The Financial Accounting Standards Board is on the cusp of enacting an accounting standards update for Current Expected Credit Losses, which goes by the acronym CECL.
Based on the proposal as it is written, accounting standards will change as they relate to the impairment of financial assets and the recognition of credit losses.
Essentially, the process of accounting for loan loss will change and more data will be required than currently exists in many incurred loss models. In this case, more is not less as it relates to documentable data for measuring loan loss.
Some unprepared credit unions may find themselves on the wrong side of their examiners once the proposal is initiated.
"Core loan systems may not be sufficient for acquiring the necessary data," Chris Emery, director of special projects for Atlanta-based MainStreet Technologies, said.
Last week, the company hosted its "Preparing for CECL" webinar.
The accounting update from FASB was issued as an exposure draft in fourth quarter 2012, with a final version due in fourth quarter this year, or possible first quarter 2015, Emery said.
With implementation of the standards possible as early as 2017, Emery offered five levels of CECL preparedness to help get credit unions moving in the right direction.
Level 1: Ignorance is bliss. Credit unions at this level follow the "Hear no CECL, speak no CECL, see no CECL" approach to preparation, Emery said. If the examiners have to be the ones to educate you, your credit union will be in trouble, he warned.
Level 2: Knowledge is power. As the polar opposite of the previous level, level two credit unions undertake an aggressive, yet still largely passive campaign of reading and analyzing the proposal and talking to regulators and other experts about the changes and how they may apply, Emery said.
Level 3: Become a data-hoarder. Since increased data lies at the heart of the change, this active level requires that systems be adjusted to provide increasing amounts of data to create a clear loss picture of member accounts. At the loan level, balances as well as segmentation, risk and vintage information will become essential. Transaction level knowledge that quantifies charge-offs and recoveries are also is important.
Level 4: Explore forecasting. Data hoarding is important, but only speaks to half the equation, Emery said. Use the data to create and revise forecast models. Assumptions made must be reasonable and supportable, and credit unions must understand past correlations and their ramifications on balance sheets, he added.
Level 5: Run a parallel ALLL model. Emery said it's more time consuming and costly, but credit unions that can run parallel Accounting for Loan and Lease Loss models until the change takes effect will fully understand the operational and financial impact the proposed FASB regulations will have on the safety and effectiveness of their lending program.
Lifetime loss measurement is more than a matter of multiplication and understanding the traditional effect of loan vintages and how to adjust for current and forecasted conditions is necessary to measure the full impact of the current CECL proposal, he noted.
"You can expect your reserve requirements to rise 10% to 50% once CECL is implemented," Emery said. "With any luck running a parallel model will help you be fully prepared for the changeover."
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