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Pending Accounting Standards Updates
 9 Months Ended
Sep. 30, 2022
Accounting Standards Update and Change in Accounting Principle [Abstract]  
Pending Accounting Standards Updates Accounting Standards Updates
Pending
ASU No. 2016-13: “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”, as amended
In June 2016, ASU No. 2016-13 was issued and updated the measurement for credit losses for AFS debt securities and assets measured at amortized cost which include loans, trade receivables, and any other financial assets with the contractual right to receive cash. Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. Under the incurred loss approach, entities are limited to a probable initial recognition threshold when credit losses are measured; an entity generally only considers past events and current conditions in measuring the incurred loss.
Under the new guidance, the incurred loss impairment methodology is replaced with a methodology that reflects current expected credit losses (CECL). This methodology requires consideration of a broader range of reasonable and supportable information to calculate credit loss estimates. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances which applies to assets measured either collectively or individually.
The update allows an entity to revert to historical loss information that is reflective of the contractual term (considering the effect of prepayments) for periods that are beyond the time frame for which the entity is able to develop reasonable and supportable forecasts. In addition, the disclosures of credit quality indicators in relation to the amortized cost of financing receivables, a current disclosure requirement, are further disaggregated by year of origination (or vintage). The vintage information will be useful for financial statement users to better assess changes in underwriting standards and credit quality trends in asset portfolios over time and the effect of those changes on credit losses.
Overall, the update will allow entities the ability to measure expected credit losses without the restriction of incurred or probable losses that exist under current GAAP. For users of the financial statements, the update requires disclosure of decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The new authoritative guidance was originally effective for interim and annual periods beginning after December 15, 2019. Effective October 16, 2019, the FASB approved and issued changes to the implementation date of this guidance for some filers. As a smaller reporting company, as defined by the SEC, our implementation date was delayed from January 1, 2020 to January 1, 2023. Early adoption continues to be permissible under the revised implementation date.
Since 2016, we have invested a considerable amount of effort toward this guidance. An internal committee was formed and is accountable for timely and accurate adoption of the guidance. A service provider that has focused on the ALLL for more than 10 years and serves hundreds of financial institutions was engaged to provide us with education, advisory, and a software solution exclusively related to the ACL. We run parallel processes to ensure we are ready to calculate, review, and report the ACL by the required implementation date.
Our CECL implementation efforts continue to focus on model validation, developing new disclosures, establishing formal policies and procedures and control documentation. Based on our loan balances and forecasted economic conditions as of September 30, 2022, management believes the adoption of CECL could result in an increase in the current reserves of approximately 20% to 40%, as compared to our current reserve levels as of September 30, 2022. The estimated increase in reserves is driven by the guidance changes, which requires us to reserve based on expected credit losses over the expected life of the loan and also considers reasonable and supportable forecasts of expected future economic conditions.
This preliminary estimate is contingent upon continued testing and refinement of the model. The actual impact of the adoption will be dependent upon the loan portfolio size and composition, credit quality, and economic conditions and forecasts at the time of adoption. We will continue to evaluate and refine the results of our loss estimates through the end of 2022. Additionally, we will continue to run parallel calculations during the remainder of 2022.
Upon adoption on January 1, 2023, we will record a cumulative-effect adjustment to retained earnings for the change in ACL. While not expected to be material, the impact of the adoption of CECL will also affect our regulatory capital and other asset quality ratios.