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Industry thankful for CECL delay but concerns persist

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Banking
Friday, November 16, 2018

Non-public entities will have an extra year to implement new accounting standards crafted by the Financial Accounting Standards Board (FASB). Multiple trade groups advocated for a delay in the implementation date but recently proposed updates to eliminate redundancy have raised other concerns that have nothing to do with the timing of compliance.   

Such entities will not have to comply with FASB’s updated Current Expected Credit Loss (CECL) standard until Jan. 1, 2022, rather than Dec. 31, 2021, as originally required. For public institutions required to file with the Securities and Exchange Commission (SEC), CECL will be effective for fiscal years beginning after Dec. 15, 2019, including interim periods within those fiscal years.

For public institutions not required to file with the SEC, CECL would be effective for fiscal years beginning after Dec. 15, 2020. Non-public entities would include privately owned financial institutions including community banks and credit unions.

The change affords qualifying entities an extra year to implement CECL, a delay for which trade groups such as the American Bankers Association and the National Association of Federally-Insured Credit Unions (NAFCU) long have advocated to alleviate anticipated challenges.

However, Independent Community Bankers of America (ICBA) First Vice President of Accounting and Capital Policy James Kendrick told Dodd Frank Update some recently proposed updates to CECL, put forth by a coalition of regional banks, could create more concerning issues.

The coalition’s proposal would update the CECL standard by instituting a three-part model for recognizing credit losses in the recording process – non-impaired financial asset loss expectations within the first year, non-impaired asset loss expectations beyond the first year and impaired financial assets.

For non-impaired financial assets, the coalition recommended that loss expectations within the first year be recorded to provision for losses in the income statement, with loss expectations beyond the first year recorded to Accumulated Other Comprehensive Income (AOCI). For impaired financial assets, the coalition recommends lifetime expected credit losses be recognized entirely in earnings.

“We believe the proposal would better align CECL with the ‘matching principle,’ the definition of an expense per FASB Concepts Statement No. 6, international filers under IFRS 9, and economics of lending, while still providing financial statement users with decision-useful information,” the coalition wrote in a letter to FASB Chairman Russell Golden.

Kendrick explained how some elements of the coalition’s proposal could prove counterproductive to FASB’s intention in creating the new CECL standards. 

“Under the proposal described in the letter, the estimate of losses for the vast majority of the portfolio is buried in equity, even if the bank forecasts a large uptick in losses that could put the institution at risk for failure in an extended economic downturn,” Kendrick said. “Once losses hit critical mass, they are then all recorded in earnings but only after it’s too late for the institution to take the necessary actions required to remain solvent. This is essentially no different than what we have today under the incurred loss model. And this is counterproductive to what FASB is attempting to accomplish with CECL, which is to recognize future credit losses in a more timely fashion to reflect current and future economic conditions as they change over time.”

Kendrick also said the coalition’s contention for using the AOCI field for recording expected losses as a means to “address inherent capital redundancy concerns if the agencies amend the capital rules to include an adjustment for CECL’s component of losses included in AOCI” would open the door to more risk to go unnoticed and create confusion.

“AOCI has been labeled as a ‘parking lot’ for temporary impairment, which is essentially unrealized losses that will never be realized,” Kendrick explained. “Once you comingle the temporary losses of investment securities with the very real expected losses of loan portfolios, the financial statement user becomes very confused about what the meaning of AOCI really is in the world of already complex financial statements, especially as they relate to the largest banks.

“I would be concerned that this proposal might be dangerous for stakeholders by masking credit risk within the institution at a time when credit risk should be most transparent,” he added.

Trade groups affected by the delay in CECL implementation have urged FASB to coordinate with federal regulators to on guidance for the new standards. NAFCU recently sent a letter to the National Credit Union Administration outlining the association’s efforts to help address credit unions’ CECL concerns and encouraged the agency to work with FASB “to reduce burdens on credit unions and alleviate industry uncertainty.”

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