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The Basics of CECL

The Financial Accounting Standards Board (FASB) issued an accounting standard, Accounting Standards Update No. 2016-13, Topic 326, “Financial Instruments—Credit Losses,” (ASU 2016-13) in June 2016. The accounting standard, when implemented, will replace the incurred loss methodology with the current expected credit losses (CECL) methodology for estimating allowances for credit losses. Below are some key points for consideration as your financial institution transitions to CECL:

Preparation:

  • The transition time is unusually long- See Key Dates
  • Each institution must make a determination of its effective date to transition to CECL,
  • Financial institutions should take advantage of this lead-time to prepare.
  • Financial institutions should involve all relevant business lines in CECL preparation and keep its board of directors informed of progress. Financial institutions should perform necessary due diligence to include appropriate discussions with the financial institution's information technology data processors, third-party accountants, and other consultants and advisors.

Application:

  • CECL is an accounting change and applies to all issuers of U.S. Generally Accepted Accounting Principles (GAAP) statements, not just banks.
  • It does not scope out small institutions.
  • It affects loans and securities held at amortized cost (and also modifies some accounting rules for available-for-sale (AFS) debt securities)

What’s Involved?

  • Removes the “probable and incurred” thresholds for determining loan loss provisioning.
  • Expands the time horizon to consider expected losses:
    • Retains the use of historical information.
    • Retains the use of adjustments for current conditions.
    • Adds the use of forward-looking analysis.
  • It is data dependent; loss factors applied to risk categories and groupings will need to be supported by data.

Methodology:

  • Reduces the number of standards which must be applied for impairment of different asset types.
  • Is principle-based and not prescriptive as to methodology.
  • Is scalable:
    • Financial institutions should adopt approaches that are appropriate for their complexity and risk profile.
    • Many of the methods used today by community banks will be acceptable under CECL but will require some adjusting.
  • Under CECL, the total amount of net charges on financial assets does not change, but rather the timing of credit loss provision expenses changes.
  • CECL requires “day one” booking of the estimate of impairment on financial assets.
  • Some methodologies measure impairment by estimating the contractual cash flows that are not expected to be collected.
  • Allows pooling or “grouping” of financial loans for analysis by risk.
  • Assets not sharing risk characteristics with other assets can be measured separately.
  • Requires allowance for off-balance sheet exposure unless the contract is unconditionally cancellable by lender.

 Technical Details:

  • Retains certain concepts of troubled debt restructuring, loan write-offs, nonaccrual, and loans held for sale.
  • Changes current accounting for purchased credit deteriorated loans (PCD) loans and requires a “day one” allowance.
  • Retains concept of “collateral dependent expediency” impairment analysis but modifies definition of collateral-dependent loan.
  • Modifies rules for loss accounting on AFS debt securities by requiring charge-off through an allowance with a fair value floor applied to the carrying value of the asset.
  • Requires consideration and support of both qualitative and quantitative factors in determining the allowance.

Implementation

  • For assets carried at amortized cost the initial adjustment to the allowance for credit losses (ACL) at adoption of CECL will be to record the cumulative effect through capital, not the income statement.
  • GAAP does permit increasing retained earnings as CECL effective dates approaches; however, GAAP does not permit artificially “ramping up” the allowance. 
  • Federal Reserve is taking the approach that, at this time, examiners will not criticize a financial institutions efforts to prepare for CECL.