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.

IRR and Liquidity Risk Review – Model Back-Testing / Validation of Measurements

Effective risk control requires conducting periodic independent reviews of the risk management process and validation of the risk measurement systems to ensure their integrity, accuracy, and reasonableness. To meet the requirements of the Joint Policy Statement on Interest Rate Risk (IRR), as well as the Interagency Guidance on Funding and Liquidity Risk Management and the subsequent regulatory guidance, Young & Associates, Inc. can assist you in assessing the following:

  • The adequacy of the bank’s internal control system
  • Personnel’s compliance with the bank’s internal control system
  • The appropriateness of the bank’s risk measurement system
  • The accuracy and completeness of the data inputs
  • The reasonableness and validity of scenarios used in the risk measurement system
  • The reasonableness and validity of assumptions
  • The validity of the risk measurement calculations within the risk measurement system, including back-testing of the actual results versus forecasted results and an analysis of various variance sources

Our detailed interest rate risk review reports and liquidity risk review reports assess each of the above, describe the findings, provide suggestions for any corrective actions, and include recommendations for improving the quality of the bank’s risk management systems, and their compliance with the regulatory guidance. We are happy to customize the review scope to your bank’s specific needs.

For more information, contact Martina Dowidchuk at mdowidchuk@younginc.com or 330-422-3449.

Liquidity Risk Management

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

Does your liquidity management meet the standards of increased regulatory scrutiny?
What was once deemed acceptable is gradually coming under a more rigid review, and financial institutions need to be prepared to show that their liquidity risk oversight complies with both supervisory guidance and sound industry practices.

The liquidity risk may not be among the areas of community banks’ immediate concern given the abundance of liquidity in the banking industry today. However, the history shows that liquidity reserves can change quickly and the changes may occur outside of management’s control. A bank’s liquidity position may be adequate under certain operating environments, yet be insufficient under adverse environments. Adequate liquidity governance is considered as important as the bank’s liquidity position. While the sophistication of the liquidity measurement tools varies with the bank’s complexity and risk profiles, all institutions are expected to have a formal liquidity policy and contingency funding plan that are supported by liquidity cash flow forecast, projected liquidity position analysis, stress testing, and dynamic liquidity metrics customized to match the bank’s balance sheets.

Some of the common liquidity risk management pitfalls found during annual independent reviews include:

Cash Flow Plan:

  • Lack of projected cash flow analysis
  • Inconsistencies between liquidity cash flow assumptions and the strategic plan/budget
  • Lack of documentation supporting liquidity plan assumptions
  • Overdependence on outdated, static liquidity ratios and lack of forward-looking metrics
  • Lack of back-testing of the model

Stress Scenarios:

  • Stress-testing of projected cash flows not performed
  • Stress tests focusing on a single stress event rather than a combination of stress factors
  • Stress tests lacking the assessment of a liquidity crisis impact on contingent funding sources
  • Insufficient severity of stress tests

Contingency Funding Plan Document:

  • Contingency funding plan failing to address certain key components, such as the identification of early warning indicators, alternative funding sources, crisis management team, and action plan details
  • Lack of metrics defined to assess the adequacy of primary and contingent funding sources in the baseline and stressed scenarios

Liquidity Policy:

  • Inadequate risk limits or lack of acceptable levels of funding concentrations defined in the liquidity policy
  • Liquidity policy failing to address responsibilities for maintenance of the cash flow model, model documentation, periodic assumption review, and model validation

Management Oversight:

  • ALCO discussions related to liquidity management not containing sufficient detail and not reflected appropriately in the ALCO meeting minutes
  • Lack of periodic testing of the stand-by funding lines
  • Lack of liquidity model assumption review or documentation of such review
  • Lack of periodic independent reviews of the liquidity risk management process

If you are interested in an independent review of your existing liquidity program and a model validation, or are looking for an assistance with developing a contingency funding plan, liquidity cash flow plan, and liquidity stress testing, please contact me at 330.422.3449 or mdowidchuk@younginc.com. Young & Associates, Inc. offers an array of liquidity products and services that can help you to ensure compliance with the latest regulatory expectations.

CRE Portfolio Stress Testing

CRE Stress Testing is widely viewed by bankers and bank regulators as a valuable risk management tool that will assist management and the board of directors with its efforts to effectively identify, measure, monitor, and control risk. The information provided by this exercise should be considered in the bank’s strategic and capital planning efforts, concentration risk monitoring and limit setting, and in decisions about the bank’s loan product design and underwriting standards.

Young & Associates, Inc. offers CRE Portfolio Stress Testing that provides an insightful and efficient stress testing solution that doesn’t just simply arrive at an estimate of potential credit losses under stressed scenarios, but provides a multiple page report with a discussion and summary of the bank’s level and direction of credit risk, to be used for strategic and capital planning exercises and credit risk management activities.
Our CRE Stress Testing service is performed remotely with your data, allowing for management to remain free to work on the many other initiatives that require attention, while we make use of our existing systems and expertise.

For more information, contact Kyle Curtis, Director of Lending Services, at kcurtis@younginc.com or 330.422.3445.

Ag Lending Considerations in 2020

By: Robert Viering, Director of Lending

On January 28, 2020, the FDIC published Financial Institution Letter (FIL-5-2020) Advisory: Prudent Management of Agricultural Lending During Economic Cycles. It’s a good summary of many items to consider in the management of your ag portfolio and I recommend you taking a few minutes to read it.

In our loan review practice we have many clients that have a reasonable exposure to agriculture, including agribusiness. We’ve seen a decline in the cash flow generated by these borrowers as the ag sector declined from the historic highs of a few years ago. Over the last two years, we have seen this sector stabilize as most producers have been able to make adjustments to their operation and, while not back to the same levels of profitability, reach a level of acceptable cash flow. For many it has been a case of reducing expenses not only for crop inputs, but also cutting family living. For some that were over-leveraged, we have seen the sale of land (or sale-leaseback) that has brought debt service in line with today’s cash flow or a slowing of capital expenditures. We’ve seen many instances where debt was refinanced to a longer term to bring payments in line with cash flow. However, even with the vast majority of borrowers making adjustments, we have seen more classified ag credits and increased non-performing loans. This has typically been due to high leverage or not being able to make the tough decisions needed to operate successfully today. Management skills are near the top of the list for success in agriculture today.
Based on what we have seen in our reviews of our ag clients and our own experience managing ag portfolios, the following is our list of “best practices” for 2020:

  • Have all the information needed to make an informed credit decision at renewal, including:
    • A complete financial statement with detailed schedules. Take the time to review this with your borrower and ask if they have any other bills, such as payables to input providers or loans from family or friends.
      • For more complex borrowers that may have various partnerships or corporate entities that make up the farming operation, make sure you have financial information for each of the entities, not just the one you may be financing. You need a global financial statement, as well as a global cash flow.
      • Ask about actual ownership of assets. Some assets may be owned by a trust; if so, consider making the trust a co-borrower or guarantor.
      • Have your borrower complete the financial statement as of 12/31 each year. You’ll need this to make accurate accrual adjustments when used with the tax return.
    • A credit report on all individuals that sign personally. Use this report to check for levels of personal debt and compare this report to past years to see if personal debt is increasing or decreasing.
    • A new UCC search. Use this to see if there are other secured lenders.
    • Estimated Costs. If you are getting a cash flow from the borrower to support an operating line, compare the estimated costs to historical costs. We see a lot of borrowers that underestimate their actual costs.
      • Government payments have been a big part of some farms’ cash flow. It is important to understand the impact of those payments on an operation. Consider what happens if the Market Facilitation Program is not extended in 2020.
      • Obtain a basic stress test on the borrower’s cash flow. If small changes in revenue or expenses will bring cash flow below break-even, do understand the level of crop insurance, any hedging program, and have a “Plan B” discussed with those in the operation regarding how they will get through if things are tough. It’s a lot easier to have that conversation about selling some land now than when payments are due in the fall if things don’t go as planned.
    • Cash Flow for New Debt Structure. If you’re going to restructure debt, make sure the operation can cash flow the new debt structure. If it can, great; you probably have a pass loan (or will be soon). If not, then you probably have a classified loan.
    • Trends. Trends matter. What direction are leverage, liquidity, and cash flow going?
    • Working Capital. Working capital is your real secondary source of repayment. If working capital is strong, that will cover an off year and not require a restructure or asset sale.
    • Future Plans. Ask about the plans for 2020, including any capital expenditures (for your good borrowers, don’t forget to pre-approve them for these loans); their marketing plans; and any changes in expenses from the prior year.
  • Know your portfolio:
    • Track risk rating changes for the portfolio. What is the direction of your average risk rating?
    • Stress test your portfolio. Develop moderate and high stress scenarios. Stress revenue, expenses, and collateral values. Understand the impact of moderate and high stress on your capital. (Young & Associates, Inc. can work with you to provide a stress test of your ag or CRE portfolio.)
  • Be proactive:
    • Don’t put off those farm visits. You’ll learn far more about your borrowers’ operation, their concerns, and what they most enjoy by spending a few hours with them at the farm than you ever will just talking in your office, making phone calls, and sending emails or text messages. Document those visits and take pictures for the file. Some banks list all farms they need to visit, estimate when the visit will take place, and track their progress each month.
    • Ask your borrower what information they monitor to manage the farm. You’d be surprised how many operators have a lot more information than they share with you. It’s almost never that they are holding information back as much as it is we haven’t asked.
    • Develop an exit plan if needed. If you have a struggling operation and there doesn’t appear to be a good way to turn it around, you need to have that tough conversation with the borrower about how you will get repaid sooner rather than later. Having a well-planned, cooperative exit plan is almost always in everyone’s best interest.
  • Know that best practices are not for every borrower:
    • Having more information than less is always best, but sometimes we have those very strong, long-time borrowers that provide minimal information. If every indication says the operation is strong, then sometimes you can get by with more limited information. But, in those cases, spell out in your loan presentation what you are not getting and why that does not pose a risk to the bank.

Need Assistance?
Please feel free to reach out to us if we can help you with your loan review, stress testing, or other aspects of your lending operation that you’d like to improve. Our lending team is made up of well-experienced bankers that provide you with realistic solutions. For more information, you can contact me at bviering@younginc.com or 330.422.3476.

Banks as Federal Contractors, A Brief History

By: Mike Lehr, HR Consultant

Unless legal counsel says otherwise, if FDIC covers a bank’s deposits, it’s best to assume it’s a federal contractor. That not only means the bank likely needs an affirmative action plan if it issues fifty or more different W2s in a year, but the federal government holds the bank to higher employment standards.

Still, as human resources professionals know, bank CEOs, presidents, and other senior executives often want to know, “What law says so?” After all, when we think of a “federal contractor,” we often think huge employers with thousands of employees.

For banks with only a few hundred (if that) employees, this all seems very unnecessary. Yet, the short answer is that a reinterpretation of existing law after the 2008 financial crisis made most banks federal contractors if they obtained federal deposit insurance.

Reviewing the way our government works and the history of banks as federal contractors can clarify this answer. After all, the law is not clear. It hasn’t changed much in over twenty years.

This review begins by reminding others that federal laws change in three main ways:

    1. Congress passes or revises laws.
    2. Executive branch reinterprets existing laws.
    3. Courts rule on and clarify regulations causing disagreements among parties.

While Congress neither passed nor revised any law specifically stating banks are federal contractors, the Department of Labor (DOL) reinterpreted the law. Until the 2008 financial crisis, the Office of Federal Contract Compliance Programs (OFCCP), an agency of the DOL, mainly interpreted the law to say FDIC made banks contractors. The DOL, its boss so to speak, never accepted this however.

So, until 2008, unless a bank clearly acted as “an issuing and paying agent for U.S. savings bonds and notes” or “a federal fund depository,” in a substantial manner, the DOL likely didn’t consider it a federal contractor.

Until 2008, FDIC payouts to banks were rare, almost non-existent. This crisis though saw many sizeable payouts. As a result, the DOL accepted OFCCP’s interpretation of the law. The crisis forced the DOL to see FDIC coverage as doing business with the federal government. So now, by its “boss” agreeing, the OFCCP has more authority to enforce its regulations such as affirmative action plans on banks.

Again, a reinterpretation of existing law after the 2008 financial crisis increased dramatically the likelihood that a bank is a federal contractor. This brief history has helped human resources professionals answer questions related to “what law says so?”

For more guidance and support on complying as a federal contractor, you can reach Mike Lehr at mlehr@younginc.com. Mike Lehr is not an attorney. As such, the content in this article should not be construed as providing legal advice. For specific decisions on compliance with OFCCP regulations, readers should consult with their legal counsel.