SRA Pandemic Risk Management Roadmap‍

As the world slowly starts to “open back up” and the COVID-19 case level begins to level and hopefully decline, the economic reverberations and impact on the financial services sector will be long lasting and significant.

We are already seeing earnings adjusted downward, deferment levels spike and a host of other risk factors that need to be navigated successfully NOW or potential peril waits for those who do not.  

Our team at SRA helped many financial organizations successfully navigate the Great Recession. A few high-level lessons were learned during that time and should be considered now:

• Many in bank leadership were consumed with saving the bank and addressing problems, they did not have capacity to think about the future.
• Problems were diverse and spread across the bank with credit issues, funding/ liquidity issues, increased overhead costs, reputational issues, compliance issues, as well as strategic issues. The CEO and board were especially challenged to stay abreast of issues that for many, like ALCO, BSA and bond portfolios, were unfamiliar with the intricacies of these issues. Entirely new concepts such as “Unfair and Deceptive Practices” were also introduced.
• Information flow was often poor between executives and the board. The organization often did not have a banker on the board, so they often didn’t know what to ask. At the same time, the leadership was hesitant to divulge too much as it might confuse board members, raise more questions for which the banker might not have a good answer and further extend the board meetings.
• Leadership teams were aware of the regulators, who were looking over their shoulders and second guessing them, if not hitting them with private or public enforcement actions. Longstanding, previously acceptable industry practices were now being openly questioned by the regulators.
• The banks had few, if any, people who knew anything about problem loans and workouts. Although banks today are more informed, most of their special asset groups (workout area) are small or non-existent as most borrowers have been performing as expected.
• Loan risk ratings and the typical loan review are backward looking. Banks need something that is forward looking to help them identify those borrowers most at risk. A key part of this review is a stress test, which is a great forward-looking tool to stress each loan and see who’s most at risk of non-payment.
• From a compliance standpoint, clients need to look at today’s decisions and actions from a “three years down the road” lens – as that is when the regulators will assess practices and responses that are made today.  Risk decisions will need to be well documented and conveyed to the regulators early. Crisis is not a basis for shortcuts and a free ride – controls need to be followed; documentation is key, as well as operational integrity. The 2008 crisis exposed numerous systemic weaknesses that resulted in industry sanctions and fines, e.g. robo-signing, MERS, uncontrolled third parties (foreclosure attorneys, lost paperwork).
• The government will be looking for revenue; they made billions from fines and penalties last time, there is no reason that this will not happen again.
  

As a result of these high-level lessons learned, we believe there is a solid roadmap of steps that Banks, Credit Unions and other Financial Entities should be considering as they look to navigate the many risks facing the future of their organization.

That roadmap is divided into 5 logical categories of activities:‍

Transparency

Evaluate Risk Appetite. A great deal of lending expansion is the result of the reversal of conservative risk appetites adopted during the crisis. Now is a good time to review the credit risk components of the bank’s risk appetite statement, including types of loans, concentrations of loan types to capital, and estimates of potential losses.  Then, to revise financial forecasts based on this review to determine if management remains confident the bank will have sufficient earnings and capital to cover possible future losses and expenses of problem credits.  ‍

Executive Direction from:
BOARD OF DIRECTORS / CEO / CFO / CRO‍

Assess Loan Portfolio and Adequacy of Loss Reserves and Capital Position– This is immediately critical; something to do now. Analyze the composition of the loan portfolio and identify exposures to significant local and nationwide economic drivers. Identify risk trends in the portfolio, such as concentrations with declining aggregate risk grades and other potential problem areas, such as loans with excessive extensions and renewals. Expand the coverage ratio of the independent loan review program, whether internal or external, and increase the level of loan officer reviews of credits in their portfolio. Reprioritize the review of the need for assessing new data sources to independently segment your consumer portfolio (enhanced refreshed credit bureau scores, alternative credit data, new trended data, payroll data, for example.)‍

Executive Direction from:
CRO / CCO / CFO‍

Review Risk Ratings. Revisit credit risk rating systems. Many rating systems are too general. (Many are so general that it is impossible to distinguish between good-, acceptable-, and pass-rated loans.) Include more objective measures like specific ratios for capital adequacy, debt service coverage ratios, earnings ratios, etc. Consider also who has the last word on ratings. In a well-managed credit risk environment, it should be the loan review or the credit administration department.  If your consumer portfolios have a refresh process, quickly assess the impact on the risk score distributions.‍

Executive Direction from:
CCO / RISK ASSURANCE‍

Manage Liquidity.  Review deposit vulnerabilities (push out deposit maturities with bump-up CD’s, staggered maturities…such as 15 month CD’s instead of 12 month)‍

Executive Direction from:
CFO / CHIEF BANKING OFFICER‍

Responsiveness

Enhance the Loan Approval Process.  Increase the level of review on new loan requests. Expand the use of “preflight” reviews. These are discussions of potential loans between lenders and the credit administration department prior to offering terms and conditions to a borrower. Have the credit administration review and comment on the structure, terms, conditions and collateral coverage of proposed loans as well as the financial condition of the borrower. Adjust lending limits to include increased review of new loans in areas of emerging risk by experienced lenders and the credit administration. Consider adopting a concurring loan approval scheme where lenders and the credit administration must approve the loan together and significantly reduce the loan committee approach to approving loans. Establish a Pandemic Hotline for consumers; for both for new credit requests and existing borrowers.‍

Executive Direction from:
CHIEF BANKING OFFICER / CCO‍

Strengthen Credit Analysis. (Evaluate capital plans and update forecast of earnings and capital). Do it now. Adopt guidelines requiring that more loans be submitted to the credit administration for preparation of financial analyses, global debt identification and global cash flow analyses. Review credit administration staffing to ensure they are qualified, capable and sufficient to support lenders and any increase in work volumes. Review policies and procedures relative to income and employment documentation for retail and consumer credit.‍

Executive Direction from:
CCO‍

Review Loan Documentation. Now is the time to step up loan quality reviews and audits. Review loan documentation to ensure properly executed loan agreements are on file, liens are properly recorded, exceptions are cleared, etc. Review how well you are really protected. Ensure the bank has an enforceable claim for repayment or to cease and liquidate collateral. Review covenant compliance and take care to ensure the bank’s rights to enforce these covenants are maintained. If a borrower does not meet all covenant requirements, notify the borrower that the bank recognizes this and has not waived the future enforceability of its rights.‍

Executive Direction from:
CREDIT ADMINSTRATION EXECUTIVE / LEGAL‍

Triage

Develop a Comprehensive Customer Modification Program and Workout Strategy to react to anticipated increases in delinquency and default. Have a specific strategy for residential real estate:

• Customer contact management – avoid giving them the runaround; avoid lost paperwork, etc.
• Effectively manage your foreclosure staff – don’t just outsource it.
• Pay close attention to SCRA – avoid military foreclosures and remember that members of the public health service are covered by SCRA.
• Also be mindful of first responders and healthcare workers as collecting on them poses heightened media and reputation risk.
  

Increase Collection Activities. Increase early stage collection efforts, such as notices, letters, and calls. Shift responsibility for these activities from lending officers to dedicated collectors. For consumer borrowers, assess your risk-based queuing methodologies and consider adjusting the hours of your call center efforts.  More borrowers, if employed, are working from home.  Assess all outbound calling strategies.

Manage Problem Assets. Many banks leave the collection and the working out of problem loans to the lending officers for too long. Adopt guidelines for involving an experienced loan workout officer with the lender in developing a plan to improve credit. Ensure that specific objectives are included in any plan agreed to with the borrower. If those objectives are not met, transfer the loan to the workout team. Develop problem asset plans, and review these action plans regularly with the loan committee.

Executive Direction from:
CREDIT ADMINISTRATION EXECUTIVE / COLLECTION EXECUTIVE / PROBLEM ASSET EXECUTIVE‍

Operational Excellence

Evaluate Office Facilities and rehabilitate them to provide a safer environment for the employee and the customer.‍

Evaluate Technology Priorities. Focus on remote capabilities for employees and customers.‍

Manage Expenses; Consolidate Technologies.  For example, stop using four risk solutions instead of one; stop using two CRA solutions, etc.) renegotiate technology contracts to reduce costs, realign staff, look at all contracts (phone, network costs, suppliers, etc.) and consolidate/reduce costs.‍

Executive Direction from:
CTO / COO‍

Compliance

Address AML/BSA Make sure the engine is running

• Develop pandemic specific fraud strategies, especially for PPP loans.
• Keep your models tuned up.
• Make sure the program continues to meet statutory requirements.

Fair Lending

• Be mindful of actions that impact vulnerable customers and LMI customers.
• Ramp up customer complaint procedures – especially verbal complaints and complaints made to branches and call centers – these are early warning indicators.

Regulatory Relations

• Learn from 2008 – interaction is key and put it in writing.
• Understand you will continue to be examined.
• The crisis is not an excuse to cut corners.
• While the regulators have delayed a number of things, they have waived very little.
• The current regulatory “guidance” is fraught with qualifiers and caveats – beware of it.

Executive Direction from:
CHIEF LEGAL COUNSEL / COMPLIANCE EXECUTIVE / REGULATORY RELATIONS EXECUTIVE

To assist companies as they step through this roadmap, SRA has aligned our service offerings to help financial institutions through every step of the way. Please visit our Pandemic Services overview to see how SRA can assist as you embark upon this roadmap.  

Good luck and please don’t hesitate to connect with us for assistance.