CECL Implementation Date Draws Closer. Is Your Credit Union Ready?
The Allowance for Expected Credit Losses (CECL), is effective for credit union in 2021. Recent indications are that many credit unions are not ready, or may not even started to prepare. One recent survey we saw indicated only 38% of credit unions are well on their way toward implementation.
Many groups are writing to the Financial Accounting standards Board (FASB) asking for repeal or delay. One regional bank proposal has asked FASB to allow only the first year impact of CECL to hit the income statement, and the balance recorded as other comprehensive income, on the equity statement, and recognized as expense over time. We think this is unlikely to be accepted by FASB.
Despite some who hope that CECL will be further delayed or repealed, our view is that this is unlikely and credit unions should be preparing for implementation.
Here are some thoughts to help you get prepared.
Make a roadmap of steps to follow. This could include establishing a committee, consisting of your CFO, CLO and IT director. This committee should consider the following process:
- Analyze your loan data, including recovery information on a loan by loan basis, and assess whether it will be adequate for the calulations or needs to be cleaned up.
- Select a third party to help you with CECL implementation, preferably an organization that already houses your loan data.
- Select a model for each loan pool. The models allowed by the CECL are:
- Static pool – loss rates calculated by taking the losses from a pool divided by the starting balance of the loan pool.
- Vintage – Vintage loss rates are calculated by segmenting the portfolio into vintages and dividing historical losses by each balance.
- Probability of Default – Life of loan losses are estimated by modeling the probability of default based on collateral, economic, loan and borrower attributes.
- Discounted cash flow – estimates future cash flows based on probability of default and prepay.
- Roll rate – Observes historical progression through various stages of delinquency and subsequent default.
- Loss migration – Aggregates historical loss performance by grade and uses multiple snapshots to estimate expected losses.
- Think about how you want to segment your loans pools.
- Make sure you have recovery history on a loan by loan basis
- Run reports parallel with your existing ALL, so you can gauge the impact and make adjustments to the process.
- Consider other ways you can use this information, such as using it for loan risk anaylsis or pricing purposes.
New FASB Exposure Draft
The FASB has recently issued an exposure draft which would allow organizations to elect the fair value method for both existing and future financial instruments, like loans. This would permit credit unions to simply record their loans at fair value and avoid the need for an allowance for loan loss reserve complete and not have to implement CECL. The election is irrevocable. The charge to earnings for the difference between fair value and book value, would impact the income statement and would require a study be done monthly or quarterly, to fair value loans. The exposure draft is targeted toward sub-prime lenders who don’t hold loans on the book very long, but it applies to everyone. We think it will be interesting to see if credit unions consider implementing this approach if FASB approves.
Initial Impact of CECL
A recent survey we saw indicated that 42% of credit unions think that the initial increase in the allowance for loan loss reserve will increase between 10 and 25%, with the implementation of CECL. This could have a big impact on earnings and capital. NCUA has not said much yet about whether they will allow some relief for credit unions whose capital would drop below 7% and therefore no longer be well capitalized. Stay tuned for this!
NCUA examiners are being trained on CECL and you should expect them to ask you about the CECL process and try t understand if you are making progress. Like most of us, they are still in the process of trying to understand this new standard. NCUA is encouraging credit unions with questions about the new CECL standard to review the updated frequently asked questions now on the NCUA web site: https://www.ncua.gov/files/letters-credit-unions/financial-instruments-credit-losses-faqs.pdf
AICPA CECL Practice Aid
The AICPA plans to issue a practice aid for auditors by end of April 2019. More about this once it is issued.
We are here to help. Contact Deleon & Stang if you need help with CECL implementation and we will be happy to meet with you and discuss the process with you.