Financial institutions gained some breathing room last summer when the implementation deadline for the new CECL reporting standard was pushed to 2022 for non-publicly traded institutions.
That’s good news for Maine credit unions. However, there is no time for foot dragging. All financial institutions should be well into the planning phase in preparation for CECL.
Adopted in 2016 by the Financial Accounting Standards Board (FASB), the Current Expected Credit Loss (CECL) model of reporting loan loss data is the most sweeping change in financial reporting standards for financial institutions in decades. It replaces the current Allowance for Loan and Lease Loss (ALLL) standard, which relies on historical data, and requires financial institutions to estimate anticipated loan losses over the life of a loan. In other words, it is a forward-looking forecast rather than a report of losses already incurred.
To effectively create these forecasts, financial institutions may use any one of several modeling methods, and larger institutions may find it necessary to invest in CECL modeling software.
Perhaps the most challenging aspect of CECL planning for many credit unions is choosing a methodology that best fits each institution’s unique profile. A large credit union serving an economically diverse population in a metropolitan area will have a different profile – and will require different methodology – than a smaller institution serving a more economically homogeneous membership group.
The primary methodologies available to financial institutions are:
Static Pool – a simple approach that follows one pool of loans over a five to seven-year period.
Vintage Pool – similar to Static Pool, but tracks historic groups of loans over time.
Roll Rate Method – a more complex method often referred to as “migration analysis” that utilizes statistical modeling and requires the use of software.
Discounted Cash Flow and Probability of Default Method(s) – methods that look at current economic conditions and leverage loan and economic factors to produce projections of credit loss.
Aging Methods – utilize historical loss data to predict losses on existing loan portfolio.
Whether to invest in software to ease CECL adoption and compliance is a critical question for many credit unions.
For institutions with more complex loan portfolios, CECL software can help speed up calculations, formulate loan analytics, produce supporting documentation and provide data warehousing. However, purchasing software also represents added compliance costs and vendor due diligence, and it does not relieve the institution of responsibility to produce accurate, supportable results.
Getting there from here
For Maine credit unions, CECL adoption requires careful analysis of each institution’s profile and resources.
Once it is fully adopted, CECL may bring benefits such as increased understanding of each institution’s credit risk, and better utilization of quality indicators such as FICO and credit scores. These benefits could lead to more effective determinations about different types of lending.
But getting there from here – the planning and implementation phase – is a complex journey for most credit unions.