“It was the best of times.” The economy was humming along, and bank profits were stable to increasing; then, Covid-19 changed almost everything, and suddenly, “it was the worst of times.” A large part of the country and world went into shutdown, and economic turmoil ensued, followed by civil unrest. 2020 is a year of tremendous chaos and uncertainty; a year many want to see over and done with, knowing it will haunt them for a long time.
Community bankers have been preparing for a pandemic for years and had business continuity plans on their shelves ready to be activated. The Federal Reserve Board and the Federal Government stepped in immediately to offer assistance through products and programs to assist households, small to large businesses, non-profits, and the education sector. The bank regulators quickly provided relief by allowing for Covid-19 loan modifications. The Payroll Protection Program (“PPP”) was a lifeline for individuals and organizations struggling to make ends meet. Bankers responded to the PPP by becoming SBA lenders and serving those in need.
The abruptness of the shutdown and transformation of the bank offices and a move to remote work environments provided significant challenges for customers, employees, management teams, and boards. So many balls in the air at once added to regular daily duties. Bankers worked so hard to stay on top of everything.
During the 2021 regulatory examination cycle, will bankers’ 2020 efforts be recognized? Yes, the actions will be acknowledged; however, federal and state examiners have jobs to do, and they will verify whether efforts and accomplishments were safe and sound. The CAMELS ratings are their scorecard. Are you ready to be challenged on your decision making and documentation supporting the safety and soundness of your institution?
There remains time to prepare for bank exams. Every bank is different in size, personnel, and resources. What changed in 2020 compared to your strategic plan? How were new products and strategies adopted, administered, and reported through the management ranks and to the board of directors?
The CAMELS ratings provide a reference point to assess each performance component important to regulators and assist bankers in identifying the positives and negatives for each category. For instance, here are some CAMELS positives that might result from an internal CAMELS review:
C – Capital reduced loan loss provisions and suspended dividend payouts have boasted capital ratios.
A – Asset quality remains satisfactory as there has been no immediate downgrading of loans or leases due to the current economic recession.
M – Management continues to report to the board and has activated business continuity plans.
E – Earnings continue with some stress with interest rate reductions
L – Liquidity is acceptable as savings rates have grown in part due to various government stimulants.
S – Sensitivity to changes in interest rate risks has not adversely impacted franchise value.
It is important to note that once the Covid-19 loan modification period ends, proactive identification of individual modified loans will require a significant amount of management attention. Some bankers are proactively attuned to this phenomenon, while others may be taking a wait and see approach. Regardless, bankers must take a measured approach to the early identification of potential CAMELS stress. For example, consider the following as an example:
C – Capital ratios decline because of asset quality deterioration, increased loan loss provisions, and non-budgeted loan growth.
A – Asset quality problems increase with previous “Pass” loans being workout situations.
M – Management made great strides to catch up in its reporting and documenting actions, but it has not been timely in addressing those materials to the board of directors.
E – Earnings are lower due to increased loan loss provisions, reductions in interest income, and unplanned expenses.
L – Liquidity sources such as wholesale funds are less reliable or require additional collateral.
S – Sensitivity to interest rates has shocked the bank’s net interest income and net income more severely than modeled and expected.
Where should bankers start? Here are five steps to take now:
- Assess your bank’s overall condition.
- Identify critical actions and other adjustments and changes that warrant short-term attention.
- Discuss your assessment with your board of directors.
- Ask the board of directors to be involved in the development of your action plans.
- Prioritize action steps, assign accountability, and use your resources (internal and external) to prepare for the future.
History tends to repeat itself. The Great Recession resulted in many bank failures, some recaps, and other industry consolidation. There is no time like the present to access the strength and challenges your bank faces and develop plans to manage through 2020 into 2021.
Artisan Advisors’ launched the Covid-19 Assessment Readiness Program to assess and address your challenges from a top-down perspective. Further, Artisan Advisors is prepared to assist you in identifying, developing, and implementing action plans to prepare for your next bank exam and your future success. For more information, please contact Dan Kadolph, Managing Director, at [email protected] or (224) 633-2100 x 5.