The continual uncertainty and change we’ve seen across all areas of business, including financial institutions, calls for in-depth discussion. Join CRI Partners Rob Demonbreun and Chris Cain for this episode of It Figures as they talk about credit risk management, the impacts of PPP loans included in government stimulus packages, Part 363 temporary relief requirements, and much more.
From Carr, Riggs & Ingram, this is It Figures: The CRI Podcast, an accounting advisory and industry focused podcast for business and organization leaders, entrepreneurs and anyone who is looking to go beyond the status quo.
We want to welcome you today to the CRI It Figures Podcast. My name is Rob Demonbreun, and I’m a financial institutions partner with CRI in our Nashville office. And I’m joined today by Chris Cain. Chris, I’ll let you introduce yourself.
Yeah, absolutely. I’m Chris Cain. I’m a financial institution partner in CRI’s Birmingham office, and I’ve been working with financial institutions over 20 years and buddy Tom Flaws when you’re having fun.
That is the truth and this is our specialty, financial institutions. And we thought today, what we would bring during this Podcast is to talk about hot topics in the risk management area. 2020 has definitely been a challenging year, both from a business standpoint for financial institutions, and all businesses and partially as well. And we thought it’d be a great time to talk about some of those hot topics that are before us now related to risk management. Chris, I know you’re seeing it with your clients, for sure. We’re talking to them all day. What are you seeing?
Yeah. Thanks Rob. Absolutely. There’s a lot of uncertainty right now because of the pandemic that’s created economic uncertainty. There’s also a level of political uncertainty regardless of your political party. There’s a new president with a new cabinet and that brings a level of change and uncertainty to the landscape as well. So, with uncertainty presents challenges. And one thing that we’re seeing a lot of banks focused on right now because of that uncertainty is credit risk management and having a robust credit risk management function. And I know Robin, talking with you earlier that you’ve been saying that with your clients as well. So, what are you seeing on the credit risk management front among your clients?
Well, Chris, definitely as you know, when you come into uncertain times and where things are fluctuating, and it isn’t just a status quo that credit risk management becomes key. It is so important as we all know for financial institutions to focus on credit risk management in uncertain times, and then March 2020, everything changed. We obviously went through the national emergency with the pandemic. And things started being in question about how we were going to deal with borrowers. How was it going to affect the ability to repay from our borrowers? And so, initially the question was, well, what do we need to do with deferring loan payments? Borrowers started asking questions. Guidance was issued then the Cares Act was passed at the end of March 2020, which gave some guidance on how to handle trouble there restructurings. And then quickly following that, the regulatory agencies put out some joint inter-agency guidance clarifying some of their thoughts as it related to those topics, specifically, just safety and soundness considerations in general.
Also, from an accounting and regulatory standpoint, things to be keeping in mind related to the Cares Act, related to troubled debt restructuring, we created this thing called section 40/13 loan modifications, generally talking about credit risk, talking about past due reporting for any of these loans that were received accommodations, not accrual status. So all the things you would expect to be talked about, the regulatory agencies gave us some guidance on that.
And then they followed that up in August 2020, with some additional information. Some of these loans that received accommodations early on in the pandemic started coming to the end of that accommodation period. And they gave some more guidance on prudent risk management practices that banks should be following and how to identify, measure, and monitor credit risk, looking at risk writings, grading, accrual status, all the things we know need to be done during a time of uncertainty, just reiterating that, making sure we have appropriate monitoring systems, reporting systems in place, so we can gather information to make decisions from.
And then also talking about consumer protection, that was another area that they hit on. Stressing again, accounting and regulatory guidance, but specifically this time talking more about the allowance for loan losses or the allowance for credit losses, if you’ve adopted CECL, and how to make sure you’re integrating that into your decision making process and your financial reporting. Now, I think that’s been one of the challenges and one of the things I’m talking with my clients and other bankers about is, as we’ve gone through this fluid process, through the pandemic of really figuring out where the problems are, we knew it seemed like the population was so large early on, that we were dealing with. And now as we come later in the pandemic or during the timeframe, we can get more targeted in how we look at our borrowers. Which ones are truly having problems? Which ones can project out that the things aren’t going to get better much quicker?
And what are we looking at to determine that past due reports, overdraft reports, looking at risk rating changes?, And then how do we take that information on those borrowers and then have that appropriately reflect in our allowance for loan losses through qualitative factors, for uncertainties, through historical experience, and maybe other times of uncertainty? How do we do that? And that’s been the challenge to be able to aggregate all this information that we have, fine tune it to come up to an appropriate reflection in our financial statements. Chris, I know you’re going through the same thing and having the same discussion with your clients. What are you seeing in Birmingham?
Yeah. Absolutely, Rob. Thank you. Talking to a lot of banks right now, talking about credit risk management, and I’m a practical person and like to give bankers and clients practical tips. So, what are some of the things that we’re seeing in practice? So first off, we’re seeing a lot of analysis done on the loan portfolio, looking at particular industries that have been impacted by COVID-19, by the pandemic. And what are some of those industries or some of those segments? Clearly, hotel, motel loans have been impacted with less occupancy. We’ve seen retail impacted. We’ve seen restaurants heavily impacted, as well as religious organizations impacted, and others. So, what financial institutions, community banks are doing is they’re looking at those industries. They’re saying, Hey, what, what are our largest credits, or what are our credits within those? And they’re usually having a meeting among senior lenders and saying, what is our strategy for managing that credit risk?
And one thing they’re doing is they’re encouraging loan officers for those particular credits to routinely reach out to bank customers and borrowers and ask for interim financial information. And what we’re telling our buying clients right now is interim financial information is definitely your friend, and talk to your borrowers about really setting the expectation that quarterly interim financial information is expected and is really necessary for the bank to perform a financial assessment, and really look at the accuracy of the risks writing for that particular loan. And also, it really gives the bank some good information into the customer’s business, and they might be able to use that information to offer additional products or services to that customer. So, that’s some of the things that we’re saying in that space.
Again, other things reporting to the board risk writing migration. And I know if you go back to 2008 and 2009, during that economic downturn, we really encourage a lot of our clients to say, let’s look at risk writing migration, and let’s look at the current quarter, what are our risks writings among the loan portfolio? And how does that look compared to maybe the last two or three quarters? And then, how does that look from a year ago? And really analyzing that risk writing migration. Does it make sense from an overall standpoint, given what management knows about the portfolio, as well as discussing that with board members? Is it migrating to a place that causes concern or is it looking okay? So, those are the things that bankers are really dealing with and really looking at is, how to proactively manage credits, given the uncertainty.
I want to mention to you there, that is one of the most important things is that, what you just talked about is that proactive management of credit risks during a time like this, a time of uncertainty. And I referenced earlier the interagency guidance that was issued later in the year in August 2020. And it talked about being proactive in the credit risk area. One of the things I thought it was interesting, we talked about this earlier, that it mentioned at the end were internal control systems, internal control systems around working with borrowers, helping them through these uncertain times, mentioned things like quality assurance, credit risk review, operational risk management, compliance management, internal audit function.
And we think about that in relation to today’s problem. Borrowers are the ones that are struggling. No, it’s also, as we think about other risk management areas to focus on, that this internal control systems is something we don’t need to forget during this time either. So I thought it’d be a good opportunity for you to talk about some… About other risk management things that we need to keep in the top of our mind as we move forward.
Yeah. Absolutely, Rob. And I think it’s a good time for banks to really revisit entity wide risk assessment. As I mentioned earlier, there’s economic uncertainty, some level of political uncertainty and really challenging times. So really quantifying those risks by revising the entity wide risk assessment and making sure that those are considered, one thing that we’re saying among banks is active communication. And sometimes that communication can be difficult when you have a remote workforce. But really discussing risks with board members, with senior management and particularly with audit committee, and really setting some expectations about what does this look like moving into the next year? And really with regard to expectations, I like to tell banks is, you really need to say your risk assessment is a fluid document. And the regulators that often, but really need to look at periodically updating that and really telling the audit committee, Hey, the risk management team is going to reassess the bank’s entity wide risk assessment at least mid year next year, and can do that more frequently depending on changes in circumstances, changing Zen environment and particularly changes with the overall pandemic.
Also, other things to consider as part of that is the bank’s budget process. Having discussions between risk management and the CFO, the finance department, and talking about how is COVID-19 impacting various revenue streams and expenses? And on the expense side, what we’re seeing among our banks is, banks that may have had some IT projects, or maybe delaying those a bit because of the economic uncertainty, and just reconsidering, Hey, do we really need to be spending right now given that uncertainty? And then also looking at revenue forecast for certain revenue streams. One thing that has gotten a lot of discussion among bankers is NSF, the revenue, and that significantly lower in the current year because of the pandemic. And there are many reasons for that.
One is, because so many bank customers are staying at home. They’re not swapping their debit card as much, and they’re not spending as much money, so they’re not having as many NSFs. And then secondly is, we’re saying that people have more money because of these government stimulus programs. So because of that, they’re also not creating as many NSFs. So, revising the risk assessment, revising the budget, and then once that process is done, I think an important step is to revise the internal audit plan.
And clearly, linkage between the entity wide risk assessment and the internal audit plan is vital. And that’s one thing that regulators say. And that’s one thing that we really focus on for the clients that we assist on the internal audit front, is having direct linkage between the risk assessment, the internal audit plan. And here, some of the things that I wanted to mention are our coordination between the various business owners within the bank and the internal audit plan, making sure that plan is modified again based on the uncertainty, and then discussing that plan with the audit committee, discussing that with others in the organization, and really making sure that the internal audit plan is up to date. And which may mean that risk management department makes changes throughout the upcoming year.
I know that’s one thing we’re talking about is, Hey, your internal audit plan may change. You may have multiple revisions. Keep track of those revisions and what that looks like. And make sure that your audit committee is informed and understanding the reason for those changes. So, communication is key obviously as well as coordination among various departments within the bank. So as part of that, the ever evolving Paycheck Protection Program, or the PPP program and other government stimulus programs are being a challenge for community bankers. And I had a community bank that said, Hey, it’s like… A PPP is like you’re flying in an airplane and you’re building an airplane as you’re flying in it Chris. So Rob, what are you seeing among your bank clients in the PPP space and other government stimulus programs, and what are some of the things they’re doing around the forgiveness process, as well as the necessity questionnaires that have been issued by the SBA?
Yeah, absolutely. That’s a great description of what it has been like with the PPP program that’s administered by the SBA. And it’s interesting that the start of this, financial institutions, banks have been the lifeline to their customers including small businesses and during the pandemic. And obviously from the government stimulus standpoint, one of the most publicized stimulus programs was the PPP, Paycheck Protection Program. And it has been an ever evolving process, as you mentioned, for financial institutions. And it’s been a challenge to stay on top of the information as it’s come out, because it has been ever evolving. And now we’re in that forgiveness stage. But as we look back several months ago, financial institutions were always at the forefront in guiding their customers through the process. And from the giving general information of what the process looked like to helping through the application process, then giving advice on what forgiveness may look like.
It was just… A lot of information was needed to be provided and it had to happen quick. So a lot of resources were allocated to it, to make sure the program worked fluidly as it could for customers. And now we get to this forgiveness stage and have been in it for a few weeks in getting these PPP loans forgiven, and the bankers, the lenders are at the forefront of that. And the key takeaway from this process for me is just the timeliness that’s needed on the side of the lenders. And they’re aware of that. And it’s just another allocation of resources to make sure things get done so that these loans are forgiven. There’re three applications that can be filed depending on certain circumstances. So with the lenders, keeping current on this is so important.
And then also, just a few weeks ago, Folly received these necessity questionnaires that are required to be filled out for borrowers that have received generally over $2 million in PPP funds, that the banks are helping facilitate that as well through the SBA platform. And that’s occurring by bank being informed that the questionnaire needs to be completed, letting the borrower know that, getting the information back from the borrower, uploading that to the SBA. So it’s just a continual process of information flow back and forth. And because of that, keeping on top of the timelines is so important into making sure that the allocation of resources of bank staff is appropriate as well. And in many cases I know with my clients, it was employees that were pulled from other areas to help head the PPP function within the institution.
And so, because of that, it’s important now from a risk management standpoint, to not only ensure that the PPP program is flowing properly, but also that those functions that those individuals were working with before haven’t been neglected, and that they’re also being addressed as well and not forgotten about, because that’s hard to do when you’re under the gun. And so, just important to keep up with information as it comes out, because it’s still evolving, and staying on top of that information is so important, with all this government stimulus between the PPP, between these liquidity facilities that regulators have put in place, and then just other government stimulus. We’ve seen bank balance sheets blow up during 2020. They’ve grown large. And sometimes with unintended consequences. And Chris, I know the FTSE issued some information and guidence on things banks should be thinking about related to that. I thought, I’d let you talk about that for a few minutes.
Yeah. Absolutely Rob. So it’s really refreshing to see that community banks have been part of the solution during this pandemic, and been a really vital function within the overall economy within the US, and really has shown the real need for community banks in the marketplace. And I think that’s fantastic. Because, these community banks have been really originating a lot of the PPP loans, it was good to see that the regulators issued some regulatory relief for financial institutions, particularly related to FDICIA part 363. And really the financial institution letter, this interim final role allows community banking organizations, these organizations to determine the applicability of certain asset-based regulatory thresholds using asset data as of December 31st, 2019, if the organization’s assets, as of that date were less than its assets on the date as of which the applicability of a threshold would normally be determined.
So what does that mean? So, basically what that means is that asset growth in 2020 or 2021 will not trigger a new regulatory requirement for these community banks until January 1st, 2022. At the earliest, there is an exception if there’s some merger or acquisition. So the threshold is to think about in the part 363 guidance, or the $500 million asset threshold, as well as the billion dollar threshold, and give some relief there. Because of the government stimulus programs, we’ve seen a lot of banks’ balance sheets increased dramatically. And if that’s the cause of that, then the banks get some relief from part 363. And then, one thing I wanted to mention also is that there’s been renewed discussion around these asset threshholds.
The 500 million and the $1 billion asset threshold as part of 363 have been in place for, I think, about 15 years or so. And there’s been significant discussion over the last few years among bankers, among various banking associations as well about should those asset levels be increased, because they’ve been in place for such a long time? And I know we have a number of bankers that are hoping that those thresholds get increased even after this temporary guidance. So, I think rather that’s something for us and for our clients to look for is, a potential additional guidance around 363 and those thresholds. So before the pandemic, we’re really seeing organic growth in community banks outside of the pandemic, clearly before that, and had had discussions with banks about how they might get ready for 363 and some key elements within that, or developing a robust action plan, meeting with the banks’ external auditors early in the process to talk about those plans, look at potential entity level controls, as well as activity level controls and what the plan might look like for that financial institution.
And I know that’s one space that we at CRI have really helped a number of financial institutions during the past few years, is implement FDICIA part 363 at the billion dollar threshold is something that we really Excel at and have helped a number of clients. So, I wanted to mention to bankers if they’re facing that asset threshold and it’s really a two year process, in my opinion, to get prepared for, to have plenty of time to anticipate various ineffective controls and challenges. So, I would encourage bankers to reach out to us at CRI if they have questions around that space, or if they have any questions about the financial institution space. It would be our pleasure to talk to them.
And there’s a wealth of information on our website, cricpa.com, and look under financial institutions as well as sign up to follow our future podcast. So, Rob, I think this is some really good information for community banks, and really served a huge need in the U S as part of this pandemic. And I have done this, as I mentioned earlier, for over 20 years, and it’s really a pleasure to serve community banks, and is something I really enjoy. So hopefully our clients and others will find this information valuable and really enjoy doing this podcast with you.
Absolutely Chris. And we thank you for being here today and sharing this information with us.
Yeah. Absolutely Rob. Hopefully, community bankers will find this information valuable and will really help them in their day-to-day functions. So thanks everyone for joining us and have a great day.
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