Financial regulators have issued new Frequently Asked Questions (FAQs) to address changes stemming from the Financial Accounting Standards Board’s (FASB) Current Expected Credit Loss (CECL) standard, which was changed in June 2016.
The new Frequently Asked Questions (FAQs) were announced via a letter, recently distributed by the Federal Deposit Insurance Corp. (FDIC). They apply to all FDIC-supervised banks and savings associations, including community institutions with total assets less than $1 billion.
The FAQs focus on the application of the updated standard, which introduces the current expected credit losses methodology for estimating allowances for credit losses and related supervisory expectations. The standard requires bankers to record credit losses expected throughout the life of the asset portfolio on loans and held-to-maturity securities at the time of origination. The revisions will affect entities holding financial assets and net investment in leases that are not accounted for at fair value through net income, as well as loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables and any other financial assets not excluded from the scope that have the contractual right to receive cash.
The federal regulatory agencies said they plan to update the FAQs periodically as part of their efforts in supporting institutions as they prepare to implement CECL, which will become effective in 2020 for Securities and Exchange Commission registrants and 2021 for all financial institutions.
The following are some notable highlights in the FAQs:
- CECL applies to all financial assets carried at amortized cost, including loans held for investment and held-to-maturity debt securities, and certain off-balance-sheet credit exposures such as loan commitments and standby letters of credit. Although CECL does not apply to available-for-sale debt securities, the new accounting standard modifies the existing accounting for impairment on such securities.
- The FAQs address topics such as changes the new accounting standard makes to existing U.S. generally accepted accounting principles (GAAP), the standard’s effective dates, the application of the standard upon initial adoption, acceptable allowance estimation methods under CECL, and portfolio segmentation for credit loss estimation on a collective basis.
- The FAQs reiterate that CECL is scalable to institutions of all sizes; community institutions are not expected to need to adopt complex modeling techniques to implement the new accounting standard; and institutions are not required to engage third-party service providers to assist management in estimating credit loss allowances under CECL.
- Institutions are encouraged to plan and prepare for the transition to and implementation of the new accounting standard, including its potential impact on regulatory capital. The FAQs provide examples of initial implementation activities. The agencies expect institutions to make good faith efforts to implement the new accounting standard in a sound and reasonable manner.
“The new standard addresses concerns from a wide range of our stakeholders — including financial statement preparers and users — that the existing incurred loss approach provides insufficient information about an organization’s expected credit losses,” FASB Chairman Russell G. Golden said in June when the update was announced. “The new guidance aligns the accounting with the economics of lending by requiring banks and other lending institutions to immediately record the full amount of credit losses that are expected in their loan portfolios, providing investors with better information about those losses on a more timely basis.”
Prior to the June announcement, the American Bankers Association (ABA) and Independent Community Bankers of America (ICBA) advocated for more clarifications and modifications to the standard, which first was proposed in 2012.
ICBA stated, at that time, that although the final standard is “not perfect” it shows that FASB “heeded the calls of community bankers for a more workable solution.”
ABA referred to CECL as “the biggest change in the history of bank accounting.”