Handle ARM Adjustments with Care

By William J. Showalter, CRCM, CRP, Senior Consultant

Adjustable-rate mortgages (ARM) have not been much of an issue for many banks and thrifts in recent years since fixed rates have been so low. But they are still an important tool for serving those customers who cannot meet the secondary market qualifications applied to most fixed-rate loans. And, many institutions have a portfolio of existing ARM loans that they service. One potential complication for some lenders is the impending discontinuance of the LIBOR index, requiring them to find another comparable index for their ARMs.

ARMs were in the spotlight over 10 years ago because of problems in the subprime market. Many subprime products have variable interest rates, which shift the interest rate risk from lender to borrower. Besides the issues raised then over putting borrowers into inappropriate products, there also are concerns over errors in ARM rate changes.

Do an internet search for “ARM errors” or similar terms and you will come up with numerous firms offering loan audit and information services to borrowers. These firms tell borrowers that their companies can correct ARM errors, bring loans into compliance, and get the borrower a mortgage refund.

Background

The initial furor over these mistakes arose over a report on ARM adjustment errors prepared by a former Federal Savings and Loan Insurance Corporation employee in 1989. His assertions sent a tremor through the mortgage industry. The report concluded that miscalculations in periodic adjustments to rates on ARM instruments resulted in significant overcharges. He found ARM adjustment errors in about 50 percent of the loans he sampled. From these results, he estimated the potential overcharges to be up to $15 billion for ARMs nationwide at the time. This figure has been estimated as high as $50-60 billion in recent years.

The controversy was further stoked by a study from the Government Accountability Office (GAO) released in September 1991 which found between 20 and 25 percent of the ARM loans at the time contained interest rate errors. Such errors occurred when the related mortgage servicer selected the incorrect index date, used an incorrect margin, or ignored interest rate change caps.

The damaging studies kept coming. In July 1994, Consumer Loan Advocates, a non-profit mortgage auditing firm announced that as many as 18 percent of ARMs had errors costing the borrower more than $5,000 in interest overcharges. And, another government study in December 1995 concluded that 50 to 60
percent of all ARMs contained an error regarding the variable interest rate charged to the homeowner. The study estimated the total amount of interest overcharged to borrowers was in excess of $8 billion. Inadequate computer programs, incorrect completion of documents, and calculation errors were cited as the major causes of interest rate overcharges.

Even though no other government studies have been conducted into ARM interest overcharges to date, the potential issue continues to simmer below the surface and lenders need to be vigilant so that it does not erupt into a veritable supervolcano of enforcement actions and lawsuits.

Types of Errors

The kinds of errors lenders are said to make in implementing ARM rate and payment adjustments run the gamut from calculation mistakes to carelessness, including:

  • Mistakes in original loan set up/data input
  • Miscalculation of payment amount
  • Improper allocation of payments between interest and principal (amortization)
  • Use of the wrong index
  • Selection of incorrect index value
  • Application of incorrect interest rate caps
  • Failure to adjust in some years
  • Use of incorrect margins
  • Improper rounding methods (e.g., rounding up instead of rounding to the nearest 1/8th of 1 percent)
  • Math mistakes causing an incorrect rate
  • Use of incorrect loan balance

Banking regulators point out that these errors may be considered breaches of contract and could expose the financial institution to legal action.

Extent of Errors

Since ARMs involve changing index values periodically and oftentimes complex computer calculations, they seem to attract human and software errors. Mortgage audit firms point out that leading publications such as The Wall Street Journal, MONEY, Forbes, and Newsweek have warned borrowers about miscalculations occurring in up to 50 percent of ARMs.

  • The firms get borrowers’ attention by pointing to figures of lender overcharges and borrower refunds like these:
  • Average borrower refund of over $1,500
  • 21 percent of refunds ranging from $3,500 to $10,000
  • 13 percent of errors exceeding $10,000

Reasons for Errors

The calculation of ARM rate changes is a complex process and errors can occur in a variety of ways. Add to this the fact that many lenders offer, and servicers support, a variety of ARM products with different rate adjustment intervals, indices, margins, and other terms. Another potential complicating factor is the widespread practice of transferring loan servicing, presenting another opportunity for human mistakes and software mismatches to cause errors.

In addition, some of the mortgage audit firms assert that ARM rate and payment adjustment errors have been linked to:

  • Lack of training, supervision, and experience of loan servicing personnel
  • Simple human error
  • Computer data entry or software errors
  • Clerical or calculation errors
  • Fraud
  • Sale or transfer of the loan to a different company
  • Rider, handwritten changes, or other irregularities in the note
  • Very complex calculations, use of an unusual index, or interest rate
  • Dissolution or merger of the original loan institution

How to Avoid These Problems

The federal banking supervisors began encouraging financial institutions back in 1991 to perform reviews of their adjustable-rate loan systems to ensure that interest rate information is correctly ascertained and administered, and that rates are adjusted properly.

Banks and thrifts should have effective internal controls and procedures in place to ensure that all adjustments are made according to the terms of the underlying contracts and that complete, timely, and accurate adjustment notices are provided to borrowers. Also, a system for the ongoing testing of adjustments should be in place to ensure that adjustments continue to be made correctly.

A critical component of any successful loan servicing program, including correctly implementing rate and payment adjustments, is a thorough training regime for lending personnel involved in the process. Those involved must be given the appropriate tools – including knowledge – to succeed in their jobs.

Any review of ARM adjustments should include documentation indicating the basis for interest rate adjustments made to a lender’s ARM loans, showing whether changes have been made consistent with the underlying contracts.

If a lender finds that it has made errors in the adjustments for interest rates which have resulted in interest overcharges on ARMs, the supervisory agencies expect that you will have in place a system to correct the overcharges and properly credit the borrower’s account for any interest overcharges. In general, undercharges cannot be collected from borrowers.

Young & Associates, Inc. offers a variety of compliance management and review services that are proven effective for institutions of all types and sizes. For more information on this topic or how Young & Associates, Inc. can assist your institution, contact Bill Showalter at wshowalter@younginc.com or 330.422.3473.

Dealing with Pandemic Disruption – and What Happens Next

By:  Bill Elliott, CRCM, Senior Consultant and Director of Compliance Education, and William J. Showalter, CRCM, CRP, Senior Consultant

For years banks have had pandemic policies, and have done some level of testing, but never really thought the day would come when it would represent more than another examiner-required policy. Then came COVID-19, and in a matter of days, the world changed.

Managing Bank Policies and Procedures

When we teach in live seminars, we always ask, “How many of you believe that your policies are up to date?” That always gets some hands, but not 100 percent of attendees. Then we ask, “How many of you believe that your procedures are up to date?” Seldom does anyone raise their hand. These two situations are revealing.

Keeping policies current is the easier of the two. But many banks rubber stamp policies that could be much more effective. If it is a Regulation B policy, it usually follows the regulation and indicates that the bank intends to comply. That is fine for that type of policy. But other policies, notably operations and loan policies, need to do more than restate a regulation – they need to be a document that can be read and used. And, a pandemic policy needs to cover a wide range of subjects and issues.

It might be time to review these types of policies and add significant language as to how you will address situations such as we have experienced – lobbies closed or restricted, limited staff, staff working from home, and the same job to be completed. At a minimum, these policies should address:

How jobs are done in an off-site world

How electronic solutions are to be used

Safeguards that must be used to protect customer data

What types of paper documents can be used “at home” by staff working off site

Proper disposal and the safekeeping of any documents that are off site

Other protections, such as how the computers being used at home are protected from intrusion

With a little brainstorming, we are sure that you can add to this list.

Procedures are more difficult to maintain. A consultant from our company was recently in a bank and was examining procedures. Most of the procedures could be summed up as “Bill takes care of that.” As long as Bill is there, things probably work well. But if Bill is out sick, is working from home, on vacation, or no longer there, how does someone accomplish the task?

Procedures are always changing. It is far too easy to tell the three people that need to know about the change and then make a mental note to “update the procedures someday.” That elusive “someday” often never materializes. We believe that each bank should have a formal procedures review at least annually, and for some areas, maybe more often. For many banks, the inadequate procedure manuals that they have will not offer sufficient information for anyone to complete a task correctly. And with the staff more scattered, this can really complicate the situation.

The Future

Many banks have switched to imaging all files and documents. The banks that have made that decision generally are in a little better shape for off-site work, as it is easier to send employees home and still get the work done in a timely manner. If your bank has not made the transition to electronic files, this may be your cue to consider the advantages of this technology. We have talked to numerous banks recently that in the past have said “NEVER” to imaging only to discover that “never” may not have been the right answer.

As the world becomes more electronic, and the cost of maintaining offices and buildings continues to increase, this may also be a time to reconsider the locations from which employees work. This may be especially critical if your brick and mortar buildings are getting close to capacity. Many tasks, with the right policies, procedures, equipment, and software, can easily be done from home, saving wear and tear on your building, perhaps reducing occupancy costs, and maybe, as a side benefit, resulting in happier and more productive employees.

Of course, everyone working from home is not going to be effective for banks. But it can be a great tool. For instance, you have a long-term excellent employee who does a job that could be done from home. While they are currently working in the office, their spouse gets transferred 300 miles away. In the past, that probably meant a resignation. But, properly managed, there may be no reason why you could not retain that employee by just letting them work from home – even if that home is not local.

The authors of this article are most aware of compliance officers. Over the last several years, we have seen more and more situations where compliance officers work from home, with some compliance officers going south for the winter and continue to work remotely, etc. In our company, none of our compliance consultants work in our office, even in “normal” times.

Conclusion

So we encourage you to reimagine the bank – to the extent possible. Face-to-face customer contact employees need to be local, but much or the rest of the staff may not really need to be “in the building,” at least not every day. We encourage you to use this mind set for the future – and let it help your bank thrive.

For more information, contact Bill Elliott, Director of Compliance Education, at bille@younginc.com or 330.422.3450, or William Showalter at wshowalter@younginc.com or 330.422.3473.

Off-Site Reviews, Virtual/Teleconference Training, and Management Consulting Support

Young & Associates, Inc. remains committed to keeping our employees, clients, and partners safe and healthy during the COVID-19 pandemic. During this difficult and unprecedented time, we have continued to successfully leverage technology to fulfill our commitments to our clients and partners through secure remote access for reviews, virtual/teleconference training, and other management consulting support.

Young &Associates’ commitment to virtual/teleconference training and remote access reviews date back well over five years. We see this ability as a win-win for everyone – the review and training get completed in a timely manner and the bank avoids paying any travel expenses. Concerned about security, please be assured that we use the latest secure technology.

We remain committed to helping our clients with all areas of their operations through off-site reviews and providing the most current regulatory updates through our virtual/teleconferencing training.

Contact one of our consultants today for more information about our off-site reviews or virtual/teleconferencing training:

Bill Elliott, Director of Compliance Education:
bille@younginc.com or 330.422.3450

Karen Clower, Director of Compliance:
kclower@younginc.com or 330.422.3444

Martina Dowidchuk, Director of Management Services:
mdowidchuk@younginc.com or 330.422.3449

Bob Viering, Director of Lending:
bviering@younginc.com or 330.422.3476

Kyle Curtis, Director of Lending Services:
kcurtis@younginc.com or 330.422.3445

Aaron Lewis, Director of Lending Education:
alewis@younginc.com or 330.422.3466

Dave Reno, Director – Lending and Business Development:
dreno@younginc.com or 330.422.3455

Ollie Sutherin, Manager of Secondary Market QC Services:
osutherin@younginc.com or 330.422.3453

Jeanette McKeever, Director of Internal Audit:
jmckeever@younginc.com or 330.422.3468

Mike Detrow: Director of Information Technology Audit/Information Technology:
mdetrow@younginc.com or 330.422.3447

Young & Associates, Inc.’s consultants provide a level of expertise gathered over 42 years. In our consulting engagements, we closely monitor the regulatory environment and best practices in the industry, develop customized solutions for our clients’ needs, and prepare detailed and timely audit reports to ease implementation moving forward. With backgrounds and experience in virtually all areas of the financial services industry, our consultants bring a broad knowledge base to each client relationship. Many of our consultants and trainers have come to the company directly from positions in financial institutions or regulatory agencies where they worked to resolve many of the issues that our clients face daily.

We look forward to working with you as you work to obtain your goals in 2021 and beyond.

Strategic Planning for 2021

By: Bob Viering, Senior Consultant and Director of Lending

Young & Associates, Inc. is a leader in assisting financial institutions to move successfully through the strategic planning process. We remain flexible to your bank’s specific needs, and work with you to create a vision with a focus on both your short- and long-term future.

Pre-Planning – Where are We Today?

At Young & Associates, Inc., our approach to strategic planning is individualized for your bank. Prior to your planning session, we feel it is important to get to know your bank. We do this by sitting down with your management team, discussing the biggest issues facing your organization, and reviewing your results and progress from your prior strategic plan. Next we send out a confidential questionnaire to both directors and senior officers to determine if there are specific issues of importance that need to be addressed. Based on your assessment of your bank’s direction and the results of the questionnaire, we will work with you to craft an agenda that is specific to your bank. The pre-planning session and analysis is geared to answering the question: where are we now?

Planning Session – Where do We Want to Be?

On the day of your planning session, we spend time discussing what is going on in the banking world and the analysis of the pre-planning work so everyone is on the same page about where we are today. This may include updating your SWOT analysis. We focus on a critical piece of the planning session, which is to answer: where do we want to be? Young & Associates will facilitate the discussion and use our years of real-world experience to help you craft a plan that reflects your vision. The goal is to have a vision of where you want your organization to be next year, in five years, or ten years down the road, and determine what it will take to get there. Strategy is about making choices about who you want to serve, how you plan to serve them, and often just as important, who you are not going to serve.

Plan Execution – How will We Get There?

The goal at the end of the day is to have an agreed direction for your bank and the strategies/goals you will use to get there. Finally, we discuss the most important item of all planning: execution. The best plan in the world won’t get you anywhere without a plan for how you will execute your plan, who is responsible for each goal you set, a timeline for completion, and periodic updates on the progress of your plan.

Written Strategic Plan

After the planning session, we will take the information about your goals and strategies and, with the assistance of your CFO, craft a financial plan that reflects your future direction. Our financial modeling tools allow us to show the impact of various “what-if” business scenarios, whether it is an alternative/stressed budget, impact of alternative strategies on the bottom line, capital, shareholder value, liquidity etc. All of the above are then included in your written strategic plan that we complete for you.

Why Young & Associates, Inc.? 

Our consultants working on strategic planning are former CEOs and senior executives that were responsible for planning in their own banks so we know the realities of running your bank every day, along with the need to balance your time with executing your plan.

For more information, contact Bob Viering:

Email: bviering@younginc.com

Phone: 330.422.3476.

Testing Your Balance Sheet’s Capacity to Weather the Pandemic and Embrace New Opportunities

By: Martina Dowidchuk, Senior Consultant and Director of Management Services

As we adjust to the new reality and navigate through the immediate operational challenges, long-term planning comes back into focus. What is the bank’s balance sheet capacity to weather the economic downturn, absorb the potential losses, and leverage the existing resources to support households and businesses affected by the pandemic?

Community banks, with their relationship-based business models, are uniquely positioned to support their markets by using their in-depth knowledge of the local economies and the borrowers’ unique situations to provide timely and individualized assistance for impacted customers. This is an opportunity to facilitate a return to economic stability and be the source of information and communication, but also to enhance customer relationships and trust over the long term.

Unlike during the 2008 financial crisis, most banks have stronger risk infrastructure, larger capital buffers, and higher liquidity reserves. How long the existing safeguards will last depends on the length and severity of the downturn. As we continue to work surrounded by an array of unknowns, there are planning steps that can be taken now to get in front of problems and position the bank to leverage its strengths to support the local communities and shareholders.

Capital Plan Review – How much capital can be deployed into new credits? How much stress can we absorb? 

Considering the abrupt economic changes, the bank’s risk-specific minimum capital level requirements should be revised to reflect the likely changes in the levels and direction of credit risk, interest rate risk, liquidity risk, and others. The recently issued regulatory statement relaxing capital requirements includes modifications related to the amount of retained income available for distribution, allowing banking organizations to dip into their capital buffers and to continue lending without facing abrupt regulatory restrictions. Institution-specific capital adequacy calculations can also provide a basis for the decision whether or not to opt in to using the community bank leverage ratio, which has been temporarily reduced from 9 percent to an 8 percent minimum threshold.

Stress testing the capital against credit losses, adverse interest rate environment, and other earnings challenges can help identify potential vulnerabilities and allow management to proactively prepare and protect the bank from losing its well-capitalized status should the simulated stress scenarios unfold. The sooner the problems are identified, the more flexibility you have in developing a solution. Every bank should have an up-to-date capital contingency plan to be implemented if the capital levels approach the minimums needed for a well-capitalized bank designation.

The review of the minimum capital requirements and the stress tests can provide valuable insights regarding not only the bank’s ability to survive a recession, but also to estimate the amount of “excess” capital that can be used to support additional lending. Many banks can justify lower capital requirements once they customize the capital adequacy calculations to their specific risk profiles. If additional asset growth can be supported from the capital perspective, the plan should be further evaluated from the liquidity standpoint.

Liquidity Plan Review – Are the existing liquidity reserves sufficient to support additional loan growth and the potential funding pressures?

Liquidity plan review needs to go hand in hand with capital planning. While most community banks have strong liquidity positions, the scale and speed of the coronavirus shock have raised concerns that credit drawdowns, sudden declines in revenues, and a higher potential for credit issues will strain bank balance sheets. Funding pressures may be building because of uncertainty about the amount of damage that the coronavirus might cause. Banks may be experiencing deposit drains from customers experiencing financial hardship or seeing withdrawals driven by fear. On the other hand, the volatility of the stock market and the uncertainty may drive the “flight to safety” and increases in bank deposits.

Changes in the business strategies and the results of the capital stress tests should be incorporated in the liquidity plan and the projected cash flows should be stress tested. Banks need to plan for ways to meet their funding needs under stressed conditions. The simulations should cover both short-term and prolonged stress events using a combination of stress constraints that are severe enough to highlight potential vulnerabilities of the bank from the liquidity perspective. The analysis should show the impact on both the on-balance sheet liquidity and the contingent liquidity, while taking into consideration changes in the available collateral, collateral requirements, limitations on access to unsecured funds or brokered deposits, policy limits on the use of wholesale funding, and other relevant stress factors.

Credit Risk Assessments – What is the loan loss potential?

Credit risk has the highest weight among the risk factors affecting capital and it is the biggest unknown in today’s environment. The assessments will need to shift to be more forward looking rather than solely relying on past performance. The stress tests will be most useful when customized to reflect the characteristics particular to the institution and its market area. Banks need to understand which segments of their portfolio will be the most affected and perform targeted assessments of the potential fallout, along with the review of other segments that may have had weaker risk profiles before the pandemic, higher concentrations of credit, or those segments that are significant to the overall business strategy. The estimates might be a moving target in the foreseeable future; however, once the framework is set up, the analyses can be regularly repeated to determine the current impact. The results of these credit risk assessments will provide a valuable input for fine-tuning the capital plan and assessing adequacy of liquidity reserves, as well as for formulating strategies for working with the affected borrowers and extending new credit.

Measuring Impact of Plans

As we face abrupt changes in the strategic focus, taking the time to diagnose strengths and weaknesses, to understand the range of possible outcomes of the new business strategies, and to line up contingency plans ready to be invoked as the picture get clearer is a worthwhile exercise. Young & Associates, Inc. remains committed to assist you in every step of the planning process. Our modeling and stress testing tools will allow you to generate valuable support information for your decision making, ensure regulatory compliance, and be proactive in addressing potential problems and positioning for new opportunities. For more information, contact Martina Dowidchuk at mdowidchuk@younginc.com or 330.422.3449.

Loan Modifications: A Proactive Approach for Working with Borrowers Impacted by Coronavirus (COVID-19), Guided by Recently Issued Interagency Statement

By: Bob Viering, Director of Lending, and Aaron Lewis, Director of Lending Education, Young & Associates, Inc., March 25, 2020

On March 22, 2020, the federal banking regulators issued an interagency statement on loan modifications for customers affected by the Coronavirus Disease 2019 (also referred to as COVID-19). In a number of ways, it resembled historical statements issued in the wake of natural disasters. In keeping with previously issued statements following natural disasters the federal regulators recognize that there can be an impact on borrowers and encourages banks “to work prudently” with those borrowers. However, given the sudden and significant impact of the rapidly spreading coronavirus pandemic that has had a nationwide impact, the breadth of the statement was far more reaching than previous statements issued following natural disasters which historically have been isolated to specific geographic regions. In the statement the federal regulators included the following provisions:

    1. The federal regulators confirmed with the Financial Accounting Standards Board (FASB) that “…short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not troubled debt restructurings (TDRs).”
    2. “…short term (e.g., six months)…”modifications can include: payment deferrals, fee waivers, extension of payment terms or other delays in payments that are “insignificant.”
    3.“Current” is defined as less than 30 days past due. If the credit is current at the time of the modification the borrower is deemed to not be experiencing financial difficulties.
    4. Banks can choose to work with individual borrowers or as “part of a program.”
    5. Borrowers granted a modification will not be “automatically adversely risk rated” by agencies’ examiners. In fact, it is stated that agency examiners will use judgment in reviewing credits modified and “regardless of whether modifications result in loans that are considered TDRs or are adversely classified, agency examiners will not criticize prudent efforts to modify the terms on existing loans to affected customers.”
    6. Loans granted modifications will not be classified as past due if modified, unless they become past due per the terms of the modification.
    7.During the temporary short-term arrangements (as provided in the Interagency Statement), loans should not be reported as “non-accrual.”
    8. As information is gathered, if an adverse classification, non-accrual, or charge-off is warranted, bank actions should follow existing guidance on the topics.

The best way to interpret the Interagency Statement is to consider it as providing banks breathing room while more information is developed that allows the bank to accurately assess the borrower’s financial strength. It is clear throughout the statement that any modifications must be temporary and short-term to not be classified as TDR. This guidance is in keeping with previous statements regarding TDR and relative impact to the credit. While there is no specific definition of what constitutes short-term or temporary, the mention of six months in the Interagency Statement should be a reasonable maximum to consider.

The statement mentions that working with either individual borrowers or as part of a program is acceptable. The term “individual borrowers” is fairly self-explanatory. A “program” for working with borrowers will require a bank to determine criteria to allow for a more automatic deferral decision. This would need to include checking that the borrower was not past due for reasons other than the impact of COVID-19, that the deferral meets the criteria as outlined in the Interagency Statement, and that the bank believes the borrower has been impacted by the Coronavirus. In the case of a program, the decision on granting deferrals may be made by a lender or manager close to the front lines.

Once the deferral decision has been made, the real work begins. As mentioned above, this statement really provides banks with a near-term way to deal with an unknown impact while providing time to fully assess the actual impact on the borrower. Here are the steps we would recommend that banks take in response to the impact of COVID-19:

    1. Make a list of borrowers most likely impacted by COVID-19. Hotels, restaurants, non-essential retailers, ‘Main Street business,’ some manufacturers, distributors, and especially non-owner occupied commercial real estate owners with tenants impacted by COVID-19 are examples of customers that are most vulnerable to the current health crisis.
    2. Reach out to those borrowers to see how they are doing, how they have been impacted, and what they see as next steps for their business. Let your borrowers know you are here to work with them as they navigate through the downturn, including taking pro-active steps to ensure the viability of their business. Let them know what you are doing in the community to help. This is the most important time to keep up communications with your customers. They may well be concerned about what might happen to them and a few kind words of support from their bank can go a long way to letting them know they are not alone.
    3. Based on your initial analysis and conversations with potentially impacted borrowers, you should derive a shorter list of borrowers for which deeper analysis is warranted. As you develop a forward-looking analysis the following considerations should be made:
      a. Last year’s tax return or financial statement may well be meaningless as a source of cash flow analysis if they have been significantly impacted by recent events.
      b. This is the time to work with these borrowers to develop honest, meaningful projections to help determine their ability to overcome any short-term cash flow impact.
      c. For CRE borrowers, a current rent roll with any concessions the owner has made to help tenants or identify tenants that may be at highest risk of defaulting on their lease should be included as part of the bank’s analysis.
      d. It’s also important to have a current balance sheet for any C&I borrowers. This can provide you with another method of assessing the borrower’s financial strength and ability to withstand a downturn. Cash flow analysis alone cannot tell the whole story of a borrower’s repayment ability. A strong balance sheet will include substantial liquidity and limited leverage beyond minimum policy requirements.
      e. Your analysis should be in writing and reviewed by the bank’s loan committee and especially its board of directors to keep them informed about the level of risk to the bank.
      f. For those borrowers where your analysis shows limited long-term problems, great news! Keep in touch to assure that things are actually going as expected.
      g. The overall thrust of the analysis should be on a forward-looking basis in terms of the borrower’s repayment ability, including a defined expectation for receiving frequent and timely financial information. Relying on a tax return, with financial information that could be aged up to 10 months following the borrower’s year-end date could result in a false calculation of future repayment ability.
    4. It is imperative that a pro-active approach is taken by the institution in response to the impact of COVID-19. Sufficient human resources should be dedicated to the bank’s response and outreach to impacted customers. If human resources are limited at the institution, the aforementioned list of borrowers should be prioritized based on factors developed by management, i.e., size of credit, borrower sensitivity to the impact of a downturn, and those businesses considered critical to the well-being of the community (large employers).

In addition to the bottom-up (customer level) analysis discussed above, we would recommend that the bank perform a comprehensive stress test of its loan portfolio to determine the level of impact, if any, on capital which should be addressed by the board and senior management. (This is a great time to update your capital plan as well.)
The next few months are likely to be a difficult period for many banks and their borrowers. As of today, we don’t really know the actual impact on the economy from COVID-19. But, we can be sure it won’t just be a quick blip and a return to normal for all borrowers. Take the time allowed by this unprecedented Interagency Statement and be proactive.

Dealing with Pandemic Disruption

By: Bill Elliot, CRCM, Director of Compliance Education, and William J. Showalter, CRCM, CRP, Senior Consultant, Young & Associates, Inc., Kent, Ohio

For years banks have had pandemic policies, and have done some level of testing, but never really thought the day would come when it would represent more than another examiner-required policy. Then came COVID-19, and in a matter of days, our world changed.

Managing Bank Policies and Procedures
When we teach in live seminars, we always ask, “How many of you believe that your policies are up to date?” That always gets some hands, but not 100 percent of attendees. Then we ask, “How many of you believe that your procedures are up to date?” Seldom does anyone raise their hand. These two situations are revealing.

Keeping policies current is the easier of the two. But many banks rubber stamp policies that could be much more effective. If it is a Regulation B policy, it usually follows the regulation and indicates that the bank intends to comply. But other policies, notably operations and loan policies, need to do more than restate a regulation – they need to be a document that can be read and used. And, a pandemic policy needs to cover a wide range of subjects and issues.

Given the current situation, it might be time to review these types of policies and add significant language as to how you will address situations such as we have now – lobbies closed or restricted, limited staff, staff working from home, and the same job to be completed. At a minimum, these policies should address:

  • How jobs are done in an off-site world
  • How electronic solutions are to be used
  • Safeguards that must be used to protect customer data
  • What types of paper documents can be used “at home” by staff working off site
  • Proper disposal and the safekeeping of any documents that are off site, and
  • Other protections, such as how the computers being used at home are protected from intrusion

With a little brainstorming, we are sure that you can add to this list.

Procedures are more difficult to maintain. A consultant from our company was recently in a bank and was examining procedures. Most of the procedures could be summed up as “Bill takes care of that.” As long as Bill is there, things probably work well. But if Bill is out sick, on vacation, or no longer there, how does someone accomplish the task?

Procedures are always changing. It is far too easy to tell the three people that need to know about the change and then make a mental note to “update the procedures someday.” That elusive “someday” often never materializes. We believe that each bank should have a formal procedures review at least annually, and for some areas, maybe more often. For many banks, the inadequate procedure manuals that they have will not offer sufficient information for anyone to complete a task correctly.

Many banks have switched to imaging all files. The banks that have made that decision generally are in a little better shape for off-site work, as it is easier to send employees home and still get the work done in a timely manner. If your bank has not made the transition to electronic files, this may be your cue to consider the advantages of this technology.

As the world becomes more electronic, and the cost of maintaining offices and buildings continues to increase, this may also be a time to reconsider the locations from which employees work. This may be especially critical if your brick and mortar buildings are getting close to capacity. Many tasks, with the right equipment and software, can easily be done from home, saving wear and tear on your building, perhaps reducing occupancy costs, and maybe, as a side benefit, resulting in happier and more productive employees.

Regulators and COVID-19 Loan Modifications
On March 22, 2020, all of the prudential banking regulators, along with other agencies, released the
Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus. The full text can be found on many websites, however, the Federal Deposit Insurance Corporation (FDIC) has it at:

https://www.fdic.gov/news/news/press/2020/pr20038a.pdf

The document states, “The agencies understand that this unique and evolving situation could pose temporary business disruptions and challenges that affect banks…businesses, borrowers, and the economy. The agencies encourage financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19. The agencies view loan modification programs as positive actions that can mitigate adverse effects on borrowers due to COVID-19. The agencies will not criticize institutions for working with borrowers and will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as troubled debt restructurings (TDRs).”

The agencies also offered comments on the issue of TDRs. They state that, “Modifications of loan terms do not automatically result in TDRs…The agencies have confirmed with staff of the Financial Accounting Standards Board (FASB) that short-term modifications made on a good faith basis in response to COVID- 19 to borrowers who were current prior to any relief, are not TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented.”

Many banks have in place or are considering modifications to meet the needs of their customer base. It would appear that the regulators are going to react positively, provided the actions of the bank are reasonable and logical. The pronouncement states, “The agencies’ examiners will exercise judgment in reviewing loan modifications, including TDRs, and will not automatically adversely risk rate credits that are affected by COVID-19, including those considered TDRs. Regardless of whether modifications result in loans that are considered TDRs or are adversely classified, agency examiners will not criticize prudent efforts to modify the terms on existing loans to affected customers.”

The pronouncement also discusses Past Due Reporting, Nonaccrual Status and Charge-offs, and Discount Window Eligibility. You should consult the Interagency Statement for details.

When implementing your program to deal with this crisis, compliance cannot be ignored. Regulations that need to be considered include:

  • Regulation B (Equal Credit Opportunity Act) – This applies to both consumer and commercial loans.
  • Flood insurance regulations – If you extend maturity dates, a new determination may be required. This also applies to both consumer and commercial loans.
  • Regulation O (Loans to Insiders) – If anyone who is an “insider” is requesting payment or other forms of relief.
  • Regulation X (Real Estate Settlement Procedures Act) – You need to consider the impact of non-payment into required escrow accounts.

CRA Credit Possible
The Community Reinvestment Act (CRA), in part, requires banks to take good care of the credit needs in their communities. Keeping good records of exactly what you did during this crisis could certainly be shared with your CRA examiners at your next CRA examination. While it may not directly impact the examination, remember that the CRA rating is at least partly based on their opinion of your bank.

The FDIC, Federal Reserve Board (FRB), and Office of the Comptroller of the Currency (OCC) issued a Joint Statement on March 19 stating that the agencies will favorably consider retail banking services and retail lending activities in a financial institution’s assessment area(s) that are responsive to the needs of low- and moderate-income (LMI) individuals, small businesses, and small farms affected by COVID-19 and that are consistent with safe and sound banking practices. The agencies emphasize that prudent efforts to modify the terms on new or existing loans for affected LMI customers, small businesses, and small farms will receive CRA consideration and not be subject to examiner criticism.

Impact of Accommodating Distressed Customers
There will be long-term consequences for any decision you make to alter a contract. For instance, if you allow a customer to skip a payment completely and do not change the maturity date, you will have a balloon at maturity. And since interest continues to accrue for that extra month(s), the principal/interest calculation will likely not be quite correct. So even if you do extend a maturity date, you may have a balloon simply because of the principal and interest calculation.

Having that discussion with your customer now seems preferable to fighting about it in a few years. The only real solution to assure that the loan amortizes correctly is to do the analysis to determine what payment amount will be required to avoid a balloon. And even then, things may still go awry at maturity.

Future Developments
As with many things today, this whole issue continues to evolve. The agencies had planned to present a webinar on this interagency statement on March 27, but have postponed it as of this writing. Keep on the lookout for further word from the agencies on when this will be available.

There is also a Frequently Asked Questions (FAQ) document available at https://www.fdic.gov/coronavirus/faq-fi.pdf, to provide some clarification regarding the interagency statement.

Conclusion
We hope that this article helps you to address these issues. We encourage you to consider what your situation will be post-crisis, as it will likely have lasting impacts on your bank. Try to assure that the lasting impacts are positive, as we all learn from the experience how to handle future disruptions (should they occur) with even more professionalism.

Dealing with Pandemic Disruption

By: Bill Elliott, CRCM, Director of Compliance Education, and William J. Showalter, CRCM, CRP, Senior
Consultant, Young & Associates, Inc.

For years banks have had pandemic policies, and have done some level of testing, but never really thought the day would come when it would represent more than another examiner-required policy. Then came COVID-19, and in a matter of days, our world changed.

Managing Bank Policies and Procedures
When we teach in live seminars, we always ask, “How many of you believe that your policies are up to date?” That always gets some hands, but not 100 percent of attendees. Then we ask, “How many of you believe that your procedures are up to date?” Seldom does anyone raise their hand. These two situations are revealing.

Keeping policies current is the easier of the two. But many banks rubber stamp policies that could be much more effective. If it is a Regulation B policy, it usually follows the regulation and indicates that the bank intends to comply. But other policies, notably operations and loan policies, need to do more than restate a regulation – they need to be a document that can be read and used. And, a pandemic policy needs to cover a wide range of subjects and issues.

Given the current situation, it might be time to review these types of policies and add significant language as to how you will address situations such as we have now – lobbies closed or restricted, limited staff, staff working from home, with the same job to be completed. At a minimum, these policies should address:

  • How jobs are done in an off-site world
  • How electronic solutions are to be used
  • Safeguards that must be used to protect customer data
  • What types of paper documents can be used “at home” by staff working off site
  • Proper disposal and the safekeeping of any documents that are off site
  • Other protections, such as how the computers being used at home are protected from intrusion

With a little brainstorming, we are sure that you can add to this list.

Procedures are more difficult to maintain. A consultant from our company was recently in a bank and was examining procedures. Most of the procedures could be summed up as “Bill takes care of that.” As long as Bill is there, things probably work well. But if Bill is out sick, on vacation, or no longer there, how does someone accomplish the task?

Procedures are always changing. It is far too easy to tell the three people that need to know about the change and then make a mental note to “update the procedures someday.” That elusive “someday” often never materializes. We believe that each bank should have a formal procedures review at least
annually, and for some areas, maybe more often. For many banks, the inadequate procedure manuals that they have will not offer sufficient information for anyone to complete a task correctly.

Many banks have switched to imaging all files. The banks that have made that decision generally are in a little better shape for off-site work, as it is easier to send employees home and still get the work done in a timely manner. If your bank has not made the transition to electronic files, this may be your cue to consider the advantages of this technology.

As the world becomes more electronic, and the cost of maintaining offices and buildings continues to increase, this may also be a time to reconsider the locations from which employees work. This may be especially critical if your brick and mortar buildings are getting close to capacity. Many tasks, with the right equipment and software, can easily be done from home, saving wear and tear on your building, perhaps reducing occupancy costs, and maybe, as a side benefit, resulting in happier and more productive employees.

Regulators and COVID-19 Loan Modifications
On March 22, 2020, all of the prudential banking regulators, along with other agencies, released the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus. The full text can be found on many websites; however, the Federal Deposit Insurance Corporation (FDIC) has it at:

https://www.fdic.gov/news/news/press/2020/pr20038a.pdf

The document states, “The agencies understand that this unique and evolving situation could pose temporary business disruptions and challenges that affect banks…businesses, borrowers, and the economy. The agencies encourage financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19. The
agencies view loan modification programs as positive actions that can mitigate adverse effects on borrowers due to COVID-19. The agencies will not criticize institutions for working with borrowers and will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as troubled debt restructurings (TDRs).”

The agencies also offered comments on the issue of TDRs. They state that, “Modifications of loan terms do not automatically result in TDRs…The agencies have confirmed with staff of the Financial Accounting Standards Board (FASB) that short-term modifications made on a good faith basis in response to COVID-
19 to borrowers who were current prior to any relief, are not TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented.”

Many banks have in place or are considering modifications to meet the needs of their customer base. It would appear that the regulators are going to react positively, provided the actions of the bank are reasonable and logical. The pronouncement states, “The agencies’ examiners will exercise judgment in
reviewing loan modifications, including TDRs, and will not automatically adversely risk rate credits that are affected by COVID-19, including those considered TDRs. Regardless of whether modifications result in loans that are considered TDRs or are adversely classified, agency examiners will not criticize prudent efforts to modify the terms on existing loans to affected customers.”

The pronouncement also discusses Past Due Reporting, Nonaccrual Status and Charge-offs, and Discount Window Eligibility. You should consult the Interagency Statement for details.

When implementing your program to deal with this crisis, compliance cannot be ignored. Regulations that need to be considered include:

  • Regulation B (Equal Credit Opportunity Act) – This applies to both consumer and commercial loans.
  • Flood insurance regulations – If you extend maturity dates, a new determination may be required.
  • This also applies to both consumer and commercial loans.
  • Regulation O (Loans to Insiders) – If anyone who is an “insider” is requesting payment or other forms of relief.
  • Regulation X (Real Estate Settlement Procedures Act) – You need to consider the impact of nonpayment into required escrow accounts.

CRA Credit Possible
The Community Reinvestment Act (CRA), in part, requires banks to take good care of the credit needs in their communities. Keeping good records of exactly what you did during this crisis could certainly be shared with your CRA examiners at your next CRA examination. While it may not directly impact the examination, remember that the CRA rating is at least partly based on their opinion of your bank.

The FDIC, Federal Reserve Board (FRB), and Office of the Comptroller of the Currency (OCC) issued a Joint Statement on March 19 stating that the agencies will favorably consider retail banking services and retail lending activities in a financial institution’s assessment area(s) that are responsive to the needs of low- and moderate-income (LMI) individuals, small businesses, and small farms affected by COVID-19
and that are consistent with safe and sound banking practices. The agencies emphasize that prudent efforts to modify the terms on new or existing loans for affected LMI customers, small businesses, and small farms will receive CRA consideration and not be subject to examiner criticism.

Impact of Accommodating Distressed Customers
There will be long-term consequences for any decision you make to alter a contract. For instance, if you allow a customer to skip a payment completely and do not change the maturity date, you will have a balloon at maturity. And since interest continues to accrue for that extra month(s), the principal/interest calculation will likely not be quite correct. So even if you do extend a maturity date, you may have a balloon simply because of the principal and interest calculation.

Having that discussion with your customer now seems preferable to fighting about it in a few years. The only real solution to assure that the loan amortizes correctly is to do the analysis to determine what payment amount will be required to avoid a balloon. And even then, things may still go awry at maturity.

Conclusion
We hope that this article helps you to address these issues. We encourage you to consider what your situation will be post-crisis, as it will likely have lasting impacts on your bank. Try to assure that the lasting impacts are positive, as we all learn from the experience how to handle future disruptions (should they occur) with even more professionalism.

Job Grades . . . For You?

By: Mike Lehr, Human Resources Consultant

Are job grades for you? “Yes,” is the short answer. The challenge is coming up with ones that fit your bank and don’t break the bank.

First, as a Federal contractor, banks must abide by the Pay Transparency Nondiscrimination Provision. This means employees can discuss their pay with other employees. Moreover, banks must post notifications stating as such. Employees will compare and assess positions accordingly.

Second, what to pay an employee is a tough question. Competitive pressures and meeting managers’ needs make this very subjective and inconsistent when hiring and promoting. Is the pay increase in line with the increase in responsibility? Are managers seeing this the same way? How well do officer titles relate to positions?

Third, what are the career paths in your bank? How do different jobs rank? Is the move upward, lateral, or downward? When is a finance officer on par with a commercial lender? Should an increase in title come with a different job? In all banks, positions come with different statuses. Employees’ and managements’ views don’t always sync on this.

Finally, community banks differ from regional and national ones. They differ from other federal contractors who are typically much larger. At those places, jobs have very specific descriptions. At community banks, a job could contain the responsibilities of three different jobs as those places. Moreover, they change. It’s not unusual for employees to trade job duties.

Yes, job grades can solve these problems and answer these questions. The problem is that the job grading industry is armed with fancy calculations and formulas to create them. Here, think cost. They follow a recipe, the same one no matter the size of the project.

Of course, they “customize” in the end after they burn hours running through the numbers. It’s like applying a six-sigma process to a two-sigma project, using that preverbal sledge hammer to kill a flea, or buying a Ferrari to arrive quicker when the road is rough and breaking fifty safely isn’t possible.

Also, speaking of rough roads, finely tuned calculations and formulas work best on clearly defined jobs. When it comes to community banking, defining jobs is like driving an all-terrain vehicle. It depends on the needs and talent on hand. It’s highly variable compared to the big guys.

So, that brings us to the point about job grades. You can do it. Yes, training helps. You might even have it now. Remember, the process they teach is a recipe, not a concept. Following it blindly will waste time and yield bad results. Do the parts that only make sense and return high value. Improvise, too – it’s all right.

Lastly, these guides apply too if you hire out for part or all of the effort. Pay for value. People modify recipes all the time. That’s why the phrase “to taste” is in them.

Regardless, think all-terrain vehicle. Job grades can solve a variety of compensation, career-pathing, employee engagement, and officer-titling problems. It’s also insurance against pay discrimination.

For more insights and guidance on how to get your employees to make better decisions, you can reach Mike Lehr at mlehr@younginc.com.

Assessing your Compliance Training

By: Bill Elliott, CRCM, Director of Compliance Education

Last fall, the Consumer Financial Protection Bureau (CFPB) updated their Regulatory Agenda for the next few months. As has been the reality for a while, there does not seem to be any particular rush to accomplish many final rules. The Economic Growth, Regulatory Relief and Consumer Protection Act (EGRRCP Act) was signed into law in May 2018. In that law, there are a number of required changes that should be fairly easy to implement – if the CFPB would just do so. But in the short term, there appears little likelihood that the changes dictated by the law (or many other changes) will be placed into regulation. But change is still in our future – it is just a question of the timing.

Part of the problem is the regulatory process. Although all banks are not subject to the Home Mortgage Disclosure Act, it is an excellent example. The “new version” of Regulation C was published as a final rule, effective January 2018. Before the 2018 date, the CFPB changed the regulation. With the passage of the EFRRCP Act, many of the new required fields were eliminated for smaller reporters. Although a fairly simple series of changes were necessary, many months passed before the regulation was updated (October 2019). And when those changes were made final, there were still some outstanding issues in HMDA that needed to be addressed, and remain open at this writing. So even with all the changes, it is not “final” yet. The latest Small Entity Guide for HMDA (which will have to be modified again) is Version 4.

This complicates the life of any bank, regardless of size. When the regulatory process is poor and disjointed, it makes training and implementation more difficult. But the reality is that regardless of how confusing the regulatory process is, banks still have to comply.
Training is a necessary expense, as a failure to train, especially when things are in flux, opens the bank to regulatory scrutiny and/or fines for non-compliance. And keeping your policies and procedures current with the latest changes is always a challenge.

Banks should assess how information is disseminated throughout the bank as these changes occur to assure that training dollars are spent effectively. And the time to assess is now, while things are relatively “calm.” Many banks have delegated training to electronic or web-based systems, and there are many good choices available. But, because of the nature of this type of training, they focus on the facts and requirements, but usually do not include information on what to expect of your employees, or the implementation strategies of your bank. Be wary of buying a training system and then assuming all your training needs are met.

We do not market electronic or web-based systems. But Young & Associates, Inc. offers a wide variety of personalized training opportunities, including:

  • Live seminars with some of our state association partners
  • Live in-bank training
  • Conference calls
  • Private webinars
  • Virtual Compliance Consultant program, which includes a monthly telephone call that can be used for compliance support and/or training sessions as well as policy support, and any other personalized training that you may need

In this period of relative quiet, take this time to assess your training methods and your training needs for the future. Eventually the regulators will begin to issue more regulation, and Young & Associates, Inc. stands ready to assist. To discuss how we can help, please contact Karen Clower at 330.422.3444 or kclower@younginc.com.