Potential Quantitative Impact of CECL on Banks: Learning from IFRS 9
Potential Quantitative Impact of CECL on Banks: Learning from IFRS 9

Potential Quantitative Impact of CECL on Banks: Learning from IFRS 9

Both the International Financial Reporting Standards (IFRS) and U.S. GAAP have shifted towards expected credit loss models for financial instruments. While the IFRS impairment model (IFRS 9) has differences when contrasted with U.S. GAAP’s current expected credit losses impairment model (CECL), the intent of both models is similar. At the end of the day, both IFRS and U.S. GAAP aim to reflect, on the balance sheet, the net amount of the asset the entity expects to receive. This net amount is achieved by offsetting the financial asset with an allowance for expected credit losses. The impairment model under IFRS standards, IFRS 9, had a much earlier effective date than the U.S. GAAP model, CECL; IFRS 9 was effective January 1, 2018, while the first required effective date for the CECL model is for years beginning after December 15, 2019. Luckily for CECL adopters, there is valuable information U.S. GAAP entities can glean from the implementation challenges observed by IFRS entities.

IFRS 9 vs. CECL

Like I mentioned above, the intent of the impairment models is the same, but let’s take a high-level look.

Both models share the same:

  • Intent: To reflect the actual amount of the asset the entity expects to receive via the use of an allowance 
  • Recognition: A loss allowance is established based on the calculated estimate, with the offsetting entry via net income
  • Unit of Account: Entities are required to evaluate assets on a pool basis when assets share similar risk characteristics. When an asset does not share a similar risk characteristic, the entity is required to evaluate the asset individually.
  • Methodology: No required methodology to measure expected credit losses is required by either standard
  • Estimate Considerations: Require the consideration of past events, current conditions, and reasonable and supportable forecasts of the future when developing an estimate of expected credit losses

Where the two models have the ability to differ significantly relates to the estimate at inception;  under IFRS, typically only a portion of the lifetime expected credit losses is initially recognized whereas under U.S. GAAP, lifetime expected credit losses is required to be recognized.

U.S. GAAP: The U.S. GAAP credit loss model requires entities to utilize an allowance for credit losses to reflect lifetime expected credit losses on in-scope financial assets. At the time of asset origination or acquisition, the entity must estimate lifetime losses and recognize these losses via the establishment of a loss allowance, with the offsetting entry via net income.

IFRS 9: Under IFRS 9, there is a three-stage approach for recognizing credit losses. Typically, entities are only required to recognize the portion of lifetime expected credit losses that represents the expected credit losses that result from default events that are possible within the twelve months after the reporting date (i.e., 12-month expected credit losses). Recognition shifts to be lifetime expected credit loss for all possible default events over the expected life of the financial instrument only when there is an increase in the credit risk.

  • Stage 1: As soon as the financial instrument is originated or purchased, 12-month expected credit losses are recognized by establishing a loss allowance, with the offsetting entry via net income.
  • Stage 2: If the credit risk increases significantly and is not considered to be low credit risk, the full lifetime expected credit losses are recognized via the loss allowance (again, with the offsetting entry via net income).
  • Stage 3: This final stage is when the financial asset is deemed to be impaired and the asset is individually assessed to determine lifetime expected credit losses.

We’d be remiss to not mention that differences also exist between the IFRS 9 and CECL models related to instruments that have experienced credit deterioration since origination. You can read more about those differences in an article dedicated solely to that topic – Credit-Impaired Differences Between U.S. GAAP and IFRS.

Although U.S. GAAP entities will estimate lifetime losses at implementation, while IFRS entities were required to recognize only a 12-month expected credit loss at implementation unless there was significant increase in credit risk, U.S. GAAP entities can still look to IFRS entities for anticipated implementation effects.  

Quantitative Implementation Impacts

Estimates of the quantitative impacts of the CECL model have been all over the charts. Early estimates in 2011 indicated 30-50% increases in the ALLL. In September 2015, KBW’s prediction for small and mid-sized banks was a median increase of approximately 3%. Regardless of the size of the entity, an estimated range of 3% to 50% is pretty scary to think about! The GAAP Dynamics team’s curiosity grew, as we had not heard any predictions recently, so we looked to our neighbors around the globe to discover the effects they were seeing on the income statement from implementing IFRS 9.

Many of the large IFRS 9 financial institutions published implementation guides or included expanded details in their interim financial statements to explain to users the effects of the new standards. We used the figures in those guides and statements to arrive at implementation effects listed below for a sample of 10 financial institutions that implemented IFRS 9 as of January 1, 2018: 

As you can see from above, the implementation effects for the entities sampled reflected an increase ranging from 8% - 58%! That is quite the spread! Furthermore, U.S. GAAP entities must keep in mind that the implementation of CECL is anticipated to have an even larger quantitative effect than IFRS 9, since the CECL model requires recognition of lifetime expected credit losses at inception or acquisition. Factors that influence the range of the impact include the size of the financial institution, portfolio mix, institution asset quality, and management judgment.

While the first quantitative effects of CECL implementation are not anticipated to be seen until 2019 10-K’s are published, hopefully this post has provided you with some insight into the effects of IFRS 9 implementation. (Don’t forget, SEC issuers will need to disclose the quantitative effects of CECL as part of their SAB 74 disclosures!)

Confused about CECL? Have a question on a different aspect of CECL or IFRS 9? We’d love to help! GAAP Dynamics offers courses on the CECL model as well as IFRS 9 across a variety of delivery methods.

Disclaimer  

This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.

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