On June 23, 2020, the Board of Governors of the Federal Reserve (Federal Reserve), the Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA) and the Office of the Comptroller of the Currency (OCC), in conjunction with the state bank and credit union regulators, jointly issued examiner guidance outlining supervisory principles for assessing safety and soundness during the COVID-19 pandemic.
While the guidance recognizes the importance of using uniform ratings to promote consistency and transparency across the industry, it also stresses the need to take into account management’s assessment of individualized pandemic risks in assigning composite and component ratings for a particular institution. In addition, the guidance indicates that examiners should exercise the appropriate amount of flexibility and patience in their supervision, recognizing that the impact of COVID-19 could be highly localized, constantly evolving and potentially long term.
In the course of an examination, examiners are directed to take into account whether new weaknesses were the result of the pandemic and its many economic effects or mismanagement and failures of corporate governance. Examiners should also consider the extent to which institutions have attempted to work with borrowers who have been unable to meet obligations because of the pandemic.
In determining whether or not to take enforcement action, the guidance indicates that regulators will consider whether management has appropriately planned for financial resiliency and continuity of operations, has implemented prudent policies, and is pursuing realistic resolution of its issues. In evaluating management’s assessment of the pandemic’s risks to determine whether it is sufficient in scope and content, the guidance reminds examiners to recognize that these issues are complex and evolving and that the impact may be very localized and specific.
The bulk of the guidance centers on the component ratings, listed here as capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk. While the guidance points out some of the ways in which each of these components has been affected by the pandemic, particular focus is placed on asset quality. The guidance recognizes that the wide-ranging economic effects of the pandemic have created a great deal of uncertainty in the classification of credit and, in some cases, the need to relax underwriting standards. Additionally, the reduction in operational capacity may exacerbate the uncertainty by slowing down credit risk reviews as well as appraisals and evaluations.
The guidance reiterates support for institutions electing to participate in the Paycheck Protection Program (PPP) and working with borrowers as part of a risk mitigation strategy intended to improve existing loans. Examiners will not criticize institutions for participating in the PPP in accordance with the Small Business Administration’s guidance, or for engaging in prudent loan modifications and working with borrowers in a safe and sound manner.
While this guidance does not eliminate the difficulties inherent in trying to make precise calculations in times of extreme uncertainty, financial institutions should take some comfort in the way the agencies have worked together to draft a document that stresses patience and flexibility. Safety and soundness concerns are more important than they have been in decades, and financial institutions are struggling to balance these concerns with the needs of their customers, many of whom are faced with their own personal financial crises.
There’s no easy answer or one-size-fits-all solution, and this guidance recognizes that and suggests that principled efforts made in good faith will not be punished. However, the guidance makes it clear that the regulators will still expect to see the effort; there’s no permission to take a “safety and soundness break” here. Financial institutions should heavily document their good faith efforts and be prepared to support their decisions at all levels.
We will continue to monitor all the COVID-19 guidance coming from state and federal regulators. Our broader COVID-19 resources are available here.