ABA Banking Journal - September/October 2016 - (Page 20)

FEATURE > LOAN LOSS ACCOUNTING CECL: What You Need to Know Now BY MICHAEL GULLETTE T 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. 20 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 your portfolio. 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

PRESIDENT'S VIEW
UPFRONT
LEGAL BRIEFS
PICTURE THIS
COVER STORY
CECL FROM THE INSIDE: A CONVERSATION WITH FASB’S RUSSELL GOLDEN
WHERE ‘HABITS OF ECONOMY’ WERE SHAPED
HAT TIPS
CARD-LINKED REWARDS GIVE BANKS A COMPETITIVE EDGE
MARKETING
CYBERSECURITY
BANK-INSURANCE SALES
ABA COMPLIANCE CENTER INBOX
FROM THE STATES
CORPORATE SOCIAL RESPONSIBILITY
INDEX OF ADVERTISERS

ABA Banking Journal - September/October 2016

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