Mergers & Acquisitions Expected to Rebound in 2021

By: Bob Viering, Director of Management

The Covid-19 pandemic brought M&A activity for community banks and credit unions to a halt in 2020. All expectations for 2021 are that M&A activity is likely to pick up significantly. Much of this activity is due to organizations that had planned to sell or start acquiring in 2020 to make up for lost time, but it will also be due to the changes in the industry as a result of the pandemic.

Electronic and mobile banking adoption accelerated as financial institutions closed branches or provided limited access during the pandemic. Today, not having a digital banking platform (internet and mobile apps) is no longer an option. Financial institutions need to re-assess branch networks in light of how customers/members bank today. Among the reasons that will drive many organizations to sell are:

  • Long-term impact of low interest rates, today’s compressed margin, and the future impact of rising rates
  • Cost/liability of data security
  • Regulatory compliance costs
  • Lack of management succession

Conversely, those organizations that have made the technology infrastructure investments, have staffing in place that can succeed in this volatile time, and are comfortable thinking outside the traditional banking box have great opportunities.

How We can Assist

Young & Associates has been assisting banks and credit unions for over 43 years and have assembled a team of qualified professionals that can assist you in your acquisition or help you prepare to sell your organization and maximize your return.

The industry is fortunate in that we have many excellent investment bankers, law firms, and accounting firms that provide great advice on the pricing, structure, and regulatory requirements. But as anyone who has been through an acquisition or merger can tell you, it is the knowledge you gain during due diligence and post-merger integration that, in the end, will determine if the transaction was successful. Our services will supplement the services acquired from your investment banker, law firm, and accounting firm.

While due diligence and post-merger integration can be done by your staff, our breadth of knowledge, gained from decades of working for hundreds of banks and credit unions, brings a broader perspective. We deal with many of these issues regularly and can often be more efficient. We also understand that time is of the essence for due diligence and will make your engagement a priority to be completed in the time needed.

Due Diligence Assistance

Loan Due Diligence: We can provide a timely assessment of the underwriting, management, and quality of the target’s loan portfolio. We have experts from all disciplines of lending, including ALLL analysis and credit process. We will help you understand the culture of the organization you are acquiring.

Interest Rate Risk and Liquidity Management Due Diligence:  We can assist you in determining the target institution’s level of interest rate and liquidity risk. This can then help you as you consider the combined organization’s level of risk. This will help you answer the following question:  Does the combined organization fit within your risk “comfort zone?”

Compliance Due Diligence: Many aspects of compliance, such as Fair Lending and BSA/AML, will become the acquirer’s problem if there was an issue prior to acquisition. Having the target’s compliance program reviewed prior to closing can help you understand the degree of compliance risk you will be assuming.

IT Due Diligence: This is an often overlooked but critical piece of information to understand how well or what IT-related issues a target bank may have that will need to be addressed post-acquisition.

Strategic Planning: We can help you assess how the acquisition will fit into your strategic direction. If your strategic plan involves potential acquisitions, have you put a plan/process in place to prepare for it, or will you put it together on the fly if an acquisition comes along? Analyzing how the target fits with your culture and your strategic direction is one of the most important aspects of a successful acquisition.

Succession Planning: While much of the attention in an acquisition analysis is on the financial aspects of the transaction, the quality and depth of the human resources of the target institution are the drivers of the target’s current success or challenges. We can assist you with reviewing the target’s succession plan or help you craft a new one for the combined organization. (See “Succession Planning – The Key to Remaining Independent,” page 1.)

Interagency Bank Merger Application Assistance

We can assist you with the delineation of the relevant geographic markets, evaluation of competitive factors in the proposed transaction, CRA assessment area data and mapping, demographic information, business environment data, information on traffic patterns, and other relevant market information. We can also help you craft your business plan that is a required part of the application.

Post-Acquisition Integration

Post-acquisition integration is the key to whether your merger/acquisition is successful. You will have just spent many millions of dollars to buy an organization. Buying the organization is not the end result but the beginning of many months and years of hard work to get the return you expect.

There are several ways we can help you achieve the results you expect from the transaction:

  • Employee and customer communications
  • Strategic, capital, and succession plan updates, based on the combined organization
  • Re-assessment of your branch network. Does it make sense to consolidate any branches, especially given the changes that the pandemic has brought in regard to digital banking adoption?
  • Periodic loan review and compliance review will allow you to assess the quality of results at both the overall organization and the acquired organization.
  • Analysis of workflow and staffing of the combined organization
  • Assessment of your human resources management. Retaining key members of the acquired organization’s staff is often the biggest determinant of future success. This is especially true for your frontline commercial/ag/private bankers and key deposit/cash management personnel who are often the day-to-day face of the organization for your largest customers.

These are just some of the ways Young & Associates can work with you to have a long-term successful acquisition, based on your unique needs. Contact us today for more information on how we can assist you with your M&A efforts.

To learn more about how we can assist your organization, visit our website or contact Dave Reno, Director – Lending and Business Development, at dreno@younginc.com or 330.422.3455.

Regulation B Interpretive Rule on Sexual Orientation and Gender Identity

By: Bill Elliott, CRCM, Director of Compliance Education

March 2021

The Bureau of Consumer Financial Protection (Bureau) issued an interpretive rule to clarify that, with respect to any aspect of a credit transaction, the prohibition against sex discrimination in the Equal Credit Opportunity Act (ECOA) and Regulation B, which implements ECOA, encompasses sexual orientation discrimination and gender identity discrimination, including discrimination based on actual or perceived nonconformity with sex-based or gender-based stereotypes and discrimination based on an applicant’s associations.

The interpretive rule became effective upon publication in the Federal Register.

At Young & Associates, we have been teaching for years that this is the correct approach. The reality is that an applicant’s sexual orientation or gender identity has absolutely nothing to do with whether they will be able to repay the loan. The focus of all bankers should be on the same things that are important in all credit decisions – cash, collateral, and credit. Nothing else really matters.

The Equal Credit Opportunity Act (ECOA) makes it “unlawful for any creditor to discriminate against any applicant, with respect to any aspect of a credit transaction,” on several enumerated bases, including “on the basis of … sex …” Likewise, Regulation B prohibits a creditor from discriminating against an applicant on a prohibited basis (including “sex” ) “regarding any aspect of a credit transaction,” and from making “any oral or written statement to applicants or prospective applicants that would discourage on a prohibited basis a reasonable person from making or pursuing an application.”

Before this interpretive rule, twenty states and the District of Columbia prohibited discrimination on the bases of sexual orientation and/or gender identity either in all credit transactions or in certain (e.g., housing-related) credit transactions. This interpretive rule now makes this the new national standard. So financial institutions must recognize sexual orientation and/or gender identity to be protected classes and must incorporate practices that prohibit discrimination on these bases.

This interpretive rule addresses any regulatory uncertainty that may still exist under ECOA and Regulation B as to the term “sex” to ensure the fair, equitable, and nondiscriminatory access to credit for both individuals and communities and to ensure that consumers are protected from discrimination. It serves a stated purpose of Regulation B, which is to “promote the availability of credit to all creditworthy applicants without regard to … sex …”

As an interpretive rule, it is exempt from the notice-and-comment rulemaking requirements of the Administrative Procedure Act.

To learn more about how we can assist your organization with your compliance efforts, contact Dave Reno, Director – Lending and Business Development, at dreno@younginc.com or 330.422.3455.

Managing Compliance

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

We have been told repeatedly over the years that we need to manage compliance, just like all aspects of our business. This maxim is particularly true in today’s escalating compliance environment. There are so many new and changed rules that have been added to the mix over the past decade that we could easily be overwhelmed if we did not proactively manage the compliance process.

Over the years, supervisory agencies have shared general outlines of compliance management systems with the financial institutions they regulate. They have been quick to point out that there is no one “right” way to manage compliance, but that there are certain basic needs that must be met by any such program.

Compliance Management Systems
The Consumer Financial Protection Bureau (CFPB) and other agencies view compliance management as vital to the prevention of violations of federal consumer financial laws and the resulting harm to consumers. In its Supervisory Highlights publication, the CFPB spelled out its expectations for an effective compliance management system (CMS) – which mirror those from other supervisory agencies.

The CFPB states that it expects every entity it supervises (large financial institutions and nonbank financial firms) to have an effective CMS adapted to its business strategy and operations. According to the CFPB, a CMS is how a supervised entity:

  • Establishes its compliance responsibilities
  • Communicates those responsibilities to employees
  • Ensures that responsibilities for meeting legal requirements and internal policies are incorporated into business processes
  • Reviews operations to ensure responsibilities are carried out and legal requirements are met
  • Takes corrective action, and
  • Updates tools, systems, and materials, as necessary

No agency requires financial institutions to structure their CMS in any particular manner. They recognize the differences inherent in an industry comprised of banking organizations of different sizes, differing compliance profiles, and a wide range of consumer financial products and services. In addition, some financial firms outsource functions with consumer compliance-related responsibilities to service providers, requiring adaptations in their CMS structure.

However compliance is managed, financial entities are expected by all the federal supervisory agencies to structure their CMS in a manner sufficient to comply with federal consumer financial laws and appropriately address associated risks of harm to consumers.

CFPB Findings
The CFPB has found that the majority of banks it has examined have generally had adequate CMS structures. However, several institutions have lacked one or more of the components of an effective CMS, which creates an increased risk of noncompliance with federal consumer financial laws.

The most common weakness identified during CFPB reviews of banks’ CMS is a deficient system of periodic monitoring and independent compliance audits. The CFPB has noted that an effective CMS implements an effective internal compliance review program as an integral part of an overall risk management strategy. Such a program has two components – both periodic monitoring reviews and an independent compliance audit. These two types of controls are not interchangeable. They must be complementary.

The periodic monitoring reviews are more frequent and less intensive than the audits, focusing on areas that carry the most risk – where mistakes should not be allowed to go uncorrected too long. Monitoring is an ongoing process, conducted by either the individual business lines or the compliance officer/department on a relatively frequent basis, and allows the bank to self-check its processes and ensure day-to-day compliance with federal consumer financial laws.

The independent compliance audit is a review of all operations impacted by consumer laws. An audit is performed on a less frequent basis, usually annually, to ensure that compliance is ongoing, that the CMS as a whole is operating properly, and that the board is aware of consumer compliance issues noted as part of these independent reviews. Audits are best performed by an independent party – usually either an internal auditor or an outside consultant.

The CFPB notes that an entity lacking periodic monitoring increases its risk that violations and weaknesses will go undetected for long periods of time, potentially leading to multiple regulatory violations and increased consumer harm. Additionally, these entities increase the risk that:

  • Insufficiencies in the periodic monitoring process may not be identified
  • The board is not made aware of regulatory violations or program weaknesses, or
  • Practices or conduct by employees within the business lines or compliance department that are unfair, deceptive, abusive, discriminatory, or otherwise unlawful could go undetected

CMS Elements 
Although the CFPB states that it does not require any specific CMS structure, it notes that supervisory experience has found that an effective CMS commonly has four interdependent control components, elements that have been advocated by all regulatory agencies over the years:

  • Board of directors and management oversight. An effective board of directors communicates clear expectations and adopts clear policy statements about consumer compliance for both the bank itself and its service providers. The board should establish a compliance function, allocating sufficient resources and qualified staffing to that function, commensurate with the entity’s size, organizational complexity, and risk profile. The board should ensure that the compliance function has the authority and accountability necessary to implement the compliance management program, with clear and visible support from senior management, as well. Management should ensure a strong compliance function and provide recurring reports of compliance risks, issues, and resolutions to the board or to a committee of the board.
  • Compliance program. The CFPB and other federal financial institutions supervisors expect supervised entities to establish a formal, written compliance program, generally administered by a chief compliance officer. A compliance program includes the following elements: policies and procedures, training, monitoring, and corrective action.

The agencies assert that a well-planned, implemented, and maintained compliance program will prevent or reduce regulatory violations, protect consumers from noncompliance and associated harms, decrease the costs and risks of litigation affecting revenues and operational focus, and help align business strategies with outcomes.

  • Consumer complaint management program. Financial service providers are expected to be responsive to complaints and inquiries received from consumers. In addition, financial institutions should monitor and analyze complaints to understand and correct weaknesses in their programs that could lead to consumer risks and violations of law.

Key elements of a consumer complaint management program include establishment of channels through which to receive consumer complaints and inquiries (e.g., telephone numbers or email addresses dedicated to receiving consumer complaints or inquiries); proper and timely resolution of all complaints; recordation, categorization, and analysis of complaints and inquiries; and reviews for possible violations of federal consumer financial laws.

The agencies expect financial firms to organize, retain, and analyze complaint data to identify trends, isolate areas of risk, and identify program weaknesses in their lines of business and overall CMS.

  • Independent compliance audit. A compliance audit program provides a board of directors or its designated committees with a determination of whether policies and standards are being implemented to provide for the level of compliance and consumer protection established by the board. As noted above, these audits should be conducted by a party independent of both the compliance program and the business functions. The audit results should be reported directly to the board or a board committee.

The agencies expect that the audit schedule and scope will be appropriate for the entity’s size, its consumer financial product offerings, and structure for offering these products. The compliance audit program should address compliance with all applicable federal consumer financial laws, and identify any significant gaps in policies and standards.

When all of these four control components are strong and well-coordinated, the CFPB states that a supervised entity should be successful at managing its compliance responsibilities and risks.


To learn more about Young & Associates, Inc. and how we can assist your organization in developing a strong Compliance Management System, visit our website, or contact Dave Reno, Director – Lending and Business Development.

www.younginc.com
Email: dreno@younginc.com
Phone: 330.422. 3455

About Young & Associates, Inc.
Young & Associates, Inc. has provided consulting, training, and practical products for community financial institutions for over 43 years. We strive to provide the most up-to-date solutions for our clients’ needs, while remaining true to our founding principles and goals – to ease the management of your organization, reduce the regulatory burden, improve your bottom line, and increase shareholder value.

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.