When it Comes to CECL, Don’t Panic
When it comes to the Federal Accounting Standards Board’s expected loan loss requirements anticipated to be finalized the first half of this year, pay attention but don’t panic…Yet. That’s my takeaway after listening to an excellent round table discussion between regulators and community banks that took place last Thursday.
Under existing accounting standards, you are required to recognize losses when they become probable. Critics of this approach argue that it ends up underestimating the weakness of financial institutions. For example, many banks and some credit unions had low Allowances for Loan losses immediately prior to the financial crash of 2008. The Current Expected Credit Loss (CECL) Model is intended to address this problem by making banks and credit unions account for expected loan losses over the lifetime of the loans by anticipating losses. Supporters of this approach argue that it will force bankers to more realistically account for the fact that some of their loans will go bad. No one disputes that under this approach over time you will have to put more money aside for a rainy day since you will have to anticipate losses earlier in the lending process.
The Model makes little sense for credit unions. One of the main reasons why FASB wants to make these changes is so investors get more accurate, real time information about a bank’s financials. But, as Susan Hannigan, a CFO at Jeanne D’Arc Credit Union in Massachusetts, pointed out at the round table, credit unions don’t have potential outside investors. Furthermore, credit unions already monitor expected loan losses, but in a very unique way that comes from living in the community where the loans are being made or being dependent on a company’s continued growth. But we are past a time for criticizing the proposal. Hopefully additional changes will be made but it is time to start seriously thinking about how credit unions should implement it before it takes effect probably in 2019.
Here is where I have some good news. The regulators were adamant that the purpose of the accounting standard changes is not to make small financial institutions invest in sophisticated modeling or change their hands-on approach to anticipating loan losses. In fact, if your credit union’s primary modeling tool is an Excel spreadsheet and it works, you can continue to use it. That being said, the participating financial institutions were quick to point out there is a potentially huge disconnect between what the regulators say sitting around the table and what your enthusiastic young examiner will tell you is required.
As a non-accountant my advice would be to approach this issue methodically. Wait for the Standard to be finalized before listening to vendor pitches and take a look at your existing practices. Many of you already do a fair amount to account for expected losses, you just don’t reflect this due diligence on paper.
If all goes according to plan, the sky isn’t falling but you should certainly expect some rain.