As the credit union industry continues to navigate the impact of COVID-19 and the current economy on allowance for loan losses, it’s time to reinvigorate efforts to implement the Current Expected Credit Loss (CECL) guidance from the Financial Accounting Standards Board (FASB). For a majority of credit unions, the dates for adoption and implementation of CECL remain right around the corner.
CECL Effective Dates
On Nov. 15, 2019, FASB updated the effective dates for implementation of the CECL standard to the following:
- All other entities (i.e., credit unions) Annual reporting periods beginning after Dec. 15, 2022, including interim periods within those fiscal years.
Note: Early adoption is permitted for fiscal years beginning after Dec. 15, 2018.
Identify Key Information
One of the significant aspects of the allowance for credit losses (ACL) or CECL standard will be quantifying the qualitative adjustments to be applied to your lifetime loss calculation. As ASC 326-20-30-7 states, An entity shall consider relevant qualitative and quantitative factors that relate to the environment in which the entity operates and are specific to the borrower(s).
This will require management teams to identify both internal and external information that may impact the ACL calculation. Management teams should evaluate data elements that could result in changes in expected future credit losses when compared to the historical lifetime loss calculation.
Guidance On Qualitative factors
Final Interagency Policy Statement on Allowance for Credit Losses issued by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the National Credit Union Administration provide guidance on factors to consider when adjusting historical lifetime loss information. These items include, but are not limited to:
- Nature and volume of the credit union’s financial assets
- Existence, growth, and effect of any concentrations of credit
- Volume and severity of past due financial assets, the volume of nonaccrual assets, and the volume and severity of adversely classified or graded assets
- Value of the underlying collateral for loans that are not collateral-dependent
- The credit union’s lending policies and procedures, including changes in underwriting standards, collections, write-offs, and recoveries
- Quality of the credit union’s credit review function
- Experience, ability, and depth of the credit union’s lending, investment, collection, and other relevant management and staff
- Effect of other external factors such as the regulatory, legal, and technological environments; competition; and events such as natural disasters
- Actual and expected changes in international, national, regional, and local economic and business conditions and developments in which the credit union operates that affect collectability of financial assets
These factors are similar to those already being evaluated under the current allowance for loan loss methodology. The main difference when evaluating these criteria is for management teams to apply a forward-looking lens.
For example, if management is evaluating the underlying collateral value element, and in the current year management changed the required loan-to-value (LTV) requirement on commercial real estate loans from 70% to 80%, the inherent risk of loss was increased from historical levels as a higher LTV is now accepted. Thus, management will likely want to add to the ACL to compensate for this risk.
Conversely, if underwriting standards are tightened compared to the historical information being included in the calculation, management may need to apply negative factors to reduce the expectation of loss.
Use Reasonable Forecasting
In addition to qualitative assessments, management teams are also required to incorporate reasonable and supportable forecasts into their ACL calculation. As noted in ASC 326-20-30-9, An entity shall not rely solely on past events to estimate expected credit losses. When an entity uses historical loss information, it shall consider the need to adjust historical information to reflect the extent to which management expects current conditions and reasonable and supportable forecasts to differ from the conditions that existed for the period over which historical information was evaluated.
Management teams will need to identify data elements that may produce different results than historical data. This will likely require forecasting these elements and their effect on charge-offs over a reasonable and supportable forecast period, and then reverting to historical data. Per the standard, An entity may revert to historical loss information immediately, on a straight-line basis, or using another rational and systematic basis.
For example, if management determines that the unemployment rate is a strong indicator of charge-off activity, it will need to forecast what it believes unemployment rates will be over a reasonable and supportable forecast period. Say management believes, based on industry data, it can reasonably forecast the unemployment rate for the next two years. Management would then evaluate its expectation of the unemployment rate and the impact on its expected charge-offs over that two-year period i.e., if they expect unemployment to increase, they will add to the ACL. After the two-year forecast period is concluded, reversion to historical loss rates is appropriate for the remaining life of the loans.
Available Tools For Evaluating Data Elements
Take time to review tools and data available for determining the appropriate means of evaluating these elements, such as the Federal Reserve Bank’s FRED Graph tool. This tool can provide access to many economic data points and the forecasts of certain data elements from the U.S. Federal Open Markets Committee (FOMC), such as unemployment rate.
Bryan Mogensen is Principal at CLA Phoenix. David Heneke is Principal at CLA St. Cloud (Waite Park).
For more information on CECL implementation, contact Bryan Mogensen at bryan.mogensen@CLAconnect.com or 602-604-3551.
The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CliftonLarsonAllen) to the reader. For more information, visit CLAconnect.com.
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