Approximately 100 U.S. Securities and Exchange Commission financial institutions with less than $50 billion in assets across the country have now adopted new rules from the Financial Accounting Standards Board on measuring credit losses on financial statements. More commonly referred to as CECL, or current expected credit losses, the standard requires banks to estimate the credit losses for the estimated life of the loans, essentially estimating the lifetime loss for loans at inception.
While calendar-year SEC filers not considered smaller reporting companies or emerging growth companies were to implement this new standard on Jan. 1, the Coronavirus Aid, Relief and Economic Security Act allowed for a delay of CECL implementation through the earlier of the termination of the COVID-19 national emergency or Dec. 31. Of the publicly traded institutions below $50 billion in assets required to adopt, approximately 25% elected to delay.
Highlights from the banks that have adopted the standard could prove to be very useful to other community banks as many work toward a January 2023 effective date. Here are six relevant highlights:
1. Unfunded commitments had significant effects. It is important that an institution understands the potential effect of unfunded commitments at the time of CECL adoption, as the new standard has caused significant increases in reserves recorded for these commitments. Of the institutions that already have adopted, approximately 20% had a more significant effect from unfunded commitments than they did from funded loans.
2. Certain loan types were correlated with higher reserves. In comparing CECL reserves to loan concentrations for CECL adopters under $50 billion in assets, institutions with high levels of commercial and commercial real estate/multifamily loans experienced larger increases in reserves as a percentage of loans for the period ended March 31.
3. Certain models were more prevalent in banks with less than $50 billion in assets. Approximately 60% of the banks under $50 billion in assets indicated they used the probability of default/loss given default model in some way. Other commonly used models were the discounted cash-flow and loss-rate models. Less than 10% of adopters thus far have disclosed using the weighted-average remaining maturity model.
4. One to two years were the most commonly used forecast periods. A reasonable and supportable forecast is required by the new standard, which demands a significant amount of judgment and estimation on the part of management.
Of the banks that have adopted, more than half used one year and approximately one quarter used two years.
5. Acquisitions made a big difference in the amount of additional reserves recorded at adoption. Of the 10 CECL adopters that had the most significant increases in reserves as a percentage of loans, nine had an acquisition completed in the previous year. This is due to the significant changes in the accounting around acquisitions as a part of the CECL standard.
The new standard requires reserves to be recorded on purchased loans at acquisition, whereas the old standard largely did not.
6. Reserves increased. Focusing on banks that adopted CECL in the first quarter that were less than $5 billion in assets (21 institutions), all but one institution had an increase in reserves as a percentage of loans, and approximately 70% of those institutions had an increase between 30% and 100%.
CECL allows the calculation method to be highly customizable to each bank and even different types of loans within the portfolio.
Because of that, and because each bank’s asset pool will look a little different, there will be variations in the effect of CECL on each institution.
However, the general highlights seen in these first adopters can provide useful insight to help community banks make strides toward implementation.
Brandy Buckler is a partner at BKD LLP. She can be reached at email@example.com.
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