Banks Buckle Down for Hard Transition to New Loan-Loss Rule

It's official.

After a fierce debate, the Financial Accounting Standards Board has issued its long-awaited and highly controversial Current Expected Credit Loss standard.

The June 16 announcement served as coda to a grueling process that began in 2008 when the FASB and the International Accounting Standards Board established a working group to study ways financial reporting could be improved. Since then, the FASB has worked through three separate requests for comment, 3,360 comment letters and more than 220 meetings with bankers, regulators, auditors and accountants.

For the seven FASB board members, it's time for a victory lap, right?

Wrong.

"There's way too much work to be done," board member R. Harold Schroeder said. He and his colleagues will shift their focus from advocacy to education, and they plan to continue talking and meeting with bankers and other interested parties until the new standard, widely referred to as CECL, wins acceptance, Schroeder said.

Schroeder, moreover, said he will continue to field phone calls from bankers — although he asked them to read the official CECL version thoroughly before they dial.

"I'm hoping they'll read it, think about it, absorb it and then start to develop their list of questions," he said.

The rule proved to be such a hard sell because it asks financial institutions to value a loan as "the net amount expected to be collected." In other words, the FASB wants banks and credit unions to "immediately record the full amount of credit losses that are expected in their loan portfolios," FASB Chairman Russell G. Golden said in a news release.

Golden went on to say the new standard "aligns accounting with the economics of lending," and would result in significantly improved financial reporting.

It is, of course, a sea change from the traditional incurred-loss methodology that delays reserving for loan losses until it becomes probable a lender will lose money. Bank groups have described CECL as the most significant change to bank accounting practices in history, but they responded the final rule with cautious optimism.

"CECL … has the very real potential to affect how banks do business," Rob Nichols, president and chief executive of the American Bankers Association, said in a news release. "While we continue to have strong concerns with the costs related to CECL's life-of-loan loss concept, we are committed to working with both regulators and auditors to ensure banks of all sizes can meet the implementation challenges of the new standard."

Timothy K. Zimmerman, president and CEO of Standard Bank in Monroeville, Pa., and vice chairman of the Independent Community Bankers of America, said in a release that the rule was much improved over earlier drafts.

Changes made along the way "will make the standard more flexible and scalable for local financial institutions and the communities they serve," Zimmerman said. "We'll continue to work with federal regulators to advance further improvements."

Complaints, Concessions

In January, banking and credit union trade groups were loudly bemoaning the rule, questioning whether it could be implemented in a way that was workable for banks, particularly smaller institutions. One of the big concerns then was whether lenders would be required to use costly complex modeling to develop the loan-loss forecasts that the rule requires.

After two tough and sometimes contentious meetings with representatives of banks and credit unions, FASB addressed those concerns by explicitly stating in the rule that modeling is not required and that financial institutions may use their customary methodologies and tools to calculate their allowance for loan losses under CECL.

According to the standard, FASB "does not specify a method for measuring expected credit losses and allows an entity to apply methods that reasonably reflect its expectations of the credit loss estimate." Additionally, it states "an entity can leverage its current systems and methods for recording the allowance for credit losses. However, the inputs used to record the allowance for credit losses generally will need to change to appropriately reflect an estimate of all expected credit losses and the use of reasonable and supportable forecasts."

In a joint statement issued Friday by the Office of the Comptroller of the Currency, the Federal Reserve and the Federal Deposit Insurance Corp., federal banking regulators said they expected CECL "to be scalable to institutions of all sizes." They added that they did not believe complex modeling would be necessary.

According to the statement, "the agencies expect that smaller and less complex institutions will be able to adjust their existing allowance methods to meet the requirements of the new accounting standard without the use of costly and complex models."

Regulators also ruled out a requirement that institutions use third-party vendors as part of their compliance. 

Potential Pitfalls

Despite the compromises, Tim McPeak, executive risk management consultant at Sageworks, a Raleigh, N.C.-based financial information company, cautioned bankers against thinking implementation would be easy.

"Though the [the standard] notes that 'many of the loss estimation techniques applied today will still be permitted,' we think it is important to note that it goes on to say that the inputs to those techniques will change," McPeak wrote in an email to American Banker. "Institutions should not assume that their current allowance methodology will suffice, as to move to a lifetime expected loss is a fundamental change."

Another concern that continues to worry many is that the rules forward-looking requirements will result in significant additions to financial institutions' loan-loss reserves.

In the June issue of the NCUA Report, a newsletter sent to credit unions by the National Credit Union Administration, NCUA board member J. Mark McWatters, who's also licensed as a certified public accountant, noted fears that credit unions' allowance for loan losses "will need to be significantly increased, at least initially. … This is an issue that federal regulators must take seriously," McWatters wrote.

Implementation Schedule

Given the controversy that has surrounded the rule, the FASB is allowing for a long phase-in period. Financial institutions that file with the Securities and Exchange Commission will not have to begin using CECL for annual and quarterly reports until after Dec. 15, 2019. Thus, for a company that reports on a calendar-year basis, the standard would be effective Jan. 1, 2020.

For stock companies that are not SEC filers, it becomes effective a year later. For nonpublic fliers, such as credit unions and mutual banks, CECL goes into effect for end-of-year reporting in 2021 and quarterly reporting in 2022.

Companies will be able to opt for voluntary early adoption starting in December 2018. Schroeder said he has heard that a number of banks are considering early adoption, but he added it is too early to predict how many will actually take advantage of it.

Outlook

The Transition Resource Group that the FASB assembled in March will continue to operate, Schroeder said. While there are no meetings currently scheduled, it will stick around for "as long as it's needed" to help smooth over any rough patches in implementation, he said.

Throughout all the criticism CECL has generated, Schroeder said a number of bankers have told him they believe the standard will end up benefiting banks by prodding them to take a forward-looking approach to loan-loss calculation.

"They've said it isn't a bad way to think about the portfolio," Schroeder said. "We've seen and heard some very positive comments."