The federal banking agencies (Federal Reserve Board, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation) have jointly published proposed rules that would amend their regulatory capital rules to respond to banking organizations’ implementation of the new Current Expected Credit Losses (CECL) methodology under U.S. Generally Accepted Accounting Principles (GAAP). Adoption of the CECL accounting standard will necessitate one-time adjustments to retained earnings, temporary difference DTAs (deferred tax assets), and credit loss allowances eligible for inclusion in regulatory capital, which will impact a banking organization’s regulatory capital ratios.
Key features of the agencies’ proposed rules follow.
Phase-in Option. All banking organizations would have the option to elect a three-year phase-in of the “day 1” regulatory capital effects from adopting CECL (referred to as the CECL Transition Provision and determined to be the difference in the amount of credit loss allowance required under the incurred loss methodology and CECL) if they experience a reduction in retained earnings as a result of adopting the new accounting standard. Further:
Definitions. A new term, “allowance for credit losses” or ACL, would take the place of ALLL for banking organizations that have adopted CECL. ACL would include credit loss allowances related to financial assets measured at amortized cost, except for allowances for PCD assets (purchased credit-deteriorated assets). It would also exclude allowances for AFS (available-for-sale) debt securities. ACL would be eligible for inclusion in Tier 2 capital subject to the current limit for ALLL. PCD assets and AFS debt securities would be treated separately.
The agencies are also proposing to revise the regulatory definition of “carrying value” under the capital rules to provide that, for all assets other than PCD assets and AFS debt securities, the carrying value is not reduced by any associated credit loss allowance.
AA Banks. Advanced Approaches Banking Organizations (AA Banks) that adopt CECL would be subject to certain additional provisions, including:
Disclosures. Banking organizations would be required to update certain regulatory disclosures to reflect the adoption of CECL. AA Banks that have elected the phase-in option would be required to disclose two sets of regulatory capital ratios: one with the CECL Transition Provision and one on a fully phased-in basis.
Stress Tests. For purposes of the stress testing rules, banking organizations that adopt CECL would be required to begin using the provision for credit losses in the 2020 stress test cycle even if they adopted CECL in 2018 or 2019. For the 2018 and 2019 stress test cycle, a banking organization would continue to use its provision for loan and lease losses. Banking organizations that adopt CECL in 2021 would not be required to use the provision for credit losses until the 2021 stress test cycle.
Applicability. The new accounting standard for credit losses applies to all banking organizations that are subject to the agencies’ regulatory capital rules and file regulatory reports that are required to conform to U.S. GAAP. The agencies intend to use regulatory capital ratios adjusted by the CECL Transition Provision when determining whether a banking organization that has elected the phase-in approach is in compliance with its regulatory capital requirements.
CECL Accounting Standard. The CECL methodology was issued in 2016 as part of Accounting Standards Update No. 2016-13. The effective date varies for different banking organizations based on certain characteristics; it becomes effective for the first group of banking organizations in their first fiscal year beginning after December 15, 2019, including interim periods within that fiscal year (e.g., quarterly reports). Early adoption is permitted for all banking organizations for fiscal years beginning after December 15, 2018.