Prepare Now for CECL
By Dennis Child, Research Specialist, TCT Risk Solutions, LLC
The Federal Accounting Standards Board (FASB) issued in the past few weeks some clarification regarding Current Expected Credit Losses (CECL) standards. First, we in the credit union industry can look forward to a final draft of standards in June. Second, the compliance deadline for credit unions has been delayed by a year to December 2020 (all affected organizations can adopt the new standards beginning after December 2018 if they choose). Third, the Board decided to scale back on some requirements regarding how financial institutions disclose credit quality indicators by year of origination.
CECL rules are expected to change fundamentally how credit unions, banks and other financial institutions calculate their credit loss reserves. CECL is expected to alter credit operations as well. CECL encourages financial institutions to take a “forward-looking” approach to loan instruments and recognize possible credit losses earlier. CECL will apply to loan commitments, financial guarantee contracts, reinsurance receivables, leases, trade receivables, as well as debt instruments.
CECL is expected to be one of the most extensive regulatory changes affecting debt instruments to be implemented in over 30 years. The near collapse of the financial industry and the “Great Recession” of 2008 highlighted the need for timelier reporting of credit losses. Current Generally Accepted Accounting Principles (GAAP) reflects credit weaknesses using an “incurred loss” approach, which requires recognition of a credit loss to be deferred until the loss is probable (or actually incurred). Thus, there were concerns the incurred loss approach failed to alert investors about credit losses in a timely enough manner. As noted, CECL takes a forward looking approach to reporting, and reserving for, credit losses. Even though credit unions do not have “investors” in the traditional sense, they are still expected to adhere to CECL standards.
FASB is responsible for determining the final standards to be included in CECL. FASB was established in 1973. It is an independent, not-for-profit organization that establishes financial accounting and reporting standards for public and private companies and not-for-profit organizations (including credit unions) that follow GAAP. FASB is recognized by the Securities and Exchange Commission as the designated accounting standard setter for public companies. FASB standards are considered authoritative by many organizations including Boards of Accountancy and the American Institute of CPAs. FASB develops and issues financial accounting standards intended to promote financial reporting that provides useful information to investors and others who use financial reports. The Financial Accounting Foundation oversees FASB. For more information on FASB, visit www.fasb.org.
Surveys show that fewer than 25% of financial institutions including credit unions have even begun to prepare for CECL. Opinions as to the impact CECL will have on credit unions vary from “non-event” to disastrous. The actual impact will depend on how well a credit union is prepared for CECL. This author recommends that at the very least credit unions should by the end of 2016:
- Line up systems with the ability to amass the data that will be required for CECL, including (by individual loan): risk ratings, loan duration's, loan write-offs and recoveries and loan segmentation's. These data points will help a credit union create models for calculating and reporting expected loan losses.
- Form a CECL specialty committee comprised of the CEO and CFO as well as others who have an understanding of A/LM, loan operations, IT, budgeting and forecasting. This committee should meet at least quarterly. Assign at least one committee member to be the CECL “specialist” who reports to the committee. Committee members should make recommendations as appropriate regarding planning and preparing for CECL.
- Prepare for the changes to IT that CECL will require and the additional expenses that are likely.
- Look into Credit Migration models that are compliant with CECL standards. As recommended previously, credit unions should consider running parallel loan loss models (a CECL compliant model vs their present incurred loss model) to test what to extend CECL will have on ALLL placements.
TCT Risk Solutions, LLC (TCT) provides a Credit Migration model that meets CECL standards. On June 8, TCT will provide a webinar on its Credit Migration management tool and how it helps assure user credit unions are in compliance with CECL. Watch for notices from TCT of its June 8 webinar.
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Amy Rapp, Virtual Corps.
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