Dissecting CECL

The Current Expected Credit Losses (CECL) accounting standard changing how financial institutions calculate their allowances will impact financial institutions enterprise wide. Through a series of conferences, webinars, whites papers and articles, MST is providing access to information and insights on CECL from the industry’s leading experts. The following are the primary takeaways from MST’s Dissecting CECL Webinar of July 14 featuring Rahul Gupta, Partner, Grant Thornton LLP.

• The Current Expect Credit Losses (CECL) accounting standard requires institutions to calculate an allowance for all financial assets measured at amortized cost. That includes two types of assets: loans and receivables measured at amortized cost and debt securities.

• The basic difference between the existing incurred loss model and CECL is that CECL eliminates the recognition threshold, that is, it requires measurement and recognition of losses even if they are remote.

• For loans and receivables held for sale, accounting remains as it is today, the difference between the discounted or amortized cost and the market is recognized as the allowance.

• For loans and receivables held for investment, the allowance will be calculated based on current expected losses. A CECL allowance is essentially the difference between the amortized cost of the asset and what the institution expects to collect on it. And to make that estimate, the institution will have to make “reasonable and supportable” assumptions about the future.

• Loans and receivables should be pooled, measured collectively with assets of similar characteristics, except for assets that do not share similar characteristics with others.

• Debt securities will be treated under an allowance model. Securities held to maturity (HTM) will be pooled, like loans, according to similar characteristics. Because securities might not have a historical loss as a staring point, the institution must also consider external factors, like default ratings.

• Assets-for-sale (AFS) securities will be recorded through an allowance, which will be calculated based on the difference between fair value and the amortized cost.

• The FASB Guidance on CECL does not prescribe an allowance methodology.

• CECL measures credit loss over the contractual life of a financial asset; only if restructuring is imminent, should it be taken into account.

• CECL requires the institution to consider all available information relevant to collectability. Past experience can be adjusted for asset-specific factors, like changes in underwriting criteria, and should be adjusted for current conditions and reasonable and supportable forecasts, which include consideration of qualitative factors.

• For periods where forecasting is not available, use historical losses and base forecasts on previous experience and current internal and external conditions.

• CECL allows for a zero loss allowance on assets where there is no expectation of nonpayment, such as U.S. Treasury securities.

• CECL addresses off-balance sheet credit exposure, such as credit cards, in two ways: where a lender has an unconditional right to cancel borrowing, there is no credit loss exposure and no allowance; where non-cancellable, a credit loss is recognized based on funding and expected amount of nonpayment.

• For collateral-dependent loans, measure expected losses by comparing to fair value in terms of sale or operation to amortized cost.

• A credit quality disclosure is required for held-to-maturity (HTM) securities as well as loans and receivables. All non-revolving financial assets must be assessed by their year of origination (vintage); this applies only to public institutions, and there are some considerations for non-SWEC filers.

• Calculate an allowance on day one for purchased assets with more than insignificant credit deterioration, then treat them the same as other credit impaired assets.

Webinar attendee poll

Nearly 400 financial professionals from banks and credit unions registered for MST’s Dissecting CECL webinar. Following the presentation and a question-and-answer session, they were polled about their planning and expectations relative to CECL. To great extent, the results are consistent with three other MST polls taken in 2016. The results:

• 58 percent said they will need between 5-7 years of historical data to comply with CECL. There was an even split between those saying they will need more or less than 5-7 years’ data. Nine percent were unsure.

• 38 percent currently use an automated solution to estimate their allowances; 72 percent said they will use an automated solution to comply with CECL.
• 66 percent have begun CECL preparations.
• 78 percent said CECL will serve to increase their reserves.

The Dissecting CECL webinar is now available on demand.