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Sandy Spring deal shows CECL's 'double count' can be more than double

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Sandy Spring deal shows CECL's 'double count' can be more than double

Sandy Spring Bancorp Inc. bought an in-market competitor to leap over the $10 billion asset threshold and offered the industry another data point on how a new accounting standard affects deal metrics.

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The bank agreed to pay $460.7 million to acquire Revere Bank in a 100% stock deal that will push Sandy Spring to $11.2 billion in assets with an expected close date in the first quarter of 2020. By then, the bank will have adopted the current expected credit loss, or CECL, accounting standard that will drastically change how banks provision for loan losses.

The accounting change affects deal metrics, and multiple bankers have said it could affect pricing or how the market evaluates deals. President and CEO Dan Schrider said in an interview that CECL did not change Sandy Spring's price.

"We looked at how it plays out under current accounting standards, and that's how we priced it," he said. At the same time, he said it was important to report how CECL affected deal metrics.

Bankers have focused on how CECL "double counts" the credit marks of certain acquired assets. CECL changes the definition of credit-impaired assets, introducing a new classification known as purchased credit deteriorated, or PCD. The "double count" issue affects non-impaired assets, or non-PCD assets. The acquirer bank has to mark non-PCD assets to fair value, including a credit mark. The acquirer also has to build reserves to cover the expected lifetime of losses, which some bankers have argued to the Financial Accounting Standards Board results in accounting for the assets twice. On Sept. 18, FASB declined to add the issue to its agenda.

In Sandy Spring's case, the bank would have booked a credit discount of about $20 million under current accounting standards. Under CECL, management said, the bank will record credit impacts of $45 million, a 125% increase.

The CECL total includes a $13 million credit mark for PCD loans, a $15 million mark for non-PCD assets and an expected $17 million increase in the bank's allowance for the acquired non-PCD assets. Management said the non-PCD allowance build is expected to be larger than the credit mark due to qualitative and forward-looking factors in its CECL model.

On the deal call, Catherine Mealor, an analyst for Keefe Bruyette & Woods, asked if the $20 million credit mark should be compared to the $45 million total under CECL.

"At the end of the day, that's essentially the answer," CFO Philip Mantua said in response. Replying to a follow-up, Mantua said the acquired portfolio includes about $95 million of PCD assets.

On deal metrics, the CECL impact will increase the bank's expected tangible book value earnback timeline to 3 years from 2.5 years since it increases the expected book dilution to 4.8% from 3.8%. Investors have focused intently on earnback periods and have punished the stocks of banks disclosing lengthy earnback timelines for the deals they announce.

"The challenge is that the investment community has not established, 'How do we think about earnback periods under CECL?'" Schrider said.

The market reaction to Sandy Spring's deal was not positive, with the bank's shares closing the day down 6.76%. Schrider said the selloff could be a short-term reaction.

"I think the market ought to really love this. The metrics — the earnings accretion; the tangible earnback, even with this CECL implication — in one of the best markets in the country. I think the investor community will turn out to like this," he said.

Management expects 45% cost savings, driven in part by significant overlap in branch networks in the Washington, D.C., area. Schrider said the bank plans to consolidate nine branches as part of the deal. The in-market acquisition will also push Sandy Spring significantly past the $10 billion asset threshold that subjects banks to the Durbin amendment, a legal provision that limits interchange income. It is the eighth bank over the last 12 months to cross the asset threshold with a deal.

While cost savings and the asset threshold leap were beneficial, Schrider said the primary driver of the deal was the expectation of delivering revenue growth. Schrider also said there was significant familiarity and comfort with Revere Bank's lenders as talented and rational competitors.

On the prospect of another deal, Schrider said the two years elapsed since the bank's acquisition of WashingtonFirst Bankshares Inc. was a "natural timeframe." He said the bank would continue having conversations with potential targets, both banks and nonbanks, but would be unlikely to pull the trigger on another whole-bank deal as it integrates Revere Bank.

"I think we'll be very focused, specifically from a banking standpoint, on getting this transaction done, integrated and working," he said. "On the fee income side, that would be a little bit different since that obviously requires different resources."