In recent weeks, you may have heard that the Current Expected Credit Loss accounting standard - the regulation known as CECL - has been delayed. You may have questions about what this means for you. Let’s take a closer look at what has actually changed.
CECL Delay: The Facts
On October 16, 2019, the Financial Accounting Standards Board (FASB) voted unanimously to delay the adoption of CECL for small companies.
Specifically, private companies, not-for-profit companies and certain smaller reporting companies will not need to adopt CECL until January 2023.
Smaller reporting companies as reported by the SEC have a public float of less than $250 million or annual revenues of less than $100 million and either no public float or a public float of less than $700 million.[i] Companies not covered under the delay still need to comply with the accounting standard, which requires loan-loss reserves to be made at the point of origination instead of when a loss becomes likely, by Jan. 1, 2020. This includes large SEC-registered banks and finance companies. The good news is that the vast majority of these institutions have been planning for CECL all year long. Some have even provided initial guidance on the impact to their loan-loss allowances and earnings. Managers may not like the CECL rule or have concerns around its implications for earnings, capital and lending across the business cycle, but they’re ready. Like its international counterpart, IFRS9, CECL will likely be adopted early next year without much fanfare. Bank analysts and shareholders will have to adjust to the new rules, but the impact on lending could be relatively small – at least in the short term given expectations of stable economic growth.
Use the Delay to Your Advantage
Smaller institutions that will benefit from the delayed adoption can use the extra time to their advantage. They shouldn’t be lulled into the hope that the delay is just a step towards repeal.
Despite lobbying efforts by banks and credit unions, every indication is that CECL will be adopted as a universal accounting standard for ALL institutions in the United States.
While the expectations for how CECL is adopted will differ substantially across institutions of varying size, the delay offers an opportunity for small institutions to learn from the filings of large banks that will go live with CECL in 2020. It will be beneficial to understand the processes and assumptions used to come up with an estimate of lifetime credit losses.
Step 1: Set up processes to collect and supplement data
One of the primary complaints of small institutions – and one of the reasons why the FASB granted them extra time – is that they lack sufficient historical data upon which to develop a “reasonable and supportable” estimate. So the first step should be to immediately set up processes to collect and supplement data. Even an institution with no historical performance data today will have at least three years of information by the time 2023 rolls around. It’s also worth investing some time to explore alternative sources of data including, but not limited to information from peer institutions, credit bureau data, or data from securitized mortgages, auto and other consumer loans. Not only does the amount of data available for modeling and analysis continue to grow, but it’s now available to even the smallest institutions at an affordable price.
Step 2: Evaluate a range of CECL estimation techniques
Second on the list of CECL-induced agita is the assumption that CECL loss estimates need to be complex. They don’t. There is no requirement that an institution uses a statistical model or an economic forecast. When we walk through the range of Moody’s Analytics CECL solutions, the main drivers for making a decision on the estimation methodology are based on the availability of internal data, current risk management practices and consideration for other use cases across the organization. For a small credit union or bank, it may be sufficient to look back at historical loss performance and overlay an assumption on where the economy is headed to derive an estimate. Operationally, the process of setting the allowance may not look all that different from what it is today. Now that doesn’t mean that a more formal approach is a wasted effort. On the contrary, it may be easier to justify and defend a statistical approach. Wise institutions will use the delay to evaluate a range of CECL estimation techniques and consider how they will incorporate forward-looking economic information or scenarios.
Step 3: Invest in and leverage new technologies to make better, faster decisions
Most importantly, institutions should consider investments in systems that go beyond simple CECL compliance. Accurate credit loss forecasts can improve decisioning, pricing and portfolio risk management. It’s a missed opportunity to simply check the CECL compliance box. A recent McKinsey report revealed that banks and credit unions are falling behind on their technology investments relative to fintechs and other newcomers in financial services. Rather than viewing CECL as yet-another-regulatory-burden, it should be embraced as an opportunity to leverage new technologies to make better, faster decisions. FASB made it clear that the delay is being adopted to allow institutions to take a “business approach” to the implementation rather than simply implementing a “compliance exercise.” Bottom line, don’t assume that the FASB extension will lead to further delay or even a retraction of CECL. The IFRS 9 international loss allowance standard has already been widely adopted across the globe, and there is absolutely no discussion of delaying CECL for large banks. But even if I’m wrong and lobbying efforts ultimately prevail, the investments made to upgrade information systems and estimate credit losses will pay dividends that go far beyond CECL. Still not convinced? Every IFRS9 and CECL adopter I’ve spoken to regrets not having started their processes earlier. Don’t make the same mistake. 2023 will be here before you can blink! The information contained in this document does not constitute legal advice from Equifax or Moody’s Analytics. All organizations should consult their legal counsel for interpretation of the rules, determination of impact to their business, and suitability of individual compliance solutions. For more information on how we can help your financial institution prepare for CECL, call your Equifax or Moody’s Analytics account representative, or contact us today. Additional resources can also be found on Equifax and Moody’s Analytics websites.
[i]Source: Wednesday, October 16, 2019 FASB Board Meeting [hyperlink: https://www.fasb.org/jsp/FASB/FASBContent_C/ActionAlertPage&cid=1176173591745&rss=1]