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CECL: Expect the unexpected

New loan loss concept doesn’t fit community banking

From the “Examiner from Hell” to “The director time forgot,” attorney-consultant Jeff Gerrish knows community bankers’ challenges, and uses his blog to provide practical advice and awareness. From the “Examiner from Hell” to “The director time forgot,” attorney-consultant Jeff Gerrish knows community bankers’ challenges, and uses his blog to provide practical advice and awareness.

I am sure all of you by now are aware of the Current Expected Credit Loss proposal—“CECL,” as it is more commonly known.

This is the Financial Accounting Standards Board’s attempt to change the way that banks account for loan losses. As it sits currently, CECL will be applicable to community banks beginning in 2020 and is expected to increase community banks’ ALLL by 30% to 50%.

I personally hope the Financial Accounting Standards Board gains some “perspective” (translated: “common sense”) prior to that time and exempts community banks from CECL compliance.

Only time will tell if that occurs, but for now, this blog will serve as my soapbox for why CECL makes no sense for community banks.

“Your loan is granted. Now, what will we lose?”

The details of CECL are complex, but it is essentially a revised credit loss model that requires all banks to recognize all future credit losses expected over the life of the credit on the day the loan is booked. (The methodology would also apply to debt securities.) 

In order to estimate these future credit loses, community banks will be required to have sufficient systems in place to record and analyze not just historical lifetime (rather than annual) credit loss data, but also current operational and environmental data and reasonable and supportable future expectations related to credit quality and economic conditions.

Oh, and by the way, you cannot simply base expected losses on a worst case scenario or most likely outcome.

Simple, right?

Why CECL should be ceased, for small banks

Other than the fact that no one has a crystal ball, there are a couple of practical problems with CECL.

1. No community banker makes a loan which he or she does not expect to get paid back in full.

The running joke is that bankers never make a bad loan at all— only a good loan that goes bad.

If a community bank only expects to be repaid $800,000 on a $1,000,000 loan, then the most the community bank would even consider funding is $800,000—and likely at a higher rate.

If the bank is doing its job well with respect to underwriting, any circumstances leading to a loss would be unexpected by nature.

Under the current ALLL model, the community bank records a provision expense based on a point-in-time analysis of historical losses for that class of loans and any change of circumstances such that the bank collecting payments in full and on time is no longer probable.

Any provision is based on circumstances related to the specific loan or class of loans on the bank’s balance sheet.

CECL, however, is structured to assume that when a community bank loans money, it is with an existing expectation that a certain portion of that loan will not be recovered based on lifetime historical losses, future economic conditions, and future circumstances.

More conservative? Maybe.

More effective? Not in my opinion.

2. I am concerned that CECL is being pushed and promoted despite the existence of a reasonable alternative for community banks.

It would be one thing if CECL were the only option on the table, and there was no time to come up with something better. But that simply is not the case here. The banking industry has proposed alternatives.

The Independent Community Bankers of America, for example, has presented a reasonable alternative for community banks with less than $10 billion in total assets.

Under the proposed model, those community banks would record expected losses over time based on historical losses for that specific class of credits. If circumstances arise in the future such that a loss is probable, an additional provision would be made equal to the estimated loss at that time.

That model would be much a easier (not to mention cheaper) methodology for community banks to account for credit losses than what is contemplated under CECL.

Time to avoid a smash-up

As I mentioned at the beginning of this blog, I am hopeful that FASB changes its tune prior to 2020. Four years should be enough time to change this pending train wreck—assuming that community bankers are willing to take the fight to FASB.

And now is not too soon.

Community bankers across the nation have and need to continue to band together through grassroots efforts to make a lot of noise with FASB—this year.

The good news is that community banks are gaining a voice. If they continue to increase the volume, I see no reasons why we don’t have a good opportunity to get some relief from CECL.

I plan on using whatever stump I have, this blog included, to argue against it! 

I trust you will do the same.

Jeff Gerrish

Jeff Gerrish is chairman of the board of Gerrish Smith Tuck Consultants, LLC, and a member of the Memphis-based law firm of Gerrish Smith Tuck, PC, Attorneys. He frequently contributes to Banking Exchange and frequently speaks at industry events.

In mid-2016 Gerrish's blog received a national bronze excellence award from the American Society of Business Publication Editors. This followed his receipt of the regional silver excellence award for the Northeastern Region from the same group.

Gerrish formerly served as regional counsel for the FDIC’s Memphis regional office and with the FDIC in Washington, D.C., where he had nationwide responsibility for litigation against directors of failed banks. Since the firm’s formation in 1988, Gerrish Smith Tuck has assisted over 2,000 community banks in all 50 states across the nation with matters such as strategic planning, mergers and acquisitions, common stock private placements, holding company formation and reorganization, and a wide variety of regulatory matters. Jeff Gerrish can be contacted at [email protected]

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