By Ray Birch
LAKEWOOD, Colo.–With the CECL standard now here for most credit unions, so too is the biggest accounting challenge the industry has addressed in years, according to one person, who believes the new credit loss accounting standard will initially be more costly and time-consuming for credit unions than the previous loan loss accounting standard—especially for some CUs.
In addition, another big concern is that the Financial Accounting Standards Board’s new Current Expected Credit Loss model (CECL) will degrade credit unions’ net worth, more so than under preceding Generally Accepted Accounting Principles, or GAAP, that were not as forward-looking. That reduction in net worth could reduce or limit needed expenditures to drive growth, said says Holla Walker, CFO with Aux, the backoffice CUSO that provides accounting and CECL services to CUs, among other services.
“The adoption of CECL as the method for calculating the allowance for loan loss is probably the biggest change in the accounting and finance area of credit unions in quite some time,” said Walker. “The historical loss methodology that has been used by credit unions for so many years became almost foolproof in most institutions due to all the cycles of audits and examinations those models went through.”
After its implementation was delayed for years for credit unions, CECL is now the standard for CUs that run on a calendar year. The small number that work off a fiscal year have until October of 2023 to adopt the new rules.
Early Issues Expected
The prior methodology had become a well-known process for credit unions, CFOs, accounting staffs and boards, Walker noted, and that will likely initially lead to early issues and struggles with the new rules.
“CECL’s burdens include time and resources that most credit unions would choose instead to apply to more member-focused projects,” Walker explained. “Time is needed to research the accounting rules to understand the requirements to comply, and more time has been spent compiling data to feed into the chosen model.”
If a credit union contracts with a third-party vendor to complete the CECL calculation, that is an additional cost, as well, Walker pointed out.
“Of course, making the initial CECL reserve transfer reduces the credit union’s net worth position, which may put in jeopardy investments in other areas within the credit union, such as technology or member programs,” she said.
Many are Prepared
Holla Walker
With CECL being proposed and then delayed for years, Walker contended most credit unions are not in bad shape when it comes to using the new calculation.
“Credit unions have been aware the CECL adoption deadline has been coming for quite a while,” she reminded. “In fact, part of the state and federal level examination process has included a CECL readiness questionnaire for a few years now. Most credit unions have had discussions internally and with their board on the different calculation models available, and whether they were going to contract with a third party to complete the calculations, or attempt to do them in-house.”
Walker added she expects most credit unions have been able to run their chosen CECL model simultaneously with the historical loss model for the last few months of 2022 to get an idea of the impact to capital the CECL transfer will have, and work out any “gremlins” in the model.
“When NCUA offered the Simplified CECL Tool in mid-2022, it was a great relief to many of Aux’s credit union clients under $100 million in assets,” Walker said, “because it uses Call Report data to populate historic loss rates and provides the related weighted average remaining maturity for the loan pools. It really eliminated a lot of the heavy lifting from smaller credit unions.”
Large CUs Opting for Partners
But Walker noted that for very large shops, a partner is often needed to address CECL.
“Most of the larger, more complex credit unions I’ve seen are contracting with a third-party vendor to assist with their CECL calculations,” she said. “They tend to use multiple CECL methodologies within the overall calculation. For example, they might use a WARM (weighted average remaining maturity) calculation for unsecured loans, a vintage model for autos and a discounted cash flow model for member business loans. This way they can dial in the best method to really capture the expected losses in their loan portfolios.”
For credit unions that still may not be fully ready to work with CECL, there are answers, said Walker.
“Although they may have missed out on being able to run the historical loss model parallel to the CECL model for several months before implementation, any credit union facing CECL adoption has resources available through the NCUA, trade organizations, and, of course, many vendors who have developed credit union centric models,” said Walker. “The Simplified CECL Tool is available on NCUA’s website, uses the WARM method and is free of charge. Credit unions may want to consult with their independent auditor or CPA to determine which calculation model is appropriate for them.”
The Real Impact
The real impact from CECL will first be felt from the hit to undivided earnings as a result of the initial CECL transfer, predicted Walker.
“From what I’ve seen, from credit unions that have already adopted CECL, that initial transfer can be significant, in some cases doubling the required allowance for loan loss balance when considering the pooled analysis, any individually classified loans, and environmental factors,” she said. “This initial transfer comes directly out of retained earnings. So, for credit unions that are on the lower end of the well-capitalized spectrum, it is a big deal.”
Walker noted that for some of Aux’s client credit unions the company has been running simulations on the transfer well in advance of implementation to ensure the credit unions maintain their well-capitalized status.
Another impact credit unions may face under a CECL allowance methodology may be felt with new loan originations, added Walker.
“If a credit union sees large reserve factors for certain loans now, at the time of origination they may choose to change their loan offerings,” she said. “For example, if a credit union sees that reserving for unsecured personal loans is significantly higher on an up-front dollar-for-dollar basis, than say some other secured loan type, will the credit union change its loan offerings or increase the interest rates on unsecured loans? This is yet to be determined, and I suspect that credit unions will continue to serve their members’ needs no matter how the accounting rules change.”
A Weakness for Some
Despite the time to prepare, understanding CECL model calculations within the credit union is still a weakness for some, observed Walker.
“We are already seeing some credit unions that may have early-adopted in 2022 and who are now going through their audit or examination and are being asked to talk through the calculations with their auditors and examiners,” Walker said. “Having a clear understanding of the data points and being able to explain how the final numbers are compiled is an integral part of the process.”
She emphasized that auditors and examiners need to be able to test and validate the data inputs and results.
“Having a working knowledge of how the model works within the credit union, clear documentation, and an updated allowance for loan loss policy are vital,” she said.
Changes are an Option
As credit unions work more with CECL this year, they may make changes, suggested Walker, especially those that simply chose a CECL model to meet the Jan. 1 adoption deadline.
“I’ve had some credit unions that have chosen a CECL model in order to meet the adoption deadline, but who are now considering researching other models,” Walker said. “For example, a credit union may have chosen the WARM method for expediency and simplicity, but now can take some time to research other options, such as discounted cash flows or vintage analysis, which may result in a different reserve requirement. Also, a CU may want to adjust the loan pools used to classify the portfolio. Talking through these changes with the credit union’s auditors will be extremely important to ensure that any changes to the process or procedures are well documented and the policies are updated accordingly.”