Preparing for CECL: What you should do now

Just about two years ago, the Financial Accounting Standards Board issued its standards update for financial instruments and credit loses (ASU 2016-13), which is commonly referred to as the current expected credit loss, or CECL model. The new standard eliminates the "probable" recognition threshold in current generally accepted accounting principles, and instead reflects an organization's current estimate of all expected credit losses over the contractual term of its financial assets. .The new model will require a company to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. Companies such as financial institutions and other organizations will be required to use forward-looking information to better estimate their credit losses. It also will require financial statement disclosures to be enhanced regarding estimates used in calculating credit losses..For public companies that file with the SEC, the new standard will be effective for fiscal years, and interim periods within those fiscal years, beginning after Dec. 15, 2019. For public business entities that are not SEC filers, the new model will take effect for fiscal years beginning after Dec. 15, 2020, and interim periods within those fiscal years. For privately held companies, the new model will take effect for fiscal years beginning after Dec. 15, 2020, and for interim periods within fiscal years beginning after Dec. 15, 2021..Despite early requests by a consortium of community bankers to exclude community banks from the new CECL standard, it is applicable to all banks and entities that have financial assets that fall within the scope of FASB's Topic 326..Many financial institutions are already starting the process for implementing the CECL model. Here are some helpful tips to consider as you begin your implementation:.Create an implementation committee: An implementation committee will guide the institution through the process of adopting the new standard. This committee should be educated regarding the requirements of the new standard, the different methodologies available, and the information that will be needed for implementation. This will guide final implementation. Key personnel that may be on the implementation committee include operations personnel, information technology personnel, senior credit officers and the chief financial officer..Review CECL options and select a method: The standard does not dictate a particular model or method that must be used. Common approaches that may be used include migration analysis, discounted cash flow, probability of default/loss given default and vintage analysis..Selecting the perfect method will prove somewhat challenging as there are several methods and versions of the same method that could be used. The implementation committee should select an approach that is appropriate, based on the size, complexity and risk profile of the institution. The method selected may be driven by data available, ease of use, cost, time commitment, what is most relevant, availability of support and the complexity of your institution..Establish a Life Loss approach: Many smaller financial institutions are using annual loss experiences to calculate the historical loss rate. The annual loss can no longer be used for calculating the historical loss experience under CECL. The new standard requires the loss rate to be based on some form of lifetime loss approach. The method for calculating the lifetime loss rate is fairly open. If the financial institution plans on piggy backing off its current method of loan loss reserve calculation based on an annual loss rate, modifications to a lifetime loss approach will be required. .Remember the three elements to CECL: The calculation of the allowance under CECL equals: Historical Loss Rate +/- Current Economic Conditions/Qualitative Factors +/- Reasonable and Supportable Forecasts. Many training sessions and discussions on CECL focus on the historical loss calculation and not on the current economic/qualitative factors and the forecasted economic elements of the CECL calculation. As part of the educational process, institutions should be looking for information that covers all aspects of the CECL calculation process..Consider options for historical data: Obtaining historical loan data may be difficult or limited. In a recent CECL planning meeting for a small community bank, we recommended using previous monthly board reports that provided various loan information for the month. From this information, the bank was able to calculate its historical loss rate. This is an example of having to be creative in obtaining historical loan information that might not otherwise be available using the traditional loan accounting systems..CECL trial runs: Once the method has been chosen and the data gathered, the institution should begin trial runs of the model concurrently with their incurred loss model. This will identify weaknesses in the calculation process and data collection. Refinement of the approach may be needed based on: . Results of the initial calculations Evolution of regulatory perspective, and Best practices seen as peer institutions roll out their models..By starting early in the implementation phase, financial institutions will be better prepared for implementing CECL by having early feedback as to the potential impact the new guidelines will have on earnings and regulatory capital. Financial institutions will have many questions during the process of implementing CECL, and it will be important to reach out to various individuals, groups, accountants, consultants and others to help you through the process. .Tom Fogarty, CPA, and Darrell Lingle, CPA, are partners at Eide Bailly, Fargo, N.D. They can be reached at 605-367-6719 or TFogarty@eidebailly.com, and 701-255-8434 or DLingle@eidebailly.com respectively.