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The basics of verifying checks for government-issued payments

Fraudsters target government checks at tax time and beyond. Banks and credit unions have several tools, including a new one, to fight fraud through U.S. Treasury check verification.

Key topics covered in this post:

The growing need to verify Treasury checks
Security features to help validate U.S. Treasury checks
Treasury Check Verification System: New payee name validation
How fraud detection software strengthens check authentication

Confirming the legitimacy of tax refund checks

With tax season in full swing, financial institutions must be ready for an influx of U.S. Treasury checks as Americans receive their IRS refunds. Most IRS refunds are direct deposit, but fraudsters often target government-issued payments, making Treasury check verification an essential step in fraud prevention.

Fortunately, banks and credit unions have several tools at their disposal, including the Treasury Department’s Treasury Check Verification System (TCVS)—which recently introduced payee name validation to help institutions confirm the legitimacy of Treasury checks before processing them.

Find check fraud faster and smarter.

Abrigo’s Fraud Detection Software harnesses AI-powered inspection, sophisticated machine learning, and a configurable decision engine to help banks and credit unions detect and prevent fraudulent government check and transaction activity more accurately and efficiently.

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The growing need to verify Treasury checks

U.S. Treasury checks remain a favorite target for fraudsters because they are guaranteed funds. In addition, under Regulation CC, the funds are made available to depositors the next business day.

The sheer volume of Treasury checks processed yearly makes authenticating the checks even more challenging. In 2024 alone, the Federal Reserve processed 36 million government checks valued at $1.75 trillion. For many people, the federal tax refund is often the largest single check they receive, so the personal or business impact of a fraudulently cashed check can be huge.

Synthetic ID fraud makes it harder to authenticate Treasury checks

A recent fraud case shows how increased synthetic identity theft and other scams reinforce the ongoing need to make sure federal government checks are legitimate.

In February 2025, a woman was indicted for her role in a multi-check U.S. Treasury fraud scheme, in which she deposited over $1.9 million in fraudulent Treasury checks using stolen identities. One of the victims, a Louisiana woman, expected an IRS refund check but later discovered it had been stolen and fraudulently deposited under another person’s name. By the time the fraud was detected, the suspect had already transferred thousands of dollars into personal accounts.

In part because of the fraud risks, the IRS recommends people have tax refunds directly deposited. In fact, 97% of refunds are delivered by direct deposit. Even so, 772,000 refunds totaling $674 million have already been issued in checks this year – just through February. In other words, authenticating federal checks is vital.

How to validate Treasury checks using security features

An important initial line of Treasury check fraud defense is for tellers and other staff accepting deposits to be able to spot counterfeits or altered documents when they are presented. Front-line workers can prevent fraud by manually verifying U.S. Treasury checks for several built-in security features.

The following features help distinguish genuine Treasury checks from counterfeits or altered documents:

Ultraviolet overprinting pattern – An invisible security pattern consisting of “FMS” or "FISCALSERVICE" appears under a black light. Any tampering with the amount box disrupts this pattern.
Treasury seal – The seal, located just to the right of the Statue of Liberty, identifies the Bureau of the Fiscal Service. Older checks may still show the Financial Management Service seal.
Bleeding ink – The Treasury seal contains black security ink that turns red when moisture is applied, making alterations easily detectable.
Microprinting – Certain areas of Treasury checks contain microprinted words that appear as a solid line to the naked eye but are visible under magnification. Counterfeit checks will often show a blurred line or series of dots instead.
Watermark – Genuine Treasury checks are printed on special watermarked paper. A check held up to the light shows the “U.S. TREASURY” watermark, and the watermark cannot be photocopied.

Despite these security features, fraudsters have become increasingly sophisticated, using high-resolution printers or altering check details while keeping the legitimate address intact. Mitek, a global leader in mobile deposit identity verification and fraud prevention, noted in a recent blog that missing watermark or ultraviolet overprinting might not be noticed in a busy branch or using deposit-image capture software for remote deposit.

In addition, fraudsters are constantly refining their tactics. In another recent Treasury check fraud case, two California people—including one who worked part-time as a bank teller—were indicted for bank fraud and conspiracy tied to a scheme to cash at least 339 stolen U.S. Treasury checks totaling more than $850,000.

Additional fraud prevention and detection measures are critical.

Treasury Check Verification System (TCVS): How it works & what’s new

Financial institutions can use the Treasury Check Verification System (TCVS) to find out if a check is a valid Treasury check. The Treasury Department’s TCVS is available through a public-facing website and an API (application programming interface).

To find a check in the TCVS, financial institutions need:

Check routing transit number
Check number
Check amount

TCVS history and API updates

However, until November 2024, financial institutions could not confirm whether the payee name matched Treasury records—a key gap in authenticating checks and detecting fraud. Late last year, the Treasury unveiled its new payee name validation feature. While only available via API, the feature enables financial institutions to confirm whether the payee name matches the check on record, helping prevent stolen or altered checks from being cashed.

“This enhanced version of the API portal is another tool in the fraud prevention toolbox,” noted Nancy DeGrandi, Manager of Federal Compliance Analysis and Research for Americas Credit Unions, who wrote about the feature on the association’s compliance blog.

Financial institutions already using the API portal for TCVS should immediately be able to obtain payee information for checks issued in the last 13 months, she said.

How to enroll in the TCVS API

To enroll in the API portal and gain a key to it, institutions must:

Review the TCVS Terms and Conditions
Provide the financial institution’s name
Complete the signature page
Submitting additional questions and the request via email to [email protected]

DeGrandi said the review process likely takes a few weeks before institutions receive their API credentials.

FedDetect Duplicate Notification

Another government resource to mitigate fraud losses tied to Treasury checks is the Federal Reserve Bank Service’s FedDetect Duplicate Notification for Check Services (FedDetect Duplicate Notification). It can provide banks of first deposit (BOFDs) early notice of potential duplicate checks processed by the Federal Reserve Banks. In addition to a report on Treasury checks, FedDetect can provide reports for commercial checks deposited by your institution or another BOFD on the current day or within a specific date range.

Government tools still have gaps

While FedDetect Duplicate Notification and TCVS payee ID service add extra layers of security, they are not standalone solutions to Treasury check fraud. Banks and credit unions also need real-time fraud detection solutions to make sure federal government checks aren’t counterfeit or altered checks before they are processed.

How fraud detection software strengthens Treasury check security

Abrigo Fraud Detection has partnered with Mitek to help financial institutions identify fraudulent Treasury checks and other types of checks at the point of deposit—whether through mobile, ATM, or in-branch transactions. Texas National Bank recently implemented Abrigo’s fraud detection solution and identified and prevented over $377,000 in fraudulent check transactions within just two months.

Here’s how the solution works:

AI/ML-powered image analysis – It scans Treasury checks, analyzing check images with advanced AI models for anomalies, including incorrect formatting, missing security features, and suspicious alterations.

Nationwide fraud data consortium – It leverages a database of known fraudulent checks to identify suspicious transactions.

Configurable rules engine – It allows credit unions and banks to customize fraud detection parameters based on risk tolerance and evolving threats. Reducing false positives minimizes manual workloads and improves detection accuracy.

Step-up authentication – It involves customers in verifying suspicious transactions for added security.

End-to-end protection- It provides protection across teller systems, mobile deposits, and ATMs to detect forgeries, flag fraud, and streamline investigations with precision.

By identifying fraudulent checks quickly, financial institutions can lower fraud losses and protect their customers and members.

Treasury checks: A constant need for authentication

Fraudsters are constantly evolving their tactics and will continue to target checks written by the federal government. Financial institutions can significantly reduce check fraud losses and protect their customers by combining front-line, manual security feature checks, TCVS payee verification, and AI-powered fraud detection.

This blog was written with the assistance of ChatGPT, an AI large language model, and was reviewed and revised by Abrigo's subject-matter expert.

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Popular AML/CFT and fraud checklists, guides, and more

Tens of thousands of FinCrime professionals in 2024 accessed these guides, checklists, and other resources produced by Abrigo's team, which includes former bankers, BSA officers, and regulators.

This article covers these key topics:

Training materials for anti-money laundering & fraud professionals

Access to reliable fraud and AML resources will be vital for compliance teams at financial institutions in the year ahead. Check fraud and other vexing fraud schemes persist while money laundering and terrorism financing tactics evolve. Combined, these challenges threaten financial institutions’ reputations, finances, and customers or members.

Regulators also expect financial institutions to have a formal BSA training plan. They look for training to be tailored to staff members’ job functions within anti-money laundering/countering the financing of terrorism (AML/CFT) and fraud programs. This makes sense, given that a board member’s AML/CFT information needs are so different from those of a front-line compliance officer, for example.

But juggling the day-to-day demands of compliance and hunting down helpful AML/CFT and fraud resources can be tricky for AML/CFT Officers, BSA Analysts, Fraud Investigators, and other financial crime compliance pros. It’s one reason Abrigo’s team of former bankers, BSA officers, regulators, and other experts spends significant time developing financial crime management content to make compliance staffs’ lives easier.

Blend the reliability of rules-based fraud detection with cutting-edge AI. See how our fraud detection solution identifies sophisticated fraud patterns.

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From "pig butchering" to check fraud: Top helpful resources for AML/CFT staff

Abrigo, a leading technology provider of AML and fraud software solutions for banks and credit unions, has a long history of providing complimentary resources such as briefings and webinars to financial crime fighters.

This year alone, Abrigo produced 13 complimentary webinars on fraud and AML hot topics. The company’s experts also created 53 AML/CFT blogs and fraud prevention blogs, 3 podcast episodes, and 8 checklists, infographics, and whitepapers specifically for AML and fraud staff. Additionally, Abrigo hosted dozens of webinars to inform customers about user resources and new software capabilities as they were rolled out. Tens of thousands of FinCrime professionals have accessed these resources for banking compliance staff throughout the year, including nearly 16,000 webinar attendees.

Below are some of the most popular resources on fighting fraud, money laundering, and terrorism financing. The webinars, infographics, and guides cover everything from regulatory guidance to operational considerations.

Click on the link next to the number to access each resource.

AML investigations checklist: Red flags for detecting money laundering

Resources describing red flags are among Abrigo’s most popular educational materials. BSA officers and AML investigators will equally benefit from this AML Investigations checklist, developed by the Homeland Security Investigations Financial Crimes Unit, to show how advancements in AML can improve the quality of transaction monitoring and identify red flags for money laundering. The compliance tool can be used for initial training and quality assurance for trained staff.

6 Steps for compliance with the new AML/CFT program rules

Your organization must be fully prepared to meet FinCEN’s updated requirements for AML/CFT programs. This infographic gives a brief overview of the new rules by FinCEN as an AML learning aid. It offers steps to evaluate existing AML/CFT programs to identify areas that will need improvement. The program aid also provides guidelines on revising policies to meet the new requirements. This 6-step guide is an essential tool for compliance officers and financial institution managers. Read this blog for even more information on the new program rules.

Fraud unveiled: Strategies to safeguard against fraud

This discussion about fraud investigations with Homeland Security Investigations (HSI) agents was by far the most popular financial crime webinar this year. HSI agents discussed their experiences with fraud investigations and information-sharing approaches. We cannot provide the webinar for viewing on demand, but a handout on HSI resources available to financial institutions is available at the link above.

“Pig butchering” and other financial grooming scams: Safeguarding against investment fraud

In the age of cryptocurrency and social media romances, it’s easier than ever for financial institution clients to be exploited financially and emotionally. This blog offers steps to tighten security and educate staff, customers, and members. Learn the programs, tools, and data that will protect against identity theft, damaged credit scores, and personal hardships.

The state of fraud survey: Key findings and recommendations for financial institutions

Fraud leads to substantial losses, damages reputations, and can disrupt banking relationships, affecting profitability and growth. Abrigo’s nationwide survey of more than 1,000 Americans delves into the prevalence of different types of fraud. It examines respondents’ expectations and preferences regarding how institutions prevent and manage fraud, and it explains how AI can both facilitate and combat fraud. There’s also a version explicitly covering credit union survey results.

8 Strategies for wire fraud prevention

Wire fraud complaints are increasing, seriously impacting financial institutions and their clients. This infographic provides wire fraud prevention efforts representing recommended practices for protecting clients and financial institutions. From educational efforts to robust verification procedures, learn how to head off the negative impacts other institutions are experiencing from sophisticated schemes and technology exploits.

Examiner focus: 4 areas to check before credit union and bank exams

Risk governance is under the regulatory microscope, and supervisory downgrades have increased. This checklist reviews published supervisory priorities and specific areas that are likely to receive additional examiner focus during upcoming bank and credit union examinations. It covers operational risks like cybersecurity threats as well as liquidity, credit, and interest rate risks.

What is check image analysis, and how does it prevent fraud?

Even though consumers use checks less each year, check fraud is rising. This blog, one of our most popular this year, explains a new fraud detection tool to leverage in their fight against fraudsters. Learn more tips in this blog, “10 Check fraud red flags,” or by watching this check fraud webinar featuring a U.S. Postal Service inspector’s walk-through of efforts to combat check theft. This infographic also shares how checking fraud’s costs and impacts snowball: "Beyond immediate losses.”

Compliance culture: Strengthening customer due diligence

This popular on-demand webinar is tailored to Bank Secrecy Act (BSA) professionals and covers the critical aspects of customer due diligence (CDD) practices. Program leads and senior executives will get valuable guidance to strengthen compliance efforts. This checklist is also a perennial favorite among readers: Customer due diligence: A checklist.

The check fraud ecosystem: Fraudulent checks and their complexities

Another extremely popular webinar, this session described check fraud trends and the connection between check fraud and other fraudulent activities. Abrigo and experts from Mitek also discussed strategies to combat fraud. Another webinar that discussed check fraud, Tackling operational risks: Strategies for check fraud and ransomware prevention, also drew a huge crowd and featured advice from Lloyd E. McIntyre III, CFE, an Examination Specialist for fraud in the FDIC’s Cyber Fraud and Financial Crimes Section.

Free newsletter: Stay updated on AML, fraud trends

Most of these resources take just a few minutes to check out, but scanning them regularly will go a long way toward keeping AML and fraud staff updated on the latest regulations, trends, and tips for managing FinCrime programs.

If you’d like to know about the latest resources as they are released, sign up for the FinCrime email newsletter. You can unsubscribe at any time, and you’ll hear about webinars, new checklists, guides, and other information right away.

Get ready for the new year. Watch this webinar, "AML/CFT & fraud hot topics for 2025: What to expect for financial crime"

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Bank and credit union leaders can use data to inform small business lending

Small businesses are showing resilience. Despite borrowing more and tapping credit lines, they're managing leverage and meeting debt obligations, according to Abrigo's proprietary data.

Business credit line utilization is up.

As rates stay high, concerns about credit risk and borrower health are top of mind for bank and credit union leaders, especially as it relates to lending to small businesses. In conversations with community banks and credit unions across the country, we’re hearing about a significant increase in line utilization, raising questions about both liquidity and credit risk.

However, recent data from Abrigo shows that privately held companies across the U.S. are displaying their financial resilience. They’re borrowing more, but they’re also managing their leverage and meeting debt obligations —even as they feel the pressure of high rates.

For financial institution leaders and their lenders, this data would indicate that there are opportunities to grow the small business loan portfolio in a safe and sound manner, particularly with rates apparently peaking. A recent U.S. bank survey of 1,000 small businesses found strong optimism about the future among owners.

Abrigo’s proprietary analysis comes from the largest real-time database of private-company financial statement information in the United States. Thousands of banks, credit unions, and accounting firms use our risk management and lending solutions, contributing to this cooperative data model for banking intelligence. Nearly all U.S. businesses are privately held, and most are small, so the unique, aggregated view into how these private firms perform provides leadership teams with insight to make informed decisions about the large and growing small business market.

How do you gauge competitor loan rates? See Abrigo Loan Origination Benchmarks for real-time data.

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Steady debt service coverage despite rising rates

The debt service coverage ratio (DSCR) is a fundamental measure of cash flow strength. The latest data from Abrigo shows that even with a 350-basis-point increase in interest rates, the average DSCR for privately held businesses was 5.75x in 2023, nearly unchanged from 5.73x in 2019. Businesses are feeling the pinch but handling it well, with enough cash coming in to service debt as contractually agreed.

Improved leverage ratios

Many businesses have taken a more cautious approach to borrowing in the rising-rate environment. Abrigo’s data shows that the debt-to-equity ratio has decreased from 4.10x to 3.45x. Despite increased utilization, the reduction in leverage indicates that companies are prioritizing financial stability. Leverage actually decreased, showing that companies are not overextending themselves.

Longer working capital cycles drive line utilization

Businesses are holding inventory longer (81 days in 2023 vs. 72 in 2019) and extending receivables (31 to 41 days). Those trends have driven an increase in Days Needed Financing from 77 to 93 days. Companies are borrowing more to cover operational costs but continue to pay suppliers on time, with payables remaining under 30 days. Companies need more working capital, but they’re still paying their suppliers as they should.

Strong interest coverage

Interest coverage ratios, another critical indicator of a company’s ability to meet interest payments, have remained strong. Interest coverage rose slightly, from 10.67x to 10.80x, indicating the increase in interest rates hasn’t derailed businesses’ ability to meet interest expenses.

Abrigo receives more data daily, and the preliminary data indicates that the increase in rates and the end of stimulus measures are finally being felt. The rate decrease in September came at just the right time to prevent further financial stress. Early 2024 figures show a dip in DSCR to 4.62x. However, leverage continues to improve.

Historically, increased line utilization, particularly in somewhat benign times, has been a cause of concern since higher utilization can reduce a borrower’s “dry powder” for downturns. However, Abrigo’s data shows that businesses are meeting obligations and reducing overall leverage.

As banks and credit unions weigh small business portfolio expansion, monitor loan demand, and assess the health of borrowers, private companies’ financial condition sheds light on the option of adding new, creditworthy borrowers in a higher-rate environment.

The board’s role in guiding supportive lending responsibly

Directors play a key role in guiding portfolio growth responsibly by setting policies that allow the financial institution to respond to business owners’ cash flow needs while balancing risk and growth objectives. The real issue for many bank and credit union leaders is how to add incrementally to that portfolio in a profitable manner.

Investing in small business lending technology, such as automated loan processing that allows for easy lender intervention and supports Section 1071 reporting, can foster growth in a way that enhances risk management. Automating administrative tasks lets lending teams dedicate more time to building client relationships, making informed decisions quickly, and maintaining compliance with minimal disruption.

Privately held companies are showing adaptability in today’s economic climate. By leveraging data on their business performance, banks and credit unions can confidently offer client-centered solutions that reinforce trust and strengthen their role in helping small businesses and their communities continue to thrive.

Key Takeaways

“Abrigo’s SMB Lending platform has not only made us more efficient but has also helped us maintain our competitive edge."

- Daniel Fowler, SVP, Capital City Bank

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Ahead of the curve: A banker’s podcast episode 1 – CFPB 1071 and CFPB 1033 update

10 good podcasts for bank & credit union execs & staff

These banking podcasts discuss current events, strategic and policy issues, competition, digitalization advice, and more. And all release a new episode at least monthly.

You might also like this webinar, "How to confidently navigate AI/generative AI"

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Podcast popularity

Podcasts are booming as more people find the listen-anywhere-anytime audio format fits their lifestyle needs. Thankfully for bank and credit union executives, lenders, risk managers, and Bank Secrecy Act (BSA) Officers, banking podcasts and podcasts for credit unions are plentiful, and options are growing.

According to Edison Research, nearly half of all Americans 12 and older (47%) listen to at least one podcast each month, up from 15% a decade ago. The average time spent listening to podcasts has surged 450% since 2014, and listeners span all ages. Indeed, people 35 and older spend 7 to 8 hours a week listening to podcasts.

Podcasts’ popularity is understandable. Podcasts can be a productive and enjoyable way to pass commuting time or a fast way to catch up on industry trends or news while cooking dinner. Some people even earn continuing education credits for listening to podcasts, making podcasts an efficient, inexpensive way to boost professional development.

Busy financial services professionals have many opportunities to hear timely discussions on banking issues. Listening to podcasts can help them manage risk, drive growth, and fight financial crime.

Regular, timely episodes

Indeed, with 3.4 million podcasts worldwide, you might find it daunting to weed through the lists on Apple Podcasts, Spotify, Pandora, or other platforms to find the best banking podcasts.

Why is it challenging to find banking podcasts?

One challenge for listeners is that banking podcasts often don't have their own category on these platforms. As a result, you must wade through a bunch of podcasts on financial markets or general business news to find podcasts focused on the banking industry itself.

Another challenge to identifying good podcasts for bankers is that that many excellent podcasts die – that is, the hosts stop hosting, and the podcasts end. Even so, some platforms’ podcast rankings seem to promote podcasts that haven’t put out new episodes in years.

Other podcasts might be internationally based and of little interest to community financial institutions or credit unions based in the U.S. or those primarily focused on the domestic banking market.

Finding podcasts that consistently release new content and cater specifically to the interests of U.S. banks and credit unions can be difficult. A curated list of banking podcasts can give you a head start.

We have webinars, whitepapers, and other resources to make your job easier.

Check them all out in our Knowledge Center.

A quick look at top banking podcasts worth a listen, according to Abrigo:

1. Banking Transformed

2. Banking on Fraudology

3. Banking with Interest

4. Ahead of the Curve: A Banker’s Podcast

5. Bank Slate Convos

6. With Flying Colors

7. Main Street Banking: A Podcast for Community Bankers

8. Banking on Digital Growth

9. The Community Bank Podcast

10. Fraud Talk

Stay up to date

Below is a list of 10 banking podcasts, in no particular order, that discuss current events, strategic and policy issues, competition, digitalization advice, and more. Many of these banking or credit union podcasts are among the most popular based on rankings by podcast search engine Listen Notes.

Others are hosted by former regulatory officials and current financial institution executives who have a knack for finding interesting guests to interview or well-timed topics to discuss. In many cases, the podcasts or hosts have sizable social media followings, and all release a new episode at least once per month so you can stay up to date with the latest trends in the finance world.

If you have an interesting podcast to share, please send it to [email protected].

Banking Transformed

Banking Transformed by the Financial Brand’s Jim Marous has new episodes several times a month. It features executives from financial institutions, financial technology firms, authors, consultants, and other experts in the banking industry. Some recent episode titles include: “How micro-engagements generate sales and build loyalty,” “The art of standing out in financial service marketing,” and “Building a future-ready digital banking platform.”

Banking on Fraudology

Banking on Fraudology is hosted by Hailey Windham, CFCS, who was named a 2023 CU Rockstar.

She’s passionate about educating people and credit unions on scams and how to avoid them. Among recent episodes, Windham has tackled data breaches fueling fraud, provided tips on educating credit union members about fraud, and called on fraud fighters to help stem tech support scams.

Banking with Interest

Banking with Interest, hosted by former journalist Rob Blackwell and Intrafi Network, is a weekly podcast that headlines former regulators, current legislators, and banking industry reporters to discuss banking policy, commercial real estate risk, check fraud, and community bank consolidation.

Ahead of the Curve: A Banker’s Podcast

Ahead of the Curve: A Banker’s Podcast features insights from banking leaders and advisors across the industry. This monthly podcast, hosted by Abrigo, helps bankers stay ahead of developments in the fast-changing environment. Recent episodes have tackled elder financial exploitation, preparing for CFPB 1071, the pros and cons of outsourcing asset/liability management, and stress testing.

Bank Slate Convos

Bank Slate Convos with Paul Davis features Davis, a consultant and advisor to financial institutions and former editor and reporter for American Banker. He hosts banking executives, regulators, and association leaders to talk about critical issues in banking. Discussions focused on retaining talent, AI and automation, and corporate governance are among the topics from recent episodes.

With Flying Colors

With Flying Colors, presented by Credit Union Exam Solutions, is on top of the latest regulatory issues for credit unions. The host, Mark Treichel, is the former NCUA Executive Director and now a consultant to credit unions. Episodes recently have covered banking cannabis-related businesses, the impact of the Supreme Court’s Chevron decision, trends in CAMEL codes, and tips for what to do if your credit union receives a letter of understanding.

Main Street Banking: A Podcast for Community Bankers

Main Street Banking: A Podcast for Community Bankers is hosted by the Barret School of Banking, which posts new episodes once a month or so. Sometimes 20 minutes, sometimes 50 minutes, this podcast digs into topics such as managing data, handling anxiety tied to report-writing or meetings, identifying risk, and deposit pricing. It also examines how community banks are different from other types of financial institutions and provides strategies for optimal operations.

Banking on Digital Growth

Banking on Digital Growth is hosted by digital marketing and sales strategist James Robert Lay. The podcast shares stories from digital marketing and sales technology firms as well as financial brand marketing and sales leaders. Titles of recent episodes include “If I were a bank CEO: Empowering change for financial leaders” and “Navigating user experience pitfalls: The impact of misaligned expectations.”

The Community Bank Podcast

The Community Bank Podcast, sponsored by the Correspondent Division of SouthState Bank, features interviews with investors, consultants, and SouthState specialists to cover a wide range of topics. Recent episodes have included discussions on bank failures, CRE loans, resolving team conflicts, and helping lenders succeed.

Fraud Talk

Fraud Talk is a monthly podcast for the Association of Certified Fraud Examiners (ACFE). It covers case studies and tips from anti-fraud experts to provide tools to spot and prevent fraud. Episodes include insights into occupational fraud trends, navigating difficult discussions with examiners, using AI in compliance and risk management, and fraud within homeowners associations.

Banking resources

Of course, there are numerous other excellent banking podcasts available that are also worth a listen. Other banking podcasts that provide a good variety of resources for industry professionals include the ABA Banking Journal Podcast, the Independent Community Bankers Association’s Independent Banker Podcast, the Credit Union National Association (CUNA) News Podcast, and Adrenaline Group’s Believe in Banking. Others to check out are Simply Stated, hosted by the Conference of State Bank Supervisors, This Month in Banking by consulting firm Kafafian Group, and BankTalk by Remedy Consulting.

Listen to the podcast episode, "ALM Outsourcing" to hear best practices for the current interest rate landscape.

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How to respond to commercial real estate loan distress

Use these tips for banks and credit unions to identify and handle commercial real estate loans that are showing signs of being problem CRE credits.

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Protecting portfolio health

Media organizations are reporting scary-sounding data, and the headlines scream about the most recent victims. Government entities are issuing advisories and guidance for addressing this unfamiliar phenomenon and for shielding the financial institution from the potential threat. Individuals and business owners are starting to contemplate the worst-case scenario and how it can impact their earnings and balance sheet.

Is the above scenario another pandemic akin to our recent COVID experience? No, it’s the current situation in the commercial real estate (CRE) market tied to the threat that distressed properties and problem CRE loans pose to investors, banks and credit unions, and the economy at large.

While no potential CRE “disaster” is comparable to the COVID pandemic in terms of the human impact, it is still a clear and present danger to our banking system and the economy.

CRE is now arguably the riskiest asset class due to a perfect storm of:

Systemic changes in the way we utilize real estate (not just office, but retail, housing, and other sectors).
Unprecedented increases in interest rates from an abnormally historic low-rate environment.
Inflationary impacts on costs of various inputs.
A wave of pending maturity events ($2 trillion of CRE loans are reported to mature in the next years).

Consequently, all stakeholders of CRE assets are understandably nervous, including bankers and their investors who, due to the highly leveraged nature of CRE transactions, provided the bulk of capital financing the industry.

Bank and credit union leaders who recognize souring CRE loans with the potential to manifest like an illness in their institutions should engage their workout professionals/team. Doing so is akin to taking a relative to the doctor when sick or showing symptoms. The workout team can help lenders diagnose distressed CRE assets. Workout specialists can also provide consulting and advice (treatment) that either helps alleviate the loans’ distress (symptoms) and restore them to health or helps mitigate the spread of the “illness” to protect the health of the financial institution.

Here’s how banks and credit unions with strong CRE risk management can identify weakening property loans, assess them, triage them, and assist with their prognosis and treatment.

You might also like this podcast on leveraging the Fed's stress test scenarios.

Early symptoms

Given the heightened and well-established risks that commercial real estate loans pose, banks and credit unions should be on high alert for any signs of sickness in their CRE portfolio. In this environment, any indication of early warning signs of distress from a CRE loan should be addressed immediately. Bring together the deal team, credit approvers, and workout experts to discuss and determine the grade and next steps.

Beyond a hard money default due to a payment or maturity event, early warning signs for commercial real estate loans typically manifest as a:

Failure to pay real estate taxes.
Failure to sustain adequate insurance coverage.
Failure to maintain the property.
New lien on the commercial real estate.
Failure to deliver required financial information.

Each of these signs is a major commercial real estate red flag as it represents a lack of cash and resources to pay required obligations, mitigate catastrophic risks, and support value. Furthermore, failure to pay taxes and insurance is almost always an event of default, and the mortgage instrument provides the bank or credit union the ability to advance funds and force-place insurance to protect the collateral.

Additionally, any new liens on the property demonstrate cash flow issues with the property, especially if the financial institution was notified as required under the loan documents.

Finally, any failure to deliver required financial information in a timely manner (including rent rolls/operating statements) or any covenant defaults (e.g., debt service coverage, debt yield requirements, or loan-to-value maximums) all represent major issues with respect to the loan. They should be addressed immediately. Ignoring any actual defaults is unacceptable and creates liability for the bank or credit union because this “course of dealing” can be interpreted as the institution waiving its rights. The bank or credit union can even lose the collateral (in the event of a tax deed sale or casualty event with no insurance coverage).

Learn more about managing CRE loan distress. Watch this webinar on problem loans and how to identify them quickly with data and reports.

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Take timely action

As stated above, once an early warning sign for a distressed commercial real estate loan is identified, there is an increased probability of future non-performance, or if an event of default occurs, it is imperative that the bank or credit union take appropriate and timely action. What should the institution do? Here are three actions to take:

Engage CRE credit partners

The institution’s deal team should engage with their credit partners and determine if the CRE loan should be downgraded and more closely monitored.

Engage the workout team

If there is an actual event of default or a hard money default that cannot be resolved (missed payment(s) or maturity event that doesn’t meet renewal policy), the deal team and credit approvers should engage the workout team for consultation and discussion. At this point, with the workout team involved, a diagnosis of the commercial property loan can be made as to the appropriate steps in protecting the financial institution and mitigating losses (either through further downgrades or even charge offs).

The workout team or expert will be able to approach the deal from an independent viewpoint and provide important feedback to the deal team as to current risks, future problems, and prospective strategies. Most loan workout experts are not in the blame game with their bank or credit union counterparts and are providing credible challenges as to current assumptions in order to determine the best course of action for a troubled CRE loan (similar to a doctor not shaming the patient while advising the best course of treatment).

Consult on potential treatment

After discussions, the group might determine that the issue is a short-lived, one-time event, and a waiver of default is appropriate. On the other hand, they may decide a more long-term and intensive solution is necessary, including a formal workout shadow arrangement or a full-blown transfer to the workout team. The former is similar to a doctor prescribing medication to take at home, while the latter is more like outpatient therapy and admittance to the hospital. If the illness of the property credit is significant, then intensive care is needed, and workout should own the asset.

The benefit will be that the workout specialists will have an independent and objective relationship with the commercial property owner since they didn’t originate the deal. They have no preconceptions regarding the credit or the loan documents, and they also have experience in managing the riskiest of assets so they can forecast and strategize on the best course of treatment.

Appraisals and analysis

If the bank or credit union team determines that the commercial real estate loan should be moved to workout, or even if a formal consulting and shadowing relationship with workout is warranted, then the loan should be admitted to what’s essentially the financial institution’s emergency room. Typically, when a patient is admitted to the ER, vital signs are taken (current financial package), symptoms are closely observed (problems analyzed), new tests are ordered (new appraisals obtained and/or requests made for additional financial information), and the patient is asked probing questions to help in the diagnosis (interview with the borrower). A similar triage process and triage checklist can be administered in the case of CRE loan distress.

Reengage the deal team

The workout banker should reengage the deal team, especially the relationship manager who was working with the customer or member. Obtaining access to all of the loan documents and credit file is of paramount importance and the relationship manager can provide context and share any important email, correspondence, and servicing notes with the customer or member. At this point, the workout officer will conduct a full and comprehensive review of the loan documents (which are essentially the Bible governing the loan), including email correspondence, letters, or other documentation that may provide a “smoking gun” indicating lender liability or a commitment made about the loan (either directly or inadvertently). If there are weaknesses in the loan documentation or if any lender liability is discovered, the workout officer should engage legal partners and craft a strategy on how best to resolve it, first and foremost. The financial institution may also want to engage a lawyer to formally review the loan documents and title to verify there are no gaps or insecurities.

Meet with the borrower

A meeting should occur with the borrower to introduce the loan officer and workout officer (warm handoff – if possible) – hopefully at or near the collateral property. Note: I am a firm believer that a commercial property inspection must be conducted by the credit union or bank or its officer if possible. The on-site inspection can illuminate any issues with the neighborhood or the property itself (e.g., unreported vacancies, visible deferred maintenance, and busyness of the property).

Some best practices for this initial meeting with the borrower, which can be contentious if the customer or member has never been sent to workout, are to:

Have two bank or credit union representatives at the meeting.
Take good notes and minutes.
Email those minutes to all attendees to recap the discussion.

Often, workout meetings can be difficult discussions, and if emotions run high or the borrower makes accusations, it is best to have a record of what was discussed. It is important to note that the introductory meeting will not resolve the issues but is more for explaining the role of the financial institution, the rules of the road for communication going forward, the issues that predicated the transfer, and to make requests for additional information needed (financial and otherwise) that will be necessary to work on a solution. Again, follow up in writing with the formal request for information, and be sure to include any and all parties to the loan (including co-borrowers and guarantors).

Re-underwrite the CRE credit

The loan workout team will essentially want to re-underwrite the commercial real estate credit, especially if the borrower is open and transparent in providing updated financial information (both current and projections). It is also at this point that the bank or credit union should obtain an updated third-party appraisal of the collateral, especially if the last appraisal on the real estate or other collateral is stale (older than 12 months old) or if there have been substantial changes to the property or surrounding market. Additionally, if the loan documents allow or if the loan has an actual declared default, the institution should obtain updated financial information from all guarantors (corporate and personal).

Revisit the loan grade

Once all of this information has been obtained on the primary, secondary and tertiary sources of repayment, the bank or credit union can revisit the current grade on the distressed CRE loan and strategize on the best course to resolve the asset. The financial institution should make the distinction of whether the credit is a “retain” or “exit” customer or member. The former indicates a strategy of rehabilitation and return to line of business. The latter indicates a collection posture that seeks to get repaid via the strategy that provides the best resolution on a net present value basis.

Go-forward strategy

Once the workout team has developed its recommendation and strategy for the problem CRE loan, it should follow up with the deal team to share findings and explain the go-forward strategy with the credit, i.e., the manner and course of treatment as to the patient.

If the deal team has reservations or wishes to provide a credible challenge, they should feel free to do so, as it is important that the entire bank or credit union team be on board with the ultimate strategy for the credit. Note, however, that the workout team must hold the ultimate decision. The workout group will want to keep its business partners in the loop as the deal and negotiations develop, especially in cases where the customer or member is politically or socially sensitive. It may be important to have a media relations or legal representative aware in the event any media inquiries are made regarding the CRE asset.

In essence, the workout team should be clear and deliberate in achieving its strategic objectives with respect to resolving the asset. Loan workout is not always a straight journey between diagnosis and the ultimate cure, as is the case with many medical treatments. The problem may be a chronic condition, or there may be many iterations, stop-and-starts, relapses, and even “death” via bankruptcy/liquidation. However, if the workout team follows the example set by the medical field’s principle of “First, Do No Harm” and follows a strict ethical path to achieving its desired resolution, the financial institution’s stakeholders will ultimately be best served.

Struggling to track and report on construction loans? Learn how Heritage Bank cut days off its processes.

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Address risk by fine-tuning your AML transaction monitoring program

Financial institutions must stay on top of their scenarios and settings. Above-the-line/below-the-line testing can help get the right parameters.

This article covers these key topics:

Financial institutions must regularly assess and enhance their anti-money laundering (AML) programs to include a specific focus on the effectiveness of their transaction monitoring systems. According to the Federal Financial Institutions Examination Council (FFIEC) BSA/AML Examination Manual, institutions should tailor their AML programs to align with their unique risk profiles. Transaction monitoring platforms must employ reasonable and risk-based criteria, independently verified for optimal performance.

False positives within a suspicious activity monitoring program are frustrating and an inefficient use of valuable AML resources, but what if adjusting parameters leads to too few alerts and suspicious activity is missed? Financial institutions must determine the sweet spot for each scenario and risk rating setting within their AML software.

You might also like this resource: "AML investigations checklist: Red flags for detecting money laundering."

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Calibrate your program with above-the-line/below-the-line testing

One of the best ways to address dynamic and emerging risks is conducting above-the-line/below-the-line (ATL/BTL) testing to ensure your software operates at its peak efficiency. Above-the-line/below-the-line testing is a statistical exercise that rigorously analyses transaction monitoring parameters to identify the optimal settings for suspicious activity monitoring for your institution’s unique risk profile.

The ATL/BTL process involves testing thresholds at three levels: the baseline, below the line, and above the line. The goal is to generate productive alerts that might represent illicit activity while ensuring no suspicious activity goes undetected.

Baseline testing: Begin by establishing a baseline for transaction monitoring parameters. This represents the standard against which adjustments will be tested. Generally, the baseline is the current parameter or setting used in the software.
Above-the-line testing: Test the parameters by elevating them above the baseline. This identifies the threshold at which false positives might increase, potentially overwhelming investigators with non-suspicious alerts.
Below-the-line testing: Conduct tests by lowering the thresholds or criteria below the baseline. This helps identify the point at which the system may generate false negatives, thus missing potentially suspicious activity.
Iterative adjustment: ATL/BTL testing is an iterative process. Adjustments to parameters should be made based on the outcomes of below and above-the-line analysis until an optimal balance is achieved, maximizing the effectiveness of the monitoring software.

Let’s look at an example of ATL/BTL testing in practice. For illustration, we’ll use a wire scenario with current parameters set at $50,000. This means that any wire meeting this threshold will create an alert. To test that this is the appropriate threshold, you would increase the setting (testing above the line) to $100,000 and generate the alerts. Through a sample review, you would determine whether these alerts were quality alerts with actual potential suspicious activity.

Keep in mind that seeing some false positives during this test is necessary to ensure nothing is missed. Currently, there is no regulatory guidance on the acceptable rate of false positives. A financial institution must rely on testing and expertise to determine what is appropriate for its unique program. If sample testing determines that $100,000 is not the suitable threshold, analysis should be performed above or below the $100,000, depending on which direction the results lead. If your testing results in a parameter with no possible suspicious activity detected, that parameter is not the sweet spot. Below-the-line testing is conducted the same way but in the opposite direction, with a starting point possibly at $40,000 in our example.

Better detection: Benefits of above-the-line/below-the-line testing

The primary advantage of ATL/BTL testing is the significant efficiency gains it offers. By accurately tuning parameters, financial institutions can enhance the effectiveness of their AML program, ensuring that suspicious activities are promptly identified while minimizing disruptions caused by false positives.

Another essential benefit is documentation for auditors and examiners. The documentation generated during ATL/BTL testing is a valuable resource during regulatory examinations and audits. It provides a clear rationale behind the selection of specific parameters and settings, demonstrating the institution's commitment to a risk-based approach in combating money laundering and terrorist financing. All working papers, alert analysis, and testing data should be retained in a clear and organized manner.

Testing frequency and triggering events

ATL/BTL testing must be performed periodically, but what does that mean? Transaction monitoring parameters should be regularly reviewed every 12-18 months. This periodic assessment ensures the system remains aligned with the evolving risk landscape and the institution's characteristics. In addition, financial institutions may find it beneficial to engage in ATL/BTL testing under various triggering circumstances. Whenever such events occur, a reassessment of parameters and settings is prudent. Triggering events include:

Significant organic growth: Rapid expansion in asset size may necessitate a reassessment of AML parameters.
Merger or acquisition: Merging two risk profiles through a merger or acquisition almost always changes the enterprise-wide risk assessment.
Introduction of new products or services: Innovative offerings, especially higher-risk products and services, demand a review of monitoring parameters.
Opening of new branch location(s): Geographic expansion can impact your institution’s risk landscape. Considerations such as cannabis banking in some geographic areas increase the importance of a parameter review.
Shifts in the market area or customer base: Changes in the institution's market demographics necessitate a corresponding AML setting adjustment to reflect the customer base.
Changes in false positive rates: An uptick in false positives may indicate the need for adjustments to reduce unnecessary alerts. In contrast, an increase in false negatives may require a relaxation of criteria to capture more suspicious activities.
Inadequate documentation for prior parameters: Perhaps your financial institution has received regulatory criticism for lack of documentation or discovered records are missing from your last reevaluation. Either way, shoring up your documentation is crucial.
Outdated parameters: Technological advancements or changes in regulatory AML requirements may render existing parameters outdated. Keep up to date with industry knowledge to know when your program may need a refresh.

Prepare for your next exam with ATL/BTL testing

Above-the-line/below-the-line testing is a fundamental practice in optimizing the effectiveness of AML monitoring software. It maximizes efficiency and ensures adaptability to evolving risks and regulatory landscapes. Regular reviews and proactive adjustments ensure the monitoring system remains a robust defense against money laundering and terrorist financing activities. Regulatory authorities will expect periodic tuning with thorough process documentation. If you feel that ATL/BTL testing is overwhelming, contact Abrigo Advisory Services for assistance, and be ready to impress at your next BSA examination.

Download this infographic for details on 5 examples of fraud typologies affecting your institution:

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Streamline your annual review process

Which loans need them, what processes to avoid, and how to save time working with borrowers' complex credit needs.

Read the 2023 Loan Review Survey results for expert analyses of emerging trends

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Fine-tune annual review

Annual loan reviews are a critical component in monitoring the health of a credit after it is initiated. How is it distinguished from the loan review process (credit risk review), and what common pitfalls can impede an effective annual review process? 

What is interesting about annual reviews is that there is no standard process or method that all banks follow. However, in a recent poll, 47% of banks reported that they require annual review for all loans above a certain threshold, while 54% of banks perform a full-blown analysis—as if underwriting new money—during an annual review.

The 2020 Interagency Guidance on Credit Risk Review Systems recommends that loan review should occur "typically annually, on renewal, or more frequently when internal or external factors indicate a potential for deteriorating credit quality or the existence of one or more other risk factors.” Regulators expect financial institutions to develop loan review or credit review systems tailored to their specific risks and circumstances. This means that loans that are already examined throughout the year do not necessarily need a scheduled annual review. Credit risk review is ongoing, and the annual review component is intended for loans that would otherwise not be touched from year to year.

Director of Abrigo Advisory Services Kent Kirby says many financial institutions waste time on overly robust annual loan review processes. Kirby and Abrigo Senior Advisor Rob Newberry recently provided guidance on the annual review process during the webinar “Navigating annual reviews: How should you approach them?”  The following can help your financial institution develop a more efficient, effective annual review framework.

What annual review isn't

By taking a comprehensive approach to annual reviews, many financial institutions end up duplicating work that would have been (or will be) performed during other cyclical processes, such as the processes in the following examples:

Covenant testing on loans is typically performed quarterly to ensure that covenants are not breached. Instead of performing a covenant test as part of an annual review, keep this process separate.

Underwriting financial transactions involves a level of detail that does not belong in your annual review process. The annual review process needs to be treated with the same gravity as the underwriting process, but it needs to be treated with less attention to detail.

Problem loan processes are unique at each financial institution, but typically, problem loans are isolated, documented and discussed, analyzed for root problems, and frequently reevaluated. As a result, a separate annual review does not need to be performed on these loans.

Kirby emphasized that what these “don’ts” have in common is they involve loans that are being analyzed far more frequently than annually. Spending time doing an annual review on loans already on your institution’s radar is unnecessary. So, what should you be doing for an annual review?

An annual review/assessment is meant to be conducted on customers with an outstanding credit facility where there is no financial transaction on the near horizon. An independent annual review isn't necessary to conduct separately on loans that will soon be examined anyway.

“If you’re doing a financial transaction such as a renewal, you can let that renewal act as part of the annual review,” Kirby said. “It sounds like semantics, but it’s a big deal because otherwise, you’re duplicating work by performing the entire annual review process and then doing the financial transaction.”

Perfect your assessment

Once your institution has established which loans need a separate annual review, create a plan for what to include in their assessment. The following are actions to consider incorporating into the annual review:

Risk rating assessment and grading. If a loan’s rating is on the decline, add the details of the problem into its assessment. Stable loans don’t necessarily require the same amount of work and detail. In any case, address whether or not the borrower is performing as expected and mention any threats to a loan’s rating.
Evaluation of the history of the transaction(s) since the last review. Look at patterns in customers’ businesses, whether seasonal or otherwise, so you know what is typical for them and understand the red flags to watch for. This may also include performing a collateral analysis if you are working with a collateral-dependent loan
Assessment of general credit history since the last review. Address any issues from prior annual reviews and consider assessing the borrower’s credit outside your institution. Kirby recommends performing a record search through a third party to understand your borrower better. “Record searches can be very enlightening. If your customer is borrowing money from other creditors or is involved in any type of lawsuit, you will find that information through a simple records search. You can use it to see the trajectory of their financial situation.”
Review of outstanding documentation exceptions. “While a late financial statement isn’t unimportant, banks typically don’t lose money from policy exceptions,” Kirby said. But they can lose significant money quickly on lien documentation exceptions if they are not perfected. “I’ve seen a lot of special assets situations where forbearance has been put in place because the documentation wasn’t perfected, and they needed to get through the preference period to be able to do something. You don’t want to be in that situation.” Perform documentation in a centralized operations function so controls are in place to generate exceptions. Make sure to look at lien perfection, tax payments, and insurance.
Profitability analysis. High transaction accounts are not always the most profitable, and even if the bank is excited about a significant deal, analysis should always be done to ensure that the deal will be profitable.

Tracking the progress of an annual review and related correspondence can get confusing. Automating the process with loan review software may help your financial institution make better decisions faster with summaries of reviews, exceptions, and portfolio concentrations.

Stay up to date on loan review best practices.

Which loans need review?

Your credit systems should warn you 30, 60, or 90 days out that an annual review is coming up so that you know when to expect the additional work. A good first step in the process is risk rating assessment and grading, which will help you determine which loans need review.

Once the risk rating is complete, you need to decide whether a financial transaction is coming up, such as a renewal, new money, or a restructuring. If a transaction is being contemplated, the loan will not continue through the annual review process. It should go straight to the regular underwriting process, which counts as its annual review.

The next fork in the road is deciding what kind of annual review to perform. Sometimes, a risk rating and assessment could be all you need on the loan. If the loan needs more than just a risk rating and assessment, use some or all of the elements of an effective loan review above. But regardless of whether or not the loan review will be very involved, there should be no reason to re-underwrite the loan. “If you have a three-rated credit to an established company, there is no need to do a full-blown review,” said Kirby. “Don’t re-underwrite perfectly acceptable credit.”

Justifying guidance lines

If your bank is used to performing annual review on all of its loans regardless of how often they are touched, a risk-based approach can be a huge timesaver. But managing annual reviews for customers with fluctuating credit needs can be tricky. In these situations, Kirby recommends utilizing guidance lines to streamline the approval process for businesses that undergo frequent changes.

A guidance line is a line of credit approved by the financial institution but never disclosed to the borrower. Rather, it is an internal accounting facility that transfers loan authority from a higher lending source to a lower one for a specific period of time under specific conditions.

A guidance line allows you to approve certain facilities ahead of time. For example, during a conversation with the bank’s account officer, a real estate development company indicates it wants to purchase properties to renovate and sell. It does not have specific properties in mind, but it wants the flexibility to move quickly when an opportunity presents itself. The bank approves the developer for a $1 million guidance line. The line is fixed for a set term (usually one year), and there are specific conditions that have to be met (get an appraisal, rent rolls, debt-service coverage covenant, and so on). When the developer comes to the bank asking for credit, the approval process is greatly compacted since the internal approval is already in place and the focus is simply fulfilling the conditions of that approval.

Guidance lines may be appropriate for businesses that know they will have multiple financing or refinancing needs in a given period. Not only do they help you quickly make moves for customers who meet specific requirements, but guidance lines also provide an excellent opportunity to talk to customers about their financing needs for the year in advance (so you can be ready). Guidance lines can also be a good marketing tool because you can give customers approval faster within certain parameters.

Conclusion

An annual review is a yearly assessment of an existing credit, not a re-underwriting of a loan. Keep elements of an annual review distinct from the underwriting process to save your staff valuable time. Taking a risk-based approach to which loans need a complete annual review can help your financial institution be more efficient with its time without compromising the safety and soundness of the bank. And for an extra time-saving measure, consider guidance lines as an effective way to manage the credit needs of specific customers.

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Stress testing & deposit strategies in the spotlight

The failure of Silicon Valley Bank offers other financial institutions the chance to reassess their approaches to and management of interest rate risk, liquidity risk, and credit risk.

You might also like this whitepaper, "Inflation and rising rate's impacts on earnings and margins."

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Historic collapse

The FDIC closure and assumption of Silicon Valley Bank (SVB) – the largest bank failure since 2008 – is a stark reminder that when a crisis occurs, it can spread as fast as a wildfire in dry fields with a strong wind.

While details of the root cause of failure will come to light in the coming weeks, we do know that one major issue was the loss of depositors in a short period of time. Much attention has been placed on the sale of the securities portfolio at a loss and if that move itself was causal. I’d say not likely the cause, but for sure it was a warning flag that things were not right in this institution.

Not having any knowledge of the bank’s actual practices or internal discussions, I am relegated to supposition. But we do know that this bank had a unique business practice.

Banks in rural America are not going to have the same kind of lending activities, or depositor relationships as this bank seemingly had. Lending to startup companies with a plan to go public is not itself a problem. But what we are not aware of is how leveraged these loans were and how the economic conditions that dried up the IPO market have impacted loan performance. I’d love to know what kind of stress testing was being done on these loans. Was the loan repayment plan based on the IPO? Did the stress test consider the impact of not going public on the bank’s position?

Finding vulnerabilities

While this bank had unique loans that most community financial institutions won’t be dealing with, it does raise the question of appropriate stress tests. Financial institutions have been hounded over and over to run stress tests on every part of the business ever since the Great Recession. I liken the design of the stress tests to the video game Angry Birds. The goal of the game is to shoot different bird types at structures to topple them and capture points, but finding the right spot to topple the structure is key to winning. Finding the connection that makes all points of the structure vulnerable is key.

Similarly, a stress test needs to be aimed at the single point of failure that could bring down the business line. Looking back to the Great Recession, I recall the banks that made Jumbo Alt-A mortgages that woke up one morning to the realization that their one conduit to sell these loans (Countrywide Mortgage) was now gone, and they were then stuck holding loans that ballooned the total assets of the bank. Boy, did that impact capital ratios.

For SVB, many of their customers didn’t need loans. In addition, the bank had money pouring in as a result of being associated with the startup tech industry. As more and more money came in from their customers, the levels of concentration risk rose.

Deposit studies

Concern over the stability of funds should always be a major discussion point at financial institutions as they consider deposit strategies. Listing services to insure funds can also help bring more stability to retaining funds beyond that offered solely by the interest rates paid.

We often talk about how the role of a good deposit study is not just to understand the way to manage non-maturity balances in an ALM model but rather to better understand the overall concentration risks within the deposit base and offer guidance to the liquidity plans for managing or replacing large funding blocks. Do you get that from your deposit analysis? How are you designing stress tests for liquidity?

With lots of cash and lending not a central asset to generate earnings, Silicon Valley Bank needed to find a way to generate earnings. And while liquidity risk most certainly had a major role in the closure, given deposit runoff, there has been a great deal of discussion over the sale of the investment portfolio to meet liquidity needs. Enter interest rate risk.

Clearly, every bank or credit union that has purchased securities prior to the Fed raising rates has been feeling the effect of unrealized losses on those decisions. Hindsight is always 20-20, so let’s not go back and focus on the decision to buy bonds. Not many folks forecasted a Fed rate rise like the one we have seen to date. If we knew then what we know now, we’d make a lot of different decisions. But the interest rate risk hit this bank in the decline in the securities portfolio. It tanked the value of the “liquid investments” and put pressure on their tangible equity capital.

I am always amazed when I discuss with a banker how they are so dead set against making long-term, fixed-rate loans to customers for fear of interest rate risk. But then I watch the institution invest in securities with longer durations than many of the loans they could have made and think that they didn’t take on any interest rate risk. Well, we know now that is simply not the case.

Reviewing the call reports for SVB through Q4 2022, I see a bank that began increasing security positions after Q3 2021. The mix was balanced between Treasury bonds, mortgage-backed securities, and municipal bonds – nothing overly complicated, based on call report reviews. But the move was likely an extension of duration in order to pick up yields since there was no incentive inside the 2 to 3 year window as seen in the Treasury Yield Curve below.

Stay up to date on the best ALM strategies for the current environment.

Anyone looking for yield in Q4 2021 would be drawn to the 5 to 7 year window of maturity. As we know, longer term equals higher price volatility. And like many banks, SVB encountered this in their portfolio, seeing a major decline in value when funds were needed.

Avoiding contagion

So the early returns indicate that SVB had issues surrounding liquidity that stemmed from presumably a less-than-stable depositor base that saw opportunities to increase returns in the new rate environment that outpaced the ability of SVB to meet demands. The resulting sale of securities created real losses on capital levels and likely restricted access to other funding options. The unknown in this is the role if any that the credit conditions played on loans that are not typical across community banking institutions.

The question is really if this is a precursor to a “crisis” and what other financial institutions should do to make sure they aren’t swept up in the aftermath. Keep reading for actions to take now.

Here are five steps financial institutions can take from the lessons of SVB's failure:

Reassess your approach to stress testing of each area individually, and then how well you combine these into realistic but painful scenarios.
Understand the nature of your funding and the rate sensitivity, particularly in high-balance relationships. Liquidity remains the one risk that is hard to fix once broken. Liquidity makes the banking wheels go around.
Be mindful of the exposures to other risks: credit risk in a continued Fed tightening posture, or interest rate risk when the Fed begins to ease, for example.
Decide when to insure against risks, even though the best of times may have passed us already. Insurance may be more expensive now but may be needed to cover the catastrophic losses that are possible.
Make sure you are working with others who can help you identify big-picture risks and opportunities.
Reassess your approach to stress testing of each area individually, and then how well you combine these into realistic but painful scenarios.

We know one thing is for certain, the regulators will be making this event a focus of upcoming exams.

Stay tuned for more analysis and discussion from Abrigo’s advisory team on the impact of these events and what it means for you and your institution in the coming months.

Access resources to help you navigate credit, interest rate & liquidity risks

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How to balance AML priorities

Transaction monitoring is a critical component of a strong BSA program and a risk-based approach will allow for the best use of valuable resources.

You might also like this risk assessment checklist for BSA/AML professionals.

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Risk-based approach

In an economic and regulatory environment where compliance resources and budgets are stretched thin, financial institutions must carefully evaluate their priorities when it comes to their BSA/AML program. Currency transaction reports, enhanced due diligence reviews, board reporting, and suspicious activity monitoring are just a few of a BSA team’s responsibilities. All requirements of a risk-based BSA program are crucial to the safety and soundness of your institution, so what should banks and credit unions prioritize when resources are strained?

Suspicious activity monitoring is the cornerstone of a strong BSA/AML reporting system. As stated by the Federal Financial Institutions Examination Council (FFIEC), transaction monitoring and reporting are critical to the United States’ ability to combat financial crime. Suspicious activity reports (SARs) assist law enforcement in deterring illegal activity, but financial institutions may wonder whether they are expected to detect and examine every unusual transaction that comes through their doors.

The Financial Crimes Enforcement Network (FinCEN) and federal bank examiners understand that financial institutions can't detect all suspicious transactions, but solid policies, procedures, and processes must be in place to monitor higher-risk products, services, and customers’ entities, and geographies. This means that financial institutions’ suspicious activity monitoring systems must be risk-based and efficient.

Individualized programs

The risk-based focus is not a new philosophy, having long appeared in the FFIEC Exam Manual. In July 2019, regulatory bodies reinforced this idea in a joint statement that validated examiners’ use of tailored pre-examination request lists based on each bank’s risk profile, complexity, and planned examination scope. This is a powerful message to financial institutions for several reasons. The statement:

recognizes the regulatory exam burden for financial institutions,
emphasizes an individualized risk-focused approach for exams, and
refocuses the regulatory agencies to consider banks’ unique risk profiles

The statement also stresses that within an institution’s transaction monitoring processes:

Scenario optimization should be risk-focused
Riskier typologies should alert to tighter parameters
Acceptance of certain risks should be accounted for and documented within policies and procedures
Proper monitoring will validate the institution’s risk profile

In July 2022, the FFIEC released a second joint statement emphasizing the risk-based approach to assessing customer relationships and customer due diligence. The statement reminds financial institutions that no customer type presents a single, uniform level of risk related to money laundering or terrorist financing. Without flexible transaction monitoring, a risk-based approach to CDD cannot be fully accomplished.

Financial institutions have unique risks based on several factors, including size, customer profiles, and geographical locations. Suspicious activity monitoring is not one-size-fits-all. The institution’s risk assessment should be used as a road map of where the risks lie and where more resources such as software should be used.

Remember, however, that a BSA department must have adequate staff as supported by an institution’s risk assessment. Examiners are not likely to accept slow investigations or late SARs due to budgetary constraints. FinCEN issued a Civil Money Penalty of $185 million to U.S. Bank for several BSA violations, including inadequate resources and “capping” of the number of alerts generated by the bank’s AML software. Recently, the cases of First IC Bank in Georgia and Oxford University Bank in Mississippi emphasize the continuing need for a strong culture of compliance, including the need for adequate risk-based transaction monitoring.

If your financial institution does not have a supportive culture of compliance at the executive and senior management levels, it may be time to share these assessments and consent orders and encourage a change. If staffing is the more pressing issue, consider short or long-term staffing relief to ensure that your bank or credit union has the bandwidth to carry out its risk-based BSA initiatives.

Get more BSA training on the latest fraud trends with this webinar

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Sophisticated measures

System optimization, or parameter tuning, is critical for BSA/AML software to remain risk-based. Smaller institutions may be able to provide sound transaction monitoring with manual processes, while larger institutions may use a hybrid approach to suspicious activity monitoring. The FFIEC BSA Examination Manual agrees that the sophistication of monitoring systems should be dictated by institutions’ risk profiles. Several methods for initial identification of unusual activity may be used by financial institutions including:

Employee identification (particularly front-line staff)
Law enforcement requests (i.e. grand jury subpoena and National Security Letters)
Information Sharing 314(b) requests

Manual review of internal reports for unusual transaction activity

In addition to the manual identification processes, surveillance monitoring by automated AML systems is becoming the expected norm for medium to large institutions. Another statement issued by FinCEN and the federal banking agencies encourages financial institutions to use innovative approaches to combating money laundering and terrorist financing, and artificial intelligence is one innovative alternative that is top of mind. Banks and credit unions are starting to use artificial intelligence, particularly machine learning, to streamline processes and manage compliance risks.

After assessing a bank or credit union’s risk, BSA officers should develop procedures and tune their programs to support higher-risk products, services, customers, and geographies. Decide collectively with the Board of Directors and executive management what level of risk the institution is willing to accept. Be sure to document these decisions, which should be defended and supported by data used within the risk assessment. When the institution’s next examination time comes, be prepared with sufficient supporting documentation for risk-based decisions. Whether they are using AI, software, manual procedures, or a hybrid of methods, BSA professionals can look to regulatory guidance to prioritize areas of risk, use their resources wisely, and mitigate financial crime.

Your institution is unique.
Your BSA/AML software should be, too.

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