34 Hoosier Banker June 2015 LENDING / CREDIT As of this writing, the Financial Accounting Standards Board (FASB) is nearing the end of a multiyear project to revise accounting rules surrounding the recognition of impairment on financial assets. In plain English, this means that a fundamental change is coming to the rules and approaches used by financial institutions to estimate the allowance for loan and lease losses (ALLL) and the level of provisions needed to fund the ALLL. The new standard may well be released in 2015, though there will be a transition period, and the effective date of the new standard has not been decided. The main change from current practice in the proposed CECL model (current expected credit loss) is that institutions will be required to reserve for expected lifetime losses for the held-to-maturity loans (and several other types of financial assets) in their portfolios. This “expected loss” model is a departure from the current “incurred loss” model, which requires that a loss be “probable” before reserves are recognized. While detailed planning for transition to the CECL model can await the FASB’s final standard (and likely regulatory guidance in response to the standard), all financial institutions would be wise to begin some preliminary planning now. Practical Planning for the CECL Model At this stage, any bank planning for the transition to the CECL model should assess its likely data needs under an expected loss approach and begin working to fill in data gaps to ensure the integrity of existing data. The FASB does not intend to be prescriptive with respect to the exact methodology used to determine lifetime losses. However, loss estimates will be expected to be informed by historical experience, current circumstances and even “reasonable and supportable forecasts” of the future. Further, there is no reason to believe that standards for the types of factors that influence lifetime expected losses ‒ and therefore should be considered in an institution’s ALLL methodology ‒ will be lowered from current expectations regarding incurred losses. This means that all of the factors that a bank currently considers to be relevant for estimating incurred loss will remain important considerations under the CECL model, and the adequacy of segmentation also will remain a key factor. Qualitative factors will continue to be a meaningful part of the ALLL methodology, as well. There are a few areas of data on which it may be practical to begin focusing now: • Loan duration. A necessary component of a lifetime loss approach is the expected life of a loan in a particular segment. Each segment of loans considered in your bank’s ALLL methodology may have a certain contractual structure, but in practice prepayments and defaults will lead to an expected life that is shorter than the contractual structure. There certainly remains some room for clarification of how the new approach will be expected to work in practice for revolving credit. • Economic factors. Though the state of the economy should be a qualitative factor consideration About the Author Tommy Troyer is senior consultant and loan review manager of Young & Associates Inc., Kent, Ohio. In addition to assisting clients with loan reviews, he performs ALLL reviews, credit process reviews and other lending-related services. He also helps develop and present seminars and webinars related to credit risk management. Troyer previously served with the Federal Reserve Bank of New York, initially in the research group, then in the bank supervision group, where he focused on credit risk management practices at supervised institutions. Troyer earned a bachelor’s degree from Wittenberg University. The author can be reached at 330-678-0524, email: ttroyer@ younginc.com. Young & Associates Inc. is an associate member of the Indiana Bankers Association. Looking Ahead: Proposed Changes to the ALLL
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