What Does It All Mean for Smaller Institutions?
The Current Expected Credit Loss (CECL) standard has been a contentious subject since the Financial Accounting Standards Board (FASB) issued it in 2016. Recently, the debate has heated up with FASB, Congress, federal financial regulatory agencies and industry advocates all weighing in on the new approach that would require institutions to estimate expected losses over the life of a loan.
Unfortunately, all that talk hasn’t yielded a consensus. We still don’t know with absolute certainty whether CECL is a done deal: Depending on whom you listen to, CECL might go through as planned (FASB), it might get delayed or cancelled (certain members of Congress), and its implementation will impact capital reserves and consumer lending (regulatory agencies and industry advocates).
This confusing debate increases the temptation for financial institutions to put CECL preparation on hold until the question is completely settled. However, once you sift through the noise, the tremendous risk of not preparing for CECL becomes apparent.
FASB’s Concessions and Convictions
FASB has been inundated with feedback and pushback ever since CECL was issued. CECL critics argued that the standard was too complex and costly to implement, and that it was not needed for smaller financial institutions. This advocacy has had some success.
On Nov. 15, 2018, FASB made a significant concession. For the second time, it revised the CECL implementation dates, specifically moving the date for all non-public companies out to 2022.
The overall implementation dates are now as follows:
- 2020 for all SEC-registered public companies
- 2021 for all other public companies not filing with the SEC
- 2022 for all “entities other than public business entities,” which includes most community banks and credit unions
Despite “considerable bipartisan pressure,” Warren Averett notes that, “FASB seems reluctant to reopen the debate” on any further delay of CECL. The chance of a complete cancellation is even more remote. Given these poor odds, the accounting and advisory firm warns that regardless of the uncertainty, “both public and private institutions should be preparing for CECL implementation in earnest.”
Federal Regulatory Agencies’ Concerns and Remedies
All along, federal regulatory agencies have lauded the general concept of modernizing the Allowance for Loan and Lease Losses (ALLL) methodology, which has not changed in decades. However, they also have expressed concern about the potential negative impact on bank capital. While still serving in his position, former Comptroller of the Currency Thomas Curry went so far as to estimate that CECL could increase the required capital levels at many institutions by 30 to 50 percent.
More recently, Federal Reserve Chairman Jerome Powell was questioned about CECL by members of the House Financial Services Committee. Although Mr. Powell did not suggest a delay for CECL, according to one member’s website, he did indicate that the “Federal Reserve will be watching carefully to see what the actual results are and will take appropriate action if they find there will be harmful effects.”
These agencies have not completely sat on the sidelines, however. In a joint release from the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC), the agencies issued a final rule on Dec. 21, 2018, that provides financial institutions with “an option to phase in over a period of three years the day one regulatory capital effects” of CECL.
This final rule notes that, “It is possible that despite adequate planning to prepare for the implementation of CECL, unexpected economic conditions at the time of CECL adoption could result in higher-than-anticipated increases in allowances.” This option remedies some of the concerns about bank reserves and blunts the argument for a further delay or halt to CECL.
To take advantage of this three-year transition period, electing institutions must:
- Apply it as of their CECL adoption date
- Indicate it on their Call Reports for the first quarter in which they report losses under CECL
It is important to note that institutions that don’t elect to use the three-year transition period from the beginning will not be allowed to change their mind and use it later.
Congressional Action Required and Introduced
As the first CECL implementation date for SEC-registered public companies looms at the start of 2020, calls from members of Congress to delay or halt CECL have gotten louder. In addition to hearings on the subject, 28 House members penned a letter to Treasury Secretary Steven Mnuchin on the subject late last year. They noted that the Financial Stability Oversight Council was planning to evaluate the negative impact of CECL and recommended that its implementation be delayed until that study was complete.
Around the same time, then-chair of the House Financial Institution and Consumer Credit subcommittee, U.S. Representative Blaine Luetkemeyer, R-MO, took the important step of introducing legislation regarding CECL. House Bill 7394 would “prohibit the Federal financial regulators from requiring compliance with” CECL. The bill also asks the SEC to study CECL more carefully.
This is a critical step because the federal financial regulatory agencies are limited in their ability to stop or change CECL on their own because it is a FASB rule. If FASB itself does not delay or cancel CECL, legislation is the only other option.
Industry Advocates Continue the Fight
Industry advocacy groups have consistently voiced concerns about CECL. In December, the American Bankers Association again warned about its “potential to disrupt lending to consumers and small businesses, increase the volatility of regulatory capital, and exacerbate procyclicality in our financial system.”
Advocates that represent smaller institutions have been some of the most vocal in arguing for a delay or halt to CECL altogether—or at least for their constituents. Both the Independent Community Bankers of America (ICBA) and the National Association of Federally Insured Credit Unions (NAFCU) have repeatedly raised concerns about the CECL transition costs for community banks and credit unions.
Preparing for CECL’s Implementation
What does all this debate around CECL mean for smaller institutions? According to Compliance Week, it doesn’t really mean anything: “Theoretical and political debates aside, the long-awaited new accounting for credit losses is moving forward in 2019 unless someone takes definitive action to delay or alter it.” The article urges all institutions to continue to prepare for CECL, warning that if they don’t and it goes through as planned, “the consequences of being wrong” will be “really big.”
In January, our Compliance Advisor suggested that institutions should be somewhere on the following CECL implementation continuum:
- Data Gathering Phase: Pulling all loan and lease data together into one repository
- Loan Categorization Phase: Grouping and categorizing loans and leases based on risk
- Parallel Modeling and Methodology Selection Phase: Running parallel models of categorized loans against the current ALLL model to determine the best expected loss methodology to use and gauging the effect on your required capital reserves
This recommendation is even more important today. For the most part, FASB has only heard predictions about CECL disruption; significant factual data proving substantial increases in capital reserves has yet to be presented. Until institutions run parallel models between their current ALLL and their future CECL models to gauge the difference, they can’t prove to FASB or argue to Congress that the predictions of 30 to 50 percent increases will occur or that they were underestimated.
Nor can they determine that CECL will be less harmful than expected. Invictus Group conducted a study last year on the potential impact from CECL. Their results were quite optimistic for smaller institutions, as their modeling concluded that the “bigger banks would feel the brunt of the pain.” They estimated that, “slightly more than two-thirds of banks under $50 billion in assets will NOT feel a significant impact from CECL,” and “only approximately 31 percent of these banks are under-reserved and vulnerable.”
Invictus predicts that, “Small community banks may actually benefit from” CECL, “even though they will face the toughest challenges in implementing” it. So, go ahead and bite the bullet now, while there is still adequate time to ready your institution for CECL. If your parallel modeling shows a harmful hit, share those results with your Congressional representatives and consider taking the three-year transition period election upon your CECL adoption. If it doesn’t show harm, you’ve got a great news story about your safety, soundness and overall financial stability to share.
Still don’t feel prepared for CECL? You’re not alone. Download our CECL by 2020-21: One Step At A Time white paper to learn best practices for CECL compliance.
Keith Monson serves as CSI’s chief risk officer. In this role, Monson maintains an enterprise-wide compliance framework for risk assessment and reporting, as well as other key components of CSI’s corporate compliance program. With nearly 25 years of banking experience, he has a wide range of expertise in the compliance arena, having served as chief compliance officer for both large and small financial institutions.