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Report on Underwriting Practices
Characteristics of the Underwriting Report
Purpose and Design of the Report
Beginning in early 1995, the FDIC instituted a system to report on the riskiness of current underwriting practices at the conclusion of each bank examination it conducts. Those banks examined are primarily small, state-chartered depository institutions. The first results were published in April 1996. This report covers responses during the six-month period from April through September 1996.
By systematically collecting observations from examination sites, the survey is designed to provide an "early-warning" mechanism for identifying potential lending problems. The primary source of information on trends in credit quality problems--the institutions' "Call Reports"--only provides information after loans become troubled. Another goal of the survey is to establish a benchmark, during a period of relative economic stability, against which to compare future reports about underwriting practices.
The survey focuses on three topics: material changes in underwriting standards, the degree of risk in current practices, and some specifics of the underwriting process for major loan categories. Questions about the latter topic focus on weaknesses that have caused problems in the past at banks nationwide. Loan types covered include business credits, construction lending, commercial real-estate loans, general consumer lending, credit-card loans, home-equity loans, and agricultural credits.
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 at the institution just examined as above, below, or at normal or average levels. In other cases, examiners classify the frequency of specific practices as "common" or "frequent enough to warrant notice."
Results: General Underwriting Trends and Practices
Most reports received during the six months ending September 30, 1996 showed neither widespread tightening nor loosening in underwriting practices. Nationwide, examiners noted no material change in overall underwriting practices since the prior exam at 90 percent of the almost 1,400 examination sites reporting. Of the 10 percent of reports citing a change, just under 5 percent (70 reports) showed a loosening in recent lending practices; just over 5 percent (77) showed practices had tightened. Where standards were relaxed, examiners most frequently attributed the change to loan growth goals or increased competitive forces.
These results were little different from the earlier report released last April in which 89 percent of the responses had no change in underwriting practices. The results from the six-month report, however, showed a slightly lower percentage of responses with tighter standards, and a small increase with looser standards.
When asked to rate the overall level of riskiness of current lending practices, examiners indicated that underwriting standards showed "more-than-normal" or "high" risk in 12 percent of the examination sites nationwide. The proportion also was about the same as in the earlier report. Higher-than-normal risk in current practices occurred most frequently at institutions with assets less than $25 million (18 percent). At depository institutions with more than $300 million in assets, only 7 percent of the responses revealed underwriting was riskier-than-normal.
Although the report focuses on the underwriting of new credits, examiners also were asked to characterize the level of risk of the entire loan portfolio at the institution they reviewed. Thirteen percent of responses nationwide showed "above-average" levels of risk in existing loan portfolios.
Several follow-up questions were asked concerning general underwriting practices. One focused on the role of competition on the institution's underwriting standards. Examiners reported that the degree of competitive pressures was "above average" at just under 20 percent of the banks.
The failure to adjust current loan pricing based on loan quality continued to be a commonly-observed weakness. Almost 5 percent of responses had inadequate pricing as a "common" problem, and an additional 28 percent were noted with failure to adjust pricing to loan quality "frequently enough to warrant notice." Among the institutions that were reported to have higher-than-average risk profiles for new underwriting, almost 60 percent also were characterized as having pricing weaknesses.
Individual Loan Types
Reports on the quality of underwriting were received for a wide array of loan categories. Approximately 93 percent of the institutions were active consumer lenders, and 90 percent were making business loans. A majority of institutions also were active lenders in other loan areas: commercial real-estate loans (73 percent), new construction loans (62 percent), and agricultural loans (59 percent). Only 46 percent were active home-equity lenders.
Examiners were asked to comment on specific questionable practices at institutions actively lending in each loan type. A few questionable practices were commonly noted by examiners in a number of institutions. However, examiners did not suggest that any loan type was particularly risky due to multiple deficiencies in underwriting practices.
Business Loans. Business loans represent a large percentage of the loan portfolio of most commercial banks. 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 a project typically does not generate funds to repay the loan fully until its completion. 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. For every practice surveyed, the percentage of responses showing problems was down during this six-month period from the earlier period.
Commercial Real-Estate Loans. In commercial real-estate lending, the income generated from the property is the primary source of repayment. However, because such income often is subject to uncertainty, underwriting practices generally include providing for alternative sources of repayment. As was the case in the earlier results, no widespread weaknesses were detected at examinations conducted during the six-month period.
Agricultural Credits. Many FDIC- supervised depository institutions are active agricultural lenders, and such credits often comprise a large portion of the lender's loan portfolio. Earlier results suggested that examiners had some concerns regarding the phasing out of farm subsidies and its subsequent impact on banks with large agricultural loan portfolios. Accordingly, after the Congress passed legislation to implement such phaseouts, the survey was revised to evaluate the effect specifically of the new legislation.
Consumer Loans. Examiners were asked about both the level of risk in general consumer lending and more specifically about credit-card lending. No major problems were reported in either aspect of consumer lending.
Credit-Card Loans. Beginning in April 1996, the survey included revised questions regarding credit-card lending. Just over 20 percent of the institutions examined during the six months ending in September 1996 were reported to be active in such lending. Of these institutions, six were credit-card specialty banks. (None of the six showed "above-average" risk in their current underwriting practices for new credit-card loans). The remaining institutions were not major players in the credit-card area, holding, on average, just 1 percent of total assets in such credits.
Home-Equity Loans. Reports on the underwriting of home-equity loans continued to reveal few deficiencies among the approximately 650 institutions actively making home-equity lines of credit.
Regional Differences:General Underwriting Trends
The specific insured depositories for which reports are received in any given period depends on examination scheduling requirements that reflect such factors as the financial condition of the banks, coordination with state regulators, and the availability of staff. Thus, regional differences can vary from period to period and must be interpreted cautiously. Nonetheless, the most recent results suggest no widespread changes in underwriting standards nor any serious concentration of risky practices in any given region during the six months ending in September 1996. These patterns are consistent with the earlier results.
For this reporting period, the institutions examined in the San Francisco region stood out as having tightened underwriting more frequently and loosened less frequently than other regions. With regard to the overall riskiness of current practices, banks examined in the Boston and New York regions were rated as having less risky underwriting than elsewhere. At the same time, examiners in the San Francisco region continued to find a disproportionate number of institutions with above-average risk.
Last Updated 7/8/1999