CECL debate heats up

Financial Accounting Standards Board (FASB) board member Larry Smith chaired a February 2016 public meeting for financial institutions and other interested parties to express concerns about the proposed Current Expected Credit Loss (CECL) standard, such as administrative burdens of compliance, increased auditing costs, unrealistic modeling expectations and the potential impact on loan loss provision requirements.

Smith opened the meeting by noting that CECL was conceived to address concerns that the incurred loss model failed to consider forward-looking information. He said that in 2005, long before the financial crisis, 10 to 15 employees from mid-sized financial institutions met with FASB because they knew loan loss provisions were too low, yet there was no accounting method allowing them to increase reserves. They wanted to use expectations to determine loan loss reserves and avoid writing loans they knew might go bad even though such loans didn’t show typical loan failure characteristics. Auditors determined that the three bucket model would not achieve this objective and created the CECL model.

Those who attended the public meeting said that even though they were not significantly involved in creating the financial crisis, they will be unduly burdened by CECL as proposed:

  • Only eight percent of community banks failed, and 56 percent of those were in just five states.
  • Those institutions failed because they didn’t have enough capital to put into reserves to withstand drops in property values.
  • They were allowed to fail because they were small and not systemically important like big institutions.

The institutions also said that since they routinely talk to customers, they can anticipate if they need to book more loan loss reserves. They witness firsthand changes in customer situations and local economic conditions; this “on-the-ground” knowledge is far superior to inputting information into an expensive model that will not apply to their institution and for which no back testing on financial institutions has been completed. While they agree that a forward-looking model is appropriate and helpful, they want to use the systems they have been using and simply add an uncertainty factor to calculate any increase in reserves. Their audit and accounting firms have told them it will be harder and much more costly to prepare financial statements under CECL, too.

FASB steadfastly responded that CECL is largely misunderstood — it does not proscribe any particular modeling technique. Those in attendance quickly noted that while saying this is positive, it needs to be documented in the final standard because they anticipate push back from examiners who will interpret it as requiring the use of a specific model. A FED representative said they are informing examiners they should expect to see CECL implemented differently at the various-sized institutions.

FASB reps also said that the intent of CECL is not to create bigger reserves but rather to let expectations of what will happen in the future be reflected in the reserves, whether the reserves go up or down.

The FASB has formed a transition resource group (TRG) to address pre- and post-issuance concerns. TRG has a draft of CECL and will incorporate comments from the February public meeting into the new standard. Those in the industry want to see another draft with a period to express concerns prior to implementation.

Click here to listen to the full audio from the February meeting.

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