Current Expected Credit Losses (CECL)

Under this accounting standards update (ASU), the current assortment of impairment models for loans and investment securities will be replaced with a single impairment model that community banks will use to project future credit losses on loans held at amortized cost.  Under this impairment model, community banks will use information about past events, historical loss experience, current observations about market conditions, and future estimates to project future losses.

The ASU is intentionally silent on this question, giving the bank a wide selection of potential methodologies with which to use when projecting future credit losses.  For example, a bank could choose to discount future expected cash flows to generate a net present value calculation.  Or the bank could focus exclusively on expected future principal losses.

The bank must consider historical loss experience, current market conditions, and future projections when it can make reasonable judgments about future events.  Beyond that basic requirement, the standard allows the bank to make its own judgment about what information is relevant in making a decision about the impact of potential credit events.

The bank is required to look only as far as it is able to reasonably project future credit losses.  Once the bank is no longer able to project losses forward, it will switch to an estimate based on historical loss experience.  Regardless, the estimate of loss is a life-of-loan concept requiring the bank to generate its loss estimate over the contractual life of the financial instrument.

Yes.  The bank is required to consider estimated prepayments when determining the cash flows related to the contractual life of the loan.

No.  The bank is not permitted to consider future loan extensions unless it expects to make a modification to the terms of the loan that would result in a troubled debt restructuring (TDR).

The ASU eliminates the impairment requirements surrounding “other-than-temporary impairment” (OTTI) and replaces them with a requirement to record an impairment through the allowance for credit losses.  The measurement of impairment is limited to the amount that the cost basis of the security exceeds fair value and is based only on credit concerns.  In the event that the credit quality of the security improves after impairment is taken, the bank would reverse the previous impairment taken based on updated credit information.  This would be an improvement over the current accounting for OTTI, which does not permit the reversal of previous impairment during improving credit conditions.

For SEC filers, the ASU is effective for fiscal years beginning after December 15, 2019, including interim periods.  For public business entities that are not SEC filers, the ASU is effective for fiscal years beginning after December 15, 2020, including interim periods.  For all other entities, the ASU is effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021.

Yes.  Early adoptions would be permitted for fiscal years beginning after December 15, 2018 and would require that CECL apply to the interim periods within those fiscal years.

No.  Prudential bank regulators have openly stated that they do not expect community banks to implement complex modeling techniques.  In fact, regulators have cautioned against using third party solutions without properly understanding the risks that the counterparty pose to the institution.