FASB's CECL Model
The Financial Accounting Standards Board (FASB) issued the final current expected credit loss (CECL) standard on June 16, 2016. After the financial crisis in 2007-2008, the FASB decided to revisit how banks estimate losses in the allowance for loan and lease losses (ALLL) calculation. Currently, the impairment model is based on incurred losses, and investments are recognized as impaired when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms. This model will be replaced by the new CECL model.
Under the new current expected credit loss model, financial institutions will be required to use historical information, current conditions and reasonable forecasts to estimate the expected loss over the life of the loan. The transition to the CECL model will bring with it significantly greater data requirements and changes to methodologies to accurately account for expected losses under the new parameters.
Key CECL finalization links and resources:
What credit unions need to know about CECL
Over the course of the next several years, any number of aspects of the financial industry can change. Information security could become tighter to better protect a financial institution’s sensitive data, or restrictions could relax allowing more credit union members access to lines of credit for mortgages or auto loans. One critical change in the landscape, though, isn’t member-facing – transitioning from the incurred loss model to the expected credit loss model in a credit union’s allowance for loan and lease losses (ALLL).
Life of Loan Concept
The more forward-looking CECL model will require institutions to adopt a methodology that takes into account the lifetime of the loan. This will require institutions to gather significantly more data components in order to perform the calculation.
An Update on CECL
Final guidance on the Current Expected Credit Loss (CECL) model has been an anticipated event in the eyes of bankers and other financial professionals. Its release marks the end of the incurred loss model in accounting for expected losses and brings with it a slew of process changes in the way financial institutions collect data and perform their ALLL calculations.
Institutions should defer to final guidance for the implementation schedule once it is released. One can conjecture now, however, that the implementation schedule will be largely similar to prior guidance timetables. With this in mind, it is likely that the FASB will require implementation of the CECL model in 2019 for public institutions and in 2020 for private institutions.
After pushing on the intended deadline, final guidance on the CECL model is expected to be released in the first quarter of 2016.
Thomas Curry, Comptroller of the Currency, has been on the record stating that banks should expect a 30%-50% increase in their allowance levels upon implementation of the CECL model. This will be a one-time adjustment to capital, not a provision expense.
With the transition to the CECL model, institutions will likely need to rely on archived loan-level detail. This could include individual loan segmentation, individual charge-offs and recoveries, risk ratings by individual loan, loan balances and duration.