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good afternoon everyone and thanks for joining us today if you're not familiar with info pro we have uh been around for over 20 years providing real estate tax monitoring escort processing and flood determination services for financial institutions across the u.s over the years we've partnered with many companies across the country to promote our services and we're not using these partnerships to educate financial institutions like yourselves on hot topics new services technology trends and other general topics that will speak to a wide variety of financial institutions i'm happy to introduce to you today this month's presenter ken proctor the managing director of risk consulting and strategic risk associates during his 40-plus year professional banking and consulting career ken has served as an internal consultant with a major regional bank and held management positions in auditing departments of two southeastern regional commercial banks he created and managed the risk management practice areas for britain tech incorporated and cheshire off management services ken is a frequent speaker for financial institution industry conferences and seminars and we're happy to have him joining us today if you have any questions throughout the presentation feel free to click the chat bot button on the bottom of your screen and i will relay those questions to ken at the end of the presentation i don't want to steal any more of his thunder so at this point i'm going to hand it over to ken to guide you the rest away okay okay brian thank you if you'll bear with us a moment we're gonna do a little screen hand-off here and then i'll see if i can get my presentation to come back up but we appreciate you taking time to join us today let me swap these two things here like most of you guys were all trying to adjust to uh to zoom and go to meeting and teams teams seems to be my most difficult one so hopefully you're seeing the the presentation version brian you let me know if that's not what you're seeing we are seeing it ken i love it when it works okay well um appreciate the opportunity to speak with you i i wanted to share with you uh a word of the day my old boss used to have one of those word of the day calendars that he kept on his desk and every day he would tell us the word of the day and you know we'd uh go through some strange story about the word of the day and he'd tell us even if we didn't want to hear it but i did want to share this one with you i heard this one from my from part of the consulting team that does credit risk the other day and it was called exogenous risk um i wasn't terribly familiar with that term so i had to go look it up but it turns out it's a risk originating from or due to some sort of external cause outside the system so outside the bank exogenous risks or shocks like natural disasters and banks really don't have a lot of influence or control over those events they can only react to them so um one definition i i read described it as an asteroid might hit the earth so nothing that shocking but kovid certainly has been an exogenous risk it wasn't a risk that you know most people even had on their radar i think like you 10 12 years ago we went through the h1n1 flu the swine flu and and most people got you know i had a client that had boxes of masks and gloves and disinfectant all lined up in their hallway and never used it and so i think that that made us a little bit jaded but this has certainly been a real pandemic and you can see by the by the unemployment it just skyrocketed after um after this crisis started in in april of this year um unemployment in in industries like travel industry retail stores hotels restaurants especially and we're kind of going through that uh lockdown period in some states over the winter now so some of those jobs have come back some have just been permanently lost and totally altered the landscape in in some communities so it's difficult to project how uh the recent lack of government support we've had difficulty putting together another aid package uh hard to estimate how that's going to impact job recovery in the future but it's definitely impacted income at banks as you can see uh the first couple of quarters of this year and into the third quarter of this year banks have been strengthening their loan loss reserves pretty much every one of my clients is seeing that interest margin compression increase you know net interest margins are down in the lower threes for most banks non-interest expenses increased as banks moved into remote work environments strengthened their network bought new a computer equipment for people to work remotely with made changes to their facility these two to make them a little bit safer the ones that were open so non-interest expense has gone up incomes come down total earnings is is taking a hit so what i'd like to do today provide a little bit of historical perspective on risk management i teach this class at southwest graduate school of banking and i use this same set of information a lot of it to to demonstrate that in almost every community in the country there's a set of economic drivers that are somewhat unique there are national economic drivers there are local economic drivers and so i want to show you how some of those impact strategic thinking and risk management so take a little look back at the 2008 to 2012 crisis and some of the things we might have seen coming and some of the effects we might have been planning for but we didn't like i say this is an exogenous event it happened very suddenly i don't think anybody had it on their radar but we'll talk about how you might implement an erm program put your risk appetite statement together develop key risk indicator dashboards based on that risk appetite statement and some other factors and then how we might address this covid risk the impact from kovid in the future and we might assess you know some of the the risk impacts so uh with that in mind um i you know i spent a good part of the late 90s early 2000s working at alex cheshire off management services and i participated in a number of strategic strategic planning sessions for banks and i was always kind of amazed many of them set very aggressive goals for loan growth uh either focused on residential lending in in large part or financing multi-family housing condos and apartments or other related commercial real estate lending for strip centers and small office buildings and those kinds of things i heard them all talk about their goals and have discussions on how they might you know generate the growth that was needed to hit those goals how they'd fund it how that might impact the balance sheet but i rarely heard them talk about um what would happen to the bank and and their strategic goals if they achieved all those goals but somehow something went wrong you know the economy took another hit and i've been around in banking since a wee led of 16 years old back in 1972 so i've seen the third world debt crisis uh the savings and loan crisis the banking crisis of the 80s the internet bubble and that problem in the late 90s the 2001 recession i've seen them all i mean so they all have common characteristics and so i was kind of curious why nobody was thinking that you know it'd been a while and and we might just have another downturn and what would happen if we did what would happen if home prices dropped dramatically mortgage loan defaults increased housing construction declined unemployment started to rise rental rates declined and vacancies increased those were all things i'd seen happen in the past but you know we go through these planning sessions and people just really didn't talk about those things what would happen if this occurred again well all of that happened in the 2008 time frame and we also had an international liquidity crisis so i took away a lot of the funding for future growth so we had a really long protracted recovery from that crisis so i'd like to to share some information about how we got there in the early 2000s you you see this increase in subprime loan products um they began to increase in the in the early 2000s peaked around 2005 they were easy to qualify for loan originators were unscrupulous and dishonest helped people by having them sign blank loan applications fill them in later we call those liar loans um if you saw the movie the big short you saw examples of that the two guys in miami that they talked with my favorite scene in that movie is steve carell going into a bar and speaking to a lady let's just call her an exotic dancer and he tells her you know you're not going to be able to to refinance those loans those loans you got at a teaser rate and you know they're all about to come do and what are you gonna do and she says you mean all of my loans i have five houses and a condo financed and and his look was just amazing but i did see that i saw people borrowing against their primary residents taking that money out buying a second second home somewhere at the beach or in the mountains all these loans had very low interest rates after 2001 the fed dropped the interest rate 14 or so times so the subprime loans the low interest rate loans all made it possible for more people to qualify for loans so you saw a lot a lot more people borrowing increased the number of buyers which in turn drove up the price of houses when you've got more buyers in the market than sellers you know pricing goes up so values went up significantly from 2004 to 2007 increased number of buyers people were refinancing and cashing out using equity loans wall street was packaging up all of these mortgages as aaa rated mortgage-backed securities and and selling them off many of them supported by credit default swaps no one was tracking the notional value of credit default swap so they really had no idea how many they'd written um just all a giant recipe for disaster so what you saw was the the price of homes go up dramatically from 2003 to 2007 and then as the teaser rates begin to convert to you know teaser rates and negative amortization loans began to convert to full payout you saw prices housing prices start to drop home values fell dramatically foreclosures increased um we could have seen some of that coming at the same time in 2005 there used to be this annual underwriting survey that the occ would would prepare they stopped doing it a year or so ago i don't know exactly why they stopped doing that there's great information they do have their risk report they put out on a quarterly basis now but in 2005 if you look back at that survey you would have seen a trend at banks that showed an increasing trend toward easing underwriting standards rather than tightening underwriting standards 34 percent of banks eased versus 12 percent who were tightening their underwriting standards same thing in 2006 again more banks easing their underwriting standards making it easier for for commercial borrowers to to buy you know buy and build small buildings warehouses those kinds of things so you'd see more strip shopping centers going up here in the atlanta area where i live now you could drive across the north side of town through roswell and places like that and just see one strip center after another that was you know built on spec nobody you know didn't have any anchor tenants wasn't leased out just one after the other so the last time that examiners had reported banks easing credit like that was right before the the late 1990s it was 98 99 right before the um 2001 recession that we had just before 9 11. you also saw commercial real estate concentrations increased pretty significantly um in areas like san francisco there's a between sacramento san francisco and oh out in the valley there there was sort of this bermuda triangle of of banks that were lending heavily on commercial real estate in 2006 the occ recommended certain cre guidelines and started measuring banks performance against those guidelines and what we see is reflected here in this chart the san francisco area 60 percent of the banks in that area exceeded the guidelines pretty significantly the same with the atlanta market outside of chicago doing the same sort of thing dallas kansas city um i can remember doing a loan review for a bank in las vegas in 2007 and i looked at the concentration they had a total commercial real estate exposure of fifteen hundred percent of tier one capital and so i spoke to the chairman about that and i said you know there's these new guidelines that say you really shouldn't exceed three hundred percent and you're at fifteen hundred percent and in that you know aren't you aren't you pretty badly exposed to a commercial real estate downturn and he said son there's only two things to lend on in las vegas and that's real estate and casinos and i don't really like casinos and besides we had the fed out of san francisco come in and take a look at our lending practices and they think we're just fine that was mid-2007 two years later the bank had failed commercial real estate in las vegas area took a severe downturn and they didn't have the capital to to ride that out so again areas in california georgia illinois as you can see from that chart all had significant commercial real estate concentrations as i said you know the early subprime loans converted defaults began to increase in 2007 2008 as the refis came along foreclosures began to climb pretty dramatically once that happened you got all kinds of foreclosures housing values started to drop so all the appreciation from 2003 to 2006. sorry that's supposed to say 2006 essentially got reversed over the next three year period from late 2007 to 2009-2010 so the home price has bounced along you know for several years back to basically the the historical trend line as you can see there home values declined as the inventory of unsold homes and foreclosed units increased and borrowers you know were taken out of the market by changing loan terms so once you have a an increase in foreclosures and problem real estate you don't need to build any more houses so unemployment spiked pretty dramatically housing starts plummeted unemployment spiked um unemployment got up over 10 we don't need people to build houses we don't need any washing machines for houses or new carpet out of out of georgia for for the houses so um unemployment spiked up pretty dramatically and at that point you know let's face it the good times were pretty much over um it was a tough few years after that from 2010 to 2012 or so when when most people started to recover so if you look back in that same time period this is one of the things i wanted to show you if it's very similar to to what's happening or what could possibly happen now [Music] at that time most banks were setting their long loss reserves based on past loan loss experience and a lot of banks have continued to do something similar to that although cecil is supposed to take effect it was supposed to take effect this year but it has been has been postponed so banks were setting their reserve levels based on past loan loss experience so they're looking at loan losses declining pretty dramatically so they're reducing their loan loss reserves and then 2007 rolls along and there they go and when delinquencies and charge-offs increase that dramatically you really don't have the time [Music] to make it up in your reserve so i had a good friend was offered a job as ceo of a 120 million dollar commercial bank just south of atlanta in that time period and i i told him i said david are you sure you want to take this job they've got 40 40 million dollars worth of loans that are what we called adc loans acquisition development and construction i said you know a good portion of those are land loans um those are the ones that are going to go you know when you start to have problems those are the ones that will go bad first and it'll take the longest time to sell those off and he said oh no no they get they're doing great they've got plenty of reserves got plenty of capital um their earnings are really good i think they're going to be fine 2009 they burned through an additional 5 million in capital and they were gone they had failed so 24 months later after he took the job they failed so it does happen and when it does happen it happens ery quickly so that's why i tell people when you when you start to see these events when you start to see it go bad that's the time to take action don't wait until it's really going bad it's when you start to see those warning signs and that's what we'll talk about later in the session what are some of the signs to be looking for today it just goes so dramatically bad if you were to take that chart back to you know the late 80s 88 89 90 you would see that same rise from that time period so the chart starts in 1993 when things were recovering but they were just as bad in that time period and and they go quickly the result of all of those delinquencies and charge-offs and foreclosures you can see it you know they made the high-risk mortgage loans three years later they've got you know foreclosures are increasing a couple of three years after that you start to see the failures increase pretty dramatically so at least this wasn't as bad as as the 80s were when we lost 1800 banks to failure and this time we only lost about 600 i think and the interesting thing is if you you know you see that risk play out over um over that eight nine ten year time period if you go back to those things i was pointing out before where banks were taking unnecessary risk or unacceptable risk in my opinion over concentrating in commercial real estate setting unrealistic goals and then you know reducing their lending standards in order to hit those goals and you look at those areas where there were heavy concentrations of commercial real estate that's where the failures were it goes right back to that same chart that i showed you previously um california georgia illinois you know the kansas city missouri area texas that's where the failures were where they took too much risk got overexposed to commercial real estate so for you kung fu fans as master blind master po would say when the student is ready the lesson appears so here's what we learned from that last last crisis in my opinion many banks had absolutely no understanding of their ability to absorb loan losses just like my friend he thought oh we got plenty of capital we're well reserved earnings are good it took two years and it wiped out his bank even when they injected an additional 5 million and 120 million dollar asset bank long-term growth can't really be sustained if you're going to fund it with what regulators referred to then and probably are starting to again is hot money high rate cds federal home loan bank advances back then i saw banks do a lot of that without a real plan it was just i need to fund my balance sheet i'm growing so this is what i'm going to do i spoke with a bank president out in california who ran a what was then considered to be a pretty innovative and progressive bank and his concern was he'd just been placed under a cease and desist order they'd call them consent decrees now um and i asked him so he was asking you know could we come and assist in dealing with this cease and desist order and i said well can you tell me a little bit about how you got there he said well my chief financial officer grew the bank 500 million dollars too large and i thought gee i've heard a lot of reasons but i don't think i've ever heard that one before so i said can you explain what that means and you said well he took out all these federal home loan bank advances and their 10-year terms and i can't get out of them and their high rate and we're having you know a lot of problem loans and foreclosures so we're not yielding as much interest income as we used to and so now we're suffering losses because we have all this high cost funding and i said did you have a you know were you monitoring this risk and he said oh yeah we had a great risk management program we were monitoring all this stuff and i said i don't know i i think maybe your cfo was just trying to run as fast as he could to keep up with your lenders and your lenders grew your bank 500 million dollars too large so he wasn't happy with that response uh and they failed you know about a year later they they had failed those banks that did have an understanding of their risk appetite if they had even gone to the trouble to define it really didn't translate those into risk guidelines in their policies their policy limits didn't necessarily have anything to do with how much risk they were taking um and if they did have risk guidelines in a lot of cases they just disregarded them they lack discipline to stay within those those guidelines um you know i i can't tell you how many times i heard you know a bank loan officer or ceo tell me well everybody else in town is still lending on those properties so we are that's probably not the best reason to continue doing that and probably the most important thing was that banks didn't have very good risk information systems they were backward-looking systems still today i asked bank ceos you know how do you judge risk in your credit portfolio and they'll tell me oh i look at things like past dues and classifieds and watch list loans well those are sort of backward looking those those things those are loans where problems have already happened you know about those problems it's the ones in your portfolio who have stopped paying their taxes who aren't sending you financial statements those are the ones that are going to be problems in the future or they're the same type of project or property that you already have in foreclosure so we we didn't really do a lot of forward-looking risk management and i don't want you to think it's just residential and commercial real estate you'd find a similar situation with farmland farmland prices jumped up pretty dramatically in that same time period especially in places like illinois a lot of farmland was being converted into residential tract housing outside to the west of chicago so farmland prices you know per acre prices jumped up pretty dramatically um i asked bankers about it in that time period they all said yep we don't think this is sustainable this is this is unusual and so i ask have you changed your lending culture practices and i mean you don't think these are sustainable prices are you still landing at the same loan to value guidelines that you were and they said oh yeah we're still doing that we're still in an 80 you know 75 80 percent loan to value and even with the expectation that these prices weren't real and we're likely to drop and so that's what happened and so now you're sitting on loans that you know are under water and and you're hoping that they'll come back and the farmland price has declined because cash rentals derived from those properties declined in in 2018 cash rentals declined development slowed down and stopped uh projections don't really indicate that you know there's going to be a great deal of of increasing crop prices now we have you know tariffs on crops um so it's uh you know we just don't see increases in the near term uh if you look at the fourth quarter of 2016 farm income income declined from the prior year it continued down in 2017 started to recover slightly dropped again in 2018. so overall incomes stayed pretty steady i don't know what the long-term impact of of the tariffs will be uh farmers would tell you they lost markets to other you know to farmers in other countries because of the tariffs so the key is to be aware of what the possible changes are and what's going to be the impact on the bank and and how is it going to mitigate that risk you know you would continue to see those same kinds of declines in income even though you know if you look at that lower right hand chart you see what appears to be an increase in income but it's all um all supported by bailout payments that's what's really generated all that red section of the of the bar graph over in 2017 18 and 19 that's where income started to move up basically from government payments bailout funds as a result the number of bankruptcies in the farming community increased to an eight-year high this past year haven't seen statistics for 20 20 yet but i suspect it's just as bad number of bankruptcies has been increasing since 2014 this is despite 28 billion in bailout funds which is twice as much as what we spent on bailing out the the auto automobile makers back in 20 and 2009 so i didn't want you to think it was only um [Music] you know residential real estate and commercial real estate that took us into recessions in some cases it's farming farm prices trade wars could be any any number of things so how can we improve our performance by tracking some of these risks and avoiding some of the the unacceptable levels of risk well start with a risk appetite statement i don't know if your bank has one if not it's a great exercise to go through especially during the this time of the year when you're putting your strategic plan together um risk appetite is is nothing more than the amount of risk on a pretty broad level that your bank's willing to take in order to pursue its strategic goals and objectives it's helpful to understand what those risks are and then try to interpret them in such a way that you set risk limits in your policies a well-defined risk appetite statement should have the following characteristics let me paraphrase those a little bit first is that risks need to be aligned with the strategic objectives of the bank as i said earlier in the 2000s you'd see strategic objectives that were totally out of line with risk limits and the bank's policy statements they should be based on the objectives selected and the understanding that the bank may have to take different risk greater risk in order to get to those objectives and and understand you know what the potential implications of those risks are it's critically important that board of directors and management get on the same page and what i mean by that is they've got to be in sync if you're going to take this risk the board needs to understand that you're taking that risk and you need to understand that it's different i worked with a bank that was under a cease and desist order required to diversify its loan portfolio they were about 13 billion at the time had a heavily heavy concentration in commercial real estate in several markets across the country and the regulator said you really need to diversify and get out of so much exposure to commercial real estate get into traditional cni type of lending or consumer lending and diversified geographically as well so they went out and they enticed an entire group of people away from u.s bank that were doing cni lending in los angeles that group came along and the first loan that they brought to committee was a five million dollar line of credit for a company that provided catering services to movie companies and and the committee looked at the deal and said where's the collateral they said well there isn't any collateral it's a it's a line of credit they have the you know the financial support to uh you know it's worthy of this credit and here's their financials and the spreads and you know we think this is a deal you should do and they said gee we're just not comfortable without some collateral don't they have a piece of real estate they could pledge and it's like no no you're missing the whole point the whole point is to diversify not have real estate collateral on your books so they needless to say didn't approve that loan and they didn't approve almost every loan that that group brought to the committee for the next two years until they all quit and went somewhere else so you gotta gotta get on the same page there are linkages between business units and business objectives uh if you say you're gonna grow your loan portfolio you're gonna have to figure out how to fund it and you're going to need to understand the risks associated with that funding just like the bank as i mentioned that you know took out the 500 million in federal home loan bank advances do you understand that those things have long term uh maturities and you're locked into the rate unless you want to pay a really high prepayment penalty you know how are you going to fund this growth and are you managing that risk correctly and then last you need to take a look at you know do you have the right skills and resources can you can you look at the strategic objectives its impact on the bank decide how you need to be organized our business processes effective to manage that risk do you have the right technology systems and the right people the right skill sets to manage that new risk so a lot of things that go into a risk appetite statement give you a quick example this was a credit union in new york right outside of new york city out on long island they had adequate capital but just barely they were just above their seven percent net worth requirement they needed to increase it because banks at the time were in trouble and depositors were moving to credit unions as a as a flight to safety so now they had all these deposits some 2 billion worth of investments because they couldn't generate enough loan volume to deploy all that money and that was hurting their income so they decided that commercial lending would be the way to go about it it would increase fee income it would have a higher interest rate and yield and and they'd make more money so they started buying loan participations in places like california and illinois and georgia and i asked him gee did you you didn't think to buy any in florida i mean you hit every problem market in the country um so they they experienced some losses some they had about 250 million dollars worth of participations and they took some pretty substantial losses and decided that they would originate their own commercial loans but they just couldn't afford a big surprise they couldn't afford a significant loss and that was pretty clear so initially they said their goals were to generate um to take their portfolio up to 420 million dollars which was roughly 10 percent of assets they defined their new market as a 100 mile radius around new york city now keep in mind they were to the east of new york out on long island about an hour they did not have an office in new york city all their offices were out on the on the island and that market included northern new jersey the hudson valley western connecticut didn't have any offices there either portfolio was only defined as going to be commercial and commercial real estate lending but no construction lending and i asked you know okay if you have a member who's had an account with you for 20 years has a small plumbing business wants to build a warehouse next door on a piece of property they own would you finance that warehouse and they said oh yeah we'd do that and i said well that's construction lending so you need to be clear about what kind of lending you're going to support here if you're going to do commercial real estate is does is should it be owner-occupied buildings or will you do non-owner-occupied investment buildings and they said what's the difference and i said oh man we've got a long way to go we've got a long way to go here so loans are going to be approved by the ceo cfo and and their investment officer none of whom had any lending experience at all not commercial lending experience only residential lending so we needed to get a whole lot more specific by the time we ran several projections um okay your portfolio grows to 420 million here's one possible set of loss scenarios uh we looked at credit unions in their market that had gotten into commercial lending we looked at credit unions across the country that got into commercial lending and i made them look at banks commercial lending experience in their market even though as they said they weren't a bank i said you're about to make loans that banks have made for years so you you should see what's happened to them once they understood the the possible magnitude of loss wasn't necessarily probable but possible they scaled back the growth of the portfolio would only take it to 290 million they they clarified where they were going to lend reduce that to a 25 mile radius around their principal office on long island um really spent some time thinking about what types of loans are you going to see in a second a chart that shows they went from basically three types of loans to 15 or so we spent a good bit of time working on the characteristics of the the types of loans they would make loan to value guidelines concentrations and so forth and we spent a great deal of time on underwriting controls went out and engaged a consultant who had been a former commercial lender very well respected in the community and he would sit on the committee and if he decided not to approve a loan it didn't get made so we made several revisions to their risk rating guidelines their policies changed their staff got them the proper supporting systems as i said we went from three categories of loans to you know 15 categories very specific types with very specific limits of exposure to um their net worth how much net worth could be exposed to these types of loans and what the composition of the total portfolio would be and we also put in you know guidelines that said okay if the quality of these loans starts to deteriorate if the risk ratings decline on the loans that you've already made we're going to put some stop loss limits in here that say okay at this point we won't make any more loans to new customers and at this point we'll stop making any of these loans and try to price some of them out move them out of the bank so that if we continue to have deterioration we've minimized some of the losses [Music] an example of a risk appetite statement this is just very basic stuff this is at a summary level but you can see they all have very specific measures this is from a two and a half billion dollar bank if you look at the credit risk the bank has a moderate appetite for credit risk and related losses and is willing to accept the risk of a moderate level of credit losses in pursuit of higher returns well again we went through that same process working our way through projections to say okay if you actually get this many loans if you put this many loans on the books and you have a similar scenario to 2010 in terms of losses do you have enough capital to survive that and came up with some fairly specific concentration limits if you're going to implement a risk appetite statement you need the board's buy-in management and board like i said i've got to get on on the same page you need to have outlined your initial set of strategic plans and objectives very specific set of of kpis and kris key performance indicators and key risk indicators those are the things that you're going to measure to tell you when things are coming off the track it could be risk limitations it could be volumes of loans concentrations i'll show you some examples of kpis and krs in just a moment you want to push those limits down into your policies and procedures the things that people actually use to to manage the bank with and you want to set up an accountability structure reporting and monitoring of those kpis and kris so that as you approach those limits you can stop and ask yourself okay where am i today is is the economy still are all of my economic assumptions the same as when i set these limits do i want to continue lending into this limit or do i want to stop and and reduce my exposure so one way to get a risk dashboard create those kpis and kris is to look at your your policies and your strategic plans because you've got limits in those um the thing about a kri is it's it's not really a piece of information that's going to tell you what to do it's just going to tell you something's wrong something is different than what you expected it to be so they're really not an answer to a question they are just a warning sign okay things are different are you sure you want to continue going the way you go they can include a variety of different measures reports of new business compared to strategic plan loan exception loans made as exceptions to policy i always find that's a great one to track concentrations of credit compared to industry guidelines your guidelines by industry type or collateral credit grades if you start seeing credit grades decline that's that's a big red flag you can support these high level kpi and kri by more detailed i call them indices indexes of specific measures specific criteria and this is a very simplistic set of key risk indicators done in an excel spreadsheet and the idea that you know you have two types of risk indicators either leading indicators or lagging indicators lagging indicators would be things like your delinquencies and your criticized asset numbers charge offs exam ratings they're all the backward looking things that that i mentioned before the leading indicators stress test results to plan concentrations versus limits loans as exceptions to policy again i'm taking more risk i'm exceeding loan to value guidelines i'm waving covenants i'm doing non-recourse loans or i'm limited recourse guarantees changes in the mix changing the yield the yield of loans is going up that usually means i'm taking on more risk scoring exceptions my scoring model said don't make this long but i made it anyway documentation exceptions those are all great leading indicators of credit risk problems the kpi and the kri can help you improve performance by telling you something is wrong and where to go look for it um the more detailed information that i mentioned before would be things like i want to link my i want to link my tracking back to my strategic plan so my strategic goal is i want to increase mortgage loans 15 over the next year but now i'm looking at my reports and i'm not getting there so several things could be the cause of that some could be internal factors some could be external factors it could be that my economic assumptions when i made those goals just aren't panning out things are changing interest rates are rising housing starts or are falling so there's fewer houses that makes prices go up there's a longer sellout period unemployment rates are going up there's fewer buyers in the market average income is down so they're buying smaller homes there's not as many people moving into the area in fact they're moving out of the area so that's impacting the possible loan origination volume or it could be some set of internal factors everything that we thought was going to happen is happening in the economy just as we expected and we're still not getting our share of loans well our application volumes could be below expectation or we could be getting lots of applications but we're not approving very many why don't know are the underwriting criteria too strict are we not doing a good pre-qualification review what's causing these loans to to not be approved maybe it's because it takes too long and they're falling out people are withdrawing them going somewhere else or we could just be making small loans instead of large loans and so our volume you know we're making more as many loans but our loan volume is not going up so that's what a kpi and kri dashboard supposed to do for you is point you to the things to look at to figure out why you're not getting where you thought you were going to be this is a much more sophisticated dashboard comes out of a out of strategic risk associates the company i work for this is one of the software tools they offer you know tracks quantity of risk by risk category quality of risk management controls the aggregate risk based on those two factors compares it to your risk appetite tells you what the direction of risk is you know and supports that with much more detailed information so i always liked this report i like to know where i am in comparison to things what's my trend over time so this particular report gives you key risk indicators over a period of time it tells you where you are in comparison to your peers you know what's my adc to tier one capital loan concentration compared to my peers if you look all the way to the far right where it's where you see that white circle with a v in it that's the value for the bank so you can tell if they're way past their peers they're past their target and uh you know they've blown through any limits that they had in their risk appetite statement and they pretty much continue to do that every quarter so you see comparative quarters stacked on top of each other uh the only reason those numbers look better at the bottom is that came out of our demo when somebody changed the they changed the rating scale so it didn't really get better it just looks better but that's a much more sophisticated chart supported by this type of information which are indicators at a very very detailed level so they're tracking loan growth total risk-based capital ratios cre loans to total capital those kinds of things so they're tracking them by strategic objective so this links the risk appetite statement in the dashboard back to your strategic goals and objectives okay let's take a little look at foresight here what's happening in the future um [Music] getting back to exogenous risk well here's what has happened over the last three quarters since this crisis has has has come on us the non-current rate on loans are starting to tick up so as i said earlier when it starts to tick up like it is right now you can see it down here in the corner um now is the time to start looking at your portfolio where where am i exposed in my portfolio to the impact of covid what's causing my delinquencies to rise what loans do i have in my portfolio that are going to be impacted so much that they're going to start to go delinquent this is complicated by the deferral and forbearance programs that are in place so it's a little difficult to use current information to get there but there are companies that are providing things like um you know forward-looking economic projections and you may be able to find data you know from local sources chamber of commerce um local colleges economic data that shows you those industries in your area being impacted and you can look back at your portfolio and say okay here here's where in my portfolio i have those same types of loans so i want to look forward to see what industry groups what types of businesses are being impacted by covid look at my portfolio and see where that's going to impact me so you can monitor risk for key industry subgroups this was put together by one of the guys over my in the credit risk function that at strategic risk associates and i wish amitabh was here to explain everything he does because he confuses me sometimes but he sure knows his stuff so he's looking at you know previous trends um trying to project from that what the short-term prospects are for that particular industry subgroup you know how well have they recovered in the past from recessions what kind of impact has a recession had on them from an impact from an income and employment status so he's you know basically said things it might be very familiar i mean retail is is severely negative short-term prospects negative long-term prospects office space that's a key question now that we've all been working from home will we ever go back to the office do we need as much office space as we have now so again he's looking at factors like susceptibility to virus transmission you know that's until we get the vaccines in place for the next few months we still those businesses that are you know where their operations are susceptible to transmitting the virus those are going to be impacted by the by the virus they're not going to have as much business or they're going to be closed or their hours are going to be curtailed the ability to disperse their operations work from home work from other regions that are safer dependency on affected businesses does it affect their supply chain or are they you know like farmers again the agricultural industry is being impacted by the restaurant industry they're not using as uh farm products meat so forth so um you know clearly things like hotels motels recreational properties although i find people are still going to orlando they still want to go to disney world but hotels and motels in general occupancy rates are down pretty significantly there may be some impact on things like skilled nursing regulations and competition with home health care just people exiting that that industry so he's looking at those kinds of things [Music] again retail businesses hotels motels typical acquisition development construction loans for offices those are the highest risk for credit deterioration in the in the near term office buildings golf courses municipal and local governments all are going to be impacted it won't be as much tax revenue for the local governments multi-family and 1-4 in investor real estate may be moderately impacted but they could benefit in the long run unfortunately as people lose houses they're going to move into into apartments i saw this study put out by grant thornton you can see there's their ratings are pretty pretty similar leisure and hospitality retail trade finance businesses mining of all things i wouldn't have thought about mining those are all going to be particularly impacted geographic analysis again amitabh did this one based on the metropolitan areas in indiana um looking at how resilient they've been in past recessions uh how they might recover from from this covid recession uh and done projections and so those may help you decide where to lend where to curtail operations if you're looking to reposition branch offices you may or lpos you may decide to close them in these areas so in summary understanding the potential risk impact of the strategic decisions you make today in setting appropriate risk appetite tolerances and monitoring that performance will improve your performance reduce the risk and help ensure the success of the bank backward looking risk management information systems just simply are not up to the task anymore they're not adequate to manage strategic risk just like in the run-up to the 2008 crisis there are generally warning signs these are somewhat different in the cove crisis but we can look at where we are today we know things are going to change government stimulus programs aid programs there may be one more round but then that's going to stop we know that you know eviction forbearance is going to stop um so what are going to be the impacts of those events over the next two to three to four months what what industries are going to be impacted it's now is the time to take a look at that and to to set the metrics that you're going to start to follow you know just like metrics for commercial real estate and offered by companies like costar you know what's the rental rental rate per square footage what's the vacancy rate for these buildings in different markets those are the kinds of indicators to be looking for the use of industry sector analytics is essential to managing the risk of of the coveted recession in the future the ones i just showed you identify those industries types of projects that are going to be impacted look at your operations look at your loan portfolio the more coveted 19 fractures industry and business the harder it's going to be for them to recover the economy that comes out of this next year will probably look very similar to us but it may not function as well and there will be dramatic changes as i said people working from home i don't know what that's going to do to commercial real estate values office rents office occupancy rates that's going to hurt investor income that's going to trickle down to the banks and whether or not they get paid on those loans so it may look dramatically different we we have some time you know to start looking at those those indicators and making some decisions about repositioning the loan portfolio but but we don't have a lot uh time is running out so with that i don't know if you have questions but i'm happy to answer them uh in the time that we have remaining yeah we had one and thanks again ken for coming on today that's great uh presentation there and obviously uh a lot of things that have impacted your business as uh risk assessors uh this year's gotta be a crazy year for you guys um absolutely has been someone has a question regarding um are there any libraries of key risk indicators or kpis that banks can access on their own yeah there are i would tell you like i did in the presentation the best place is to to look to your strategic plans your policies there's a group called k-r-i- -g dot com it's a it's a collection a consortium of banks that publish oh i think they had 2500 key risk indicators the last time i looked so there are libraries out there available if you go to companies that provide risk management software they all have their own library so you don't have to start from scratch they can help direct you to you know to the types of krs and kpis you need to to manage risk with sure and can and just in general um like i mentioned with covet hitting and things kind of get turning upside down how how have you guys internally had to change things or kind of reassess things i know you went through a lot of historic data there have you been able to kind of depend on some of that historic data in the past that showed you things that have helped you through at least the last nine months of of covet and what's how's it it's impacted banks credit unions um yeah i i even though covet itself is an exogenous event happened very rapidly had a pretty severe initial impact the the actual impact of it has played out over several months so there has been time to start tracking you know some of the data that i showed that amitabh tracks you know and and to look back at the historical data to say you know how quickly has this industry recovered from a recession how quickly has this particular geographic area you know what how badly was it affected by a recession how quickly did it recover and what was the industry structure in this area that permitted it to recover so there there are some perspectives that can be gained by looking backward at the historical data to say okay how does that how is that reflected in the current data what's the current data telling me about how quickly this particular industry that i'm lending to is going to recover or how slowly so yeah it does okay well again thank you for coming with us today and uh representing your information is really helpful at anyone on the call and those who might not have been able to attend will have access to this video um as early as tomorrow the next day um we'll be sending out a link to ken slides as well as long as well some information on how you can contact ken for any further questions again thank you ken uh for attending today um next month we are switching it up a little bit usually it's the second tuesday of the month but due to some schedule switches we're going to do it on the third thursday on january 21st we have derek sutton from auto books he's going to be discussing building the small business case in 2021 kind of tailored all around how you can work with smart businesses and grow your small business business within your financial institution so again thank you for everyone for attending and we hope to see you again next month thanks brian thank you you