Despite the hopes of many bankers, recent indications from regulators strongly suggest that CECL is happening. While your immediate focus may be on PPP and COVID-related issues, it is important to prepare.
- Review effective dates for your institution as you prepare to implement CECL.
- Leverage takeaways from early adopters of CECL as you begin to plan.
- Get started on CECL now, time is running out.
- Utilize relevant data to develop the qualitative factors in your CECL calculation.
Need assistance with CECL implementation?
As the financial institutions industry continues to navigate the impact of COVID-19, implementing the Current Expected Credit Loss (CECL) guidance from the Financial Accounting Standards Board (FASB) has temporarily become less of a priority. While your immediate focus may be on Paycheck Protection Program (PPP) forgiveness and other COVID-19 relief programs, adoption and implementation of CECL remains on the horizon for the majority of institutions.
CECL effective dates
On November 15, 2019, FASB updated the effective dates for implementation of the CECL standard to the following:
- Large accelerated and accelerated filers — Annual reporting periods beginning after December 15, 2019, including interim periods within those fiscal years.
- All other entities — Annual reporting periods beginning after December 15, 2022, including interim periods within those fiscal years.
Note: Early adoption is permitted for fiscal years beginning after December 15, 2018.
Institutions that received relief from the Coronavirus Aid, Relief, and Economic Security (CARES) Act were allowed to delay the adoption of CECL until either the termination of the national emergency related to COVID-19 or December 31, 2020 (whichever came first). The 2020 AICPA National Conference on Banks & Savings Institutions reported that 23% of the institutions that were previously required to adopt CECL in 2020 opted to delay adoption pursuant to the CARES Act. A closer look at the institutions that adopted and implemented CECL in 2020 can help you prepare to do so.
Takeaways from early adopters
In September 2020, the United States Department of the Treasury released an update on an interagency study to determine if any changes to CECL were necessary. This study monitors the transition to CECL, along with the effects on regulatory capital and financial institution lending practices. Given the impacts of COVID-19 and the related delays in implementing CECL, it was determined that a definitive assessment on the impact of CECL is not feasible at this time. But what have we learned from the institutions that have implemented CECL?
One study by S&P Global found that nearly all U.S. banks with over $10 billion in total assets that adopted CECL saw an increase in their year-over-year allowance. Additionally, banks with less than $500 billion in assets that adopted CECL reported a median increase in the provision for credit losses of 30%.
Similarly, as discussed at the 2020 AICPA National Conference on Banks & Savings Institutions, institutions that adopted CECL on January 1, 2020 experienced an impact to their allowance for credit losses of approximately 36%. Since adoption, overall reserve percentages in comparison to total loans have increased from 1.21% to 1.79% (PPP loans excluded) as of June 30, 2020.
While it is difficult to determine how much of this increase is related to the implementation of CECL versus the impact of COVID-19, be mindful of these early results as you begin to discuss implementation.
Steps to prepare
There was early criticism regarding how CECL calculations would respond during the next economic cycle. COVID-19 brought an ideal test case for this new methodology, since most forecasting models would not have predicted this current cycle. Learn from the current environment to help inform a CECL model that is appropriate for your institution. For example:
- Start planning early — Use the time leading up to the implementation date effectively. At the AICPA conference in September, Federal Deposit Insurance Corp. (FDIC) chief accountant John Rieger stated, “Use this time advantageously and don’t waste it.” While many had hoped to see a permanent delay in CECL implementation, all indications imply it is here to stay.
- Monitor early adopters — Despite some institutions opting to defer the implementation of CECL under the CARES Act, large accelerated and accelerated filers are required to implement CECL by December 31, 2020. Monitor these adopters for at least two years, learn from their experiences, and build this information into your own calculations.
- Leverage available data — Due to the strength of the economic environment over the last several years, many financial institutions have experienced limited losses in their loan portfolios. While this is a positive trend for the health of an institution, it poses challenges as you calculate your required reserve under CECL. Regardless of which methodology you plan to use, you will likely incorporate historical loss rates into your analysis. With limited losses, the bulk of your reserve under CECL will probably come from qualitative adjustments. The qualitative and environmental factors utilized under CECL are similar to what you are doing today. Be sure to use relevant data as you develop qualitative factors in your CECL calculation.
- Federal Reserve Economic Data (FRED) — This database provides a significant amount of economic data that you can segment in a variety of ways, including local, state, regional, and national levels. Use this tool as you develop forecasts.
- Call report data — While there are limits to the depth of call report data, you can still use it to provide a comparison to peers, as well as how other institutions are affected by CECL. Leverage analytical tools such as BankTrends or CU-Metrics to aggregate call report data.
- Internal data — In the wake of CECL’s issuance, you may have been instructed to save your historical data. While some of the more streamlined methodologies (e.g., Weighted Average Remaining Maturity [WARM] methodology) will likely not require the depth of data once feared, you should still utilize information in your internal systems to support your analysis. If you use a more complex methodology or analyze your portfolio at the individual loan level, this set of data could potentially be the most important information in your CECL analysis.
- Model Validations – If your institution has already selected its CECL methodology, it is important to keep proper model risk management practices in mind to enhance the accuracy and validity of this high-risk model. Due to the complex nature of some CECL models, as well as the significance of the CECL calculation and its impact on the financial statements, make sure your institution has developed an adequate control structure that validates the inputs, outputs, assumptions, and other variables in the calculation.
Over the last few years, financial institutions have often stated, “I’ll start my implementation process when I need to,” “CECL is going to keep getting delayed or repealed so I’m not going to worry about it,” or a favorite, “I’ll be retired by the time CECL is implemented.”
While 2023 seems far off, the expectation is to run your existing methodology parallel to your CECL methodology for a period of time. Start your process of implementation soon, if you have not already done so. Consider the following tactics to begin.
- Develop your CECL implementation team.
- Select your methodology.
- Identify data sources to support your analysis.
- Leverage external resources to support your implementation efforts.
- Run the calculation parallel to the existing methodology.
- Perform model validation of your methodology.
The standard of CECL implementation is not prescriptive, which means there is not a specific methodology that must be used in your process. For many small or non-complex institutions, a simplified methodology such as WARM may be the most efficient way to implement CECL. Regardless of your specific methodology, plan ahead and prepare.
How we can help
We’re here to help you with your implementation plan.
- Review our CECL resources.
- Attend our webinar on December 1, 2020, at 1 p.m. CT, co-hosted with Informa Financial Intelligence, the developer of the BankTrends and CU-Metrics CECL calculator. We will discuss what we have learned from the approximately 200 institutions using Informa’s CECL calculator, takeaways from early adopters, and recommendations for your implementation.
- Contact CLA with questions surrounding various methodologies, implementation assistance, and model validation support.