Pub. 10 2021 Issue 4

18 often used in conjunction with a new “COVID-19 Q-Factor” that many banks now incorporate into 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. The rules for placing credits on nonaccrual have not changed. For regulatory reporting purposes, an asset is to be reported as being in nonaccrual status if: (1) it is maintained on a cash basis because of deterioration in the financial condition of the borrower, (2) payment in full of principal or interest is not expected, or (3) principal or interest has been in default for a period of 90 days or more unless the asset is both well secured and in the process of collection. Further details can be found in the Call Report instructions. 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 loan modifications, 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, 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. In cases where a bank has a significant volume of modified loans, stress testing of these loans as well as other loans in the bank’s portfolio is a critical element in evaluating risk. And perhaps most importantly, the bank needs to have loan workout officers with the skill sets required to deal with troubled credits. While this may result in increased expenses, the benefits of having the right staff in place will most likely result in less expense than the losses which could result from missteps in collecting problem credits. 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 regulatory concerns. Of course, there will undoubtedly be situations where the decision on whether to downgrade a credit to classified status or place a credit on nonaccrual is a close one. This decision can be complicated in cases where payments on credit have been deferred and are not yet scheduled to begin. As a result, the ability of the borrower to perform on even modified terms has yet to be demonstrated. In these cases, some banks have Continued from page 17 conservatively opted to place such loans on nonaccrual, in part to prevent having to ultimately reverse income that would continue to be accrued. Typically, these credits will also be downgraded to adversely classified status. The safest course of action to avoid regulatory criticism would be to take the conservative approach. Rarely, if ever, have regulators criticized a bank for aggressively placing loans on nonaccrual or adversely classifying them. However, a bank can expect criticism if a regulator thinks the bank has been too slow to do so. And regulators will be less aggressive in dealing with a bank if management can demonstrate a willingness and ability to identify problems and put plans in place to deal with them. Why is all of this of significant importance? In June 2020, the regulators issued “Interagency Examiner Guidance for Assessing Safety and Soundness Considering the Effect of the COVID-19 Pandemic on Financial Institutions.” FinPro recommends that this document be shared with every bank’s senior management and board of directors. Included in this document are some statements regarding CAMELS ratings and how regulators will deal with a bank as follows: “When assigning the composite and component ratings, examiners will review management’s assessment of risks presented by the pandemic, considering the institution’s size, complexity and risk profile. When assessing management, examiners will consider management’s effectiveness in responding to the changes in the institution’s business markets and whether the institution has addressed these issues in its longer-term business strategy.” “An examiner’s assessment may result in downgrading component or composite ratings for some institutions. In considering the supervisory response for institutions accorded a lower rating, examiners will give appropriate recognition to the extent to which weaknesses are caused by external economic problems related to the pandemic versus risk management and governance issues.” Rarely , i f ever, have regulators cr i t icized a bank for aggressively placing loans on nonaccrual or adversely classifying them.