While community banks have so far weathered the coronavirus pandemic, Federal Deposit Insurance Corp. officials said in two recent advisory committee meetings that the worst is yet to come. And that means banks must begin proactive measures now – or face increased regulatory scrutiny in 2021.
FDIC Director Martin J. Gruenberg noted that while the last seven months have been challenging, the next six to 12 months will be “even more so.”
Regulators don’t yet have a “good line of sight” into the impact on community banks, primarily because the economic consequences have largely been muted by the Paycheck Protection Program (PPP) and other relief efforts, said John Conneely, FDIC Regional Director, Chicago, at last month’s FDIC Advisory Committee on Community Banking.
“We’re nowhere near the end of the crisis. We haven’t yet felt its full effects,” he said. “We are waiting for the other shoe to drop.”
For the first half of 2020, one out of every four FDIC satisfactory-rated banks received a Matters Requiring Board Attention (MRBA) citation, the FDIC revealed at the October 14 FDIC Advisory Committee of State Regulators. Most of those MRBAs concern board or management oversight. Commercial real estate-related supervisory recommendations most often involve concentration limits, strategic planning, and portfolio sensitivity analyses.
Although the FDIC said the MRBA number has decreased in recent years, expect it to increase if banks do not properly manage pandemic risks.
CRE concentrations and declining Net Interest Margins (NIMs) are at the top of the regulatory worry list. Credit quality has so far been good, but regulators know that problems await. “While it’s not showing up in the numbers, deterioration is happening,” Conneely said. “The question is where and how much.”
Kathy Moe, FDIC Regional Director, San Francisco, said regulators are watching CRE closely. Retail and hotels have been the hardest hit, while some industrial segments, such as warehouses, have improved.
Moe noted that some banks have already put loans on watch lists. Regulators are tracking the number of permanently closed businesses and are concerned about the complicated, long-term outlook for office space.
Bank examiners indicated in June that they would begin looking at how bank management has assessed pandemic risks, and whether they have adapted their business policies to account for them. The best tool banks can use to avoid regulatory action is a pandemic stress test. One Texas banker recently used a pandemic stress test to successfully avoid an MRBA during her OCC safety and soundness exam.
“Banks have done a better job of stress testing their portfolios,” Moe acknowledged.
Some banks are using creative measures, such as sending out monthly surveys or questionnaires, to understand their borrowers’ financial conditions, since “historical financial statements are not a good source of information,” Conneely said. He noted that it is crucial for banks to track pandemic deferrals.
Several community bank CEOs said their banks were raising capital during the pandemic, just to be on the safe side. Others said they had dramatically increased their loan loss reserves.
“The big question that remains is asset quality. We are waiting to see what happens when the deferral period ends,” said Camille Schmidt, FDIC Chief of Emerging Issues in the division of risk management supervision.
Editor’s Note: Invictus based this article on webcasts of the Oct. 14 FDIC Advisory Committee of State Regulators and the Oct. 28 Advisory Committee on Community Banking.
