Pub. 7 2018 Issue 4

June2018 21 l e a d i n g a d v o c a t e f o r t h e b a n k i n g i n d u s t r y i n k a n s a s O N APRIL 13, 2018, THE OFFICE OF THE Comptroller of the Currency, Federal Reserve System and Federal Deposit Insurance Corporation issued a joint proposal to revise regulatory capital rules in anticipation of the adoption of Accounting Standards Update (ASU) 2016-13, Financial Instruments—Credit Losses (Topic 326), which includes the implementation of the current expected credit losses (CECL) methodology. ASU 2016-13 is effective for public business entities (PBE) for fiscal years beginning after December 15, 2019, and effective for non-PBEs for fiscal years beginning after December 15, 2020. Under this proposal, the allowance for credit losses (ACL) methodology replaces the allowance for loan and lease losses (ALLL) methodology. ACL expands the required credit loss allowance beyond finance receivables to also include allowances related to held- to-maturity debt securities and certain off-balance-sheet credit exposures, as determined in accordance with generally accepted accounting principles. Adoption is expected to affect retained earnings, deferred tax assets and liabilities and the credit loss allowance. The adjustment for this adoption, which will be the difference (if any) between the allowance calculated by the ALLL and ACL methodologies, has previously been expected to only be recorded as a one-time entry on the first day of an institution’s fiscal year of adoption. While early adoption for non-PBEs is permissible, regulators have clarified institutions must consider CECL’s adoption to be a future event, and institutions aren’t allowed to build reserves for CECL prior to adoption. While this one-time adjustment to capital wouldn’t affect earnings in the year of adoption, both tier one and tier two regulatory capital ratios likely will be affected, and the revised ratios would be effective for the first regulatory reporting period after the adoption date. In addition, since the standard will be effective at the beginning of the fiscal year of adoption, a full year of provision using ACL methodology also will be recorded in the year of adoption. This proposal allows institutions the option to record the entire adjustment on the first day of adoption or phase in the regulatory capital effects of the adoption over a three-year period. This option only would be available during the first regulatory reporting period in the year of adoption. The intention of this option is to mitigate concerns regarding the uncertainty of capital planning, including planning for economic conditions at the time of implementation. Institutions would estimate CECL adoption’s day-one effect on retained earnings, deferred tax assets and liabilities, and ACL, and would then record a portion of that effect each year over a three-year transition period. This phase-in would slow implementation’s effects on tier one and tier two capital and the effect on the amount of average total consolidated assets for purposes of calculating the tier one leverage ratio. The proposal includes an illustration of the phase-in mechanics and considerations for how it would be handled in business combinations. The proposal also addresses additional requirements for advanced approaches for banking organizations. For more information, see the proposal’s press release. Contact Jason Seaton, Michael Flaxbeard or your trusted BKD advisor if you have questions. Jason is a Senior Manager with BKD working with finan- cial institutions on CECL implementa- tions, audits, internal controls, directors examinations, and trust procedures. PROPOSED REGULATORY CAPITAL PHASE-IN ON CECL By Jason Seaton