6 Burning CECL Questions Answered by Former FASB CECL Project Manager
Mr. Gupta is a Partner with the National Professional Standards Group of Grant Thornton LLP. He served as a staff member of the Financial Accounting Standards Board as a Senior Project Manager until his return to the firm in February 2016. Mr. Gupta will answer attending bankers’ questions about CECL in a special Q&A session at the upcoming National ALLL Conference, May 24-26, at Torrey Pines, California presented by MST.
MST. We’ve heard from the FASB members and bank regulators that this is no quick fix. “This is going to take a ton of work,” according to Fed Chief Accountant Steven Merriett. Why will it take three years for a bank to get ready?
Gupta. The time required to implement the forthcoming guidance will depend on the availability of historical data and the methodology that is currently being used for calculating ALLL. A lot depends on the data availability. If your allowance today is based on historical data you’ve collected internally over years, implementation most likely will be less burdensome. But if you have everything in a pile of Excel sheets, everything manual, and only high-level data, then it may take you some time to implement.
MST. I think we understand that the reason for a new standard was to avoid another bank crisis. But did the goals for CECL expand or change over the years of development?
Gupta. The primary objective of this project is to make sure that the allowance reflects the credit risk that the bank has. If the allowance is right, it won’t prevent another credit crisis by itself, but it will at least notify people in advance of a forthcoming crisis; it won’t shock the system.
I think it is important to understand a little bit of the history of this project to understand the Board’s logic in getting to this point. In 2005, the Board heard from financial statement preparers that the guidance in GAAP that was based on the incurred loss notion before an allowance can be recognized was prohibiting them from recognizing losses that they expect to incur on their portfolios. Before the Board added the project to its agenda in 2008, the FASB and the IASB established a Financial Crisis Advisory Group (FCAG) to advise the Boards on improvements to financial reporting for the measurement of credit losses. The FCAG identified the delayed recognition of credit losses which results in the overstatements of assets as a weakness in current GAAP. As a result, the FCAG recommended exploring alternatives to the incurred loss model that would use more forward-looking information. The FASB researched many alternatives during the course of the past eight years, but came back to the conclusion that the allowance has to reflect the entirety of expected losses in a portfolio. An initial objective was also to have one single model for calculating credit losses on all financial assets, but that was not achieved by the Board.
MST. Was the FASB responsive to banker input along the way?
Gupta. Yes, definitely. There was a tremendous amount of outreach that the Board performed, including three publicly issued proposals. There was quite an effort to get feedback, which the Board then used to develop the final model.
MST. What kind of tweaks resulted from industry feedback?
Gupta. There were many. The ones I think would be most impactful will be the exclusion of available-for-sale debt securities from the CECL model, lower threshold for what is considered a credit-deteriorated purchased asset that will be subject to a day-one gross up instead of a bad debt expense, keeping credit loss and interest income models separate, and removal of the disclosure of roll-forward of financial assets that are measured at amortized cost.
MST. How would you suggest that a bank with less than five quarters of loan level and other transactional data project a life-of-loan loss on a portfolio of loans with an average life of five years?
Gupta. That is the most prominent piece of misinformation currently circulating about CECL, that you have to project a loss for the life of the loan. That is not what the guidance will say when it is issued in June. What it will say is that you look at your historical losses, then adjust them for a future period you reasonably believe you can project for. It could be 3 months. It could be a year. It depends on how sophisticated your system is, how forward looking you can be. For the remaining estimated life of the loan for which no forward looking estimate can be made, the historical losses should be used to calculate the allowance.
For example, take your portfolio of loans with an average life of five years. One way to do it is to look at a similar portfolio. Let’s say what you had in 2004 was similar. Take the 2004 and look five years beyond. How did it behave? What were your losses like over those years? What happened to cause those losses? Then you use the data to project losses for your 2016 portfolio. So does that mean you have to do vintage analysis? Not necessarily. That is one way, but there are other ways. The Board doesn’t dictate what you do. Your method will rely a lot on your up-front tactics – your data, charts, and so on. It will require a substantial up-front investment to compile and categorize all the data you need, but then you’re all set; it’s a one-time cost.
MST. Will the FASB engage in any activities to help bankers with CECL in the coming months and years?
Gupta. The Board has set up a Transition Resource Group that includes bankers, audit firms and regulators to meet regularly. If there are questions submitted to the Board, the TRG will discuss them and see if the Board needs to issue new guidance or new examples or do something else about it.
If you would like to submit questions for Mr. Gupta to possibly answer in the Q & A session at the National ALLL Conference, please email your question and contact info to firstname.lastname@example.org.
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