Pub. 10 2020-2021 Issue 2

O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S — H E L P I N G C O L O R A D A N S R E A L I Z E D R E A M S September • October 2020 9 Banks must properly “Risk Rate” COVID-19 Loan Modifications and incorporate such risk ratings into their ALLL/ACL calculations. Loans modified under Section 4013 or the Interagency Guidance pertain ONLY to borrowers who have been impacted by the coronavirus. By definition, these borrowers have financial performance less robust than before COVID-19. In some cases, these borrowers may have serious cash flow problems driven by the coronavirus that impact their ability to service their debt. It is incumbent on banks to accurately “Risk Rate” these borrowers at the time of loan modification and on a regular basis going forward. FinPro has observed that many banks have internally “risk-rated” their COVID-19 loan modifications to a “watch” category. Moreover, these new risk ratings must be incorporated into the ALLL/ACL calculation. One “best practice” observed for community banks across the country is to establish a “homogenous pool sub-tier” within the ALLL/ACL methodology to break out all such loan modifications within each homogenous pool. It is noteworthy that this approach is often used in conjunction with a new “COVID-19 Q-Factor” that many banks now incorporate their ALLL/ ACL methodology. Some banks have actually appended a one- or two-digit code to COVID-19 loan modifications to ensure easy identification over time. Lastly, effective corporate governance is critical to avoid CAMELS downgrades and enforcement actions. Corporate governance starts with a comprehensive documentation process. As noted earlier, banks must maintain records of all COVID-19 loanmodifications, specifically noting whether such modifications were executed under Section 4013 of the CARES Act or the Interagency Guidance. Remember, modifications cannot fall under both categories since they have different (and competing) requirements. This information should be reported to the board of directors on a regular basis. Similarly, the management must inform the board of risk rating trends for COVID-19 loan modifications and how such ratings have impacted the bank’s ALLL/ACL. These actions, together with updated policies and procedures to incorporate coronavirus actions, robust MIS and Risk Management practices, and comprehensive Internal Controls will properly prepare banks to address any regulatory concerns. n The Lyric Theatre, CCS CHFA business finance customer, Fort Collins Scott Polakoff, CAMS, is executive vice president with FinPro, a full-service management consulting firm specializing in providing advisory services to the financial institutions industry. He can be reached at spolakoff@finpro.us/ www.finpro.us