For many financial institutions, the effective date of adopting Accounting Standard Update (ASU) 2016-13, “Measurement of Credit Losses on Financial Instruments”, also known as Credit Expected Credit Loss (CECL) has been delayed to January 1, 2023. CECL affects all entities holding loans, debt securities, and off-balance-sheet credit exposures. The significance and widespread impact of this new standard demands that institutions take an early and disciplined approach to CECL as there are many steps that must be taken to properly gather data and implement the standard. Now is the time to look at where you are in the process and where you need to be. Several key items to address are as follows:
- Determine the steps and timing needed to implement the new accounting standard.
- Identify the functional areas within the institution that should participate in the implementation of the new standard.
- Review existing allowance and credit risk management practices to identify processes that can be leveraged when applying the new standard.
- Determine the methodology that best fits the financial institutions’ portfolio for each segment (i.e., discounted cash flows, vintage, snapshot, weighted average remaining life, probability of default etc.).
- Identify current available data that should be maintained and consider whether any additional data may need to be collected or maintained to implement CECL. Examples of types of data that may be needed to implement CECL include the following: origination and maturity dates, initial and subsequent charge-off amounts and dates, and recovery amounts and dates by loan, cumulative loss amounts for loans with similar risk characteristics, loan-to-value, and credit scores.
- Determine how best to segment the loan portfolio for CECL calculation.
- Proper vendor due diligence is required for software and vendor tools utilized and establishing a time frame and locking in an implementation schedule.
- Evaluate and plan for the potential impact of the new accounting standard on regulatory capital. Some of the key takeaways from those institutions that have implemented CECL have been: (1) start early, full implementation can take up to a year or more, (2) review of the loan data is key as there may be gaps in the data that must be scrubbed or filled with peer data, (3) documenting the process and decisions made in implementing CECL, including assumptions, inputs, calculations, outputs and resulting impact, (4) having three to four quarters of CECL calculations running against current accounting for credit losses under the incurred model can provide time to identify and fix mistakes or assumptions, and (5) networking with peers that have implemented or in the process of implementing to see what has worked best or other things to consider. CECL is scalable to the institutions size and risk within the portfolio. As you have questions or need assistance, please reach out to ABS at firstname.lastname@example.org or 913-599-7471.