On CECL, Time for Everyone to Just Take a Deep Breath

The debate over the Financial Accounting Standards Board's new loan-loss reserve model has been dominated by this question: How burdensome will the new standard, known as the Current Expected Credit Loss model, be on community banks?

Unfortunately, the debate has been dominated by two extremes in terms of answering that question. One camp has come to the conclusion that community banks can breathe a sigh of relief and the CECL will be no big deal. Another camp, typically made up of vendors seeking to assist banks in following the new model, have adopted a "sky is falling" view, rousing bankers by stating that smaller institutions can never meet the FASB requirement without purchasing very expensive solutions.

While no one has actually seen the final FASB rule — although the approach favored by the board is now well-known publicly — the true answer to the question of how burdensome it will be is probably somewhere in between those two extremes. But more importantly, all the noise is serving as a distraction, paralyzing bankers when they should be taking reasonable and practical steps to prepare for the CECL model now, when they have the time to do so.

It is difficult for bankers to think about beginning to prepare when even the bank regulators are inconsistent in their statements about the CECL's impact.

For example, during an April 7 meeting of the Federal Deposit Insurance Corp.'s advisory committee on community banking, FDIC Chief Accountant Robert Storch, responding to a question, implied that the impact of applying CECL on a bank's current "incurred loss" model for calculating loan-loss provisions was minor. He suggested that life-of-loan calculations are not really needed, and banks should not be overly concerned about projections beyond a typical business planning cycle.

"If you have a fairly straightforward approach today, even using Excel spreadsheets and so forth, there is an expectation that you should be able to continue to use that type of an approach," Storch said.

But that approach appears to be different from that expressed in an Oct. 30, 2015, "Fed Perspectives" webinar hosted by the Federal Reserve. The webinar mentioned many approaches to use to calculate CECL projections, but life-of-loan estimates and the "vintage model" were examined and explained in depth as a good and valuable method for determining projections.

The average banker's lack of understanding of the true impact of CECL is based on a combination of factors and drivers that continue to build. A primary cause is the amount of time that FASB has taken to publish its final rule. While FASB has extended the release date in part to give time for public input, this lengthy delay has given a host of stakeholders, industry groups and vendors time to build up a number of opinions, myths and scenarios — creating a din of conflicting noise.

The cacophony has included dire warnings presented by vendors to chief financial officers of an insurmountable task of portfolio data management beyond their means.

Up to now, proposed language in the CECL model has been written as principle-based regulation, outlining many options for compliance without providing much specificity around actual roadmaps to pursue. Such an imprecise regulatory mandate provides openings for both those who say the model will be simple and those who say it will be very difficult. Principles can be interpreted in many different ways in actual practice.

There have, however, been more reasonable voices. The American Bankers Association and some other groups have tried to maintain a middle ground, saying the accounting rules will require actionable steps by bankers but those steps are doable — if they prepare appropriately.

But the perception created by others of uncertainty and undefined danger has created a "deer in the headlights" reaction to the CECL among a majority of community bankers. This creates paralysis along with their fervent hope that the whole problem will just go away and leave them alone if they just wait it out.

One of the most unfortunate byproducts of this noise-induced paralysis is that now is precisely the time that bankers should be addressing the foundation of the future CECL calculation, no matter what the final methodologies and best practices will dictate — and that foundation is in their own portfolio data.

Now is the time to be assessing the availability and quality of their credit data, identifying gaps and addressing remediation projects. There is no one recipe, but there is consensus that loan origination data (risk characteristics), loss and recovery history will be crucial. Based on average loan terms for differing asset types, 10 or more years of this historical loss information will be needed.

The fact is that once the final rule is out, and there is some time for the industry to digest it, the voices of practical wisdom will be heard. As the regulators and audit boards issue their guidance and interpretation of CECL compliance, this will also add needed clarity.

Peter Cherpack is a principal at Ardmore Banking Advisors.