After many quiet years, merger and acquisition (M&A) activity at banks has been on the rise in 2018, and several favorable trends will likely sustain the momentum through the remainder of the year.
By the middle of 2019, as banks evaluate acquisition opportunities, they likely will add a new component to their customary due diligence: an exploration and understanding of the target company’s Current Expected Credit Loss (CECL) methodology.
That’s a likelihood envisioned by Jeff Prelle, Managing Director and Head of Risk Modeling at MountainView Financial Solutions, a Situs company and author of recent white paper CECL's Impact on Acquired Loans.
“The new accounting standard goes into effect in 2020 for banks that are SEC filers, but in the middle of next year it will become common practice for an acquirer to do deep-dive research into how the target is planning to measure credit losses for CECL,” said Prelle. “You’ll not only want to consider your capital requirements in the post-CECL era, but you’ll want to compare your target’s estimation methods to your own so that you know how the provision for loan losses post-acquisition is likely to impact your capital requirements in 2020.”
CECL, by design, affords financial institutions the flexibility to model their own reasonable assumptions and loss calculations as they deem appropriate. This means there will likely be a significant disparity in the allowance for loan losses between the two banks.
Situs’ white paper discusses how CECL in total will change purchase accounting rules, including changes in fair value determination and loss estimation for both loans that are performing and loans that are impaired as of the transaction date. The impact is one of many that banks are scrambling to get their arms around as they continue to plan to implement CECL.