Rahul Gupta | Partner, National Professional Standards Group | Grant Thornton LLP
If you have a question about why or how FASB developed CECL, ask the source. Rahul Gupta returned to his post at Grant Thornton in February 2016 after serving as project manager on FASB’s CECL project, where he worked on developing the forthcoming guidance.
So why now, with the banking crisis well behind us, is CECL needed? Why institute change now? And will it be scalable or will a community bank be held to the same standard threshold as a big bank? Mr. Gupta will speak to these issues and others driven by your questions as he leads a CECL Q&A certain to be one of the liveliest and most revealing sessions of the MST 2016 National ALLL Conference.
- Identify your pools. If you can pool assets in a manner that they are really closely linked in terms of credit risk and how the entity manages the credit, you’ll get it right.
- Think about historical losses as it relates to the pool of assets. One way to track is vintage: take all loans from 2002 and track their lives, then 2003, and ongoing, year after year for data gathering. Once you have that historical data, it will be available forever
- Coming up with reasonable and supportable forecast: If you are a small bank and you can only look forward for six months, that’s fine. The guidance doesn’t prescribe a certain period of time to look into the future.
Q. Specific methodologies to be used are left up to the banks and credit unions, auditors and regulators. Was that a conscious decision?
Gupta. Yes. In the earlier proposal the Board had proposed that a method based on discounting the future expected cash flows would be used to calculate allowance, but then the Board decided not to prescribe any specific method. The guidance will allow any method as long as it is reasonable; they went to great lengths to say we’re not prescribing a method. You can tweak your current model to reflect future losses, if that works to come up with a reasonable estimate of credit losses.
Q. What about time intervals for forecasting?
Gupta. The standard doesn’t prescribe a minimum time frame for developing reasonable and supportable forecasts. How long can a forecast be developed for is left up to the entity’s judgement.
Q. Why adopt early and what kind of impact if there’s a wave of early adoptions?
Gupta. The Board generally does not support allowing early adoption because it not only results in noncomparability between various institutions’ financial statements for some period of time, it also confuses the users of the financial statements. The only reason it’s in there is because many institutions with international operations requested that early adoption be allowed so that they can use the processes they have developed for adopting IFRS 9 to adopting the FASB’s credit losses standard.
Q. PCI is moving to PCD – are we still locked into the same pools or do we re-pool?
Gupta. The thought behind PCD was once you buy a loan you gross it up on day one and now it is as good as your others, the only difference being a larger allowance for it because it has seen some deterioration. People will still want to pool PCD differently because their risk profile is different, but there is no requirement to track it separately, just pool it separately so you can create an allowance for that and track those assets.
Q. What data are most important to gather for CECL?
Gupta. Two important things:
- Historical loss information
- Data that would help in appropriate pooling of financial assets.
Get all your data at loan level as your starting point.
Q. Did the FASB think about how much data will be needed, and the implications for financial institutions lacking enough data?
Gupta. They accept that there will be a gradual improvement in the quantity and quality of inputs. It will take 2 – 3 years for an institution to get comfortable in the routine.
Q. Does a loan have a new origination date upon a renewal?
Gupta. Yes. When it is renewed it is a new start except if it is a TDR – because you reassess the borrower’s credit upon renewal.
Q. What is the appropriate look back period for a starting point in calculating allowance for credit losses?
Gupta. It is difficult to provide guidance on the appropriate history and what you should look at. The standard again has left it open for the entity’s judgement. What the guidance intends is that the quality of the loans in your current portfolio on which you are estimating your credit allowance should be similar to the loans that are in your historical period.
Q. Did the Board consider forcing financial institutions to use a discounted cash flow (DCF) model?
Gupta. Early guidance recommended a DCF model but feedback made the Board realize it wasn’t feasible to force you into that. Even in DCF, the way you apply it can be different.
Q. What if a bank doesn’t apply CECL?
Gupta. The Board never sets standards thinking people won’t be able to apply them. The standards are written with the intent that companies will apply them in good faith and therefore the Board intentionally does not put in anti-abuse provisions in GAAP.
Q. How quickly will regulators respond?
Gupta. They will respond as the need arises. In addition remember the FASB has constituted a Transition Resource Group to discuss implementation questions and regulators are part of that group.
Q. What is a practical way to look at economic factors?
Gupta. The guidance is lacking in terms of what kind of adjustments to make. It just tells you to think about those things. You need to document your story, get your process straight.
Q. What are acceptable forecasts?
Gupta. If management believes internal forecasts are more relevant and reliable, then fine. Auditors have to validate how reasonable the forecast is, and if the company uses that forecast to run its business, how can an auditor object? Just document that you are using it.
Q. What is your recommendation for all who have to adopt CECL within the next 6 years?
Gupta. The first step is to start thinking about creating a process of change. Make a list of what you do currently and what in those steps you will have to change. Planning is important, then execute.