Current Expected Credit Loss (CECL)
CECL is an Accounting Standards Update (ASU) introduced by the Financial Accounting Standards Board (FASB) in June 2016. The ASU affects the method of accounting for expected credit losses for any business issuing credit, including credit unions.
Why the change? The current accounting requirements for the Allowance for Loan and Lease Loss (ALLL) is based on historical data and known losses in the portfolio. The new standard will incorporate anticipated losses, meaning an allowance will be reported on the first day a loan is disbursed. According to the FASB, “In the lead-up to the financial crisis, financial statement users were making estimates of expected credit losses using forward-looking information and devaluing financial institutions before accounting losses were recognized. This highlighted that the information needs of users differ from what GAAP requires.”
Extension of CECL Implementation
When the CECL method was initially introduced, the FASB outlined a timeline for implementation, but after comments from the industry, the FASB realized additional time was needed to analyze the standard and review calculation options, thus adjusting the implementation date.
On July 17, 2019, the FASB again voted to propose a delay for the implementation of CECL until January 2023 for nonpublic financial institutions. Based on this proposal, CECL implementation for credit unions will apply to fiscal years beginning after December 15, 2022, and for interim periods within fiscal years beginning after December 15, 2023. For a calendar year credit union, the proposed effective date will be January 1, 2023.
Many had hoped nonpublic companies would be exempted from the CECL requirements, but, when listening to the discussions from the FASB board meetings, there is no indication that will happen. While the implementation extension is certainly a positive development for credit unions, it doesn’t extend the need for your credit union to be moving forward with your CECL implementation plan.
Preparing for CECL
Be in the know: Stay in contact with your CPA, and expect updates on changes in accounting guidance that may arise as the new requirements are implemented. Understand the historical data available, determine if you will use a purchased software product for the calculation or use an internally developed spreadsheet, and also evaluate which of the methodologies available is the right choice for a credit union of your size. Models can take either a macro view (i.e. loan pools) or micro view (i.e. individual loans). Static Pool and Vintage Pool Methods are macro views that analyze losses and recoveries over time and can incorporate analysis of the unique characteristics of the pools (e.g. original credit score or loan to value). Another macro method, the Roll-Rate Method, estimates when a pool will roll from one delinquency group to another without incorporating any economic factors. Using a micro view, the Discounted Cash Flow and Probability of Default Methods analyze loans using economic factors to create loss projections and can incorporate prepayment predictions and probability of default. These methods also increase accuracy, but they require an incredible level of attention to detail and utilize software for the calculations. Note that the more simplistic calculations might result in greater deviations from actual losses, which may indicate the model isn’t accurately assessing the losses inherent in the portfolio.
Don’t wait; gather data early: Your financial statements and loan portfolio are in new territory. Loans will need to be pooled and classified differently, new risk assessment methodologies will need to be adopted, and testing, tweaking, and streamlining will certainly follow.
Understand your technology, personnel, and software capabilities in accessing newly required historical data, and determine if your credit union will require CECL-specific software. Applying the new methodology to the current portfolio in advance of the implementation date will help you determine if changes need to be made to best represent the estimated allowance in advance of actual CECL implementation.
Don’t go through it alone: CECL is a complex adoption. Every credit union faces challenges that won’t have one-size-fits-all solutions. Seek professional assistance in making a plan and guidance for successfully navigating the changeover and future compliance.
The professionals at Albin, Randall & Bennett are credit union industry leaders here to help you through the CECL adoption process. We are available to assist with understanding the new standards, staying alert to accounting changes, and creating a plan for implementation and compliance. If you haven’t started evaluating the standards, contact us to discuss a strategy for getting started.