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Changes in Accounting for Allowance for Loan Losses and Investments
Wednesday, February 10, 2016 6:30 AM

Cheryl Ehmann, AVP Staff Analyst, Credit Union Resources

You may or may not have heard the news that the American Institute of CPAs (AICPA) is issuing a new pronouncement on how to record credit losses. This is causing quite a lot of concern in the financial services industry and, in particular, in credit unions.

The new method of accounting for such losses is referred to as the Current Expected Credit Loss method. The acronym for this model is CECL, and it's pronounced Cecil. This is drastically different from the way credit unions currently determine how much money should be in the Allowance for Loan Loss account.

This will also impact the way credit unions account for investments. Once the new pronouncement is in effect, an allowance account will be established for investments too. This will replace the different accounting required for investments classified as available for sale or held to maturity and available for sale investments.

At this point, not a lot of detail is known about exactly how credit unions will be expected to comply with the new standard. The new pronouncement is expected to be issued in early 2016, and will more than likely have a three-year phase-in for implementation. Credit unions would be among the last required to implement the standard, so we are looking at a probable drop-dead date of 2019 or 2020. And it is very likely that NCUA and other regulatory agencies will issue their own guidance as well. But don’t think you can put off preparing for the new rules until then.

The new standard will require you to account for all contractual cash flows (interest and principal) that are not expected to be collected. This is going to require a lot of high-level math. You will have to use regression analysis in order to determine the probability of default on your loans. In short, most credit unions will require outside assistance. 

The most important aspect of preparing for this change is making sure you have the necessary data. Start now to collect and store all the data you can that might impact this calculation, including things like credit scores (ideally collected at least quarterly on borrowers).

Collect month-by-month charge-off and recovery data for every different category you can think of. An abundance of data will be key to having flexibility in determining the required allowance account balance. The more data, the better the forecasting model.

You will need to have a least one life cycle plus one year for every loan pool you have, which will utilize different time periods. For example, if you offer 30-year mortgage loans, you will need 31 years of history on those; but if your new car loans pay off on average in 24 months, you will need 36 months of history on those (one cycle of 24 months plus one year, or12 months).

Some things to consider:

  • How do you determine what year an open-end loan was granted? Do you track each advance separately? Do you assign it to the year the plan was opened? 
  • Deferred fees and costs (origination fees, etc.) will affect the yield on loans and will play into the calculation.
  • Credit commitments that are not yet funded will need to be included in the calculation (e.g., credit card credit lines.)
  • Troubled debt-restructured loans will need to be written up or down immediately based on present value calculations—yes, believe it or not, they could actually be written up—and then added back into the loan pools.

For investments, you will need to determine the risk of loss at the time you purchase the investment.

The bad news is this looks like a really complicated change. The good news? You have time to prepare. Get started collecting data now. We will keep you updated as more details become known.

Credit Union Resources is a subsidiary of Cornerstone Credit Union League. For more information, please visit