CECL down, but not out

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Lawmakers and regulators, while willing to delay a new accounting standard for expected credit losses, seemed unwilling to eliminate it completely.

The new stimulus package includes language allowing lenders that had already implemented the Current Expected Credit Losses standard, or CECL, to delay compliance until the end of the national emergency declared by President Trump or until Dec. 31, whichever happens first.

The Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. unveiled an interim final rule on Friday allowing those same banks to fully defer the expected hit to regulatory capital for two years. It comes on top of February 2019 guidance permitting banks to phase in CECL’s day-one impact on regulatory capital over three years.

At first glance, the decisions are a setback for CECL's opponents, who argue that the standard will be damaging to the economy during downturns. But they also allow for more time to collect data and support for getting rid of CECL when the coronavirus outbreak ends.

“The inclusion of a short-term CECL delay is a good start, but there is more to be done,” Rep. Blaine Luetkemeyer, R-Mo., said in a Friday press release. “I look forward to working with members in both chambers to delay CECL even further and finding a permanent solution.”

A spokeswoman for the Financial Accounting Standards Board declined to comment on the interim final rule.

Pushback against CECL gained momentum earlier in the week when FDIC Chairman Jelena McWilliams released a letter urging the accounting standards board to let banks indefinitely delay the new standard.

The interim rule made it clear that other banking regulators, jot just McWilliams, also believe CECL would take a toll on banks.

The pandemic “has presented significant operational challenges to banking organizations at the same time they have been required to direct significant resources to implement CECL,” the agencies wrote. “In addition, due to the nature of CECL and the uncertainty of future economic forecasts, banking organizations that have adopted CECL may continue to experience higher-than-anticipated increases in credit loss allowances.”

The interim final rule lets banks fully postpone the regulatory capital impact of CECL until 2022. After that, lenders would have three years to phase in any capital hits that would have taken place during the two-year delay. Lenders would need to calculate that on a quarterly basis, using a 25% scaling factor.

Large, publicly traded banks converted to CECL on Jan. 1. The rest of the industry, along with credit unions, is scheduled to follow suit in January 2023. While opponents had hoped to win a moratorium for those institutions, for now they will need to keep preparing for a CECL switchover date.

While two and a half years seems like a long time, their impending conversion still represents a huge burden during a time of crisis, said Jeremy Newell, an attorney at the Washington law firm Covington.

“There are real changes to reporting and operating infrastructure,” Newell said. “It’s a big project with timelines that extend out well over a year.”

The accounting standards board approved CECL in June 2016 after eight years of discussion and debate. The standard, which many have termed the most significant change to bank accounting in decades, requires institutions to front-load the allowances, forecasting and recording of credit losses at the time they originate a loan — and before they’ve booked any interest income.

Critics have argued that CECL would be procyclical, discouraging lending in downturns. The coronavirus crisis has removed all room for debate, they argue.

CECL “doesn’t work," Luetkemeyer said in an interview before the regulators' intervention.

“When firms estimate expected credit losses upfront, they do that using a near-term economic forecast [that] can change dramatically when you go from a benign environment to a crisis," Newell said.

“CECL will require much higher reserves for new loans than it did a few months ago," Newell added. "Absent steps to address those accounting and regulatory capital impacts, that’s a big disincentive to lend and creates significant new barriers to extending credit. We’re living through precisely the kind of situation in which CECL would have the biggest procyclical impact.”

Still, not everyone is certain there’s a direct connection between CECL and elevated reserve levels. A number of measures in the stimulus package, including treatment of troubled-debt restructurings and new lending initiatives, might make it hard to tell what impact, if any, CECL would have on the economy.

And any reduction in lending in coming months could have more to do with the pandemic instead of higher reserves tied to CECL, said Alia Luria, chief technical officer at InFront Compliance.

“We may not know the direct effect on one versus the other for a long time, if ever," Luria added.

At the same time, CECL's backers note that the standard was created in response to concerns the incurred-loss method, where losses are recognzied only when a loan shows signs of stress, failed to produce an accurate picture of credit quality during the financial crisis.

“CECL is the product of a long and thoughtful reassessment of the accounting rules for loan-loss recognition in the wake of the financial crisis,” said Matt Broder, a spokesman for the Financial Accounting Foundation.

“It's important to remember the incurred-loss model created real problems for investors at the time," Broder added. "There was bipartisan consensus accounting models needed to be improved. CECL is the result of that process."

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CECL Law and regulation Coronavirus Community banking FASB Federal Reserve FDIC OCC
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