Faced with a nine-month deadline to implement a major new accounting standard, one-third of public banks in a recent survey said they would only barely be ready on time.

With less than one year to go, most public banks appear to still be in the formative stages of implementing a new nationwide accounting rule, while at the same time trying to assess its impact on their consolidated financial statements.  

Banks currently recognize their loan losses through an incurred model, meaning some type of event likely occurred that impaired the loan and caused it to lose value. The bank reflects this on their financial statements after such an event occurs. 

The Financial Accounting Standards Board first issued the current expected credit losses rule, or CECL, in June 2016. Public banks must implement the new standard on Jan. 1, 2020. 

Victims of ‘Wishful Thinking’ 

Under CECL, banks will essentially have to forecast losses on the life of a loan and anticipate which loans are likely to become impaired based on detailed data. As a result, most banks are projected to have a higher allowance for loan and lease losses under CECL as opposed to the current system, which could have a variety of implications on how banks operate and do business. 

“This is not something that banks look at and get excited about,” David O’Connell, a senior analyst at the Boston-based research firm Aite Group, told Banker & Tradesman. “Most of them are basically saying, ‘We expect to be ready on time for implementation, but we have no idea how we are going to get there.’” 

O’Connell surveyed 20 community banks about CECL in December and 32 percent of respondents said they only expect to be ready right before implementation. In response to a different question, 71 percent agreed with this statement: “Although we are still working on the data, the calculation models, or their testing, we expect to be ready on time.” 

Part of the slow preparation response from banks is likely due to ambiguity – CECL is not a regulatory guideline, but rather a rule change by FASB, which has not been forthcoming in its guidance, said O’Connell.  

Financial institutions and other stakeholders may also hope that perhaps there is still a chance implementation could be pushed back.  

The Credit Union National Association earlier this month sent a letter to FASB, urging the agency to delay implementation of the rule. Other banking and trade groups have called for a delay until further study of CECL’s impact could take place. 

“One thing I couldn’t capture in the survey is that there is this really odd undercurrent, where people think this won’t be required of them,” O’Connell said. “I and others involved can’t see where this wishful thinking is coming from, but this is driving the delay.” 

Where Banks Stand Today 

In recent regulatory filings released this month, public community banks in Massachusetts were vague as to where they stood on implementation.  

Most said they had formed a project team or working group to address implementation, while others reported creating a project plan. Most of the larger community banks with over $3 billion in assets are considering or already committed to purchasing a third-party software solution that can help with the modeling and assist in determining CECL’s impact. 

But some of the smaller public community banks have elected to do the work on their own. 

“For a small bank like ours with very little losses, it didn’t make sense to spend $50,000 to $100,000 on an external solution,” said Michael Dvorak, CFO and executive vice president at the nearly $870 million–asset Wellesley Bank. “We thought we had the resident knowledge and expertise in–house with people from our finance and accounting groups to develop it on our own.” 

While still in the early stages of the bank’s analytical review, Dvorak said his team first separated Wellesley’s loan portfolio into different risk segments. Then the bank dug into historical data to understand what the loss patterns were, going as far back as 2001 in some cases, to look at loss rates by product groupings. 

“That might not give us full picture, so we are applying a couple of other qualitative factors, like factoring for past dues, to be quantitative about those loss rates going forward,” he said. “Because we have had very few losses over the past few years, we are developing a seasonal factor to take into consideration the losses we might see as the economy slows down.” 

Lenders Face Forecasting Challenges 

Forecasting loans out through their lifecycle can be a difficult process with many variables involved. 

For a 30-year mortgage, for example, Dvorak said Wellesley takes the current principal loan balance and amortizes it through its remaining life by applying the projected prepayments. But most people don’t own a house for 30 years or will pay off their mortgage early, so the bank examined historical performances and compared it to industry statistics to determine the expected prepayment speeds. 

Bram Berkowitz

Wellesley is in the process of finalizing its framework and then will need to run its modeling by its external auditor and senior bank management. 

Based on the work the bank has done so far, Dvorak said he expects loan loss allowances under CECL to be close to what they are now, and he has in general found the laborious process helpful. 

“I think it’s worthwhile,” he said. “It forces us over time to look for additional relationships between leading indicators like delinquencies and expected losses … and dig into the data to better understand the relationships and riskiness of different pieces of the portfolio.”