The CECL Challenges You Didn't See Coming

In this Q&A, Victor Cecco, CIT Group’s Director of External Reporting, discusses preparations for the current expected credit losses (CECL) standard, key challenges, and CECL’s broader impacts on financial institutions.

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While parts one (Revenue) and two (Leases) in the FASB’s new GAAP were industry agnostic, part three (CECL) is poised to disrupt accounting for financial institutions. Accounting’s most polarizing new standard is drawing scrutiny from Congress and the Federal Reserve. Public companies have disclosed their CECL implementation, and we’re seeing tremendous diversity in practice.

FEI Daily spoke with Victor Cecco, Director of External Reporting for CIT Group Inc about preparations, implementation comparison between CECL and Leases, and CECL’s broader impact on financial institutions.  

FEI Daily: What is CIT doing to prepare for CECL? 

Victor Cecco: We have a formalized project structure with an executive-level steering committee. We are taking a multi-disciplinary approach, so we have representatives from credit modeling, risk management, accounting, systems, tax, and treasury. Just about every discipline that the Company maintains is involved in this project, because it touches on so many different areas. We're working towards a parallel run in advance of the January 1, 2020 effective date that will focus on the technical functionality of the CECL calculation, operational execution of the end-to-end process as well as disclosure requirements.

Like many medium-sized banks, we don't have a team of PhD economists on staff, so we're leveraging a third party’s   forecasting capability and software to help us generate lifecycle loss estimates. Ultimately, we’ll be using a mix of internally and externally developed models. For each portfolio, we are developing a “champion” and “challenger” style model approach.  

FEI Daily: How would you compare the implementation efforts that are going into CECL with those going into ASC 842 (the new lease standard)?

Cecco: Obviously both are very critical implementations for CIT. In addition to nearly seven billion dollars of operating lease assets, we have almost two and a half billion dollars of finance leases. We took a similar type approach to that described above for CECL in implementing ASC 842, but the team was a little bit smaller.

One of the things that we found to be ironic about the 842 implementation is when we first started looking at it two years ago: the buzz on the street was that its main impact would be the disclosure of a right-of-use asset and liability on a company’s balance sheet, but that it would not have too much impact on lessor accounting. For us, we've found that it really did have a big impact on our lessor accounting operationally, the way we disclose pass through property taxes, and in the way that we treat certain initial direct costs; you can’t defer as much under the new 842 model.

So, both standards were consequential for CIT; although CECL is broader. Maybe it's just the way we're organized, but our leasing businesses are centered within our commercial finance business. Conversely, CECL impacts just about every business line that we have.

FEI Daily: What are some of the challenges associated with CECL that no one is talking about?  

Cecco: Like with ASC 842, there is a level of uncertainty with CECL. With ASC 842, the FASB just finalized a vital clarification of the leasing rules in the first quarter of 2019 – after the leasing standard was meant to be implemented. With the CECL standard, the recently issued ASU 2019-04 has a lot of important content, which impacts how we deal with recoveries and assess contract extensions among other things. So, like most preparers I’m sure, we’re going into a time where we'd love to have the rules locked down. It's an interesting time: it’s hard to believe that the CECL implementation is only eight months away.

FEI Daily: How would you characterize the comments from Congress and the Federal Reserve?

Cecco: There is some interesting dialogue that's going on in Congress related to this particular provision and the impact it'll have on the Fannies and the Freddies. They're subject to this, too. So, what will their capital requirements be and who's going to fund those increased capital requirements?

FEI Daily: In April, J.P. Morgan announced that they would probably have to increase reserves by 35% with the implementation of CECL. Do you expect other financial institutions will be similarly impacted?

Cecco: It’s possible – but not many mid-sized banks have disclosed an estimated impact. The impact on any given entity will depend on the tenure of their portfolio (how long lived their loans and other in scope assets are), the credit quality of their portfolio, and – of course – the entity’s outlook regarding where we are in the economic cycle.

FEI Daily: Do you think CECL will negatively impact lending? 

Cecco: During the good times, probably not. When it’s a benign credit cycle, banks will be out there lending. We have heard concerns relating to the concept of estimating a lifecycle loss and having to incorporate economic forecasts, which some studies indicate are not that great at forecasting the depth of a downturn or the timing of the subsequent recovery – as we’ve seen, economic forecasts are imperfect over long horizons.

There is some concern about what will happen when we are in a less benign credit cycle, where the credit cycle is beginning to get to a point where it was in 2008 and 2009. In those cases, models might be forecasting longer recovery periods than what might actually occur. You might have a contraction in lending during that time. Will this force banks to be counter-cyclical?

FEI Daily: How do you think CECL will impact comparability among banks? 

Cecco: From a macroeconomic standpoint, you're going to have a lot of variety in practice. CIT is a mid-sized bank, so how are our models going to differ from a J.P. Morgan Chase, Goldman Sachs, or Citi? How will we look in terms of our view of a reasonable and supportable forecast period? How will that be the same as or different to a Citi or to a smaller banker? For example, how is that community bank down the block going to be applying CECL?

Additionally, CECL is a principles-based standard; that impacts comparability in terms of people's economic outlook, timing of peaks and troughs in a cycle, what preparers think they have in terms of a reasonable and supportable period, and on top of that, when and how entities choose to revert to historical loss rates. There are a number of different options there. So, that is something that we see, not so much a challenge for CIT as an individual bank, but for the industry as a whole. I suspect over time that we'll all sort of gravitate towards a mean, but how long will that take?