4 Pieces to Solving the CECL Puzzle for Loan Participations

The new Current Expected Credit Loss standard is having a profound financial and operational impact on the way credit unions and other financial institutions collect data and analyze loan performance – and loan participations create an added wrinkle for compliance.

CECL implementation has placed new burdens on financial institutions to both collect and organize the relevant loan data and operationalize a reliable system of ongoing compliance. As a result, financial institutions are increasingly relying on third-party specialists to streamline these efforts – especially as they relate to in-house portfolios. But how can they comply with the new CECL rules if they pursue loan participations? After all, the loan data required to compute the lifetime charge-off rate will come from a number of external sources, rather than internal ones.

Harvesting the data necessary to achieve CECL compliance presents unique challenges for financial institutions that pursue loan participations, but they are, in truth, quite manageable. The good news is that the combination of some advanced planning and new technology will allow financial institutions to collect and organize data from a number of different loan participations without complicating their existing in-house efforts to operationalize ongoing compliance.

Here are four tips to help prepare:

1. Tailor Your Participation Diligence Process

First, you’ll need to be sure that your loan participation due diligence process captures all the components of your CECL calculation. For instance, if your standard diligence process is to request charge-off history dating back to a fixed period of 24 months, confirm that the requested period at a minimum covers the participation portfolio’s expected loan life. Given the significant variance in CECL adoption dates and implementation progress for each financial institution, it is critical that you work with your CECL team or third-party specialist to develop alternative processes for when the available data behind the participation portfolio is insufficient to support a compliant calculation.

2. Ensure Efficient & Sufficient Ongoing Reporting

The most pronounced changes CECL injects into the loan participation process lies within the ongoing reporting. For instance, the accuracy of your CECL loan reserve calculation, regardless of the chosen methodology, hinges on the quality of loan-level data, such as individual loan payments and credit risk migration. Access to this data directly affects the ability of your CECL team or third-party specialist to integrate the loan participation calculation into your existing in-house process. Therefore, before entering a loan participation, both the seller and purchaser must be certain that the seller can provide ongoing information sufficient to meet the purchaser’s CECL model requirements. At a minimum, confirm that the following is available at the individual loan level:

• Payment level detail;
• Current credit scores;
• Delinquency;
• Performance: Bankruptcy, foreclosure, repossessions, etc.; and
• Gross charge-off, recoveries and net charge-offs.

Additionally, ensure the format of the report is easily exportable and includes key loan identifiers, such as:

• Loan type;
• Collateral type;
• Origination date;
• Maturity date;
• Original credit score; and
• Unique loan IDs

Providing the right information in a manageable and simplified process is not unduly burdensome to the seller if the right loan participation technology is utilized. If the sufficiency or logistics of the ongoing reporting is the only hurdle to closing on an otherwise attractive participation opportunity, re-evaluate the method that you and the counterparties originally contemplated for ongoing reporting.

3. Don’t Just Rely On In-House Data

Downplaying the importance of sufficient, ongoing reporting and overreliance on in-house data invites undue risk. For example, if your participation in a portfolio of loans comprises automobile loans originated in a region wholly distinct from that of your in-house automobile loan portfolio – a scenario presented to regulators in their April 2019 CECL webinar – your in-house data would be insufficient to properly calculate your loan reserve.

4. Take Advantage of Loan Participation Technology

Trying to manually harvest all of the data from a loan participation transaction to achieve CECL compliance is a bit of a fool’s errand. But today’s loan participation software makes managing your CECL obligations easy, convenient and fast. Automated reporting can capture all of the relevant data necessary to seamlessly deliver the information to a third-party CECL specialist in a structured and timely way. The result? Not only will your credit union be compliant with CECL requirements, but you also will benefit from the myriad options for diversification and liquidity of a loan participation solution.

Ian Lampl is CEO of LoanStreet Inc. He can be reached at 646-828-9000 or ian.lampl@loan-street.com.