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FDIC SUPERVISORY INSIGHTS, WINTER 2015

Posted on March 16, 2016 Published by

In fall 2009, the FDIC implemented an examiner survey to assess the level of risk and quality of underwriting for loan portfolios, among other items. The FDIC recently released its most recent results of this survey in their Winter 2015 “Lending Viewpoint: Results from the FDIC’s Credit and Consumer Products/Services Survey,” which provides a summary as to the FDIC’s current assessment of the state of credit. We would like to highlight some of the information included in this Supervisory Insight.

In large part, the FDIC’s Credit Survey, “reflects continuing improvement in the financial condition and overall risk profile of the banking industry.” In addition, “while selected indicators suggest the direction of risk is increasing, examiners still report these indicators in the context of low to moderate levels of overall risk.” “Generally liberal” underwriting was identified in 9% of Credit Surveys, an increase of 8% over the previous year.

Summary of facts regarding FDIC insured institutions:

  • Total loans and leases grew by 5.4% ($8.5 trillion) as of June 30, 2015, compared with the previous year.
  • During the second quarter 2015, 78% of banks grew their lending portfolios, up from 74% in the second quarter 2014.
  • Broad-based rise in loan volumes (based on June 30, 2014 to June 30, 2015):
    • Acquisition, development and construction (ADC) loans increased nearly 15%
    • Commercial and industrial loans reflected an 8% increase
    • Consumer lending increased by 4%
    • Nonfarm, nonresidential commercial real estate loans grew by 4%
    • Residential mortgage loans held on balance sheet increased by 2%

The FDIC attributes this growth to “a low interest rate environment and a fair economic outlook encouraging individuals and businesses to tap into available credit.”

  • Past due and nonaccrual (PDNA) loan ratio was 2.38%, a 67-basis-point improvement (reduction)
    • All other loans and leases (including farm) increased 6 basis points to 0.45
The FDIC considers the PDNA to be a lagging indicator regarding increasing risk in loan portfolios.
Although the FDIC continues to assess risk in loan portfolios as low to moderate, it does identify select portfolios or lending practices that may show an increase. For example:
  • Based upon examiner surveys, approximately 22% of surveys reflect higher risk ADC lending activities during the past 18 months.
  • The surveys identified an increase in the number of institutions that are extending or renewing unpaid production/operating loans structured to be paid in full at maturity for agricultural operations.
  • Additional agricultural lending findings representing increased risk include:
    • Making livestock loans without documenting livestock inspections
    • Lending to borrowers who lack documented financial strength to support the loan.
  • Purchased participations and out-of-area lending as a standard practice:
    • Approximately 19% report out of area lending as a standard practice, an increase from  15% in 2014 and from 14% in 2013. (remains below the levels from 2009-12)
    • FIL-49-2015 to update the FDIC Advisory on Effective Credit Risk Management Practices for Purchased Loan Participations (FIL-38-2012)
  • Concentrations were reported in approximately 55% of Credit Surveys
    • 49% of institutions with one or more concentration exceeding 300% of capital grew such a portfolio over 10%.
    • The FDIC maintains the position that the growth of concentrated portfolios was a key contributor to asset problems in many prior banking crises.

At this point in the credit cycle, alarms are not sounding and bells are not ringing to warn us of the next credit apocalypse. Credit risk is increasing as loan growth is returning along with the fierce competition that exists in the lending markets, as is expected.

The recent Supervisory Insight serves as a reminder that “prudent loan risk selection remains vital to a bank’s financial health, and a bank’s first line of defense against booking excessive risk is the initial underwriting process.” The FDIC has specifically identified several areas for banks to be aware of at this stage of the credit cycle, including underwriting, agricultural lending, purchased participations and out-of-market lending and concentrations, to either avoid or better manage mistakes of the past. The opportunity is now for banks to be diligent regarding their efforts for quality underwriting and loan portfolio management.

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“By questioning some of our methodologies, Enlighten has helped us say, ‘Okay, this is where we need to train staff better and focus on so that they understand what they're doing better.”
— Robert McPherson, VP of Risk Management, Peoples State Bank
“The organization of the communication — before, during, and after the reporting process — was certainly better with Enlighten than what I've experienced with a lot of auditors.”
— Bill Beardsley, President, Michigan Business Connection
“The staff at Enlighten have been available for questions, in addition to the engaged work that they do. They've been very helpful as a resource beyond the major audit.”
— Meghann Kasper, Chief Credit Officer, Bank First
“Enlighten gives us a very good second set of eyes on our transactions. They're not afraid to challenge us on some of the work that we've done, which is what is needed. I don't need to pay somebody to tell me I'm good, I need to pay somebody to tell me where I've made mistakes.”
— Robert McPherson, VP of Risk Management, Peoples State Bank
“Enlighten provided industry best practices that weren’t going to show up in an audit report. They would say, ‘Hey, I noticed you do this. This is really unique, you do a really great job of it.’ And then they might add, ‘Some other clients that I have are doing something like this.’”
— Bill Beardsley, President, Michigan Business Connection
“By questioning some of our methodologies, Enlighten has helped us say, ‘Okay, this is where we need to train staff better and focus on so that they understand what they're doing better.”
— Robert McPherson, VP of Risk Management, Peoples State Bank
“The organization of the communication — before, during, and after the reporting process — was certainly better with Enlighten than what I've experienced with a lot of auditors."
— Bill Beardsley, President, Michigan Business Connection