In April 2017, Mazars published our first article on the new Current Expected Credit Loss (“CECL”) standard, under Accounting Standard Update (“ASU”) No. 2016-13. The new credit loss model will not be effective until after 2019, but institutions should have already been taking steps over the past year to understand and prepare for the impact.
In September 2017, the agencies (the Federal Reserve Board, Financial Depository Insurance Corporation, National Credit Union Administration and the Office of the Comptroller of the Currency) published an updated version (from the December 2016 draft) of the interagency Frequently Asked Questions (FAQs) on CECL implementation.
The question our clients still ask is what changes are needed in their current Allowance for Loan and Lease Losses (ALLL) methodology. While the interagency FAQ addresses most of these questions, it has many interesting details. One item that it clarified was how an entity’s status impacts the standard’s effective date. For purposes of the CECL adoption, the agencies provided examples and discussed in more detail three different iterations of effective dates that apply, depending on whether an entity is a Public Business Entity (“PBE”) that is an SEC Filer, a PBE that is not an SEC filer, or an entity that is not a PBE. The FAQ also further clarified certain criteria in the assessment of whether an entity that is not an SEC filer is a PBE. Note that while all SEC filers are PBEs, not all PBEs meet the definition of an SEC filer. The FASB provided the definition of a PBE in its Master Glossary; however, the PBE concept is still fairly complex. Management needs to be familiar with the PBE criteria to know when the new standard will apply to them.
For a PBE that is an SEC filer, the new credit loss standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Thus, for a calendar year-end PBE that is an SEC filer, it must first apply the new credit loss standard in its financial statements and regulatory reports (i.e. Call Report) for the quarter ended March 31, 2020. For a PBE that is not an SEC filer, the new standard is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. For an entity that is not a PBE, the new standard is effective for fiscal years beginning after December 15, 2020 and for interim period financial statements for fiscal years beginning after December 15, 2021. Early application is permitted for all institutions for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.
The new credit loss standard further requires institutions that are PBEs to disclose credit quality indicators by vintage (i.e. year of origination) for a minimum of five annual reporting periods, with the balance for financing receivables and net investment in leases originated before the fifth annual reporting period shown in the aggregate. For PBEs that are not SEC filers, the FASB allows a “phase-in” approach which permits such entities to disclose three-year vintage information and then phase in over the next two years to the full five-year requirement described earlier.
The interagency FAQ also stated that the agencies will not establish benchmark targets or ranges of allowance levels upon the adoption of CECL or for allowance levels going forward, and that the agencies do not require institutions to reconstruct data from earlier periods, that are not reasonably available, in order to implement CECL. This will hopefully abate some concerns that the implementation of the new CECL standard will be a highly complex process.
Under CECL, the qualitative factors identified in the December 2006 Interagency Policy Statement on the Allowance for Loan and Lease Losses remain appropriate considerations. Historical loss information will be a good starting point; however, an institution should incorporate, as necessary, its expectations of current conditions and reasonable and supportable forecasts not already incorporated in the historical loss information over the contractual term of the asset.
On another note, the FASB Transition Resource Group (TRG) issued tentative decisions during its September 2017 meeting on certain implementation issues relating to the identification and measurement of reasonably expected troubled debt restructuring (TDR) loans under the new credit loss model. There was lack of clarity on the accounting for TDRs under the new ASU as to whether entities should be forecasting all types of reasonably expected future TDRs on a portfolio basis, and including their effect in the calculation of expected credit losses. The TRG clarified in its September 2017 memo that entities should only reflect the effects of a TDR in the allowance for credit losses when a loan is individually identified as a reasonably expected TDR, rather than considering all types of reasonably expected future TDRs on a portfolio basis. The TRG also clarified that an entity must use a discounted cash flow (DCF) method if the TDR involves a concession that can be captured using only a DCF method or reconcilable method, rather than allowing preparers to use various methodologies. These tentative decisions should be a welcome clarification for most financial institutions.
I encourage management to read the interagency FAQ and recent TRG tentative decisions, as these discuss other matters relevant to different entities’ specific circumstances. It is also important for banks to start the process in spite of the current hiatus state. Has management read and educated themselves with the new CECL standard along with the board of directors and other departments that should be involved? Has management determined the applicable effective date of the standard based on the PBE criteria discussed above? Has management outlined the implementation project, including the level of data needed to be collected and maintained to estimate lifetime credit losses under the new standard? Organizations cannot afford to wait to answer these questions – the time to address them is now.