Credit unions shouldn't count on a CECL delay
With the Federal Accounting Standards Board signaling last month that it may delay small institutions’ implementation date for a controversial new credit loss standard, credit unions may have a bit of a reprieve.
But analysts say the underlying message hasn’t changed: regardless of any possible delay, CUs need to be preparing now.
Jan. 1, 2022 – the current implementation date, if FASB doesn’t follow through on a delay – may seem a long way off, but that time will pass quickly. FASB’s current expected credit losses methodology, better known as CECL, was issued in 2016 and has garnered controversy throughout the financial services industry, with bank and credit union trade groups raising a variety of objections – one of the few issues on which both sides agree.
CECL isn’t just a new rule, noted one credit union executive, but an entirely different way of thinking.
“It is both a mindset shift and an accounting shift,” said Christine Messer, VP of accounting at Heritage Family Cu in Rutland, Vt., noting that CUs will be forced to shift from using a loss history to a forecasting method. “As accountants we were trained on the matching principle: matching revenue with expenses in accrual accounting. But what we will be doing now is quite the opposite: expenses before the revenue.”
The new rule, said Joel Pruis, senior director for Cornerstone Advisors, is likely to have a “significant impact” on a credit union’s loan loss reserve and regular allocations to reserves for future losses.
“Rather than being reactive and simply applying a gross reserve percentage against the loan portfolio balances, there will need to be a direct correlation between what loan types are being originated, the quality of loans at time of origination and how the credit risk may change during the life of the loan,” Pruis explained. “Once a credit union attempts to apply the mechanics associated to CECL, there may be material changes to the reserve balances and/or required contributions to the reserves.”
Credit unions also need to understand that the new standard will require them to consider expected future economic conditions in making their estimates, said Steve Hood, strategy, risk and assurance partner for Rochdale Paragon Group. In many cases, he added, implementing CECL will increase the amounts credit unions must carry in their ALLL accounts, “sometimes substantially,” and the initial adjustments will flow through equity, so CECL will not decrease earnings initially.
But, he cautioned, CECL won’t affect actual loan net charge-offs. “The opportunity is, all of a sudden, credit unions should have better information available to project their actual loan losses given the current underwriting characteristics of their portfolios and economic expectations.”
One-in-five haven’t started preparing
Regardless of if FASB delays implementation, Salt Lake City-based Visible Equity is advising credit union clients to allow at least a year in order to run parallel calculations of ALLL so they can fully assess CECL’s impact. And a study from the company indicates most institutions need all the time they can get.
In a Visible Equity survey asking “Where are you in your CECL journey,” just 2% of respondents reported full implementation, while 20% haven’t started any preparations. Just over 40% have formed a committee on the topic, while 37% have a plan in place and are testing methodologies.
Scott Blakeslee, CECL product director at Visible Equity, said forming a committee is the first step most institutions need to take, since that will help establish an implementation plan along with goals and milestones. After that, he said, CUs need to ensure they understand the historical data requirements the rule will entail.
“After the data is ready, begin assessing CECL methodologies and results,” he advised. “Run the data through the various CECL methods to get an expected credit loss number. Compare that to your existing loan and lease loss number. You can mix and match methodologies to see capital requirements and the amount to set aside.”
In the next year, no more than two years, credit unions will have to tell National Credit Union Administration examiners which methodology was chosen and why, he noted. “If you are not getting your data ready now, it will be difficult to be ready.”
What CUs are doing
Speaking before FASB confirmed the possibility of a delay, Ed Lis, VP of finance and compliance at First Choice Financial FCU, said his institution is moving ahead on the assumption the new standard will take effect as scheduled.
“You have to put a line in the sand and start the implementation process,” he declared.
That process started with the formation of a CECL committee consisting of Lis, the VP of finance, the IT department, the VP of lending and one board member. The committee meets quarterly.
“We have a simplified process and are hoping to maintain that simplicity while meeting NCUA compliance standards,” Lis said. “With all this data we are organizing, we are hoping to identify new lending opportunities.”
First Choice Financial FCU uploads nine different files on a monthly basis. Lis said it is reconciling that data and adding other fields to help assess the different methodologies.
“The current allowance for loan losses is a range of estimates; that will be no different under CECL, but there will be a disconnect because we will be setting aside the entire amount of loss right when the loan is made,” Lis said. “NCUA wants to know how much it will affect net worth, and we are working on answering that question as we evaluate all the different methodologies.”
In January 2020, First Choice Financial FCU will begin running parallel calculations with the CECL methodology against its existing ALLL methodology. It then will work with a third-party provider to develop reports over 2020 and 2021.
“We want to start ahead and be prepared rather than hoping Congress and the trade associations can delay implementations,” Lis said. “It will be a lot of work, but starting early allows me to not feel as if I have my mouth over a fire hose. We want enough time to make good decisions.”
Heritage Family CU’s Messer said her institution is planning for 2022 implementation and, among other measures, has purchased software to assist with sorting data for a variety of loan types.
“Also, we have been working for the past few years on cleaning up our data and gathering ‘clean’ history for use with CECL calculations and methodologies,” Messer said. “While daunting, it has been a great process for us because it has opened the door to greater loan analytics.”
Messer and several other executives there have undergone training from the credit union’s software vendor and various industry groups in order to better understand what to expect when the rule takes effect.
“The impact of CECL on our credit union is still to be determined, but as we get further into testing methodologies, the more we will know,” Messer said.