The journey to implement the Current Expected Credit Losses (CECL) accounting method has proven to be especially complex for credit unions. The Financial Accounting Standards Board (FASB) initially introduced CECL over five years ago in an effort to bridge the gap between what financial statement users need and what GAAP currently requires. The long and winding transition has also presented the NCUA and other oversight agencies with challenges of their own, and the content and timeliness of official guidance hasn’t been ideal at every turn.
In the beginning, there were hopeful, albeit short-lived, discussions of exemption for nonpublic companies. While the requirement to transition to CECL was affirmed for public and nonpublic companies alike, the implementation was delayed in 2019 for many of those affected to account for the additional time needed to adopt the new method. The deadline for credit unions to adopt the standard was extended to 2023, but the journey didn’t stop there.
The long-standing accounting method, Allowance for Loan and Lease Losses (ALLL), is based on historical data and known losses in the portfolio. CECL, on the other hand, incorporates anticipated losses earlier on in the life of a loan. The new method requires financial statement users to estimate expected credit losses based on forward-looking information, which isn’t easy in a volatile, uncertain lending market.
Many credit unions had already invested heavily in the technology, personnel, and software necessary for the CECL transition and chose to move ahead rather than delaying implementation. In their annual letter to credit unions covering supervisory priorities for 2021, the NCUA cited ALLL as one of its areas of focus since the CECL transition was delayed. But, with the increased oversight and scrutiny, and with so many early adoptions and others well on their way, the need for formal guidance has loomed large. Fortunately, the NCUA recently finalized two long-awaited rules on the CECL transition methodology and capitalization of interest.
NCUA’s Final Rule on the Transition to the CECL Methodology
Under the NCUA’s final rule, FICUs that adopt CECL in fiscal years beginning on or after December 15, 2022, will be eligible, for purposes of determining their net worth classification under the prompt corrective action (PCA) regulations, to phase in the potential day-one adverse effects on regulatory capital over 12 quarters across three years. Credit unions must record a reduction in retained earnings due to the adoption of CECL to be eligible for the transition provision.
According to the NCUA’s final rule, “Consistent with regulations issued by the other federal banking agencies, the final rule will temporarily mitigate the adverse PCA consequences of the day-one capital adjustments, while requiring that FICUs account for CECL for other purposes, such as Call Reports.”
The final rule also allows FICUs with less than $10 million in assets to determine their charges for loan losses using “any reasonable reserve methodology (incurred loss), provided that it adequately covers known and probable loan losses.” The rule also clarifies that “state-chartered FICUs with less than $10 million in assets and that are required by state law to comply with GAAP are eligible for the transition phase-in.”
The Administration recognizes the need for additional guidance in the areas such as Call Reporting based on public comments. The NCUA also states, “The Board will continue to assess the impacts of CECL on regulatory capital and will consider these— and any other future recommendations made by the Department of the Treasury—in taking further action to address the impacts of CECL implementation on the credit union industry.”
NCUA’s Final Rule on Capitalization of Interest in Connection with Loan Workouts and Modifications
“For borrowers experiencing financial hardship, a prudently underwritten and appropriately managed loan modification, consistent with safe and sound lending practices, is generally in the long-term best interest of both the borrower and the FICU. Such modifications may allow a borrower to remain in their home or a commercial borrower to maintain operations and can help FICUs minimize the costs of default and foreclosures. Thus, the prohibition in the May 2012 final rule on the capitalization of interest might be overly burdensome and, in some cases, possibly hamper a FICU’s good-faith efforts to engage in loan workouts with borrowers facing financial difficulty,” stated the NCUA.
The NCUA’s final rule amends previous regulations to provide technical updates, improve clarity, and remove the prohibition on the capitalization of interest in connection with loan workouts and modifications. The NCUA’s final rule applies to workouts of all types of member loans, including commercial and business loans, and only to loan modifications involving the capitalization of interest. In addition, the final rule establishes documentation requirements to address loan workouts and nonaccrual practices “to help ensure that the addition of unpaid interest to the principal balance of a mortgage loan does not hinder the borrower’s ability to become current on the loan.”
The NCUA also voted to affirm the 18% interest rate cap on loans made by federal credit unions for another 18 months. The rate was initially set at 18% in 1987 but, without this latest vote, would have reverted to the 15% per annum standard rate. The 18% interest rate cap will remain in effect through March 10, 2023.
As a Team Leader for ARB’s Credit Union Advisory Services Team, I am actively involved in the industry and committed to helping credit unions understand and stay alert to new and evolving accounting standards. I want to help you create and implement a strategic plan that ensures a smooth transition and ongoing compliance. If you’re ready to talk strategy, contact me today!
Laura Everett is a principal at ARB. She provides accounting, attest, and business advisory services primarily to credit unions, auto dealerships, and buy here/pay here finance companies. As an actively involved member of the credit union industry, Laura specializes in helping credit unions with financial reporting, compliance, and mergers. Her industry expertise includes comprehensive services from financial statement audits, supervisory committee audits, and internal audits to Bank Secrecy Act independent testing, fraud investigations, and other agreed-upon procedures.