank and banks not actively making any of the above-mentioned types of loans.

Examiners evaluate underwriting practices in

terms of FDIC supervisory practices. They are

asked to rate the risk associated with a bank's underwriting practices as “above average,” “average,” or “below average,” and to classify the occurrence of specific risky practices as “frequent

enough to warrant notice” or, if the risky practice

is more prevalent, as “common or standard procedure.” Systematic collection and analysis of

questionnaire responses provides an earlywarning mechanism for identifying potential

lending problems.

The questionnaire is completed at the conclusion of each bank examination the FDIC conducts. Which banks are included during a report

period, therefore, depends upon how the FDIC

schedules bank examinations. Examination

schedules are heavily influenced by the financial

condition of a bank, with examinations generally

becoming more frequent the poorer a bank's financial condition. In addition, the FDIC shares

examination authority of state-chartered nonmember banks (those that are not members of the

Federal Reserve System) with state bank regulators; and to avoid excessive regulatory burden,

the FDIC generally alternates examinations with

state regulators (who do not submit questionnaires). Finally, examination schedules are affected by the availability of examination staff.

For these reasons the group of banks included in

any given report is not randomly selected and,

therefore, may not be representative of the population of FDIC-supervised banks.

Division of Research and Statistics

Virginia Olin (202)898-8711

Internet address: World Wide Web, www.fdic.gov.

Division of Supervision

Robert W. Walsh (202)898-6911

HIGHLIGHTS

• Beginning with this issue, responses have been weighted to better represent the total

population of FDIC-supervised banks (see below, “Purpose and Design of the

Report”).

• During the six months ending September 30, 1998, the proportion of banks that

loosened underwriting practices since the previous examination was slightly higher

than the proportion that tightened them (6 percent and 5 percent, respectively).

• There was a slight increase in the potential risk associated with current underwriting

practices during the six months ending September 30, 1998 compared with the six

months ending March 31, 1998.
Beginning with this issue...

. . . to partially address the potential bias that examination scheduling might introduce into the report's results, we have statistically weighted the responses. The weights are designed to make questionnaire responses in the aggregate more reflective

of the population of FDIC-supervised banks. Simply put, when we compute aggregate questionnaire

responses, we give greater weight to FDICsupervised banks that are “under represented” in the

questionnaire (when compared with the population

of FDIC-supervised banks) and less weight to “over

represented” groups.1 As a result, responses are

more comparable and trend analysis is less subject

to bias. Throughout this report, the percentages

reported refer to these weighted responses and

represent an estimate of the underwriting practices of all FDIC-supervised banks. We also wish

to point out that the data used to weight responses in

this report are subject to slight revisions. Therefore,

some of the weighted response rates might be revised in subsequent reports, but we expect no substantive changes.

GENERAL UNDERWRITING TRENDS

Reports received from examiners during the reporting period April 1 through September 30, 1998,

showed that slightly more than 6 percent of FDICsupervised banks had loosened their underwriting

practices, while 5 percent had tightened them. During the previous reporting period (October 1, 1997,

through March 31, 1998), 6 percent had loosened

practices and 4 percent had tightened them.2

When banks relax underwriting practices, loangrowth goals or increased competition or both have

typically been the reasons given by examiners. Loan

growth since the previous examination was “rapid”

in 20 percent of banks, down from 25 percent during

the six-month reporting period ending March 31,

1998.

When questioned about the banks' underwriting

practices for new lending and loan administration,

examiners were slightly more concerned during the

six months ending September 30, 1998, than during

the previous reporting period. For example, the percent of FDIC-supervised banks with “aboveaverage” risk in current underwriting practices crept

up to 12 percent compared with 10 percent during

the previous six-month reporting period ending

March 31, 1998.

September 1998 2 Report on Underwriting Practices

1To compute weights, we post-stratified the population of FDIC-supervised banks into groups, or “post-strata,” with an eye toward

grouping banks with similar examination frequencies together. Specifically, the three characteristics used to define the post-strata were

two asset size groups, eight FDIC regions, and three safety-and-soundness risk ratings.

For more information about the weights, please contact Virginia Olin, FDIC, 202/898-8711.

2The past response rates reported here are also weighted.

Proportion of FDIC-Supervised Banks Having "Above Average"

Risk in Current Underwriting Practices

(Six-month period ending . . .)

3/97 9/97 3/98 9/98

0

3

6

9

12

9 9

10

12

Proportion

General Underwriting Practices

Proportion of FDIC-Supervised Banks Having "Above Average"

Risk in Their Overall Loan Portfolio

3/97 9/97 3/98 9/98

0

3

6

9

12

10

9

10

11

Proportion

(Six-month period ending . . .)

General Underwriting Practices
Other findings for FDIC-supervised banks

showed:

• 11 percent were reported to have “aboveaverage” risk in their current loan portfolios, up

from 10 percent during the previous reporting

period.

• Approximately 13 percent were reported to

have “above-average” risk in loan administration (up from 11 percent reported during the

previous reporting period).

• Approximately 8 percent “commonly or as

standard procedure” made loans that resulted in

high concentrations of loans to one borrower or

to one industry (up from 7 percent reported during the previous reporting period).

• Six percent had written lending policies that

differed “substantially” from actual practices

(up from 4 percent during the previous reporting period).

• Five percent failed to require a material reduction in principal before renewing term loans

“commonly or as standard procedure” (down

from 6 percent during the previous reporting

period).

While examiners reported increased concern

about general underwriting practices, concern about

underwriting practices within individual loan categories remained about the same or decreased. Comments received from examiners indicated two likely

reasons for this divergence. First, while the questionnaire covers key underwriting practices within

loan categories, there are other underwriting practices not specifically addressed. Second, increased

uncertainty about the economy might have contributed to increased risk in underwriting practices

overall, even though most specific underwriting

practices did not change.

INDIVIDUAL LOAN CATEGORIES

The questionnaire asks examiners to indicate the

types of loans that were a significant portion of the

bank's new lending and were reviewed during the

examination. Responses during this reporting period show that 679 of the 1,104 banks examined were

active business lenders; 517 banks were actively

making consumer loans (excluding credit cards);

and 517 banks were actively making commercial

(nonresidential) real estate loans. The number for

other loan categories is shown in the accompanying

chart.

Compared with a year earlier, examiners showed

increased concern about underwriting practices for

new lending in each loan category, but compared

with the previous six-month reporting period ending March 31, 1998, concern remained about the

same or decreased.

Business Loans

Examiners review underwriting practices for

business loans to ensure that each borrower's financial strength and source of repayment are taken into

account. With asset-based loans, examiners review

practices to verify that the bank monitors the collateral pledged. Among the FDIC-supervised banks

actively making business loans,

• Almost 19 percent made business loans to borrowers who lacked documented financial

strength to support such lending “frequently

enough to warrant notice.” An additional 3 percent did so “commonly or as standard procedure.”

• Slightly under 13 percent made business loans

without a clear and reasonably predictable repayment source “frequently enough to warrant

notice.” Two percent did so “commonly or as

standard procedure.”

• Of the banks making asset-based loans, 14 percent failed to monitor the collateral pledged

“frequently enough to warrant notice”; another

2 percent “commonly or as standard procedure” failed to monitor.

All but one of these percentages (the percentage

of banks “commonly” making business loans withReport on Underwriting Practices 3 September 1998

Number of Banks Actively Making Loans by Loan Type

Responses Received: 4/98 - 9/98

Business

Consumer

Non-Residential

Agricultural

Construction

Other*

Home Equity

Not Applicable**

Credit Card

0 200 400 600 800

679

517

517

399

298

138

133

104

53

**Loans not specified that pose more than normal risk to the institution.

**Mainly residential loans that do not pose more than normal risk to the institution.
out a clear and reasonably predictable repayment

source) was lower than the percentages reported

during the previous reporting period.

Consumer Loans (Excluding Credit Card

Lending)

Among the FDIC-supervised banks actively

making consumer loans (excluding credit card lending), concern about underwriting practices remained about the same compared with the previous

reporting period. For example,

• Approximately 16 percent were considered to

have made loans to borrowers who lack a demonstrable ability to repay “frequently enough

to warrant notice”; an additional 5 percent were

cited for lending in this manner “commonly or

as standard procedure.” (During the previous

reporting period, the comparable figures were

18 percent and 3 percent, respectively.)

• Slightly more than 13 percent made consumer

loans without adequate collateral protection

“frequently enough to warrant notice”; an additional 4 percent made loans lacking collateral

protection “commonly or as standard procedure” (compared with 14 percent and 3 percent,

respectively, during the previous reporting period).

Commercial (Nonresidential)

Real Estate Loans

In commercial real estate lending, examiners review underwriting practices to ensure that the income generated from the property is not the only

source of repayment. Because future income is uncertain, sound underwriting practices generally

require alternative sources of repayment. Of the

FDIC-supervised banks that were active in commercial real estate,

• Thirteen percent made short-term commercial

real estate loans with minimal amortization and

large balloon payments “frequently enough to

warrant notice” (down from 15 percent during

the previous reporting period). Another 3 percent (down from 4 percent during the previous

reporting period) did so “commonly or as standard procedure.”

• Approximately 12 percent failed to consider repayment sources other than the project being

September 1998 4 Report on Underwriting Practices

Business Loans

Loans Made Without Clear and Predictable Repayment Source

(Six-month period ending . . .)

Proportion of FDIC-supervised banks making such loans either "frequently enough

to warrant notice" or "commonly."

3/97 9/97 3/98 9/98

0

5

10

15

20

10

14

17

15

Proportion

Consumer Loans

Loans Made to Borrowers Who Lack Demonstrable Ability to Repay

(Six-month period ending . . .)

Proportion of FDIC-supervised banks making such loans either "frequently enough

to warrant notice" or "commonly."

3/97 9/97 3/98 9/98

0

5

10

15

20

25

14

18

21 21

Proportion

Loans Made with No Consideration of Repayment Source

Other than the Project Being Funded

Commercial (Nonresidential) Real Estate

3/97 9/97 3/98 9/98

0

4

8

12

16

7

11

14

15

Proportion

Proportion of FDIC-supervised banks making such loans either "frequently enough

to warrant notice" or "commonly."

(Six-month period ending . . .)
funded “frequently enough to warrant notice”

(down from 13 percent during the previous reporting period). Almost 3 percent (up from 1

percent previously) failed to consider alternative sources of repayment “commonly or as

standard procedure.”

• Seven percent made interest-only, extendedamortization, or negative-amortization permanent commercial real estate loans “frequently

enough to warrant notice” (up from 6 percent

during the previous reporting period), but 0 percent did so “commonly or as standard procedure” (down from 1 percent previously).

Agricultural Loans

Examiners saw few problems with underwriting

practices for agricultural loans. They did, however,

continue to monitor the extent to which banks' agricultural loan portfolios were tied to major crops affected by the Federal Agriculture Improvement and

Reform Act of 1996.3 Twenty-eight percent of

FDIC-supervised banks active in agricultural lending — up from 27 percent during the previous reporting period — had portfolios tied to crops affected by the phaseouts “enough to warrant notice.”

And 21 percent — compared with 14 percent previously — were affected by the phaseouts “substantially.” Further, 13 percent made agricultural loans

using unrealistic cash flow projections “frequently

enough to warrant notice.” An additional 3 percent

did so “commonly or as standard procedure” (compared to 9 percent and 3 percent, respectively, previously).

Construction Loans

Examiners review underwriting practices for

construction lending to ensure that these loans are

covered by commitments either for the sale or lease

of the property or for the refinancing of the property

by another lender. Moreover, sound policy also requires that the lender consider sources of repayment

other than the project being funded (unless the bank

has set loan terms, such as collateral, pricing, and

loan-to-value ratios, which fully mitigate the need

to consider an outside source of repayment).

Of the FDIC-supervised banks active in construction lending,

• Thirty percent funded speculative construction

projects (that is, those unaccompanied by commitments) “frequently enough to warrant notice” (down from 31 percent during the

previous reporting period); a little more than 7

percent did so “commonly or as standard procedure” (unchanged from that reported during the

previous reporting period).

• Further, 23 percent made construction loans

without considering sources of repayment

other than the project being funded “frequently

enough to warrant notice” (up from 19 percent

previously). Approximately 3 percent did so

“commonly or as standard procedure” (down

from 5 percent previously).

• In addition, 14 percent required alternative

sources of repayment but failed to verify the

quality of these sources “frequently enough to

warrant notice”; an additional 2 percent failed

to verify the quality of these sources “commonly or as standard procedure.” (Both percentages were lower than those reported

previously.)

• Fourteen percent funded, or deferred, interest

payments during the loan term “frequently

enough to warrant notice”; an additional 6 percent did so “commonly or as standard procedure.” (Both percentages were essentially

unchanged from those reported previously.)

Report on Underwriting Practices 5 September 1998

3Whereas previous laws allowed traditional subsidies tied to

prices and limits on production, this law allowed declining payments to farmers until the year 2002 for certain crops.

Proportion of FDIC-supervised banks making such loans either "frequently enough

to warrant notice" or "commonly."

Construction Loans

Loans Made on a Speculative Basis

(Six-month period ending . . .)

3/97 9/97 3/98 9/98

0

10

20

30

40

21

27

38 37

Proportion
September 1998 6 Report on Underwriting Practices

Have the institution's underwriting practices

materially changed since the last examination:

If practices have materially changed, are they:

How would you characterize the institution's

recent loan growth since the last examination:

How would you characterize the potential risk

associated with the institution's current

underwriting practices:

How would you characterize the potential credit

risk of the institution's overall loan portfolio:

To what extent has recent lending been made in

amounts that resulted in—or contributed to—

concentrations of credit to one borrower or industry:

How would you characterize the risk associated

with loan administration:

To what degree does the institution fail to adjust its

loan pricing on different quality loans to reflect

differences in risk:

To what extent does the institution's written

lending policies differ from actual practices:

To what extent does the institution fail to require a

material principal reduction before renewing term

loans:

To what extent does the institution make business

loans without a clear and reasonably predictable

repayment source:

To what extent does the institution make business

loans to borrowers who lack documented financial

strength to support such lending:

With respect to asset-based business loans, to what

extent does the institution fail to monitor collateral:

To what extent is the institution funding

construction projects on a speculative basis (i.e.,

without meaningful pre-sale, pre-lease or take-out

commitments):

To what extent are construction loans made

without consideration of repayment sources other

than the project being funded:

When alternative repayment sources are

required, to what extent does the institution fail to

take appropriate steps to verify the quality of these

sources:

To what extent does the institution fail to use

realistic appraisal values relative to the current

economic environment and/or to the performance

observed on similar credits:

To what extent does the institution fund, or defer,

interest payments during the term of its commercial

construction loans:

Yes 9.7% 8.1% 9.0% 10.7% 11.7%

No 90.3 91.9 91.0 89.3 88.3

Tighter 4.7 5.3 4.8 4.4 5.3

Looser 4.9 2.8 4.2 6.4 6.3

Zero or Negative NA 14.7 11.9 11.2 14.9

Moderate NA 66.3 66.3 64.0 64.9

Rapid NA 19.1 21.8 24.8 20.2

Below Average 25.3 28.8 33.2 32.6 27.0

Average 63.6 62.5 58.3 57.0 61.5

Above average 11.1 8.7 8.5 10.4 11.5

Below average 38.5 35.7 39.5 40.6 32.8

Average 50.5 54.8 51.8 49.7 56.0

Above average 11.0 9.5 8.8 9.6 11.3

Never or infrequently 86.1 85.4 81.1 79.1 77.7

Frequently enough to warrant notice 9.1 9.5 12.5 13.9 14.5

Commonly or standard procedure 4.8 5.2 6.4 7.0 7.8

Below average 32.3 31.1 33.9 35.7 30.7

Average 53.5 57.4 54.3 52.9 56.2

Above average 14.2 11.4 11.7 11.4 13.1

Rarely 68.0 69.8 68.3 72.1 73.0

To some degree 27.7 26.1 26.6 23.4 22.3

Commonly 4.4 4.2 5.1 4.6 4.7

Identical or minimal difference 85.4 76.6 75.8 72.5 71.5

Moderately different 11.8 20.4 21.1 23.1 22.7

Substantially different 2.9 3.1 3.1 4.4 5.8

Rarely NA 58.6 60.9 63.1 62.5

To some degree NA 35.4 33.9 31.3 32.7

Commonly NA 5.9 5.2 5.6 4.8

Never or infrequently 89.9 90.2 85.9 82.6 85.1

Frequently enough to warrant notice 9.3 9.2 13.0 15.6 12.6

Commonly or standard procedure 0.7 0.7 1.1 1.8 2.3

Never or infrequently 93.7 89.0 79.8 76.7 78.6

Frequently enough to warrant notice 5.8 10.3 18.8 20.6 18.9

Commonly or standard procedure 0.4 0.7 1.4 2.7 2.5

Never or infrequently NA 85.8 81.5 79.0 83.6

Frequently enough to warrant notice NA 9.4 17.2 18.0 14.4

Commonly or standard procedure NA 4.8 1.4 3.0 2.0

Never or infrequently 89.6 79.2 72.6 62.2 63.2

Frequently enough to warrant notice 8.3 17.3 23.8 30.6 29.7

Commonly or standard procedure 2.2 3.5 3.7 7.2 7.2

Never or infrequently 92.5 89.3 81.3 76.4 74.3

Frequently enough to warrant notice 7.0 10.0 16.1 18.7 22.6

Commonly or standard procedure 0.5 0.7 2.5 5.0 3.1

Never or infrequently 91.2 91.0 84.0 79.1 83.6

Frequently enough to warrant notice 5.4 7.6 13.8 16.7 14.1

Commonly or standard procedure 3.4 1.4 2.2 4.1 2.2

Never or infrequently 94.9 93.0 90.2 86.0 86.0

Frequently enough to warrant notice 4.7 6.4 9.2 12.2 11.8

Commonly or standard procedure 0.3 0.6 0.6 1.8 2.2

Never or infrequently 94.0 89.2 85.7 80.3 79.8

Frequently enough to warrant notice 4.2 5.9 10.6 13.9 14.4

Commonly or standard procedure 1.8 4.9 3.7 5.8 5.8

Results from the Report on Underwriting Practices

Percent of respondents

WEIGHTED

6-month period ending:

9/96 3/97 9/97 3/98 9/98

NA – Not available
Report on Underwriting Practices 7 September 1998

To what extent are commercial real estate loans

made without consideration of repayment sources

other than the project being funded:

To what extent does the institution make interestonly, extended amortization, or negative

amortization permanent commercial real estate

loans:

To what extent does the institution make shortterm commercial real estate loans (Mini-perms) with

minimal amortization terms and large balloon

payments at maturity:

To what extent does the institution fail to use

realistic appraisal values relative to the current

economic environment and/or to the performance

observed on similar credits:

To what extent does the institution make home

equity loans that push mortgage indebtedness

above 90 percent of collateral value:

To what extent does the institution calculate equity

for home equity loans based on recent escalation in

home prices:

To what extent does the institution qualify

borrowers for home equity credit based on initiallydiscounted loan rates:

To what extent does the institution make

agricultural loans based on artificially-inflated land

values:

To what extent is the institution's agricultural loan

portfolio tied to major crops affected by the phase

out of farm subsidies:

To what extent are agricultural loans being made

based on unrealistic cash flow projections:

How would you characterize the change in the

level of the institution's agricultural related

carryover debt since the lst examination:

To what extent does the institution make

consumer loans without adequate collateral

protection:

To what extent does the institution make

consumer loans to borrowers who lack demonstrable

ability to repay:

If the institution's underwriting practices for new

credit card loans have materially changed since the

last examination, are they:

How would you characterize the level of risk

associated with the institution's current

underwriting practices for new credit card loans:

How would you characterize the level of risk

associated with the institution's credit card

portfolio:

Infrequently 93.5% 92.9% 89.5% 86.1% 85.1%

Frequently enough to warrant notice 6.1 7.0 9.6 12.5 12.3

Commonly or standard procedure 0.4 0.2 0.9 1.4 2.6

Never or infrequently 95.9 95.8 93.6 93.0 92.8

Frequently enough to warrant notice 4.0 3.6 6.1 6.3 7.2

Commonly or standard procedure 0.2 0.5 0.2 0.7 0.0

Never or infrequently 90.7 87.9 84.7 80.6 84.7

Frequently enough to warrant notice 7.7 9.8 12.5 15.0 12.7

Commonly or standard procedure 1.6 2.3 2.8 4.4 2.7

Never or infrequently 95.1 95.3 91.8 90.0 89.6

Frequently enough to warrant notice 4.7 4.3 7.5 9.2 9.9

Commonly or standard procedure 0.3 0.4 0.7 0.8 0.6

Never or infrequently 96.3 92.7 88.0 88.1 86.8

Frequently enough to warrant notice 3.1 5.0 7.9 9.9 11.5

Commonly or standard procedure 0.7 2.3 4.1 2.0 1.7

Never or infrequently 97.5 95.7 90.3 82.2 79.8

Frequently enough to warrant notice 2.1 4.1 8.0 16.4 12.3

Commonly or standard procedure 0.3 0.3 1.7 1.5 7.9

Never or infrequently 99.0 99.1 97.1 99.0 98.3

Frequently enough to warrant notice 0.6 0.8 1.6 1.0 1.7

Commonly or standard procedure 0.3 0.2 1.4 0.0 0.0

Never or infrequently 98.3 98.7 96.2 96.4 96.1

Frequently enough to warrant notice 1.7 1.3 3.3 3.2 3.7

Commonly or standard procedure 0.0 0.0 0.5 0.4 0.3

None or minimally 59.9 66.2 54.9 59.2 51.2

Enough to warrant notice 36.3 27.0 30.3 27.1 27.7

Substantially 3.8 6.9 14.8 13.7 21.1

Never or infrequently 91.2 93.0 89.3 88.1 84.3

Frequently enough to warrant notice 7.2 6.1 8.7 9.4 12.6

Commonly or standard procedure 1.6 0.9 2.0 2.5 3.1

Sharp decline NA 2.5 4.7 2.4 0.8

Moderate decline NA 26.1 30.3 25.5 17.6

No change NA 51.1 50.1 60.5 55.8

Moderate increase NA 18.7 13.5 10.4 23.5

Sharp increase NA 1.6 1.5 1.2 2.4

Never or infrequently 91.5 86.4 82.4 83.0 82.6

Frequently enough to warrant notice 6.6 11.6 14.7 14.2 13.5

Commonly or standard procedure 1.9 2.0 3.0 2.8 3.9

Never or infrequently 90.5 85.8 82.3 78.9 79.5

Frequently enough to warrant notice 8.1 12.9 15.6 18.0 16.0

Commonly or standard procedure 1.4 1.3 2.2 3.1 4.5

Not applicable 95.1 89.9 82.0 84.3 89.1

Tighter 2.5 7.6 14.0 13.7 9.4

Looser 2.4 2.6 3.9 2.0 1.5

Below Average 29.0 24.6 34.2 22.9 27.9

Average 70.0 71.8 63.8 73.8 67.5

Above average 1.1 3.6 1.9 3.4 4.7

Below Average 23.6 23.1 29.2 27.2 27.0

Average 73.5 70.6 63.0 70.0 65.8

Above average 2.9 6.3 7.7 2.8 7.2

Results from the Report on Underwriting Practices (continued)

Percent of respondents

WEIGHTED

6-month period ending:

9/96 3/97 9/97 3/98 9/98

NA – Not available
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Characteristics of Banks Examined in the

Report on Underwriting Practices

• Coverage: 1,104 FDIC-supervised banks.

• Period: Reports filed between April 1 and September 30, 1998.

• Charter types: state-chartered commercial banks, 91 percent; state-chartered savings banks,

9 percent; branches of foreign banks on U.S. soil, less than 1 percent (3 banks).

• Size distribution of banks: assets of $1 billion or greater, 4 percent; assets between $300 million and $1 billion, 9 percent; assets between $25 million and $300 million, 69 percent; assets less than $25 million, 18 percent.

• Proportion of all FDIC-supervised banks (as of June 30, 1998): 21 percent of assets and 18

percent of the number of banks.

The Report on Underwriting Practices seeks

• To identify (1) material changes in underwriting practices, (2) overall risk in new lending

practices, and (3) specific risks in underwriting practices for major loan categories.

• To track emerging issues in underwriting practices of new loans.

• To provide an early-warning mechanism for identifying potential problems.