The FDIC has not published its issue of Supervisory Insights, Summer 2019, yet and I suspect that won’t be coming until September (if past years are any indication). Regional issues of regulatory messages do circulate periodically and one of our clients in the OCC Southern District provided a recent publication, Condition and Risk Profile of Southern District Financial Institutions, that may indicate a trend in sentiment across the country.
The OCC voiced three areas of concern in the release along with suggestions on OFAC and FDPA.
“Credit Risk remains the primary risk for Southern District institutions due to heavy competition for new loans…” The concern is competition leads to relaxed underwriting standards and the potential for “elevated CRE concentrations.”
The OCC suggests managing credit risk should include stress-testing. These can occur pre-funding (as part of the underwriting process), and on the current portfolio using moderate and severe stress scenarios. These scenarios can include:
· The ability of the collateral’s cash flow to support loans under stress
· Stress ratings for core collateral and overall collateral position
· Stress Parameters for Capitalization Rate, Interest Rate and Vacancy Rates
· Debt Service Coverage and Loan to Value ratios
These are a few examples for CRE loans. C&I and Construction loans add additional dimensions including the borrower and guarantor’s ability to repay the loan through income and cash reserves. For a more detailed blog post on credit stress analytics, follow this link.
Interest Rate Risk
“Interest Rate Risk has the potential to challenge future earnings and is viewed as moderate and stable.” The paragraph devoted to IRR focuses mainly on the deposit side and the fear of migration to time deposits at higher rates.
Then this today, July 29, 2019: “U.S. Bankers are expected to lower borrowing costs for the first time…in more than a decade.” (Reuters) Good? Bad? We don’t know today. But we do know that IRR systems should be modeling the chatter we see not only in publications but in social streams. (Yes, there are tweets on the heels of the Fed announcement and Wall Street does not appear to have reacted this morning).
Here’s the thing: IRR systems have been in use for some time and no one has reinvented the PV formula. But you might want your provider to do the input, care, and maintenance of the system for you. This can also include independent analysis of the deposit portfolio:
· Decay rate calculations (average life) and
· Pricing (rate) sensitivity analysis
The results are institution-specific – a key element to proper IRR management. You might also include prepayment analysis, especially with the Fed lowering rates. We find that deposit behavior in times of rate changes can impact earnings far more dramatically.
Also of value is a deposit profitability analysis. Although this won’t feed your ALM assumptions this analysis will eliminate guessing on which accounts are profitable and help you understand how to motivate profitable behavior.
The short paragraph in the publication says quite a lot. On the surface it says cybersecurity risk is moderate and stable. Then mentions some institutions still “fail to meet baseline standards” for detection and prevention of risk. It specifically calls out email vulnerability and, at risk of assumption, the conclusion I draw is employee awareness.
There is only one way to prevent an employee from making a mistake and that is through education. Employees remain a soft point of entry for cyber criminals – over 90% of breaches are traced back to an unsuspecting employee in the private sector or government personnel not being prepared in the basic steps of cybersecurity.
This short video by Frank Abagnale will get you started. To learn more, visit NXTsoft.com and navigate to the Cybersecurity page.
Bonus Topic: CECL
A supervisory update wouldn’t be complete without mentioning CECL and this is no exception. The regulators continue to encourage bankers to prepare early despite the potential delay in rollout by FASB.
Many bankers I speak with are unaware of a webinar from March 7 of this year which addresses the viability of the WARM method for CECL calculations. You can watch the replay here – spoiler alert: it’s OK to use aggregate models and the WARM method. Like all regulatory enforcement, you need to pick models and calculations that are appropriate for the size and complexity of the balance sheet.
One last link to help you with CECL preparedness – Howard Lothrop created a CECL timeline to help put into perspective what steps are necessary leading up to the final deadline. This timeline was created prior to the recent FASB decision to delay but regardless of the final date, institutions should be preparing now – it could be beneficial to adopt early.