Our banking industry has our loan loss allowance provisioning almost exactly wrong. To quote our favorite show, Game of Thrones,
winter is coming. We don’t know when the cold weather will be here,
maybe the first part of October or maybe around Halloween, but we know
it’s coming. Since winter is coming, the question arises - How many
coats should we have for the winter? For that answer, we simply look at
the data and see what the average daytime temperature over the past
three months has been, and we can see it is a warm 81 degrees. Based on
the data, we can then conclude that we need zero coats for the winter.
We should be fine come January.
Winter Is Always Cold
Of course, any banker can see the mistakes in our coat methodology,
yet that is roughly how our industry arrives at our allowance for loan
and lease loss (ALLL) reserve. Many banks improve on the methodology by
looking back longer and taking into account last winter, but the data
still gets dampened by the good / warm times. Right now, banks are still
reducing their loan loss provisions as the economy is relatively strong
and loans are performing. That is a problem as risk is increasing not
decreasing. In some markets, commercial and residential property prices
are well above their peaks of 2006. Let’s consider markets like New
York, Miami, San Francisco and Seattle. In these markets, prices can be
20% to 40% above their peaks of 2007. Can this continue? Maybe, just
like we can have two more months of warm weather, but it is not likely
to continue for an extended period of time. Cycles happen and when they
do, banks are going to want a warmer coat.
Compounding the Problem
Part of the issue is how banks handle risk management. It is bad
enough that property appraised values are at a near-record level in many
markets, yet loan loss provisions are now back towards their lows,
similar to how they were in 2007 before the downturn (below).
To compound the problem, as of August, loan pricing in some markets
are back to their tightest spreads, comparable to 2007. Pricing of Libor
+ 1.50% is becoming more common. Underwriting has loosened and
concentrations to commercial real estate are increasing. Commercial real
estate loans are now 75% of total risk-based capital and construction
lending is back to 16% of total risk capital. Finally, interest rate
risk has never been greater, as banks now have the longest duration in
the history of banking once you take into account index, floors, caps
and prepayment penalties. All this adds up to increasing risk at the
loan level and at the balance sheet level. This is at a time when
margins continue to contract and are set to further contract even if
rates rise in the short and intermediate term.
While banks are highly correlated to real estate prices, let’s just
isolate commercial real estate prices for the sake of simplicity. A
regression of more than 900 banks in a study by the Bank of
International Settlements from 2005 looks at the impact of commercial
real estate on bank performance. Their coefficients have some very
practical applications for modeling. For example, as can be seen below,
the correlations of commercial real estate prices have a larger impact
than macro-economic factors such as GDP. For every one-standard
deviation of expansion (about 10.85% growth) in real asset prices, bank
lending increased 1.74%, return on assets increased 0.10%, margins were
reduced by 0.10%, non-performing assets decreased by 0.22% and ALLL
dropped by 0.05%. This is greater than the impact of 1 standard
deviation of production movement.
The implications for banks are that in good times, banks reap
positive performance, however in doing so; they also set themselves up
for hard times because the opposite is true. In times of falling prices,
the above correlations also hold and banks experience shrinking assets,
lower earnings, more asset problems and higher ALLL. What happens if we
reverse these correlations?
A Better Model
The industry adopting the new Financial Accounting Standards Board
(FASB) Current Expected Credit Loss (CECL) Model is a step in the right
direction since it forces banks to be more forward looking. To see if
this is true, we built a rudimentary model based on the above
correlations and tied ALLL to property prices (and as a result, property
level net operating income). Thus, every time net operating income was
expected to go up, we increased the reserve, while when net operating
income was expected to drop, we decreased the reserve.
What we got was a model that back tested as follows:
As can be seen, our model not only moderates some swings caused by
overestimation, but it also moves largely in reverse of how most banks
handle their ALLL now. Interestingly, the model also allows us to
optimize reserves and ask the question: how much should we be reserving
given our current loan mix and historic underwriting exposure? The
output was that while banks reserved an average of 1.98% of their net
loans, they should have reserved a lower amount to the tune of 1.69%
(below). Interestingly, most of the issue came in 2009 and 2010 when
banks were largely using the worst case from the downturn to fuel their
Does The Model Work?
As a test, we reran cash flows for the industry to see if an ALLL
model largely based on the inverse of today’s methodology could reduce
risk. We then compared them to actual results to produce the below
The inverse ALLL Model does serve to moderate income and reduce
earnings volatility by 13% which can graphically be seen above. This is a
step in the right direction and places banks in a more proactive and
forward looking position. This model could be refined even further to
include forecasted data that has a better fit (such as effective rents)
and be expanded to include other lending lines such as residential real
estate (a huge missing piece).
Given the empirical data, we believe banks that face major metro
markets should be increasing reserves, not decreasing them. We think the
past extraordinary period of low rates has inflated a real estate
bubble in many areas and banks are at risk. Current loan loss reserves
have been dropping and instead of a 1.38%, banks should be closer to
1.94% and rising. We all know winter is coming and while we don’t know
the severity, we know it will be cold. Just like basing your wardrobe on
the past will leave you out in the cold, so will having your historic
data biased by some of the best credit times in banking. Incorporate
more forward-looking measures in your loan loss allowance methodology
and you will find that you will stay warmer during the winter months.
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CenterState Bank is a $4B community bank in Florida experimenting
their way on a journey to be a $10B top performing institution.
CenterState has one of the largest correspondent bank networks in the
banking industry and makes its data, policies, vendor analysis, products
and thoughts available to any institution that wants to take the
journey with us.
On August 11, the Federal Communications Commission handed down a $2.96 million fine
against Travel Club Marketing Inc., related entities, and owner Olen
Miller (collectively “Travel Club”), the largest fine in FCC history
related to autodialed calls. The fine stems from allegations that the
companies violated the Telephone Consumer Protection Act in their
telemarketing efforts, including sales of vacations and timeshares.
Travel Club was accused of making at least 185 “prerecorded advertising
calls” to more than 142 cellular and residential telephone numbers,
many of which were listed on the National Do Not Call Registry.
The fine culminates a formal regulatory process that began on October
31, 2011, when the FCC issued a Notice of Apparent Liability (NAL) to
Travel Club proposing the $2.96 million forfeiture for “willful and
repeated violation” of the TCPA. When Travel Club finally responded,
the FCC noted the failure “to provide any information or make any
arguments whatsoever to challenge the NAL’s findings” and that Travel
Club “continued to make unlawful robocalls during the time that the NAL
underlying this Forfeiture Order has been pending, the fact of which
militates against a cancellation or reduction of the proposed forfeiture
Under FCC rules applicable when the calls were made, such
telemarketing calls were allowed only with “either prior express consent
or an established business relationship” with call recipients, which
Travel Club did not possess. The FCC has since further tightened these
restrictions, ending the “established business relationship” exemption in 2012.
The previous record fine was $2.9 million, ordered by the FCC in May
2014, in relation to autodialed calls made during the 2012 United States
Although the fine represents a new high for an administrative
enforcement action by the FCC, an ongoing enforcement action by the FTC
and several states against Dish Network under the TCPA, the FTC’s
Telemarketing Sales Rule, and parallel state laws is seeking,
theoretically at least, billions of dollars in penalties arising out of
allegedly illegal telemarketing calls. Our take on the Dish Network
action can be found here.
Troutman Sanders LLP has unique industry-leading expertise with the
TCPA, with experience gained trying TCPA cases to verdict and advising
Fortune 50 companies regarding compliance strategy. We will continue to
monitor regulatory and judicial interpretation of the TCPA in order to
identify and advise on potential risks.
The Consumer Financial Protection Bureau sent a questionnaire
with almost 60 questions to randomly selected debt collectors and
service providers as part of its potential rulemaking regarding debt
collection, a process that began almost two years ago.
The CFPB received 23,000 comments in response to its Advance Notice of Proposed Rulemaking
(ANPR) for debt collectors, which included 162 questions. According to
the CFPB, this new “survey is being conducted in order to build the
[CFPB’s] knowledge of the operational costs of collecting debt that is
in default” and the answers provided to the questions are intended to
“help the CFPB better understand the burden of potential regulations
affecting the debt collection industry.”
This questionnaire was sent with a cover letter
from John McNamara, the Debt Collections Program Manager in the CFPB’s
Division of Research Markets & Regulations. In it, the CFPB
explains it “will be gathering information from a variety of debt
collection firms, creditors, and service providers” that will “inform
the Bureaus’ analysis of the benefits and costs of potential new rules
relative to debt collection.”
The questionnaire asks about basic activities and operational costs
of collecting debt, including, for example, questions about vendors used
for activities such as dialers or print mailings, maintaining data
about consumer accounts, and furnishing information to credit bureaus.
The CFPB also stated that it plans to conduct “follow-up phone
interviews” with some of the companies that respond to the survey “to
help us understand their operations in more detail.”
We previously reported
on the remarks made by Consumer Financial Protection Bureau Director
Richard Cordray on May 12 that the CFPB would not voluntarily change the
August 1 effective date for the TILA-RESPA Integrated Disclosure Rule
(TRID). This officially changed on June 24 with the CFPB’s issuance of a
proposed amendment to TRID, postponing its effective date from August 1 to October 3.
The CFPB issued the proposal to correct an administrative error.
Specifically, the CFPB recently discovered that it inadvertently had not
submitted the rule report to Congress as required. Upon discovering
its error, the CFPB submitted the rule report to both Houses of Congress
and the Comptroller General of the Government Accountability Office on
June 16, 2015. However, under the Congressional Review Act, the
TILA-RESPA Final Rule cannot take effect until, at the earliest, August
15, 2015 – two weeks after the currently-scheduled effective date.
In light of the administrative error, as well as the extent of
“unique implementation challenges for industry, requiring major
operational changes” that even the CFPB recognizes, it wisely decided to
propose that TRID’s effective date be delayed to October 3. The
proposal is open for public comment until July 7, and the CFPB expects
to make its final decision shortly thereafter.
posted on 2015-06-26 by Kali Geldis It’s every consumer’s worst nightmare: You’re busy at work,
mired in debt, and your cellphone keeps ringing. You’re doing your best
to pay off that bill, but the unknown number flashing on your phone’s
screen is a dismal reminder you haven’t.
“Most people want to pay their debt, they just run into bad
situations where they can’t,” Gerri Detweiler, director of consumer
education for Credit.com, says. “If a debt collector will work with
them, a lot of times, they’ll resolve the debt.”
But not every debt collector plays by the rules, and luckily there
are protections in place that allow consumers to fight back if a debt
collector has run afoul of the law. Here are 12 times when consumers can
1. Calling Early & Calling Late
A debt collector may not call you before 8 a.m. or after 9 p.m.
The time frame may sound arbitrary, but think about it: This is when
you’re away from work, at home with family, or resting in bed. When a
debt collector calls at a time that is known to be inconvenient, David
Menditto, director of litigation for Lifetime Debt Solutions, a law firm
in Chicago, says, that’s a violation of the federal Fair Debt
Collection Practices Act (FDCPA).
2. Calling at Other Inconvenient Times
If you’ve told the collector not to call at a certain time, even if
it’s when you take a nap, Detweiler says, that’s another violation of
the FDCPA. “If you were to tell the collector, I work nights, so don’t
call me then, they can’t,” she says. Consumers can set the parameters.
3. Discussing Debt With Third Parties
“If a debt collector calls your mother and says, ‘Hi, we’re looking
for John, he owes us money. How do we get in touch?’” that’s yet another
violation of the FDCPA, Menditto tells Credit.com. “They can call, ask
to speak with John, and ask whether this is a good number to reach him
at, but they can’t be discussing the debt,” he says. Collectors are
allowed to contact a debtor’s spouse, however.
If a collector calls even though he or she knows that you’ve hired an
attorney, that’s a violation of the FDCPA, Menditto says. The reason:
The consumer may intend to file for bankruptcy
and they’ve probably told the collector to stop contacting them. “We’ve
had clients who claimed they told the debt collector to stop calling,
and they didn’t,” Menditto says. “Then they got an attorney and said,
‘Talk to him,’ and the collector kept calling and the collection got
5. Making False Threats
Some collectors threaten to take action without really meaning it.
For instance, they might say, “If you don’t pay in the next five days,
we’re going to sue you,” Menditto says. If they keep making threats and
don’t follow through, that’s a sure sign they’ve violated the FDCPA and
you can sue.
6. Calling the Wrong Party
When a collector continues harassing you even though he’s got the
wrong number, that’s grounds for a lawsuit, Menditto says. Typically,
the collector thinks the person is lying about their identity, so they
keep calling in the hopes the debtor will come clean.
7. Using Pre-Recorded or Automated Voice Calls
Robocalls aren’t just annoying, they’re flat-out illegal, Menditto says, citing the Telephone Consumer Protection Act
(TCPA), which regulates what’s known as automated calls. “The TCPA
prohibits any company, not just a debt collector, from calling you on
your cellphone using an automated telephone system or pre-recorded voice
without your express consent,” he says. “We typically, in the majority
of cases, get relief because the debt collector knows they did it.”
8. Using Automatic Phone Dialing Systems
Yes, there are machines that exist to solely crank out numerous phone
calls. Known as a predictive dialer or ATDS, these telephone systems
dial numbers one after another, and may contact consumers up to five
times a day. They’re illegal under the TCPA and can net consumers who
sue anywhere between $500 and $1,500 per call, as part of the damages.
9. Misrepresenting the Nature of the Debt
Though this tactic may work for collectors, it’s illegal to
misrepresent the nature of the debt, Detweiler says, citing the FDCPA. A
collector can’t pressure family members to pay a deceased relative’s
debt because they’re responsible (which they aren’t, unless they were
co-signers or joint account holders on the debt) or because they have a
“moral obligation.” The law has severe penalties for these kinds of
collectors, so those who are being harassed should contact a lawyer.
10. Threatening Violence
Has the collector threatened violence? That’s a violation of the FDCPA.
“It can get pretty ugly if a collector is crossing the line,” Detweiler
says, and “the ones who do create a lot of stress and anxiety that
leads consumers to make a bad financial decision.”
11. Using Profanity
Fortunately, the FDCPA protects debtors from verbal abuse such as the
use of obscene or profane language. If it’s meant to cause harm to the
hearer or reader, it’s grounds for a lawsuit, according to the Federal
12. False Representation
If a collector doesn’t state who they are to the consumer, be it in
writing or over the phone, that’s yet another violation of the FDCPA,
according to the FTC’s website. A collector must disclose to the
consumer that they’re attempting to collect a debt and that any
information obtained will be used for that purpose.