The Federal Reserve has issued guidance that updates loan sampling expectations for examinations of community state member banks and clarifies when statistical sampling is expected to be used. The July 22 guidance, published as Supervision and Regulation Letter SR 14-7, also establishes minimum coverage expectations for judgmental samples for full-scope and asset quality target examinations. According to the guidance, Federal Reserve examiners are expected to select for review a sample of loans that is of sufficient size and scope to enable them to reach “sound and well-supported conclusions about the quality of, and risk management over, a community state member bank’s lending portfolio.” The guidance describes the criteria examiners should consider when selecting loan samples for review. For example, for community state member banks with composite and Asset Quality ratings of 1 or 2 that have not materially changed the composition of their loan portfolios or their credit administration practices, and whose most recent overall SR-SABR rating is not 1D, 1F, 2D or 2F, examiners are expected to use the statistical loan sampling procedures outlined in Supervision and Regulation Letter SR 02 19 for C&I and CRE loan samples. For all other community state member banks, examiners are expected to draw a judgmental sample that includes a selection of large, insider, problem, watch, renewed and new credits. The guidance includes a table that shows the percent coverage of loan samples as a factor of the Asset Quality component rating and whether the bank’s credit risk management is rated as strong, acceptable or weak.

     Nutter Notes: The examination guidance, which applies to state member banks with $10 billion or less in total consolidated assets, also provides loan sample guidance for the examination of retail consumer loans. According to the guidance, the supervisory review and classification of retail consumer loans should be carried out in accordance with the procedures set forth in the Commercial Bank Examination Manual and Supervision and Regulation Letter SR 00-8, and should generally be limited to past due and nonperforming assets. The guidance requires that if a bank has a concentration (i.e., 25% percent or more of risk-based capital) in retail consumer loans, examiners should review the bank’s underwriting standards and policies, and related risks and controls. In such cases, the guidance also directs examiners to consider sampling a portion of credits in those segments (for example, residential mortgages or HELOCs) of the bank’s retail loan portfolio with a high concentration in order to assess risks and the adequacy of underwriting, internal controls and credit risk management practices. The guidance requires that examiners select a judgmental sample size that is “commensurate with concentration and credit risks and sufficient for the examiner to assess the quality and risks of the portfolio.”