Rapid Ratings Blog

CECL & Community Banks - Why the Effective Deadline Is Nearer Than You Think

Posted by Rapid Ratings on April 25, 2018

The Headline Dates for CECL

iStock-544673428When FASB released its Accounting Standards Update 2016-13 – Measurement of Credit Losses on Financial Instruments –  in June of that year many in the banking community took comfort from how distant the effective dates were for radical new Current Expected Credit Loss (“CECL”) recognition. The nearest date would involve financial reporting released after 12/15/19 and apply to SEC registrants only. The next date would come a year later and apply to non-registrant public companies. The last date would not come until after 12/15/21 and apply to private companies, a group which in the banking industry consists almost entirely of community banks.

FASB, Regulators, Auditors, and Consultants  -- The Same Clear Message

From the outset, however, FASB made clear the need for careful preparation for CECL among all three classes of respondents, well ahead of these three effective dates. Federal financial-services regulators, in turn, released guidance to reinforce the point within hours of FASB’s posting of the ASU. Within a month, all of the Big Four audit firms conducted lengthy client webinars to join in the messaging. Their consulting arms were promptly forthright along exactly the same lines.

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CECL Preparation Thus Far – Larger Banks vs. Smaller Banks

There has been no let-up ever since from any of these parties. Therefore, nearly all executives in banking have heard something substantive by now about the CECL-derived administrative, logistical and analytical challenges facing their institutions. At this stage, preparedness varies enormously within each class of respondents. The largest banks with which RapidRatings is in active discussion appear to be the farthest along – and yet some of them are the ones who see the most work remaining. In some unfortunate cases, there are medium and smaller banks whose executives still believe CECL will be set aside before the effective dates, as the eventual result of the industry’s strong and continuing opposition and the Administration’s favorable attitude towards regulatory relief. As RapidRatings CEO James Gellert has insisted in multiple commentaries, this latter expectation is fraught with danger for those institutions that allow it to delay the hard work they will later have to rush to complete. His warnings take on added force in the wake of the proposal which federal banking agencies made jointly on April 17th, by which they intend to phase in CECL’s effects on regulatory capital over three years and thereby remove one of the banking industry’s primary complaints about the Standard[i].

Rethinking the Private Bank’s Effective Date – Caution from ABA’s Michael Gullette

A valuable contribution to CECL deliberations within the community banking industry comes in a recent essay by Michael L. Gullette, the ABA’s SVP for Tax and Accounting. Mr. Gullette has been one of the industry’s best-known, most authoritative and most outspoken commentators on the CECL project for several years. In the essay Mr. Gullette makes a case that private banks should consider 1/1/21 rather than 12/31/21 their effective date of CECL for audit purposes, since performance reporting for the year will depend on governance and internal controls at both times of the year[ii].


The Hidden Imperative – Addressing CECL’s Threat to Capital Adequacy

Another essay that will likely prove useful to private banks in judging their appropriate timeframes for CECL planning comes from co-authors Ethan M. Heisler of The Bank Treasury Newsletter and Joshua S. Siegel of StoneCastle [iii]. They move quickly past CECL’s familiar technical challenges to address an equal, if not greater, challenge – the challenge to capital adequacy. “Specifically, we find more than one thousand U.S. commercial banks will struggle to maintain their Well-Capitalized status when CECL is adopted, with TRBC ratios particularly vulnerable.” They explain that CECL will burden smaller banks more heavily than larger banks because smaller banks hold higher percentages of longer-term residential mortgages whose cumulative expected losses will extend much further than those of C&I loans. They also point to Tier 2-qualifying subordinated debt as a potent remedy that looks attractive now but cannot be expected to remain so indefinitely, as rates increase and especially as more and more banks awake to the utility of tapping that market. It is impossible, however, to understand any of these capital requirements in relation to CECL without performing proper analysis beforehand.

Mr. Heisler and Mr. Siegel effectively call out the entire private banking industry on CECL. Is your proper deadline what FASB says it is or what the capital-planning imperative says it is? Is that extra year or two of your unconcern worth the prospect of a regulatory breach?

It will surprise few observers if CECL results in a shift in the community banking industry towards more C&I origination and less residential mortgage origination; the Heisler-Siegel paper appears to suggest as much. The industry therefore has even more reason to avail itself of effective third-party analytical tools than it would otherwise have, to make sure that such C&I expansion takes place in the most prudent way.

Key Takeaways

  • To be fully prepared for CECL, ABA’s expert believes that private banks need to consider 1/1/21 rather than 12/31/21 as their effective date.
  • Smaller Banks will carry a larger burden due to a higher percentage of longer-term residential mortgages that CECL penalizes.
  • Large numbers of banks, especially smaller banks, will need to raise capital to address CECL. The sooner a bank knows, the better it can plan.

[i] April 17th, Phasing in CECL’s effects on regulatory capital: https://www.federalreserve.gov/newsevents/pressreleases/bcreg20180417a.htm

[ii] 2. Mr. Gullete’s Essay: https://www.aba.com/Advocacy/Issues/Documents/DP-CECL-Effective-Date-feb-18.pdf

[iii] 3. CECL Planning, Ethan M. Heisler of The Bank of Treasury Newsletter and Joshua S. Siege of StoneCastle: https://stonecastle.com/wp-content/uploads/2018/01/2017-12-18-CECL-and-Tier-2-Final.pdf

Topics: Third-Party Risk Management, CECL