By Ben Wu
Many credit unions breathed a sigh of relief when the Finaancial Accounting Standards Board (FASB) announced that it would delay implementation of its Current Expected Credit Losses (CECL) standard for credit unions and other non-public entities from fiscal years beginning after Dec. 15, 2020 to Dec. 15, 2021.
This one-year extension gives credit unions, particularly those required to implement in the fourth quarter, more time to adopt and test process and technology updates. While two and a half years seems like a long time, here are three simple things credit unions should begin doing now to ensure a smooth and compliant CECL implementation.
Educate Yourself on CECL
FASB, CUNA, and NAFCU all provide educational resources for CECL, but here are some “Cliff’s Notes” on the standard.
Issued by FASB on June 16, 2016, CECL is the new “expected loss” accounting model for estimating the Allowance for Loan and Lease Losses (ALLL). It replaces the current “incurred loss” model, which requires credit unions to hold loan loss reserves after there has already been a default or late payment. According to FASB, the incurred loss methodology restricts “an organization's ability to record credit losses that are expected, but do not yet meet the ‘probable’ threshold.”
Under CECL, credit unions will be required to use historical information, current conditions and supportable forecasts to estimate the expected loss over the life of the loan before a payment has even been made. Loans that fall under the new standard include first and second mortgages, home equity lines of credit, auto loans, and commercial loans. While CECL helps improve financial reporting by requiring timelier recording of credit losses on a loan, it requires changes to methodologies, as well as a significant amount of data to accurately calculate expected losses.
Mind the Data Gap
Unfortunately, most credit unions do not have enough data to predict a loan’s potential loss. They may have a small sample of loans and/or data for only a short historical period, which prevents them from being able to identify predictable patterns of loss. Take mortgages, for example. The delinquency and foreclosure rate for mortgages has fallen to 4%—the lowest level in 12 years—according to CoreLogic. An economic downturn or a natural disaster has the potential to change a loss pattern that is only based on loan performance over the past few years.
It is critical for credit unions to not only determine how much data they have access to now, but also what data they will need in the future and if they have any gaps in resources or infrastructure that could prevent them from accurately calculating loan loss reserves.
Consider the Best CECL Solution for Your Credit Union
As long as credit unions can justify how they calculated their loan loss reserves, then they can tackle CECL either manually, using spreadsheets and in-house economists, or by using a third-party vendor, such as one of the Big Four accounting firms, or a CECL technology provider. The best solution is different for each credit union. Manual processes are commonplace, but can take some credit unions up to a week each month to complete.
Third-party vendors have access to more data and analysis so that they can easily forecast loan performance in various scenarios—filling the data gap significantly. Technology providers, in particular, can integrate their solutions into origination and servicing platforms to provide not only the exact amount for loan loss reserves, but also a full report on how that number was calculated. This option not only is cost-effective, but also makes implementing CECL simple.
Ben Wu is executive director of LoanScorecard, a provider of non-agency automated underwriting, CECL loan-loss reserve, and borrower point-of-sale solutions designed to meet today's regulatory challenges and capitalize on market opportunities. He can be reached at ben_wu@loanscorecard.com.