Q3 2020 is ending this week. Everyone will be busy closing out the books on the quarter and, in particular, determining the credit loss exposure of the Bank. And with no further relief passed by Congress, the rest of the year will continue to be an uncertain challenge.
A significant number of community banks (maybe all?) have worked with their commercial borrowers to grant short term forbearances (up to six months) and their mortgage borrowers (up to one year, in six month segments) without having to be treated as a Troubled Debt Restructuring (TDR) as discussed in the Interagency Statement from April 7, 2020. Q4 2020 sees the commercial forbearance program ending and the mortgage one confronting the second extension. This short summarization shows that it will be a difficult year end. The Interagency Statement on Additional Loan Accommodations Related to COVID-19 (August 3, 2020) states, “For all other subsequent loan modifications, a financial institution can appropriately evaluate the subsequent modifications…to determine whether such modifications are accounted for as TDR’s…”. This does not provide the same leeway granted under the earlier Statement. And then, of course, something could be enacted and this could all be pushed off into 2021.
Plan for the Worst, Hope for the Not Quite So Worst
As I discussed last quarter, the planning process Q4 requires a strong crisis management approach. The amount of uncertainty that exists right now is significant and the prospect of credit write-downs and foreclosures (on commercial real estate this time) looms ever larger in our future. The Tabletop Walkthrough continues to be one of the best ways to address this risk and to document your decisions. As a refresher, a Tabletop Walkthrough involves pulling together key people (tacticians), laying out the scenario and playing it through to a future state. I don’t talk about playing it through to the end because in this case we are dealing with defined periods of time: quarters. Repeating this process enables you to “continue the game” and stay ahead of the worst state. As you go along, you create a document trail that shows the decisions you made, the reason for the decisions and the expected results. It is like combining an offensive plan with defensive documentation.
Begin with Questions
Since we are dealing with an uncertain future, a good place to start is with questions. Questions like;
- Current State
- How did we do in the third quarter?
- What was the source of our earnings or losses?
- How much capital do we have?
- What do our borrowers look like, beginning with those that are most at risk?
- What does the real estate market look like?
- Future State
- Which borrowers will we move to a classified state in Q4 2020 and Q1 2021?
- How will deposits change?
- How will our year end financials look without additional stimulus?
- What is our goal for year end 2020 and fiscal year 2021?
After answering the questions, we are ready to identify the actions we need to take to react to the current situation and attempt to meet our revised goals. These actions may include:
- Do we have enough information? Is it the right information? How do we get more information? Who is responsible?
- Are we correctly staffed? Do we have enough or the right people to work our TDR’s and Classified Loans?
- How do we communicate with the Board? The regulators, our customers, the stock market, our employees, our vendors?
- What actions do we need to take to survive?
Did I say, don’t forget to document?
Documentation is an area that many people push back on. It can be to your detriment, however. What should this documentation consist of? First off, I always recommend someone who is not involved in the walkthrough take minutes of the exercise. This sort of distance from the meeting(s) enables the participants to be fully engaged and actually speeds everything up. When we facilitate scenarios like this we always ensure the minute taker is separate from the team. The person taking the minutes should capture some of the discussion so that others can see how the discussion took place. The key here is on others. When someone else reads the documentation, they should be able to understand what was discussed and the way in which it was discussed. As I said, some of this is for the plan and some of this is for defense. The way I refer to it is that when the “bad day” happens, you will be able to show that the actions you took were for the purpose of avoiding or mitigating the bad situation.
Worrying signs regarding a lack of preparation
I have had the opportunity to review some credits that are currently in forbearance. While I found the forbearance appeared to be granted quickly and according to what was permitted in the regulatory statements, I did not find any attempt to consolidate the information from all of the borrowers who were granted forbearance. In addition, there was not an attempt to group the loans by industry or purpose. Thus the borrower who had purchased the property to use as an Airbnb and saw their revenue source disappear was not grouped with like borrowers in order to understand how the bank will be impacted as travel restrictions continue into 2021. Stress testing did not take this into account as well. In short, preparation for the future state of the portfolio was not being addressed.
Risk involves probability and uncertainty. The measurement of these components is key, but so is the preparation for different states of the future. Q3 is turning into Q4 and, quite frankly, things are not looking better. I do hope, however, that everyone is staying safe and taking the actions needed to remain safe.