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Banks hint at product changes as CECL impact comes into focus

With less than two months to go before many banks have to overhaul the way they account for credit losses, several have issued estimates showing big jumps in credit loss allowances.

The increases, which will hit balance sheets at large, publicly traded banks Jan. 1, 2020, are a result of the requirement that creditors set aside money for lifetime losses. This differs from the current approach, under which provisions are made when losses become probable. In particular, the projected increases are being driven by consumer portfolios, which typically have longer lifetimes than commercial portfolios. In fact, a few banks have projected that allowances for commercial portfolios will decline under the new accounting standard.

Ongoing provisioning, sometimes called the Day 2 impact, could also be higher under the current expected credit loss standard. If lenders expand portfolios that have larger allowance requirements under CECL than before, future set-asides will also have to be larger to maintain higher allowance ratios. For example, if portfolios stay the same size and allowance ratios, which are determined in part by economic forecasts, remain stable, lenders would just have to replenish charge-offs.

These dynamics — the varying impact based on loan duration, and potentially from relative growth in different loan portfolios — have led some banks to hint that they or their competitors might tweak product design, portfolio mix and other practices, even if the economics of the lending business are unchanged.

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Umpqua Holdings Corp. has said CECL could result in "possible changes to pricing."

"It is a general statement around the portfolio in total" and the industry, CFO Ronald Farnsworth Jr. said during the company's third-quarter earnings call.

In addition to price changes, Farnsworth said lenders could shorten the length of loan terms. But, he added, "I don't think anything has been hard and fast in the market yet. I'm expecting we won't see any movement on that front until early 2020."

Umpqua estimated that its total allowance could jump 30% to 45% on Jan. 1, 2020, with a 105% to 115% increase for its lease and equipment finance portfolio and as much as a 15% decrease for other commercial loans. Farnsworth said Umpqua's lease and equipment finance arm produces strong returns, and the bank does not expect to change the way it approaches the business because of CECL.

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Huntington Bancshares Inc. and Citizens Financial Group Inc. made similar comments, with Huntington saying CECL will increase its focus on "relationship" products in the mortgage business, and Citizens saying it might "tweak" how it designs loans because of the new accounting standard.

"There may be certain product twists that we're offering a longer duration version of a loan, but it may not make as much sense," Citizens Chairman, President and CEO Bruce Van Saun said on the bank's third-quarter earnings call.

Vice Chairman and CFO John Woods elaborated on Citizens' CECL views during a conference presentation Nov. 8, saying the standard would lead the bank to optimize maturities within loan categories.

"Long duration loans have just been assigned a capital surcharge. And so we can't ignore that," he said. "We want to think about this as purely accounting, but it's not."

Both Huntington and Citizens traced their anticipated CECL allowance builds to retail loans, with Huntington projecting a 160% to 180% increase for its consumer portfolio.

Some lenders have asserted that they have no plans to alter their strategies or tactics even as CECL introduces new considerations. On the third-quarter earnings call for the auto finance company Santander Consumer USA Holdings Inc., an analyst asked whether the accounting change would make loan modifications easier since lifetime reserves are already required for troubled debt restructurings.

Modifications are "an important way of helping consumers that deserve the help to get back on track," President and CEO Scott Powell replied. However, he said, "We wouldn't view that kind of activity in the context of accounting optimization."

Santander Consumer estimated that its allowance will increase by 55% to 70% under CECL.

On Capital One Financial Corp.'s third-quarter earnings call, CFO Richard Blackley said categorically that "CECL is not going to change the way that we approach our businesses and how we conduct the business of lending."

Capital One estimated a 30% to 40% increase in its allowance because of the new accounting approach.

Nevertheless, Blackley suggested that CECL could have a profound impact during a deep downturn.

"In periods of stress, in a deep recession, I continue to be worried that CECL will make it more difficult for the banking industry to lend when you have to record lifetime expected losses before you get to record any of the related revenue," he said. "And so I'm anxious about that."