Final Rule Phasing in Regulatory Capital Effects of CECL
In late December 2018, the federal banking agencies (Federal Reserve, FDIC, and OCC) adopted a joint final rule revising their regulatory capital rules to address the upcoming implementation of the current expected credit losses (CECL) accounting standard under US GAAP. The final rule makes a number of changes to the regulatory capital rules to reflect CECL’s revised credit loss standards. For most banks, however, the rule’s most important feature will be its optional three-year phase-in period for the recognition of CECL’s expected adverse effects on regulatory capital.
The CECL methodology was introduced in 2016 by the Financial Accounting Standards Board (FASB) as a new accounting standard to replace the current “incurred loss” impairment approach. The new standard requires an estimate of expected credit losses over the life of the portfolio to be effectively recorded upon origination. For most banking organizations, the implementation of CECL is likely to require earlier recognition of credit losses as well as an increase in credit loss allowances, resulting in a reduction in retained earnings and tier 1 capital as of the end of the quarter in which CECL becomes effective.
In recognition of the expected one-time negative adjustment to regulatory capital ratios—and of the difficulty in forecasting a banking organization’s revised credit loss allowances under CECL until the organization’s CECL adoption date nears—the final rule permits banks, savings associations, and their holding companies to elect to phase in, over a three-year period, the day-one adverse effects of the CECL adoption on their regulatory capital. For a banking organization electing the transition period, CECL’s regulatory capital effects would be phased in at 25 percent per year, beginning in the first quarter of the organization’s CECL adoption year. It is important to note that the final rule’s transition period applies only to bank regulatory reporting; FASB has not indicated any intent to allow the phase-in of CECL’s effects on a company’s audited financial statements.
For SEC-registered bank holding companies and savings and loan holding companies, the CECL accounting standard will become effective beginning with the first quarter of 2020. Therefore, all such companies will need to reflect their CECL calculations in their SEC and bank regulatory filings for the quarter ending March 31, 2020, and they are required under the final rule to choose, no later than the end of that quarter, whether or not to elect the phase-in of CECL’s effect on regulatory capital. Banking organizations that are not SEC-registered are required to adopt the CECL accounting standard, and to make a determination regarding the final rule’s transition period, according to the following schedule:
- “Public business entities” (generally, banking organizations that have assets of $500 million or more and have stock outstanding) that are not SEC filers: first quarter of 2021.
- All other banking organizations: first quarter of 2022.
In their release of the final rule, the federal banking agencies stated that, during the phase-in period, they would be “committed to closely monitoring the effects of CECL on regulatory capital and bank lending practices.” However, the possibility of any additional relief from CECL’s adverse effects—whether from the banking agencies, Congress, or FASB—is highly speculative. Accordingly, all banking organizations should make appropriate plans to comply with the requirements under the final rule as issued, as well as continuing to prepare for their implementation of CECL.