Banks learned many difficult lessons during the previous financial crisis, particularly involving the need to be vigilant about strategy, planning, and governance. Although banks and their customers have been affected very differently in many respects during the current COVID-19 (coronavirus) crisis, those lessons from the past, which are summarized below, should now be reconsidered in light of the ongoing pandemic and its likely effects over the coming months and perhaps years.
During the current crisis, much like the last recession, bank boards are now becoming more engaged. They are rightly asking for more information and, because of the severity of the crisis and the rapidity of its onset, are seeking that information on a more timely basis. Although boards should be careful not to usurp the management role of their executive teams, it is appropriate that directors enhance their oversight role. This will better position them to fulfill their fiduciary duties, properly assess risk, and reevaluate the risk tolerance of their institutions.
Regulators will carefully scrutinize the extent to which banks follow their own policies, and being in a crisis will be no excuse for significant deviations from board-approved risk expectations. Accordingly, banks should reevaluate their policies in light of any pandemic-related operational changes, such as those involving SBA PPP loans, loan modifications, and troubled debt restructurings.
Stress testing is a necessary component of a bank’s risk management process, but any such efforts conducted before the pandemic might now be stale. Banks need to revisit their stress testing models to account for the probable effects of the pandemic, including the impact to particular industries in their portfolios that are most likely to be negatively impacted.
Banks should evaluate their capital options well before the time they may actually need them. The results of their updated stress testing will dictate the degree to which each bank may need to explore sources of capital, such as around the board table, from friends and family, or using the public market. Banks also should understand the current environment to evaluate properly the different types of capital options, such as subordinated debt and stock issuances. With interest rates at historically low levels, subordinated debt is emerging as a very attractive option to many organizations, even those that currently have adequate capital.
Dividends, Stock Redemptions & Stock Repurchases
As described in the Federal Reserve’s SR 09-4 guidance1, banking organizations should consult with the Federal Reserve and take into account certain factors when considering the payment of dividends, stock redemptions, and stock repurchases. Those include the following factors, the evaluation of which should be memorialized in any board discussion of these actions:
- Overall asset quality, potential need to increase reserves and write down assets, and concentrations of credit;
- Potential for unanticipated losses and declines in asset values;
- Implicit and explicit liquidity and credit commitments, including off-balance sheet and contingent liabilities;
- Quality and level of current and prospective earnings, including earnings capacity under plausible economic scenarios;
- Current and prospective cash flow and liquidity;
- Ability to serve as an ongoing source of financial and managerial strength to a subsidiary bank and the condition of that bank;
- Other risks that affect the institution’s financial condition and that are not fully captured in regulatory capital calculations;
- Level, composition, and quality of capital; and
- Ability to raise additional capital in prevailing market and economic conditions.
Those factors all should take into account the unique and evolving challenges presented in the current environment.
Examinations & Enforcement Actions
A more challenging economy generally translates into more intrusive regulatory examinations, which means a greater likelihood for enforcement actions. Banks should be proactive about managing the examination process, addressing issues promptly, and taking all possible steps to avert enforcement actions, which can restrict strategic transactions, create public relations issues, and increase compliance costs. Banks also should be prepared to adjust to new off-site examinations and the challenges these entail, such as the loss of face-to-face contact, the increased difficulty of addressing issues in real time, and the greater need for comprehensive documentation.
Banks can mitigate their litigation risk by adopting clear and transparent procedures. They should implement effective training for their employees to ensure that these procedures are applied consistently. Banks also should ensure that any changes in accountholder fees, agreements, and policies are clearly communicated to customers and are easily accessible to them, such as through the bank’s website.
We Can Help You
Having helped our clients navigate through all of these issues in the last crisis, we stand ready to help you address these challenges today.
We recommend reviewing the following pandemic-related business and legal considerations we have been discussing with our clients:
Barack Ferrazzano Financial Institutions Group's COVID-19 Resource Center
- Nicholas M. Brenckman
- Nicholas H. Callahan
- Joseph T. Ceithaml
- Bill Fay
- Robert M. Fleetwood
- John E. Freechack
- John M. Geiringer
- Katherine Fritzi Getz
- Edward F. Malone
- Brent McCauley
- Abdul R. Mitha
- Stanley F. Orszula
- Neil R. Patel
- W. Scott Porterfield
- Brandon C. Prosansky
- John "Jack" W. Roberts
- Andrea L. Sill
- Jack Snyder
- Karol K. Sparks
- Dennis R. Wendte
- Steven J. Yatvin