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The Financial Accounting Standards Board (FASB) issued ASU 2016-13, which introduces the current expected credit loss (CECL) model and represents the most significant financial reporting change in decades for many financial services companies. The new standard affects accounting for loans, held-to-maturity (HTM) debt securities, accounts (trade) receivables, net investment in leases, certain off-balance-sheet credit exposures, reinsurance receivables, and other financial assets included within the scope. Although not exclusive to financial services, those most significantly impacted by the forthcoming changes include banks, thrifts, credit unions, insurance entities, and other specialty finance companies.
The CECL model replaces the current “incurred loss” methodology and must be applied at the initial recording of the financial asset. It also considers both current conditions and forecast of conditions that are reasonable and supportable in order to estimate the credit loss over the contractual life of the asset, adjusted for prepayments. This results in an escalation in the timing of the recognition of losses associated with financial assets.
As such, the implementation and ongoing application of the CECL methodology serves to significantly impact capital deployment, earnings projections, and credit risk management on a prospective basis.
Stakeholder Identification and Training
- Identify relevant stakeholders from management, senior management and the Board of Directors.
- Determine structure (working groups, CECL Committee, etc.) for CECL implementation efforts.
- Evaluate training needs and assess internal/external sources.
Risk Identifications and Segmentation
- Identify portfolio characteristics and drivers of portfolio performance.
- Assess current pooling methodologies and consideration of significant risk drivers for each.
- Evaluate effects on pool life and credit risk and modify as needed.
- Perform historical trend analysis and assess alignment with risk drivers.
Data Inventory and Gap Analysis
- Identify the data elements and related sources that are needed.
- Determine the accessibility of accurate and complete data sets.
- Identify data gaps and assess alternatives.
Technology and Resource Assessment
- Assess the capabilities and limitations of in-house systems and resource.
- Evaluate the cost-benefit and suitability of third-party providers/solutions.
- Select model(s) and perform a parallel run.
Governance and Oversight
- Define ongoing roles of senior management and the Board of Directors.
- Develop formal policies, procedures, and processes around the maintenance and execution of the CECL model.
- Establish initial and ongoing processes for internal and external financial reporting and disclosure (Internal Controls over Financial Reporting or ICFR).