When the economy is stable and it’s “business as usual,” it’s reasonable to assume historical experience can be used in estimating future outcomes. Conversely, periods of instability can have a profound impact on things like loan collectability, delinquency, and risk. And 2020 has proven to be anything but a “stable” year.
A plethora of uncertainty exists in today’s economy. We want to provide credit unions with effective solutions for assessing and managing their allowances throughout the current crisis, highlight recent inter-agency guidelines on categorization for COVID-19-related loan modifications, and share recent news of advocacy for the exemption of credit unions from current expected credit losses (CECL).
Following multiple CECL implementation delays and debates on whether non-public entities should be exempt, industry-wide adoption is far from complete. Currently, CECL for credit unions goes into effect on January 1, 2023, meaning, for regulatory reporting purposes, it begins with the March 31, 2023 Call Report.
As a result, the Allowance for Loan and Lease Losses (ALLL) incurred loss method is still widely used across the credit union industry. The full impact COVID-19 will have on the economy isn’t yet known, but, in preparation for potential effects, credit unions should be closely monitoring their loan portfolio performance and identifying areas where qualitative and environmental (Q/E) factors come into play, as well as what tools are helpful as early indicators of economic trends to come.
Qualitative and Environmental Considerations
Q/E factors are those not accounted for in your base loss rate calculation that should be included as direct adjustments to loss rates. On a class/segmentation level, the appropriate adjustment amount is calculated for each factor, and the assumptions used for each adjustment should be well-documented and backed by relevant, data-driven analysis. As Q/E factors are subjective by nature, we want to take a closer look at certain areas where these factors may be identified.
Consider how the state of the economy, general business conditions, and changes to specific market segments have affected your loan portfolio. Look at new and used auto sales, for example, to begin preliminary estimates for your expected auto loan losses. When assessing for a decline in residential homes in terms of collateral, look at new home sales, area trends in home values, as well as the latest industry average data available for commercial loan portfolios collateralized by real estate.
Take a look at local unemployment statistics. Loan payments may be difficult to make for individual members employed within an industry or by a business not deemed essential. If members in your area are experiencing financial hardship due to furloughs, layoffs, and unemployment, an adjustment may be warranted. Concentrations of credit, as well as the effects of changes in the level of concentrations, should be considered.
The way a member chooses to pay their loan can potentially impact your levels of loan delinquency and default. Take a look at the percentage of loans for which your credit union receives payment via direct debit. Members with loan payments set up for direct debit may be less likely to pay late or default on their loans.
Take into account changes in lending policies, and process changes in areas such as underwriting, collection, charge-offs, recovery, or other processes not generally considered in estimating credit losses. Consider internal processes such as the quality of your credit union’s loan review system. And, in examining personnel changes, consider the effects of the level of experience and lending ability and knowledge of management and other remaining staff.
Loan Classification for COVID-19-Related Modifications
The revised interagency statement issued on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus aligns agency regulations with the CARES Act provision granting financial institutions the option to suspend certain U.S. generally accepted accounting principles (U.S. GAAP) requirements related to troubled debt restructurings (TDR) for a limited time.
According to the statement, financial institutions are not required to classify a loan modification as a TDR if the loan was:
- related to COVID-19;
- executed on a loan that was not more than 30 days past due as of December 31, 2019; and
- executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the National Emergency or (B) December 31, 2020 (applicable period).
Additionally, short-term (up to 6 months) modifications, such as payment deferrals, fee waivers, extensions of repayment terms, or insignificant delays in payment made in response to the National Emergency to historically credit-worthy borrowers do not require additional TDR analysis.
The statement also aligns with the CARES Act legislation on the forbearance program for federally-backed mortgage loans and the protection provided to borrowers against negative credit reporting due to National Emergency-related loan accommodations. The agencies assure financial institutions that they have “broad discretion to implement prudent modification programs consistent with the framework included in this statement.” They encourage financial institutions to make “prudent efforts to modify the terms on existing loans to affected customers” and express that the agencies will “not criticize institutions that mitigate credit risk through prudent actions consistent with safe and sound practices.”
Advocacy for CECL Exemption for Credit Unions
NCUA Chairman Rodney Hood sent a letter to FASB Chairman Russell Golden requesting exemption from CECL for credit unions. Hood’s letter asks for an alternative that keeps the general framework established by the incurred loss model. He argues that implementation costs for credit unions to adopt CECL are far greater than the expected benefits. Hood expresses that, while the implementation was delayed, the time afforded by the delay has been focused on crisis management and member needs. He states his concerns on the ability of certain credit unions to collect the necessary data to comply with CECL and strongly requests a permanent exemption for the credit union sector.
The National Association of Federally-Insured Credit Unions (NAFCU) is on board as well. “We applaud Rodney Hood for urging the Financial Accounting Standards Board to exempt credit unions from complying with FASB’s CECL standard. NAFCU has pushed hard for credit unions to be exempt from this onerous and costly accounting standard as it could place significant strains on credit unions’ capital levels, particularly amid the coronavirus pandemic,” stated President and CEO Dan Berger.
Credit Union National Association (CUNA) Chief Advocacy Officer Ryan Donovan is actively advocating the exemption as he works with Congress on Phase 4 legislation. “We appreciate NCUA listening to the case that we’ve made in taking this action, and hope Congress and FASB will follow through as well,” stated Donovan.
ARB’s Credit Union Services Group is dedicated to your industry. We will continue to monitor these developments, and we are available to assist with understanding new standards and creating a plan for implementation and compliance. Contact us for more information, and visit our COVID-19 Financial Resource and Tax Center for additional information on related matters.
by Samantha Pedersen, CPA