As we move one year closer to the implementation of the Financial Accounting Standards Board's (FASB's) new CECL rules, which overhaul the way credit unions calculate ALLL (allowance for loan and lease losses), Accolade is here to provide guidance to your credit union. Below are some basic facts about CECL we hope you will find helpful as we progress toward the first live webinar in a five-part series designed to review important aspects your credit union will need to understand to remain compliant and successful.
Why is the current incurred-loss model of estimating credit losses changing?
With the issuance of ASU 2016-13, "Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," in June 2016, the FASB approved the replacement of the incurred-loss model of estimating credit losses with the expected credit loss (CECL) model.
Who is impacted by CECL?
The new FASB standard for estimating expected credit losses will require significant effort for banks and other financial services entities. This new accounting model is the most significant financial reporting change in decades.
What financial instruments are subject to CECL?
CECL applies to:
- Financial assets measured at amortized cost basis
- Lessors' net investments in lease
- Off-balance-sheet credit exposures not accounted for as insurance.
Examples of financial assets expected to have the most significant impact on credit unions include loans, held-to-maturity debt securities, and off balance sheet credit exposures. Other examples of financial assets subject to CECL include receivables resulting from revenue transactions (ASC Topics 605, 606 and 610); reinsurance receivables resulting from insurance transactions (Topic 944); and receivables related to repurchase agreements and securities lending agreements (Topic 860).
How is the allowance measured under CECL?
Your credit union will measure expected losses of financial assets by pooling assets with similar risk characteristics. Similar to current U.S. GAAP, the allowance measured using CECL may be determined using a variety of methods, including discounted cash flow, loss-rate, roll-rate, probability-of-default, and use of an aging schedule.
A significant difference from current GAAP is the requirement to estimate expected credit losses over the life of the financial asset. An entity must consider prepayments as a separate input in the credit losses evaluation. With respect to the life of the financial asset, expected extensions, renewals, and modifications will not need to be considered, unless there is a reasonable expectation at the reporting date that a troubled debt restructuring will be executed with the borrower.
Like now, the estimate of expected credit losses should consider available internal or external information relevant to assessing the collectibility of cash flows and related to past events and current conditions. The significant change under CECL is the requirement to include reasonable and supportable forecasts.
What else will change?
Purchased financial assets with credit deterioration. The model has been simplified. The initial recorded investment of a loan will be the amortized cost plus or minus any noncredit discount or premium allocated to the loan. The initial carrying amount will be the recorded investment less an allowance for loan losses. The initial carrying amount of a loan should be equal to the purchase price allocated to the purchased loan.
Disclosures. CECL requires expanded disclosures to enable a user to understand: 1) the credit risk inherent in a portfolio and how management monitors the portfolio's credit quality; 2) management's estimate of expected credit losses; and 3) changes in the estimate of expected credit losses that have taken place during the period. The disclosure of credit-quality indicators by class of financing receivables by year of origination ("vintage") is a new requirement for public business entities. The vintage disclosures are optional for non-public business entities.
When will CECL be effective?
Although the first phase of reporting changes will not take effect until 2019, due to the complex nature of CECL, we encourage credit unions not to wait until the last minute to implement the new rules. The effective dates for ASU 2016-13 are staggered:
- Public business entities (PBEs) that are U.S. Securities and Exchange Commission filers – Fiscal years beginning after Dec. 15, 2019, including interim periods within those fiscal years
- All other PBEs – Fiscal years beginning after Dec. 15, 2020, including interim periods within those fiscal years
- All other entities – Fiscal years beginning after Dec. 15, 2020, and interim periods within fiscal years beginning after Dec. 15, 2021
How can I learn more?
For more information, check out Get ready for CECL with this five-part live webinar series. This webinar series is targeted for a specific audience, and one of the overall goals is to help your credit union establish a "CECL committee." Collaboration between departments is key to being fully prepared for the new rules. The people who should attend the webinar series and be on your CECL committee include staff from the following departments:
- Accounting
- Lending
- IT
- Risk
- Audit