The Lifeline Financial Institutions Need Amid COVID-19 Crisis
Abby Progin – Vice President – Product Management
July 20, 2020
When COVID-19 made its entrance into the United States, there were many experts that predicted health and economic turmoil for months and even years to come. With all the dire warnings, many thought . . . sure, there would be an unbelievable number of households that would be hurting, jobs lost, and an economy that was shaken. The NCUA published their 2020 Stress Testing Scenarios in February 2020, prior to the pandemic’s effect on the United States. An event like the COVID-19 pandemic did more than complicate the exercise of stress testing – it changed the limits, preconceptions and economic views. The severely adverse scenario included a severe global economic recession, but it didn’t even get close to hitting the reality of the economic downswing we are currently experiencing. For example, the severely adverse scenario included a climb to unemployment of 10% by 2021, whereas the actual Labor of Department Numbers show that nationally, we hit 14.7% unemployment in April 2020.
U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UNRATE, July 19, 2020.
For Financial Institutions, this also means that portfolio analytics can bring a whole new level of importance. From probability of default and charge-off odds, to loan loss allowance and withholdings calculations; there are new considerations and data elements that, when measured correctly, can produce actionable insights. Dramatically different loan losses are expected and adjusting your current allowance based on the global pandemic is the reality for all Financial Institutions. Do you have the ability to model credit risk quantification with multiple stress testing scenarios that allow you to effectively look ahead? Can you include external factors easily into your modeling? Here are a few challenges every Financial Institution is currently facing and some solutions to consider while revisiting your efforts on portfolio analytics:
- Loan modifications are proving to be more difficult to predict and will complicate your stress testing and modeling efforts. During these unprecedented times, I have found that it is not unusual for banks and credit unions to have loan extensions on 10-20% of their portfolio specifically on credit card and automobile products. These loans will skew the numbers since they are showing as current, but unfortunately the majority will eventually become delinquent. So how do you manage this and measure it against something we’ve never seen before? One way to ensure you are producing the most accurate results is to introduce other factors like credit quality indicators. Using original and current FICO scores and stress testing up to a 10% downswing on those scores would be one aggressive approach. Including LTV, appraisals, DTI are always important elements to consider, but what about external factors? External factors are going to have a more significant impact in this economic cycle. Unemployment, consumer confidence, GDP, and the housing market are key factors to include in your portfolio analysis that will help you be more effective in your measurements against an economic cycle where the reality of unemployment numbers and hardships are hitting all-time highs.
- Get a baseline. If you haven’t done so already, stress test your portfolio to get a baseline that can be used next quarter. It’s even better if you have performed a portfolio analysis in the early stage of this unprecedented economic cycle. Get those soft pulls done to obtain current credit scores for your account holders before extensions begin to run out. This starting point allows you to analyze migration and can be a great indicator for use in projected loan loss scenarios.
- Examiners are going to be looking for answers harder than ever before once the dust settles and we move out of this economic cycle. They will want answers to justify your financial institution’s decisions. Appropriate stress testing allows you to model effectively and provide examiners with solid information that explains the moves you have made on portfolio adjustments, lending decisions and withholdings at your Financial Institution.
Now more than ever, portfolio analytic toolsets have become a lifeline. How successful your Financial Institution performs these predictions and projections depends on how effectively you can properly monitor, evaluate and solution with smart business actions provided by your portfolio management solution.