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Report on Underwriting Practices
February 1995 to February 1996
Characteristics of the Underwriting Report
Purpose and Design of the Report
Beginning in early 1995, the FDIC required its examiners to report formally on the riskiness of underwriting practices at the conclusion of each examination for institutions the agency supervises. The program was initially tested at selected examination sites beginning January 1995, and it was extended on June 1, 1995 to cover all xaminations. Through February 1996, reports from just over 2,000 institutions have been received.
One aim of the survey was to establish a benchmark, during a period of relative economic stability, against which to compare future reports about trends in underwriting. However, the first year's results also provided a picture of recent trends in underwriting -- and the extent of risk-taking -- at state-chartered depository institutions that the FDIC supervises, including many small and community banks. As such, the observations extend recent efforts of other Federal bank egulators to monitor similar developments at larger institutions.
The report is designed to monitor trends and practices in the underwriting of new loans. Normally,
examiner observations of credit quality problems from on-site examinations are systematically
tabulated only when loans become troubled. This report is an effort to identify changes in
underwriting standards and to assess the overall riskiness of new lending. It is meant to provide an
"early warning" mechanism for identifying potential lending problems.
The questions focus on three topics: material changes in underwriting standards, the degree of risk
in current practices, and specific underwriting practices for major loan categories. The latter set of
questions addresses specific practices that have caused problems in the past at banks across the
country, or are likely to cause problems as markets change. The types of lending reviewed in the
earlier reports included business credits, construction lending, and commercial real estate credits.
At midyear, the report was expanded to include questions on practices for consumer lending,
home-equity loans, and agricultural credits.
Examiners were asked to evaluate practices based on their experience and generally-accepted
industry standards. In some cases, they were asked to rate the risk associated with underwriting
practices at the institution they had just examined as above, below, or at normal or average levels.
In other cases, examiners were asked to differentiate the frequency of specific practices as
"common" or "frequent enough to warrant notice."
Results: General Underwriting Trends
The results of the 2,000-plus reports on underwriting practices for the year ending in mid-February
1996 did not reveal widespread deterioration in underwriting standards nor significant areas of
concern. However, examiners reported a noticeable incidence of troublesome practices in some
areas of the country.
Examiners were asked to comment on recent changes in underwriting practices at the banks they
were examining. Less than 75 reports of the 2,000 received noted a material deterioration in recent
lending practices. In fact, more than twice that number reported practices had tightened. Where
standards were relaxed, it was primarily attributed to increased competitive forces and/or to achieve
loan growth goals. However, only two percent of the reports cited both looser underwriting
standards and rapid loan growth.
When asked to rate the overall level of riskiness of current lending practices, over 11 percent of the
reports nationwide indicated that underwriting standards involved "more-than-normal" or "high"
risk. This proportion held fairly steady throughout the first year of reporting. Reports of
higher-than-normal risk in current practices occurred most frequently at smaller institutions. At
depository institutions with more than $300 million in assets, only 4.5 percent of the examinations
revealed underwriting was riskier-than-normal.
One underwriting practice stood out: the failure to adjust loan pricing based on loan quality. Ten
percent of the reports indicated inadequate pricing was a "common" problem, and an additional 36
percent noted failure to adjust pricing to loan quality "frequently enough to warrant notice." The
frequency of reports of weakness in loan pricing, however, diminished considerably during the
course of the year.
Although the report focused on the underwriting of new credits, examiners also were asked to
characterize the level of risk of the entire loan portfolio that they had just reviewed. Thirteen
percent of examiners nationwide reported "above-average" levels of risk in existing loan portfolios.
In some areas of the country such reports occurred more frequently than elsewhere in the country.
For instance, reports from examined banks in several states with relatively competitive markets cited
overall portfolio risk as "above-average": California (38 percent), Louisiana (25 percent), and New
York (24 percent).
According to the results from completed examinations between February 1995 and February 1996,
the quality of underwriting varied considerably across the country. Examiners operating out of the
FDIC's San Francisco and Dallas regional offices, for example, reported a loosening of underwriting
standards twice as frequently as examiners in other parts of the country. This primarily reflected
relatively frequent reports of loosening in most Western states as well as in Texas and Louisiana.
A similar regional diversity was found with respect to the assessments of the overall risk of current
underwriting practices. Examiners in the West noted some concern regarding the risk of current
underwriting standards more frequently than elsewhere in the nation. This result was heavily
weighted by reports from California. However, various other states outside the West also came in
with a relatively frequent incidence of reports of above-average risks. In fact, reports from
examined banks in such diverse states as Louisiana, New Hampshire and New Mexico indicated
above-average risk more frequently than in California.
Individual Loan Types
Reports on the quality of underwriting were received for a wide array of loan categories. At over
90 percent of the examination sites, the institution was an active business lender, 65 percent were
making new construction loans, 77 percent were making commercial real estate loans, 67 percent
were making agricultural loans, and 93 percent were making consumer loans. The least represented
loan type was home-equity loans; nonetheless, half of the institutions were active in this area.
Examiners were asked to comment on specific questionable practices at institutions actively lending
in each area. A few common questionable practices were noted by examiners in a number of
institutions. However, specific weaknesses must be viewed in the context of the institution's overall
standards to determine whether they will lead to higher-than-normal risk levels. One or two
weaknesses can often be offset by strengths in other underwriting factors. Multiple weaknesses
generally can not. Thus, it is important to note that in no lending area did examiners suggest that
a specific loan type was particularly risky due to multiple deficiencies. Nonetheless, early detection
of any risky practice provides valuable information that can be used for supervisory actions to limit -- or reverse -- trends before they become serious problems.
Business Loans. The strength of the borrower and the quality of the collateral pledged are
both important elements in business lending.
Construction Loans. Construction credits can be particularly risky, as the project typically
does not generate funds to repay the loan fully until it is completed at some future date. Lenders
have inserted a variety of terms into such loans to reduce the risk involved. Still, examiners cited
a number of practices that have led to problems in construction lending in the past.
Home-Equity Loans. Despite the wide-spread perception of increasing competitive
pressures in home-equity lending, reports on the underwriting of home-equity loans revealed few
reports of deficiencies.
Consumer Loans. Examiners were asked about both the general level of risk in the
consumer lending area and specifically about credit-card lending. No major problems were reported
in underwriting practices in consumer lending.
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