The COVID-19 outbreak has created disruptive and unprecedented times. First and foremost, our thoughts are with you as you make difficult decisions about how to continue providing critical services, protecting employees and customers, and adhering to recommendations from public health experts.
The Perfect Storm
Current events have created a banking industry “Perfect Storm” — “a critical or disastrous situation created by a powerful concurrence of unpredictable and negative factors.”
This Perfect Storm in our industry stems from many factors:
- Coronavirus outbreak
- Inversion of the yield curve from February thru early March
- Recent emergency rate cuts of 150bp by the Fed
- The reality of negative rates in the U.S.
- Expected economic downturn
The short- and long-term outlooks are uncertain at best, with a challenging rate environment, expected economic recession, and limited ability to interact with clients on a personal level for an unknown period.
Positive Steps to Take Now
So how can your Financial Planning and Analysis (FP&A) team help your organization weather the storm? Here are some ideas and best practices, based on our team’s collective experience and direct client feedback.
The budget that you put together just a few short months ago is no longer valid! You need to reforecast your plan with an entirely new set of assumptions, based on the new market conditions and resulting changed drivers for:
- Interest rates
- Growth plans for loans
- Growth plans for deposits
- Pricing on new business
- Balance sheet mix and asset allocations
- Expected mix between margin income and fee-based income
- Credit quality (potential increase in non-performing assets and charge-offs)
- Non-interest income and expense (any changes in expected fees, salary expense, costs, etc.)
This doesn’t need to be done at a department level (you are not re-budgeting), but rather should be done quickly at an institution, line of business, and perhaps regional level depending on the structure of your organization.
Once you get your arms around what the new economic environment means for these assumptions, reforecast your plan to understand the expected impact. Your executive team should then use the results to adjust the plans even further — what changes are needed operationally, procedurally, etc. to optimize performance in this new world?
Perform Scenario Analysis
Once your new plan (reforecast) is in place, evaluate what will happen under different sets of conditions. What will happen if the impact isn’t as big as you think? What will happen if it is much worse than you think?
As a best practice, you should run those scenarios, not just to understand the potential financial impact and risks, but to also evaluate what your plans will be if those scenarios start to take shape. Plan for the bad, model the worst, hope for the best.
Evaluate Your Risks
As part of this planning and scenario analysis, but also as a separate and specific process, your organization needs to address the various risk aspects of this new and changing environment.
· Credit Risk:
- Expected Credit Losses: look at new expectations regarding GDP and unemployment. What is the impact via your current expected credit losses (CECL) models? If you don’t have a CECL model yet, how are you assessing this?
- Is your institution planning to take on additional credit risk to drive loan growth and higher yields?
- If so, what is the expected impact on income, charge-offs, provision for loan loss amounts, etc.?
- If not, what is the impact on loan growth and yields, and resulting income?
- What is your organization doing to manage these risks?
· Liquidity Risk:
- Do you have enough liquidity? How quickly are you adjusting deposit rates?
- Do you have too much liquidity? What is the expected impact on investment returns?
· Interest Rate Risk (IRR)
- How is your IRR profile changing with the recent movement and shift in rates?
- Will your IRR profile change based on any of the plans mentioned above (e.g., balance sheet restructure, asset allocation, loan growth, etc.)?
Know Your Profitability Drivers
Now more than ever, your institution needs to understand the sources of profit.
- What if your most profitable, large customers leave, or their business is severely affected?
- What happens if demand for your most profitable products dries up?
- Should you consider permanently or temporarily closing branches, and if so, which ones?
- What channels should you be investing in and promoting?
- Should you modify your pricing strategy? What is the impact on profitability, on liquidity, on deposit levels and loan growth?
Take a Hard Look at Costs
Assuming Covid-19 will push the economy into a recession, your institution should analyze where to reduce costs to soften the impact. While you can’t save your way to profits in the long term, a detailed analysis of costs can help your institution minimize the impact in the short term and create a foundation for sustained profitability going forward. Will the current circumstances push more of your customers to less costly digital and mobile channels? Is your institution prepared for this both in the short term and long term?
Many of your customers are stressed; they are worried and even panicked about what the future will hold in terms of health and finances. Many of them live paycheck to paycheck and will need advice, understanding, and assistance. Perhaps now is the time to think about creative and unique ways that you can be there for them. Consider:
- Short-term personal loans and emergency small business loans
- Skip-a-payment service
- Auto loan refinancing with a cash out option
- Lower credit card interest rates, and raised credit limits
- Fee waivers
- 24/7 call center support
- Emergency treatment center at a temporarily closed branch location
We hope the information above gives you some actionable ideas to help right the ship and guide your teams as they develop plans to navigate these troubled waters for the rest of your organization.
Bryan Ridgway is a Senior Solutions Engineer in Kaufman Hall’s Financial Institutions practice. He assists financial institutions of varying sizes and complexity in the development of solutions to analyze and improve their financial performance, using the Kaufman Hall Axiom Financial Software Suite. Mr. Ridgway has more than 25 years of experience in financial risk and performance management for the banking industry. He can be reached at 847.441.8780 and firstname.lastname@example.org.