The current expected credit loss (CECL) model requires financial institutions to overhaul many aspects of their accounting for the allowance for loan and lease losses (ALLL), including the essential shift to estimating losses for the lifetime of loans rather than on an incurred-loss basis. As a result of these changes, financial institutions’ disclosures to investors and other financial statement users will also need to be modified.
Some banking industry leaders expect ALLL disclosures will become increasingly important under CECL. In a discussion paper, the American Bankers Association said:
The measurement of credit losses under CECL is assumed to be highly judgmental, adding significant subjectivity to what is already experienced with current accounting. Thus, the comparability of credit loss estimates between banks – a key aspect of analysis conducted by investors, analysts, and bankers – should significantly decline over the foreseeable future. As a result, the importance of disclosure will be magnified under CECL.
Whether disclosures will become more important remains unclear, but companies have been actively working to implement new disclosures, and the SEC has been monitoring implementation and helping companies and auditors learn more about CECL disclosures.
Other subject matter experts have also provided guidance on their expectations for CECL disclosures. Dorsey Baskin, an independent consultant to Abrigo, and Rahul Gupta, an Abrigo contributor and a Partner in the National Professional Standards Group of Grant Thornton, recently described nine of the top ways that typical ALLL disclosures will need to be modified under CECL. In Abrigo’s whitepaper, “CECL Modifications of Typical ALLL Disclosures,” Baskin and Gupta also provided sample wording and tables, along with notations and advice on specific challenge areas.
Here are five top CECL modifications Baskin and Gupta expect of typical ALLL disclosures:
- Terminology. It has changed. One example is that the disclosures will no longer speak of “impaired loans” but of expected credit losses for all loans and held-to-maturity debt securities, the authors said. “So, for example, disclosures that currently talk about triggers for impairment measurement and loss accrual would no longer be appropriate.” Another example? The ALLL is now called the allowance for credit losses (ACL), and the provision for loan and lease losses is now called the expense for credit loss. “These and many other terminology changes reflecting the new accounting standard need to be considered in all disclosures,” according to Baskin and Gupta.
- Debt securities. Under CECL, all debt securities will now be treated under an allowance model. As a result, financial institutions have new requirements to provide related disclosures to the allowance for credit losses on debt securities.
- Cut, kept, added. Some disclosures, such as those for identified impaired loans, went away. Others were retained, including those for troubled debt restructured loans. The Financial Accounting Standards Board (FASB) added some, such as vintage information about the loan portfolio.
- Purchased loans disclosures. Along with the change in accounting for purchased credit impaired loans to purchased deteriorated loans, the requirement related to initial disclosures about purchased loans has changed.
- Uncertainty and future changes. Baskin and Gupta say that disclosures about both the uncertainty in the current ACL estimate and the likelihood of future changes in the ACL may be more important than they are with the incurred loss allowance. They cite two reasons:
a. The ACL for expected future losses should be capturing future losses for the existing loan portfolio. “Explaining the substantial uncertainties in the estimation and, even, quantifying such uncertainties, may help lay the groundwork for explanations of changes over time that are based on new information,” the authors say.
b. Since the ACL level will fluctuate with expectations about future economic conditions and how they impact expected collections and losses, it may be critical to explain why, how, and how much changes in those expectations resulted in changes to the ACL. This is important so that financial statement users understand the adjustments and have confidence in management.
To see additional ways that disclosures are expected to change under CECL and to see sample disclosures along with notes explaining the CECL guidance related to disclosures, download the Abrigo whitepaper, “CECL Modification of Typical ALLL Disclosures.”
A companion document from Abrigo, “Loan, Debt Security, and ACL Disclosures Required by CECL,” contains disclosure requirements and related disclosure guidance copied from ASU 2016-13. It can be downloaded here.