Government stimulus packages and loan programs developed and launched during COVID-19 have had a positive impact. However, given the many public health and economic uncertainties, the road ahead remains perilous for both lenders and their borrowers.
Many small businesses that have applied for Paycheck Protection Program loans anticipate needing additional financial support in some form or another over the next 12 months. Individual consumers who have obtained forbearance from lenders and homeowners face the harsh reality that they will have to find ways to manage for much longer than expected before things get better. In the absence of further government action, many of the benefits available to borrowers diminish or disappear, and participants on both sides of the credit market need to prepare for what is to come.
For consumers, widespread deferrals mean lenders really can’t tell which borrowers are creditworthy. On the business side, the likelihood of significant changes in their operations after the pandemic means examining historical performance will not be relevant. New credit decisions will need to take full account of the impact of changes in the operating models of these companies on future revenues and debt service coverage capacity. Added to these problems is a lack of transparency about the ability of large financial institutions to withstand increasing credit losses.
What does this mean for financial institutions? Institutions can take immediate steps to continue supporting their borrowers and mitigate credit risk.
- Reassess existing loan portfolios. Reassess how credit concentrations are aggregated and reported, and modify them to align with the pandemic. Consider taking a different look at the credit portfolio by assessing occupations, geographies, and rating agency downgrades, among other areas.
- Improve data collection. Continue to improve data collection and ensure that the data collected during this period is complete and can be used to provide more in-depth information on credit risk in the future. Establish COVID-19 system indicators or flags to facilitate ongoing monitoring and reporting. As an example, some institutions have established COVID impact indicators to distinguish borrowers who have been severely affected from those who have had a moderate or indistinguishable lasting impact.
- Reassess the subscription criteria. Make sure that credit ratings are forward-looking and not based on the historical performance of an industry segment or an individual borrower. As much as most financial institutions want to work with borrowers in these troubled times, bad credit decisions ultimately serve neither the financial institution nor the borrower. Lenders need to be able to differentiate borrowers with temporary disruptions and in need of interim support until normal operations can resume from those whose business models are no longer viable.
- Keep up to date with changes. Create a working group focused on credit risk management strategies. Ensure that the institution has a process to assess and respond quickly to the rapidly changing regulatory landscape with respect to policies such as forbearance, foreclosure moratoria and credit report changes.
- Reassess the borrower’s communications. Review the way the institution communicates with borrowers. Adopt self-service models that incorporate technology that allows customers to send messages, share documentation, contacts, or SMS through a mobile app or website. Analyze borrower concerns and look for trends that could potentially lead to further policy changes. Engage early with those borrowers considered most at risk.
- Recalibrate credit risk rating models. In this global crisis, the scoring models used to calculate the probability of default and the loss given default may have lost their predictive capabilities. Consider recalibrating the model inputs and assumptions to align them with the current environment. Additionally, they might consider establishing a temporary COVID-19 risk rating.
- Be realistic about balance sheet risks. Aside from possible changes to Federal Reserve stress testing requirements, perform frequent scenario analysis (at least quarterly) to understand and manage the financial impact of credit risk on the organization.
- Remove barriers for resources. Assess necessary resource skills, such as legal and compliance knowledge, special assets and problematic bad credit payday loans experience, and customer service. A rapid inventory of these skill sets across the organization, including identifying staff who could benefit from cross-training, will help support the areas that need it most and identify gaps that need to be filled. .
The effects of COVID-19 on businesses and the economy continue to evolve. As governments around the world take action to stem the pandemic, financial institutions should take action to understand the current situation of borrowers, express empathy with the circumstances they are living in, and support borrowers while protecting the situation of borrowers. the institution through effective credit risk management practices.
Bill Byrnes is Managing Director of Risk and Compliance Practice at Protiviti.
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