Implementing CECL: Updates from the Regulators and Auditors
This blog contains notes from the 2018 National CECL Conference session with Graham Dyer, Grant Thornton and TRG Member; Larry Smith, FTI Consulting and Former FASB member; and Chad Kellar, Crowe Horwath.
Major sources of current thinking and best practices around CECL are: FDIC and FRB joint webinar series, periodic Interagency updates, and the AICPA annual National Banking Conference. The information at this point is fairly rudimentary, the thinking being to wait to see how practice develops then provide more thorough, insightful direction.
The indication from the regulators is that they appreciate the flexibility in the standard. They are willing to listen to various approaches, assuming there is good supporting documentation. Institutions should be aware of that to the extent that if examiners take a hard line, you can push back. Experience indicates it is not uncommon for a field examiner to interpret things in a manner not entirely consistent with GAAP, so it is not problematic to ask them to call the agency’s chief
accountant’s office to clarify.
There is a lot of uncertainty associated with the new standard. Institutions are advised to have those discussions up front with their regulators about issues
they’re trying to address and their limitations with data. Show what you’re working with and how you are moving forward. Show that you have internal governance. Demonstrate that you thought about capital adequacy and other issues, that you are on top of them.
One of the big changes is in the lexicon, from ALLL to ACL (allowance for credit losses).
The ACL will be included in Tier 2 capital up to existing limits. An optional three-year transition arrangement will allow institutions to phase in any adverse day-one regulatory capital effects of adopting CECL on retained earnings, DTAs, the ACL and average total consolidated assets.
Auditors look for controls established for how the data flows into the system. The biggest issue in implementation so far has been “garbage in-garbage out,” so make sure there are controls around whatever process you choose and the data points.
Auditing firms want their teams to do things consistently, so they might try to get their clients to do things consistently. That is contrary to the flexibility provided in the standard. The standard’s setters are concerned that its built-in flexibility will be undone by auditing firms.
At the end of the day, your CECL process has to be conceptually sound and use quality data. You must have consistency through the approach and understand how your methodologies work.
When there is a difference of opinion between auditor and regulator, who wins? Regulators have won over the last 15 years.
Auditors understand there are aspects of the allowance that can’t be found in your historical losses. There is some amount of judgment required that is not pure mathematics.
Some recent developments of TRG discussions and considered questions:
• There is general agreement that the use of prepayment-adjusted EIR is a policy election, but also that the use of such an EIR is preferable.
• A significant difference between expected and contractual should not be due to prepayments.
• TRG expressed differing views on whether TDRs should be estimated as pooled or individually and on how to measure the impact of certain concessions.
• Credit card loans: Future expected payments should be allocated according to the CARD Act.
The FASB is starting to deviate from codification. You have to be aware that there is guidance elsewhere that you need to look for.
The SEC expects strict adherence to PCD provisions. Institutions have been using a fair value option for high-yield portfolios. If a loan was not in the scope of PCI to begin with, then it is not accounted for as a PCD. Materiality is the issue.
Reversion methodology will be a disclosure issue.
What is the likelihood that the PCAOB will prescribe certain methodologies? They will evaluate your judgments and how you document them. They won’t try to undo things that are in the standard. They will look to how you establish a system of internal controls and how you document that your reasons are sound. They are likely to push whatever methodology you use to a more quantitative base.
One takeaway: We’re seeing a consistency of messages from regulators and auditors, which are broad and principles-based. While some issues are not fully
worked out, a lot of new information is coming out. That will continue well into the future.
To download the full 2018 National CECL Conference Digest, click here.