Applying CECL in Allowances for Loan and Lease Losses Is Your Credit Union Preparing?
By Dennis Child, Compliance Specialist, TCT Risk Solutions, LLC
In the eyes of many, the upcoming guideline referred to as Current Expected Credit Loss (CECL) hangs over credit unions like the Sword of Damocles. As the Financial Accounting Standards Board (FASB) continues deliberating on the new CECL guidelines, credit union people are left wondering how the changes will impact their organizations. Some “clarification” was issued in 2015. In response to International Accounting Standards Board (IASB) guidance, the Basel Committee on Banking Supervision (BCBS) released what is referred to as a consultative document in early 2015. The consultative document notes that “the objective is intended to set forth supervisory requirements for Expected Credit Losses accounting that do not contradict the accounting standards established by the IASB or the FASB”. We expect more consultative documents in the near future.
The primary fear among credit union professionals is that this guideline will require significant changes in loan-loss modeling and will also result (at least initially) in the need to set aside much larger amounts in credit unions’ Allowance for Loan and Lease Losses (ALLL).
While FASB hasn’t released its final guidance, many credit union professionals are relatively sure on a few points. Recent articles in trade publications report expert’s interpretation of the information issued so far regarding CECL:
- The CECL guideline is anticipated as a significant change from how institutions currently calculate their ALLL, such as requiring credit unions to account for expected credit losses throughout the contractual life of the loan
- Under CECL, credit unions will need to gather and track much more loan data than present and factor this information into their loan-loss modeling. Data they will need to track includes: risk rating by individual loan, loan duration, loan balance, loan charge-offs (and recoveries) as well as individual loan segmentation
- CECL could result in a 30% to 50% increase in ALLL levels for many credit unions.
- Depending on size, credit unions will be phased into compliance with the final tranche implemented by 2019
- A big change in transitioning to CECL is that credit unions will need to consider many factors far and above what is considered presently that typically impact the likelihood of a loan’s repayment schedule. These new factors include “environmental” factors that could impact loan repayments. Furthermore, CECL requires accounting for expected credit losses over the life of the loan
- Another big change is the requirement to perform multiple scenario analyses when determining potential loss rates
- Credit unions will need to perform regular back testing to determine the validity of their lending risk models
Credit unions will be scrambling to find loan loss modeling tools that meet CECL guidelines. Whether they can develop their own or find and implement a model from an outside source, CEOs and boards might find the process daunting.
Credit unions need to accurately and consistently account for the risk in their loan portfolios and make necessary placements to their ALLL according to GAAP on a regular basis. CECL changes how credit unions have been traditionally performing this process.
For years, Dr. Randy Thompson of TCT Risk Solutions, LLC (TCT) has been developing and refining a Credit Migration model with the impending guidelines of CECL in mind. Dr. Thompson’s Credit Migration tool has been heralded among accounting firms as one of few credit risk-management models that already meet the foreseen requirements embedded in CECL. TCT’s Credit Migration tool:
- Adheres to GAAP and other regulatory guidelines
- Provides an integrated process supported by an empirical method for accurately determining amounts to be set aside in the ALLL
- Can be run as frequently as desired
- Has the ability to upload recent credit scores for every loan
- Provides detailed reports broken out by a number of criteria including loan types, credit grades, etc.
- Provides reports that identify loans individually and by loan type where significant credit score digression is taking place
- Identifies problem loans far in advance of traditional loan-delinquency reports
- Has the ability to track credit quality trend lines by loan type and the over-all portfolio which is helpful in determining the effectiveness of loan policy, collection procedures, etc.
- Provides an empirical method to assess trends in a credit union’s market area as well as delinquency/charge-off experience (environmental issues) to run simulations and project possible impacts on loan portfolios and loan losses
- Has the ability to be integrated with a credit union’s other risk management models such as A/LM
- Has a regular back-testing process for the purpose of assessing the validity of the model and determining necessary changes
- Has the ability to identify borrowers whose credit scores are improving so appropriate marketing can be implemented
CECL will have a significant impact on many credit unions in their operations and their profitability. TCT has been at the forefront of preparing for CECL and creating management tools that address its guidelines. As more credit unions are impacted and must meet the requirements imposed as a result of CECL, TCT will be providing training and practical solutions to make the transition easier. Stay tuned.
If you have any questions please contact:
Amy Rapp, Virtual Corps.