Pub. 7 2018 Issue 3

9 F a l l | 2018 F E A T U R E will be required to cover these fu- ture losses at most institutions. Many institutions could struggle to maintain their well-capitalized status based on additional loss reserves under CECL. In the calculation of total risk-based capital under Basel III, reserves are treated as a deduction to Tier 1 Capital and an addition to Tier 2 Capital, with a cap of 1.25% of risk-weighted assets. The 1.25% cap poses the largest capital challenge, as CECL drives up reserve amounts. Any reserves recorded in excess of the 1.25% cap, therefore adversely affect total risk based capital. Shareholders are likely to be displeased, as retained earnings could be held in anticipation of the capital impact of CECL, thereby potentially reducing dividend payouts or stock buybacks, as well as potentially impact- ing M&A strategies. While we acknowl- edge that some banks may adopt the new Community Bank Leverage Ratio under the recently passed regulatory reform signed into law in May, CECL will have a capital impact regardless of the capital methodology your institu- tion selects. Lenders must also follow the accounting and regulatory capital im- pacts of CECL very closely. Given the almost universally expected increase in reserves based on the life of loan loss requirement, an increase in rates charged on loans is likely to follow, at least for those banks who struggle with accurate risk-based pricing. Instinc- tively, longer-term loans are projected to receive the largest rate increases, as the life of loan model will likely cause higher reserves on these credits. This could correlate to a slowdown in loan growth due to the potential for changes in your lending strategy and lending guidelines. However, it will also likely result in opportunities to more accurately price loans and more closely align rates with risk. However, this could also result in some difficult discussions with borrowers about rate adjustments when their credits are renewed or on new loans. The areas of vendor management, regulatory capital and lending only begin to discuss the institution-wide ef- fects of the largest accounting guidance to affect banks in decades. Elliott Davis is ready with a team of professionals dedicated to the Banking and Financial Services industry who can assist your bank as it navigates the implementa- tion of CECL, as well as the impact of regulatory reform. For more informa- tion, contact Josh White at josh.white@ elliottdavis.com , Marshall Trull at marshall.trull@elliottdavis.com, or your Elliott Davis advisor.