LIBOR Changes On the Horizon for Syndicated Loans on Bank Books

LIBOR-9-2-19.pngAlthough the shift from LIBOR to a new reference rate is several years away, banks should start preparing today.

Syndicated loans make up only 1.7% of the nearly $200 trillion debt market that is tied to the London Interbank Offered Rate (LIBOR), a figure that includes derivatives, loan, securities and mortgages. But many banks hold syndicated loans on their balance sheets, and will be directly affected by efforts to replace LIBOR with a new reference rate.

In 2014, federal bank regulators convened the Alternative Rates Reference Committee (ARRC) in response to the manipulation of LIBOR by banks during the financial crisis. In 2017, the ARRC identified the Secured Overnight Financing Rate (SOFR) as the rate that represents best practice to replace LIBOR in USD derivative and other financial contracts.

Shifting from LIBOR to SOFR requires various moving pieces to converge as well as addressing legacy issues for existing contracts tied to LIBOR. The ARRC was reconstituted in 2018 with an expanded membership that includes regulators, trade associations, exchanges and other intermediaries, and buy side and sell side market participants. The group now oversees the implementation of the Paced Transition Plan and coordinates with cash and derivatives markets as they address the risk that LIBOR may not exist beyond 2021. This includes minimizing the potential disruption associated with LIBOR’s potential phase-out and supporting a voluntary transition away from LIBOR.

In April 2019, the ARRC released proposed fallback language that firms could incorporate into syndicated loan credit agreements during initial origination, or by way of amendment before the cessation of LIBOR occurs.

Contracts need recommended fallback language to provide consistency across products and institutions. The definition of LIBOR, the trigger events that would require use of the fallbacks and the fallbacks themselves vary significantly — even within the same product sets. Additionally, existing contractual fallback language was originally intended to address a temporary unavailability of LIBOR, like a glitch affecting the designated screen page or a temporary market disruption, not its permanent discontinuation. Until recently, fallback language rarely addressed the possibility of the permanent discontinuance of LIBOR. As a result, legacy fallback language could result in unintended economic consequences or potential litigation.

The ARRC recommends contracts have two sets of fallback language for new originations of U.S. dollar-denominated syndicated loans that reference LIBOR. Syndicated loan fallback provisions try to balance several goals of the ARRC: flexibility and clarity.

  1. Hardwired Approach:” This approach uses clear and observable triggers and successor rates with spread adjustments that are subject to some flexibility to fall back to an amendment if the designated successor rates and adjustments are not available at the time a trigger event becomes effective.
  2. Amendment Approach:” This approach is meant to offer standard language, which provides specificity with respect to the fallback trigger events and explicitly includes an adjustment to be applied to the successor rate, if necessary, to make the successor rate more comparable to LIBOR. It also includes an objection right for “Required Lenders.” In the Amendment Approach language, all decisions about the successor rate and adjustment will be made in the future.

As the market continues to prepare for LIBOR’s eventual exit, there are several steps that BancAlliance recommends that banks take to prepare for this transition:

  1. Quantify, document and monitor exposure to loans in your portfolio with LIBOR-based pricing.
  2. Ensure that executives are familiar with the current LIBOR fallback language in the individual credit agreements within the portfolio.
  3. Be mindful should any amendments occur to your existing portfolio, as SOFR’s acceptance grows in the marketplace.
  4. Continue observing new originations to see how fallback language is being drafted, and any other structural changes with regards to LIBOR.
  5. Review ARRC pronouncements and market-related current events to ensure your institution is up to speed on the latest news and changes with respect to LIBOR.

FASB Sheds Light On CECL Delay Decision


CECL-8-15-19.pngSmall community banks are poised to receive a delay in the new loan loss standard from the accounting board.

The Financial Accounting Standards Board is changing how it sets the effective dates for major accounting standards, including the current expected credit loss model or CECL. They hope the delay, which gives some banks an extra one or two years, provides them with more time to access scarce external resources and learn from the implementation lessons of larger banks.

Bank Director spoke with FASB member Susan Cosper ahead of the July 27 meeting discussing the change. She shed some light on the motivations behind the change and how the board wants to help community banks implement CECL, especially with its new Q&A.

BD: Why is FASB considering a delay in some banks’ CECL effective date? Where did the issue driving the delay come from?
SC: The big issue is the effective date philosophy. Generally speaking, we’ve split [the effective dates] between [Securities and Exchange Commission] filers or public business entities, and private companies and not-for-profits. Generally, the not-for-profits and private companies have gotten an extra year, just given their resource constraints and educational cycle, among other things.

We started a dialogue after the effective date of the revenue recognition standard with our small business advisory committee and private company council about whether one year was enough. They expressed a concern that one [extra] year is difficult, because they don’t necessarily have enough time to learn from what public companies have done, they have resource constraints and they have other standards that they’re dealing with.

We started to think about whether we needed to give private companies and not-for-profits extra time. And at the same time, did we need to [expand that] to small public companies as well?

BD: What does this mean for CECL? What would change?
SC: For the credit loss standard, we had a three-tiered effective date, which is a little unusual. Changing how we set effective dates would essentially collapse that into two tiers. We will still have the SEC filers, minus the small reporting companies, with an effective date of Jan. 1, 2020.

We would take the small reporting companies and group it with the “all-other” category, and push that out until Jan. 1, 2023. It essentially gives the non-public business entities an extra year, and the small reporting companies an extra two years.

BD: How long has FASB considered changing its philosophy for effective dates? It seems sudden, but I’m sure the board was receiving an increasing amount of feedback, and identified this as a way to address much of that feedback.
SC: We’ve been thinking about this for a while. We’ve asked our advisory committees and counsels a lot of questions: “How did it go? Did you have enough time? What did you learn?” Different stakeholder groups have expressed concern about different standards, but it was really trying to get an understanding of why they needed the extra time and concerns from a resource perspective.

When you think about resources, it’s not just the internal resources. Let’s look at a community bank or credit union: Sometimes they’re using external resources as well. There are a lot of larger companies that may be using those external resources. [Smaller organizations] may not have the leverage that some of the larger organizations have to get access to those resources.

BD: For small reporting companies, their CECL effective date will move from January 2020 to January 2023. How fast do you think auditors or anyone advising these SRCs can adopt these changes for them?
SC: What we’ve learned is that the smaller companies wait longer to actually start the adoption process. There are many community banks that haven’t even begun the process of thinking about what they need to do to apply the credit loss standard.

It also affords [FASB] an opportunity to develop staff Q&As and get that information out there, and help smaller community banks and credit unions understand what they need to do and how they can leverage their existing processes.

When we’ve met with community banks and credit unions, sometimes they think they have to do something much more comprehensive than what they actually need to do. We’re planning to travel around the country and hold meetings with smaller practitioners — auditors, community banks, credit unions — to educate them on how they can leverage their existing processes to apply the standard.

BD: What kind of clarity does FASB hope to provide through its reasonable and supportable forecast Q&A that’s being missed right now? [Editor’s note: According to FASB, CECL requires banks to “consider available and relevant information, including historical experience, current conditions, and reasonable and supportable forecasts,” when calculating future lifetime losses. Banks revert to their historical loss performance when the loan duration extends beyond the forecast period.]
SC: There are so many different aspects of developing the reasonable and supportable forecast in this particular Q&A. We have heard time and time again that there are community banks that believe they need to think about econometrics that affect banks in California, when they only operate in Virginia. So, we tried to clarify: “No, you need to think about the types of qualitative factors that would impact where you are actually located.”

The Q&A tries to provide an additional layer of clarity about what the board’s intent was, to help narrow what a bank actually has to do. It also provides some information on other types of metrics that banks could use, outside of metrics like unemployment. It talks about how to do the reversion to historical information, and tries to clarify some of the misinformation that we have heard as we’ve met with banks.

BD: People have a sense about what the words “reasonable” and “supportable” mean, but maybe banks feel that they should buy a national forecast because that seems like a safe choice for a lot of community banks.
SC: Hindsight is always 20-20, but I think people get really nervous with the word “forecast.” What we try to clarify in the Q&A is that it’s really just an estimate, and what that estimate should include.

BD: Is the board concerned about the procrastination of banks? Or that at January 2022, banks might expect another delay?
SC: What we’re really hoping to accomplish is a smooth transition to the standard, and that the smaller community banks and the credit unions have the opportunity to learn from the implementation of the larger financial institutions. In our conversations with community banks, they’re thinking about it and want to understand how they can leverage their existing processes.

BD: What is FASB’s overall sense of banks’ implementation of CECL?
SC: What we have heard in meetings with the larger financial institutions is that they’re ready. We’re seeing them make public disclosure in their SEC filings about the impact of the standard. We’ve talked to them extensively about some of how they’ve accomplished implementation. After the effective date comes, we will also have conversations with them about what went well, what didn’t go well and what needs clarification, in an effort to help the smaller financial institutions with their effective date.

Six Reasons to Have a Fintech Strategy


fintech-7-23-19.pngFinancial technology, or fintech, is rapidly and dramatically changing the financial services landscape, forcing banks to respond.

Banks are taking different approaches to capitalize on the opportunities presented by fintech, mitigating the risks and remaining competitive. Some of these approaches include partnering with fintech companies, investing in them, investing in internal innovation and development or creating or participating in fintech incubators and labs. Some banks focus on a single strategy, while some mix and match. But many have no plan at all.

The board of directors oversees the bank’s strategic direction and provides senior management with risk parameters to exercise their business discretion. Fintech must be part of that strategic direction. A thoughtful and deliberate fintech strategy is not only a best practice, it is a necessity. Here are six reasons why.

1. Fintech is Here to Stay. Bankers who have seen many trends come and go could be forgiven for initially writing off fintech as a fad. However, fintech is wholly reshaping the financial services industry through digital transformation, big data, cybersecurity and artificial intelligence. Fintech now goes far beyond core systems, enhancing capabilities throughout the bank.

2. Customers Expect It. Demographics are changing. Customers under 40 expect their banking services to be delivered by the same channels and at the same speed as their other retail and consumer services like online shopping and ride-hailing applications. Banks that cannot meet those expectations will force their younger customers to look elsewhere.

3. Competition and Differentiation. Community banks may not be able to compete with the largest banks on their technology spend, but they should be competitive with their peers. Developing and executing a thoughtful fintech strategy will enhance a bank’s identity and give them a competitive advantage in the marketplace.

4. Core Systems Management. Banks must have a strategy for their core banking systems. Replacing a legacy system can take years and requires extensive planning. Banks must weigh the maintenance expense, security vulnerability and reduced commercial flexibility of legacy systems against the cost, potential opportunities and long-term efficiencies of the next generation platforms.

5. Fiduciary Duty Demands It. A board’s fiduciary duty includes having a fintech strategy. The board is accountable to the bank’s shareholders and must create sustainable, long-term value. Director are bound by the fiduciary duty of care to act in the best interest of the bank. Given fintech’s rapid expansion, heightened customer expectations and the need to remain competitive, it is prudent and in the long-term best interest of the bank to have a fintech strategy.

6. Regulatory expectations. Boards are also accountable to bank regulators. The Office of the Comptroller of the Currency issued a bulletin in 2017 to address the need for directors to understand the impact of new fintech activities because of the rapid pace of development. The OCC is not the only regulator emphasizing that insufficient strategic planning in product and service innovation can lead to inadequate board oversight and control. A deliberate fintech strategy from the board can direct a bank’s fintech activities and develop a risk management process that meets regulatory expectations.

The best fintech strategy for a bank is one that considers an institution’s assets, capabilities, and overall business strategy and allows it to stay competitive and relevant. Not having a fintech strategy is not an option.

CECL Delayed for Small Banks


CECL-7-18-19.pngSmall banks hoping for a delay in the new loan loss accounting standard could get their wish, following a change in how the accounting board sets the effective dates for new standards.

On July 17, the Financial Accounting Standards Board (FASB) proposed pushing back the effective date of major accounting changes like revenue recognition, leases and — key to financial institutions — the current expected credit loss model (CECL). The board hopes the additional time will offer relief to smaller companies with fewer resources and provide more space to learn from the implementation efforts of larger peers. Under the proposal, community banks and credit unions now have a new effective date of Jan. 1, 2023, to implement CECL.

The board’s proposal also provided relief for a new category they call “small reporting companies,” and thus simplified the three-tiered effective dates into two groups. The proposal retains the 2020 effective date for companies that file with the U.S. Securities and Exchange Commission that are not otherwise classified as a small reporting companies.

CECL will force banks to set aside lifetime loss reserves at loan origination, rather than when a loss becomes probable. The standard has been hotly contested in the industry since its 2016 passage, and banking groups and members of Congress had unsuccessfully sought a delay in the intervening years.

But on Wednesday, some finally got what they were looking for. The proposed CECL delay for many banks comes as FASB grapples with how it sets the effective dates for different standards, said board member Susan Cosper in an interview conducted prior to the July 17 meeting.

In the past, FASB would pass a new accounting standard and set an effective date for SEC filers and public business entities in one year, then give private companies and nonprofit organizations an extra year to comply. The gap in dates recognizes the resource constraints those firms may face as well as the demand for outside services, and provide time for smaller companies to learn from the implementation lessons of large companies. However, the board’s advisory councils said this may not be enough time.

“What we’ve learned … is that the smaller companies wait longer to actually start the adoption process,” Cosper says. “There are many community banks that haven’t even begun the process of thinking about what they need to do to apply the credit loss standard.”

The extra time should allow these companies the ability to digest and implement the credit loss overhaul using existing resources. During the meeting, FASB member R. Harold Schroeder said that bankers tell him they could quickly apply the CECL standard in a “compliance approach” as a “box-checking exercise” for their banks. But, they tell him, they need more time if they want to implement CECL in a way that allows them to use it to make business decisions.

“The companies I talked to are taking these standards seriously as an opportunity to improve; ‘We want the data to flow through our systems, but it takes more time,’” he said.

The board also adopted an SEC filer category, called “small reporting companies” or SRCs. The SEC defines a small reporting company as a firm with a public float of less than $250 million, or has annual revenues of less than $100 million and no annual float or a public float of less than $700 million. For CECL, SRCs have the same implementation deadline as their private and not-for-profit peers. Companies with a 2023 effective date have the option of adopting the standard early.

The proposal to extend the CECL effective dates for small companies received unanimous support from the board. The proposal now goes out for public comment.

“The process of gathering, cleaning and validating [loan loss] data has taken longer than we expected,” says Mike Lundberg, national director of financial institutions services at accounting firm RSM US. “Having a little more time[for banks] to run parallel paths or fine-tune their models is really, really helpful.”

Lundberg points out that small banks will now have nearly six years to implement the standard, which passed in 2016. He also warns against bankers’ complacency.

“[The implementation] will take a long time and is a big project,” he says. “It’s definitely a ‘Don’t take the foot off the gas’ situation. This is the time to get it right.”

FASB also offered additional assistance to financial institutions with a newly published Q&A document around the “reasonable and supportable” forecast, and announced a multi-city roadshow to meet with small practitioners and bankers. Cosper says the Q&A looks to narrow the work banks need to do in order to create a forecast and includes additional forward-looking metrics banks can consider.

“I think that people really get nervous with the word ‘forecast,’” she says. “What we tried to clarify in the Q&A is that it’s really just an estimate, and it goes on to describe what that estimate should include.”

Takeaways from the BB&T-SunTrust Merger


merger-2-27-19.pngIn early February, BB&T Corp. and SunTrust Banks, Inc. announced a so-called merger of equals in an all-stock transaction valued at $66 billion. The transaction is the largest U.S. bank merger in over a decade and will create the sixth-largest bank in the U.S. by assets and deposits.

While the transaction clearly is the result of two large regional banks wanting the additional scale necessary to compete more effectively with money center banks, banks of all sizes can draw important lessons from the announcement.

  • Fundamentals Are Fundamental. Investors responded favorably to the announcement because the traditional M&A metrics of the proposed transaction are solid. The transaction is accretive to the earnings of both banks and BB&T’s tangible book value, and generates a 5-percent dividend increase to SunTrust shareholders. 
  • Cost Savings and Scale Remain Critical. If deal fundamentals were the primary reason for the transaction’s positive reception, cost savings ($1.6 billion by 2022) were a close second and remain a driving force in bank M&A. The efficiency ratio for each bank now is in the low 60s. The projected 51 percent efficiency ratio of the combined bank shows how impactful cost savings and scale can be, even after factoring in $100 million to be invested annually in technology.
  • Using Scale to Leverage Investment. Scale is good, but how you leverage it is key. The banks cited greater scale for investment in innovation and technology to create compelling digital offerings as paramount to future success. This reinforces the view that investment in a strong technology platform, even on a much smaller scale than superregional and money center banks, are more critical to position a bank for success.
  • Mergers of Equals Can Be Done. Many have argued that mergers of equals can’t be done because there is really no such thing. There is always a buyer and a seller. Although BB&T is technically the buyer in this transaction, from equal board seats, to management succession, to a new corporate headquarters, to a new name, the parties clearly went the extra mile to ensure that the transaction was a true merger of equals, or at least the closest thing you can get to one. Mergers of equals are indeed difficult to pull off. But if two large regionals can do it, smaller banks can too.
  • Divestitures Will Create Opportunities. The banks have 740 branches within 2 miles of one another and are expected to close most of these. The Washington, D.C., Atlanta, and Miami markets are expected to see the most branch closures, with significant concentrations also occurring elsewhere in Florida, Virginia, and the Carolinas. Deposit divestitures estimated at $1.4 billion could present opportunities for other institutions in a competitive environment for deposits. Deposit premiums could be high.
  • The Time to Invest in People is Now. Deals like this have the potential to create an opportunity for community banks and smaller regional banks particularly in the Southeast to attract talented employees from the affected banks. While some banks may be hesitant to invest in growth given the fragile state of the economy and the securities markets, they need to be prepared to take advantage of these opportunities when they present themselves.
  • Undeterred by SIFI Status. The combined bank will blow past the new $250 billion asset threshold to be designated as a systemically important financial institution (“SIFI”). While each bank was likely to reach the SIFI threshold on its own, they chose to move past it on their terms in a significant way. Increased scale is still the best way to absorb greater regulatory costs – and that is true for all banks.
  • Favorable Regulatory Environment, For Now. Most experts expect regulators to be receptive to large bank mergers. Although we expect plenty of public comment and skepticism from members of Congress, these efforts are unlikely to affect regulatory approvals in the current administration. It is possible, however, that the favorable regulatory environment for large bank mergers could end after the 2020 election, which could motivate other regionals to consider similar deals while the iron is hot.
  • Additional Deals Likely. The transaction may portend additional consolidation in the year ahead. As always, a changing competitive landscape will present both challenges and opportunities for the smaller community and regional banks in the market. Be ready!

Why Asset Size Does Not Matter To Regulators In ERM


ERM-1-21-19.pngConventional wisdom in banking has been that asset size matters in terms of regulatory expectations around enterprise risk management (ERM).

But that traditional school of thought might be changing. A new question has emerged: is it the institution’s asset size that matters, or is the complexity of the risk profile more important?

A common question among peer roundtables: what is a bank expected to do for ERM as it approaches the $10 billion asset size threshold of a regional banking organization (RBO)? The Federal Reserve considers an RBO to have total consolidated between $10 billion and $50 billion.

The next question typically is if regulatory expectations have lessened around comprehensive capital analysis and review (CCAR) or Dodd-Frank Act Stress Test (DFAST) requirements because of recent reforms in Congress?

These are hot topics especially for banks below the $10 billion asset size bubble, known as community bank organizations (CBO) by the Fed, because the cost of ERM implementation remains high.

Specific to CBOs between $2 billion and $5 billion in assets, regulatory agencies have been providing more prescriptive guidance and recommendations to upgrade and enhance ERM and model risk management frameworks consistent with existing regulatory guidance aimed at RBOs.

Examinations are more detailed, covering policies and procedures, personnel, risk appetite, risk assessment activities and board reporting. Examiners are pushing smaller banks to recognize the ERM value proposition because a keen risk awareness will inspire more informed decisions.

An effective ERM program starts with the risk culture necessary for appropriate governance of policies and procedures, risk awareness training, tone from the top and credible challenge. The culture should start with the CEO and the board establishing a proactive risk strategy and aligning the risk appetite of the bank with strategic planning.

Implementing an effective risk management program is understanding your bank’s risk profile and addressing matters proactively, having the discipline to identify emerging risks and mitigating those risks before a risk event or loss.

As banks approach $10 billion in assets, they are expected to increase the rigor around risk identification and assess risks for their likelihood and impact before identifying risk-mitigating controls.

A CBO should have a champion to effect change strategically throughout the organization, rather than a regulatory or audit check-the-box exercise. The risk management champion can be compared to an orchestra conductor who does not need to do everyone else’s job but should be able to hear someone is out of tune. Breaking down silos is key because risk management should be a continuous, collaborative process involving all stakeholders.

Regulatory expectations are converging as examiners push smaller banks to show a safe and sound risk management framework. This should encompass a separate board risk committee, or, at a minimum, a subcommittee responsible for ERM.

All banks have traditionally been expected to maintain appropriate risk management processes commensurate with their size and complexity and operate in a safe and sound manner.

The formality and documentation required is a new, evolving trend. Board and senior management oversight is important, as is risk monitoring and information system reporting. Board support is critical to understand risk areas, develop training programs and establish accountability among leadership and risk management team members.

Regulatory scrutiny for banks below $10 billion of assets has increased for ERM sub-processes, including model risk management, new products and services and third-party risk management.

We live in a post-CCAR world trending toward deregulation; however, the regulatory burden of risk management expectations for the smaller CBOs is increasing. Essentially, asset size does not matter anymore.

2019 Bank M&A Survey: What’s Driving Growth


acquisition-12-3-18.pngOver the past year, Congress has passed both tax reform and regulatory relief—signed into law by President Donald Trump in December 2017 and May 2018, respectively. And the Trump administration has appointed regulators who appear to be more favorable to the industry, including former bankers Joseph Otting, to the Office of the Comptroller of the Currency, and Jelena McWilliams, to the Federal Deposit Insurance Corp.

As a result, the 184 bank executives and directors participating in the 2019 Bank M&A Survey, sponsored by Crowe LLP, voice a resoundingly positive view of Washington, particularly for Trump and Mick Mulvaney. Eighty-seven percent say the Trump administration has had a positive impact on the banking industry. The same percentage give glowing marks to Mulvaney, the interim head of the Consumer Financial Protection Bureau who has turned the agency into less of a regulatory cop and more into a regulator with an even-handed approach toward the financial industry.

The survey examines industry attitudes about issues impacting M&A and growth, along with expected acquisition plans and expectations for the U.S. economy through 2019. It was conducted in September and October 2018.

Tax reform had a big impact on the industry, with many making investments to grow their business. Thirty-seven percent say their bank invested in new growth initiatives as a result of tax reform, and 36 percent in new technology. One-quarter indicate the bank raised employee salaries, and 19 percent paid a one-time bonus to employees. Some shareholders saw gains as well: 25 percent of respondents say their bank paid a dividend, and 10 percent bought back stock.

When asked where the bank designated the largest percentage of its tax windfall, 32 percent point to new growth initiatives, and 26 percent to shareholders.

Additional Findings

  • More than half believe the current environment is more favorable for deals, and 50 percent say they’re likely to acquire another bank by the end of 2019.
  • Thirty percent believe their bank is more likely to acquire as a result of the Economic Growth, Regulatory Relief and Consumer Protection Act, which rolled back some regulations for the banking industry. Two-thirds indicate regulatory reform will have no impact on their M&A plans.
  • Acquiring deposits is very attractive to today’s potential dealmakers: 71 percent say the potential target’s deposit base is a highly important factor in making the decision to acquire. 
  • To better compete for deposits, 29 percent say their bank will acquire deposits via acquisition.
  • Fifty-three percent say branch locations in attractive or growing markets are highly important, and 49 percent place high value on lending teams or talented lenders at the target.
  • Despite more sympathetic regulators and the passage of regulatory relief, 72 percent say their bank’s examiners have grown no less stringent over the past two years.

To view the full results to the survey, click here.

Focus On Two Key Areas to Capitalize on Overdrafts


overdraft-10-16-18.pngBy all accounts, the outlook for overdraft programs is encouraging for community banks.

Increasingly more consumers are choosing to access the service as a short-term funding solution, while regulatory burdens are easing. Banks that manage their customers’ overdrafts with outdated programs—those that do not put their account holders’ best interests at the forefront or utilize outdated technology and procedures—cannot capitalize on this real opportunity to improve service and compliance, as well as fee income.

The Overdraft Landscape
According to Moebs Services Inc., an economic-research firm, overdraft revenue increased 3 percent industry wide from 2016 to 2017, the largest increase since 2009, and is on pace to an all-time high above $37 billion by 2020.

One reason for this increase in overdraft fee income is more consumers are making the decision to access the service when funds fall short. Moebs Services reported there were approximately 1.12 billion overdraft transactions in 2016, up from nearly 1.09 billion in 2015. According to a 2017 Wall Street Journal article, these numbers suggest many consumers consider overdraft a safety net—a convenience—for which they are willing to pay a price. Analysts said in the WSJ article that the increase in overdraft revenue should be expected, since rules and regulations have been in place for some time now.

In addition, the Consumer Financial Protection Bureau withdrew overdraft rulemaking from the agency’s spring rulemaking agenda in May after having been on the agenda for years, signaling that no new overdraft regulations will be forthcoming.

With this landscape set, how should your bank capitalize on it?

A Data-Driven, Automated Solution
The first place to start is to review your current overdraft procedures and software capabilities to ensure you are using a modern, data-driven solution—one that automatically manages risk and strives to meet customer expectations. Although there are several essential components of such a system, two are listed below.

Intelligent Limit-Setting
Updated automated overdraft programs should enable your bank to set individual overdraft limits that align with an account holder’s ability to repay the overdrawn balance. The software analyzes the key risk variables of your accounts, identifies the accounts that have the highest probability of charge off and calculates individual “intelligent” limits. It then reassesses that ability to repay daily.

Providing these dynamic limits helps to serve customers better than employing fixed overdraft limits (where the same overdraft limit is assigned to every customer of a certain account type) by granting higher overdraft limits to those customers whose ability to repay warrants it, while pulling back on those who have more limited repayment capacity.

Just as important, using intelligent limits addresses the Federal Financial Institutions Examination Council (FFIEC) 2005 Joint Guidance on Overdraft Protection Programs, which states, “Institutions also should monitor these accounts on an ongoing basis and be able to identify consumers who may represent an undue credit risk to the institution. Overdraft protection programs should be administered and adjusted, as needed, to ensure that credit risk remains in line with expectations.”

Reg. E Outreach
Eight years have passed since most banks conducted a formal outreach program in response to the 2010 Amendment to Regulation E, or Reg. E, which requires affirmative consent from customers for banks to charge an overdraft fee on ATM and one-time debit card transactions. Does your board know the number of customers who did not provide a decision back in 2010 or at a subsequent account opening?

Without consent, banks do not extend overdraft privilege through these channels, which can result in multiple unexplained debit card declines. Customers may not recall making a Reg. E decision or are unaware it is even an option, which leads to confusion and irritation for the customer.

Data-driven overdraft software allows your bank to identify these denied transactions and sort them by a customer’s Reg. E decision. With this knowledge, you can reach out to those customers who have not provided a decision and explain the reason for the denial, offer overdraft alternatives and obtain a Reg. E preference. Customers appreciate this level of communication, which provides assurance your debit card will consistently help them meet their liquidity needs.

Capturing just a few percentage points more Reg. E opt-ins can result in a tangible increase in both interchange and fee income as well. A qualified third-party overdraft provider will offer employee training, best practices and scripts to ensure your Reg. E outreach program is successful and compliant.

Is your bank positioned to capitalize on the opportunity for better service and income that a well-run overdraft program represents? With the right technology and procedures, you can.

Five Tips on Choosing the Right CECL Solutions for Community Banks


CECL-10-8-18.pngAny big accounting change—especially one as large as CECL (current expected credit loss)—is bound to cause some pain. But, there are ways to make sure your bank is not making the challenge bigger than it has to be. Here are five tips on selecting a calculation methodology that’s compatible with your institution.

1. Consider the complexity.
Banks can choose from several methodologies that range in complexity. The more complex the methodology, the more data needed—and the more inherent risk of error. Both the Financial Accounting Standards Board (FASB) and regulators have consistently indicated that complex CECL models aren’t required. Nevertheless, some community institutions seem to be choosing more complex methodologies over simpler solutions that can decrease cost and reduce risk.

Overall, the choice of a more complex methodology can impose additional costs and risks to a bank. If a community bank is going to use a complex methodology, it should go into it with clear understanding of the cost and risk involved.

2. Select your methodology first.
Regulatory agencies — including the Securities and Exchange Commission and the FASB — have continually discussed how Excel is an acceptable tool for fulfilling CECL requirements. As a general rule, the more complex the methodology, the more likely you’ll need new software. Industry participants are becoming aware that they can use, with some adapting, methodologies similar to those they use today. That means they can continue to use Excel.

CECL software does have its advantages. For example, there’s functionality for quickly disaggregating the portfolio to a finer degree and the ability to explore various methodologies, which could be beneficial. But, new software won’t eliminate all of the hard work of making estimates requiring a managerial decision.

3. Don’t panic about the reasonable and supportable forecast requirements.
The accounting standard provides a framework for incorporating a reasonable and supportable forecast. The standard doesn’t require fancy and sophisticated forecasting techniques with regression equations. Using charts with historical economic information compared to long-term trend lines can be a way to reasonably support a forecast. This framework is illustrated within the accounting standard and consists of comparing the general direction of two economic indicators (unemployment and real estate values) and using historical loss periods with similar directional trends as a basis for qualitative adjustments.

4. Start with what makes sense and add complexity as needed.
The more complex the methodology, the more historical, loan-level data will be required. Many institutions won’t have accurate and complete data from several years ago readily available. They could do a tremendous amount of work right now to obtain that historical data. A better solution might be for those institutions to start changing their processes for the current year, so that going forward, they’ll have the correct data. In the meantime, they can use a less complex methodology that’s acceptable to regulators, such as the weighted average remaining maturity that doesn’t require loan-level information.

5. Ignore the hype and do what’s right for your institution.
Much of the focus in the industry now is on the big banks that are closest to adoption. A big, complex institution will require a complex CECL solution, so much of the dialogue in the industry relates to those complex methodologies. But, what’s good for your bank? Much of the industry buzz around advanced methodologies and CECL software has little to do with the needs of community institutions. The adoption deadline for community banks, which is still a couple of years away and simpler than that for large banks, is not an argument for procrastination. Rather, it’s a reminder that community institutions can craft solutions appropriate to their own needs that are efficient, effective, and economical.

Some community banks are still not working on CECL with necessary diligence and speed. Others are introducing complexity that makes the process more difficult than it has to be. An approach that recognizes there’s work to do—but understanding it can be minimized—is the right CECL strategy for the large majority of banks.

Dodd-Frank Reform Creates New Strategic Considerations For Community Banks


regulation-9-14-18.pngIn May, President Donald Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Growth Act”), which provided long-awaited—and in some cases modest—regulatory relief to financial institutions of all sizes. Due to the adjustment of certain assets thresholds that subject banks to various regulatory burdens, the biggest winners from the regulatory reform are community banks with assets below $10 billion and regional banks with total assets above the $10 billion threshold and aspirations for future significant growth. As a result, it is incumbent upon these institutions to include in their strategic planning a new set of issues, examples of which are provided below.

Congress Eases Regulatory Environment for Community Banks
For community banks under $10 billion in total consolidated assets, the Growth Act repealed or modified several important provisions of the Dodd-Frank Act. In particular, the Growth Act:

  • Increases the total asset threshold from $2 billion to $10 billion at which banks may deem certain loans originated and held in portfolio as “qualified mortgages” for purposes of the CFPB’s ability-to-repay rule;
  • Requires the federal banking agencies to develop a Community Bank Leverage Ratio of not less than 8 percent and not more than 10 percent, under which any qualifying community banks under $10 billion in total assets that exceeds such ratio would be considered to have met the existing risk-based capital rules and be deemed “well capitalized;” and
  • Amends the Bank Holding Company Act to exempt from the Volcker Rule banks with total assets of $10 billion or less and which have total trading assets and trading liabilities of 5 percent or less of their total consolidated assets.
  • It is expected that these changes will have a significant effect on the operations of community banks. As an example, qualifying banks under the Community Bank Leverage Ratio will be relieved from the more stringent international capital standards and, as a result, may be better able to deploy capital.

Crossing the $10 Billion Threshold is Now a Lot Less Ominous, but There is Still a Price to be Paid
The revisions to asset thresholds are not limited to those affecting smaller institutions and offer significant regulatory relief to institutions with greater than $10 billion in assets and less than $100 billion in assets. Such relief changes the calculus of whether to exceed the $10 billion threshold.

On the plus side, the $10 billion threshold at which financial institutions were previously required to conduct annual company-run stress tests, known as DFAST, has been moved to $250 billion in assets. In addition, publicly traded bank holding companies no longer have a regulatory requirement to establish risk committees for the oversight of the enterprise-wide risk management practices of the institution until they reach $50 billion in assets. We anticipate, however, that most if not all institutions near or exceeding $10 billion in assets will continue to maintain board risk committees and will be conducting modified forms of stress testing for safety and soundness purposes.

On the downside, and perhaps most important, is what the Growth Act did not change: financial institutions with assets over $10 billion in assets continue to be subject to the Durbin Amendment, the Volcker Rule and the supervision and examination of the CFPB. In addition, the regulatory benefits the Growth Act newly provides to community banks will be lost when the $10 billion asset threshold is crossed.

New Strategic Issues To Consider
Based on the changes described above, senior executives and boards of directors should continue to carefully consider the regulatory impact of growing (or possibly shrinking) their institution’s balance sheet. Such considerations may include:

  • How will the institution’s capital position change under the simplified capital rules applicable to qualifying community banks?
  • Will compliance with the Community Bank Leverage Ratio rule ultimately result in a more efficient capital structure, or result in a need for more capital, compared to compliance with the current multi-faceted capital requirements?
  • Will near term compliance with a simplified Community Bank Leverage Ratio be outweighed by the cost of transitioning back to the existing regime once $10 billion is assets is achieved?
  • Given the institution’s loan portfolio and target market, would the institution benefit from the automatic qualified mortgage status now afforded to institutions under $10 billion?
  • Will the institution meaningfully benefit under the revised provisions of the Volcker Rule, and how might that affect the institution’s financial position?
  • Will the new benefits of being under $10 billion alter an institution’s strategic plan to grow over $10 billion, or is the relief from the company-run stress test and risk committee requirements enough to outweigh the regulatory relief provided to institutions under $10 billion?