In late December, an interagency body of regulators closed the comment period for a set of proposed changes to the ever-evolving CECL standard. Regulators have recently come back with their responses to industry comments in the form of the “Final Policy Statement for FASB ASC Topic 326” found here: https://www.fdic.gov/news/board/2020/2020-02-20-notational-fr.pdf
If you haven’t yet read the comprehensive 63-page document, below are seven key takeaways that are most relevant for community bankers:
The timeline extensions discussed last fall are again confirmed
“As noted in ASU 2019-10, FASB ASC Topic 326 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, for public business entities that meet the definition of a Securities Exchange Commission (SEC) filer, excluding entities eligible to be small reporting companies as defined by the SEC. FASB ASC Topic 326 is effective for all other entities for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For all entities, early application of FASB ASC Topic 326 is permitted as set forth in ASU 2016-13.” (Page 20)
There remains a significant amount of flexibility, or a lack of clarity, depending on your perspective
“The final Policy Statement does not prescribe requirements for estimating expected credit losses. It describes the measurement of expected credit losses in accordance with FASB ASC Topic 326; the design, documentation, and validation of expected credit loss estimation processes, including the internal controls over these processes; the maintenance of appropriate ACLs; the responsibilities of boards of directors and management; and examiner reviews of ACLs.” (Page 5)
Regulators have confirmed (again) that, for CECL, they prefer management discretion over a single mandated methodology.
“The final Policy Statement does not endorse a specific loss estimation method or provide more detail about specific implementation choices, including providing templates for certain methods. FASB ASC Topic 326 allows management to exercise judgment to best reflect its estimate of expected credit losses given the institution’s own unique set of facts and circumstances.” (Page 8)
Weighted Average Remaining Maturity (WARM) remains in the spotlight as a valid option
The final Policy Statement recognizes that different approaches and assumptions may be used by management in estimating expected credit losses. “Institutions interested in more detailed implementation examples may continue to refer to the examples included in FASB ASC Topic 326 as well as FASB Staff Q&A —Topic 326, No. 1, “Whether the Weighted-Average Remaining Maturity Method is an Acceptable Method to Estimate Credit Losses”. (Page 8)
Your auditing firm may be impaired in their ability to validate your ACL
The final Policy Statement explains that a party independent of the ACL processes should validate the ACLs. “The agencies added language to the final Policy Statement to clarify that external auditor independence may be impaired if the external auditor performs validation activities for management when the external auditor also conducts the institution’s independent financial statement audit”. (Page 16)
Estimating loss history with limited data has been greatly clarified.
“When an institution has a long history of data with limited credit losses, management is not expected to default to external or peer data to determine expected credit losses. When an institution has loss data covering only recent periods, historical loss information should be supplemented with external or peer data, industry data, or qualitative factor adjustments to ensure that expected credit losses are appropriately captured.” For reasons discussed later, these two sentences are noteworthy. (Page 13)
Technical guidance has moved beyond the loan portfolio.
So many of our CECL-related conversations are about what it all means for a bank’s primary loan portfolio. For most small community banks, this makes sense as this is the vast majority of their assets that are impacted by the new accounting standard. However, as banks grow in size and complexity, they’ll likely need to address other asset classes as well. The final Policy Statement includes a number of clarifications around: Qualitative Factor Adjustments for Debt Securities, Treatment of PCDs, Accrued Interest Receivables, and Off-Balance Sheet Exposures. (Page 10)
Most of the items previously mentioned had been long anticipated. In this regard, the final Policy Statement provides much needed clarification, but few surprises. However, there are two items the Qaravan team found particularly interesting:
- The first is the language around estimating loss history with limited data. We believe this guidance will have a very powerful impact on the delta between today’s incurred loss ALLLs and tomorrow’s expected loss ACLs. Many of our clients are banks that have a long history of data that indicates little to no losses. For these clients, there is an opportunity (or risk, depending on your perspective) to reduce loss allowances to something approaching zero. The implications for capital, as both a funding opportunity and as a risk buffer, could be immense for similarly situated institutions.
- The second noteworthy item is the numerous references to banks being able to “tell their stories.” Today the technical nuts and bolts of CECL are top of mind for most banks, but regulators seem to be looking a step ahead and expressing a requirement that banks be able to effectively communicate how their program works. The Qaravan team is particularly interested in this because it mirrors the guidance we’ve been providing our clients, and it validates the purpose of our “Stakeholder Reports” functionality that is so prominent in our solution.