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SNL: Tweak to FASB loan-loss rule could prove ‘a disastrous idea’

Community banks’ chief lobbying group hails it as a victory, but other observers call a recent Financial Accounting Standards Board concession aimed at easing the anticipated tumult of a change to the way lenders build up loan-loss allowances a big mistake.

“It’s just such a bad idea that it’s laughably bad,” Jon Winick, CEO of bank consultancy Clark Street Capital, said in an interview, pointing his criticism at FASB.

At issue is the FASB’s plan to move the banking and credit union industries away from their current loan-loss model — one based on incurred losses — and toward an expected-loss model, under which lenders would forecast loan losses years into the future and, notably, set aside allowances for such projected losses at origination. The FASB has said one goal is to enable banks to fortify allowances during normal periods so that when downturns strike, they are not caught off guard and left to hastily ramp up allowances to catch up with mounting losses induced by a recession, such as happened in the aftermath of the 2008 financial crisis. The change also is aimed at minimizing the likelihood of wild earnings swings and providing investors more transparency.

Amid larger industrywide worries about the feasibility of making projections for the life of multiyear loans — and whether banks will ultimately have to focus mostly on short-term loans because accurate forecasts for longer ones would essentially be impossible — community bankers also raised concerns about costs.

They have said that many big banks would use complex computer models to handle their forecasting work to comply with the FASB’s so-called Current Expected Loss Model, or CECL, which is expected to be finalized around midyear. Often, these bankers noted, when Wall Street firms and megabanks take the lead on addressing change, regulators tend to pass down an expectation that smaller lenders follow their lead. Doing so in the case of CECL would require major investments in new technology that many small banks have said they cannot afford.

Addressing those concerns, a FASB panel earlier this month issued a new CECL draft that the ICBA interpreted as an accommodation on the expense front. The panel indicated that it did not expect community banks and other small lenders to invest in costly new models — and that regulators, by extension, should not expect them to either. Instead, community lenders will be able to continue using spreadsheets and their own personal experience with borrowers and local market conditions to make projections.

“That was important,” James Kendrick, vice president of accounting and capital policy at the ICBA, said in an interview. “They don’t expect community banks to use exhaustive, expensive and unprecedented resources to calculate the allowance going forward. … We think it’s a solution that’s very doable.”

In short, the ICBA claimed a win in the fight against one of the elements that bankers fear about CECL. “We think they (FASB) are listening to community bank concerns,” Kendrick said.

But that is not the universally held view.

“Allowing each bank to come up with its own model is a horrible, horrendous, and horrifying idea.”
  –– Jon Winick, CEO of Clark Street Capital

Winick, for one, said in a report for clients that the FASB concession actually would make CECL worse from the perspective of investors and others who try to compare banks — an original goal posited by the FASB when it first introduced the change some five years ago. It also could create industry-changing competitive issues.

“Allowing each bank to come up with its own model is a horrible, horrendous, and horrifying idea,” Winick wrote. “How could one possibly compare one bank to another when each bank gets to make its own predictions of future losses?

“At least today,” he continued, “all banks do it basically the same way. …  Imagine the market disruptions when one bank uses a conservative model to predict future losses, while its top competitor uses an aggressive model, and is able to price loans far more favorably.”

At a Hovde Group conference this month, several community bankers privately echoed those sentiments.

In the interview, Winick put it this way: “Right now, we have everyone speaking English with some regional dialects. But this change would create dozens of languages with no good way to interpret any of them.”

As such, he added, “It’s a disastrous idea.”

And, of course, it does not address bankers’ overriding concern: That predicting loan losses on 10-year business loans, or worse, on 30-year mortgages is all but impossible to do. Critics say forcing banks to make such projections, and then requiring them to set aside upfront allowances for possible future losses would accomplish two things: Require banks to absorb big hits early as they work to comply with the change, and secondly, send a false message to investors that the loan-loss projections are something more than guesswork.

“It’s really a horrible, horrible principal,” Joseph Stieven, chairman and CEO of Stieven Capital Advisors, said at the Hovde conference. The bank investor was speaking to a hall full of mostly community bankers, and his words were met with applause and cheers.

Boenning & Scattergood bank analyst Matthew Schultheis offered a similar bottom-line assessment, calling it “an abomination to the rational mind.”

The FASB’s proposed change is an attempt to help banks bolster their allowances to better guard against future downturns — and many in the industry, including Winick, say that’s an admirable goal.

But CECL “is a strange way to go about it,” Winick said. “It’s the wrong way.”

The FASB’s board is scheduled to meet April 27 to further discuss the costs and benefits of CECL. Board members are also slated to discuss the effective date of the change. The latest publicly discussed timeline calls for CECL to take effect in 2019 for publicly traded companies and 2020 for others.

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