This past summer, the Financial Accounting Standards Board (FASB) delayed the implementation of CECL for credit unions moving it to January 2023. Although this will provide credit unions some relief in implementing CECL, many credit unions continue to cite compliance with CECL as one of their top concerns. Some groups are campaigning to have CECL abolished for credit unions and point to the fact that credit unions, in general, did not cause the issues that led to the creation of CECL. Besides, a majority of credit unions typically have appropriately funded allowance accounts.
As strong credit union advocates, we certainly support such endeavors and are in complete agreement with the reasoning. However, in our continued efforts to help credit unions, we’ve taken a different approach. Rather than spend energy and resources trying to make CECL go away, we’ve focused on how to make CECL compliance comfortable, easy, affordable, and attainable.
At Mark H. Smith, Inc., we believe the right approach and methodologies for CECL do not need to be a daunting task and a tremendous resources drain. Instead of hoping for a seemingly difficult challenge to go away, we’ve chosen to address it head-on for credit unions. In this article, we discuss some of the areas of concern and provide you with some considerations.
Data Requirement
One area of concern around CECL has been the historical data requirement—particularly the questions of what data do I need and how far back. Some (in-sourced and out-sourced) solutions stipulate five to seven years of historical loss experience data. This sounds reasonable on the surface, but will that be sufficient to help you forecast expected loss for the estimated remaining life of the loan portfolio? Another approach suggests the credit union needs to look at its own historical credit loss experience through a full economic and credit cycle. Unfortunately, for the recent cycle, that would mean over ten years of data and most likely closer to 15 years.
Another consideration is what if the next several years of credit performance conditions don’t look like the last several years? Put another way, what-if economic growth contracts, unemployment increases, and credit loss conditions change from the past several years? One answer could be that an adjustment would be necessary, but what is that adjustment, and how does it relate to your credit union’s loan loss experience and expectations? Is the adjustment predictive of your credit union’s specific loss experience or does it rely on other factors that may not be related to your credit union? The right amount of data elements and the amount of history needed for an excellent CECL solution continues to be a question for many credit unions.
Data Assessment
How to prepare for CECL and what data is needed are essential questions in performing your CECL assessment, and we completely understand that it can sound rather daunting, particularly for credit unions with staff and resource limitations. After all, you have a credit union to run and members to serve as opposed to spending your time gathering and assessing years of historical data. At Mark H. Smith, Inc., we have learned that it doesn’t need to be a significant resource drain for the credit union at all. The answers lie in choosing a methodology and solution that works for your credit union. Options are available that may not require you to spend your time gathering and assessing years of data. Don’t look at in-house or outsourced solutions and think they all have the same data gathering and assessment requirements. Ask yourself if you want to do all of the data gathering, cleansing, analysis, and reporting,or do you want the methodology and/or solution to do the work for you? All solutions are not created equal, and there is the right solution for your credit union. For example, consider the possibility that you can meet the historical look-back time frame and data element considerations discussed above without having to expend a lot of your resources. Your own credit union’s historical loss experience data may be readily available with the right methodology. We have seen in-house as well as out-sourced solutions with methodologies that are very resource-draining while others are a piece of cake. We encourage credit unions to look for in-house and outsourced solutions that complement business goals and objectives, fulfill the CECL requirements, and enable staff more time to serve members.
Forecasted Loss Experience
Following the above data assessments, we have found some credit unions with a few loan types that do not have enough historical loan loss experience (due to the number of loans or lack of enough history) to mathematically and reliably use as a component for forecasting loss experience. Also, keep in mind there is an optimal level of segmenting loan types. More segmenting does not necessarily mean better or more compliant results. Too much segmentation can result in a higher degree of error or unreliability as segmented sizes become too small.
We strongly suggest that a credit union’s first and primary CECL analysis and assessment should begin with using their own loss experience, but we have found that for smaller loan portfolios, it is also imperative to have peer loss experience resources for comparison. The peer information is not only insightful to the credit union but in some instances, it is crucial to provide support for the CECL results. Loan types with a small number of loans can be problematic, but new loan types, new lending goals, change in underwriting practices, and other loan developments should be considered. Peer historical loss information comes into the equation to supplement and in some cases, support or confirm the results of the analysis using the credit union’s own historical loss data. In the hundreds of CECL reports that we have run for credit unions, we have learned that peer and industry comparison loss experiences by loan type are a crucial part of their CECL analysis. In determining the right solution for your credit union, the availability of peer and industry loss experience, along with having more than one methodology available for comparison should be essential components.
Wishful thinking can at times be a strong force to make the positive happen, and we are all about working to make the positive happen for credit unions. However, wishful thinking to make a FASB requirement go away is probably not the best strategy. That doesn’t mean addressing CECL has to be an insurmountable endeavor as many fear-mongers would have you believe. With the right approach to finding the right solution and methodology, CECL can be comfortably addressed without being a resource drain. If you would like to know more about how Mark H. Smith, Inc. can help your credit union comfortably, easily, and affordably address CECL, please feel free to contact us.