December 6, 2017 - CECL is the acronym du jour. But what is it, what will it mean for loans and what is the LSTA doing? We discuss all below.
First, what is the LSTA doing? The LSTA is organizing a CECL Working Group to focus on the implementation challenges of FASB’s Accounting Standards Update (“ASU”) 2016-13, an impairment model known as the current expected credit loss (“CECL”) model. This applies to most debt instruments (other than those measured at fair value).
And why is CECL important? Today, generally accepted accounting principles (“GAAP”) require an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. The ASU eliminates the “probable” threshold. Instead it requires an entity (such as a bank) to recognize, as an allowance, its estimate of expected credit losses utilizing more forward-looking information. Clearly this is a significant change in accounting for credit impairment.
Now, into the weeds! The ASU describes the impairment allowance as a “valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset.” The income statement reflects the measure of credit losses for newly recognized financial assets, as well as the expected changes in expected losses that have taken place during the period. According to the FASB, the revised measurement will be based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. The FASB did not mandate a specific method for measuring expected credit losses and allows an entity to apply methods that reasonably reflect its expectations of the credit loss estimate occurring over the contractual life of the financial asset. Some approaches project future principal and interest cash flows (i.e., a discounted cash flow method) while others project only future principal losses.
What are the key dates? This ASU will become effective for public businesses entities that are SEC filers during the 2020 financial statement period and will become for all other entities during the 2021 financial statement period. If they so desire, entities can adopt the new guidance during the 2019 period.
So why do you care and what can you do? To ensure compliance, banks and loan portfolios will need to modify their processes, operations and systems in order to establish the allowances. The CECL model, whether new or a modification of an existing model, will impact accounting policy, financial reporting, credit risk, operations, technology and business units. To discuss CECL’s effect on the loan market and your institution in particular – including implementation strategies – we urge interested members to join a working group that will begin meeting in January. If you are interested in joining this Accounting Committee sub-group, please contact Ellen Hefferan (firstname.lastname@example.org).