Branching Out

Heading for GAAP-ageddon?

‘Hurricane CECL’ may be the newest game-changer on the block.

August 21, 2015

‘Hurricane CECL’ may be the newest game-changer on the block.

This month’s column deals with an arcane accounting change. While this may sound as exciting as an NCUA board meeting, it’s something that, at the very least, could leave you nauseated.

Fulfilling the ancient prophesy of “bad news always comes from four-letter agencies,” the issue comes this time from the Financial Accounting Standards Board (FASB). And, true to form, it also has a four-letter acronym: CECL, or the “Current Expected Credit Loss” model.

This is a new way to determine your allowance for loan and lease loss (ALLL) calculation. Why? Following the economic downturn, FASB was asked to look at what failures occurred in the accounting arena. It found four issues:

  1. Delayed recognition of credit losses due to probable and incurred levels.
  2. Inability to consider forward-looking information.
  3. The use of numerous and disparate credit impairment models.
  4. The discovery that some accounting staffs were made up of horses that would beat their hooves to questions like, “Should we cross-collateralize to AIG these worthless loans?”

The theory is that the allowance should be equal to the present value of future loan losses. But it also means you’ll need to perform a complicated calculation to determine your appropriate level of reserves by using historical loss ratios, an estimate of future economic factors, and a Magic 8 Ball supplied by FASB.

The impact of this change will be both unpredictable and consequential. Some of the notable effects:

Increasing allowance requirements. The estimated impact might be huge. One source pegged the increase in ALLL to be 30% to 50% industry-wide—while some institutions might see an increase of up to 300% in ALLL.

Falling net worth, return on assets, and growth. That huge increase in the allowance account will come out of net worth, of course. But the larger impact will come later as new loans will need to be offset with a larger provision for loan loss. Counterintuitively, lenders will realize that not booking loans will lead to higher profits in the short-term.

Rising prompt corrective action (PCA) implications. Lower net worth might force some credit unions to fall below the regular PCA capital threshold of 7%.

Ironically, and for once in my life, I need to give NCUA credit. The agency’s revised risk-based capital proposal will not treat the allowance account as a form of capital. As such, it has no effect.

Growing complexity. CECL is tricky because historic information isn’t nearly as valuable as predictive data.

While the old model relied on pooling and historic loss ratios, this new method requires one to look at aspects such as changing loan to value (to market), recent credit scores, delinquency, and other factors. The continual feed of new data and constant calculation will be much more costly to determine.

The upside? The new system is infinitely less provable one way or the other, so neither you nor your examiner may know if the calculation is right!

Investments might not be immune. Held-to-maturity assets, which also might have underlying credit risk, also should be evaluated using CECL. The ability to pool such assets might be difficult, requiring you to conduct evaluations on a security-by-security basis.

If this sounds like one of those Weather Channel disaster shows, it is. This time, it’s Hurricane CECL, the newest game-changer on the block. While its timing is uncertain, it’s coming. We can only hope NCUA will step in and save the day.

Oops—isn’t NCUA another four-letter acronym? So is “GAAP.”

JAMES COLLINS is president/CEO at O Bee CU, Tumwater, Wash. Contact him at 360-943-0740 or at