On April 14, 2020, the US federal banking regulators held a webinar to provide further guidance on relief from the effect of the current expected credit losses methodology (“CECL”) on regulatory capital.1 This guidance was intended to clarify the interaction between two recently issued rules (the 2019 CECL rule and the 2020 CECL interim final rule) that provide the option to delay the impact of CECL on regulatory capital and a provision of the Coronavirus Economic Stabilization Act of 2020 (“CARES Act”) that provides optional temporary relief from complying with CECL. Presentation materials used during the webinar can be found here.
Many banking organizations were already struggling with the implementation of CECL prior to the COVID-19 pandemic. We expect that the industry will welcome the options provided by the recent regulatory and legislative actions. However, it remains unclear what will happen after 2020, when some banking organizations may be required to report different loss reserves for regulatory and financial purposes. Therefore, further guidance or action from the banking regulators, Securities and Exchange Commission (“SEC”), or Financial Accounting Standards Board (“FASB”) may be necessary.
Background
A banking organization is required to record a one-time adjustment to its credit loss allowances as of the beginning of the fiscal year in which it transitions from the incurred loss methodology to CECL.2 This adjustment is equal to the difference, if any, between the amount of credit loss allowances required under the incurred loss methodology and the amount of credit loss allowances required under CECL. With limited exceptions, banking organizations must recognize the adjustment to the credit loss allowances with offsetting entries to deferred tax assets, if appropriate, and to beginning retained earnings.
Relief
In December 2018, the banking regulators modified the regulatory capital rules to provide an option to phase-in over a period of three years the day-one effects of the transition from the incurred loss methodology to CECL.3 (The change was published in the Federal Register on February 14, 2019 and became effective on April 1, 2019, and therefore, is known as the 2019 CECL rule.)
In March 2020, the banking regulators further modified the regulatory capital rules to provide relief related to the COVID-19 emergency by issuing an interim final rule. The 2020 interim final rule created another option for banking organizations to phase-in over a period of five years the effects of the transition from the incurred loss methodology to CECL that occur during the first two years of implementation (i.e., day-one effects plus subsequent changes).4 Under this option a banking organization will not recognize any of the effects of CECL for the first two years, and then will phase-in the effects over the subsequent three years.
In March 2020, the CARES Act also was enacted to address COVID-19.5 Section 4014 of the CARES Act provided banking organizations with the option to not comply with CECL until the earlier of the end of 2020 or the end of the COVID-19 emergency.6
The banking regulators subsequently released a three-page statement describing the interaction of the regulatory relief and Section 4014 of the CARES Act and the SEC issued a statement that incorporates Section 4014 into GAAP.7 The webinar on April 14, 2020 expanded on that banking regulators’ statement by providing visual examples of how the options interact and clarifying that the options operate independently (e.g., Section 4014 does not extend the start date of the five year phase-in period).
The CECL implementation guidance is part of an evolving COVID-19 response that is moving across regulatory agencies. For information on other regulatory developments related to the pandemic, please visit our COVID-19 Portal.
1 FIL-41-2020 (Apr. 10, 2020), https://www.fdic.gov/news/news/financial/2020/fil20041.html. The US federal banking regulators are the Board of Governors of the Federal Reserve System, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation.
2 Banking organizations must transition to CECL in 2020, 2021, or 2022, depending on whether they file financial statements with the SEC or are another public business entity under US Generally Accepted Accounting Principles (“GAAP”).
3 Agencies Allow Three-Year Regulatory Capital Phase In for New CECL Accounting Standard (Dec. 21, 2018), https://www.fdic.gov/news/news/press/2018/pr18102.html; see also 84 Fed. Reg. 4222 (Feb. 14, 2019).
4 Agencies Announce Two Actions to Support Lending to Households and Businesses (Mar. 27, 2020), https://www.fdic.gov/news/news/press/2020/pr20041.html; see also 85 Fed. Reg. 17,723 (Mar. 31, 2020).
5 CARES Act, Pub. L. 116-136, 134 Stat. 281 (Mar. 27, 2020), https://www.congress.gov/bill/116th-congress/house-bill/748/text.
6 The banking regulators had requested that FASB grant similar relief, but it was unclear at the time of enactment if it would do so and FASB had stated its opposition to the inclusion of Section 4014 in the CARES Act. See FDIC Chairman Urges FASB to Delay Certain Accounting Rules Amid Pandemic (Mar. 19, 2020), https://www.fdic.gov/news/news/press/2020/pr20036.html; Ltr. from Kathleen Casey (Mar. 23, 2020), https://d2l6535doef9z7.cloudfront.net/Uploads/x/p/b/fafletter_846416.pdf; Steve Marlin, CECL working as intended amid Covid-19 crisis, says FASB, Risk.Net (Mar. 18, 2020).
7 FIL-32-2020, Joint Statement on the Interaction of the CECL Revised Transition Interim Final Rule with Section 4014 of the CARES Act (Mar. 31. 2020), https://www.fdic.gov/news/news/financial/2020/fil20032.html; Sagar Teotia, Statement on the Importance of High-Quality Financial Reporting in Light of the Significant Impacts of COVID-19 (Apr. 3, 2020), https://www.sec.gov/news/public-statement/statement-teotia-financial-reporting-covid-19-2020-04-03#_ednref10.
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