Ready or not, CECL is coming.
The current expected credit loss, or CECL, standard was instituted by the Financial Accounting Standards Board (FASB) in June 2016, giving financial institutions time to prepare for what promises to be a sweeping change in calculating credit losses.
The CECL standard goes into effect for public banking entities on Dec. 15 2020, and for nearly everyone else by the end of 2021. Though the deadline may seem far away, the adjustment could be complicated—so proper planning is essential for a smooth transition.
The upheaval caused by CECL is expected to be significant. A Deloitte survey found that 90 percent of responding banks expect the new standard will have to be implemented by stakeholders from more than just credit modeling and finance/controller groups. IT, compliance, various reporting groups, and other lines of business will be affected by CECL. Buckle up—this ride may get bumpy.
What Is CECL?
Current expected credit loss redefines how financial institutions set aside money in anticipation of loan losses. CECL combines historical lifetime losses, adjustments for past and current conditions, and a reasonable and supportable forecast to determine how much capital should be provisioned to offset potential loss. A reason for this change is to avoid a repeat of the lending crisis that factored into the 2008 recession, when banks suddenly found themselves unable to cover defaults.
The big change with CECL: Expected credit loss must be calculated for the life of the loan. Although this is proactive in theory, practical implementation becomes a challenge, which is one reason why the FASB pushed back its CECL deadlines.
How Does It Affect Lenders?
Lenders grappling with CECL face the obstacle of developing new credit models to account for expected losses. Participants in the Deloitte survey cited this as the top challenge in implementing the new guidelines. More data and analysis, which might not be available under current methods, will inevitably be necessary for this modeling to be effective. Also, what constitutes a reasonable and supportable forecast is a loaded question; lenders must figure out what thresholds are sufficient to comply with CECL and minimize risk.
Combine the aforementioned factors with the need for additional reporting, and lenders are looking at more work and potentially fewer resources for mortgages. Furthermore, loans with shorter terms or higher interest rates may be more favorable in computing CECL, however these products aren’t as popular with borrowers and could reduce the number of loans originated.
How Does It Affect Borrowers?
To borrowers, CECL may appear administrative—a minor accounting tweak that happens behind the scenes and doesn’t affect them. However, requiring more capital to offset heightened loss expectations, the lender could possibly tighten credit requirements to secure a mortgage. The new guidelines may also impact taxes in ways even the accounting industry has yet to fully understand.
The Role of Technology
CECL offers multiple benefits, including reduced risk and stronger portfolios, to make the effort worthwhile. Technology can help lenders comply with CECL and set them up for success after the deadline passes.
A good LOS helps by offering:
- A streamlined mortgage process can lighten your burden if CECL adds more steps
- Strong data collection and analysis capabilities that assist in meeting the new standards
- Robust reporting and compliance features
- Timely updates to help keep you in compliance with the most current CECL rules and amendments
The vendor that supports your LOS can also be an asset when trying to sort out CECL standards. For a technology partner with decades of experience in the mortgage industry, developments such as CECL aren’t platform-busters, but rather another standard to address with lenders. The best providers will help you through the CECL journey and support your team beyond implementation.