Allowances for Loan Losses Under the Transition to CECL During the Pandemic
The Banking Law Journal, 2020
In an article published in The Banking Law Journal, Vice President John Drum, Associate Evan Carter, and Professor Stephen G. Ryan, an Analysis Group affiliate, examine how the uncertainty created by the ongoing COVID-19 pandemic may affect banks that have made the transition to the new current expected credit loss (CECL) methodology for estimating and reporting loan loss allowances. The article, “Allowances for Loan Losses Under the Transition to CECL During the Pandemic,” discusses the controversial accounting standards update ASU 2016-13 issued by the Financial Accounting Standards Board (FASB). The FASB’s final rule requires banks and other loan holders to adopt CECL methodology for recording credit loss allowances.
As the authors note, the methodological change was intended to improve the timeliness of banks’ recording of loan loss allowances by requiring reporting entities to consider, for the first time, relevant information about “past events, current conditions, and reasonable and supportable forecasts.” Under the previous incurred loss methodology, forecasts of future conditions had little or no effect on credit loss allowances.
Using the quarterly statements from three large banks, the authors provide examples of the difficulties encountered using CECL to estimate credit loss allowances during the pandemic. With the dramatic increase in estimation uncertainty in projections of the economic conditions affecting collectability, the authors point out that estimations of expected loan losses have become even more subjective and prone to revision from quarter to quarter. Consequently, the potential exists for regulators and shareholders to question banks’ CECL estimates in hindsight as the effects of the pandemic play out.