CFOs reveal how they’re budgeting for change

Q: How has COVID-19 affected your role within your community bank?

Haynes Standard Jr.: COVID has had an impact on my bank; however, for the most part, it still has not changed my role in the organization. We closed and then reopened our branches, but that had little effect on my role as CFO. We had to make adjustments throughout operations, and I manage most of that for the bank as well.

Emily M. Hofer: I also wouldn’t say that my role changed so much due to COVID. However, there was a shift in what I was—and am—spending time on. After we laid the initial groundwork for the acceptance of PPP loan applications, established our internal procedures and started customer education, I have now been spending more time on funds and interest rate management than ever before.

Jon Drake: I didn’t see any change in my role, but with the benefit of hindsight I can see how much growth there’s been on our team. From better communication to the acknowledgement of one another’s strengths, we are better for having gone through this.

“The PPP has also enabled our bank to create a tremendous amount of goodwill within the communities that we serve, solidifying long-standing customer relationships and attracting new customers.”

—Emily M. Hofer, Merchants State Bank

Q: How has the PPP affected your role?

Hofer: For me, it’s been a time-consuming process. As chairman of our Funds Management Committee, I have never seen a period of such high liquidity. These funds have come into the bank, and it appears that our customers have a general reluctance or hesitancy to actual deploy them.

Standard: PPP hasn’t affected my role.

Drake: I agree it hasn’t affected my role much, aside from the need to determine the financial implications for the bank. I’m expecting some lumpy income streams in 2021 and 2022.

“The PPP has been the most significant concentration of our loan activity. It forced us to automate portions of our loan processes. We have now committed to reworking our entire loan origination process.”

—Brett demilliano, First American Bank

Q: What impact has the PPP had on your community bank more generally?

Brett deMilliano: The PPP has been the most significant concentration of our loan activity. It forced us to automate portions of our loan processes. We have now committed to reworking our entire loan origination process.

Standard: PPP loans have been attractive to our customers, and we have actually made more loans in the second round than in the first, although the average size has been much smaller.

Steven S. Nutt: I mentioned last year that [the PPP] ballooned our balance sheet and caused our budget to be thrown out, but fees recognized during 2020 allowed us to make net income pretty close to what we had originally budgeted.

Hofer: The PPP has inflated our balance sheet at a rate that we would not normally care to experience. However, the fee income has relieved the margin pressure. The PPP has also enabled our bank to create a tremendous amount of goodwill within the communities that we serve, solidifying long-standing customer relationships and attracting new customers.

Q: What role has the PPP played in your community bank’s deposit gathering activities?

Standard: Deposit gathering has grown over the past year, as many borrowers in the first round held onto the PPP loans until they were forgiven. Even after that, the funds were used to support small businesses throughout our markets. I believe the second round will be used for the same support but will not generate as much deposit growth.

Nutt: We hoped that by offering [PPP loans] in our communities we would get new customers into the bank and be able to create new deposit customers based on the service level we provided in PPP [lending]. We have seen this come to fruition.

Drake: We also saw—and continue to see—large deposit increases. Last year, we increased deposits by over 20% and most have stayed with us.

Q: Most community banks’ funding sources have been heavily affected by recent economic stimulus that could result in a return to more traditional, albeit higher, rate levels. How do you think this will affect the CFO role?

deMilliano: The additional stimulus payments that have been provided by Congress directly to individuals and families have contributed to additional deposit growth. This growth created an additional challenge for me in terms of managing our net interest margin and controlling interest rate risk.

Standard: Strong deposit growth has also affected my role as CFO, as I work to find investment vehicles for better net interest income until loan demand catches up with the deposit growth.

Drake: With the excess amount of liquidity, we have to worry about not only current earnings, but also future interest rate risks. Do you seek income now knowing excess cash earns nothing? Or do you not deploy it because you think conditions will change and interest rates rise? Every day is interesting.

Q: Do you feel the budgeting and planning process has or will change due to ongoing uncertainty in the economy?

Standard: Yes, it has changed. We did not forecast the deposit growth, PPP growth or balance growth that has occurred. Net income has been better than forecast. However, net interest margins are lower and will be impacted over the remainder of 2021. Liquidity is much higher than projected due to higher deposit growth. Uncertainty over what will occur next, or what action the U.S. government may take, will be a primary issue throughout this year and next year as well.

deMilliano: Budgeting and planning for 2021 has been challenging given the timing of PPP forgiveness for round one loans and the acceleration of PPP fees as loans are paid back. Also, during our normal budgeting timeframe, vaccinations were in preliminary testing stages and our state had one of the most restrictive health orders in the country, which significantly restricted small businesses. With this backdrop, we budgeted for less net income in 2021, due to margin compression and a slower recovery and return to normal. So far, we are fairly close to our projections and feel more optimistic about the second half of the year.

Hofer: I believe the budgeting and planning process for most institutions will become more flexible. I say this with the expectation that economic recovery from the disaster we call 2020 is going to take years, not months. With the exception of some outliers, I believe we will see most community banks taking a moderately conservative approach to growth for the next few years.

Nutt: I also think that, going forward, modeling “what ifs” and stress testing will be emphasized at the board level as much—or more—than budgets.

“[COVID-19] obviously sped up the digital adoption in community banks. I believe it has helped us focus on the right risk and, in turn, allowed us to focus our technology in the right areas.”

—Steven s. Nutt, Community National Bank & Trust

Q: Inflation is a hot topic right now. What sort of actions are you taking ahead of any economic challenges that lie ahead?

Standard: I am following economic reports carefully and reviewing economic forecasts from a number of resources to help meet the challenges that I expect to occur over the next year or two. I don’t expect that inflation will get out of hand; however, that remains to be seen. No matter what the [Federal Open Market Committee] predicts, overly exuberant spending and stimulus by the government, as well as the ongoing support from the Federal Reserve, at some point will have a negative impact on inflation and the economy as a whole.

Drake: We are watching inflation but have not done anything specifically to position ourselves for any impact. We have excess liquidity we think will be used, but, like others, have not found that movement to be as rapid as projected. Consequently, we are thinking about investing for the short, medium and long term [and] not placing any big bets on a particular timeframe or outcome. Some believe inflation is transitory and some believe it to be something much more impactful. We try to manage the business we know and plan for the unexpected, with constant monitoring to adjust, if needed.

Nutt: Inflation is a real threat to the economy given the trillions pumped in to the economy, which can obviously lead to economic issues. We really just continue to emphasize the basics of banking, making sure underwriting standards must remain strong, and not taking extra duration [or] interest rate risk in the moment reaching for yield. We continue to work to find a neutral to slightly asset-sensitive balance sheet to reduce risk and fluctuation in earnings.

Hofer: I agree inflation is a very real concern. However, given the amount of government debt, I have a hard time seeing it ramp up too high or too fast. We are taking measured steps to shift our balance sheet to shorter-term assets and longer-termed liabilities. The liquidity that we enjoy today will not be here forever.

“COVID brought to life business continuity plans that were mostly academic exercises. We learned how to assess operational risk better through reviews of daily processes versus policy and practical applications.”

—Jon Drake, Peoples Bank

Q: What impact has the pandemic had on your community bank’s overall risk assessment capabilities? What have you done to react?

Drake: I think COVID brought to life business continuity plans that previously were like academic exercises. We learned how to assess operational risk better through reviews of daily processes versus policy and practical applications. We also begin to assess risk in terms of it being something threatening today, sometime soon or somewhere in the future?

Nutt: It obviously sped up the digital adoption in community banks. I believe it has helped us focus on the right risk and, in turn, allowed us to focus our technology in the right areas.

deMilliano: We have incorporated our new bank and overall branch operating processes into all of our risk assessment areas. One area of difficulty has been the human capital portion of planning, given employee fatigue and lack of qualified applicants to fill positions in particular skilled positions.

Q: If community banks had been subject to CECL, or current expected credit losses, how would your bank have been affected given that large banks that used CECL significantly overestimated their loan losses?

Standard: I don’t know for certain. However, even under CECL requirements, should we have been subject to those, there would not have been any significant impact that would have required a sharp increase for ALLL [allowance for loan and lease losses] provisions. We simply did not ever see a great deal of stress or increased past dues from our borrowers last year. The PPP may have helped in that regard, but virtually all of our consumer borrowers maintained their payments and had few, if any, losses because of that.

Drake: Implementation of CECL would not have had a significant impact based on our loss history as a guide for future losses. We have only had loan losses of about [0.1 basis points] annually for the past 22 years. By our calculations, we would have more than enough in the ALLL and could have had excess reserves that might cause a negative provision.

Nutt: I feel like we did a pretty good job of taking a measured approach in an unprecedented situation. CECL worked how it was supposed to with the large banks, and that was based on future expected credit issues. Then, when the factors improved, they reduced reserves. For community banks, that fluctuation might have been larger than needed in the short run, but, in the long run, [it] would have ended up about where we are now. So, [CECL would’ve had a] minimal overall impact, but 2020 would have seen a bigger impact.