U.S. banks and credit unions, preparing for proposed changes to how they must estimate credit losses, anticipate they'll eventually need to boost allowances for loan and lease losses by up to 50 percent, according to a new survey by Sageworks, a financial information company.
Among more than 300 bankers surveyed during a webinar, 87 percent said they expect an increase of up to 50 percent to these rainy-day type funds under a credit-loss model proposed by the Financial Accounting Standard Board, the independent body responsible for establishing generally accepted accounting principles. Only about 11 percent of those surveyed expected no impact to the reserve if the board adopts the leading proposal.
Higher allowances for expected loan and lease losses (called the ALLL) would have pros and cons - for financial institutions, business customers, individuals and shareholders, said Sageworks analyst Regan Camp. "The ALLL is probably one of the most, if not the most, important estimates on a bank's balance sheet, because ensuring you have adequate reserve levels is essential to a bank's safety and soundness," he said. At the same time, as banks reserve more capital for expected losses, they have less available to lend, which means they have less available with which to generate earnings - something shareholders might not like.
The expectations among bankers surveyed by Sageworks are consistent with an earlier poll by Sageworks and with previous comments by Comptroller of the Currency Thomas Curry. Curry in September told a banking conference that implementing the FASB proposal would require most banks to boost allowances, probably around 30 to 50 percent.
Having less unreserved capital could also tighten credit availability and potentially affect loan terms for businesses and individual customers, Camp said. That's because financial institutions, which now estimate the upcoming year's losses on a loan based on a historical review of at least one year of past performance, would have to project losses (and make reserves) based on expected losses for the life of the loan - whether that's one year, five or 30. From the financial institutions' perspective, Camp said, "The higher the risk of the loan, the more the reserve's going to be, and more capital is tied up that I can't make money from."
"The bank's going to look extra close at that loan when it goes through underwriting."
Survey participants were volunteers drawn from those attending a webinar hosted by Sageworks, which provides risk management solutions and consulting services to financial institutions. About half of the webinar participants represented banks and credit unions with assets of less than $500 million, and 36 percent represented institutions with assets topping $1 billion. The remaining 16 percent had total assets between $500 million and $1 billion.
Assuming the current proposal is finalized this year ("and that's a big 'if'," Camp said), financial institutions might have a year or so to implement changes to ALLL calculations, including the ability to gather and compute what Sageworks estimates will be up to 1,000 times more data on loans than they're currently collecting. Many financial institutions are trying to determine how and when to make changes, something that's particularly challenging for smaller banks and credit unions, which may have fewer resources at the ready and which may be impacted relatively more if big swings in reserves are ultimately required, Camp said.
Meanwhile, the OCC has warned banks not to reverse their reserves too quickly and count that income toward earnings, even if loss rates have been declining compared with historical rates as the economy and borrower health has improved. Instead, Camp said, banks are being encouraged to hold onto some unallocated reserves in light of uncertainty in the economy. Holding onto reserves might also benefit banks as they grapple with the uncertainty tied to the FASB changes, Camp said.
That's something shareholders can be assessing now, Camp said. "Is your bank one that's recognizing these excess reserves as income when they report earnings, and if so, is that maybe of concern to you? Or are they holding onto these in anticipation of this new requirement? " he asked.