CECL – Data and Methodology
The Financial Accounting Standards Board's (FASB) Accounting Standards Update (ASU) 326 provides the guidance for estimating allowances for credit losses, as the current expected credit losses methodology (CECL) will be applied. The allowance will be reported as a valuation account, or the difference between the financial assets’ amortized cost basis and the net amount expected to be collected. Two common questions that bankers ask about FASB's CECL model are: 1) What methodologies make the most sense for CECL? 2) What are the data requirements for my institution?
The Case for Early Adoption of the FASB’s Current Expected Credit Loss (CECL) Model
The standard, issued in ASU 326 (Financial Instruments – Credit Losses) in June of 2016, contains several timelines for required adoption of the standard depending on the type and existing reporting requirements of the financial institution. While the timelines are (directly) independent of institutional size and complexity, all financial institutions do have one thing in common: For fiscal periods beginning after December 15, 2018, and for interim periods within those years, use of the CECL standard is permitted.
Other Regulatory Considerations for CECL Preparation
On December 19, 2016, the Board of Governors of the Federal Reserve System (the Fed), Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corp. (FDIC), and National Credit Union Administration (NCUA) issued an 18-page, 23-question statement titled, “Frequently Asked Questions (FAQs) on the New Accounting Standard on Financial Instruments – Credit Losses,”
FASB’s CECL Model: Navigating the changes
Final deliberations by the FASB on the impairment of financial instruments are drawing to a close, and the board is expected to issue a final standard in 2015. Prior to deciding to issue a final standard, the board will ask themselves whether re-exposure is warranted. While the deliberations are not yet complete, the CECL model removes the “probable” threshold that exists today and requires the development of an estimate of all contractual cash flows not expected to be collected. Given the pervasive impact, many financial institutions are beginning to think about the impact the new model is likely to have on their allowance methodologies.
Financial instruments: Credit impairment
Since the financial crisis, the FASB has been debating wholesale changes to the U.S. GAAP credit impairment model. The FASB completed the majority of its deliberations in April and expects to issue a final standard in the fourth quarter of 2015. This standard, which uses the CECL model, fundamentally will change the way the allowance for credit losses is calculated. The standard will have a pervasive impact on all financial institutions, and questions are circulating about what changes are in store.
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).
The National Credit Union Administration, or NCUA, is responsible for oversight of both federal credit unions and FDIC-insured state-chartered credit unions.
The Federal Reserve, or FED, oversees bank holding companies, financial holding companies, S&L/thrift holding companies and state-chartered member banks of the Federal Reserve System.
The Federal Deposit Insurance Corporation, or FDIC, oversees FDIC-insured state-chartered non-member banks as well as FDIC-insured state-chartered thrifts.
The Office of the Comptroller of the Currency, or OCC, is largely viewed as holding its constituents to the strictest standards of the three bank governing bodies. It oversees national banks and federally chartered thrifts.
IASB’s IFRS 9
On July 24, 2014, the International Accounting Standards Board (IASB) issued its own standard for accounting for credit losses, IFRS 9 Financial Instruments. Under this model, financial institutions must account for expected credit losses when they are first recognized, as well as recognize expected losses over the life of the loan.