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Tweak to FASB loan-loss rule could prove 'a disastrous idea'

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Tweak to FASB loan-loss rule could prove 'a disastrous idea'

Kevin Dobbs isa senior reporter and columnist. The views and opinions expressed in this piecerepresent those of the author or his sources and not necessarily those of S&PGlobal Market Intelligence. Follow on Twitter @Kevin1Dobbs.

Communitybanks' chief lobbying group hails it as a victory,but other observers call a recent Financial Accounting Standards Board concessionaimed at easing the anticipated tumult of a change to the way lenders build up loan-lossallowances a big mistake.

"It'sjust such a bad idea that it's laughably bad," Jon Winick, CEO of bank consultancy Clark Street Capital, said in an interview, pointinghis criticism at FASB.

At issueis the FASB's plan to move the banking and credit union industries away from theircurrent loan-loss model — one based on incurred losses— and toward an expected-loss model, under which lenders would forecast loan lossesyears into the future and, notably, set aside allowances for such projected lossesat origination. The FASB has said one goal is to enable banks to fortify allowancesduring normal periods so that when downturns strike, they are not caught off guardand left to hastily ramp up allowances to catch up with mounting losses inducedby a recession, such as happened in the aftermath of the 2008 financial crisis.The change also is aimed at minimizing the likelihood of wild earnings swings andproviding investors more transparency.

Amid larger industrywideworries about the feasibility of making projections for the life ofmultiyear loans — and whether banks will ultimately have to focus mostly on short-termloans because accurate forecasts for longer ones would essentially be impossible— community bankers also raised concernsabout costs.

They have said that many big banks would use complex computermodels to handle their forecasting work to comply with the FASB's so-called CurrentExpected Loss Model, or CECL, which is expected to be finalized around midyear.Often, these bankers noted, when Wall Street firms and megabanks take the lead onaddressing change, regulators tend to pass down an expectation that smaller lendersfollow their lead. Doing so in the case of CECL would require major investmentsin new technology that many small banks have said they cannot afford.

Addressing those concerns, a FASB panel earlier this month issueda new CECL draft that the ICBA interpreted as an accommodation on the expense front.The panel indicated that it did not expect community banks and other small lendersto invest in costly new models — and that regulators, by extension, should not expectthem to either. Instead, community lenders will be able to continue using spreadsheetsand their own personal experience with borrowers and local market conditions tomake projections.

"That was important," James Kendrick, vice presidentof accounting and capital policy at the ICBA, said in an interview. "They don'texpect community banks to use exhaustive, expensive and unprecedented resourcesto calculate the allowance going forward. … We think it's a solution that's verydoable."

In short, the ICBA claimed a win in the fight against one of theelements that bankers fear about CECL. "We think they (FASB) are listeningto community bank concerns," Kendrick said.

But that is not the universally held view.

Winick, for one, said in a report for clients that the FASB concessionactually would make CECL worse from the perspective of investors and others whotry to compare banks — an original goal posited by the FASB when it first introducedthe change some five years ago. It also could create industry-changing competitiveissues.

"Allowingeach bank to come up with its own model is a horrible, horrendous, and horrifyingidea," Winick wrote. "How couldone possibly compare one bank to another when each bank gets to make its own predictionsof future losses?  

"Atleast today," he continued, "all banks do it basically the same way. …  Imagine the market disruptions when one bank usesa conservative model to predict future losses, while its top competitor uses anaggressive model, and is able to price loans far more favorably."

At aHovde Group conference this month, several community bankers privately echoed thosesentiments.

In theinterview, Winick put it this way: "Right now,we have everyone speaking English with some regional dialects. But this change wouldcreate dozens of languages with no good way to interpret any of them."

As such, he added, "It's a disastrous idea."

And, of course, it does not address bankers' overriding concern:That predicting loan losses on 10-year business loans, or worse, on 30-year mortgagesis all but impossible to do. Critics say forcing banks to make such projections,and then requiring them to set aside upfront allowances for possible future losseswould accomplish two things: Require banks to absorb big hits early as they workto comply with the change, and secondly, send a false message to investors thatthe loan-loss projections are something more than guesswork.

"It'sreally a horrible, horrible principal," JosephStieven, chairman and CEO of Stieven Capital Advisors, said at the Hovde conference.The bank investor was speaking to a hall full of mostly community bankers, and hiswords were met with applause and cheers.

Boenning & Scattergood bank analyst Matthew Schultheis offered a similar bottom-lineassessment, calling it "an abomination to the rational mind."

The FASB's proposed change is an attempt to help banks bolstertheir allowances to better guard against future downturns — and many in the industry,including Winick, say that's an admirable goal.

But CECL "is a strange way to go about it," Winick said."It's the wrong way."

The FASB'sboard is scheduled to meet April 27 to further discuss the costs and benefits ofCECL. Board members are also slated to discuss the effective date of the change.The latest publicly discussed timeline calls for CECL to take effect in 2019 for publicly traded companies and 2020 for others.