If you are looking to get any type of loan, then you need to understand the recent changes in finances. These changes came with the passage of the Current Expected Credit Losses (CECL) were announced on June 16, 2016, by the Financial Accounting Standards Board. They will go into effect for all entities with a United States Stock Exchange Commission listing on December 15, 2019. The goal behind CECL is to stabilize the market so that huge financial swings cannot cause a global recession.
CECL is a Big Change
Until CECL was implemented, financial institutions did not include losses in their portfolios until 90 days after a loan payment was missed. Now, these institutions calculate the expected loss average into their portfolios at the time that the loan is first generated. From the beginning, many have criticized the new CECL plan because non-prime borrowers find it harder to get a loan. Many fear that after a downturn in the economy, this will make it harder for the market to start moving in a positive direction again. It also requires financial institutions to see into the future to determine what the market might do.
What Does the CECL Do?
U.S. SEC entities must file an allowance for loan and lease losses (ALLL) regularly. Under current laws, they use Financial Accounting Standards (FAS)-5 and FAS-114. Under FAS-5, a loss must be included in the entity’s balance sheet if it is probable that an asset has been impaired while under FAS-114, the loss must be included if it is probable that the entity will not be able to collect the money that is due on the loan that it made. On December 15, 2019, entities must switch to using CECL. You need to understand how CECL affects ALLL. Under CECL, the calculation of the expected credit loss must now be calculated over the loss of the loan. Therefore, everyone can expect discounted cash flow rates to occur after the change is made.
Who Will Be Affected by Changes in CECL?
While those holding U.S. SEC licenses, like banks and credit unions, will be the most impacted by the changes in accounting methods, many other businesses will be affected as well. If you own a company that makes any type of loan, then you will be affected by the changes. This includes car companies who offer their own financing, rent-to-own furniture stores and mobile phone companies who let you purchase your phone over time. The changes will not occur all at one time, so consumers will see a rollout of the new rules. While those regulated by the SEC must be in compliance by December 15, 2019, public businesses who do not have to file with the SEC have until December 15, 2020, to be in compliance. Private companies do not have to be in compliance until December 15, 2021.
How Could the CECL Affect the Economy?
CECL could have a major impact on the economy. Even if the total amount that SEC entities and others need to keep in reserve remains unchanged, the new rules may still affect the amount of money available for lending. Entities will have to put back the money sooner, and that may make them less willing to loan money. The largest impact may be seen on long-term loans because the entity will have their money tied up for a longer period of time. Therefore, long-term loans, such as 30-year mortgages, may have a higher interest rate to cover the cost of having the money tied up that long. The switch is designed to act as a countercyclical weight in the credit cycle. Lenders will be forced to look forward, so highs and lows may not be as dramatic.
Will CECL Level the Playing Field?
Following the 2008 financial crisis, banks and credit unions became much more tightly regulated. This gave rise to a new type of lender who did not have to comply with those new regulations. The new methods will require all types of lenders to play by the same rules within the next three years. This can be seen as good news for traditional lenders while those who have used aggressive marketing techniques to get new customers outside of traditional methods may be most severely affected.
What Should Companies Do to Implement CECL?
Those companies who lend money need to be actively making changes in their procedures to meet CECL implementation. The first step is to install the needed software and get key personnel trained to use that software. Then, loan paperwork must be modified to recognize the changes that were made.
CECL is one of the biggest changes to lending methods to ever occur in the United States. The road will not be a smooth one, but you need to start moving forward now to prepare for it.
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- Warren Averett