How Might CECL Affect Your Credit Union’s Finances?
By Dennis Child, Research Specialist, TCT Risk Solutions, LLC
After a year of delays, the Financial Accounting Standards Board (FASB) is expected to release the final standard of the Current Expected Credit Loss (CECL) model in the first half of 2016. Whether this standard will actually be released in this time frame is yet to be seen. Hopefully, the final standards will answer the many questions swirling around in the credit union industry regarding CECL. Last month, in this publication, Dollars & Sense, I described those issues that I think (at this date) are most likely to affect credit unions as a result of CECL. The CECL model is a change in guidance for the allowance for loan and lease losses (ALLL) that will include (among other provisions) forward looking requirements, a longer loss horizon and removal of “probable loss”. Credit unions will most likely be required to implement CECL standards by 2020. This deadline is only four years out and hardly any credit unions have begun to prepare.
CECL guidance is not prescriptive as to the specific model that should be used to meet the standards it sets forth. Many in the financial industry are looking at three methods in particular: credit migration analysis, vintage analysis and probability of default/loss given default (PD/LGB). There is not space in this column to describe each. Suffice it to say that we at TCT believe through experience and research that Credit Migration Analysis is the most useful and beneficial method for credit unions.
CECL is being heralded by FASB as a proper method for accounting for potential loan losses because it best reflects credit risks in institutions’ balance sheets and therefor is of benefit to investors. What regulators seem to be ignoring is that for credit unions and financial non-profits, there are no stock-holders in the traditional sense. This leaves us to speculate that maybe credit unions are being included in this standard to benefit the National Credit Union Share Insurance Fund and to bring all federally regulated financial institutions to some level of regulatory parity. Never-the-less, credit unions will need to consider how CECL will impact their balance sheets and prepare accordingly.
Even though the final draft of CECL standards for credit unions is pending, this author believes that credit unions need to give consideration at least to the following issues that could impact their financials:
The need to gather and accumulate different and more data than present
Depending on the type of ALLL forecasting being used presently and the model a credit union chooses to use under CECL, there is a good chance that more data will need to be gathered and stored. Depending on a number of factors, this expansion in data gathering will increase DP costs.
The need to train staff, board, and auditors in how the new loan loss model works
As far reaching as CECL requirements might be, extensive training will need to take place in all levels of management. A credit union may choose to send one staff member for training who will then be responsible for training others in the credit union. Or, a credit union may find it more advantageous to contract outside trainers to bring all affected personnel up to speed at once. Whichever option chosen, there will be additional expenses.
Purchasing or developing a CECL compliant loan loss model
Unless a credit union already has a CECL compliant loan loss model in place, finding, purchasing and implementing such a model could be expensive. It would be advisable for credit unions to have some idea of the potential cost of a compliant system well in advance of the implementation date for CECL standards.
Running parallel loan loss models in advance of the final CECL implementation deadline
Many advisors are suggesting credit unions may find it advantageous to run their present loan loss forecasting model parallel with the CECL compliant system they plan to use before the actual date they must switch to a CECL system entirely. In this way, they will have some idea of the impact the CECL complaint system will have on their operations and profitability. Of course, running two systems will add to expenses – at least in the short term. Running parallel systems will also give credit unions some idea of what is driving risk in their loan portfolios.
The potential for needing to set aside more initially in ALLL once CECL is implemented
Information on CECL released to date indicates that if a credit union needs a one-time increase in ALLL required due to the implementation of CECL, it can take place from capital (Undivided Earnings). Depending on final information from NCUA, this deduction from capital will need to be made up at some point to assure a credit union’s capital meets minimal requirements. Affected credit unions will need to plan how they will boost profitability to rebuild any capital shortfalls.
CECL is projected by many financial experts to be one of the most impactful regulations to be issued to financial institutions in over a generation. Preparation is key. As soon as a final CECL standards are available, credit unions should begin to address and prepare for the impacts CECL will have on growth and profitability.
It is noteworthy that TCT Risk Solutions, LLC is one of few management tool providers to have a Credit Migration system available that many CPA firms project will meet CECL standards.