CECL – It’s coming and how to prepare
In June of 2016 the Financial Accounting Standards Board (FASB) finally issued its pronouncement on the Current Expected Credit Loss (CECL). Although this pronouncement does not go into effect until the year 2021 this is not something you should put on the back burner. CECL is going to take time and planning in order to implement it correctly. The allowance for loan loss account (ALL) is not just going to be the responsibility of the CEO, it is going to rely on the entire management team.
The current ALL model is an incurred loss model in which you recognize the loss when it is probable that you will take the loss. According to CECL, you will record the expected credit loss based on forecasted information. FASB does not expect that the credit union will forecast over the entire life of the loan, instead, only for two or three years. For the remaining life of the loan, the credit union will be allowed to revert to historical loss information.
Data is going to the most important part of this conversion. How much and the type of data you collect is going to determine what model you are able to use. The more data that you can collect the more flexibility you are going to have in that choice. This is going to take help from your data processer to make sure that they can store the data you need and for the duration that you will need it. You will also want to have access to this data quickly and in a form that you can use.
Things you can do today to prepare for the implementation of CECL. Review your loan portfolios, looking to understand the structure of the loan not just the loan type. Have an open mind and a willingness for change. Find observable points (credit scores every year, unemployment rates, delinquent rates of similar borrowers, LTV data, housing market) some outside force that helps explain your loan portfolios and how they react to this force.
This pronouncement is not all bad. One thing that FASB has allowed: the initial adjustment to the ALL will be made through retained earnings. This means that you do not need to increase your ALL account now to prepare for CECL. The second thing that FASB has allowed is flexibility, not only in the choice of what model you may want to use, but in how you use it. You are also not required to use the same model for each pool. For example: auto loan and mortgage loans do not have to be calculated the same way.