Key Risks and Exam Prep June 3, 2021

Key Risks and Exam Prep

June 3, 2021

Today’s webinar will cover the following areas . . .

1. The Landscape

2. How to prepare for your next examination

3. FDIC 2021 Risk Review

4. OCC Spring 2021 Semiannual Risk Perspective

Traditional risk metrics continue to be muted by government actions and other programs protecting

troubled borrowers

OCC semiannual Risk Perspective

The system-wide offering of proprietary relief and mandated programs coupled with unprecedented

stimulus efforts may be deferring potential losses within the financial services industry

OCC semiannual Risk Perspective

Polling Question #1

Do you believe that the government stimulus packages and foreclosure moratoriums have deferred potential losses in portfolios?

A. Yes

C. I don’t know

Polling Question #2

Have you introduced new lending products into your portfolio in the past 12 months?

A. Yes

C. I don’t know

Polling Question #3

Have you expanded your lending market area in the past 12 months?

A. Yes

C. I don’t know

Bankers need to be prepared for a changing regulatory environment . . .

Changes priorities at the banking

agencies

Return of Onsite Examinations

The New Administration

1. Review last Examination and be 100% certain that all items are full addressed:

a. Formal or Informal Orders

b. MRBA, MRIA, MRA

c. Entire ROE

2. Ensure you have strong credit admin practices . . . Do not simply rely on lagging indicators

a. New products?

b. Expanded territory?

c. New staff?

d. New policies?

e. Effective credit risk reviews?

3. Maintain an appropriate ALLL/ACL . . . Q-factors are critical

a. Independent review of the methodology

4. Document an effective Risk Management Program

a. Identify, measure, monitor, control

b. Financial metrics and risk thresholds

c. Peer groups (or comparable groups)

5. Verify an effective Corporate Governance Program

a. Board and Committee minutes

b. Appropriate policies

c. Succession Planning

Top 10 rules for exam preparation . . .

6. Ensure that all internal items have been fully addressed by the Board’s Audit Committee

a. Audit Plan

b. Exceptions and remedies

c. Documentation

7. Perform Stress Tests

a. Loan Portfolio

b. Interest Rate Risk scenarios

c. Liquidity position

8. Establish an internal communication strategy to avoid surprises

a. Daily updates

b. At least two bankers in room

9. Focus on key compliance issues

a. BSA

b. Fair Lending

10. Perform (or engage FinPro to perform) a thorough pre-exam assessment

Top 10 rules for exam preparation (continued) . . .

Polling Question #4

Have you had a negative provision to your ALLL in the past 9 months?

A. Yes

C. I don’t know

The FDIC is focused in two key areas . . .

Credit Risks

Market Risks

Key Risks to Banks

Let’s take a deeper dive into some of the Credit Risk categories . . .

Credit Risk

Commercial Real Estate

Consumer

Housing

Leveraged Lending & Corp Debt

Small Business

Nonbank Financial

Institutions

Agriculture and Energy are also key areas.

Market Risk has two key components . . .

Interest Rate Risk and Net Interest Margin

Liquidity and

Deposits

Market Risk

Let’s take a deeper dive into the Commercial Real Estate risk profile . . .

Credit Risk

Consumer

Housing

Small Business

Nonbank Financial

Institutions

CRE loans held by FDIC insured banks reached a record high at year end 2020 . . .

Clearly the Luxury Hotel industry has been hardest hit . . .

Some markets have an excess supply of multifamily units . . .

The pandemic negatively impacted almost all CRE values in early 2020 . . .

CRE loans at FDIC insured institutions reached a record high at year end 2020 . . .

FDIC insured banks held $487.6 billion of CMBS at year end 2020. Approximately 39% of FDIC insured banks hold CMBS, although such holdings generally do not represent a large percentage of capital . . .

Let’s take a deeper dive into the Consumer risk profile . . .

Credit Risk

Consumer

Housing

Small Business

Nonbank Financial

Institutions

No doubt the CARES Act impacted U.S. personal income growth . . .

Overall consumer debt was down 5% for a year earlier while consumer loan performance was stable in 2020 . . .

Did the stimulus programs help defer

deterioration in these portfolios?

Let’s take a deeper dive into the Housing risk profile . . .

Credit Risk

Consumer

Housing

Small Business

Nonbank Financial

Institutions

The residential real estate market is heading toward a problem in some parts of the country . . .

Low Inventory

Low Interest Rates

Hot demand

Bubble waiting to happen

“Ability to Repay” vs “Willingness to Repay”

The delinquency rate of 3.4% is up 71 bps from a year earlier and the sixth consecutive quarterly increase . . .

Let’s take a deeper dive into Leveraged Lending risk profile . . .

Credit Risk

Consumer

Housing

Small Business

Nonbank Financial

Institutions

Both high-yield and investment grade bond issuance ended 2020 about 60% above 2019 levels . . .

Improved defaults rates are somewhat mitigated by light or missing covenants . . .

• The low interest rate

environment helped

improve cash flow

ratios

• The share of

leveraged loans

lacking lender-

protecting covenants

remained at an all-

time high

• More than 86% of

newly issued

institutional leveraged

loans lack appropriate

covenants

Let’s take a deeper dive into the Small Business risk profile . . .

Credit Risk

Consumer

Housing

Small Business

Nonbank Financial

Institutions

What impact did the stimulus have on bankruptcies . . .

Small businesses tend to file Chapter 7 (liquidation) rather than Chapter 11 (reorganization)

Small businesses benefited from the various stimulus programs

Chapter 11 filings increased 33% in 2020

The industry experienced negative loan growth rates excluding the PPP . . .

The PPP effect on C&I performance cannot be ignored . . .

Let’s take a deeper dive into the nonbank risk profile . . .

Credit Risk

Consumer

Housing

Small Business

Nonbank Financial

Institutions

Community banks are not heavily involved in this lending area . . .

From an overall industry perspective, though, this lending segment shows the greatest growth . . .

Liquidity and

Deposits

Market Risk

Liquidity and

Deposits

Market Risk

The vast majority of banks that reported the highest levels of NIM compression – ranking in the 80th

percentile for all banks – had less than $1 billion in total assets . . .

Community banks hold more time deposits (17.5% of TA) compared to noncommunity banks (5.6% of TA) . . .

Liquidity and

Deposits

Market Risk

Stimulus programs, Stay-At-Home Orders, reduced consumer spending contributed to this unique liquidity situation . . .

Not surprisingly, Operational / Credit / Compliance are top three (3) areas of concern . . .

The OCC ultimately categorizes Key Risks into these four buckets . . .

Key Risks

Operational

Credit

Libor Cessation

Compliance and BSA

Operational Risk has three key pillars . . .

Cybersecurity

• Phishing

• Ransomware Attacks

• Supply Chain

New Products & Services

• Real Time Payments

• Mobile & digital technologies

• Open API

3rd Party Risk Management

• Due Diligence

• Service Provider Concentration

Operational

Credit Risk is segmented into Commercial, Retail, and Mortgage . . .

Commercial

• Risk remains elevated

• COVID-19 restrictions

• CRE, retail, restaurants, O&G, equip manufacturing, transportation, and commercial services

Retail

• Risk has moderated

• Borrower assistance programs

• Improving outlook for GDP and employment growth

Mortgage

• Risk has moderated

• Borrower assistance programs

• Foreclosure moratoriums could delay loss realization

Credit Risks

Banks must be aware of the 12/31/2021 “line in the sand” . . .

November 2020 Joint Statement

• Cease asap but NLT 12/31/2021

• Unsafe & Unsound

• Libor contract post 12/31/2021

• Failure to prepare for Libor disruption

Bulletin 2021-7

• Self assessment Tool

• Increased scrutiny for banks with significant exposure or less-developed transition processes

International Swaps and Derivatives Association

• Effective 1/25/2021

• Interbank Offered Rate Fallbacks Supplement

• Interbank Offered Rate Fallbacks Protocol

Cessation

Bankers may need to stock up on their supplies of Pepcid or Prilosec . . .

Bank Secrecy

• AML Act of 2020

• FinCEN has specific COVID-19 updates

Consumer Compliance

• Monitor Customer Complaints

• CARES Act

• Disparate Impact

• Disparate Treatment

Compliance

and BSA

Lending

• Mortgage Lending

• Disparate Impact

• Disparate Treatment

1. Traditional risk metrics continue to be muted by government actions and other programs protecting troubled borrowers

2. The system-wide offering of proprietary relief and mandated programs coupled with unprecedented stimulus efforts may be deferring potential losses within the financial services industry

3. ALLL/ACL

− Reflect risk in portfolio

− With QFs considering

− Current environmental issues

− Potential modeling issues related to the pandemic

4. Proactive banks continue to monitor exposures or concentrations in distressed industries, markets, or consumer products highly affected by the pandemic. Banks should continue to assess the adequacy of credit administration, including workout programs, staffing and expertise, loan accommodation programs, and resources for back-office operations

Remember these key items when planning for your next examination . . .

You cannot afford a regulatory hiccup today. Let FinPro assist you with your pre-exam evaluation to

avoid a costly mis-step

Don Musso

dmusso@finpro.us

908-234-9398

Scott Polakoff

spolakoff@finpro.us

Pat Rohan

prohan@finpro.us

Dave Mangian

dmangian@finpro.us

Key Risks and Exam Prep June 3, 2021

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