The Fed Speaks: Overview of CECL Model and Supervisory Expectations

**Please check our most recent blog post regarding the latest changes to the FASB deadlines.**

On October 30, the Federal Reserve Bank of St. Louis hosted the first of a promised series of online sessions explaining the new standard for estimating the ALLL, known as CECL (Current Expected Credit Loss model) and the options banks will have to implement it. Julie Stackhosue of the St. Louis Fed was joined by Steve Merriett, Joanne Wakim and Shuchi Satwah of the Federal Reserve Board of Governors in Washington, DC.

“The delays surrounding CECL’s release by FASB have created skepticism among some that this standard will never come to pass,” commented MST CEO Dalton T. Sirmans. “Steve Merritt’s comment that half of his staff is dedicated 100 percent to CECL, this first in a series of sessions on CECL by the St. Louis Fed, and the numerous warnings or words of caution herein should end any doubt. CECL is going to happen.”

The 90-minute Fed Perspective session intended to explain the key elements of CECL, share the Fed’s perspective on the standard and discuss one approach institutions might take to estimating losses under CECL. Presenters emphasized that no one methodology would be required for CECL, that the Vintage method used as an example in this session was just one of several approaches banks might employ and that different portfolios will require different methodologies, even multiple methodologies for some banks. The presenters surveyed call-in attendees twice during the session and took questions at the end.

Following are some of the session’s key points:

• An initial survey of listeners revealed 62 percent were somewhat familiar with CECL and only 15 percent were not familiar at all with the standard.
• The sessions are designed to address the issue “in chunks,” this one treating only on one way to measure expected credit losses. Future sessions will discuss additional methodologies and implementation planning.
• Steven Merriett said that CECL is the top priority of his office these days: “Fully half of my team is dedicated one hundred percent to CECL.”
• The CECL timeline: The Fed expects a final standard to be issued in the first quarter, 2016, “a firm date from FASB.” Implementation is currently projected as January 1, 2018, but expectations are the date will move to 2019 or 2020.
• The reason the Fed is holding these sessions is because CECL represents a fundamental change in accounting requirements, “not a tweak.” It will be a significant effort to implement the standard that will take a substantial amount of time. Bank managers will need to plan well in advance of implementation.
• The underlying principle of CECL is that you should record credit losses as they become expected. The purpose is faster recognition of losses, to reflect changes in credit quality on a timely basis, which is designed to correct the problem that resulted in the financial crisis.
• CECL applies to loans and debt instruments held at amortized cost, as well as receivables, lease receivables and loan commitments.
• CECL is not a one-time, up-front, locked estimate; estimates of loss will be updated at every reporting period over the life of the loan.
• In measuring CECL, the bank should incorporate internal and external data; information about past events, current conditions, and reasonable and supportable forecasts; and quantitative and qualitative factors specific to borrowers and the economic environment.
• A proposed formula for measuring CECL: unadjusted historical lifetime loss experience + adjustments for past events and current conditions + adjustments for reasonable, supportable forecasts = estimate of expected credit losses.
• CECL is more sensitive to underwriting standards.
• A challenge: most loan data is not lifetime, but tied to a certain period. So how do you take historical data and convert it to lifetime?
• Noted as a key message of the session: CECL is designed to be scalable for all sizes of banks and lenders, allowing for a choice of measurement methodologies: “Any reasonable approach may be used, provided it reflects that some risk of default, however small, always exists and that zero allowance for loan and lease losses would be rare.”
• The message the Fed is sending to examiners is to encourage institutions to become familiar with the standard, especially credit risk staff; to discuss it with their examiners and other regulators; and to begin collecting the data they will need.
• In collecting data, banks should be aware that their core systems might only retain data for two to three years and they might need to look back five to seven years. So banks should query their vendors for ways to retain data longer.
• Allowance balances will increase to cover expected credit losses. The Fed does not expect one-time increases to effect earnings but they will effect capital.

For the most up-to-date information regarding CECL and the impending deadlines check out our most recent blog posts.