The tough-love message to bankers is getting louder: You would be better served to spend your time and energy preparing for new loan-loss-accounting rules rather than fighting to stop them from taking place.
It is hard advice to hear. The banking industry has been strongly urging the Financial Accounting Standards Board to drop its plans to create a Current Expected Credit Loss standard. Under the proposal, financial institutions would be required to build loan-loss reserves when a loan is made; the current practice is to set aside funds when default is likely. Lenders fear the new method would be costly overkill.
Yet a prominent state regulator and others are arguing that efforts by banks and credit unions – even if federal banking regulators were to weigh in on their side – will be insufficient to change FASB's mind. If so, bankers need to take steps now for what is sure to be a turbulent transition.
"I'm not looking forward to CECL implementation," Ray Grace, the banking commissioner for North Carolina, told attendees at a recent conference hosted by the state's banking association.
Switching to the new standard "will be a real difficult lift for banks," he said in an interview after his remarks.
Grace noted that the proposal – based on FASB's belief that banks were under-reserved heading into the last recession – could prove to be a little late. The rule is not set to take effect until 2019, and the next economic downturn is likely due before then, he said.
While he expects banking regulators to "forcefully express their opposition" to CECL, Grace said he has doubts that such an effort would succeed.
Banking regulators spent years unsuccessfully battling the Securities and Exchange Commission's "incurred loss" reserve model that requires bankers to document their reasoning for loan-loss provisions, often using historical loss rates.
Banking regulators had encouraged institutions to be more subjective, in case recent historical loss rates proved overly optimistic, while the SEC asserted that banks were abusing the process to manage earnings. Ultimately, the SEC's view won out.
Keeping that experience in mind, Grace said his office is focused on education efforts with a goal of getting North Carolina-chartered banks "in a position to comply."
Banks need to begin looking at their systems and methodologies now, industry experts said at the North Carolina Bankers Association's annual directors' assembly. A key part of that preparation should involve aggregating data.
"Bring in as much data as you can," Walter McNairy, a lawyer at Dixon Hughes Goodman in Raleigh, N.C., said during his presentation on CECL. "Go back as far as you can go. You might want to go back to the recession when you had high chargeoffs to gather than data."
McNairy recommended that bankers bring in interns – or hire an outside firm – to collect data that includes historical loss and chargeoff rates, along with information on delinquencies and loan grades.
Noting that a number of smaller banks still use Excel spreadsheets to model losses, McNairy suggested that those institutions hire an outside consultant to review their procedures and determine whether they are adequate.
Other data points worth analyzing include historical real estate values, unemployment rates and commodities prices in areas such as agriculture and energy, McNairy said.
Community bankers are concerned that CECL could force them to use complex and expensive economic modeling to determine reserves.
Other concerns exist.
The research team at Keefe, Bruyette & Woods estimated in an October note that the smallest banks it covers could experience a 3% median increase in reserves if CECL had been implemented at that time, compared with 8% for regionals and 13% for the biggest banks. The analysts determined that the median book value hit for all banks they cover would be about 0.4%
Uncertainty around the proposal is unnerving, Bill Wubben, president of Apple River State Bank in Illinois, said during a recent interview at the Independent Community Bankers of America's annual conference. The ICBA and the American Bankers Association have been fighting the proposal.
Apple River could take a hit to capital if it has to use retained earnings to pad reserves, Wubben said, adding that the $297 million-asset bank may also have to hire a consultant to help it navigate the process.
McNairy, the lawyer, did not weigh in on any modeling mandates, though he noted that one of his clients had been quoted $75,000 to hire a vendor to do the job. That quote excluded annual maintenance fees and any costs a bank might incur if it decides to terminate the agreement.
Still, McNairy said, there could be some benefits to using an outside provider.
"Vendors will have data from numerous clients," he said. "Without giving competitors' names, those firms can still help banks identify if their numbers are outliers compared to other banks in their area."
Jackie Stewart contributed to this article.