Pub. 5 2015-2016 Issue 4

22 O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S - H E L P I N G C O L O R A D A N S R E A L I Z E D R E A M S Read Between the Lines Each month Bank Insights reviews news from regulators and others to give perspective on regulatory challenges. Community Banks Should Use Stress Tests to Assess Capital Needs Stress tests can be valuable to community banks to assess “adequate capital needs for their exposures and market condi- tions,” according to the community bank performance panel at the third annual Community Banking Research and Policy Confer- ence, hosted by the Federal Reserve System and the Conference of State Bank Supervisors. CSBS has been a proponent of commu- nity bank stress testing since 2010, when it issued a white paper advocating stress testing for community banks as “a fundamental part of this new era of risk management.” Survey Finds Potential Compliance Cost of $4.5 Billion Community banks have been complaining for years about their increasing regulatory bur- den, but no one has been able to calculate the cost – until now. A survey of community banks, conducted by the Fed and CSBS as part of its Community Banking in the 21st Century confer- ence, found that the “hypothetical compliance cost” could be $4.5 billion a year. That’s because banks in the survey report- ed that regulatory compliance made up 11 percent of personnel expenses, 16 percent of data processing costs, 20 percent of legal, 38 percent of auditing and accounting, and 48 percent of consulting expenses – or 22 percent of their income. The report does not indicate whether the costs outweigh the benefits, or whether they are even high or low, but it does note that “they are suffi to frustrate bankers.” Loan Growth Misleading, Auto Loans a Red Flag: OCC’s Curry While loan growth at community banks may be strong, that doesn’t mean there isn’t trouble on the horizon, Comptroller of the Currency Thomas J. Curry said in a speech at the Exchequer Club on October 21. That’s because credit quality “refl the outcome of decisions made when loans are originated, perhaps months or years earlier, possibly under tougher standards than those in eff today. So the indica- tors that many are looking at most closely actually say little or nothing about the risk now embedding itself in bank portfolios,” he warned. Curry also warned about dangerous trends in auto lending, which made up more than 10 percent of retail credit at OCC-regulated banks at the end of the second quarter. Many banks are packaging auto loans into asset-backed securities, much like mortgage-backed securities were sold prior to the financial crisis. “Today, 30 percent of all new vehicle financing features maturities of more than six years, and it’s entirely pos- sible to obtain a car loan even with very low credit scores. With these longer terms, borrowers re- main in a negative equity positionmuch longer, exposing lenders and investors to higher potential losses,” Curry warned. “How these auto loans, and especially the non- prime segment, will perform over their life is a matter of real concern to regulators. It should be a real concern to the industry.” CFPB Says Banks have Insufficient Data on Student Loans Student loan debt, which is now more than $1.2 trillion, “continues to show elevated levels of distress,” the Consumer Financial Protection Bureau writes in a report calling for reform of student loan servicing and increased standards. The CFPB es- timates more than one out of four borrowers are delinquent or in default on student loans. One problem is the lack of data. Banks lump student loans with other types of non-mortgage credit products, which hampers oversight and limits policymakers, the CFPB said. DIF Increase Means Community Bank Assessments to De- cline Banks with assets of less than $10 bil- lion should have lower assessments when the Deposit Insurance Fund reserve ratio reaches 1.15 percent, which is expected early next year, the FDIC said. The FDIC board has proposed increasing the fund to its statutorily-required minimum level of 1.35 percent. Banks with assets above $10 billion will pay for that increase with a surcharge of 4.5 cents per $100 of their assessment base.  CECL Will Focus on Forward- Looking Forecasts BY RICHARD MURPHY, INVICTUS EXECUTIVE ADVISOR One of the most vexing issues to come out of the financial crisis for banks, regulators and accounting boards was the way banks recognize impairments to loans and debt securities. It was painfully apparent that methodologies to estimate losses proved to be highly inadequate, inaccurate and untimely. By 2012, the Financial Accounting Standard Board’s model for accounting for ALLL, which focused on historical views on “incurred losses,” was deemed unreliable. Losses mushroomed during the crisis years, and delayed recognition of the losses caused pain for banks and investors alike. In response, FASB in December 2012 issued a number of draft proposals to address the need for more timely recogni- tion of credit impairment and more accurate determination of “estimated” allowance for credit losses. FASB’s draft proposal, “ASU Financial Instruments-Credit Losses – Subtopic 825-15” ushered in an ALLL model based on “current expected credit losses,” better known as CECL. The board is expected to draft the final standard in the first quarter of 2016. Under the proposed CECL model, a bank would recognize as an allowance its estimate of the contractual cash flows not expected to be collected. Unlike the incurred loss model, the CECL model does not specify a threshold for the recognition of an impairment allowance. Rather, a bank would recognize an impairment allowance equal to the current estimate of expected credit losses for financial assets as of the end of the reporting period. Under CECL, a bank’s expected credit losses represent all contractual cash flows that the bank does not expect to collect over the contractual life of the financial asset. To make their ALLL estimates under CECL, banks will need to look at the economic conditions at the time of the loan, as well as forward-looking forecasts of what could happen during the life of the loan. One tool for banks that may become essential is vintage anal- ysis, according to an April 2015 American Bankers Association Discussion paper. It suggested that “vintage analysis, whereby loan portfolios are broken out into cohorts by each issuance year, could become a minimum requirement in order to support the ALLL estimate under CECL.”  RichardMurphy, a former FDIC team leader, has spent 30 years in the banking industry