Understand What Is Changing With CECL
Our familiar incurred loss method is being replaced by the Current Expected Credit Loss (CECL) method. No longer will it be sufficient or acceptable to book reserves as losses happen. Instead now we must estimate and book expected lifetime losses at the origination date of the loan.
Discover How CECL Works
CECL has three main parts. Historic loss rates, adjustments for current conditions, and adjustments for expected future conditions. The adjustments allow management some latitude but are designed to complement, not co-opt, the loss rate component. Your historic loss rates will be the biggest and most important part of the CECL puzzle.
Consider Your Data Requirements
You may use aggregate or loan level loss rate calculations. Data depends on which one you select. Aggregate uses data from regulatory filings and is readily available. Loan level will require many years of detailed history data on every individual loan, loss and recovery, along with mapping info and personally identifiable info to tie all the pieces together.
Adjust Reserve Expectations
Today’s incurred method measures the current loss in the portfolio, often expressed as an annual loss rate. CECL will measure the current risk in the portfolio and will usually be quoted as a lifetime loss rate. It makes sense that lifetime loss rate reserves will exceed annual loss reserves, so plan for a bigger (perhaps significantly bigger) reserve with CECL.