Can CECL be easier for credit unions? Explore your options.

The current expected credit loss, or CECL, the accounting standard for estimating the allowance for credit losses became effective for federally insured credit unions for financial reporting years beginning after December 15, 2022.  CECL requires the consideration of past events and historical experience, current conditions, and forecasts during a reasonable and supportable period in the measurement of expected credit losses over the contractual life of loans and debt securities.  It considers all asset classes on the credit union’s balance sheet and therefore typically impacts all departments of the credit union in some way.

Some challenges that CECL has presented for both large and small financial institutions alike included:

• Gathering sufficient historical data over a full economic cycle
• Selecting and applying a reasonable and supportable forecast
• Over reserving or under-reserving the required loan loss allowance
• Considering the impact of prepayments and unfunded utilization during the contractual life
• Managing reserve volatility due to changes in economic forecast or portfolio composition
• Demonstrating and documenting governance and effective challenge for the methodology and assumption decisions

Now that CECL is in place at most credit unions, it’s time to assess how effective your CECL process is now and in the future for your institution.  Were you able to successfully address the challenges presented by CECL?  Are you satisfied with the methodology that was selected?  Are the results of your credit loss estimation in line with management’s expectations?  Is your process efficient and transparent or time-consuming and confusing?  How can the data and analysis required by CECL be leveraged to enhance the management of credit risk?

Maximizing the benefits of CECL implementation

After going through the burden of implementing CECL, it’s understandable to want to let it ride and not make any changes to the initial decisions that were made.  However, it is important that all institutions continuously explore options and look for opportunities to enhance their CECL process.  It’s tempting to take the path of least resistance and just do what needs to be done but putting in a bit more investment up-front may pay dividends in the short and long run.  And remember if an institution goes down the wrong CECL path its impacts can be negative and long-lasting.

Consider some of the following benefits from exploring additional options and opportunities for CECL:

• Adding time saving efficiencies and transparency
• Providing flexibility to adapt to changing economic and credit conditions as CECL evolves
• Maintaining high quality data
• Improving and leveraging metrics to measure credit quality and effectiveness of loan structuring, underwriting, and monitoring
• Performing sensitivity analysis to assess the impact of slight or significant movements to internal or external variables
• Supporting loan and deposit growth and strategic initiatives with effective data analytics

Applying a more complex methodology such as Probability of Default (PD) and Loss Given Default (LGD) may seem daunting for a small or mid-sized institution, but it provides more precision and flexibility, especially for portfolios that are growing or have evolving credit risks.  A more precise methodology may also help institutions prepare for and navigate through changes in economic conditions such as movements in interest rates or increases in unemployment. Access to a model library allows you to choose from a variety of prebuilt models. This enables you to quickly adapt to changes in market conditions, apply models to new assets or expand your portfolio. Precision in modeling does not necessarily translate into complexity in process.  In fact, precise models can lead to more accurate and reliable results, which ultimately helps in the decision-making process.  The key is to strike a balance between precision and simplicity, ensuring that the model is both accurate and easy to understand as well as explainable to your Auditors and NCUA Examiners.

Peer data may be used to fill data gaps and pre-developed models are available for ease of implementation.  Since many US financial institutions have been performing CECL estimates since 2020, including through the unprecedented economic environment of the COVID-19 pandemic, powerful and effective tools and resources are available to make CECL less painful and provide insightful portfolio and loan level analytics for improved risk management.

So, it is certainly possible to make CECL easier on your credit union, just be open to exploring your options! Learn more about the solutions mentioned in this article here.