February 8, 2018 - Who is CECL and why is everyone talking about him? This week, we explain all. On Tuesday, the LSTA hosted a webinar on the new Current Expected Credit Losses (“CECL”) accounting standard which goes into effect beginning in 2020 for public business entity SEC filers and 2021 for non-SEC filers.  Why should you care?  The new standard will change the way banks and other financial institutions account for expected credit losses. Held to maturity securities and amortized loans, including loan commitments, are included within the scope of the new standard.   All told, CECL will require a significant amount of preparation, including significant changes to process and technology.  The webinar was presented by Corey Goldblum, Harvey Plante, and Kirtan Parikh of Deloitte and is available here.

First, some background:  CECL was introduced in June 2016 by the Financial Standards Accounting Board (“FASB”), the independent organization that establishes financial accounting and reporting standards for public and private companies based on GAAP.  The FASB explained that the new standard was implemented to require timelier recording of credit losses and address concerns that the existing incurred loss approach provides insufficient information about an organization’s expected credit losses.  The new standard requires banks and other financial institutions to immediately record the full amount of credit losses that are expected in their loan portfolios over the life of the loan.

For banks and financial institutions the implementation of the CECL model will likely present many challenges.  When considering the changes that may be necessary for their processes, systems and controls they will also need to consider the evidence and documentation that will be necessary to support their estimates

The differences in the approaches are profound. Current GAAP recognizes an allowance over a defined loss emergence period after a loss event and produces an estimate of all inherent losses in the portfolio based on losses that have been incurred. In contrast, CECL requires entities to estimate the contractual cash flows that are not expected to be collected over the estimated life of the loan.  It does not have a recognition threshold and rather produces a life-of-loan estimate.  Therefore, the basis for the estimates will include not only relevant information about past events and current conditions but also reasonable and supportable forecasts.

The CECL guidance is not prescriptive and mentions a number of model approaches such as   historical loss rate, roll-rate, discounted cash flow, vintage and probability of default/loss given default methods.  Thus, there is likely to be less standardization among participants in calculating the allowances going forward.    While a variety of approaches are feasible, the level of sophistication and data requirements vary by model type.

The technology changes that will be needed to implement CECL will also be challenging.   The technology platform should be holistic in design, promote integration across multiple business units and support the needs of an evolving portfolio structure and risk characteristics.

CECL will also have many downstream implications such as price optimization, credit risk, the life of the loan, the pricing of portfolios, how economics will be adjusted, the convergence of capital allocations beyond the balance sheet and income statement and it will be important to consider these when preparing for CECL. If you are interested in participating in future discussions, email Ellen Hefferan at ehefferan@lsta.org to join the LSTA CECL Working Group.

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