Commercial Bank Portfolios to Experience COVID-19 Community Spread: Are Your Mitigation Techniques in Place?

With financial markets experiencing tremendous volatility and bank stocks falling, it is more important than ever for banks to understand the commercial portfolio risks of COVID-19.

It is not good enough to look at the portfolio on the surface and declare that the risks have been identified.  That is like using a disinfectant wipe on your countertop and declaring your environment sanitized. 

There are both direct portfolio risks as well as derivative risks.  You bank may not be large enough to be a lender to an NBA team (that stopped playing games), but if you have downstream exposure to the food vendors, food distributors, or cleaning crews, you have second-degree credit risk.  Taking this a step further, what about the uniform company that cleans the uniforms for these second-degree companies, such as food processors, or micro-breweries?  These should be considered third-degree credit risks.

If the credit lines for each of these companies are drawn, how does this impact the balance sheet?  Keep in mind that each of the borrowers in the example may need to be downgraded because EBITDA is definitely going to decrease. How does this impact your portfolio profile? 

Is your bank proactively marking down the credit quality based on known current events or do you have a policy to wait until you receive financial statements with ratio calculations 45-days after quarter-end?  Will the full extent of recent weak performance be fully reflected in the credit risk rating? 

Failure to know, communicate, and plan to mitigate risk could result in a loss of confidence in management.

Community banks, middle-market banks, and large corporate institutions should understand their credit portfolios from these perspectives and have mitigation plans in place.  Investors will want to know these things on your next earnings call.  Board members should be asking these questions.  Regulators will expect that you understand these risks.

While Coronavirus is—and should be—creating much anxiety due to the factors beyond the bank’s control, it also provides targeted opportunities to strengthen relationships with clients that have strong fundamentals.

Fully identifying and addressing hidden credit issues will enable bank leadership manage community spread of COVID-19 within the commercial portfolio, because you cannot manage what you cannot see.