The Federal Financial Institution Examination Council (FFIEC) has issued guidance for examiners to consider the effects of COVID-19 in safety and soundness examinations.

The interagency guidance seeks to acknowledge the “unique, evolving and potentially long-term nature” of the issues arising from COVID-19 and the impact on financial institutions. However, the guidance also notes, “examiners will continue to assess institutions in accordance with existing agency policies and procedures and may provide supervisory feedback or downgrade an institution composite or component ratings.” As such, while there is an acknowledgment of the unprecedented challenges posed by the pandemic, it appears the regulatory “bar” will remain intact.

As one might expect, asset quality is a focal point within the guidance. Still, there is also reference to “materially modified operational processes” as a result of stay-at-home orders and social distancing. The guidance acknowledges that such changes, coupled with rapidly deployed stimulus programs, could have stressed change management processes. Additionally, there is a presumption that operational, compliance, cyber, and fraud risks have been elevated during this time.

The guidance further indicates “the agencies will consider where an institution’s management has appropriately planned for financial resiliency and continuity of operations; implemented prudent policies; and is pursuing realistic resolution of the issues confronting the institution.”

An overview of relevant areas covered includes:

Risk Assessment – regulatory agencies expect robust and clear risk assessment processes to be in place with short-term and long-term strategies to address the risks identified.

Capital Adequacy – examiners will evaluate capital planning efforts and assess related projections considering the institution’s risk profile and the previously mentioned short and long-term strategies.

Assets Quality – areas of focus will include:

– Classifications
– Credit review
– New Loans
– Paycheck Protection program
– Modifications
– Nonaccrual
– Allowance adequacy
– Real estate values
– Appraisals

Investments – particular emphasis will be placed on the institution’s monitoring of risk exposures related to municipal bonds and the underlying creditworthiness of the issuers.

Management – much of the focus should concern the formal identification of risk and the clarity with which management implements policies, procedures, and strategies to address such risks.

Earnings – increased provisions, loan modifications, and non-interest expense (personnel, legal, IT, and fraud) are among the factors expected to impact earnings adversely.

Liquidity – fluctuations in liquidity are anticipated due to various government stimulus programs and customers draw upon savings/reserves.

Sensitivity to Market Risk – it is anticipated that time will be needed for the management to fully assess changes to the institution’s interest rate risk profile and distinguish between short and long-term modifications.

COVID-19 has and will presumably continue to create new and unique challenges for financial institutions and their regulators. CRI’s financial institution professionals stand ready, willing, and able to assist in this dynamic and unprecedented environment.