How Banks Must Respond to the FASB Issuance of CECL

The Financial Accounting Standards Board (FASB) today (June 16, 2016) issued its long-awaited Accounting Standards Update (ASU) regarding its new loan loss accounting framework. The Current Expected Credit Loss model (CECL) was first proposed in 2012. With its adoption, 40 years of standards related to how banks manage their business change, posing significant compliance and operational challenges for banks.

We have put together the information you need to know most – and most immediately – about CECL. Education will be your key to success with this new standard. We recommend you start by getting up to speed on the regulatory discussions and developments that have been happening over the past couple of months. Review them here:

• How Should My Bank Prepare for the New CECL Standard? (May 4, 2016) 
• What Banks Need to Know About the Proposed CECL Standard (February 10, 2016) 
• The Four Things You Need to Know to Manage CECL (January 8, 2016) 

What Does CECL Change for Banks?

CECL is not expected to significantly change your practices related to impaired loans, collateral dependent loans, TDRs, and nonaccruals. The primary change applies to unimpaired loans.

In simplest terms, CECL requires “life of loan” estimates of losses to be recorded for unimpaired loans. At the time of origination, the bank must record the credit losses expected throughout the life of the asset portfolio on loans and held-to-maturity securities. This is a contrast to today’s “incurred loss” accounting, under which losses are recorded when it is probable that a loss event has occurred.

In addition, the standard is expected to increase the Allowance for Loan and Lease Losses (ALLL) and credit loss provision expenses. It applies to loans, loan commitments, and “Held To Maturity” securities.

Because Life of Loan (LOL) loss expectation (pool basis) must be recorded at origination, a forecast of the future to LOL is required. Because losses don’t occur evenly throughout the life of a loan and the age of a loan will impact the charge-off rate and lifetime loss, you will use historic averages of “life of loan” losses as a starting point for estimates, and apply those averages to periods beyond “forecastable future.”

How to Prepare for CECL Implementation

Called the “biggest change to bank accounting ever,” this highly complex model will be effective in 2020 for Securities and Exchange Commission registrants and 2021 for all others. Early adoption is allowed, and ABA, regulators, and HORNE recommend that you start the CECL implementation process as soon as possible. You will incur costs for change and implementation, but can avoid unnecessary additional costs by starting the adoption process now.

Banks have three primary connections to consider as you educate, communicate, and implement the standard:

1. Investors and Management: It’s vital to communicate that the relationship of traditional metrics to provisions will cease, requiring new metrics.
2. Auditors: New and more granular supporting documentation will be required for LOL data and quantifying forecasts.
3. Regulators: It’s important to stay informed about how regulators require banks to align CECL with capital management, ALM, budgeting and planning. 

You should begin looking at how to implement two main operational changes:

1. Collecting and analyzing the type of data that supports the modeling of the LOL loss expectation
2. Processes for forecasting and quantifying losses in the future

The Upside of CECL

While CECL promises to be a major change for banks, the ABA expects it to provide some notable improvements for the industry. Banks may be able to record losses that GAAP currently does not allow. More consistent coverage and NIM ratios as ALLL will apply to most debt securities (vs. today’s OTTI charge-off). Certain allowances may decrease, including some open credit card line allowances and short term loans and renewable loans.

“After years of anticipation and countless comment letters, banking organization and regulator input and deliberations, FASB has issued the final CECL standard – one of the largest pieces of guidance ever issued by FASB. All banks will have to rethink the way they were accounting for ALLL. It’s going to require a large amount of documentation, thought, and collaboration across multiple divisions of banks. Although we’ve all been talking about this for years, now it is time to plan, act, and put the resources in place because 2020 will be here before we know it!”  – HORNE Banking

We hope this information gives you a good start to your future under the CECL standard. Start thinking through the impact now. Start collecting data and analyzing trends now. We will continue to share our point of view and guidance to help you adopt the standard and recognize benefits going forward. We’re here to support you in this process. Don’t hesitate to get in touch with any questions or concerns.

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