FTDO: An important re-look at Credit Risk within your Securities Portfolio

Summary:   History often rhymes. The excess liquidity during the Covid pandemic, and resulting dislocations -- and now corrections, may have created an environment in which the art of credit risk and ratings may need additional scrutiny given the possibility of a harder-landing than any of us would like while geo-political and global shocks persist. An additional security portfolio review and underlying assumption review of participation programs could very well be a prudent step because its likely good to re-confirm what's in the bag before one is left holding it as the music begins to slow and potentially stop.

Due to monetary and fiscal policies during the Covid pandemic, money has generally been plentiful and credit risk seems to have become a forgotten lexicon in some circles. While potentially exaggerated to make a point, from what we are seeing there may be more truth in the statement than most may want to admit. Consider finding an outside 3rd-party that has tools to 'shock' the securities portfolio -- tools that do not rely on credit rating agencies as an added precaution going into the next few years and potential expected market outcomes. All this so institutions can focus more effort on doing what they do best -- that is -- lending money into the communities that they serve.

Consider an additional review to better confirm that your institution, and vendors, are navigating and implementing policies and procedures to not only satisfy the requirements, but also better position through the headwinds that may come to fruition in the next few years. If you, like many we talk to, have doubts that current oversight may be enough through exams, consider a complementary deep-dive analysis for better peace of mind.

Historical Pre-cursor:

While there was a great deal of back-and-forth and deliberation over how to regulate financial institutions, and the markets in which they operate, after the wake that was the financial crash of 2008, the regulation of CRAs (Credit Ratings Agencies) did not seem to get as much attention. Inflated ratings on securities that turned toxic during the previous crisis played a significant role in the build-up to that financial bubble and unravelling of perceived value with costly consequences. Figuring out how to preserve the usefulness of credit rating agencies while fixing their weaknesses has proved challenging.

Dodd Frank, and why it was created:

The Dodd-Frank Act (2010) found credit ratings to be systemically inauspicious into the financial system. The Act essentially has four main components that include

  1. First, the Dodd-Frank Act requires the SEC to study the NRSROs- Nationally Recognized Statistical Rating Organisation
  2. Second, the Dodd-Frank Act reduces the official role of NRSROs by requiring regulators to remove and replace the use of credit ratings in regulations that set capital requirements and restrict asset holdings for financial institutions. This requires financial institutions to justify their holdings to regulators by proving they satisfy certain definitions -- that is, obligors ability to pay off its debt. If financial institutions couldn’t do it themselves, a third part NRSRO could be used.
  3. Third, the Dodd-Frank Act increased the legal liability of credit rating agencies. This put heightened supervision on all the rating agencies. And,
  4. Fourth, the Dodd-Frank Act gives the SEC more power to regulate the NRSROs.

As an advisory firm, we offer Community Financial Institutions complementary Transparency Analysis. Now is a great time to take advantage of it. Please get with your Financial Advisor at SB Value to guide you through these turbulent times of balance sheet change. We look forward to it.

As always, consider a first or second opinion from SB Value Partners by eMailing us back today.

Let SB Value help you examine all these, and other methodologies, to build out your future pathways to optimizing your success.

Questions? ASK US HOW to start a complementary analysis now. It’s a great time to get some additional clarity. Learn some additional truths on the front end. It may position your bank for added improvements in 2022 and into a better positioning for 2023. Listen to what a few thought leaders have to say who have written white papers on the topic at hand. Take a read through a few Fact Sheets on the subject that we would be happy to provide.

As fiduciaries we see quite a lot – in fact we have recently reviewed just under 14,000 data points from Community Financial Institutions – likely just like yours. We look forward to sharing with you some of what we have learned. In the meantime, we thought we would help with some general information that you and your team can consider right away to round out what you are already doing. There is a lot that’s beneficial, starting with cost savings, yield improvements, and likely better balance – even protection. To find out more please click here on our website.