By Ray Birch
TAMPA, Fla.—There are many concerns among credit unions when it comes to the new CECL rules, and the biggest may well be CUs reacting by unnecessarily tightening lending standards to adjust to the new accounting rule, according to Bill Hampel.
In addition, the former CUNA chief economist, now an economic consultant, is encouraging credit unions to allow for a lower capital ratio target since CECL will likely reduce net worth. Hampel emphasized the net worth reduction is simply due to accounting changes due to CECL and is not a reflection of a credit union’s overall performance.
The compliance deadline for CECL, the Financial Accounting Standards Board’s new Current Expected Credit Loss model, is expected to arrive in early 2020.
“Two things concern me the most,” said Hampel. “The first thing is that under CECL, credit unions—all things being equal—will likely have to hold larger loan loss allowances for any given portfolio.”
But Hampel stressed the larger allowances post-CECL do not signify poorer credit quality and that the same level of credit quality exists in portfolios present before CECL.
“In other words, CECL will make it appear that the riskiness of the loan portfolio has increased,” said Hampel.
Measuring the Kids
Hampel compared CECL accounting to changing measurement “tick marks” on a ruler.
“It’s like if you used a ruler to measure your kids’ height. Say they are four feet tall yesterday, but today you change the marks on the ruler and get different height readings,” he said. “Your kids are the same height, it’s just that the tick marks on the ruler have changed. So, no true difference in your kids’ height.”
Hampel said it is commonly believed that after CECL is enforced, again, with all things being equal, loan loss allowance accounts will be larger. He noted, however, that most analysts have moved away from the early thinking that CECL would dramatically send loan loss reserves higher.
“Reserves won’t be doubling,” said Hampel, who is also now a board member at Floridacentral CU in Tampa. “While those initial estimates have come way down, still most people think the allowance accounts will have to increase from where they would otherwise have been under current GAP.”
The Need to be ‘Very Careful’
Hampel hopes credit unions, given their conservative nature, do not tighten lending standards to get allowance accounts back down to pre-CECL levels.
“If their current lending practices and standards have been successful, what really only matters is the ultimate actual loss on the loan, not the guesses that accounting forces you to make,” said Hampel. “Just because it looks like the loans now are riskier, credit unions need to be very careful not to adjust their lending standards.”
Hampel is also concerned CUs may begin to change the mix of loans, making fewer loans that call for higher reserving under CECL and more loans that require less reserving.
“CECL is requiring credit unions to look at individual loan portfolio types, and they will find some loans carry a lower allowance,” said Hampel, who considers altering the loan mix as a result of CECL a mistake.
“I think because of credit unions and their cooperative structure, they often lean to the side of being too conservative,” he said. “In making the measured level of risk higher than it was before, that might kick into action the conservative inclination of credit unions to reduce that risk by changing their lending standards.”
Comfortable Now? Comfortable Then
Hampel said that not only could slow growth, but it could reduce loan options for members who need them.
“If you are comfortable with what the original measurement was, and you are now required to measure things differently and come up with a different answer, you should not change your lending standards to confirm to that different measure,” he said. “CECL will appear to indicate higher risk in the loan portfolio, but it's the same risk you had before.”
CECL is also expected lower net worth levels at most CUs as they shift more money from capital into loan loss reserves.
“This will vary from credit union to credit union. Let's say that for a given credit union CECL requires an increase of 50 basis points of loans in the allowance account, which for that credit union equals 50 basis points of assets,” shared Hampel. “That means net income for that credit union would be 50 basis points lower than it otherwise would have been, which means at the end of the year that credit union’s capital ratio will be 50 basis points lower. So, now this looks like the credit union has 50 basis points less of loss-absorbing capacity—capital is loss absorbing capacity. But actually, it's got exactly the same amount of loss-absorbing capacity, because it just basically pre-funded 50 basis points of potential loan loss. So nothing, in reality, has changed.”
Adopt New Policy
Hampel recommended that once a credit union determines how much its capital ratio will decline as a result of CECL, it should adopt a new policy to reduce the capital ratio target by a similar amount.
“If they don't do that, they will have implicitly changed their capital ratio target,” Hampel said. “If you're comfortable with the capital ratio target you have today, if you don't adjust it when CECL is implemented, you've just adopted—without even meaning to do so—a new higher capital ratio target.”
Hampel said that in discussions he had with a senior staff member at NCUA before he retired from CUNA, the agency said it would have to take action when capital levels fall below 7% as a result of CECL. But that the agency will not be concerned when well-capitalized CUs, those well above 7%, report a decline in net worth.
“NCUA said they would consider sending examiner guidance as we get close to CECL, saying examiners should expect credit unions to begin lowering capital ratio targets,” Hampel said. “So. if you are at 7.25%, which not many credit unions are, and you drop you capital target by 50 basis points, examiners won’t like that. But if the capital target was 11% and it drops 50 basis points, the credit union shouldn't expect any pressure from NCUA.”