The Financial Accounting Standards Board (FASB) released a much-anticipated standard that introduces the current expected credit losses (CECL) methodology. The CECL model requires financial institutions to immediately record the full amount of predicted credit losses in their loan portfolios rather than waiting until the losses are deemed probable (as required by the current incurred loss model). The standard requires financial institutions to present assets measured at amortized cost at the net amount (of an allowance for credit losses) expected to be collected.
The income statement will reflect the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the relevant reporting period. The measurement of expected credit losses will be based on pertinent information about past events (including loss experience), current conditions, and the “reasonable and supportable” forecasts that affect the collectability of the reported amount.
The CECL shifts the focus from a one-year period to the entire life of a loan. Learn more about how this change could affect your community bank.
The FASB does not prescribe a specific technique to estimate credit losses. Instead, it allows companies to exercise judgment in determining which method is appropriate for their “good fortune.” The mandate allows companies to continue to use many of the loss estimation techniques currently employed, including loss rate methods, probability of default methods, discounted cash flow methods, and aging schedules. However, the inputs of those techniques will change to reflect the full amount of expected credit losses and the use of “reasonable and supportable” forecasts.
The new standard also changes the reporting for credit losses on purchased financial assets with credit deterioration since origination. The allowance for credit losses for such assets will be determined in a manner similar to that of other financial assets measured at amortized cost – except that the initial allowance will be reflected in the purchase price rather than recorded as a credit loss expense. Additionally, credit losses on available-for-sale debt securities will be recorded through an allowance for credit losses rather than a one-time write-down.
The mandate expands the disclosures of credit quality indicators related to the amortized cost of financing receivables currently required. The disclosures must be disaggregated by their years of origination (or “vintage”). Note: Disaggregation by vintage will be optional for nonpublic institutions.
Let CRI Help You Predict Your Expected Credit Losses
The new standard is effective for calendar year-end public companies in 2020 and for other calendar year-end entities in 2021. While we may not be fortune tellers, we are ready to help you gather the knowledge and data to prepare for this fundamental change in accounting for credit losses. Contact CRI for proactive assistance with implementing the CECL methodology at your community bank.