Pub. 8 2017 Issue 3

www.wvbankers.org 18 West Virginia Banker CECL Data Needs By Jim Craven, McQueen Financial Advisors T he Current Expected Credit Loss (CECL) standards are new accounting methods issued for recognition of credit losses for both loans and investments. The change will impact all financial institutions, because it will require up-front recognition of expected credit losses. The standard will be implemented in 2020 and 2021, depending on your structure. Early adoption is permitted in 2017. In the past year, we have spent considera- ble time with clients, audit firms and regulators discussing new standard and implications. This update provides a brief introduction to CECL and some preliminary steps to help you prepare for implementation. Current allowance accounting stand- ards are based on what has already happened related to loan losses or impairment. These principles have been in effect for nearly 40 years and are considered incurred-loss account- ing. Measurement relates to historical annualized charge off ratios. In con- trast, CECL is based on expected future losses. We would all like to believe that no loan will fail, but we know that some will. Under CECL, loan losses have not yet occurred. Instead, future losses are assumed, and the amounts are estimat- ed into the future. Projected losses are recorded upon origination. In addition, loss estimates under CECL are not annual rates, but are estimated total losses over the expected life of a loan pool. The new standard is substantially different from current practices. Un- fortunately, CECL cannot be calculated simply by multiplying annualized loan loss rates by the expected life of a loan pool. This is because loan losses are not linear. In a typical loan pool, losses ramp up over the first few years then taper off significantly. Loss rates, timing and severity are highly dependent on loan type, borrower scores, loan-to-val- ue ratios, economic conditions and loan performance attributes. The new standard will be effective in 2020 for SEC-registered companies and 2021 for all others. That seems like a lot of time, but there is still plenty to do in advance. Estimating CECL starts with a detailed analysis of historical loan-lev- el attributes, losses and economic conditions. Unfortunately, some of the data is probably not being currently maintained. The good news is that implementation is a few years away. Although the required information may differ based on your unique business model, it is important to start collecting and saving information now. There is no such thing as having too much data. Also, it is important that the data is easy to use and analyze. We can always ignore what we do not need, but it may be impossible or expensive to retrieve information at a later date. Data needs fall into three broad categories: 1. Loan-Level Details: A detailed data set will provide the ability to analyze historical data in order to predict the possibility of future losses. Standard loan files typically include account numbers, type codes, purpose, collateral, borrow- er rates, a fixed/variable indicator, caps, floors, payment frequency, amount, due dates, delinquency and amortization period. This infor- mation is often found in standard data files and relates to loan attrib- utes, not loan performance. 2. Loan Performance: In addition to the standard data set above, it will be useful to include delinquency, charge offs, recoveries, default dates, score migration and other performance and condition indica- tors. Consider combining data sets that are typically stored separately. Analysis later will be simplified if