CECL, Like Winter, Is Coming

April 12, 2019 at 9:39 am 1 comment

Image result for night king

In The Game of Thrones, which thankfully kicks of Season 8 on Sunday night, an army of the dead is coming to attack civilization as we know it. People have been warned for years that “winter is coming” but most leaders have buried their head in the sand and either ignored the threat or refused to believe it is real.

So what does this demonstrate other than yours truly is an unabashed Game of Thrones geek? After sitting through a webinar yesterday on the impending Current Expected Credit Loss standard, which becomes mandatory for credit unions in 2022, it’s clear to me the biggest mistake that many credit unions could make is hoping it never arrives and not preparing for CECL. In fact, CECL, like winter, is coming, and its time to grapple with its complexities both perceived and real.

The good news is that the information flood gates are beginning to open. Yesterday’s webinar was a joint presentation of financial regulators including the NCUA. Allison Cook, the Chief Accountant at the NCUA, used her time to provide credit unions some good news: There is still time to prepare for CECL, but only if credit unions get started now.

So how should a credit union get started? With the huge caveat that I’m not an accountant and never will be, CECL requires financial institutions to estimate expected loan losses as opposed to probable loan losses. There are several different approaches to anticipating losses and the regulators made clear again yesterday that they are not going to prescribe a specific method. What they are going to expect is that you and your accountants can justify your assumptions.

Let’s say your credit union originates ten, fifteen-year mortgage loans this month to members that have excellent credit. Your credit union complies with Dodd-Frank so your originators believe that everyone they have underwritten has the ability to repay the mortgages. In other words, there are no probable losses on any of these mortgages for current accounting purposes.

In contrast, you know from your credit union’s loan loss history that, statistically speaking, one of these mortgages will go delinquent within the first two years. You also know that the SEG group that employs ten of these borrowers is expected to announce layoffs in the next couple of months. You can expect that some of these mortgages will end up costing you money in the form of diminished payments. CECL expects you to anticipate those losses and to set aside money much earlier in the lending cycle.

There are numerous ways of arriving at the precise amount of money that should be put aside. The presenters stressed that they won’t be mandating a specific method. That being said, the method that has gotten the most attention lately is called the WARM method and a good chunk of yesterday’s webinar was dedicated to explaining how it would work. Here is a guidance to provide you more detail on that approach.

Regardless of what method you and your accountants ultimately decide on, it’s time to get started. One step you can take is gather up the historical data on the credit losses for your lending products. In addition, many of you already have perfectly acceptable credit loss models but they are in your head. And of course its time to call your accountant and start talking about potential ways of implementing the new standard. I would even get your board involved in the discussion so that they understand what is being done and why.

CECL like winter, is coming. Enjoy the show.

Entry filed under: Compliance, General. Tags: , .

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1 Comment Add your own

  • 1. Anonymous  |  April 12, 2019 at 12:35 pm

    That was an excellent webinar.

    Reply

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Authored By:

Henry Meier, Esq., Senior Vice President, General Counsel, New York Credit Union Association.

The views Henry expresses are Henry’s alone and do not necessarily reflect the views of the Association. In addition, although Henry strives to give his readers useful and accurate information on a broad range of subjects, many of which involve legal disputes, his views are not a substitute for legal advise from retained counsel.

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