Report on Underwriting Practices

October 1996 through March 1997

Highlights

Almost 91 percent of the banks examined showed no material change in underwriting practices

since their last examination. Twice as many of the banks examined tightened underwriting

practices (6 percent) as loosened (3 percent).

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

10 percent of the banks examined. Among those banks, approximately 17 percent also failed to

adjust pricing for loan risk, according to the examiners.

“Above-average” risk in loan administration of the banks recently examined was a common

concern of examiners in each FDIC region.

Purpose and Design of the Report

Beginning in early 1995, the FDIC implemented a survey to report on the riskiness of current underwriting

practices at FDIC-supervised, state-chartered nonmember banks. The survey is completed at the

conclusion of each bank examination that the FDIC conducts. By systematically collecting observations

from examination sites, the survey is designed to provide an “early-warning” mechanism for identifying

potential lending problems. 

The survey focuses on three topics: material changes in underwriting standards for new loans, degree of

risk in current practices, and specific aspects of the underwriting process for major loan categories.

 Questions about the third topic focus on underwriting weaknesses that have caused nationwide

problems in the past. Loan types covered in the survey include: business, construction, commercial realestate, consumer, credit-card, home-equity, and agricultural.

Examiners evaluate underwriting practices based on both their experience and generally-accepted

industry standards. In some cases, they rate the risk associated with underwriting practices of an

institution as average or above- or below-average. In other cases, examiners classify the occurrence of

specific risky practices as “frequent enough to warrant notice” or, if more prevalent, “commonly or

standard procedure.”

Results from the survey can be used to monitor underwriting practices of banks within the FDIC regions.

 While interesting, comparisons across regions or different time periods must be interpreted with caution.

 As noted, the survey is completed at the conclusion of each bank examination. Thus, the sample during

any given period depends on examination scheduling requirements such as the financial conditions of the

banks, 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 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 cross-region or cross-time comparisons.

Results: General Underwriting Trends and Practices

Reports received from examiners during the six months ending March 31, 1997, showed no widespread

problems with either current underwriting practices for new loans or in existing loan portfolios. Examiners

indicated a material change in underwriting practices since the last examination in just over 9 percent of

the banks examined. Twice as many banks showed tighter practices (6 percent) as looser practices (3

percent). Where standards were relaxed, examiners most frequently attributed the change to loan growth

goals or increased competitive forces. These results generally mirrored results from the April-September

1996 survey in which 90 percent of the banks examined showed no material change in underwriting

practices. However, a larger proportion of the banks examined during this most recent six-month period

tightened standards than previously; conversely, a smaller proportion loosened standards.

Examiners indicated “above-average” risk in underwriting practices for new loans in 10 percent of the

banks examined nationwide, about the same as the April-September 1996 period. Of the banks

characterized as having “above-average” risk, approximately 17 percent also “commonly” failed to adjust

price for loan risk. In existing loan portfolios, examiners noted “above-average” risk in 12 percent of the

banks, approximately the same as during the previous reporting period.

Additional information from responses received during the six months ending March 31, 1997 indicated:

 “Above-average” risk in loan administration surfaced in roughly 13 percent of the banks examined.

 Approximately 10 percent of the banks examined booked new loans that resulted in high concentration

of loans to one borrower or industry “frequently enough to warrant notice;” and an additional 6 percent of

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the banks examined booked such loans “commonly or as standard procedure.”

Individual Loan Types

In the survey, examiners are requested to indicate the loan types that are both a significant portion of the

bank's new lending and were also reviewed during the examination. Some 84 percent of banks

examined were active business lenders, and 72 percent were actively making consumer loans. A

majority of institutions were active lenders in other loan areas: nonresidential commercial real-estate

loans (67 percent) and agricultural loans (51 percent). Only 48 percent were active construction lenders,

29 percent were active home-equity lenders, and 21 percent were active credit-card lenders. Few

deficiencies existed in any loan type. 

Business Loans. The strength of the borrower and the repayment source are both important elements

in business lending. For asset-based loans, the monitoring of the collateral pledged is critical. For the six

months ending March 31, 1997, almost two-thirds of the banks active in business lending made assetbased loans. 

Approximately 15 percent of the banks making asset-based loans failed to monitor the collateral

pledged either “frequently enough to warrant notice” or “commonly or as standard procedure.”

Of the banks actively making business loans, approximately 12 percent of the banks examined

loaned to borrowers who lacked documented financial strength either “frequently enough to

warrant notice” or “commonly or as standard procedure.”

Construction Loans. Five questions in the survey cover the riskiness of construction loans. Two deal

with borrowers' repayment sources, an important concern since, typically, developers receive funds to

repay the loan fully only upon completion of the projects. The remaining three questions request

information concerning whether the institution (1) is making speculative loans, (2) defers interest

payments during the loan term, and, (3) fails to use realistic appraisal values. Responses received from

the banks examined actively making construction loans during the six months ending March 31, 1997

yielded the following:

Just under 22 percent of the banks examined funded speculative construction projects either

“frequently enough to warrant notice” or “commonly or as standard procedure.”

Examiners noted that almost 7 percent of the banks examined 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.” 

According to examiners, just under 12 percent of the banks examined made loans without

consideration of repayment sources other than the project being funded either “frequently enough

to warrant notice” or “commonly or as standard procedure.” Additionally, for loans on which

alternative repayment sources had been required, examiners reported that 10 percent of the

banks failed to verify the quality of these sources either “frequently enough to warrant notice” or

“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 the income stream often is subject to

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

received during the six months ending March 31, 1997 from the banks examined and active in

commercial real-estate lending showed:

Less than 8 percent of the banks examined failed to consider alternative repayment sources other

than the project being funded “frequently enough to warrant notice.” Only two of the over 800

banks actively making commercial real-estate loans practiced this lending “commonly or as

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standard procedure.”

About 11 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. Last year, the Congress passed legislation to phase out farm subsidies on

selected crops. As a result, examiners were asked to determine the extent to which banks' agricultural

loan portfolios are tied to major crops affected by this phase out. Available answers included: “none”,

“enough to warrant notice”, and “substantially”. For banks active in agricultural lending:

Examiners noted that 28 percent of the banks examined have portfolios tied to crops affected by

the phase out “enough to warrant notice”; an additional 7 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 just over 18 percent of the banks examined; an additional 2 percent showed a “sharp”

increase. 

Consumer Loans (Excluding Credit-card Lending). Responses received during the six months ending

March 31, 1997, from active consumer lenders showed the following:

Banks made consumer loans without adequate collateral protection “frequently enough to warrant

concern” in just under 13 percent of the banks examined; an additional 2 percent made loans

lacking collateral protection “commonly or as standard procedure.” 

Another practice cited by examiners was that the institution made loans to borrowers who lack

demonstrable ability to repay. Just over 14 percent of the banks examined were noted for making

these loans “frequently enough to warrant notice;” and an additional 2 percent were cited for

lending in this manner “commonly or as standard procedure.” 

Credit-Card Loans. Just over 21 percent of the institutions examined during the six months ending

March 31, 1997, were reported as active in credit-card lending. Of these institutions, seven were creditcard specialty banks. (Only one of these showed “above-average” risk in current underwriting practices

for new credit-card loans, and the examiner explained that such loans are priced to account for credit

risk). The remaining institutions were not major players in credit-card lending, holding on average less

than 1 percent of total assets in such credits.

Eighty-nine percent of all institutions examined that were active in credit-card loans showed stable

underwriting practices for new credit-card lending. In comparison, 95 percent of the responses

received during the previous six-month period showed stable practices.

Eight percent of the responses from banks examined that were active in the credit-card market

indicated that practices had tightened compared with only three percent showing looser practices.

Ninety-five 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 368 institutions actively making such loans.

Regional Results: General Underwriting Trends

According to the results from examiners received during the October 1996 - March 1997 reporting period,

concerns regarding general underwriting practices were similar across the country. In each FDIC region,

examiners cited the risk in loan administration as “above-average” more frequently than weaknesses in

other underwriting practices. Lenders making loans resulting in concentrations to one borrower or

industry registered the second highest percentages of concern among examiners in four of the eight

FDIC regions (Dallas, Memphis, New York, and San Francisco). In both the Atlanta and Boston regions,

examiners were more conerned that written lending policies differed from actual practices. And, in the

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Kansas City and Chicago regions, the second greatest concern was the failure to adjust loan pricing on

different quality loans.

Characteristics of the Underwriting Report Sample

Coverage: 1,277 FDIC-supervised, state-chartered nonmember depository institutions.

Time period: Reports filed between October 1, 1996 and March 31, 1997.

Charter-types: 90 percent of the institutions are state-chartered commercial banks, 9 percent

are state-chartered savings banks, and 1 percent are branches of foreign banks on U.S. soil.

Size distribution of institutions include: 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 the industry covered (as of December 31, 1996): for FDIC-regulated

institutions — 28 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.

Last Updated 7/8/1999 research@fdic.gov

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