Why some small banks are taking their CECL lumps now

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Many banks were forced to make hard choices in the first quarter when calculating loan-loss provisions.

The first decision involved the Current Expected Credit Losses standard, which requires provisions when loans are originated. While the coronavirus rescue package passed late last month provided a short-term reprieve from CECL, a large number of publicly traded banks opted to go ahead and comply.

For those banks, the next decision involved the size of their provision.

Predicting losses in the run-up to a fast-approaching recession of uncertain duration involves as much guesswork as traditional forecasting, industry observers said. Analysts, by and large, said they favor the banks that chose to go ahead and set aside substantial sums of money to cover potential credit issues.

“Some banks are trying to be as accurate as they can for this quarter, knowing what we know now,” said Brad Milsaps, an analyst at Piper Sandler.

“Others are saying it is better to get the provisions built up as much as possible, and reverse them out later if you need to,” Milsaps added. “I think the latter is what more people are wanting to see.”

Home BancShares in Conway, Ark., chose to comply with CECL and absorb more financial pain now rather than drag it out over several quarters, relying heavily on projected 12.5% national unemployment to determine its provision.

The company set aside $87 million in the first quarter, including $72 million to specifically address fallout from the coronavirus outbreak. Its loan-loss allowance increased to 2.01% of total loans from 0.94% a quarter earlier.

“We're going to get it behind us if we can get it behind us,” Johnny Allison, Home’s chairman and CEO, said during the $15.5 billion-asset company’s quarterly earnings call.

“I like our book about as well as I've ever liked the book,” Allison said before observing that he had just endured the “strangest” quarter in his 50-year business career.

Though Home barely eked out a profit, its stock is up 4% since it reported results.

Several other banks, including Peoples Bancorp in Marietta, Ohio; Bryn Mawr Bank in Bryn Mawr, Pa.; and Triumph Bancorp in Dallas, reported quarterly losses after recording large CECL- and coronavirus-related provisions.

“We believe that moving forward with the adoption of CECL was the most appropriate path to take,” Chuck Sulerzyski, Peoples’ president and CEO, said during the $4.4 billion-asset company’s earnings call. “Prolonging the inevitable was not something we wanted to keep addressing in the future quarters.”

Peoples set aside $17 million, boosting its allowance to 1.47% of total loans from 0.75% at the end of 2019.

The decisions highlight a banker's thought process rather than predict that specific losses will occur, industry observers said.

“As we progress further through this earnings season, it’s becoming evident to us that [first-quarter] results seem more a function of a company’s initial approach to this crisis as opposed to an early read of … problematic exposure and likely ultimate loss content,” Joseph Fenech, an analyst at Hovde Group, wrote in a recent client note.

CECL also played a big role in how adopters approached their provisions.

First Horizon Financial in Memphis, Tenn., recorded a $145 million provision, a spike from $13.4 million a year earlier, to reflect a “sudden, steep decline” in economic conditions. The provision contributed to an 85% decrease in profit from a year earlier, to $16.6 million.

CECL’s life-of-loan requirements contributed to the higher provision, B.J. Losch, the $47 billion-asset company’s chief financial officer, said in an interview.

“The world changed” in the first quarter, Losch added, though he hopes federal stimulus efforts such as the Paycheck Protection Program and bankers’ proactive efforts to help borrowers will soften the economic blow.

“We’ll probably need another 90 days, maybe 120 days, to get a better sense of how well these things are working,” Losch said.

Industry experts agreed.

“We may likely be [three to six] quarters out from fully understanding if the extensive fiscal and monetary stimulus is enough to bridge both the consumer and the corporate borrower to the other side of this crisis,” Laurie Havener Hunsicker, an analyst at Compass Point, wrote in a recent client note.

As a result, some banks are taking a more incremental approach to the loan-loss allowance.

While Western Alliance in Phoenix set aside $51 million, or more than 10 times its average quarterly provision in 2019, its allowance covers roughly 1% of a loan book that includes exposure to hotels, casinos and other businesses harmed by the pandemic.

Net income fell by 30% from a year earlier to $84 million, and executives warned that an extended shutdown of the economy could spur another reserve build in the second quarter.

Economic predictions “change almost by the hour,” Dale Gibbons, Western Alliance’s vice chairman and chief financial officer, said during the $29 billion-asset company’s earnings call.

Community Bank System in De Witt, N.Y., may also need to set aside more money after recording a $5.6 million provision in the first quarter, Chief Financial Officer Joseph Sutaris said when analysts asked why the company wasn't more aggressive.

“We're going to be evaluating observed data with respect to delinquency and migration of risk ratings and those types of factors,” Sutaris said, adding that executives made the best assessment possible at this point.

The $11.8 billion-asset company’s profit fell by 4.5% from a year earlier, to $40.1 million.

A large part of decision making involves subjective views of the same data, industry experts said. Executives at Home and Western Alliance said they both reviewed April assessments by Moody’s that projected a steep recession and soaring unemployment.

Many other issues remain unclear, including the impact of federal stimulus and the future performance of loans that were modified or granted forbearance, industry experts said.

“Will the borrower who has received payment relief or forbearance eventually return to fully performing status or become a” net charge-off? Hunsicker said.

It “may be smart” to record a big upfront provision, said Damon DelMonte, an analyst at Keefe, Bruyette & Woods. “But because it’s so hard to make a reliable forecast in this environment you do run the risk of the provision being too severe.”

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Credit quality Community banks Earnings CECL Coronavirus
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