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» VISIT US ONLINE @ DSNEWS.COM INDUSTRY INSIGHT R At Odds over Loan-Loss losses. But for banks, complying with regulators on that push isn't so easy. Banking regulators' concerns about loan-loss allowances, primarily with community banks, was one of the main issues discussed at the American Institute of Certified Public Accoun- tants banking conference in September. In panel discussions, bank regulators expressed concerns that community banks had brought down their loan-loss allowance ratios to 2004 levels—back when the economy was thriv- ing—after those ratios had peaked in the middle of the recession, says Rusty Butcher, a conference attendee and director of financial institutions for the Horne accounting firm in Memphis. A bank's overall loan-loss allowance ratio is its total allowance divided by the total loan portfolio. "[The regulators] feel that with the economy the end of their draw periods will jump from $13 billion in 2013 to $29 billion, $53 bil- lion, $66 billion, and $73 billion from 2014 to 2017. HELOC borrowers will face interest rate risk, because rates will inevitably rise and most HELOC terms included adjustable rates, ac- cording to the OCC. Also, when the loans move from interest-only payments to principal and interest, borrowers will face payment shock, and refinancing will be difficult or impossible because home values have declined significantly since the HELOCs were signed. Butcher says the credit quality of loan port- Outstanding balances for HELOCs by not fully recovered, the home equity loan issues, and other uncertainties, they wonder if the pace [of reducing loan-loss allowances] has been too fast," Butcher said. That's a position that banks will acknowledge, even if they don't agree that loan-loss allowances should be maintained at 2008 levels, Butcher says. "In this environment, nobody wants to get in the crosshairs of the regulators," he said. Homing in on HELOCs The Office of the Comptroller of the Currency (OCC) reported on the home equity loan risk issue in its Semiannual Risk Perspective in July. According to the OCC's report, about 58 percent of all home equity line of credit (HELOC) balances will start amortizing between 2014 and 2017. egulators are pushing for some banks to give more weight to the home equity payment shock issue, the fiscal cliff, the European debt crisis, and other negative factors looming on the horizon when those banks calculate how much to set aside for loan headwinds, and the so-called fiscal cliff reces- sion predicted if Congress and the president don't resolve their budget stalemate by year-end, Leggett says. Accounting standards require loan-loss allow- ances to be calculated based on losses that are prob- able and estimable, he notes. "Reserve policy says you're not able to prepare for the rainy day," he said. Figuring Fiscal Forecasts The bank's allowance estimate has to be based on "loss events" that have occurred, said Michael Gullette, ABA VP, accounting and financial management. For a particular loan, an example of a loss event would be the borrower losing his job. But many of the significant risk factors identi- folios has certainly been impaired at banks in the Southeast, where his firm's clients are located. He has seen some banks bringing down their loan-loss allowance ratios, but he hasn't seen the sharp drop that regulators described. "I'm not sure where those significant decreases are coming from," he said. Banks are caught in the middle on the loan- fied by regulators, such as the fiscal cliff, have not occurred. So banks have to build into their mod- els how the potential events will affect the loss events that have already occurred, Gullette says. The struggle for banks is how to identify how much an effect the potential event will have, he notes. Another way that regulators are influencing loss allowance issue between auditors and regula- tors, says Keith Leggett, VP and senior economist with the American Bankers Association (ABA) in Washington, D.C. "When banks would like to build reserves in anticipation of loan losses, audi- tors say: 'You can't do that,'" Leggett said. "It goes to the issue of whether they're using the allowance to manipulate earnings." Regulators, meanwhile, want banks to adjust their loan-loss allowance models to anticipate potential economic crises on the horizon, such as the HELOC recasting, European debt crisis banks to account for factors like the HELOC issue is through stress tests, says Chris Cole, SVP and regulatory counsel for the Independent Community Bankers of America (ICBA) in Washington, D.C. While stress tests are required for banks with more than $10 billion in assets, community banks are also feeling pressure to "shock," or stress test, their portfolios, Cole says. Stress tests for community banks typically look at the effect of an interest rate shock of 300 basis points on their earnings and risk-based capital ratios, and the effect both on the residential and commercial sides of their loan portfolios. "Everyone knows that interest rates have got to go up. It's just a matter of when and how fast," he said. 57

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