Pub 10 2021 Issue 2

12 Reality: The CECL standard does not require the use of software when developing the estimate of credit losses. It does not require specific approaches when developing the estimate of expected credit losses. Instead, it explicitly states adopters should use judgment to develop estimation techniques that are applied consistently over time and should faithfully estimate loans’ collectability. Admittedly, a little direction would be nice. While many early adopters found software beneficial, specifically through process automation, the standard does not require its use. Myth: If my financial institution purchases software to assist in the CECL calculation, management can reply on its outputs. Reality: This myth has been a challenge to overcome. While software applications can be powerful, helpful tools, management must be able to document their understanding of the conceptual design and assess the reasonableness and appropriateness of assumptions and the resulting allowance estimate. A software application in and of itself cannot tackle the CECL standard given its subjectivity. Myth: Financial institutions with more than $1B in total assets are no longer “smaller and less complex.” Reality: The term “smaller and less complex” has been popularized through interagency guidance on CECL, risk management and compliance. The agencies have yet to define what exactly is “smaller and less complex.” Until then, this classification remains subjective and based on more than an arbitrary asset size. CECL Insights and Lessons Learned Approximately 150 financial institutions adopted CECL as of Jan. 1, 2020. These early adopters are concentrated in publicly traded institutions. Of the approximately 220 banks in Kansas, no banks were included in the round of early adopters. Further, of the 220 banks in Kansas, 205 are under $1B in total assets, and 190 are under $500M in total assets as of Dec. 31, 2020. Expectations for the vast majority of banks in the state of Kansas will not be the same as those banks that adopted CECL as of January 1, 2020. However, there are some universal lessons learned, banks of any asset size should contemplate that. Acquisitions Were a Significant Driver in Increased Reserves Looking at the 10 CECL adopters less than $50B in assets as of March 31, 2020, with the most significant increases in reserves as a percentage of loans, all but one had an acquisition in 2018 or 2019. This increase in reserves upon adoption was expected as accounting for credit losses on acquired loans has materially changed as part of the CECL standard. Historically, purchased loans fell under separate guidance that didn’t allow for recognizing an allowance at acquisition. Under the CECL standard, an allowance for credit losses is to be recorded on purchased loans, regardless of the purchase accounting discount on those loans. For more information on accounting for purchased loans under the CECL standard, see the archived BKD webinar on the topic at bkd.com/webinar/2018/12/ cecl-business-combinations. If your institution anticipates an acquisition in the coming years or expects to have a large amount of acquired loans at the date of the adoption, reach out to a BKD Trusted Advisor™ to review the day-one accounting implications of CECL adoption. Unfunded Commitments Had a Significant Effect at Adoption Another effect of adopting the CECL standard was an overall increase in the allowance for unfunded commitments. With the adoption of CECL, increases on unfunded commitments were expected. Of the early adopters with less than $50B in total assets, 21% experienced a more significant effect from unfunded commitments at adoption than loans outstanding. Further, nearly half of these adopters indicated 20% or more of the total CECL allowance increase derived from reserves on unfunded commitments. This impact is due to the fact that many institutions did not previously record an allowance on unfunded commitments. CECL defines an approach and requires adopters to record an allowance for unfunded commitments that are not unconditionally cancelable. Forecast Periods Were Generally One or Two Years CECL requires “reasonable and supportable forecasts” when determining expected credit losses. “Reasonable and supportable forecasts” make the standard forward-looking, can be viewed as the biggest change within the standard, and are the most significant assumptions when estimating future credit losses. We reviewed public filings for 116 CECL adopters with less than $50B in total assets and noted 68 used either one (39 adopters) or two years (29 adopters). Twenty-three adopters did not disclose the forecast period. CECL does not require an entity to create an economic forecast over the contractual life of loans. Rather, for periods beyond which the entity can make reasonable and supportable forecasts, reversion to historical loss information is required. A Practical Solution I completely get it. Planning, preparing, and researching for your upcoming CECL adoption is the last thing you want continued from page 11