How the CECL model could affect allowance levels
**The FASB issued the final CECL standard on June 16, 2016. For up-to-date information and resources, access the updated CECL Prep Kit.
With the FASB CECL Model proposal and the changes that impact financial institutions, it would appear that allowance levels as whole would likely rise if implemented. How much could these changes, such as the removal of the “probable” threshold for recognizing losses, increase allowance levels?
By Mike Lubansky, Director of Consulting Services, Sageworks
In a recent survey conducted by SNL Financial LC, 50 percent of more than 500 banking professionals believed the proposal would increase reserves between 10 and 50 percent. The final amount by which the allowance changes will be determined by an institution’s portfolio composition, portfolio vintage, current ALLL methodology, forecasts of future events, etc.
Most of the increase could be attributed to the fact that an institution would now need to utilize future forecasts to estimate losses and that it would need to utilize an estimate of “lifetime of loan” losses. This new methodology would cause an increase in reserve levels, particularly for the non-impaired portfolio (current FAS 5 [ASC 450-20]).
Additionally, the change that would require an institution to now hold a Day One Allowance for Purchased Credit Impaired Assets would also cause a rise in allowance levels, although it would have a net-neutral effect on earnings, as the increase in reserves would also be added to the amortized cost of the loans.
The proposal would likely alter the patterns typical of provision levels throughout an economic cycle. As an institution using the CECL model would likely recognize losses earlier at the beginning of a downturn, its provision level would increase during this point in the cycle. Then during the downturn, there would most likely be a smaller provision since these losses would have already been recognized. Finally, there would be a higher provision coming out of the downturn rather than the allowance release typical under the current model.
In theory, this could provide for less volatility in the allowance. Some observers have pointed out, however, that the model could in fact cause higher volatility, particularly because of the difficulties around trying to estimate the impact of future events.
To allow for feedback on the proposal, the FASB allows for individuals and organizations to draft comment letters. If you are interested in commenting on the proposal, it is important to review how to draft a comment letter and submit it prior to the April 30th deadline.
For more information on FASB’s CECL Model and the impact it could have on financial institutions, download the whitepaper, FASB’s New CECL Model: How it impacts your ALLL.
For updated regulatory guidance, questions, discussions or latest news on the allowance for loan and lease losses, join the LinkedIn group: ALLL Forum for Bankers.