The Financial Accounting Standards Board (FASB) recently released updates to the Current Expected Credit Loss (CECL) FAQ. You can read the 48 page FAQ here, but if you’re familiar with the original FAQ, we’ve put together a summary of the additions and changes below:
Credit Card Loan Portfolio
When looking at your credit card loan portfolio, an institution should consider borrower payment behavior to segment the portfolio for CECL. Revolvers and transactors should not be bucketed into the same segment. Additionally, because revolvers represent greater risk to the portfolio, looking at additional risk factors to determine estimation for allowance is appropriate for institutions with a large volume of revolver accounts. These factors include average historical payments, utilization rate, delinquency status and history, credit score, migration of credit score and if the borrower is in a repayment program. Not sure who is a revolver or a transactor? We work with Transunion to generate those attributes for your credit card portfolio.
With the new CECL implementation, there may be new data that is used to estimate expected credit losses (i.e. original credit score, superior loan balance). New internal controls may need to be designed and implemented, appropriate to the size and complexity of the institution, for data that may not have been previously used for reporting.
Having good internal controls also applies to data currently being used for regulatory reporting. For example, retaining loan type information on loans that have charged off is a good internal control. If you change the loan type (i.e. changing an auto indirect loan from loan type 55 to 999 once charged off) you will no longer be able to identify that loan as an indirect auto.
“Smaller and Less Complex” Scalability Definition
There is no set definition of “smaller and less complex” as it refers to the scalability of CECL. It is expected that methods will be employed for CECL in a similar manner to the current incurred loss methods, scaled to the size and complexity of the institution. Institutions use methods ranging from simple spreadsheets to complex models. This level of complexity will not change with CECL implementation. In addition, there is no formula or mandated approach to estimating expected credit losses using CECL.
Many concepts, processes, and practices in existing guidance on the ALLL will continue to remain relevant under CECL. Portfolio segments with similar risk characteristics will remain relevant. Loss history will still be used, but with a change in time horizon (life of loan vs. annual). Qualitative and environmental (Q&E) factors will continue to be important in creating a reasonable and supportable forecast of future losses.
Effective Dates for Implementation.
In November 2018, the FASB amended the effective dates for implementing CECL for nonpublic business entities, a one year reprieve as compared to the previous implementation timeline. The following table provides a summary of the updated effective dates.
Regulatory Capital Rule
An optional three year phase in of the day-one capital effects of the new accounting method was approved in December 2018. This recognizes that with the new CECL method, allowance levels are likely to increase and thus lower equity for regulatory capital purposes. Examples of the three year phase in is illustrated in the rule.
Fair Value Calculations
For collateral dependent loans, an institution should use the fair value as of the reporting date. Adjustments to the fair value for expected future changes are not permitted.
Forecasting Periods and DFAST (Large Financial Institutions Only)
A forecast period should be based on management’s expectations using factors and variables that are relevant to the institutions portfolio and not based on the stress testing process. The CECL implementation model can be based on the stress testing model if adjustments between the two are appropriate and differences between the two models are identified and documented.
As regulatory agencies provide more clarity on the practical implementation of CECL, they will begin to expect a greater level of preparedness from financial institutions. In fact, CECL readiness is a 2019 NCUA Supervisory Priority. Are you ready? We can help. Request a demo today.
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