How the Financial Accounting Standards Board’s credit losses standard (CECL) fared during the height of the pandemic and more were discussed last week as part of a virtual roundtable.
FASB staff reviewed implementation of CECL with analysts covering public and private banks, financial statement preparers, auditors, and other stakeholders. The standard took effect for public companies (excluding smaller reporting companies) for fiscal years beginning after Dec. 15, 2019, and is slated to become effective for all other entities for fiscal years beginning after Dec. 15, 2022.
For preparers who adopted the standard last year, the overall feedback was they had sufficient time and were generally well prepared for implementation. Auditors noted they started early to change their audit methods and that they faced many of the same challenges as their clients. They stated that, overall, internal controls at banks held up.
However, there were significant challenges in incorporating macroeconomic issues and risks as a result of the COVID-19 pandemic. The biggest concern raised by all participants in the roundtable was the challenge of incorporating changes in the economy in early 2020 into CECL models and the effects of extreme uncertainties in the forecasts on the recorded credit loss reserves.
Adopters appreciated flexibility in the CECL model for estimating expected credit losses that gave them the ability to react and increase their reserves more quickly than under the prior incurred loss model in these uncertain times. But no one contemplated how extreme the pandemic would be or the timing and impacts of economic stimulus and vaccines.
Reserves were increased in good faith following new guidance in the first and second quarters of 2020 based on anticipated losses that, in many cases, never manifested. As a result, there were notable reserve reductions in the fourth quarter of 2020 and first quarter of this year. This resulted in significant earnings volatility as the reserve changes went through the income statement.
Questions were raised about whether this result was useful and reflective of the actual quality of earnings and economic realities or whether the fluctuations were “noise” that were confusing to users of the financial statements because some of the assumptions have already proven to be incorrect.
A significant challenge discussed was how to estimate losses over the life of loans. The CECL model does not require a specific loss method, which allows for the use of judgment in determining what information is relevant and what estimation methods are appropriate. Because every bank’s loan portfolio and available data is different, it is critical in making best estimates of losses to incorporate this unique information into reserves. This also makes it different for analysts and others to compare banks, although some of the participants in the roundtable stated the model’s flexibility is important because banks are different.
Another implementation issue noted by preparers and auditors was the use of third-party data in modeling, especially for smaller institutions that do not have the data or resources internally. Auditors noted they are talking to their clients about the need to understand this outside data to make sure it is relevant and reliable and adjust it as needed for their circumstances, which is different from market data used for other accounting purposes. There also needs to be a process to continue to evaluate data used in the CECL model on an ongoing basis.
Additional disclosures in general were noted to be healthy and useful, providing more information than under the prior model—especially in the areas of credit quality and reserves overall. One analyst commended FASB that the level of disclosure by U.S. banks is now much better than for banks in other countries.
Analysts expressed some frustration that the standard’s principles-based model does not prescribe exact disclosures, which impacts comparability across institutions and makes it difficult to assess core profitability. They noted limited disclosures by adopters about macroeconomics, sensitivity analysis, and volatility.
The roundtable included discussions of the accounting rules related to purchased financial assets with credit deterioration and measurement of troubled debt restructuring. Those issues were noted as areas of concern that could benefit from changes to current accounting guidance.
Nonpublic entities that have not yet adopted CECL have until 2023 to continue with their implementation plans. FASB staff will assess the feedback from the roundtable, along with other information they obtain during their post-implementation review activities, to determine whether to add any additional projects to the organization’s technical agenda.