​​Accounting Standards May Drive ALLL Changes

by J. Mark McWatters, NCUA Board Member

In my role as an NCUA Board member, I believe it is critical to remain well informed on issues that affect credit unions, including rules and standards created outside of this agency as well as our own. That is why I have been focusing, among other things, on developments regarding the accounting standards update on current expected credit losses, otherwise known as CECL, particularly as federally insured institutions and examiners work to understand how financial reporting and provisioning for allowance for loan and lease losses, or ALLL, will be affected.

The new standards have evolved to address some concerns, but issues regarding the impact of the standards remain. My background as both a CPA and an attorney comes in handy, as an NCUA Board Member, but regrettably it does not give me a crystal ball to help see into the future.

In April, the Financial Accounting Standards Board indicated it would move to approve CECL standards that would incorporate revisions, such as delaying the effective date for non-publicly traded entities, such as credit unions, for fiscal years beginning after Dec. 15, 2020, and interim periods within fiscal years beginning after Dec. 15, 2021. Even with revisions to the standards, FASB also acknowledged continuing concerns and stated:

  1. Preparers may face the following potential challenges when applying the new standard:
  1. Considering the contractual term when estimating expected credit losses
  2. Estimating the prepayment effect on expected credit losses
  3. Evaluating credit losses on a collective basis
  4. Filling data gaps and completing data sets of historical loss information
  5. Developing current conditions and reasonable and supportable forecasts
  6. Developing methodologies that consider migration from period-to-period and the corresponding effect on the estimate of expected credit losses
  7. Evaluating different credit metrics from those used in current practice as well as concern for reduced comparability
  8. Auditing challenges that exist with the potential for increased estimation uncertainty.

A central issue is that the new standards will consider losses over the life of a loan. As FASB notes, the changes will "broaden the information that an entity must consider in developing its expected credit-loss estimate for assets measured either collectively or individually. The use of forecasted information incorporates more timely information in the estimate of expected credit loss, which will be more decision useful to users of the financial statements." Before the changes, generally accepted accounting principles focused on past events and current conditions to assess incurred losses.

The shift to consider losses over the life of a loan has caused some financial institution senior officials to be concerned that their ALLL will need to be significantly increased, at least initially, after the new standards take effect. This is an issue that federal regulators must take seriously, and NCUA must work with our examiners to minimize unintended consequences.

While NCUA's risk-based capital rule, which takes effect January 2019 and covers credit unions with assets of $100 million or more, allows 100 percent of a credit union's ALLL to be included in the numerator of the RBC ratio, which is positive, having to increase the ALLL—if necessary—as a result of the new accounting standards may be increasingly problematic for some, as we near implementation of FASB's new accounting standards.

As a CPA, I have no doubt that the new standards will be useful, particularly for the users of financial statements of publicly traded entities. As a regulator, I am also mindful that credit unions are wary of the new standards. While I am respectful of FASB's objective to increase transparency in financial disclosures, I have concerns that the standards will create unintended results for credit unions' ALLL. Credit unions should certainly be thinking now about the effects of these standards, and how their operations may be affected.

NCUA must also consider the impact of the new standards. We must begin planning now so that we can work with credit unions to mitigate any unintended consequences that may present themselves when the standards are implemented.