ABA Banking Journal - September/October 2016 - (Page 20)
> LOAN LOSS ACCOUNTING
What You Need
to Know Now
BY MICHAEL GULLETTE
he Financial Accounting Standards Board's newly
finalized Current Expected Credit Loss Accounting
standard, also known as CECL, represents the biggest
change to bank accounting ever. If you're a CEO
and you just tell your CFO to take care of this, you
will spend a lot of money on this-and fail. Your capital will
swing back and forth, and each quarter's results will be a big
guessing game. This will negatively affect your ability to serve
your customers and communities. Don't just think of CECL as
an accounting change-but rather a change to how all banks
manage their business.
My bet is that you have concerns about CECL. We do, too.
The American Bankers Association recommended to FASB
an impairment accounting model that largely reflects how
you evaluate loan impairment today. Instead, FASB opted to
require that both current and future losses in a portfolio be
recorded. This will require an overhaul of many processes
throughout your company. You will incur additional costs not
only in setting up a CECL process, but also in running it on an
ongoing basis thereafter.
A major change
Current accounting principles have been in place for about
40 years and loan losses are handled under "incurred loss"
accounting, meaning something probably happened that
caused impairment to the loan. For practical purposes, that
impairment is normally measured in pools of loans and is
heavily based on historic annualized charge-off rates.
In contrast, CECL is an "expected loss" notion. An event does
not have to have occurred, but can be expected in the future.
Further, the historical data that CECL relies upon are not
annual loss rates, but life-of-loan or life-of-portfolio loss rates.
This is a big difference that can be very easily misunderstood.
ABA BANKING JOURNAL | SEPTEMBER/OCTOBER 2016
Conceptually, I like to think of current accounting as recording
the losses in your portfolio and CECL as recording the risk in
CECL itself is actually relatively simple. First, a life-of-loan
loss expectation is effectively recorded at origination. For
practical purposes, just like we do today, this will be done for
pools of loans. This requires a forecast of the future, including
economic indicators such as interest rates and unemployment.
Historic averages of life-of-loan losses are very important
in CECL. Like today, they are used as the starting point for
estimates of expected loss. Many bankers, from large banks
and community banks alike, have expressed concern about
their ability to forecast into the future past a couple of years.
Under CECL, you will forecast as far into the future as you can
(that's what I call the forecastable future), then use unadjusted
historical averages of losses past that point.
Table of Contents for the Digital Edition of ABA Banking Journal - September/October 2016
CECL FROM THE INSIDE: A CONVERSATION WITH FASB’S RUSSELL GOLDEN
WHERE ‘HABITS OF ECONOMY’ WERE SHAPED
CARD-LINKED REWARDS GIVE BANKS A COMPETITIVE EDGE
ABA COMPLIANCE CENTER INBOX
FROM THE STATES
CORPORATE SOCIAL RESPONSIBILITY
INDEX OF ADVERTISERS
ABA Banking Journal - September/October 2016