CECL’s First Wave Offers Insights for Smaller Banks

By Debra Cope

The majority of banks have until January 1, 2023, before they are required to implement the current expected credit loss standard, or CECL. But it’s not too soon for them to start gleaning lessons from larger institutions that are already utilizing the new standard, bank accounting experts said.

This article originally appeared in the July/August 2021 issue of ABA Banking Journal Directors Briefing. Subscribe now.

The current transitional period provides banks with “an opportunity to see what more complex institutions are doing and adapt that to your particular circumstances,” says Garver Moore, a managing director for advisory services at Abrigo, which provides risk management technology for banks.

The CECL standard, which FASB finalized in June 2016, is the most sweeping change to bank accounting standards in at least a generation. It requires banks to make “life of loan” estimates of losses to be recorded for unimpaired loans at the time the loans are originated or purchased. Implementation is being phased in, and large SEC filers have already adopted the standard, but most banks can implement it any time between now and January 2023.

At most larger banks, it’s typical for the risk committee or some variant of it to drive the CECL process, says Brandy Buckler, a partner in the accounting and advisory firm BKD. At small banks, it’s not unusual for the loan committee or the chief lending officer to be leading the charge.

Regardless of how oversight is structured, she says, there are some questions directors can be asking to gauge management’s progress toward implementation. For example:

Has management analyzed unfunded commitments to evaluate their impact on reserves? BKG’s analysis of early adopters of CECL shows that about 20 percent had a more significant effect from unfunded commitments than they did from funded loans. Commercial lines of credit merit special focus, Buckler says.
Do we have a ballpark figure on the impact on reserves? If so, what does it look like and how would it impact our capital ratios? Among 21 banks with assets of less than $5 billion that adopted CECL in the first quarter of 2021, all but one had to increase reserves as a percentage of loans. Fifteen of the banks reported increases between 30 percent and 100 percent. “It can vary based on how well reserved you are now, how many unfunded commitments you had, and whether you had any acquisitions,” Buckler notes.
How does CECL impact our acquisitions? The new standard requires reserves to be recorded on purchased loans at acquisition; the old standard largely did not. Banks that have recently completed an acquisition will need to devaluate what the CECL impact will be; banks that are considering acquisitions need to factor it in early, Buckler says.

There is a gap between how CECL is perceived and what it actually requires, Moore says. It’s important to understand that there are no ideal answers under CECL and that the standard provides flexibility. However, he adds, “Just because there are no right answers doesn’t mean there are no wrong ones.” The key is to explain and document decisions.

Moore urges banks to start preparing early; choose options within their data constraints and supplement them with internal and external information as appropriate; follow a consistent and well-reasoned process tailored to its circumstances; and remain flexible.

“I don’t think CECL will change how you go about the business of originating loans,” Moore says. “But it’s important to understand how the loans you make will impact financial statement performance.”