Revisiting Growth, Strategy in the Face of Banking’s Known Unknowns

It’s time to hunker down.

For the last several quarters, the banking industry has been whipsawed by rapid changes in the economy due to the coronavirus pandemic, as well as the response required to keep the fallout at bay. They worked with borrowers to offer widespread deferments, rolled out the Small Business Administration’s Paycheck Protection Program loans and regraded their loan portfolios. With much of that activity winding down, institutions are getting back to the basics of block-and-tackling banking, and bracing for a prolonged period of muted loan growth and sustained low interest rates.

In this environment, the risks can sometimes seem more numerous than the opportunities. In response, banking experts weighed in on how institutions can craft a resilient and flexible strategy while planning for future growth during the first day of Bank Director’s 2020 BankBEYOND experience. Net interest margin compression, keeping up with customer demand for digital offerings and continued industry consolidation topped the list of long-term viability concerns for the CEOs and board members responding to Bank Director’s 2020 Governance Best Practices Survey; organic growth was not far behind. Notably, that survey was conducted in February and March, before Covid-19 spread through the U.S.

While loans deferrals have declined, Hovde Group Chairman and CEO Steve Hovde says he still expects to see “credit quality issues, reserve issues” emerging in the fourth quarter and into 2021, depending on whether lawmakers allocate more stimulus. He also touches on the forces compressing NIMs and what banks can do to address it.

One way that bank leaders can address these concerns is by revisiting the fundamentals of operational excellence as they craft strategies to grow and maneuver safely in this challenging landscape. People, processes and vision are the building blocks of an effective board, says Jim McAlpin, a partner and global leader of Bryan Cave Leighton Paisner’s banking practice group — but these are also the building blocks of an effective bank. Directors should be vigilant in the role they play of engaging in risk oversight and management, McAlpin says, given that they can have a “significant impact” on the bank’s risk appetite.

On the funding side, banks should reconsider how they will amass and defend their core deposit base efficiently, given the decline in branch traffic and increasing digital channel activity. Community banks need to keep their customers engaged as they continually strengthen their digital experience. They should focus on existing customers, listen to what they want, leverage data to identify and understand clients, and maintain their service cultures by personalizing interactions.

“Shut the back door, rather than worry about what’s coming in the front door,” says Bob Reggiannini, a senior manager at Crowe.

But in positioning themselves for growth, McAlpin adds that banks should ensure they have the right type of people at their institutions and on their boards. Diversity in this environment is a strength, given the perspectives and approaches that can come from individuals representing a variety of demographics, identities and backgrounds. In our recent Governance Best Practices Survey, 52% of respondents agreed that greater diversity, defined by race, gender and ethnicity, improves the performance of a corporate board; only 8% said no. Nearly 40% of respondents said they had several members who fit that definition of diversity, and another 30% said they had one or two but wanted to recruit more.

Four Traits That Will Define Successful Lenders in the Future

Covid-19 and the Paycheck Protection Program have fundamentally changed the banking industry.

In just a few months, lenders were forced to learn how to process a year’s worth of loans in six weeks. Numerated worked with lenders to process nearly a quarter of a million PPP loans on our platform. We had a front-row seat to how the pandemic transformed lending and drove a technological reckoning (which we shared with Bank Director).

We’ve identified a number of strategies, perspectives and traits that contributed to lenders’ success during the crisis. Working with banks to shift their focus to a post-PPP world, we’re seeing how incorporating these key learnings from the program will separate the winners from the losers going forward.

As banks and credit unions pivot to the new normal, the most successful lenders will be those who accomplish these four things:

Successful lenders will lean in on digital. It goes without saying that in the middle of a pandemic, every bank needed to figure out how to serve customers with closed branches. Digital capabilities were put to the test — everyone quickly figured out where their digital footprint fell short. A lot of sensitive documents were emailed, workflow was lost and most processes wouldn’t have passed audits in normal times. Digitally-mature lenders and those who successfully adopted technology for PPP had efficient, secure processes that didn’t burn out their customers or employees. Technology will be key to keeping customers satisfied and employees happy during inevitable future crises or unexpected shifts in the industry.

Successful lenders will prioritize speed to market. When Congress first announced the PPP, lenders had to make a quick decision: lean in and figure out how to help their businesses or sit it out. One of the biggest differences in PPP performance we’ve identified was how quickly lenders got into the market.

Two client banks in California both did the same number of PPP loans — despite one being 10 times larger than the other. The smaller bank identified their needs, adopted our platform and rapidly rolled it out to their borrowers faster than their larger counterpart. This gave the smaller bank a foot up in the market. Some banks think committees and consensus mean they can’t move quickly. In 2021, successful banks will understand speed matters, crisis or not.

Successful lenders will achieve efficiency ratios not previously thought possible. The workflow on Small Business Administration loans is complicated; despite the SBA’s best efforts, this was true for PPP as well. The best lenders leveraged technology to get PPP loans done the same day as applications. They pre-filled applications, automated decisions, automatically generated and digitally executed loan documents, and used APIs to board to the SBA. Loans that would have taken a banker five to six hours were done in less than an hour.

At the height of PPP, we saw lenders processing nearly two loans a second — the equivalent of $250 million of PPP loans per hour. Banks will need to find radical efficiencies like these to grow earnings in a challenging 2021 budget season. The most successful lenders are already using PPP learnings to reengineer their normal loan operations.

Using data is key. In 2021 and beyond, it will no longer be enough for lenders to digitize their processes. Going beyond these commonplace efficiency gains will require using reliable, actionable data that can automate and eliminate work. Unfortunately, as anyone who’s worked with financial technology knows, bank data is a mess.

During PPP, we worked with the SBA to create a connection to their systems that let us detect errors in our banks’ data. There were many, many errors; enabling our banks to fix these data issues saved countless hours of rework. Successful lenders are finding ways to clean their data so that software can automate more of their normal lending processes. These conversations are integral to their 2021 plans.

As the pandemic still grips the nation and without further government assistance in the immediate future, banks find themselves in uncharted waters as they set their budgets for the new year.

One of Numerated’s investors is Patriot Financial Partners’ Kirk Wycoff — one of the most successful community bank investors in the United States. In a recent Numerated webinar, he shared his perspective that this year’s budget conversations will be more focused on technology than ever before. “We need to get that message across to senior leadership teams that for investment in technology, there needs to be a realization that the building’s on fire.”

The ability to put out that fire effectively will determine much of lenders’ success in 2021 and beyond.

What Employers Need to Know about Coronavirus, Paid Leave

From lobby closures to Paycheck Protection Program loans, the COVID-19 pandemic has thrown a lot at banks and other financial services providers during this pandemic. One more item to add to the list is the Families First Coronavirus Response Act (FFCRA).

The FFCRA is not one law but a suite of laws targeted at lessening the effects of the pandemic, including two laws that establish paid leave requirements on covered employers: the Emergency Family and Medical Leave Expansion Act (EFMLEA) and the Emergency Paid Sick Leave Act (EPSLA). As is the case with many employment laws and rules, a bank that fails to comply with the FFCRA paid leave requirements does so at its peril.

Who are covered employers?
The paid leave requirements generally apply to all private employers with fewer than 500 employees. There are limited exceptions to the Emergency Family and Medical Leave Expansion Act leave requirements for employers with fewer than 50 employees relating to leave for school and child care closures. A bank looking to take advantage of the EFMLEA exceptions should closely study the circumstances and the exception criteria. Further, while the federal rules apply only to small (under 500 employee) employers, some states’ paid leave laws cover large employers as well.

Who are eligible employees?
Employee eligibility is one area where Emergency Family and Medical Leave Expansion Act and Emergency Paid Sick Leave Act diverge. Paid leave under the EFMLEA is available to employees who have been employed for a minimum of 30 calendar days. For EPSLA related leave, all employees qualify, regardless of their length of employment. EFMLEA and EPSLA each apply to part-time as well as full-time employees and neither require an employer to provide paid leave to furloughed employees.

When can employees utilize paid leave benefits?
This is another area where the two statutes diverge. The EPSLA provides for paid leave if the employee is unable to work (or telework) because the employee:

  1. Is subject to a federal, state or local quarantine or isolation order.
  2. Has been advised by a health care provider to self-quarantine.
  3. Is experiencing symptoms of COVID-19 and is seeking a diagnosis.
  4. Is caring for an individual covered by (1) or (2) above.
  5. Is caring for a son or daughter whose school or place of care is closed or whose child care provider is unavailable due to COVID-19 precautions.
  6. Is experiencing any other substantially similar condition specified by the Secretary of Health and Human Services.

The Emergency Family and Medical Leave Expansion Act, as its name implies, is an expansion of the Family and Medical Leave Act and is triggered by the need for the employee to care for someone else, in this case the employee’s child. Specifically, EFMLEA provides for paid leave to employees who must care for a minor child because of a coronavirus-related school closure or childcare provider loss. EFMLEA benefits only are available if the employee is unable to work from home or telework. We should note, however, that employees who become ill with COVID-19 or are caring for family members who have COVID-19 may still be covered by the FMLA original unpaid “serious health condition” provision.

What are the paid leave benefits?
Under the Emergency Paid Sick Leave Act, full-time employees are entitled to 80 hours (i.e., 10 days) of emergency paid sick leave at either full-rate (reasons 1, 2 and 3 above) or two-thirds rate (reasons 4, 5 and 6 above). The benefit is capped at $511 per day when the employee is absent for reasons 1, 2 or 3, and $200 per day for reasons 4, 5 and 6. Part-time employees are entitled to receive a proportionately similar amount of leave based on their average hours worked in a two-week period.
For 10 weeks an eligible employee is entitled to receive up to two-thirds of their regular rate of pay, capped $200 per day under the EFMLEA. We should note here, that an employee can take advantage of the EPSLA benefit of up to $200 per day for the first 10 days of leave to care for a child due to school or childcare closing, bringing the maximum paid leave benefit to $12,000 for child care reasons.

How does a bank pay for this new requirement?
To soften the blow on banks and other employers of the mandatory paid leave under the FFCRA, the law provides for a dollar-for-dollar refundable tax credit for amounts paid by eligible employers. The refundable tax credit applies to all EPSLA and EFMLEA wages paid during the period from April 1 to Dec. 31, 2020. Compliance with the eligibility and record-keeping requirements of the law will be critical to the bank qualifying for the tax credit.

Coronavirus Makes Community Count in Banking

In the face of an economic shutdown triggered by the coronavirus pandemic, small banks stepped up in a big way to ensure local businesses received government aid.

Over the past 50 years, the American community bank has become a threatened species. Yet these institutions rose to the occasion amid the coronavirus-induced economic shutdown. The Small Business Administration reported that 20% of loans made in the first round of the Paycheck Protection Program, were funded by banks with less than $1 billion in assets, and 60% were funded by banks with less than $10 billion in assets. In total, the first round of lending delivered $300 billion to 1.7 million businesses.

There were just 5,177 bank or savings institutions insured by the Federal Deposit Insurance Corp at the end of 2019 —a fraction of the 24,000 commercial banks in the U.S. in 1966. The majority of these institutions were local, community banks, some with only a single branch serving their market. But over the past 25 years, the banking industry has increasingly become the domain of large conglomerates that combine commercial banking, retail banking, investment banking, insurance, and securities trading under one roof.

Technology has accelerated this consolidation further as consumers select the institutions they can most easily access through their smartphone. Deposit market share tells this story most starkly: in 2019, over 40% of total assets were held by the four largest banks alone. From 2013 to 2017, total deposits at banks with assets of less than $1 billion fell by 7.5%.

Despite that erosion, small banks were willing and able to help hurting businesses. After the dust settled from the initial round of PPP loans, many of the nation’s largest banks faced lawsuits alleging they prioritized larger, more lucrative loans over those to small businesses with acute need.

Community banks filled in the gaps. USA Today reported that a food truck business with a long relationship with Wells Fargo & Co., but couldn’t get a banker on the phone during the second round of PPP. Instead, Bank of Colorado, a community bank in Fort Collins, Colorado, with about $5 billion in assets, funded their loan.

Another one of those banks, Evolve Bank & Trust, an institution with about $600 million in assets based in Memphis, Tennessee, answered the calls of customers and non-customers alike. Architecture firm Breland-Harper secured a loan through Evolve; firm principal Michael Breland the called the funds “crucial in meeting payroll.” Special education program The Center for Learning Unlimited was turned away at 15 banks for a PPP loan. Evolve funded their loan within days.

The coronavirus pandemic has proven two things for small financial institutions. First, community still counts — and it may expand beyond a bank’s local community. A bank’s willingness to work with small businesses and organizations proved to be the most important factor for many businesses seeking loans. Small banks were willing and able to serve these groups even as the nation’s biggest bank by assets, JPMorgan Chase & Co., reportedly advised many PPP loan applicants to look elsewhere at some points.

As big banks grow bigger, their interest in and ability to serve small businesses may fade further. The yoga studio, the restaurant and the small business accounting firm, may be best served by a community bank.

Second, community banks were empowered by technology. Technology is a lever with which big banks pried away small bank customers, but it was also crucial to small banks’ success amid the PPP program. Because of the pandemic many small banks accelerated innovation and digital solutions. During the crisis, Midwest BankCentre, a community bank in St. Louis with $2.3 billion in assets, fast-tracked the implementation of digital account openings for businesses, something they did not have in place previously.

By tapping tools created by fintech companies, small banks can use technology to support their efforts to assist the nation’s small businesses during and beyond these uncertain times.

When it Comes to Loan Quality, Who Knows?

Seven months into the Covid-19 pandemic, which has flipped the U.S. economy into a deep recession, it’s still difficult to make an accurate assessment of the banking industry’s loan quality.

When states locked down their economies and imposed shelter-in-place restrictions last spring, the impact on a wide range of companies and businesses was both immediate and profound. Federal bank regulators encouraged banks to offer troubled borrowers temporary loan forbearance deferring payments for 90 days or more.

The water was further muddied by passage of the $2.2 trillion CARES Act, which included the Paycheck Protection Program – aimed at a broad range of small business borrowers – as well as weekly $600 supplemental unemployment payments, which enabled individuals to continuing making their consumer loan repayments. The stimulus made it hard to discriminate between borrowers capable of weathering the storm on their own and those kept afloat by the federal government.

The CARES Act undoubtedly kept the recession from being even worse, but most of its benefits have expired, including the PPP and supplemental unemployment payments. Neither Congress nor President Donald Trump’s administration have been able to agree on another aid package, despite statements by Federal Reserve Chairman Jerome Powell and many economists that the economy will suffer even more damage without additional relief. And with the presidential election just two months away, it may be expecting too much for such a contentious issue to be resolved by then.

We expect charge-offs to increase rapidly as borrowers leave forbearance and government stimulus programs [end],” says Andrea Usai, associate managing director at Moody’s Investors Service and co-author of the recent report, “High Volume of Payment Deferrals Clouds a True Assessment of Credit Quality.”

Usai reasons that if there’s not a CARES Act II in the offing, banks will become more selective in granting loan forbearance to their business borrowers. Initially, banks were strongly encouraged by their regulators to offer these temporary accommodations to soften the blow to the economy. “And the impression that we have is that the lenders were quite generous in granting some short-term relief because of the very, very acute challenges that households and other borrowers were facing,” Usai says.

But without another fiscal relief package to help keep some of these businesses from failing, banks may start cutting their losses. That doesn’t necessarily mean the end of loan forbearance. “They will continue to do that, but will be a little more careful about which clients they are going to further grant this type of concessions to,” he says.

For analysts like Usai, getting a true fix on a bank’s asset quality is complicated by the differences in disclosure and forbearance activity from one institution to another.  “Disclosure varies widely, further limiting direct comparisons of practices and risk,” the report explains. “Disclosure of consumer forbearance levels was more comprehensive than that of commercial forbearance levels, but some banks reported by number of accounts and others by balance. Also, some lenders reported cumulative levels versus the current level as of the end of the quarter.”

Usai cites Ally Financial, which reported that 21% of its auto loans were in forbearance in the second quarter, compared to 12.7% for PNC Financial Services Group and 10% for Wells Fargo & Co. Usai says that Ally was very proactive in reaching out to its borrowers and offering them forbearance, which could partially explain its higher percentage.

“The difference could reflect a different credit quality of the loan book,” he says. “But also, this approach might have helped them materially increase the percentage of loans in forbearance.” Without being able to compare how aggressively the other banks offered their borrowers loan forbearance, it’s impossible to know whether you’re comparing apples to apples — or apples to oranges.

If loan charge-offs do begin to rise in the third and fourth quarters of this year, it doesn’t necessarily mean that bank profits will decline as a result. The impact to profitability occurs when a bank establishes a loss reserve. When a charge-off occurs, a debit is made against that reserve.

But a change in accounting for loss reserves has further clouded the asset quality picture for banks. Many larger institutions opted to adopt the new current expected credit losses (CECL) methodology at the beginning of the year. Under the previous approach, banks would establish a reserve after a loan had become non-performing and there was a reasonable expectation that a loss would occur. Under CECL, banks must establish a reserve when a loan is first made. This forces them to estimate ahead of time the likelihood of a loss based on a reasonable and supportable future forecast and historical data.

Unfortunately, banks that implemented CECL this year made their estimates just when the U.S. economy was experiencing its sharpest decline since the Great Depression and there was little historical data on loan performance to rely upon. “If their assumptions about the future are much more pessimistic then they were in the previous quarter, you might have additional [loan loss] provisions being taken,” Usai says.

And that could mean that bank profitability will take additional hits in coming quarters.

Five Ways PPP Accelerates Commercial Lending Digitization

The Small Business Administration’s Paycheck Protection Program challenged over 5,000 U.S. banks to serve commercial loan clients remotely with extremely quick turnaround time: three to 10 days from application to funding. Many banks turned to the internet to accept and process the tsunami of applications received, with a number of banks standing up online loan applications in just several days. In fact, PPP banks processed 25 times more loan applications in 10 days than the SBA had processed in all of 2019. In this first phase of PPP, spanning April 3 to 16, banks approved 1.6 million applications and distributed $342 billion of loan proceeds.

At banks that stood up an online platform quickly, client needs drove innovation. As institutions continue down this innovation track, there are five key technology areas demonstrated by PPP that can provide immediate value to a commercial lending business.

Document Management: Speed, Security, Decreased Risk
PPP online applications typically provided a secure document upload feature for clients to submit the required payroll documentation. This feature provided speed and security to clients, as well as organization for lenders. Digitized documents in a centrally located repository allowed appropriate bank staff easy access with automatic archival. Ultimately, such an online document management “vault” populated by the client will continue to improve bank efficiency while decreasing risk.

Electronic Signatures: Speed, Organization, Audit Trail
Without the ability to do in-person closings or wait for “wet signature” documents to be delivered, PPP applications leveraged electronic signature services like DocuSign or AdobeSign. These services provided speed and security as well as a detailed audit trail. Fairly inexpensive relative to the value provided, the electronic signature movement has hit all industries working remotely during COVID-19 and is clearly here to stay.

Covenant Tickler Management: Organization, Efficiency, Compliance
Tracking covenants for commercial loans has always been a balance between managing an existing book of business while also generating loan growth. Once banks digitize borrower information, however, it becomes much easier to create ticklers and automate tracking management. Automation can allow banker administrative time to be turned toward more client-focused activities, especially when integrated with a document management system and electronic signatures. While many banks have already pursued covenant tickler systems, PPP’s forgiveness period is pushing banks into more technology-enabled loan monitoring overall.

Straight-Through Processing: Efficiency, Accuracy, Cost Saves
Banks can gain significant efficiencies from straight-through processing, when data is captured digitally at application. Full straight-through processing is certainly not a standard in commercial lending; however, PPP showed lenders that small components of automation can provide major efficiency gains. Banks that built APIs or used “bots” to connect to SBA’s eTran system for PPP loan approval processed at a much greater volume overall. In traditional commercial lending, it is possible for data elements to flow from an online application through underwriting to final entry in the core system. Such straight-through processing is becoming easier through open banking, spelling the future in terms of efficiency and cost savings.

Process Optimization: Efficiency, Cost Saves
PPP banks monitored applications and approvals on a daily and weekly basis. Having applications in a dynamic online system allowed for good internal and external reporting on the success of the high-profile program. However, such monitoring also highlighted problems and bottlenecks in a bank’s approval process — bandwidth, staffing, external vendors and even SBA systems were all potential limiters. Technology-enabled application and underwriting allows all elements of the loan approval process to be analyzed for efficiency. Going forward, a digitized process should allow a bank to examine its operations for the most client-friendly experience that is also the most cost and risk efficient.

Finally, these five technology value propositions highlight that the client experience is paramount. PPP online applications were driven by the necessity for the client to have remote and speedy access to emergency funding. That theme should carry through to commercial banking in the next decade. Anything that drives a better client experience while still providing a safe and sound operating bank should win the day. These five key value propositions do exactly that — and should continue to drive banking in the future.

Approaching Credit Management, Risk Ratings Today

As a credit risk consulting firm that supports community and regional banks, Ardmore Banking Advisors has assembled some credit risk management best practices when it comes to how executives should look at their bank’s portfolio during the coronavirus-induced economic crisis.

It is clear that the expectation of regulators is that credit risk management programs (including identification, measurement, monitoring, control and reporting) should be enhanced and adapted to the current economic challenges. Credit risk management programs require proactive actions from the first line of defense (borrower contact by loan officers), the second line of defense (credit oversight) and the third line of defense (independent review and validation of actions and risk ratings).

Boards will have to enhance their oversight of asset quality. Regulators and CPAs will be focusing on process and control, and challenge the banks on what they have done to mitigate risk. Going concern opinions on borrowers by CPAs may become widely used, which will put pressure on banks to be conservative in risk ratings.

New regulatory guidance and best practices indicate that more forward-looking, leading indicators of credit must be employed. We expect greater emphasis on borrower contact and information on liquidity and projections. These concepts are also embodied in the new credit loss and loan loss reserve model that went into effect at larger banks in the first quarter.

Many banks have used Covid-19 as an opportunity to increase their loan loss provisions, reviewing their portfolios for weaknesses in borrowers that may never recover. This evaluation will be expected by regulators during examinations; it is a good indication of forward-thinking proactive oversight by a bank’s officers and directors.

Risk Rating Approaches in the Current Climate
When it comes to risk ratings, it is not advisable for banks to automatically downgrade entire business segments. Instead, executives should scrutinize the most vulnerable segments of the portfolio that include highly stressed industries and types of loans.

Banks do not have to downgrade modifications or extensions solely because they provided relief related to Covid-19; however, the basis for extensions or modifications should be evaluated relative to the ultimate ability of the borrower to repay their loans going forward, after the short-term disruption concludes or the deferral matures.

We have observed that regulators are focusing on second deferrals and asking whether a risk rating change or troubled debt restructuring are warranted. Banks should be reviewing information on further deferrals to determine if there could be an underlying problem indicating that payment is ultimately unlikely.

Paycheck Protection Program loans do not require a downgrade; however, banks may want an independent review of PPP loans to identify any operational or reputational risk. We also recommend that current customers who received PPP loans should be evaluated for their ability to repay other loans once the short-term disruption concludes.

Credit review, the third line of defense, is typically a backward-looking exercise, after loans are already made and funded. It is predicated primarily on an independent review of the analysis of borrowers by loan officers during the first line of defense, and credit officers in the second line of defense. For over 10 years, the industry has experienced relatively good economic times. The current environment requires a more insightful assessment of the bank’s actions and the borrower’s emerging risk profile and outlook, with less reliance on past performance.

The bank should evaluate historical and recent financial information from the borrower as a predicate for evaluating the borrower’s ability to withstand current economic challenges. Executives should review any new information reported by the bank’s officers on the current condition, extensions or modifications provided and the current status of the borrower’s operations to determine if a risk rating change is necessary.

Importance of Credit Review for Banks
Banks must look carefully at risk ratings to confirm that all lines of defense have properly reviewed the borrowers, with a realistic assessment of their ultimate ability to repay the loan after any short-term deferrals, modifications or extensions due to the Covid-19 disruption. This includes an assessment of whether the action requires formal valuation of troubled debt restructuring status. The banks can then follow the current regulatory guidance that an extension or modification does not in itself require a designation as a TDR.

We believe based on our years in banking that the bank regulators will test the bankers’ response and process in the current economic downturn. They, and the CPAs certifying annual financial statements, will expect realistic credit risk evaluations and controls as confirmed by independent and credible loan reviews. Bank boards and executive management teams will be well-served by accurate loan and borrower credit risk assessment during regulatory exams and the annual financial CPA audits for 2020.

Navigating Troubled, Murky Waters

Banks face a cloudy future as they navigate today’s unique environment, characterized by an economic downturn — caused by a health crisis rather than an asset bubble or industry malfeasance — and a prolonged low-rate environment.

“This downturn is different,” says Steve Turner, a managing director at Empyrean Solutions who has focused on balance sheet management and risk over his multi-decade career.

“All of the problems in the last downturn, you pretty much knew where you were. You could look at your balance sheet, you could look at the credit profiles,” he continues. But this time, “we have such a wide range of things that could be happening to us over the next number of months and years.”

With that in mind, Turner joined me as co-host for a virtual peer exchange on Aug. 5, where 10 chief financial officers shared their perspectives on how they’re planning for loan losses and handling the deposit glut, and the lessons they learned from the last crisis.

Asset Quality Remains Strong … For Now
So far, these CFOs aren’t seeing indicators of weakness in their markets. Yet, their experience in the industry tells them that losses are coming. How does a bank still using the incurred loss model justify a loan allowance that aligns with U.S. accounting principles and still prepares it for what history tells them is inevitable?

“The allowance, we’re struggling with that a little bit,” says Suzanne Loken, CFO at $1.3 billion S.B.C.P. Bancorp in Cross Plains, Wisconsin. “Just looking at our data, we don’t see the losses coming through.”

The bank provides talking points to lenders so they can conduct structured conversations with troubled clients, she adds.

Banks are doing their best to monitor the environment, sometimes employing a deeper analysis so they can better assess any potential damage. Joseph Chybowski, CFO at $2.8 billion Bridgewater Bancshares, shares that his team at the Bloomington, Minnesota-based bank created a tenant rental database to better identify troubled areas. “[It’s] a much more granular look on a go-forward basis of what our borrowers’ tenant bases look like,” he explains.

Focus on Deposits, Funding Costs
Arkadelphia, Arkansas-based Southern Bancorp planned to jettison its excess liquidity in 2020, as part of its strategy to improve earnings and profitability. Instead, Paycheck Protection Program loans have swelled the balance sheet of the $1.5 billion community development financial institution (CDFI). “And when these loans are forgiven, our excess liquidity is going to almost double from that perspective,” says CFO Christopher Wewers. “So, [we’re] working hard to drive down the cost of funds.”

In the discussion, the CFOs report that new PPP customers were required to open a deposit account with them to apply for the loan, fueling deposit growth. They expect to deepen these relationships, as their banks essentially kept these customers afloat when their old bank left them out to dry.

The group also confirms that they’re exercising caution around promoting particular deposit products, like certificates of deposit. And the retail team, like the lending team, should be provided talking points so they can better convey today’s reality to customers, says Emily Girsh, CFO at Reinbeck, Iowa-based Lincoln Savings Bank, a $1.4 billion subsidiary of Lincoln Bancorp. “We need to help walk [customers] through and educate them about the market.”

Lessons from the Last Crisis
While the root of the coronavirus crisis differs from the 2008-09 financial crisis, bankers did learn valuable lessons about managing through a prolonged low-rate environment.

“We learned a deposit pricing lesson,” says Michele Schuh, CFO at Anchorage, Alaska-based First National Bank Alaska, which has $4.6 billion in assets. To strengthen customer relationships in the aftermath of the previous crisis, the bank floored deposit rates. “Our assets didn’t immediately downward reprice [then], so we wanted to continue to share and provide some level of above-market yield to the customers that had money deposited in the bank.”

No one could have forecasted that a decade later, rates would remain low. “As rates have come back down … we’ve taken a little bit more practical approach to trying to decide where and how we might floor rates,” she adds.

There’s also caution around hedging. Out of the last crisis, “there were institutions for five years that were betting on rates going up, and [those] institutions lost a lot of money,” notes Kevin LeMahieu, CFO of $2.2 billion Bank First Corp., based in Manitowoc, Wisconsin. “

In the most uncertain environment in memory, how bank leaders look ahead will matter,” says Turner. “Stress testing should look at more scenarios, early warning indicators and processes should be beefed up, and sensitivity to staff and customer concerns should be heightened. Fee income opportunities and creating relationships with new customers from the PPP program will be opportunities to offset some of the lost income from net interest margin compression.”

Audit Hot Topics: Internal Controls

Bank boards and executive teams face a number of risks in these challenging times. They may need to adapt their strong internal controls in response, as Mandi Simpson and Sal Inserra — both audit partners at Crowe — explain in this short video. You can find out more about the audit and accounting issues your bank should be addressing in their recent webinar with Bank Director CEO Al Dominick, where they discuss takeaways from the adoption of the current expected credit loss model (CECL) and issues related to the pandemic and economic downturn, including the impact of the Paycheck Protection Program and concerns around credit quality.

Click HERE to view the webinar.

Four Questions for Three CEOs

The coronavirus pandemic has thrown the banking industry into an environment that is both rapidly changing and a prolonged grind.

The recession induced as a result of public and private response to Covid-19 has lowered the revenue outlook and increased credit risk for institutions across the country. Bankers must navigate an extraordinarily uncertain operating environment and make tough decisions. To that end, Bank Director created the AOBA Summer Series — a free, on-demand compilation of pragmatic information, honest conversations and real-world insight.  

The series goes live on Aug. 12. As a preview, we sat down (virtually) with three executives featured in the series — Chuck Sulerzyski, Jill Castilla and John Asbury — for a glimpse into where they see challenges, opportunities and inspiration. Sulerzyski is CEO of Peoples Bancorp in Marietta, Ohio, which has $5 billion in assets; Castilla is chairman and CEO of Citizens Bancshares, which has $317 million in assets and is based in Edmond, Oklahoma; and John Asbury is CEO of Richmond, Virginia-based Atlantic Union Bankshares Corp., which has $19.8 billion in assets. These conversations were conducted independently, and have been lightly edited for length and clarity.

BD: What is the biggest challenge you see for your bank?

JC: I think about businesses that aren’t able to recover as quickly and making sure that you have the tools available to get to the other side. These are unprecedented times and these businesses are struggling — not due to something they caused; it was something inflicted upon them. I think it’s going to be difficult moving through that.

JA: Navigating the credit risk implications of the Covid-19-induced recession. We remain confident in our overall asset quality, credit loss reserves, capital position and preparedness for this event. However, the duration of Covid-19 will largely determine just how great a challenge this will be. Time will tell.

CS: Maybe not in the next three months, but in the upcoming quarters, I think credit is going to be the biggest challenge, and helping our customers get through all of this. We feel good about our portfolio and its diversification. The places where we feel the most stress is in the hotel portfolio. Obviously, businesspeople aren’t traveling, and consumers are starting to travel a little more but way below normal levels. It’s very difficult for hotel operators to [meet] cash flow.

BD: What is the biggest opportunity for your bank?

JC: The biggest opportunity is continuing to be a leader and advocate, and restoring trust in financial services — both nationally as well as locally —  and being seen as a trusted advisor and a trusted advocate.

JA: The bank has demonstrated resilience, agility, courage and innovation in its response to Covid-19. We developed and launched an online portal and automated workflow system to take Paycheck Protection Program loan applications in five days because we remained agile and knew the stakes were high as our customers were counting on us. We were also quick to make difficult decisions to align our expense structure to the expected lower-for-longer rate environment, beginning in March, to ensure we emerge on the other side of Covid-19 positioned for success. Permanently ingraining these characteristics into our culture will result in an even better, stronger and more capable company.

CS: Peoples really crushed it on the PPP program. We were open for new customers and brought them in with the understanding they would become full-service customers. The biggest opportunity over the next three to six months is taking in these relatively new people and cross-selling them loans, deposits, insurance and investments. Already, we bought in over $40 million dollars of loans and deposits, and over $150,000 in fee income. 

BD: Where are you getting inspiration right now?

JC: So many places. I’m fortunate to be in a city that has diverse leadership. Whether it’s in our underrepresented and underserved communities, those leaders that have fought the odds for decades and are striving for their communities to reach higher levels and pull more out of me to be a better person, a better leader and a better businessperson, and provide access to capital and liquidity and things that. That’s been extraordinary. Seeing our leaders make hard decisions for the welfare of their communities or for the business community as well — that courage, whether I agree with the actions or not — seeing the willingness to take a stand and to stand up for something has been inspirational.

JA: Our teammates! They amaze me with their determination, resourcefulness, effort and caring for our customers and each other. Their efforts on PPP in particular were heroic.

CS: There’s much going on in the world. The healthcare workers, I’ve been touched by everything that they have done. One of my kids is a doctor, one is a nurse, and another is working on a Ph.D. in public health. All of what’s going on with healthcare workers and first responders has been very motivational. 

I know we’ve gone through a lot of social unrest, but I find inspiration in [Senator] John Lewis’ passing and everything that he stood for. I was eight years old when the Voting Rights Act was passed. It’s mind-numbing that folks of color didn’t have the opportunity to vote, and here we are, 50 years later, fighting similar fights and hopefully making progress.

BD: What has been the best thing you’ve read or watched since the pandemic began?

JC: Maybe because it’s on my mind, but the timeliness of the release of “Hamilton” [on the Disney+ streaming service]. I got to see it live in Oklahoma City a year ago; I had tickets and had waited forever to go see it. And then I got hit by a truck walking across my street two days before the show.

We ended up [seeing] the last performance before it left Oklahoma City. I’ve been really excited to see it coming back in my life a year later and in this time. The boldness of the vision to create a musical that uses a diverse cast and a difficult topic, the timeliness of the messaging and then making something accessible to everyone.

It’s the last thing I’ve seen that’s blown me away. But there’s been so many instances where someone has blown me away with something they’ve written online, an article I’ve read or a podcast I’ve listened to. This crisis is so bad, but again, you get to see this beauty of leadership, this boldness of action and constant inspiration of people stepping up and doing wonderful work.

JA: Despite having never worked longer or harder for such a sustained period of time, since Covid-19 hit I’ve read books extensively. The most impactful is “How to Be an Antiracist” by Ibram X. Kendi. It has given me a perspective on social injustice and systemic racism that I did not have before, as well as a better understanding of its root causes and what can be done about it.

CS: I’m a Yankees fan; Aaron Judge had two home runs [in the Aug. 2 game against the Boston Red Sox], and I liked that a great deal. I also think John Lewis’ obituary goodbye letter in The New York Times was the best thing that I’ve read. We shared that so that our employees could read it.