New Proposal Would Phase in CECL over 3 Years for Regulatory Capital Purposes
A new rule proposed jointly by bank regulators on Tuesday would offer institutions the option to phase in the initial effect of the upcoming CECL standards on regulatory capital. If enacted, this proposal would allow a three year transition provision for calculating regulatory capital ratios.
In the proposal, regulators acknowledge that despite adequate planning to prepare for CECL unexpected economic conditions at the effective date could result in higher-than-anticipated increases in allowances. The proposed transition provisions would give banks more flexibility when it comes to capital planning.
Background
The current expected credit loss (CECL) model replaces the incurred loss methodology currently used and requires that banks recognize lifetime expected credit losses not just those losses that have already been incurred. CECL also requires the use of reasonable and supportable forecasts in developing an estimate of lifetime losses.
Upon adoption of CECL, a bank will record an initial adjustment to its allowance and recognize offsetting entries to retained earnings and deferred tax assets, if appropriate.
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CECL Effective Dates |
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| Entity Type | US GAAP Effective Date | Call Report Effective Date |
| SEC Filers | Fiscal years beginning after 12/15/2019, including interim periods within those fiscal years | March 31, 2020 |
| Other Public Business Entities | Fiscal years beginning after 12/15/2020, including interim periods within those fiscal years | March 31, 2021 |
| Non-Public Business Entities | Fiscal years beginning after 12/15/2020 | December 31, 2021 |
Proposed Transition Provisions
The proposal does not change the timing or amount of the initial GAAP accounting entries under CECL. Instead, it changes the way regulatory capital ratios are calculated for three years (12 quarters) following CECL implementation.
Under the proposal, banks would calculate the pre- and post-CECL change in retained earnings, allowance for loan losses, and deferred taxes and would adjust their regulatory capital calculations on their call report by corresponding transitional amounts.
For example if the day-one impact of CECL is a $1,000,000 decrease in retained earnings, banks that elect to use the transition provision would addback $750,000 (75% of the day-one amount) to their total regulatory capital when completing their call reports during year one, which would result in higher capital ratios. They would addback $500,000 (50%) in year two and $250,000 (25%) in year three.
Similar provisions would also apply related to the allowance for loan losses included as part of Tier 2 capital. As a result, the regulatory capital impact of CECL implementation is effectively spread over three years.
Next Steps
This proposal is currently open for public comment. If these transition provisions are ultimately approved, they may help ease some of the CECL anxiety bankers are experiencing.
We know many community banks are just beginning to plan for CECL implementation and estimate the impact on their institutions. CLA is actively helping banks plan and build their initial models.
Please contact us for more information.
Amanda Garnett is a principal in the financial institutions practice of CliftonLarsonAllen (CLA) from Peoria, Illinois. She currently leads the firm’s Midwest financial institution tax team and serves institutions ranging in size from $15 million to $3.5 billion in total assets. In addition to tax compliance, Amanda assists clients in the areas of tax consulting, mergers and acquisitions, and regulatory reporting. She also routinely teaches courses for banking associations across the country.
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