Unwinding the COVID-19 Concessions for ‘Secret CECL’

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Michael S. Edwards Photo

5 minutes

Most credit unions will feel the effects of CECL whether they have adopted it or not.

It has been nearly two years since the beginning of the COVID-19 pandemic. While concerns about new variants continue to make the news, American society seems to have progressed to a point of weariness with the pandemic and the continuing and still-changing restrictions by various levels of government.

In what may be an indication that the pandemic will soon be over, the National Credit Union Administration and the federal banking regulatory agencies are starting to roll back their COVID-related regulatory relief, which will change the compliance situation for credit unions. Get ready for the great sorting out of credit unions’ allowances for loan and lease losses as well as supervisory actions premised on US generally accepted accounting principles’ current expected credit losses—even if your credit union has not adopted it yet.

On Nov. 10, 2021, NCUA and the federal banking agencies issued a Joint Statement on Supervisory and Enforcement Practices Regarding the Mortgage Servicing Rules in Response of the Continuing COVID-19 Pandemic and the CARES Act. The substance of this issuance is to withdraw the same agencies’ related April 2020 joint statement to return the mortgage servicing rules to their pre-pandemic status. One practical effect of this issuance is that credit unions and other mortgage servicers must return to rigid adherence to the Consumer Financial Protection Bureau’s pre-pandemic loss mitigation procedures regulation. Financial institutions’ leeway to do workouts will be much more limited.

A potentially more impactful effect, however, is that some mortgages that would likely have qualified for a workout previously will now go into default. This might result in an increase in loan and lease loss provisioning as well as more foreclosures. There will also likely be more Chapter 13 bankruptcies if three conditions occur: (a) debtors do not sell their houses; (b) the houses still have equity even with the arrearage; and (c) the amount of the arrearage and other priority claims can likely be paid-off by the debtor, within his or her means, in five years or less through the bankruptcy process.

Most credit unions will feel the effects of CECL during this process whether they have adopted CECL or not. Supervisory actions will likely be based, at least in part, on what the credit union’s capital position would look like under CECL even if CECL does not apply officially. Under GAAP, the primary difference between having adopted CECL and not having adopted CECL will be one of timing: whether these credit losses will be estimated early (as is the case with CECL) or whether one waits to recognize the loss until it is incurred, even though you can see it coming.

NCUA and other regulators already have the call report data necessary to perform their own CECL calculations and determine a credit union’s likely financial position based on its economic fundamentals. This could very well be occurring—even if the law and US GAAP technically dictate another methodology. This is because the CECL “fix” advocated by the industry trade associations of the Financial Accounting Standard Board delaying credit union CECL compliance until January 2023 is more a product of political gladhanding than the result of well-informed financial technical discussions with the regulators. Therefore, the fix is not valid from a regulatory perspective.

In fact, the fix may be being ignored to the maximum extent possible by regulators in the real world. While delays should work on paper, it doesn’t work in practice. Your credit union therefore likely has a shadow net worth ratio calculation based on what your net worth ratio likely would be under CECL. This shadow ratio using CECL could be the one that NCUA uses for supervisory purposes.

In the opinion of this writer, three main factors are behind the timing of the move by NCUA and the other agencies to withdraw the April 2020 Joint Statement in November 2021: (1) the pandemic seems to be entering its final phase, but even if it is not, the current societal zeitgeist seems to want to get back to business and move on; (2) NCUA and the federal banking regulatory agencies already likely know which financial institutions will be in trouble once the loans in forbearance become due, whether or not those institutions use CECL; and (3) housing prices and stock market values remain high, meaning that financial institutions seeking to foreclose or collect on delinquent mortgages now have higher value assets to seek recourse against than may be the case in the future.

In other words, NCUA has likely shadow-adopted CECL for your credit union already. NCUA and state regulatory agencies are likely taking supervisory actions based on those CECL-based analyses. Even if you still think that your credit union has until January 2023 to take up CECL, you are likely being regulated as though CECL were already in effect. Everyone in government, however, will probably pretend that that is not so, which deprives your credit union of the chance to discuss things properly with your regulator.

Going along to get along is hard when you are not allowed to discuss why we must go there. Knowing that you are already likely subject to CECL should help you understand your examiners’ thinking when they come to visit. This knowledge should also help you figure out what to do with your loan portfolio before that next visit comes.

Michael S. Edwards is an attorney-at-law with extensive experience representing credit unions, community banks and credit union organizations in the United States and around the world on a wide range of regulatory, compliance and other legal matters. Now with his own law firm based in the Washington, D.C., area, Edwards previously served as SVP/advocacy and general counsel of the World Council of Credit Unions and was senior assistant general counsel in the regulatory advocacy section of the Credit Union National Association.

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