CECL: Compliance Challenges and Some Proposed Relief

Complying with requests from banks and other lenders for The Accounting Standard (ASU No. 2016-13) Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments is intended to improve financial reporting by requiring timely recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets not recorded at fair value based on historical experience, current conditions, and reasonable and supportable forecasts. Within this accounting standard, the Financial Accounting Standards Board (FASB) introduced the current expected credit losses methodology (CECL) for estimating allowances for credit losses. Since that time, there has been continuous discussion and debate regarding effectively complying with the standard, implementing the new models and having the models validated before the implementation date.

Where Are We Today?

While larger community and regional banks are well attuned to the regulatory guidance on model risk management and have established policies and procedures to comply with the guidance, structure around the implementation of new models for many banks below $10 billion in assets is still a work in progress. With CECL, most recent efforts focus on implementing the standard, the type of modeling technique(s) to use, whether to develop or purchase a model and how to manage the data. However, for banks, if your organization is greater than $1 billion in assets, your new CECL model(s) will need to be validated prior to the adoption of the standard. The standard is effective in 2020 for SEC filers and a year or two later for other entities (see below for proposed relief). Most SEC filers appear to have made good progress on implementing their new models, but at the same time, many are behind in their overall project plans and working diligently to have them ready by year-end.

Data Accuracy, Completeness and Applicability Concerns

While most models used by banks have data accuracy and completeness risks, the data required to compute a lifetime expected loss, within the guidelines of CECL, has taken data needs and challenges to a new level. In most cases, thus far, banks are developing new data collection processes and even new systems for maintaining the data into the future. Developing and documenting the internal controls and procedures for maintaining the integrity, completeness and accuracy of this data will be a primary component of the control structure around this significant estimate. Keep in mind that the controls around data will likely become a significant Sarbanes-Oxley (SOX) control regarding the organization’s internal control over financial reporting.

Use of Vendor and Other Third-Party Products

The complex nature of implementing the CECL standard has led to the development of numerous products offered by vendors to assist banks with the calculation. While many of these solutions contain black boxes with proprietary algorithms, any third-party product should still be considered part of the organization’s model risk management framework and subject to validation if the guidance applies to the organization. Per the guidance, “vendors should provide appropriate testing results that show their product works as expected,” but your organization is also “expected to validate their use of vendor products.” Documenting the organization’s understanding of the vendor product, why it was selected, what controls are in place, what inputs feed into the product and what the risks are should be collectively addressed by the model operator/owner. Understanding the regulatory expectations regarding vendor products is of crucial importance, especially since they are more comprehensive than what many would expect.

FASB Proposes Relief

On July 17, 2019, the FASB met to reconsider its philosophy on establishing effective dates for major projects for private companies, not-for-profit organizations and smaller public companies. The FASB also discussed the amendment of certain upcoming effective dates for existing major standards that are not yet effective.

The FASB ultimately directed the staff to draft a proposed accounting standard update (ASU) to be exposed for public comment; the proposed ASU will introduce the following two-bucket approach to stagger effective dates:

• Bucket One includes U.S. Securities and Exchange Commission (SEC) filers, as defined by U.S. Generally Accepted Accounting Principles (GAAP), excluding smaller reporting companies (SRC) as defined by the SEC.
• Bucket Two includes all other entities, such as SRC, public business entities (PBE) that are not SEC filers, private companies, all not-for-profit entities – including conduit bond obligors – and all employee benefit plans. For Credit Losses (CECL), Bucket One entities would remain effective for annual reporting and interim reporting periods beginning January 1, 2020, for year-end calendar entities. However, Bucket Two entities would be granted additional time, with an effective date starting January 1, 2023, for yearend calendar entities. (Note: the FASB also issued a second Q&A document regarding CECL and announced its plan for a series of CECL educational workshops in various U.S. locations.)

The FASB noted that there could be some comparability issues for SRCs that make them less attractive and could potentially affect their ability to raise capital. Therefore, the FASB plans to consult with public companies during the comment period to determine if SRCs are the correct breaking point between Bucket One and Bucket Two.

Final Thought

Despite the proposed additional time, entities should not slow down their implementation efforts. If voted upon, this extra time should be utilized to enhance entities’ efforts to implement a robust approach in adopting this accounting standard that meets all their compliance and system needs.

Robin Sawyer, CPA, a partner in Dixon Hughes Goodman’s Financial Institution Services Group, has close to 20 years of financial services industry experience and more than 25 years of total business experience. Prior to joining Dixon Hughes Goodman, Robin served as a bank audit manager with a Big Four accounting firm, a CFO of a business enterprise with derivative activity, and a controller for a large international real estate investment management company.

Allison Tanju, CPA is a senior manager with more than 14 years of experience in the financial services practice of DHG. Allison works primarily in the area of model risk management but also has deep experience in financial statement audits, internal control evaluation and Sarbanes-Oxley (SOX)/FDICIA compliance and has assisted clients through multiple mergers and acquisitions and has extensive experience with Day 1 and Day 2 purchase accounting requirements.