Garnet Capital Advisors Blog

June 10, 2020

COVID-19 is Affecting CECL Implementation

EXCERPT:  The combination of COVID-19 and the FASB CECL impementation can have a significant impact on banks' capital. But either with or without CECL, estimates of losses will be increasing as well as distressed loans and borrowers. Loan sales can be an integral tool in a bank or credit union workout strategy.

CECL implementation amidst the COVID-19 pandemic is feared to have an adverse effect on the financial industry.

COVID-19 has severely impacted the financial industry, as has the implementation of CECL. Combined, both the coronavirus and the CECL are wreaking major havoc on banks’ capital.

Current Expected Credit Loss (CECL) is an accounting standard issued by the Financial Accounting Standards Board (FASB) that US financial institutions are required to follow to estimate loan losses at the time of origination or purchase.

Since its creation, lenders and investors have been trying to forecast what the effect of CECL implementation would be for SEC filers. The estimates assumed that the effect would be significant in the face of worsening economic conditions as the virus continues to spread.

CECL is already a significant accounting endeavor, and COVID-19 is magnifying its impact on banks and lenders.

CECL May Compound the Adverse Effects of the Coronavirus

Stock markets have been heavily volatile amidst the spread of COVID-19, interest rates have hit new lows, and economists are downgrading their forecasts for the economy. Banks and lenders are closely watching their bottom line amid the risk of skyrocketing deferments and forbearances as jobs are lost, and businesses are shuttered.

Some financial relief provided by Congress, however, is giving bank holding companies and insured depository institutions the chance to delay CECL implementation to December 31, 2020, or the date that the COVID-19 national emergency terminates, whichever of the two is earlier.

Supervisory agencies understand the challenges that CECL implementation is posing in this environment. On March 27, 2020, the FDIC and the Office of the Comptroller of the Currency (OCC) released a capital rule offering a new option for phasing in the CECL into regulatory capital over the next five years.

The coronavirus and CECL present a double whammy for banks' capital.

It is feared that CECL implementation will negatively impact the availability of credit to consumer borrowers, especially those in lower to moderate income levels throughout the coronavirus pandemic. Instead, commercial borrowers are likely to benefit.

CECL allowances of the largest banks in the US could spike if a significantly impacted economic scenario was factored entirely into CECL forecasts. This could have a severe effect on banks’ capital and will rely on the full extent of the assumptions considered into their CECL allowance calculations.

Financial Institutions Urged to Assess the Effect of Different Economic Circumstances

If nothing is done to hold off on implementing CECL, financial institutions are encouraged to analyze the impact of the different economic scenarios that may arise using their own banking models and the CECL accounting framework. The various scenarios assessed should include considerations that revolve around the current health crisis and its effect on borrowers. Once results are released, financial institutions should communicate their CECL allowance disclosures to investors.

Finally, financial institutions are urged to keep close tabs on credit exposures in industries and areas that are most significantly affected and work closely with clients to minimize their risk throughout the pandemic.

Regardless of whether or not CECL is in the picture, estimates of losses will likely increase along with distressed loans and borrowers. Special asset areas of banks will be stressed, and loan sales facilitated through Garnet Capital can be an integral tool in a bank or credit union workout strategy.

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