Considerations for Post-CECL Adoption

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Over the last 10 years, banks have discussed and debated the current expected credit loss, or CECL, accounting standard. Many of the larger banks adopted the standard in 2020, with the majority of smaller banks adopting on Jan. 1, 2023.

While the industry has adopted CECL, here are some items to consider in 2023 to position your institution for success in your next regulatory exam or external audit.

Prepare a CECL Adoption “Package”
When your regulators and auditors arrive in 2023, they will likely ask about your CECL implementation process. One way to address their questions is to prepare a package that  includes:

  • Board-approved allowance for credit losses, or ACL, policy.
  • The initial adoption calculation.
  • The consideration of unfunded commitments, which are recorded as a liability on the bank’s balance sheet, and debt securities, both available-for-sale and held-to-maturity.
  • The bank’s narrative that supports its CECL calculation, which should include a summary of the selected model and methodology, assessment of qualitative factors and forecasting and a summary of any individually evaluated loans.
  • The initial adoption journal entry, a reconciliation to your CECL calculation and documentation of a review and approval of the journal entry.
  • Third-party vendor management documentation and CECL model validation.

Third-Party Vendor Management
If your bank is using a third-party vendor for its CECL calculation, be sure to document the vendor management considerations over this calculation annually in accordance with your bank’s vendor management policies and your primary regulator’s guidance.

Make sure this documentation includes procedures the bank has taken to gain comfort over the third party’s calculation, obtaining a service organization controls (SOC) report for the calculation and a CECL model validation for the third-party calculation. Your institution may need to get support from the vendor to assist with articulating the math behind the calculation and a recalculation of the ACL on an individual loan basis.

Perform Back Testing in 2023
As the bank’s CECL model “ages” in 2023, management should document back testing of the model to verify it is functioning as expected. Back testing can aid the bank in understanding the model and how estimates and varying economic results impact it.

As your bank develops its back testing procedures, consider comparing estimated data points to actual results, including prepayment speeds, loan charge-offs and recoveries, economic data points and loan balances. Additionally, management should consider sensitivity or stress testing of the model, including analysis of various scenarios or assumptions and their impact on loss estimates.

Add CECL to the 2023 Internal Audit Plan
The CECL model, like the historic incurred loss model, should be subject to the bank’s internal audit plan. This internal audit program can include reviewing the policies and procedures, gaining an understanding of the model, reviewing the assumptions in the model for reasonableness and consistency with other assumptions and reviewing the model access. It should also include procedures to verify calculations are appropriately reviewed by management and governance.

CECL Model Validation
As bank regulators discussed in the 2020 interagency policy statement on the allowances for credit losses, model validation is an essential element to a properly functioning process for a bank, and should be completed annually. Validation activities for a bank include evaluating and concluding on the conceptual soundness of the model, including developmental evidence, performing ongoing monitoring activities, including process verification and benchmarking and analyzing model output, according to the interagency statement.

The CECL model validation, which is a frequently overlooked part of CECL implementation, should be performed by an individual or firm that is independent from the model’s design, implementation, operations and ownership. Additionally, the interagency statement states the external auditor of the bank may impair independence if they also perform the CECL model validation.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CliftonLarsonAllen) to the reader.

CLA exists to create opportunities for our clients, our people, and our communities through our industry-focused wealth advisory, digital, audit, tax, consulting, and outsourcing services. CLA (CliftonLarsonAllen LLP) is an independent network member of CLA Global. See CLAglobal.com/disclaimer. Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor.

CECL Model Validation Benefits Beyond Compliance

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The current expected credit loss (CECL) adoption deadline of Jan. 1, 2023 has many financial institutions evaluating various models and assumptions. Many financial institutions haven’t had sufficient time to evaluate their CECL model performance under various stress scenarios that could provide a more forward-looking view, taking the model beyond just a compliance or accounting exercise.

One critical element of CECL adoption is model validation. The process of validating a model is not only an expectation of bank regulators as part of the CECL process — it can also yield advantages for institutions by providing crucial insights into how their credit risk profile would be impacted by uncertain conditions.

In the current economic environment, financial institutions need to thoroughly understand what an economic downturn, no matter how mild or severe, could do to their organization. While these outcomes really depend on what assumptions they are using, modeling out different scenarios using more severe assumptions will help these institutions see how prepared they may or may not be.

Often vendors have hundreds of clients and use general economic assumptions on them. Validation gives management a deeper dive into assumptions specific to their institution, creating an opportunity to assess their relevance to their facts and circumstances. When doing a validation, there are three main pillars: data and assumptions, modeling and stress testing.

Data and assumptions: Using your own clean and correct data is a fundamental part of CECL. Bank-specific data is key, as opposed to using industry data that might not be applicable to your bank. Validation allows for back-testing of what assumptions the bank is using for its specific data in order to confirm that those assumptions are accurate or identify other data fields or sources that may be better applied.

Modeling (black box): When you put data into a model, it does some evaluating and gives you an answer. That evaluation period is often referred to as the “black box.” Data and assumptions go into the model and returns a CECL estimate as the output. These models are becoming more sophisticated and complex, requiring many years of historical data and future economic projections to determine the CECL estimate. As a result of these complexities, we believe that financial institutions should perform a full replication of their CECL model. Leveraging this best practice when conducting a validation will assure the management team and the board that the model the bank has chosen is estimating its CECL estimate accurately and also providing further insight into its credit risk profile. By stripping the model and its assumptions down and rebuilding them, we can uncover potential risks and model limitations that may otherwise be unknown to the user.

Validations should give financial institutions confidence in how their model works and what is happening. Being familiar with the annual validation process for CECL compliance will better prepare an institution to answer all types of questions from regulators, auditors and other parties. Furthermore, it’s a valuable tool for management to be able to predict future information that will help them plan for how their institution will react to stressful situations, while also aiding them in future capital and budgeting discussions.

Stress testing: In the current climate of huge capital market swings, dislocations and interest rate increases, stress testing is vital. No one knows exactly where the economy is going. Once the model has been validated, the next step is for banks to understand how the model will behave in a worst-case scenario. It is important to run a severe stress test to uncover where the institution will be affected by those assumptions most. Management can use the information from this exercise to see the connections between changes and the expected impact to the bank, and how the bank could react. From here, management can gain a clearer picture of how changes in the major assumptions impact its CECL estimate, so there are no surprises in the future.

Proposed TDR Accounting Relief Will Miss Most Small Banks (For Now)

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Small banks may miss out on a new proposed accounting rule that frees banks from onerous accounting and reporting requirements following a loan modification.

In November 2021, the board that sets U.S. accounting standards issued an exposure draft that will remove the reporting guidance around troubled debt restructurings, or TDRs, for banks that have adopted the new loan loss standard, called the current expected credit loss model or CECL. Under the proposal, banks that have adopted CECL could continue reporting any modifications they offer borrowers and leave TDR accounting behind, but excludes the many small banks that have yet to adopt CECL.

The move has its fans.

“I’m all for it, and good riddance. There’s not a true credit guy I know who spends much time worrying about TDRs anymore,” says David Ruffin, principal at IntelliCredit, a division of QwickRate that helps financial institutions with credit risk management and loan review. “TDRs stayed around well beyond their usefulness.”

The change from the Financial Accounting Standards Board, or FASB, stems directly from the combination of the new loan loss standard and the banking industry’s experience during the coronavirus pandemic. TDRs occur after a bank offers a concession on a credit that it wouldn’t otherwise make, because of a borrower’s financial difficulties or hardship. The bank offers a modification and it reports the value of the impaired credit using a complicated accounting approach called discounted cash flow analysis. Under the current guidance, a credit classified as a TDR could never be reclassified even when the modification ended and the borrower returned to financial health, giving rise to the phrase “Once a TDR, always a TDR.”

CECL and the coronavirus pandemic changed all that. CECL requires banks to set aside a lifetime loss estimate when they make a loan, and then periodically update that expected loss as the borrower’s financial condition or the economy changes. TDR guidance conflicted with CECL in several ways. CECL gives banks the flexibility to select what method to use to calculate loan losses, based on factors like the portfolio or borrower characteristics; the proscriptive TDR approach seemed to violate that spirit. And after the standard went into effect, banks and those who prepare financial statements told the FASB that the new approach to allowances captured most of the impacts from loan modifications that would be included in the TDR calculation.

“TDRs no longer provide decision useful information,” the board noted in the project description for this proposal.

Then the pandemic hit, and Congress took the dramatic step of dramatic step of suspending the TDR reporting requirements to encourage banks to work with borrowers facing unexpected financial hardship. Banks were free to offer loan modifications that normally would’ve triggered TDR classifications but didn’t need to engage in the accounting and formal reporting requirement.

What they did do was better. Banks voluntarily provided information on the percentage of borrowers that had received a modification, the amount of loans under modification, the type of modification and sometimes the industry. This became somewhat of an industry standard, which observers praised as more useful and actionable. Quarterly updates showed that at many banks, the percentage of secondary or continued modifications was declining, boosted by government stimulus programs and the gradual return of economic activity.

All that was slated to revert to TDRs at the end of 2021 with the sunsetting of the CARES Act provision, until the accounting board took up the mantel. If the proposal passes, CECL banks that offer a loan modification to a borrower that is facing financial difficulty in 2022 will need to provide enhanced disclosures.

But the relief would only be for some banks. CECL went into effect for most public filers — mostly large banks — at the start of 2020. But private companies and those defined as “smaller reporting companies” by the Securities and Exchange Commission received a delay until the start of 2023 and can still use the incurred accounting method, setting aside a reserve when a loss becomes probable. The argument against eliminating TDR treatment for banks using the incurred method is that because the bank doesn’t assign potential lifetime losses to its loans on a quarterly basis, the TDR guidance isn’t redundant and still applies.

Although banks large and small showed they could manage both borrower modifications and appropriate allowances during the pandemic, community banks should expect to revert to the existing TDR guidance at the beginning of 2022 until they adopt CECL.

Highlights From CECL Adoption

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On Jan. 1, 2020, approximately 100 SEC financial institutions with less than $50 billion in assets across the country adopted Accounting Standards Update 2016-13, Financial Instruments—Credit Losses (Topic 326) Measurement of Credit Losses on Financial Statements.

More commonly referred to as “CECL,” the standard requires banks to estimate the credit losses for the estimated life of its loans — essentially estimating lifetime losses for loans at origination. Not all banks adopted the standard, however. While calendar-year SEC filers that are not considered to be smaller reporting companies or emerging growth companies were set to implement the standard at the start of 2020, the Coronavirus Aid, Relief, and Economic Security Act and subsequent Consolidated Appropriations Act, 2021, allowed them to delay CECL implementation through the first day of the fiscal year following the termination of the Covid-19 national emergency or Jan. 1, 2022. Of the publicly traded institutions below $50 billion in assets that were previously required to adopt the standard, approximately 25% elected to delay.

Highlights from the banks that adopted the standard could prove very useful to other community banks, as many work toward their January 2023 effective date. A few of the relevant highlights include:

  • Unfunded commitments had significant effects. It is important that your institution understands the potential effect of unfunded commitments when it adopts CECL. The new standard has caused significant increases in reserves recorded for these commitments. At institutions that have already adopted the standard, approximately 20% had a more significant effect from unfunded commitments than they did from funded loans.
  • Certain loan types were correlated with higher reserves. When comparing the reserves to loan concentrations at CECL adopters with less than $50 billion in assets, institutions with high levels of commercial and commercial real estate/multifamily loans experienced larger increases in reserves as a percentage of total loans for the period ended March 31, 2020.
  • Certain models were more prevalent in banks with less than $50 billion in assets. Approximately 60% of the banks with less than $50 billion in assets indicated they used the probability of default/loss given default model in some way. Other commonly used models were the discounted cash flow model and loss rate models. Less than 10% of adopters so far have disclosed using the weighted-average remaining maturity (WARM) model.
  • One to 2 years were the most commonly used forecast periods. The new standard requires banks to use a reasonable and supportable economic forecast to guage loss potential, which demands a significant amount of judgment and estimation from management. Of the banks that adopted, more than half used 1 year, and approximately a quarter used 2 years.
  • Acquisitions impacted the additional reserves recorded at adoption. Of the 10 CECL adopters with the most significant increases in reserves as a percentage of loans, nine had completed an acquisition in the previous year. This is due to the significant changes in the accounting around acquisitions as a part of the CECL standard. The new standard requires reserves to be recorded on purchased loans at acquisition; the old standard largely did not.
  • Reserves increased. Focusing on banks that adopted CECL in the first quarter that have less than $5 billion in assets (21 institutions), all but one experienced an increase in reserves as a percentage of loans. Approximately 70% of those institutions had an increase of between 30% and 100%.

The CECL standard allows management teams to customize the calculation method they use, even among different types of loans within the portfolio. Because of that and because each bank’s asset pool will look a little different, there will be variations in the CECL effects at each institution. However, the general themes seen in these first adopters can provide useful insight to help community banks make strides toward implementation.

This article is for general information purposes only and is not to be considered as legal advice. This information was written by qualified, experienced BKD professionals, but applying this information to your particular situation requires careful consideration of your specific facts and circumstances. Consult your BKD advisor or legal counsel before acting on any matter covered in this update.

Key Compensation Issues in a Turbulent Market

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As compensation committee chair, Susan knew 2020 was going to be an important year for the bank.

The compensation and governance committee had taken on the topic of environmental, social and governance (ESG) for the coming year. They had conducted an audit and knew where their gaps were; Susan knew it was going take time to address all the shortfalls. Fortunately, the bank was performing well, the stock was moving in the right direction and they had just approved the 2020 incentive plans. All in all, she was looking forward to the year as she put her finished notes on the February committee meeting.

Two months later, Susan had longed for the “good old days” of February. With the speed and forcefulness that Covid-19 impacted the country, states and areas the bank served, February seemed like a lifetime ago. The bank had implemented the credit loss standard at the end of March — due to the impact of the unemployment assumptions, the CECL provision effectively wiped out the 2020 profitability. This was on top of the non-branch employees working from home, and the bank doing whatever it could to serve its customers through the Paycheck Protection Program.

Does this sound familiar to your bank? The whirlwind of 2020 has brought a focus on a number of issues, not the least of which is executive compensation. Specifically, how are your bank’s plans fairing in light of such monumental volatility? We will briefly review annual and long-term performance plans as well as a construct for how to evaluate these programs.

The degree to which a bank’s annual and long-term incentive (LTI) plans have been impacted by Covid-19 hinge primarily on two factors. First, how much are the plans based upon GAAP bottom-line profitability? Second, and primarily for LTI plans, how much are the performance-based goals based upon absolute versus relative performance?

In reviewing annual incentive plans, approximately 90% of banks use bottom-line earnings in their annual scorecards. For approximately 50% of firms, the bottom-line metrics represent a majority of their goals for their annual incentive plans. These banks’ 2020 scorecards are at risk; they are evaluating how to address their annual plan for 2020. Do they change their goals? Do they utilize a discretionary overlay? And what are the disclosure implications if they are public?

There is a similar story playing out for long-term incentive plans — with a twist. The question for LTI plans is how much are performance-based goals based upon absolute versus peer relative profitability metrics? Two banks can have the same size with the same performance, and one bank’s LTI plan can be fine and the other may have three years of LTI grants at risk of not vesting, due to their performance goals all being based on an absolute basis. In the banking industry, slightly more than 60% of firms use absolute goals in their LTI plans and therefore have a very real issue on their hands, given the overall impact of Covid-19.

Firms that are impacted by absolute goals for their LTI plans have to navigate a myriad level of accounting and SEC disclosure issues. At the same time, they have to address disclosure to ensure that institutional investors both understand and hopefully support any contemplated changes. Everyone needs to be “eyes wide open” with respect to any potential changes being contemplated.

As firms evaluate any potential changes to their executive performance plans, they need to focus on principles, process and patience. How do any potential changes reconcile to changes for the entire staff on compensation? How are the executives setting the tone with their compensation changes that will be disclosed, at least for public companies? How are they utilizing a “two touch” process with the compensation committee to ensure time for proper review and discourse? Are there any ESG concerns or implications, given its growing importance?

Firms will need patience to see the “big picture” with respect to any changes that are done for 2020 and what that may mean for 2021 compensation.

Audit Hot Topics: Internal Controls

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Bank boards and executive teams face a number of risks in these challenging times. They may need to adapt their strong internal controls in response, as Mandi Simpson and Sal Inserra — both audit partners at Crowe — explain in this short video. You can find out more about the audit and accounting issues your bank should be addressing in their recent webinar with Bank Director CEO Al Dominick, where they discuss takeaways from the adoption of the current expected credit loss model (CECL) and issues related to the pandemic and economic downturn, including the impact of the Paycheck Protection Program and concerns around credit quality.

Click HERE to view the webinar.

Dual Deal Accounting Challenges During a Pandemic

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Bank mergers and acquisitions are not easy: balancing the standard process of due diligence to verify financial and credit information, adapting processing methods and measuring fair value assets and liabilities. The ongoing pandemic coinciding with the implementation of the current expected credit loss model, or CECL, by larger financial institutions has made bank mergers even more complex. As your financial institution weighs the benefits of a merger or acquisition, here are two important accounting impacts to consider.

Fair Value Accounting During a Pandemic

When two banks merge, the acquiring bank will categorize the loans as performing or purchase credit impaired/deteriorated and mark the assets and liabilities of the target bank to fair value.

This categorization of loans is difficult — the performance of these loans is currently masked due to the large number of loan modifications made in the second quarter. With many customers requesting loan modifications to defer payments for several months until the economy improves, it is difficult for the acquiring bank to accurately evaluate the current financial position of the target bank’s customers. Many of these customers could be struggling in the current environment; without additional information, it may be very difficult to determine how to classify them on the day of the merger. 

One of the more complex areas to assess for fair value is the loan portfolio, due to limited availability of market data for seasoned loans. As a result, banks are forced to calculate the fair value of assets while relying on subjective inputs, such as assumptions about credit quality. Pandemic-response government programs and significant bank-sponsored modification programs make it difficult to fully estimate the true impact of Covid-19 on the loan portfolio. Modifications have obscured the credit performance data that management teams will base their assumptions, complicating the process even further.  

U.S. Generally Accepted Accounting Principles (GAAP) allows for true-up adjustments to Day 1 valuations for facts that were not available at the time of the valuation to correct the fair value accounting. These adjustments are typically for a few isolated items. However, the lagging indicators of Covid-19 have added more complexity to this process. There may be more-pervasive adjustments in the coming year related to current acquisitions as facts and circumstances become available. It is critical for management teams to differentiate between the facts that existed the day the merger closed versus events that occurred subsequent to the merger, which should generally be accounted for in current operations.  

CECL Implementation

For large banks that implemented CECL in the first quarter of 2020, a significant change in the accounting for acquired loans can create a new hurdle. Under the incurred loss model, no allowance is recorded on acquired loans, as it is incorporated in the fair value of the loans. Under the new CECL accounting standard, the acquirer is required to record an allowance on the day of acquisition — in addition to the fair value accounting adjustments. While this allowance for purchase deteriorated credits is a grossing-up of the balance sheet, the performing loan portfolio allowance is recorded through the provision for loan losses in the income statement.

This so-called “double-dip” of accounting for credit risk on acquired performing loans is significant. It may also be an unexpected change for many users of the financial statements. Although CECL guidance has been available for years, this particular accounting treatment for acquired performing loans was often overlooked and may surprise investors and board members. The immediate impact on earnings can be significant, and the time period for recapturing merger costs may lengthen. As a result, bank management teams are spending more time on investor calls and expanding financial statement disclosures to educate users on the new accounting standards and its impact on their transactions.  

The two-fold accounting challenges of implementing CECL during a global pandemic can feel insurmountable. While the CECL standard was announced prior to Covid-19, management teams should take a fresh look at their financial statements as they prepare for earnings announcements. Similarly, if your bank is preparing to close an acquisition, plan on additional time and effort to determine the fair value accounting. By maintaining strong and effective communication, financial institutions will emerge stronger and prepared for future growth opportunities.

Common Themes in Banks’ Critical Audit Matters

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Beginning in 2019, auditors of large accelerated filers that file with the U.S. Securities and Exchange Commission were required to communicate critical audit matters, or CAMs, in their audit opinions. An analysis of Form 10-K filings for U.S. depository institutions for reporting periods covering June 30, 2019, through Dec. 31, 2019, reveals common themes of interest to bankers. The 10-Ks of large accelerated filers with a Dec. 31, 2019 year-end represent the first time these required communications appeared in a significant amount of bank filings.

Banks that are classified as large accelerated filer might wonder how their CAMs compare to those of other banks; SEC filers that do not have the designation might wonder what to expect in their own audit opinions for fiscal years ending on or after Dec. 15, 2020.

Background
In 2017, the Public Company Accounting Oversight Board (PCAOB) adopted Auditing Standard 3101, which requires auditors to communicate CAMs in their audit opinions for audits of large accelerated filers with fiscal years ending on or after June 30, 2019.

The PCAOB defines a critical audit matter as “any matter arising from the audit … that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective, or complex auditor judgment.” CAMs are intended to provide insight beyond the boilerplate audit opinion and share important information with investors.

Each CAM included in the audit opinion should include:

  • What: Identification of the CAM.
  • Why: Principal considerations that led the auditor to determine the matter was a CAM.
  • How: A description of how the CAM was addressed in the audit, including a description of one or more of the following: (1) the auditor’s response or approach most relevant to the matter; (2) a brief overview of the audit procedures performed; (3) an indication of the outcome of the audit procedures; (4) key observations with respect to the matter.
  • Where: The relevant financial statement accounts or disclosures that relate to the CAM.

Number of CAMs
Crowe specialists analyzed the audit opinions of U.S. depository institutions that are large accelerated filers and filed directly with the SEC (“issuers”) with year-ends between June 30 and Dec. 31, 2019, using data from Audit Analytics.

In 2019, 150 depository institutions reported CAMs; and all depository institutions that both file with the SEC and are large accelerated filers reported at least one CAM. The average number of CAMs per issuer was just shy of 1.5. Approximately two-thirds of issuers reported just one CAM, while just under 10% of issuers reported more than two CAMs. Four CAMs was the maximum observed in any one depository institution, with only one institution reporting that number (Exhibit 1).

CAMs per issuer

CAM themes
Auditors of the 150 bank issuers reported a total of 221 CAMs. Unsurprisingly, the most common CAM was related to the allowance for loan and lease losses. This CAM appeared in every bank issuer’s opinion and constituted 68% of the total CAMs reported by bank auditors. In addition to the 150 CAMs specific to the allowance, eight CAMs were specific to the disclosure around the pending adoption of the Accounting Standards Update (ASU) 2016-13 (Accounting Standards Codification 326), commonly referred to as current expected credit losses accounting standard.

The second most common CAM topic — business combinations — appeared 35 times across 32 issuers’ opinions. Nearly three-fourths (27) of the business combination CAMs were specific to certain acquired assets and liabilities, most commonly loans and identifiable intangible assets. Six CAMs were more general in nature and covered entire acquisition transactions. Two CAMs were specific to Day 2 acquisition accounting.

Twenty-eight CAMs were outside of the common topics of the allowance, CECL and business combinations. These CAMs spanned topics including goodwill impairment, servicing rights valuations, deferred tax asset valuation allowances, contingencies, level three fair values and revenue recognition, among others (Exhibit 2).

Banking CAM topics

The number and nature of CAMs will vary over time, but the most frequently observed topics appearing in 2019 CAMs will likely always be prevalent in bank audit opinions. As more institutions adopt CECL, the incidence of CECL as a CAM almost certainly will increase.

The prevalence of CAMs related to business combinations likely will be directly related to the level of bank acquisitions that occur in a given period. Other CAM topics such as goodwill impairment, deferred tax asset valuation allowances, and fair value considerations might increase or decrease based on market conditions.

The CARES Act: What Banks Need to Know

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Banks will play a critical role in providing capital and liquidity to American businesses and consumers, and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) includes several provisions that benefit depository institutions. The implications for bank directors and officers are significant; they may need to make major decisions quickly.

Expanded SBA Lending
The CARES Act appropriates $349 billion for “paycheck protection loans” to be made primarily by banks that will be 100% guaranteed by the Small Business Administration (SBA) through its 7(a) Loan Guaranty Program. The SBA issued an interim final rule on the program on April 2 and has issued additional formal and informal guidance since that date. Application submissions began on April 3. Banks and borrowers will want to move quickly, due to the limited funds available for the program.

Provisions Benefitting Depository Institutions Directly

Troubled Debt Restructuring Relief. A financial institution may elect to suspend the requirements under generally accepted accounting principles and federal banking regulations to treat loan modifications related to the COVID-19 pandemic as troubled debt restructurings. The relief runs through the earlier of Dec. 31 or 60 days after the termination date of the national emergency, and does not apply to any adverse impact on the credit of a borrower that is not related to the COVID-19 pandemic.

CECL Delay. Financial institutions are not required to comply with the current expected credit losses methodology (CECL) until the earlier of the end of the national emergency or Dec. 31.

Reduction of the Community Bank Leverage Ratio. Currently, a qualifying community banking organization that opts into the community bank leverage ratio framework and maintains a leverage ratio of greater than 9% will be considered to have met all regulatory capital requirements. The CARES Act reduces the community bank leverage ratio from 9% to 8% until the earlier of the end of the national emergency or Dec. 31. In response to the CARES Act, federal banking regulators set the community bank leverage ratio at 8% for the remainder of 2020, 8.5% for 2021 and 9% thereafter.

Revival of Bank Debt Guarantee Program. The CARES Act provides the Federal Deposit Insurance Corp. with the authority to guarantee bank-issued debt and noninterest-bearing transaction accounts that exceed the existing $250,000 limit through Dec. 31. The FDIC will determine whether and how to exercise this authority.

Removal of Limits on Lending to Nonbank Financial Firms. The Comptroller of the Currency is authorized to exempt transactions between a national bank or federal savings association and nonbank financial companies from limits on loans or other extensions of credit — commonly referred to as “loan-to-one borrower” limits — upon a finding by the Comptroller that such exemption is in the public interest.

Provisions Related to Mortgage Forbearance and Credit Reporting

The CARES Act codifies in part recent guidance from state and federal regulators and government-sponsored enterprises, including the 60-day suspension of foreclosures on federally-backed mortgages and requirements that servicers grant forbearance to borrowers affected by COVID-19.

Foreclosure and Forbearance on Residential Mortgages. Companies servicing loans insured or guaranteed by a federal government agency, or purchased or securitized by Fannie Mae or Freddie Mac, must grant up to 180 days of forbearance to borrowers who request and affirm financial hardship due to COVID-19 through the period ending on the later of July 25, or the end of the national emergency.

Servicers are not required to document the borrower’s hardship. The initial 180-day forbearance period must be extended up to an additional 180 days at the borrower’s request., Servicers of federally backed mortgage loans may not assess fees, penalties, or interest beyond the amounts scheduled or calculated during this forbearance period, as if the borrower made all contractual payments on time and in full under the terms of the mortgage contract. The law also imposes a foreclosure moratorium on federally backed mortgage loans of at least 60 days, beginning on March 18.

Forbearance on Multi-Family Mortgages. Multifamily borrowers with a federally backed multifamily mortgage loan that was current on its payments on Feb. 1, may request forbearance for a 30-day period with up to two 30-day extensions, during the covered period. Servicers are required to document borrower’s hardship. Borrowers must provide tenant protections, including prohibitions on evictions for non-payment and late payment fees, in order to qualify for the forbearance, and servicers are required to document the borrower’s hardship.

Moratorium on Negative Credit Reporting. Any furnisher of credit information that agrees to defer payments, forbear on any delinquent credit or account, or provide any other relief to consumers affected by the COVID-19 pandemic must report the credit obligation or account as current if the credit obligation or account was current before the accommodation.

CECL Delay Opens Window for Risk Improvements

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The delay in the current expected credit loss accounting model has created a window of opportunity for small banks.

The delay from the Financial Accounting Standards Board created two buckets of institutions. Most of the former “wave 1” institutions constitute the new bucket 1 group with a 2020 start. The second bucket, which now includes all former “wave 2 and 3” companies are pushed back to 2023 — giving these institutions the time required to optimize their approach to the regulation.

Industry concerns about CECL have focused on two of its six major steps: the requirement of a reasonable and supportable economic forecast and the expected credit loss calculation itself. It’s important to note that most core elements of the process are consistent with current industry best practices. However, they may take more time for banks to do it right than previously thought.

Auditors and examiners have long focused on the core of CECL’s six steps — data management and process governance, credit risk assessment, accounting, and disclosure and analytics. Financial institutions that choose to keep their pre-CECL process for these steps do so at their own peril, and risk falling behind competitors or heightened costs in a late rush to compliance. Strategically minded institutions, however, are forging ahead with these core aspects of CECL so they can fully vet all approaches, shore up any deficiencies and maintain business as usual before their effective date.

Discussions over the impact of the CECL standard continue, including the potential for changes as the impacts from CECL bucket 1 filings are analyzed. Unknown changes, coupled with a three-year deadline, could easily lead to procrastination. Acting now to build a framework designed to handle the inevitable accounting and regulatory changes will give your bank the opportunity to begin CECL compliance with confidence and create a competitive advantage over your lagging peers.

Centering CECL practices as the core of a larger management information system gives institutions a way to improve their risk assessment and mitigation strategies and grow business while balancing risk and return. More widely, institutions can align the execution across the organization, engaging both management and shareholders.

Institutions can use their CECL preparations to establish an end-to-end credit risk management framework within the organization and enjoy strategic, incremental improvements across a range of functions — improving decision making and setting the stage for future standards. This can yield benefits in several areas.

Data management and quality: Firms starting to build their data histories with credit risk factors now can improve their current Allowance for Loan and Lease Losses process to ensure the successful implementation of CECL. Financial institutions frequently underestimate the time and effort required to put the required data and data management structures in place, particularly with respect to granularity and quality. For higher quality data, start sourcing data now.

Integration of risk and financial analysis: This can strengthen the risk modeling and provisioning process, leading to an improved understanding and management of credit quality. It also results in more appropriate provisions under the standard and can give an early warning of the potential impact. Improved communication between the risk and finance functions can lead to shared terminologies, methods and approaches, thereby building governance and bridges between the functions.

Analytics and transparency: Firms can run what-if scenario analysis from a risk and finance perspective, and then slice and dice, filter or otherwise decompose the results to understand the drivers of changes in performance. This transparency can then be used to drive firms’ business scenario management processes.

Audit and governance: Firms can leverage their CECL preparations to adopt an end-to-end credit risk management architecture (enterprise class and cloud-enabled) capable not only of handling quantitative compliance to address qualitative concerns and empower institutions to better answer questions from auditors, management and regulators. This approach addresses weaknesses in current processes that have been discovered by audit and regulators.

Business scenario management: Financial institutions can leverage these steps to quantify the impact of CECL on their business before regulatory deadlines, giving them a competitive advantage as others catch up. Mapping risks to potential rewards allows firms to improve returns for the firm.

Firms can benefit from CECL best practices now, since they are equally applicable to the current incurred loss process. Implementing them allows firms to continue building on their integration of risk and finance, improving their ALLL processes as they do. At the same time, they can build a more granular and higher quality historical credit risk database for the transition to the new CECL standards, whatever the timeframe. This ensures a smoother transition to CECL and minimizes the risk of nasty surprises along the way.