June 3, 2019

Banker & Tradesman

CECL Expected to Have Little Impact on Community Banks’ Reserves

Lack of Historical Losses, Stable Investment Landscape Are Key Factors in New England


Since the Financial Accounting Stan­dards Board first instituted the new current expected credit loss rule in June 2016, the banking industry has been deeply concerned over the impact CECL would have on total reserves and capital.

And for some of the larger players, these con­cerns could prove true – JPMorgan Chase re­ported in February that it expects to see a $5 billion increase in its total reserves under CECL, representing a 35 percent jump from total re­serves in 2018.

But after first quarter earnings community banks, especially those in the Northeast, are sing­ing a different tune. Many expect their reserves under CECL will be the same, if not smaller, than under the current incurred model, even as some observers reckon the economy is closer to a down­turn than at any other time in the current cycle.

“When we run the portfolios – and we have done this hundreds of times now – most people are within a standard deviation of where they     cur­rently reserve,” said William Mercer, managing director of Boston-based DebtX, a company that offers a CECL analytics solution mainly for com­munity banks. “Some people are a little higher, some people are a little lower. … In New England, we’ve seen fewer outliers actually.”

Banks currently recognize their loan losses through an incurred model. When an event oc­curs that impairs a loan and causes it to lose value, the bank reflects this on their financial statements. Under CECL, which goes into effect for stock banks in 2020, banks will essentially have to forecast losses on the life of a loan and an­ticipate which loans are likely to become impaired based on detailed data.

Mercer’s findings have certainly rung true for stock banks in Massachusetts that have discussed CECL publicly.

“We don’t have a number nailed down yet, but your instinct seems to pan out in that the CECL model may not be as big of a number as was origi­nally intended and thought about in the industry,” Chris Oddleifson, president and CEO of Rock­land Trust and the bank’s parent company, said on a recent earnings call.

Michael Dvorak, CFO and executive vice presi­dent at Wellesley Bank’s nearly $870 million-asset parent company, told Banker & Tradesman ear­lier this year that he essentially came to the same findings. Based on the work completed thus far, loan loss allowances under CECL should be close to what they are now, he said.

Few Historical Losses to Model On

Modeling CECL’s impact requires going back through past data and looking at historical loan loss patterns – but many community banks don’t have many historical losses.

“If you weren’t one of the bad boy banks that had a lot of losses back in the last downturn, it’s nigh-on impossible to back-test a model and get a model validated,” Mercer said. “Smaller banks in New England don’t have many losses to look at over time and if you do have them, they are natu­rally clustered around the downturn. There is no full cycle of losses to go look at.”

Carl Carlson, CFO of Brookline Bank’s parent company, said on a recent earnings call that the lack of actual losses has presented a challenge as the bank has been modeling for CECL.

“How you calibrate for the market and for the in­dustry and everything else is something that we will continue to be working through because if we actu­ally used our own historical loss data, no one would believe what the reserves should look like,” he said.

“I’d tell you it’s painful,” added Brookline’s CEO Paul Perrault, regarding preparation for CECL. The lack of expected change in reserves has dumbfounded some surprised to see such little impact.

“Isn’t it ironic that we are probably closer to a downturn than we have ever been, and some fairly sizable institutions are talking about reduc­ing their reserves as a result of a rule that was intended to strengthen the industry,” Matthew Breese, a managing director at Piper Jaffray, re­marked on a recent earnings call.

Why New England Is Stable

Although the majority of community banks nationwide are projecting very little change in their reserves under CECL, Mercer said the struc­tural layout of real estate in New England is what makes community banks in the region even more stable.

“New England just doesn’t tend to have the volatility that other parts of the country had,” he said. “We have pretty strict zoning and most of our available land is built out. There is not a lot of room to get in trouble. Compare that to some­where like Las Vegas, where you can go 50 miles outside the city, buy a big bunch of dirt, build a ton of houses and hope people buy them. We just didn’t experience that.”

Mercer does not downplay the huge change that the new rule brings.

CECL changes the accounting and when the accounting changes, so too does the methodology and the process of calculating a bank’s reserves, he said. Ultimately, the rule still provides value de­spite its limited impact on some banks’ reserves.

“FASB wants a safe and sound banking and lending system. It wanted people to take a hard look at their portfolios to make sure lending deci­sions were sound and I think this accomplishes it in many ways because so much of CECL depends on an institution’s loss history,” he said.

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