For years now, bankers and their accountants have waited for the Financial Accounting Standards Board (FASB) to release its final guidance on a new rule that could change the way financial institutions calculate and reserve against potential loan losses. Now that rule has come out, and bankers and accountants are waiting to see how regulators will interpret it.

“I don’t know that they moved the needle in terms of what the standard contains, but I think they’re trying to get in front of the perception that this is going to be an overly complicated and onerous thing for banks to deal with,” said Tim McPeak, executive risk management consultant at Sageworks.

Until now, financial institutions have calculated loan loss reserves using the incurred loss model. The new current expected credit losses model – CECL for short – will ask bankers to use historical loan loss data, current conditions and what it terms “reasonable and supportable forecasts” to estimate the losses they expect to incur over the life of the loan. Bankers under the new model will most certainly need to use a great deal more data and tweak their methodologies when they calculate how much to set aside in their allowances for loan and lease losses.

FASB began working on the accounting standard update in 2012 and now, more than 3,000 comment letters later, it’s finished.

The Independent Community Bankers of America praised FASB for heeding the concerns of small financial institutions – for instance, allowing community banks to continue using their personal understanding of their local markets in calculating those loan losses. Others were a bit more cautious in reading the final rule.

“One of the things that I think will be most important in reading is how it’s interpreted and implemented,” said Dan Morrill, a principal at the Boston-based firm Wolf & Co. “When I read it, I said, ‘Well, example one looks pretty simple.’ And depending on how that’s interpreted or implemented … it may not be that difficult.”

As usual, the devil is in the details. Many who spoke to Banker & Tradesman said that it all depends on how the regulators interpret the new rule. It could be a nightmare, or it could be … Not that bad.

Donald J. Musso, president and CEO of the consulting firm FinPro, said he hoped that regulators would interpret CECL to mean that banks can calculate their reserves against loan losses based on aggregate pools of similar loans, as opposed to looking at it on a loan-level basis.

“The minute they tell me we go to a pool and not to an individual loan, I think it’s OK,” he said. “Where it’s problematic is when we go to a loan level basis.”

We Can Do This The Easy Way … 

FASB originally decided to revisit the way that banks set aside cash for loans and leases that go bad after the financial crisis of 2007–2008. The point of CECL was to ensure that financial institutions recorded their loan losses in a more timely fashion, but as many have pointed out, it’s not always possible to divine the future.

“I don’t know if [a borrower is] going to have a marital problem, I don’t know if he’s going to have a heart problem. … All the things that lead to a default, I have no way of knowing that,” Musso said. “Nor can I tell you what the economy’s going to look like in five years.”

Right now, regulators are meeting with accounting firms to ask for examples of how financial institutions might calculate those expected loan losses, and experts say it could go either way. Musso, for his part, hoped the regulators would use some common sense in interpreting the rule.

Much of it also depends on the individual bank and its own loan portfolio. The rule could be complicated for some, but not others.

“I think that every bank should be, within the next six to 12 months, getting their methodology and figuring out what that is,” Morrill said. “If you’re going to do something very complex, you might need a software [solution], but if you’re going to follow the example in their standard, it looks a little bit simpler and you may not need the software.”

Of course, some financial services vendors will have software available for purchase, but bankers shouldn’t have to break the bank in making CECL work.

“I think right now the typical community bank needs to stay alert. I think that there are companies out there developing solutions as we speak,” Musso said. “There are people who are going to try to do this as smart and cost effectively as possible. Nobody wants to spend a fortune to do this, [and] we shouldn’t have to.”