By Nicole D. Prysby, J.D.
The paper concludes that the Enterprises are well-prepared for the current expected credit loss transition, although the initial impact could result in a net worth deficit for the quarter.
The Federal Housing Finance Agency Office of Inspector General issued a white paper discussing the background of the current expected credit loss (CECL) methodology and its potential impact on the Fannie Mae and Freddie Mac (the Enterprises) and the Federal Home Loan Banks (FHLBanks). According to the paper, the Enterprises are "well-prepared" for the transition to the CECL methodology on Jan. 1, 2020, and the FHFA does not expect that the impact of application of the CECL methodology will be material to the FHLBanks. However, the Enterprises reported that they may experience increased loan loss reserve volatility and increased earnings volatility after implementation of the CECL methodology, and Fannie Mae estimates the initial impact of CECL to be up to $4 billion, which could result in a net worth deficit for the quarter.
In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2016-13, requiring a substantial change in how certain organizations, including the Enterprises and the FHLBanks, must record credit losses in their financial statements. Specifically, FASB announced that the CECL methodology would replace the "incurred loss" methodology for calculating expected losses on covered assets. The CECL methodology requires covered organizations to establish reserves for expected losses on assets at the time that such assets are created or acquired. The regulated entities are required to adopt the CECL methodology as of Jan. 1, 2020.
Officials from both Enterprises stated that they intend to run parallel processes for the incurred loss and CECL methodologies. While the Enterprises will continue to report financial results using the incurred loss methodology through year-end 2019, they intend to run models and processes for CECL as well to test them before adoption. For the Enterprises, the impact of application of the CECL methodology will come predominantly from single-family mortgages they have purchased. Freddie Mac reported that it did not expect the implementation of CECL to require it to request a draw from Treasury due to a deficit. Fannie Mae reported that it estimated the initial impact of CECL on its retained earnings to be up to $4 billion on an after-tax basis, which could result in a net worth deficit (and a draw) for the quarter. Both Enterprises reported that they may experience increased loan loss reserve volatility and increased earnings volatility after implementation of the CECL methodology.
The FHLBanks have been focusing on the accounting methodology and operationally readiness for CECL since 2017. Their efforts included the development of new models. For example, the FHLBanks needed to revise their credit loss models to factor in lifetime losses. The FHLBanks were scheduled to implement those models and perform test runs in 2019. The FHLBanks will conduct parallel runs of their CECL processes in the third and fourth quarters of 2019. The FHFA reported that, in its view, the impact and credit exposure from the implementation of the CECL methodology on the FHLBanks will be much lower than for other financial institutions. As of their second quarter 2019, no FHLBank had yet publicly quantified the total expected initial credit losses from implementing CECL. However, seven FHLBanks disclosed that they do not anticipate implementation of CECL will have a material effect on their financial condition.
The FHFA has not issued formal guidance to the Enterprises or FHLBanks regarding CECL. Agency officials explained that they consider the FHFA’s current supervisory approach to be more valuable than issuing high-level guidance for adopting CECL.
Companies: Fannie Mae; Freddie Mac
MainStory: TopStory BankingOperations GovernmentSponsoredEnterprises Loans
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