On June 23rd the NCUA published Interagency Examiner Guidance for Assessing Safety and Soundness Considering the Effect of the COVID-19 Pandemic on Institutions. The pandemic has led to substantial strain and stresses on financial institutions and the guidance suggests that examiners should be flexible in their assessments. Here is a summary of the guidance and questions to ask in preparation for your next exam.
Examiners will be looking at how a financial institution responded to the economic changes brought on by COVID-19, considering the institutions asset size, complexity, and risk profile
Effectiveness of Institutions Assessment of Risk
What is your assessment of risk now and for the future and is it sufficient in scope and content?
Examiners will consider the following in its assessment of ratings:
While the agencies have encouraged financial institutions to use their capital buffers to help their members during the pandemic, examiners will want to make sure it has been done in a safe and sound manner by looking at capital as it relates to your risks. Have you properly assessed your capital needs and vulnerabilities caused by the pandemic? Do you have a plan to raise capital if necessary?
The guidance spends a lot of time on examiners assessment of asset quality. Has management identified loans substantially affected by COVID-19? Is management able to identify potential losses in a timely manner? They break it down as follows.
Classification of Credits
Examiners will look at the borrower’s ability to repay, their financial condition and the underlying collateral if any. Is there a reasonable plan for workouts and foreclosures in the event a borrower is not able to repay?
Credit Risk Review
The guidance acknowledges that loan reviews may be delayed, or scope changed due to the operational limitations from the pandemic. If so, what is your plan to complete the review?
Examiners will review underwriting standards before the pandemic and after while understanding that underwriting standards may have been relaxed to meet the needs of your members. In addition, if you have taken on new business strategies in response to the pandemic do they have sufficient controls and knowledge?
While the agencies support the use of PPP to continue to lend to their members, they will review to ensure the programs follow the SBA guidelines.
Like PPP loans, the agencies view loan modifications as a positive action but will assess the appropriateness of the policies and procedures for these loans. In assessing safety and soundness this action will not be criticized by examiners. In addition they will consider the CARES Act which allows institutions to temporarily suspend certain requirements in their accounting as it relates to troubled debt restructuring.
The agencies indicated that deferral of payments of principal and interest for a reasonable period with the expectation that the borrower would repay in the future is allowed. The Revised Interagency Statement issued on April 7th indicated that these short term arrangements should not be reported as nonaccrual.
Allowance for Loan and Lease Losses (ALLL)
Examiners will review your ALLL methodologies. Have you updated your ALLL to reflect changes of your lending practices and the economic impacts of the pandemic? Have you considered adding a qualitative adjustment to account for additional credit losses due to the pandemic?
Obligations of Taxing Authorities
Examiners will be reviewing loan and investment portfolios that are linked to municipalities, taxing authorities and limited purpose facilities (i.e. sports and entertainment venues) as the pandemic has adversely affected these groups.
Real Estate Values
Examiners will evaluate your process for valuing real estate collateral as they may experience fluctuations because of the pandemic. Are you evaluating the collateral in your real estate portfolio and are these values prudent and realistic?
Appraisal and Evaluation Delays
While appraisals and evaluations can be delayed during the pandemic reviewers will want to know if you are trying to obtain credible valuation of a property and how you are handling a backlog of appraisals that were forced to be delayed from the stay at home orders.
Examiners will be evaluating management’s response to the pandemic. Have you measured its effectiveness and adjusted accordingly? Have the changes been incorporated into your long term business strategy?
What steps have you made in implementing effective controls for new operational procedures?
Independent Risk Management and Audit
Examiners will be reviewing at home work arrangements and remote work technologies.
Examiners will be reviewing any core earning reductions caused by the pandemic. How are you accounting for reduced earnings including deferred interest and operational issues and its effect on earnings prospects?
Liquidity will fluctuate during the pandemic. How is your financial institution accommodating for these fluctuations and changes in liquidity? In addition, examiners will not criticize an institution for using a liquidity buffer to help members.
Sensitivity to Market Risk
Interest rate risk profiles may shift as cash flows change. These changes may be short term or reflect a permanent change. What are your procedures to review and update your asset and liability management models?
2020 Analytics can help provide the monitoring of risk the NCUA is looking for. Here’s how;
- Real Estate Valuation including superior values on junior liens.
- COVID-19 stress testing specific to your MSA.
- Qualitative and environmental adjustment to your allowance calculation for COVID-19.
- Skip-a-Pay and forbearance monitoring.