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Fed officials say flexibility built in for small banks to comply with CECL

Kevin Dobbsis a senior reporter and columnist. The views and opinions expressed in thispiece represent those of the author or his sources and not necessarily those ofS&P Global Market Intelligence.

AFederal Reserve official says regulators will rely heavily on common sense asthey work to ensure community banks comply with a major shift in loan-lossaccounting, and a study by Fed economists concludes that examiners have ahistory of providing small lenders necessary latitude in their efforts to meetaccounting standards.

"Werealize that small banks have several differences from the larger banks," Julie Stackhouse, senior vice president of bankingsupervision and regulation at the Federal Reserve Bank of St. Louis, said in aninterview.

She noted that community banks are generally simpler innature — often focused primarily on conventional lending and deposit-gathering— than their bigger, more diverse brethren. As such, regulators have and expectto continue to weave this thinking into their training of bank examiners, whowill work directly with lenders to make sure they understand and can complywith the Financial Accounting Standards Board's recently finalized model for projecting and reserving forloans losses.

Additionally,economists at the St. Louis Fed concluded in a recent study that, whenregulators determine whether banks operate within GAAP parameters, smallerlenders have historically been afforded more leeway than big banks.

Studyingthousands of samples from regulators' annual observations of banks between 2006and 2015, the economists found "that correlations of provisions for loanlosses and subsequent charge-offs, which are expected under regulatoryguidelines, are weaker for smaller banks and that, further, the weakercorrelations of smaller banks do not necessarily constrain them fromachieving" satisfactory performance ratings.

"Weconsider this to be evidence of a 'scaling' in accounting oversight," theywrote in a report."It is relevant to the enforcement of former, current and futurestandards" established by the FASB.

At issue now is the FASB's plan, and approved in June, totransition the banking and credit union industries away from their currentloan-loss model — one based on incurred losses — and toward anexpected-loss model, under which lenders will forecast losses for the entirelife of a loan. Under the so-called Current Expected Loss Model, or CECL,lenders would use these forecasts, along with data on historic losses and otherfactors, to set aside allowances to cover all anticipated losses at origination.

The new rule goes into effect in 2020 for some institutions and 2021 for others.

Noting that lenders were surprised by the depth and breadthof the last recession, and therefore forced to hastily ramp up allowances tocatch up with surging losses that created wild swings in earnings, the FASBsaid the accounting change would help banks more proactively address possiblelosses. The change is aimed at enabling banks to better fortify allowancesduring normal periods and to ensure they are not caught off guard if anothersudden downturn strikes.

Community banks, however, have loudly expressed about the change. Amongtheir biggest worries is a fear that major national and regional banks willcreate complex — and expensive — computer models to handle the long-termforecasting work. Small-bank executives say their institutions could not affordthis and would struggle to comply if bigger banks establish a path that smallones must follow.

But in releasing the final CECL rule, the FASB said smallbanks will not be required to implement any one approach to comply. Therules-maker indicated that small lenders would not need to invest in costly newmodels — and that regulators, by extension, should not expect them to either.Rather, community lenders can use methods that best suit them, the FASB said.

James Kendrick, vice president of accounting and capital policy at theIndependent Community Bankers of America, said after CECL was finalized thatthe formal nod to small lenders was vital. He said that community banks nowneed to make sure that the ways in which they plan to comply with CECL meshwith their regulators' expectations.

"Thebank regulators' role is really just now beginning," Kendrick said in aninterview. "There will have to be a lot of outreach to regulators. Yes, wehave time to figure this out, but it is going to take time."

Stackhouse said regulators have taken note of the FASB's final guidance regardingsmaller banks and have incorporated it intotheir own planning. "There is a lot of judgment involved," shesaid.

Drew Dahl — one of the St. Louis Fed economistswho studied regulators'tendency to provide community banks greater "flexibility" inaccounting compliance, as he put it — said history suggests the same woulddevelop as banks embark on the multiyear process of figuring out how to workunder CECL.

Andrew Meyer, another St. Louis Fed economist,said that while shifting to CECL is certainly a tall order for community banks,in the long run, the more forward-looking banks can be, "the better off thesystem."