February 23 2017
Implementation of the Financial Accounting Standards Board’s current expected credit loss standard is well underway at major banks, according to a survey by Deloitte, though the new standard could show how risky many of the loans really are.
The new standard could expose a much greater extent of loan impairments than previously shown, the survey indicated. Most of the 31 U.S. banks surveyed by Deloitte last summer said that if the CECL standard were in place today, their impairment number would increase by more than 10 percent for consumer loans (75 percent of banks), mortgages (71 percent) and commercial loans (54 percent). As a result, most banks anticipate a decrease in their capital ratios. Over 80 percent of the banks surveyed also expect their profit and loss to become more volatile under CECL.
FASB issued its long awaited accounting standards update for credit losses last June, part of the convergence project on financial instruments that it has been working on with the International Accounting Standards Board for eight years (see FASB releases new financial instruments standard for accounting for credit losses). FASB and the IASB diverged, however, in their approach to accounting for credit losses on loans and other financial instruments. The project became more urgent after the 2008 financial crisis, when the value of mortgage loans and derivatives such as collateralized debt obligations plunged and there was disagreement over how to account for the extent of impaired loans.
The new disclosures could be a big problem, according to many banks. More than 90 percent of the surveyed banks said that disclosure requirements are a challenge for their bank in implementing the new CECL standard. The new credit loss standard retains much of the existing disclosure criteria, but also requires additional disclosures. Financial institutions are now required to prepare a roll-forward of the allowance for expected credit losses, both for financial assets measured at amortized costs and for available-for-sale debt securities. They also need to disclose credit quality (and vintage analysis), the allowance for credit losses, the methods for estimated expected credit losses, the policy for determining write-offs, past-due status by portfolio segment, purchase credit deteriorated assets, and collateral-dependent assets under CECL.
Most of the banks in the survey don’t expect CECL to affect the cost of products, though a significant minority anticipate an impact on some types of products. The product types most often expected to see an increase in cost due to CECL are mortgages (46 percent) and consumer loans (36 percent).
The majority of banks are already working on adjusting to the new standard, with 70 percent of those polled saying they have already started CECL implementation or would have initiated it before the end of 2016. The credit loss standard will take effect for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after Dec. 15, 2019. For other public companies it won't take effect until the end of 2020, and for private companies the end of 2021.
The move from the current accounting model of an “incurred loss” accounting to “expected loss” over the life of the loan will require banks to coordinate among a number of internal functions. The banks polled by Deloitte reported that a wide array of groups at the institution would be very involved in preparing for CECL implementation, including credit modeling (100 percent), accounting policy (87 percent), finance/controller’s group (74 percent), risk and compliance (65 percent), and IT/systems (55 percent). Forty-two percent of the banks polled also said their SEC financial reporting group would be very involved.
“Implementing the new CECL standard will likely be a major undertaking requiring the active involvement of numerous functions and lines of business, as well as requiring investments in model development, new data sources, and upgrades to the IT infrastructure,” said the report. “Although the effective date of the new guidance is still several years away, the scale of the project means that banks should begin today to prepare for the dramatic transformation in their credit and financial reporting practices that will be required.”