2021 MEGA CONFERENCE Navigating the Credit Uncertainties of COVID-19 - David H. Ruffin | Principal
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2021 MEGA CONFERENCE
Navigating the Credit Uncertainties of COVID-19
(February 11, 2021)
David H. Ruffin | Principal
Today’s Speaker
David Ruffin
Principal • Extensive financial industry experience with an
IntelliCredit emphasis on credit risk
• Strategist behind IntelliCredit’s Tools:
Portfolio Analyzer and Smart Loan Review
• Review of credit policies and procedures
• Due diligence for M&A or Capital Raising
919.741.8859
david.ruffin@intellicredit.com
Raleigh, NC
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Agenda
• The 2021 credit uncertainties
• AR, national & regional Q4 ‘20 credit metrics
• Changes afoot in lending
• Five key strategies to reduce 2021credit uncertainties
• Q&A
4
The 2021 Credit Uncertainties 5
2021 Credit Uncertainties…because:
• 2020 was a high-performance banking year
— Virtually every bank out-performed financial expectations
— The banking Armageddon feared at the advent of COVID didn’t materialize
— Credit metrics at 10K feet imply nothing onerous has occurred
• Temptations to claim victory
— We’re just that good in managing our institutions through this national
disaster—and making money doing so
— We’re the beneficiaries of years of building more capital
— With the vaccines coming, the worst is over
— Unlike a decade ago, no blame can be ascribed to our industry—just the
reverse as you’ve gained huge plaudits with PPP’s
6
6
2021 Credit Uncertainties…because:
• Now for the rest of the story….
— We experienced unprecedented:
o Regulatory relief
o Massive federal economic stimulus in the early months of the pandemic
o Flush of deposit liquidity and non-organic loan growth through PPP’s and SBA
initiatives, that continue into 2021
— Bankers know intuitively that credit tails outlive economic shocks
— The federal government lifelines eventually will cease
— Our commercial bank credits reside on Main Street—not Wall Street—and
Main Street is in a recession!
— Many of our borrowers are more focused on survival than investing for
growth: normally, a credit red flag!
7
7
2021 Credit Uncertainties…because:
• The 2021 credit realities...
— All the largely government COVID initiatives, while avoiding an economic
calamity, have aligned to create the greatest masking effect of underlying credit
risk in modern banking history
— Unlike the last crisis, where all things 1-4 family housing took us into the Great
Recession, COVID has strewn the landscape with many divergent industries
negatively impacted—more complicating our risk assessments
— Thus, 2021 credit uncertainties among all stakeholders:
o Boards & Management
o Risk Managers
o Investors & Investment Bankers
— Uncertainty is anathema to managing credit risk
— Reducing these uncertainties in 2021 will be priority one!
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2021 Credit Uncertainties…because:
• Other challenges remaining:
— Instances / investigations of PPP fraud
— CECL’s not going away
— LIBOR transition
— Continuing focus on AML/BSA and Cyber risks
— The inexorable question: how long the tie to government to both abate our risks
and enhance our growth
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9
AR, National & Regional 4Q ‘20
Credit Performance Metrics
10Trifecta of Loan Quality: Banks
Trifecta of Loan Quality: Banks
AR Loan Growth Trends: Banks
AR Loan Yields / COF / NIM’s / Wholesale Funding—
Mixed to National Metrics
--As of 12/31/2020
14CRE Concentrations: Banks
Other Concentrations: Banks ≤ $10B
ARNPA’s structural challenge at smaller banks—
when credit is stressed
NPA’S+90 PD / Tang Equity+ALLL (%) ARAR Banks (≤ $10B) ‘Q4 ‘20 NPA’s: 18
Changes Afoot in Lending 19
Changes Afoot in Lending
New focus on lending opportunities
• Looking for the new prospective borrower
• Converting the PPP loans into a more stable organic loan
pool
• Capitalizing on the goodwill related to PPP’s
• Leading on the COVID recovery!
• Relying even more on government guarantee programs for
growth
20Finding Alternative Sources for Loan Growth
December 2020
21Changes Afoot in Lending
New focus on credit risk management
• Pivoting from production (COVID-related modifications, PPP’s) to credit risk
management
• Assessing talent
• Maintaining close borrower contact—virtually, of course
• Tweaking policies & procedures
• Focusing on conservatism without over-reaction
o Stressing without doomsday
o Valuations without fire-sales
o Focus on reserving / moderating charge-offs
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• Renewing focus on Loan ReviewChanges Afoot in Lending
New focus on M&A
• Predictions of more robust M&A in second half of 2021
• Investment bankers grimacing over unprecedented levels of
uncertainty in underlying credit quality
• It’s beyond 1-4 family housing industry this time
• Loan impairments fade
• There likely will be more what-if scenarios needed
• More focus on cultural synergies
• Even the mechanics of calculating the ever-present credit mark
23 may change…PD’s & LGD’s (Last Financial Crisis)
Default defined: a net charge-off
PD: An informed statistical estimate of a likely default
LGD: A measure estimating severity of loss upon a default*
EL (Loss %): The product of the above*
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*Applied to loan balances at defaultPD’s & LGD’s (Post COVID)
COVID presenting more reserve-focused sensitivities
Likely expanded definition of a default:
• charge off or write-down*
• ≥ 90-day delinquency
• On non-accrual
• Foreclosure / bankruptcy
*Gold standard in last financial crisis,
skewed by recoveries
25Five Key Strategies to Reduce
2021 Credit Uncertainties
1. Recognize Trap of Focusing Only on Portfolio At-Large
2. Create Portfolio Subsets, Identifying Hotspots
3. Drill Down to Troubled or Stressed Borrowers
4. Adopt Alternative Portfolio Servicing Protocols
5. Write Your Own Script—Before Others Do It For You!
26Let’s start with a critically informing concept…
Public Data Remember:
Non-Public Data
• The external
stakeholders see
Red Flags
you through the lens
Aggregate Affordable /
of public (call report)
Portfolio Trends Practical Portfolio
data.
Loan
Diagnostic Tools
Level Detail
• Only you are privy to
your non-public,
Enhanced Modernized Loan idiosyncratic loan
Loan Review
Findings Review data.
(Interfaced With
Diagnostics)
271. Recognize Trap of Focusing Only on Portfolio At-Large
• Avoiding the all loans are good loans—until they’re bad loans
syndrome
• Knowing that perhaps the most important variable in your credit
quality is the underlying market commodity values of our borrowers’
products and services
• Looking for Red Flags from both public and non-public data.
28Red Flags
29
292. Create Portfolio Subsets, Identifying Hotspots
• Knowing your concentrations
• Focusing on risk grade migrations within the pass
categories
• Understanding the varied COVID impacts on your portfolio.
30Unchecked Concentrations — Like Speed — Kills!
Key Findings
• >70% of 2008-2011 bank failures
were CRE lending focused
• High concentrations and late cycle
growth (vintages), lack of loan
seasoning significantly exacerbated
losses
• High correlation to collateral
dependence coincides with default
rates (worst of both worlds)
• State/regional market forces are
critical co-variants
31CRE Record Exposure at Commercial Banks
--Source: Federal Reserve
32Understand your portfolio concentrations
Concentrations
by Band
(or type)
33Understand your portfolio concentrations
Concentrations
by Average Risk-
based Capital or
Community Bank
Leverage Ratio
34Recognize the Varying COVID Impact
on Your Borrowing Industries
Understand your portfolio subsets, vintages and hotspots
Portfolio Subsets
by NAICS Codes
(Industries)
35Recognize the Varying COVID Impact
on You Borrowing Industries
Understand your portfolio subsets, vintages and hotspots
Portfolio with
COVID / PPP /
SBA Subsets
36Recognize the Varying COVID Impact
on Our Borrowing Industries
Understand your portfolio subsets, vintages and hotspots
Whole Portfolio Risk Grade Migrations Residential Construction
37 Key to early detection: RG migrations within pass categories!3. Drill Down to Troubled or Stressed Borrowers
• Aggregate trends are only meaningful if you can efficiently
identify the borrowers comprising those trends
• And peeling the onion further, which are or likely to
become stressed…
38Trends must identify loan level detail
39
39Then, the switch to the qualitative tedium of
analyzing the stressed borrowers
40
404. Adopt Alternative Portfolio Servicing Protocols
• Update loan polices to reflect current conditions
• Be more risk-focused; one size doesn’t fit all. All aspects of
post-booking loan servicing should have a risk/reward
component to its implementation (e.g. annual review
minimums may be quite different among loan types and
risk grade segmentation)
• Embrace portfolio and loan level stress testing
• Catch up on and enhance all aspects of loan review
41Why Stress Testing is a Must at Community Banks
Stress testing:
1. Gives early warnings.
2. Ties traditional transactional credit risk to modern macro
portfolio management.
3. Provides in-depth concentration management.
4. Documents defense of strategic/capital initiatives.
5. Engenders confidence in management.
Source—BankDirector.com, May 4, 2014
42 42Is Your Bank’s Loan Review Good Enough?
Key Questions:
• Is reviewer talent qualified and
effective?
• Is it in sync culturally with all aspects
of the credit process?
• Does it have relevance on real time
portfolio risk assessment?
• Is it truly independent?
• Is suppressing today’s loan review
costs exacerbating more losses later?
BankDirector.com | May 4, 2017
43 43Interagency Guidance of Credit Risk Review Systems (Issued)
Regardless of structure (or size of the institution), an effective credit risk review system accomplishes the
following objectives:
✓ Identifies loans with credit weaknesses
✓ Validates risk ratings
✓ Identifies relevant trends
✓ Assesses internal credit policies and loan administration procedures / compliance with laws and
regulations
✓ Evaluates lending personnel, including their compliance with lending policies risk assessment
✓ Provides management and the boards of directors with portfolio quality assessments
✓ Opines on problem loan management plans
✓ Provides management with timely credit quality information for regulatory, reporting, and ALLL
44
445. Write Your Own Script—Before Others Do It For You!
• The It’s beyond my control defense is no longer workable.
• 2021 will demand that banks provide evidence of proactive risk assessments.
That’s the quantitative—
now write the qualitative
narrative of your own
credit risk profile!
• All outside stakeholders, especially regulators, must perceive you as the
experts on your own credit risk profile. Taking the above steps should enable
you, credibly, to write our own scripts.
45Greatest Value Takes from Implementing the Five Key Strategies:
• Confirming you as captain of your own ship
• Minimizing credit surprises at board /regulator levels!
• Supporting the proven correlation between early detection of emerging credit risk, and:
— Reduced levels of loss / nonperformance
— Greater flexibility in managing problem loans out of the bank
• The magnitude of today’s credit uncertainties adds to your challenges in realizing this maxim—
46 but they can be overcome!Q&A 47
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