By: Tommy Troyer, Executive Vice President
I have been writing about CECL in this newsletter and providing CECL educational programs to community banks for several years. The overall theme I’ve tried to communicate in all of these settings has been: CECL is manageable for community banks, but it requires planning and preparation starting now.
I’m quite encouraged by the fact that the second part of that message, about the need to actively prepare for CECL now, seems to have been accepted by the majority of community bankers. In this article, I will provide a brief overview of a few noteworthy recent developments related to CECL, as well as some brief comments on what we are seeing from banks with respect to CECL preparation.
Regulatory FAQs Updated
On September 6, 2017, the federal financial regulators released an updated version of the interagency FAQs on CECL that were first issued in December 2016. All CECL FAQs are being consolidated into one document, so the most recent release includes both questions 1-23 from December and new questions 24-37. The information conveyed in the new questions is broadly consistent with the things I have tried to communicate in my articles and in my teaching about CECL and contains no surprises. This lack of surprises from the regulators is, of course, a good thing. I specifically recommend the expanded discussion in questions 28-33 regarding the definition of a Public Business Entity (PBE), as the PBE definition is a FASB concept that is fairly complex. The definition is important to understand because institutions can be PBEs without being “SEC Filers,” and PBE status determines the effective date of CECL for an institution. Questions 34-36 also include some helpful and fairly detailed examples of how the transition to CECL should work for call reporting purposes for institutions in various situations with respect to PBE status and whether or not an institution’s fiscal year lines up with a calendar year.
These are helpful clarifications since non-PBEs do not need to adopt CECL for interim periods, only for the year-end financials, in the first fiscal year of adoption and because call reports are completed on a calendar year basis irrespective of a bank’s fiscal year.
FASB TDR Decisions
The final CECL standard has been in place and has been public for over 15 months at this point. CECL is not going to magically disappear before implementation, and there will not be substantial changes to CECL’s requirements. However, there are still some decisions related to CECL that are being made by FASB, specifically through its Transition Resource Group (TRG), which exists to help identify potential challenges to implementing the standard as written. The TRG met in June and a number of issues were discussed, though many of the issues discussed are unlikely to have an impact on the average community bank. However, several issues related to Troubled Debt Restructurings (TDRs) were discussed and ultimately clarified by FASB in September. These issues are relevant to community banks and are worth noting.
The first decision that community banks should be aware of is one that will generally be viewed favorably by community banks. The issue at hand is that CECL requires estimating expected losses over the contractual term of loans and states that the contractual term does not include “expected extensions, renewals, and modifications unless [there is] a reasonable expectation” that a TDR will be executed. The issue FASB considered was just how expected TDRs should factor into an institution’s allowance.
The options presented were, essentially, to estimate losses associated with some level of overall TDRs that you expect to have in your portfolio even though you don’t know on what loans these TDRs might occur, or to only account for expected TDRs when you reasonably expect that a specific loan in your portfolio will result in a TDR being executed. FASB chose the latter option, which should prove to be much more manageable for community banks.
The second decision that FASB made is one that might generally be viewed less favorably by community banks. The CECL standard, when released, seemed to provide more flexibility around measuring expected losses on TDRs than current rules, which requires a discounted cash flow approach unless the practical expedients related to the fair market value of the collateral or the market price of the loan apply. The CECL rules essentially said that any approach to estimating losses on TDRs that was consistent with CECL’s principles was acceptable. However, FASB ultimately decided that the cumulative requirements in the CECL standard and in existing accounting rules for TDRs require that all concessions granted to a borrower in a TDR be accounted for through the allowance. The brief summary of FASB’s decision is that, in fact, a discounted cash flow approach to measuring the impact of TDRs will still be required under CECL in any circumstance where such an approach is the only way to measure the impact of the concession (the best example of such a concession is an interest rate concession). The TRG memo dated September 8 and available on FASB’s website is a good resource for a more detailed discussion of the above issues.
What Community Banks are Doing
What are some of your peer community banks doing to prepare for CECL? There does of course remain a wide range of preparation and some banks still haven’t gotten started in any serious way. However, many banks have at least informally assembled the team that will work on CECL, and while not as many have adopted simple project plans as we might wish, many do at least have informal steps and deadlines in mind. Many have started giving thought to data availability and needs, though again perhaps not enough have yet gotten very serious about fully evaluating the data they have, how they will store and use it on an ongoing basis, and what additional data they would like to begin capturing. Nearly all banks have undertaken at least some educational efforts around CECL, and this is an area of focus that should continue through implementation and even beyond. Options for third-party solutions are being explored by some banks, though in order to make sure that an informed decision is made, it is critical that banks go into these explorations with a good fundamental understanding of CECL as well as with an awareness of the regulatory position that such solutions are perfectly fine options but are neither required nor necessary for CECL implementation.
How We Can Help
We have presented and will continue to present webinars, seminars, and talks on CECL. Please visit our website or call or email me for an overview of these sessions, which are specifically designed for the community banker and which are not designed to try to sell any particular software solution.
Additionally, we are ready and willing to work with banks in a consultative role on CECL. Like everything else we do, there is no fee associated with an initial phone conversation or email exchange about CECL, and if we can help provide you with clarity about something related to CECL, then we are happy to do so. We are of course also happy to discuss various approaches in which we might provide consulting support in one or more capacities to assist your institution in preparing for CECL.
To discuss CECL further, contact Tommy Troyer at [email protected] or 330.422.3475.