FDIC examination guidance on construction lending has evolved over the past decade in response to the losses that poorly managed construction portfolios generated during the 2008–2012 cycle and again during the disruptions of 2020–2022. The current guidance reflects hard-won lessons about what separates construction loan programs that manage risk effectively from those that produce losses, and it is specific enough that banks whose construction lending programs do not reflect the guidance’s expectations will find examination findings waiting for them.
Understanding what FDIC examiners look for when they review a bank’s construction loan portfolio is the starting point for building a program that satisfies examination standards. The following is a practical summary of the guidance’s key expectations and what they mean for community banks with active construction lending programs.
The Concentration Risk Context
FDIC guidance on construction lending does not exist in isolation, it is part of a broader framework for managing commercial real estate concentration risk that the agencies developed following the 2008 crisis. Banks whose construction and land development loans exceed 100% of total risk-based capital, or whose total commercial real estate loans exceed 300% of total risk-based capital, are subject to heightened scrutiny of their risk management practices.
For community banks with significant construction loan concentrations, the examination focus is not just on individual loan quality but on whether the bank has the risk management infrastructure, underwriting standards, monitoring practices, stress testing, and management oversight, to manage that concentration appropriately. A bank with a 120% construction concentration and a rigorous monitoring program is in a materially better examination position than one with the same concentration and informal oversight, even if the individual loans in both portfolios are performing identically.
What Examiners Review at the Loan Level
At the individual loan level, FDIC examiners evaluating construction loans look for specific evidence that the bank conducted appropriate due diligence at origination and maintained appropriate oversight throughout the loan term.
At origination, examiners expect to find evidence that the bank evaluated the borrower’s construction experience and financial capacity, assessed the project’s feasibility and market support, reviewed the construction budget and schedule for adequacy, verified the GC’s qualifications and financial stability, and assessed the project’s risk factors, including subcontractor availability, market conditions, and the adequacy of the contingency.
A loan file that contains a borrower financial statement, a purchase contract for the land, and a GC’s bid but no independent assessment of the budget’s adequacy or the market’s demand for the project’s product type is not a well-documented origination file by current examination standards.
During the loan term, examiners look for evidence of systematic monitoring before each draw disbursement. The standard is field inspection, not borrower certification, not phone confirmation with the GC, not a drive-by observation. Independent field inspection that assesses construction progress against the draw request, produces a written report, and makes a disbursement recommendation is the documentation standard that examination guidance expects.
The inspection report itself should be in the loan file before the draw was funded, not added afterward. The sequence matters to examiners: the inspection happened, the report was produced, the bank reviewed it, and then the draw was funded. A bank that funded draws and then collected inspection reports retroactively is not demonstrating the oversight discipline that the guidance expects.
Cost-to-Complete Analysis: The Underemphasized Requirement
The guidance’s emphasis on cost-to-complete analysis is one of the areas where community bank practice most frequently falls short of examination expectations. Examiners do not consider a draw inspection that assesses what percentage of the project is complete but does not assess whether the remaining loan balance is adequate to fund the remaining work to be a complete inspection.
Cost-to-complete analysis, the comparison of the estimated cost of the remaining work against the remaining undisbursed loan balance, is required at each inspection, not just at origination. A project whose cost-to-complete gap is widening draw-over-draw is exhibiting a funding risk that the lender should be identifying and addressing, not discovering when the loan approaches exhaustion.
Banks whose inspection programs produce completion percentage reports but not cost-to-complete assessments should update their monitoring requirements to include cost-to-complete analysis at every draw.
Troubled Construction Loan Management
The guidance is specific about what banks should do when a construction loan develops problems, and the key point is that earlier action is always better than later action. When cost-to-complete analysis identifies a funding gap, when the GC’s performance has deteriorated, or when the project’s schedule has slipped significantly, the bank should document the issue, assess the severity, communicate with the borrower, and develop a plan to address it.
A bank that identifies a cost-to-complete gap at draw five and documents it, communicates with the borrower, and works toward resolution has demonstrated the active portfolio management that examination guidance expects. A bank that identifies the same gap but does not document it or take action until the loan is approaching exhaustion at draw twelve will find that the examination finding addresses both the loss and the bank’s failure to manage the problem when it was still manageable.
Building a Compliant Monitoring Program
The practical steps for a community bank building a construction monitoring program that satisfies examination expectations:
Establish an independent pre-closing review requirement for all construction loans above a threshold. The pre-closing review should assess budget adequacy, schedule realism, and GC qualifications, and the review should be documented in the loan file before closing.
Require independent field inspection before every draw disbursement. The inspection should be conducted by a qualified third party with no financial relationship with the borrower, should assess completion by line item in the schedule of values, and should include cost-to-complete analysis at every inspection.
Retain inspection reports in the loan file with documentation that the bank reviewed the report before approving the draw. The loan file should support an examiner’s reconstruction of the monitoring sequence for every draw in the loan’s history.
Document the bank’s response to any findings that suggest deteriorating loan quality. If an inspection report notes subcontractor performance concerns, schedule slippage, or a cost-to-complete gap, the loan file should contain the bank’s response to that finding, including any communication with the borrower and any action taken to address the condition.
Innergy Integral provides construction loan monitoring for community banks across the Pacific Northwest and the Southwest. Our monitoring programs are structured to satisfy the documentation standards that FDIC examination guidance expects.
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