A New Look at Problem Loan Management

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Regardless of how you describe 2020, change was the common theme.

Not only did the coronavirus pandemic and economic contaction in 2020 change the way the banking industy identifies problem loans, it changed the way it approaches them. As 2020 unfolded, CLA continued to encourage institutions to evaluate policies and procedures, given that most were written for normal operating environments. A problem loan is a credit that cannot be repaid according to the terms of the initial agreement, or in an otherwise acceptable manner. In a time when payment deferrals and modifications are numerous and widespread, and government-assisted credit is necessary, how does problem loans identification change?

Risk Identification
The first step in problem loan management (PLM) is an effective risk identification program, which includes proper monitoring and continually applying appropriate risk ratings. Management teams can use internal reviews performed periodically or annually to assist with early risk detection.

Monitoring
Frequent monitoring of the portfolio remains one of the critical pillars of PLM. This requires collecting updated financials and information to monitor the wherewithal of the borrower, guarantor and related entities on a standalone and combined basis. Increased monitoring is warranted, especially for vulnerable industries.

Resources
Who leads your bank’s PLM program? Many lenders have not been exposed to a PLM process, or have not been in the industry long enough to experience an economic downturn. The art of PLM involves objective parties, including a group independent of the loan officer, to manage the loans effectively.

Evaluation of performance
Financials for 2020 will include unusual items, and completing year-over-year comparisons will require eliminating “extraordinary” items. For example, removing funds received through the Small Business Administration’s Paycheck Protection Program will be essential to ascertain and review the performance of core operations. Banks will need to consider how a borrower’s core performance would have met the requirements of the original loan terms without modifications. It is pertinent to remove these items and evaluate how the borrower is functioning at its core.

Action plans
The routine nature of completing a quarterly problem loan action report deserves a new look. Banks of all sizes must address problem loans and develop plans to mitigate exposure. Action plans are a way for management to track and document each borrower’s circumstances and next steps to reduce credit risk exposure.

Problem Loan Action Plan Considerations

  • Borrower identification and history — Identify the obligor(s) (direct and indirect), ownership composition, type of business, underlying debt(s), and operational changes over the past few years or as a result of COVID-19.
  • Communication — If the borrower remains communicative, address commitments made, if any, and all legal correspondence.
  • Financial analysis — Update financial information with a look at historical trend on standalone and global basis and impact of COVID-19.
  • Repayment history — Review payment status, including any late payments or 30/60/90-day history. Discuss modifications.
  • Collateral valuation and analysis — Evaluate need for updated values given changes in market, property type, or other pertinent factors.
  • Risk rating — Consider current and recommended risk rating changes, if any.
  • Impairment analysis — Clearly document the analysis or testing for impairment to support quarterly Allowance for Loan and Lease Losses analysis.
  • Progress update — Address actionable items from the last review. Is workout plan effective?
  • Next steps — Detail steps the borrower and institution will take to improve the status of the loan. Establish clear and quantifiable objectives and timeframes for both parties and document results as the plan progresses.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CliftonLarsonAllen) to the reader. For more information, visit CLAconnect.com.

CLA exists to create opportunities for our clients, our people, and our communities through our industry-focused wealth advisory, outsourcing, audit, tax, and consulting services. Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor.

The Latest Look at the “New CFPB”

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CFPB-5-28-19.pngOn April 17, Consumer Financial Protection Bureau Director Kathleen Kraninger delivered her first policy speech at the Bipartisan Policy Center. She touched rule promulgation, supervision and enforcement, previewing of the tone and direction of the CFPB under her leadership.

Rule Pomulgation
One important concern for banks will be rule promulgation at the agency, or how the bureau proposes, enacts and enforces regulations. In the speech, Kraninger said that the bureau will release proposed rules to implement the Fair Debt Collection Practices Act in the coming weeks.

The promulgation of these rules has been in the CFPB’s pipeline since the Dodd-Frank Act transferred rulemaking authority related to the state exemptions under the Fair Debt Collection Practices Act to the bureau. We saw proposed rulemaking in 2013, followed by various pushes under the tenure of former Director Richard Cordray. Through these pushes in between 2011 and 2017, we learned that the CFPB’s efforts in the Fair Debt Collection Practices Act space were broad and, the industry argued, unduly burdensome on creditors. These efforts included rules to address litigation disclosures, information integrity and associated liability, time-barred debt and, possibly, first-party collector liability.

In contrast, Kraninger focused on how the new rules will provide clear, bright-line limits on the number of calls consumers may receive and how to communicate using newer technology such as email or text messages—issues the industry has sought guidance on. It will be interesting to contrast the proposed actions outlined under Cordray’s tenure to the rules issued under Kraninger.

As Kraninger made clear in her speech, “[b]ecause rules are general standards, they are not best articulated on a case-by-case basis through enforcement actions.” Rather, she said they should be developed through transparent rulemaking that allows stakeholders to submit comments and include “rigorous” economic and market analysis as well as judicial review.

Supervision
In her speech, Kraninger reiterated that “supervision is the heart of this agency–particularly demonstrated by the percentage of our personnel and resources dedicated to conducting exams.”

Though she shares this sentiment with Cordray, she pointed out that “the bureau is not the only government regulator supervising any given entity” and that it must “ensure that we do not impose unmanageable burdens while performing our duties.”

This may be the clearest demarcation between the two directors. Cordray’s leadership did not seem to consider the “burden” of supervision experienced by a supervised entity; that regime was solely focused on consumer protection.

While the industry has yet to see a substantial shift in the approach to supervision, Kraninger’s remarks hint that we will see some relief as the CFPB considers its approach to exams. The agency could make changes in the prioritization and frequency of exams, the size of the exam teams, the number days spent on-site, the supporting systems and job aids, the time it takes to complete an exam and deliver a report and how the bureau empowers examiners to provide input on the process.

Enforcement
Kraninger also stated that “enforcement is an essential tool Congress gave the bureau,” another echo to Cordray’s leadership. However, she diverged by adding that “purposeful enforcement is about utilizing robust resources most effectively to focus on the right cases to reinforce clear rules of the road.”

Kraninger’s use of the phrase “clear rules of the road” is interesting. Justice Brett Kavanaugh, then on the U.S. Court of Appeals for the District of Columbia Circuit, used similar imagery when he criticized the lack of due process in the CFPB’s “regulation through enforcement” approach with regards to their PHH enforcement action.

“Imagine that a police officer tells a pedestrian that the pedestrian can lawfully cross the street at a certain place. The pedestrian carefully and precisely follows the officer’s direction. After the pedestrian arrives at the other side of the street, however, the officer hands the pedestrian a $1,000 jaywalking ticket. No one would seriously contend that the officer had acted fairly or in a manner consistent with basic due process in that situation,” he wrote in the 2016 decision for PHH Corp. v. CFPB. “Yet that’s precisely this case.”

While only time can tell, it appears that the industry can expect clear guidance and that rules that redefine industry standards will proceed related enforcement efforts.

The more activity from the “New CFPB,” the more observers will be able to gauge how it interacts with institutions. The shift occurring under the agency’s new leadership will most likely impact those companies that push regulatory boundaries. We continue to see a deep review of institutions’ core compliance management systems and associated controls. If your bank is wading into an unsettled regulatory area, you would best served in documenting the decision-making process, including considerations of the existing regulatory framework.