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22 | TH E M R EP O RT FEATURE T he credit loss standard (CECL) issued by the Financial Accounting Standards Board (FASB) overhauls the current impairment models for loans, leases, and debt securities and also impacts commit - ments. It removes the "probable" threshold under the "incurred loss model" for recognizing credit losses. We will explore the new CECL Standards in terms of what they do and how they impact the financial Industry, and what it will take to implement CECL in summary. Then we'll take a look at pre - liminary disclosure format exam- ples: scope, sample sizes, and data requirement. We'll close with a review of how Mortgage Industry Advisory Company (MIAC) is helping our clients prepare. Overview of the Rules F irms will be required to report the current estimate of lifetime loan losses, incorporated into the Allowance for Loan and Lease Losses (ALLL): thusly, CECL brings fair value into the ALLL. While a DCF approach was considered by FASB in exposure drafts, the final standard allows any approach, as long as it is rea - sonable. Institutions, auditors, and regulators will decide, so early discussions are encouraged. Both quantitative and qualitative methods are to be utilized jointly in a process that is generally de - scribed. Although there is a strong a bias to the use of cash flow models with assumptions powered based on quantitative data and "reasonable" scenarios, a justified historical loss-based result, which is quantitative only, could suffice. The basis of Allowance Estimates is that CECL requires that estimates be based on relevant information about past events, in - cluding both qualitative and quan- titative factors such as: Historical loss experience with similar assets, then-current conditions, includ- ing evaluations of the borrower's creditworthiness, and reasonable and supportable forecasts that affect the expected collectability of the financial assets' remaining contractual cash flows. Historical experience is quanti - tative information, so many mod- els are based on it. Reasonable forecasts and conditions assess- ments are qualitative in nature as they must provide a forecast direction and estimate. Any fac- tors not otherwise addressed in the final process are likely to be qualitative in nature. Other qualitative factors include: • Changes in lending policies and procedures, collections, etc. • Changes in the experience of management and staff • Changes in the quality of the loan review system Financial assets carried at am - ortized cost less a loss allowance will reflect the current expected cash flows to be collected and the income statement will reflect the credit deterioration or improve - ment. If financial assets are carried at fair value with changes in fair value recognized through other comprehensive income (OCI), the balance sheet would reflect the fair value, but the income statement would reflect credit deterioration or improvement. Under some circumstances, the institution can elect not to recognize expected credit losses on assets held at fair value. The conditions are that both the FV exceeds or equals the amortized cost, and if expected, credit losses are insignificant. What Will it take to Implement CECL? A n array of new processes will be required, including but not limited to management, governance, risk reporting, con - trols, and functional integration. Program management will be the start, as will be newfound coordination among functional areas such as finance, originations, credit, operations and technology, and a revised governance and risk management framework. Segmentation of loan, lease, and debt portfolios into clearly identifiable portions with similar and discrete characteristics is the next step. This means specific identification and description of the characteristics of the assets will be used to model probability of default (POD) and loss given default (LGD) to make the ALLL processes Basel compliant, plus development of specific credit risk modeling and forecasting models and tools. FASB will require institutions to develop well-documented data management and data qual - ity processes. Validated Extract- Transform-&-Load (ETL) systems and procedures and data quality reporting must be created. Next, firms will identify control points in the origination and operations areas to ensure adequate support and data cap - ture, and integration of new tools within Financial and Regulatory Reporting Procedures. Importantly, dual (jurisdiction?) reporting institutions—CECL and IFRS 9—firms will need to: Handle 12-month (IFRS 9) Raising the Standards of Success The CECL is bringing fair value into the ALLL. Learn how the standards are impacting the financial industry—and how you can make sure you implement them smoothly. By Dean Hurley and Jeffrey Zuckerman