As the Financial Accounting Standards Board (FASB) continues deliberating on the new Current Expected Credit Loss (CECL) guidelines, credit union professionals are left wondering how the changes will impact their organizations. Final guidance on the FASB's CECL model is expected to be released this year, therefore, credit unions should begin to seek information and plan for the transition.
In response to the recent International Accounting Standards Board (IASB) guidance, the Basel Committee on Banking Supervision (BCBS) released a consultative document on accounting for ECL in early February. The guidance notes that the objective "is intended to set forth supervisory requirements for ECL accounting that do not contradict the applicable accounting standards established by the IASB or other standard setters (such as the FASB)…the requirements described are equally applicable under all accounting frameworks." The guidance provides a framework for both financial institutions and regulators with respect to implementing expected credit loss models. Although the current guidance is for international financial institutions, many U.S. institutions view the document as a "piece of the puzzle" in deciphering what the CECL model will mean for them.
As expected, one of the biggest changes in transitioning to an ECL model is that of forward-looking or life of loan assessments within an ALLL calculation. The Basel guidance notes that the ALLL analysis should incorporate any factors – current or within the life of the loan – that affect repayment by the borrower, including the terms and conditions of a loan and/or willingness or ability to honor the contractual obligation. Institutions will also need to consider macroeconomic factors at the international, national, regional or local levels that are or could be relevant to the assessment.
Another big change will include the requirement to perform multiple scenario analyses when determining loss rates and qualitative adjustments. Given the forward-looking nature of the calculation, multiple scenarios will allow institutions to consider a range of potential future economic outcomes.
Guidelines also suggest that backtesting will become an important component in determining the accuracy of historical ALLL calculations. The ECL guidance specifically states, "Backtesting should be performed to ensure that appropriate factors are considered and incorporated," and "Where performance thresholds are significantly breached, remedial actions to the extent of model re-development or re-calibration should be considered."
While the FASB hasn't yet released its final guidance on CECL, the Basel document provides an insight into what will be required of institutions upon transitioning to an expected loss model. The additional calculations for ECL will require large amounts of data. The new requirements are likely to impact institutions from both a time resource and monetary perspective. Basel states, "The Committee recognizes that incorporating forward-looking information and macroeconomic factors into the estimate of ECL is challenging, costly and requires significant judgment." However, proactive institutions can get ahead of the curve and mitigate the effects of transitioning to an expected loss model by upgrading their systems, tools and data processes.
For more information on the guidance and what to expect, download the complimentary whitepaper, "Transitioning to an Expected Credit Loss Model."
Emily Bogan is a senior risk management consultant at Sageworks. She can be reached at 919-851-7474 or [email protected].
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