April 1997 through September 1997

Highlights

• Slightly more than 90 percent of the responses received during the period April 1, 1997

through September 30, 1997 from bank examiners showed no material change in underwriting practices since the last examination. Almost 6 percent showed tighter underwriting practices since the prior examination of the banks, and slightly more than 4 percent of

the responses indicated that banks loosened underwriting practices.

• Examiners noted “above-average” risk in current underwriting practices for new loans in

almost 10 percent of the banks examined. Among those banks, approximately 12 percent

also failed to adjust pricing for loan risk, according to examiners.

• Of the 398 banks examined that were actively making construction loans, almost 25 percent funded speculative (unaccompanied by commitments) construction projects “frequently enough to warrant notice”; a little more than 4 percent did so “commonly or as

standard procedure.”

• In the Boston and Chicago regions, more of the banks recently examined loosened underwriting standards than tightened them since the last examination.

Purpose and Design of the Report

Beginning in early 1995, the FDIC implemented a questionnaire to report on the riskiness

of current underwriting practices at FDICsupervised banks. The examiner-in-charge completes this questionnaire at the conclusion of each

bank examination that the FDIC conducts. This

systematic collection of these responses from examinations provides an “early-warning” mechanism for identifying potential lending problems.

The questionnaire focuses on three topics: material changes in underwriting standards for new

loans, the degree of risk in current lending practices, and underwriting standards for specific major loan categories. Loan types covered include:

business, construction, commercial real estate,

consumer, credit card, home equity, and agricultural. Excluded are those banks that either do not

make loans that pose more-than-normal risk to

the institution or are not active lenders in any of

the above-mentioned types of loans.

Examiners evaluate underwriting practices

based upon FDIC supervisory standards. Examiners are asked to rate the risk associated with underwriting practices of an institution as aboveaverage, average, or below-average. In addition,

examiners are asked to classify the occurrence of

specific risky practices as “frequent enough to

warrant notice” or, if more prevalent, “commonly

or standard procedure.”

Results can be used to monitor underwriting

practices of banks within the FDIC regions.

Comparisons across regions or different time periods must be interpreted cautiously. As noted,

the questionnaire is completed at the conclusion

of each bank examination. Thus, the banks included during any given period depend on examination scheduling requirements such as the financial condition of the bank, coordination with state

regulators, and the availability of staff. As a result, the sample is not random, and the banks

sampled during a reporting period and within a

Federal Deposit Insurance Corporation Andrew C. Hove, Jr., Chairman

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
region are not necessarily selected for examination for the same reasons as banks in another region or during a different period. As such, one

cannot draw valid statistical inferences from simple cross-region or cross-time comparisons.

Results: General Underwriting Trends

and Practices

Reports received from examiners from April

1, 1997 through September 30, 1997 (reporting

period) showed no widespread problems with

current underwriting practices for new loans.

The proportion of the responses that indicated a

material change in underwriting practices since

the last examination equaled just under 10 percent. Those citing tighter practices since the last

examination totaled close to 6 percent compared

with 4 percent reporting looser practices. Both

loan growth goals and/or increased competition

have typically been reasons given by examiners

when banks relax underwriting standards.

Examiners indicated “above-average” risk in

underwriting practices for new loans in almost 10

percent of the banks examined nationwide. Of

the banks characterized as having “aboveaverage” risk, approximately 12 percent also

“commonly” failed to adjust price for loan risk.

Additional information from responses received during the reporting period indicated:

• “Above-average” risk in loan administration

surfaced in approximately 13 percent of the

banks examined.

• Approximately 13 percent of the banks examined made new loans that resulted in high

concentrations of loans to one borrower or to

one industry “frequently enough to warrant

notice”; and almost 7 percent of the banks

examined made such loans “commonly or as

standard procedure.”

• Almost 6 percent “commonly” failed to require a material principal reduction before

renewing term loans.

Individual Loan Types

In the questionnaire, examiners are requested

to indicate the loan types that are a significant

portion of the bank's new lending and were reviewed during the examination. Note that banks

may be actively lending in more than one loan

type. Reports filed during the reporting period

showed 69 percent of the 1,233 banks examined

were active business lenders, and 56 percent were

actively making consumer loans. The proportions for other loan types are shown below.

Examiners expressed the most concern about

agricultural lending. In particular, examiners

were anxious about agricultural banks having

portfolios tied closely to crops affected by The

Federal Agriculture Improvement and Reform

Act of 1996 (FAIR). (See the section on agriculSeptember 1997 2 Report on Underwriting Practices

**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.

Banks Actively Making Loans by Loan Type

PERCENT OF RESPONSES RECEIVED: 4/97 - 9/97

Business

Consumer

NonResidential

Agricultural

Construction

Home

Equity Other*

Credit

Card Not

Applicable**

0

20

40

60

80

Percent

Current Underwriting Practices

PERCENT OF RESPONSES RECEIVED: 4/97- 9/97

Have Underwriting Practices

Materially Changed?

How Risky Are Current

Practices?

Tighter

6%

Unchanged

90%

Looser

4% Average

Risk

59%

BelowAverage

Risk

32%

Above-Average

Risk

10%
tural lending.) Construction lending received the

second highest level of deficiencies. In this case,

examiners were concerned about the frequency

of speculative lending.

Business Loans. The borrower's financial

strength and repayment source are important criteria in sound underwriting standards for business lending. For asset-based loans, the monitoring of the collateral pledged is also critical. For

the reporting period, of the 852 banks examined

and active in business lending approximately

two-thirds made asset-based loans.

• Of the banks actively making business loans,

over 19 percent loaned to borrowers who

lacked documented financial strength “frequently enough to warrant notice”; an additional 2 percent did so “commonly or as

standard procedure.”

• Over 13 percent of business lenders made

business loans without a clear and reasonably predictable repayment source “frequently enough to warrant notice,” with only

1 percent categorized as doing so “commonly or as standard procedure.”

• Approximately 18 percent of the 571 banks

making asset-based loans failed to monitor

the collateral pledged “frequently enough to

warrant notice”; only nine banks failed to

monitor “commonly or as standard procedure.”

Construction Loans. Typically, developers

receive funds to repay construction loans only

upon completion of projects. Thus, an important

concern for examiners is that the majority of a

lender’s development loans be covered by commitments for either the sale or lease of the property or refinancing by another lender. Also,

sound policy requires that repayment sources

other than the project being funded be considered. Responses received from the 398 banks examined actively making construction loans during the reporting period yielded the following:

• Almost 25 percent of the banks examined

funded speculative (unaccompanied by

commitments) construction projects “frequently enough to warrant notice”; a little

more than 4 percent did so “commonly or as

standard procedure.”

• Further, in 17 percent of the banks examined, examiners reported that banks made

construction loans without consideration of

repayment sources other than the project being funded “frequently enough to warrant

notice.” However, only 12 banks did so

“commonly or as standard procedure.” Additionally, for loans on which alternative repayment sources had been required,

examiners reported that 17 percent of the

banks failed to verify the quality of these

sources either “frequently enough to warrant

notice” or “commonly or as standard procedure.”

• For institutions making construction loans,

11 percent funded, or deferred, interest payments during the loan term “frequently

enough to warrant notice”; an additional 5

percent did so “commonly or as standard

procedure.”

Commercial Real Estate Loans. In commercial real estate lending, the income generated

from the property is the primary source of repayment. However, because future income is subject

to uncertainty, sound underwriting practices generally require alternative sources of repayment.

Responses received during the reporting period

Report on Underwriting Practices 3 September 1997

0 5 10 15 20 25 30 35

Key Construction Loan Practices

Interest payments funded by lender or

deferred during loan term

Failure to verify alternative repayment

sources other than project funded

Projects funded are speculative in nature

Failure to consider alternative repayment

sources other than project funded

Frequent Enough

to Warrant Notice

Common

Percent

3% 17%

3% 14%

4% 25%

5% 11%

PERCENT OF RESPONSES RECEIVED: 4/97- 9/97
from the 659 banks examined and active in commercial real estate lending showed:

• Slightly under 11 percent of the banks examined failed to consider alternative repayment

sources other than the project being funded

“frequently enough to warrant notice.” Only

nine banks actively making commercial real

estate loans practiced this lending “commonly or as standard procedure.”

• Approximately 14 percent of the institutions

examined made short-term commercial real

estate loans with minimal amortization and

large balloon payments “frequently enough

to warrant notice.” Another 3 percent were

characterized as making these loans “commonly or as standard procedure.”

Agricultural Credits. Examiners are asked to

determine the extent to which banks' agricultural

loan portfolios are tied to major crops affected by

the FAIR, which was signed into public law in

April 1996. Traditional crop subsidies for wheat,

feed grains, rice, and cotton that were originally

tied to prices and limits on production are replaced with fixed but declining payments to

farmers until the year 2002. The dependence of

farmers on farm subsidy programs could make

them more vulnerable to any program cuts and affect their ability to repay loans.

During the reporting period, 520 of the banks

examined were active agricultural lenders. Results indicated that the approaching declining

payments to farmers remain a problem. In fact,

more examiners were concerned about this issue

than any other deficiency in the underwriting report. However, the potential severity of this

phaseout to the banking industry depends on how

both farmers and banks adapt to the new legislation.

• Thirty percent of the examiners noted that

the banks examined have portfolios tied to

crops affected by the phaseout “enough to

warrant notice”; an additional 15 percent of

the banks examined have portfolios tied

“substantially.”

• Examiners also noted a “moderate” increase

in the volume of loans carried over from the

previous season in approximately 14 percent

of the banks examined; an additional 2 percent showed a “sharp” increase.

Consumer Loans (Excluding Credit Card

Lending). Responses received during the reporting period from the 695 banks active in consumer

lending showed the following:

• Fifteen percent of the banks made consumer

loans without adequate collateral protection

“frequently enough to warrant notice”; an

additional 3 percent made loans lacking collateral protection “commonly or as standard

procedure.”

• Some institutions made loans to borrowers

who lack a demonstrable ability to repay.

Approximately 16 percent of the banks examined were noted for making these loans

“frequently enough to warrant notice”; and

an additional 3 percent were cited for lending in this manner “commonly or as standard

procedure.”

Credit Card Loans. Approximately 8 percent

of the banks examined were active credit card

lenders. Of those institutions, three were credit

card specialty banks. (None of these three were

cited with “above-average” risk in current underwriting practices for new credit card loans.) The

September 1997 4 Report on Underwriting Practices

PERCENT OF RESPONSES RECEIVED: 4/97 - 9/97

None or Minimally

55%

Substantially

15%

Enough to

Warrant Notice

30%

Agricultural Banks with Loan Portfolios

Subject to Farm Bill
remaining institutions were not major players in

credit card lending, holding, on average, less than

1 percent of their total assets in such credits.

• Slightly more than 83 percent of all banks

examined that were active in credit card

loans showed stable underwriting practices

for new credit card lending. Just over 12 percent indicated that underwriting practices

had tightened compared with more than 4

percent showing looser practices.

• Almost 98 percent of responses indicated

“average” or “below-average” risk in underwriting practices for new credit card loans.

Home Equity Loans. Reports on the underwriting of home equity loans continued to reveal

few deficiencies among the approximately 193

institutions actively making such loans.

Regional Results:

General Underwriting Trends

Responses received during the reporting period in the Boston and Chicago regions indicated

that a larger proportion of banks loosened underwriting standards than tightened standards since

the last examination. Of the 64 banks examined

in the Boston region during the reporting period,

9 percent loosened underwriting practices since

the last examination compared with only 2 percent tightening standards. Slightly more than 7

percent of the 235 banks examined in the Chicago

region loosened standards compared with almost

4 percent tightening standards.

Highlights in general underwriting practices

in the Boston region include:

• In existing loan portfolios, examiners noted

“above-average” risk in almost 11 percent of

the banks examined.

• Examiners noted “above-average” risk in

underwriting practices for new loans in 9

percent of the banks examined.

• “Above-average” risk in loan administration

appeared in approximately 9 percent of the

responses.

For the Chicago region:

• Approximately 11 percent of the banks examined made new loans that resulted in high

concentrations of loans to one borrower or to

one industry “frequently enough to warrant

notice”; and almost 6 percent of the banks

examined made such loans “commonly or as

standard procedure.”

• More than 16 percent of the banks examined

had “above-average” risk in loan administration.

• Also, more than 12 percent of the banks examined showed “above-average” risk in underwriting practices for new loans, and

slightly more than 11 percent of the banks

examined showed “above-average” risk in

existing loan portfolios.

Report on Underwriting Practices 5 September 1997

Have Underwriting Practices

Materially Changed?

How Risky Are Current

Practices for Credit Cards?

Current Credit Card Underwriting Practices

Unchanged

83%

Looser

4%

Tighter

12% Average

Risk

62%

AboveAverage

Risk

3%

BelowAverage

Risk

35%

PERCENT OF RESPONSES RECEIVED: 4/97 - 9/97

PERCENT OF RESPONSES RECEIVED: 4/97- 9/97

Have Underwriting Practices Materially

Changed in Boston and Chicago?

Unchanged

89%

Looser

9% Tighter

2% Unchanged

89%

Looser

7% Tighter

4%

Boston Chicago
September 1997 6 Report on Underwriting Practices

Characteristics of the Banks Examined in the Report

• Coverage: 1,233 FDIC-supervised depository institutions.

• Time period: Reports filed between April 1, 1997 and September 30, 1997.

• Charter types: 92 percent of the institutions are state-chartered commercial

banks, 8 percent are state-chartered savings banks, and less than 1 percent (2

banks) are branches of foreign banks on U.S. soil.

• Size distribution of institutions: 4 percent have over $1 billion in assets, 29 percent have assets greater than $100 million but less than $1 billion, and 67 percent

have assets less than $100 million.

• Proportion of FDIC-regulated banks covered (as of June 30, 1997): 25 percent of

assets and 20 percent of institutions.

Objectives of the Report on Underwriting Practices

• To identify:

• – material changes in underwriting standards since the last examination;

• – overall riskiness of new lending practices; and

• – specific risks in underwriting practices for major loan categories.

•

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

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