Allowance for Loan and Lease Losses (ALLL)

In December 2012, The Financial Accounting Standards Board approved plans to proceed with changes to banking estimates of ALLL and Other Than Temporary Impairment of debt securities (OTTI). Called the Current Expected Credit Loss impairment Model (CECL), FASB will require “life of loan” (LOL) estimates of losses on loans and debt securities.

ABA Position

ABA is concerned that the CECL model would present significant problems for banks and in a Jan. 24, 2014 letter called on FASB to initiate Roundtable Discussions between bankers, bank investors, regulators, and auditors before a final standard is issued.
 

In June 2014, FASB then held private workshops with bankers, ABA personnel, auditors, and regulators present.  The purpose of the workshop was to address specific FASB concerns related to the feedback they received from their exposure draft. As a result of the workshop, ABA again called for a public roundtable in another letter to FASB Chairman Russ Golden in order to address operational concerns noted by ABA members. ABA then sent another letter to FASB in January 2015 to follow up on existing issues still outstanding and to call for additional workshops and a roundtable meeting. In response to this, FASB held a second private workshop in September 2015, though it was to address only specific FASB concerns related to a "Fatal Flaw" draft distributed to members of their Transition Resource Group and to ABA. As part of the Fatal Flaw Review, ABA submitted 49 comments, of which seven were noted as "Fatal," including the basic premise of CECL — that expected losses shall be estimated over the expected life of the asset. 

FASB February 2016 Roundtable

In December 2015, FASB announced they will hold a public roundtable, now scheduled for February 4, 2016. Learn more:

ABA expects FASB to issue the final standard in the first quarter of 2016, with an anticipated effective date of 2019 for SEC registrants (2020 for all other banks).

ABA believes a final standard on impairment should:

  • Reflect a bank’s estimate of all losses that currently reside in the loan portfolio.
  • Retain a level of reliability critical to financial reporting integrity and required by banking regulators, and
  • Be operational to implement and audit, building on current credit loss estimation systems and not requiring wholesale changes to them.
  • Acknowledge the difference between loans and debt securities – the current OTTI process does not need change.

ABA Analysis

The CECL model will require LOL estimates of losses to be recorded for unimpaired loans at origination or purchase. However, if finalized as currently proposed, the LOL loss concept will present significant problems to bankers:

  • Wholesale changes to ALLL and OTTI estimation systems for HTM securities will be required.
    • Systems that rely on annualized charge-off rates will be insufficient.
    • Current credit metrics, such as delinquency, will have little relevance to the ALLL balance.
    • Vintage analysis will likely be required across all portfolios in order to support LOL evaluation of losses.
  • Forecasts far into the future are required
    • The decrease in reliability will result in volatility and a new buffer that will be needed in managing capital.
  • Losses that are possible several years in the future will be recorded, while the interest earned in the meantime is not.
    • Banks offering long-term products will experience a strain in capital.
    • Due to CECL's allowing discounted cash flow method in estimating ALLL, larger banks that can implement sophisticated systems that estimate the amount and timing of specific cash flows may have a competitive advantage over community banks. As its name implies, the DCF method of estimating ALLL discounts the allowance based on the timing of cash flows. As a result, DCF allowances will be lower than those allowances derived using simpler methods.
 

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Questions? For more information, contact Mike Gullette, (202) 663-4986.