Most financial institutions spent months, and in some cases years, preparing to adopt the current expected credit losses (CECL) standard (Accounting Standard Update (ASU) No. 2016-13, Financial Instruments—Credit Losses) in advance of the March 31, 2023, regulatory reports filing. While initial implementation may have passed, there is still work to be done in implementing ASU 2022-02, which eliminates troubled debt restructurings (TDRs) while adding additional disclosure requirements.
Here are seven things financial institutions should continue working on when it comes to CECL:
1. Fine-tune your CECL model
Just because you’ve made your initial CECL entries does not mean you should continue calculating your CECL reserves exactly as you have so far. Instead, monitor how your assumptions and model results are tracking against your realized losses, expectations, and other factors and refine your assumptions to get the best results.
For example, let’s say you are using the SCALE dataset in your model. Now that more banks have adopted CECL, would you get better results using data from banks in your region, a specific size range, or banks that have loan portfolios similar to yours? If your model is proving to be overly complex or simple and isn’t reacting like you expect in different scenarios, should you look into other options or change some assumptions? Your CECL model and assumptions should not be static. Rather, they should be updated and enhanced with your best estimates and assumptions every quarter.
2. Strengthen your documentation
Many institutions rightfully spent the majority of their effort on making their CECL calculations as accurate as possible prior to adoption. Now is the time to go back to your policies and allowance memos and add additional details supporting your key assumptions and decision points. By the time your audit or examination comes, you should have documents that explain your calculation, why you elected to do it that way, and how your significant assumptions were determined. Additionally, there are changes in terminology, accounting standards, and regulatory guidance to update in your memos and policies.
3. Enhance your controls
With the change to CECL, new data, formulas, and reports have become critical to the accurate calculation of your CECL reserves. Ensure you have adequate controls in place so the right data makes it into your calculations, the decisions and assumptions being made are supported, and the calculation is operating as expected.
4. Explore the nooks and crannies
CECL is a very broad standard that grants financial institutions a variety of ways to calculate an appropriate allowance for credit losses (ACL). If your institution spent the vast majority of your pre-adoption effort focused on your core loan portfolio, make sure you have properly accounted for CECL in some of the new or more nuanced areas, such as held-to-maturity (HTM) securities, available-for-sale (AFS) securities (other than temporary impairment is eliminated but impairment considerations still apply), acquired loans, and unfunded commitments.
- Remember: your ACL for unfunded commitments is a liability account separate from your ACL for loans.
5. TDRs may be gone, but are you ready for their replacement?
ASU 2022-02 eliminated accounting guidance for TDRs, but it also required enhanced disclosures for modified receivables for debtors experiencing financial difficulty. This includes the requirement to disclose each reporting period, by class of financing receivable
- Types of modifications
- Financial effect of modification by type of modification
- Receivable performance in the 12 months following a modification
TDRs have been eliminated, but many are still evaluating what modifications should be tracked under the new guidance, how best to track them, and what information must be retained for financial reporting purposes. The new guidance simplifies which modifications will require disclosure (you no longer need to assess if a concession was made), but it’s important to understand the new disclosure requirements so you’re prepared to produce your quarterly regulatory reports and annual financial statements. ASU 2022-02 was effective January 1, 2023, for most entities. The ASU itself has helpful disclosure examples, and the Basis for Conclusions section at the end of the ASU does a nice job laying out the intent behind the changes.
6. Plan ahead for financial statement disclosures under CECL
There are numerous new disclosure requirements under CECL that you should familiarize yourself with and begin to build-out well in advance of year-end. The illustrated examples within ASC 326 are a great starting point. In addition to the enhanced modification disclosures discussed above, ASU 2022-02 also clarified the presentation of gross write-offs by vintage.
7. Prepare for your next exam
The OCC, FDIC, Federal Reserve, and NCUA put out a Revised Interagency Policy Statement on Allowances for Credit Losses in April 2023 that highlights the need to calculate your CECL reserves in a way that is appropriate for the institution’s size and complexity. That phrase is repeated throughout the document, and it's clear regulators will have a wide range of expectations depending on the type of institution. The main thing they are looking for is that the model and assumptions make sense, the institution has adequate documentation to support the assumptions, and ultimately that the ending result is reasonable. Read the Interagency Policy Statement as you’re considering ways to enhance your documentation surrounding CECL or in advance of your next exam.
Next Steps When It Comes to CECL Implementation
It’s amazing how much work has gone into adopting CECL. It’s important to keep the momentum going to ensure your institution is fully compliant with the new standard and disclosure requirements.
CECL is continuing to impact financial institutions. We can help you make sense of the standard and understand what actions must occur post-implementation.