Big banks are making progress in preparing for the new accounting requirements around credit losses, but non-bank operating companies are likely to face a heavier lift as they approach the fourth quarter.
Bank of America has either validated its new models for recognizing credit losses under a “current expected credit losses” approach or is in the process of validating them, said Chris Lynch, senior vice president, at a recent American Institute of Certified Public Accountants banking conference. “We’re running our CECL process in real time to make sure it can do it at game speed,” he said. “It’s been a great experience.”
Public companies are required beginning Jan. 1, 2020, to report credit losses under the CECL model as spelled out in Accounting Standards Codification Topic 326, although smaller reporting companies are expected to receive more time to prepare along with other non-public entities. The new standard tells entities to use some historic experience along with some forecasting to estimate their lifetime credit losses and book upfront allowances, doing away with the current approach whereby losses are reported as they occur.
The American Bankers Association and other major banks have lobbied for a delay in the CECL standard so the macroeconomic effects of booking larger upfront reserves can be further studied before being implemented. CECL critics say the standard will diminish the availability of credit when economic conditions deteriorate, although a recent Federal Reserve study pokes holes in that position.
Meanwhile, major banks are moving forward with implementation activities, preparing for the scheduled effective date less than four months away. Doug Smith, senior vice president and head of credit risk administration at Wells Fargo, said the company has made “a tremendous amount of progress” preparing for the new accounting. In the first quarter the company completed dry runs of its new models, which were developed by leveraging comprehensive capital analysis and review requirements of the Federal Reserve.
“From a financial statement impact, it may not be that big of a deal. But from a global company perspective, getting everyone on the same page, getting people trained, developing processes, that’s going to take some time and effort.”
Jonathan Prejean, Managing Director, Deloitte
“We are thinking through the validation process and getting that completed and moving to final documentation,” said Smith. “If you think of all the activities together, end to end, we’re very far down the line from a timeline perspective, but we still have quite a few activities bunched into the third and fourth quarters.”
Lynch said Bank of America faces some year-end activities to finalize its preparations as well. The entity needs to finalize its documentation of internal controls over financial reporting to be ready for Sarbanes-Oxley Section 404 reporting, and it needs to complete its risk management validations, he said. “We also have to finalize our disclosures for the first quarter,” he said. “We have initial drafts, but there’s more to be done. I’m cautiously optimistic about where we are now.”
Smith said he would also characterize his view of Wells Fargo’s readiness as “cautiously optimistic,” although he agreed his organization faces a great deal of work heading toward the end of the year to be fully prepared.
At Bank of Oklahoma, which is part of the regional BOK Financial Corp. based in Tulsa, Okla., Brent Saffell says he’s also cautiously optimistic. Saffell is senior vice president in charge of credit risk management, reporting, and administration.
The company has performed parallel runs in the third quarter that include all the controls, committee approvals, and documentation that will be required under CECL, said Saffell. “We are getting people through a lot of work that they haven’t done internally before,” he said, adding the company is probably on par with what has been achieved to date at bigger banks.
A recent KPMG poll suggests that although financial institutions are making progress preparing for the standard, they are still not providing a great deal of specific detail about the expected effects. “The progress has been insufficient to lead financial statement preparers to have a comfortable idea of what their CECL impact might be,” KPMG reported. “This uncertainty is evidence by the fact that few respondents were able to provide their CECL impacts at a product level.”
Sagar Teotia, chief accountant at the Securities and Exchange Commission, said he and his staff in the Office of the Chief Accountant have seen “much progress to date on implementation” of the new CECL approach. “OCA has had many productive discussions with stakeholder, including financial institutions, other regulators, audit firms, and industry groups,” he said.
A sound implementation of CECL requires adequate time, said Teotia. The Financial Accounting Standards Board issued the standard in 2016, although companies faced equally big changes in revenue recognition in 2018 and leases in 2019. “Time is necessary to develop new accounting policies and internal accounting controls, execute systems changes, and form well-reasoned judgments,” he said.
Teotia said OCA can be expected to play fair when it comes to exercising judgments after companies have completed their filing. “OCA has consistently respected and not objected to well-reasoned judgments that entities have made in applying new accounting standards, and we will continue to do so in credit losses and in other areas,” he said.
While the CECL effect is expected to be most significant in the financial services sector, non-bank public companies are also subject to the standard and may also have assets on their balance sheet that fall within the scope of the new rules. The standard applies not only to loans, but to items like trade receivables, debt securities that are being held to maturity and are available for sale, financial guarantees, and lease receivables.
Chris Chiriatti, audit managing director at Deloitte & Touche, says many companies outside of financial services were just starting to get engaged on CECL as summer ended and companies returned from the Labor Day holiday. “Even if there’s not a heavy impact, every company is affected by the standard,” he said.
Jonathan Prejean, managing director at Deloitte, said it has been tempting for companies that will not see a material effect under CECL to give it less attention. “From a financial statement impact, it may not be that big of a deal,” he said. “But from a global company perspective, getting everyone on the same page, getting people trained, developing processes, that’s going to take some time and effort. From a process and controls perspective, they need to get it done.”