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May 21, 2020 Article 5 min read

Even if you completed this year’s risk assessment for your financial institution, it’s time to look again. The COVID-19 pandemic has upended much of how you do business, and it’s critical you understand and prepare for increased risk. Consider these four ideas.

Business professional leaning over his laptop on a desk.Chances are you recently finished your risk assessment for the year when — all of a sudden — the COVID-19 national emergency hit, forcing people and businesses to take an unwanted pause. Financial institutions everywhere are experiencing the same issues: the unknown economic impact, immediate operational changes, unprecedented lending demands, and unknown portfolio adjustments. Additionally, government programs have created a change in your risk environment that warrants attention.

Amid a “hopeful”  reopening of the economy, as your institution turns its attention toward a new way of operating, it’s critical to consider the following categories and the impact they could have on your recently completed risk assessments. Even if you’re not changing your risk assessment, we recommend documenting that you’ve considered these areas.

New government lending programs

The newly formed loan programs, including the Paycheck Protection Program and Main Street Lending Facility, bring with them increased risk. Considering the loan volume you’ve seen in the last eight weeks is typically what you’d see in a normal year, do you feel comfortable with how you’re evaluating these items:

  • Eligibility of prospective borrowers
  • Internal controls around new loans, from loan initiations, underwriting, decisioning, commitments to fund loans and loan boarding
  • Implementing new forms and related documentation
  • Compliance with terms allowing for loan forgiveness
  • Accounting for the costs and income associated with these programs
  • Tracking and reporting of these loan types to loan committee and the board
  • Continued regulatory compliance requirements on a very stressed and time-sensitive operational team
  • Fair lending implications relative to loan decisioning
  • Monitoring these loans to ensure that terms are all within the established guidelines of the SBA and Department of Treasury

Changes in the operating environment

With the pandemic causing businesses to institute sudden operational changes in people, processes, or products, you need to consider what updates are necessary to maintain strong internal controls over financial reporting. Examples include: a reduced on-site workforce, remote work-at-home arrangements, reliance on more paperless documentation, and virtual preparation and attendance of internal and board-level committee meetings. Since these arrangements may continue indefinitely, consider reviewing the following list sooner than later:

  • Impact of operational staff working from home
  • Adequacy of loan imaging or paperless documentation
  • Level and trends of loan closings with policy exceptions
  • Number of days to post-close review
  • Branch monitoring activities (cash levels)
  • Approval process for wire transfer requests
  • Segregation of duties pertaining to changes to customer accounts
  • Segregation of duties around new account openings and obtaining required documentation
  • Level of regulatory compliance exceptions (example, review of HMDA LAR)
  • Monitoring of employee production and related role expectations (are these documented?)
  • Redeploying employees from closed offices to a productive back-office position to assist stressed departments (i.e., mortgage department stress due to increased production volume)

Assisting customers during the pandemic

Regulators issued guidance on the treatment of requests for loan modifications early in the onset of the pandemic. It’s likely that your loan staff have been busy processing government loan applications, responding to requests from customers to modify current loan agreements, and monitoring forbearance guidance on sold mortgage loans, especially in light of falling interest rates. Understanding the process your institution implemented to ensure consistency and safety in the risk profile is an important baseline as you monitor asset quality through 2020 and beyond.

Do your executive management team, business line managers, and board of directors understand the following as they relate to monitoring loan modifications and loan forbearances? Has your lending portfolio softened, which could be an early indicator of the impact of these economic hardships or even pre-pandemic signs of economic hardships?

  • Identification of pre-pandemic signs of borrower economic hardships (i.e., past due or inability to pay for real estate taxes during the pre-pandemic time frame)
  • Formal program to accommodate customer requests to modify loans due to the economic impact of COVID-19
  • Understanding of Section 4013 of the CARES Act and the consideration of TDR classification
  • Understanding Interagency Statements to exclude modifications (other than Section 4013 modifications) from TDR classification
  • Understanding the impact of changes to terms with serviced mortgage loans

Prudent pandemic enhanced risk management considerations

With all of these new programs available to help your customers and to position your institution to support those in the community, there’s an underlying economic impact to your institution. We recommend sound corporate governance to ensure that your executive management team, along with your board of directors, is managing and monitoring risk management on a regular basis, as the risk changes every day. Consider the following for prudent pandemic enhanced risk monitoring:

  • How are you monitoring the temporary relief programs that are now in place? Is there regular internal and board-level reporting? What types of “dashboard” or “snapshot” information  are you including to properly ensure you are managing and monitoring related risks?
  • How are you planning on dealing with borrowers requesting temporary relief, that you have some indicators this temporary relief won’t solve their longer-term issues?
  • Have you considered what impact the pandemic has on your allowance for loan loss calculation? As it may be too early for financial impact to show, what changes are you considering to your qualitative factors and how are you documenting them?
  • Have you considered the risks inherent with information technology and cybersecurity, considering the remote working arrangements, increased loan volume, and other immediate changes?

Audit and monitoring related considerations

With all of these heightened risk issues, your internal audit, regulatory compliance, and loan review functions will look different. Their risk assessments, especially as time passes through this pandemic, will more than likely change. And, with the remote environment, let’s not forget about the impact on information technology-related audits. Although not exhaustive, here are a few things your audit and monitoring functions should consider.

  • Has your internal auditor enhanced their internal audit schedule, considering the remote working environment, the time stress on the operations department, and other  changes?
  • Has your compliance officer enhanced their compliance monitoring, especially considering the potential for impact on regulatory reporting such as the HMDA LAR and human-related errors? Should your compliance officer revisit the current monitoring schedule to a more tailored approach for this current pandemic and its impact?
  • Have you considered potential changes in your loan review scopes to identify early softening and/or potential for post-pandemic-related financial concerns?
  • Have you considered, in the near term, limited scope testing of the loan programs to ensure that loan terms and related documentation are in compliance with guidelines established by the SBA and Department of Treasury? Early self-identification will allow you to identify potential options to limit any later challenges.
  • Have you continued to monitor your asset/liability model for all of the sudden changes to your institution, and the potential for longer-term impact on decisions you may make and/or may need to discuss with your board?

Putting it all together

When you update your risk assessment or document these pandemic-related issues and their potential impact, you’ll likely force your executive management team and business-line managers to consider these items as well and, potentially, to identify an ongoing need for internal changes. That decision could create the risk monitoring instrument that your board should be mandating to allow it to manage and monitor risk in the future. Questions? Give us a call. 

COVID-19: Adapt faster, emerge stronger.

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