Integrate or Innovate?
Many state and local governments as well as private entities have turned to CDFIs to administrate COVID-19 loans. The CARES Act gave states wide latitude to establish funds to assist businesses with working capital needs in response to shutdowns of non-essential businesses. Similarly, private entities have also provided millions of dollars to establish COVID-19 loan funds. Most lenders understand the mechanics of the loan approval and loan funding processes. However, many CDFIs and community lenders haven’t fully rendered how to report and track the asset quality metrics of these loans. Furthermore, these loans may require special monitoring. What can a CDFI do to flesh out how to report these loans without breaking the organization’s operating budget?
Integrate COVID-19 Loans Into the Existing Reporting
Advantages:
- Leaves the asset quality reporting mechanics, report design and messaging unchanged. Management and Board members are familiar with the existing reports. They won’t need to re-learn how to interpret new reporting documents.
- The speed with which the COVID-19 loans are funding does not permit most organizations the time to design new ways of reporting asset quality. For example, one of our Client’s closed four years’ worth of new originations in only three months due to COVID-19 loan fund originations.
Disadvantages:
- The rapid rate of origination will impact trend analysis of performance metrics. The noise created by the COVID-19 loan fund products could mask performance changes in the “old” portfolio.
- The existing reporting framework may not capture credit risks unique to any COVID-19 fund loans. For example, if the COVID-19 loan program was a low-doc approval process, what credit risk does that introduce that isn’t reflected in the existing reporting structure?
Innovate New Asset Quality Reporting for COVID-19 Loans
Advantages:
- Allows management and Board Members to focus on the fastest growing loan product on an organization’s balance sheet. Among our clientele, all “normal” new loan origination has ceased. The only new loans that are approved are approved under the auspices of COVID-19 loan funds.
- The sources (public and/or private) of the COVID-19 loan capital often require specific on-going reporting on metrics that are not historically tracked by your organization. Therefore, the information that is needed to satisfy this reporting can serve to keep management and Board members informed about these loans.
Disadvantages:
- The resources of CDFIs already are thin. The added calorie burn needed to build out a new reporting mechanism may not be worth it. It could result in other critical functions losing effectiveness or efficiency.
- The diversity in the sources of capital and requirements for reporting back to investors could require two or three sets of reporting. However, this obviously would exacerbate already stretched resources.
Our Recommendation
What have we recommended to our clients? First, We have recommended to blending of new versus old reporting for these new COVID-19 loans. To the extent possible mirror reporting for the new COVID-19 loans based upon reporting used for the “old” portfolio. Second, layer in any specific monitoring needs required by the COVID-19 capital source. For example, what if owner FICO score is a critical component of the loan approval decision and the investor wants to know FICO score bands? Provide that data in the reporting. Third, have additional details on the COVID-19 loan credit risk profile available to produce on an ad hoc basis. This will allow for management and the Board to receive additional data quickly.
Clearly this is another situation in which doing nothing is not an option. However, we believe the balanced approach we recommend above balances the need to properly reflect asset quality metrics but minimize the additional pressure on already taxed resources.
