With implementation of the new Current Expected Credit Losses accounting standard required by December 2022, many impact lenders are beginning to feel the pressure of the impending deadline. As CDFIs begin accelerating efforts to implement CECL, many questions naturally arise.
Let’s start with the basics. What is CECL?
On June 16, 2016, the FASB issued Accounting Standards Update No. 2016-13, Financial Instruments—Credit Losses (Topic 326). The new guidance requires organizations to measure expected credit losses for financial instruments considering: 1. Historical experience, 2. Current conditions, and 3. Reasonable and supportable forecasts for future performance.
The dual aims of CECL are (i) to provide institutions with greater flexibility in the recognition of expected losses compared to the incurred loss approach CECL is replacing and (ii) to provide readers of financial statements greater clarity into how losses have been estimated.
My CDFI has never struggled with significant losses. Do we still have to implement CECL?
Yes. For many CDFIs, after years of holding 5% loan loss reserves and seeing annual charge-offs from 0-3%, going through the process of CECL implementation can seem like an undue hassle. However, high-performing CDFIs can also see this as an opportunity. CECL implementation will give you a rigorous, data-backed logic for your loss expectations, which may allow you to reduce your loan loss reserve—improving your net assets ratio and potentially improving your fundraising ability as a result.
CECL sounds complicated—do I need an equally complicated system to implement it properly?
Not necessarily. Federal bank regulators have said that for non-complex financial institutions—which means most CDFIs—a well-structured Excel model is sufficient to properly implement CECL. As long as high quality data and a well-reasoned framework are in place, the tool used to implement CECL does not need to be expensive, complicated, or hard to use.
If I don’t need a high-cost software solution, then what do I need to implement CECL?
The #1 requirement for a successful CECL implementation is quality data—both for your own institution’s performance and for external factors that can contribute to a supportable forecast for future losses. Internal data includes historic losses, information on changes in your portfolio over time, and your current portfolio composition. Institutions should perform segmentation analyses to identify loans that share risk characteristics that are likely to be deterministic of future credit losses across various economic conditions. External factors that may become part of your forecast can include data on the U.S. economy, sectors you lend in, the CDFI industry, and other relevant indicators. Once you have that data assembled, you need to enter it into a model that can interpret it to produce the “supportable forecast” that is key to CECL.
What can High Impact do to help?
Our team specializes in CDFI portfolios and understands the common data challenges CDFIs face when trying to conduct fund analytics. We manage data compilation, scrubbing, and analytics leveraging our deep CDFI knowledge.
After analyzing portfolio performance, our team is able to recommend and implement a modeling approach that fits your organization. Our team will design an Excel-based model that integrates internal and external data to develop supportable forecasts for future losses. Over the course of a 2-3 month engagement, we will populate the model for you and provide recommendations for loan loss reserve holdings that are consistent with CECL guidance. At the end of the engagement, we turn the model over to you for your ongoing internal use. Engaging High Impact is the stress-free, long-term solution to CECL implementation for CDFIs.
Interested in engaging High Impact for your CECL implementation? Contact us today at firstname.lastname@example.org or visit our CECL webpage to book a call.