Regulatory Spotlight

     If the FDIC Supervisory Insights are any indication of what is top of mind for examiners, then credit risk and liquidity risk are why they are concerned.  This shouldn’t be a surprise to anyone, especially since the Current Expected Credit Loss (CECL) accounting standard is set to take effect starting in 2020 for SEC registrants and 2021 for all other banks.  With the loan growth most banks have been experiencing, liquidity positions have also been tightening giving rise to examiner’s liquidity concerns.  The FDIC Supervisory Insights Summer 2017 release focused on trends in community banking as it relates to liquidity risk. The FDIC Supervisory Insights Winter 2017 release addresses trends in community banking concerning credit risk management.  Both now appear to be in the spotlight as we enter 2018. 

                Credit Risk

                For most community banks, loan growth continues to prop up earnings as loans grew 7.3 percent year over year as of September 30, 2017, as reported in the FDIC third quarter “Quarterly Banking Profile” report.  Net income over the same timeframe grew at 9.4 percent.  However, as many rural bankers understand, the noncurrent rate for Agriculture (Ag) loans grew 17 basis points to 0.99 percent over the year and commercial and industrial loans remained at a 1.26 percent noncurrent rate.  While there are growing concerns in Ag portfolios, this growth illustrates that it is a great time to be a community banker. 

                Of course, examiners recognize that the resurgence in earnings has been strongly correlated to loan growth.  However, in the FDIC Supervisory Insights Winter 2017 release, they warn that relying on lagging loan performance indicators (loss history, classified assets ratio, nonaccruals, etc.) alone makes it difficult to adequately identify emerging risks in the portfolio.  Utilizing more forward-looking indicators like increasing loan policy exceptions, increasing concentration levels, loosening underwriting standards, in addition to economic indicators, will help management teams be more proactive in identifying problem areas in the portfolio and help minimize the negative impact of any deterioration. 

                Over the next exam cycle, community bankers should expect questions regarding the steps being taken to satisfy the requirements for the CECL launch date.  Outside of the loan specific data needed to accurately model the “lagging” indicators, effective management teams should expect to be implementing some metrics to track internal “forward-looking” indicators, as well as, external economic trends (i.e. grain prices, land values, regional unemployment rates, etc.).  Taking steps now to be proactive around CECL implementation will pay dividends both to your bottom-line and your next exam experience.

                Liquidity Risk

                The FDIC Supervisory Insights Summer 2017 highlights loan and liquidity trends and the increasing risks associated with each.  Up until recently, community banks have been flush with liquidity.  However, the expanding economy has pushed loan demand upward eating away at the excess liquidity cushion experienced by many banks.  Additionally, the recent move up in treasury rates has caused many bond portfolios to reflect an uptick in unrealized losses, which will limit liquidity from the portfolio in the event of choosing to sell prior to maturity.  With core depositors reluctant to move their banking relationship, as banks have added more conveniences for the consumer, many banks have turned to wholesale funding options to fund this loan growth. 

                While wholesale funding can be an efficient funding source when used properly, most regulators get uneasy when seeing large increases in this strategy.  The underlying concern is that banks that are growing quickly are sacrificing underwriting standards and credit quality in the face of competition and are funding this growth with “hot money”.  If you are experiencing significant loan growth and examiners notice that your wholesale funding (borrowings both secured and unsecured, brokered deposits and internet deposits) is increasing, then expect a critical eye around your underwriting standards and your overall liquidity management practices.  Maintaining strong underwriting principles, especially in times of strong competition, and having well-defined funds management policies and procedures in place will help put examiners at ease and help keep your ship moving forward when and if the waters get choppy. 

                The products and services we provide at AMG go beyond preparing detailed interest rate risk reports.  Within our report set, we illustrate various stress scenarios for your liquidity and have an additional tool that provides you the control to run as many individual stress scenarios as necessary.  Additionally, we help in providing policy recommendations and examination prep.  If you have had a recent exam that included recommendations or simply want to remain proactive, let us know and we will be glad to help.  You can reach any of us here at AMG by calling 800-226-1923 or email