This post was co-authored by Alice Harmon, Account Executive for Jack Henry, and Matt Rank, CEO of CRMa.
To say that COVID-19 has challenged financial institutions would be a gross understatement. The problems we face now are unprecedented, and that creates a host of new problems we’ve never had to address.
While the 2008 financial crisis was large and unexpected, its general contours were well within the realm of our basic financial understanding. Unfortunately, we don’t have that same situation today. Some of our basic econometric tools are ill-equipped to help us in our current situation.
Naturally, that leads us to ask, "What can we do?"
One of the first things to recognize is that understanding the effects of this type of crisis requires a broad view. One of the best ways to obtain that view is through loan review, which provides not just a focused assessment of individual loans, but also the entire portfolio.
Given current circumstances, the importance of loan review now goes beyond the required annual assessment, which looks for signs of stress, to one of identifying where the inevitable “hit” will most likely occur. For this reason, who is doing the review, how they are doing it, and how fast they are doing it, matter.
Banking and credit union insight, as well as experience, are critical for seeing the signs of trouble. Suddenly, the difference between having an accounting firm that assigns analysts with no experience versus experienced analysts with years of first-hand banking knowledge is crucial in making management aware of impending risks.
Additionally, give more weight to review providers that utilize multiple analysts with experience over single consultants. Although experience matters, having more than one set of eyes and a wide range of specialties results in more thorough assessment, and much faster completion. You’ll ultimately have greater confidence in the report and more time to address any issues they discover.
Employ Risk-Grade Triage
Effectively identifying individual businesses and economic sectors that are particularly vulnerable are important tasks right now. While some of the hardest hit segments (airlines, cruise ships, and even hotels) rarely make up large components of a community financial institutions loan portfolio, there are others that pose significant concerns.
Probably the largest is the retail sector, where restaurants and non-essential retailers in many states had to close their doors during the initial phases of the pandemic response. Even if financial institutions don’t have direct exposure, they may be indirectly exposed via their income-producing property portfolio. The reality of high unemployment indicates that almost all portfolios will have at least a partial increase in risk profiles.
Credit officers should be combing their portfolios and proactively reaching out to customers about any available modifications or deferral options. The regulatory guidance has been very clear that these deferrals will not count as delinquencies if they’re performed prior to a delinquency event occurring.
Many borrowers will try to "tough it out" and won’t contact their bank or credit union until they realize they are unable to pay. Communicating early with potentially troubled customers can help mitigate this problem.
It’s also important to assess the effects of the current economic situation on the overall health of the financial institution’s portfolio. That can be difficult, particularly if you don’t have adequate historical data.
For those that have the data, going back to the 2008-2009 financial crisis can at least provide a baseline elevated level of losses for comparison. While unlikely to be entirely sufficient, this data can at least serve as a benchmark.
Some providers recognize today’s greater importance of reviewing the range of possible effects still to come and are offering COVID-specific stress tests as part of their review, taking advantage of not only their historical data but also information on some of the hardest-hit markets and portfolio segments. This can provide a framework of elevated losses for comparison and consideration by the institutions management so it can create a proactive strategy if the crisis extends into next year.
Choose Your Reviewer Wisely
The unique circumstances now facing the industry call for greater scrutiny in how operations are managed, particularly around credit risk. One of the most far-reaching and impactful steps that can be taken now is to carefully assess who is performing your loan review.
Experience, speed, and depth should carry heavier than usual weight when awarding contracts. With so much more on the line, choosing wisely who reviews your loan portfolio will put your financial institution in the best position to manage through this challenging period effectively.
Learn more about third-party loan reviews here.