As I write this blog, we have record wildfires scorching the west, hurricanes pounding the Gulf and Atlantic coasts, a health pandemic ravaging the world and, oh yeah, it’s an election year, so we are getting pummeled by political ads.
During 2020 we have seen the Dow Jones Industrial Average close at an all-time high of a little over 29,500 in February only to drop to approximately 18,500 in March before climbing back to above 29,000 in September. National unemployment rates were 3.5% in February and 14.7% in April and dropping back down to 8.4% in August. It is turning into quite a year.
So, what does this mean for financial institutions?
Despite the chaos, we have seen financial institutions earn record profits driven by the mortgage refinance market and anticipated income from the fees related to the forgiveness of the Paycheck Protection Program (PPP) loans. We’ve also seen customers requesting loan restructurings at a rapid pace due to the COVID-19 pandemic.
The Great Recession of 2008-09 now seems like a distant memory, but I think there are lessons to be learned from that time period. As the Great Recession began, many financial institutions hadn’t experienced any significant charge-offs in their loan portfolio in many years. They were reluctant to add funds to the allowance for loan and lease losses (ALLL) because there were limited historical losses, and their own portfolios were continuing to perform. Does this sound familiar?
If you recall, loan losses did not occur immediately when the recession started; even though the negative economic events had occurred, it took some time before the charge-offs were realized. As a result, many financial institutions found themselves recognizing substantial loan loss provisions while trying to keep up with the rapid charge-offs that in many cases hadn’t been reserved for in advance.
Today, most financial institutions are still under the “incurred loss” model for calculating their ALLL. Given the events that have happened during 2020, there likely are losses that are in the loan portfolios that haven’t become apparent yet. I encourage financial institutions to consider the lessons of the Great Recession and take a critical look at their ALLL calculation to ensure that qualitative factors include appropriate adjustments to address the additional risks that may be in your loan portfolios.
Please contact your Wipfli relationship executive to discuss further.
Measuring the impact of CECL adoption
COVID-19’s impact on the allowance for loan and lease losses determination
Using budget forecasting to recast plan after COVID-19