Does the resumption of student loan repayments impact your credit union’s Allowance for Credit Losses?
That’s a question NCUA wants all federally insured credit unions to answer now that the COVID 19 forbearance period on the payment of student loans has come to an end. It provides one of the first tests of how well prepared your credit union is to comply with the updated Current Expected Credit Losses methodology.
All but the smallest credit unions must now comply with ASU 2016-13 (fasb.org) which determines when credit losses must be recognized for accounting purposes. CECL, of course, is a crucial concept for financial institutions that are obligated to put aside adequate funds to absorb credit losses.
Under the old methodology, credit losses did not have to be recognized until a loss was ‘probable.’ To its critics, this approach resulted in delinquencies being recognized too late in the lending process and didn’t give the public or examiners an accurate view of a financial institution’s balance sheet.
The new methodology is designed to make financial institutions account for losses earlier in the lending cycle by anticipating a loan portfolio’s ‘expected’ losses and ensuring adequate reserves are put aside to account for them. Although the precise methodology used to make this determination varies depending on a credit union’s size and loan complexity, this new standard requires credit unions and banks to make defensible assumptions about a loan portfolio’s likely performance.
This is accomplished, in part, by identifying groups of loans that share common risk characteristics. As explained by NCUA, the new accounting standards “require[s] expected losses to be evaluated on a collective, or pool, basis when financial assets share similar risk characteristics, but does not prescribe a process for segmenting financial assets for collective evaluation. Financial assets may be segmented based on one characteristic or a combination of characteristics, and management should exercise judgment when establishing appropriate segments or pools.”
In the context of student loans, for example, your credit union could identify members resuming repayment who have elevated debt-to-income levels, which put them at a higher risk of falling behind on car or credit card payments owed to the credit union.
To learn more, reach out to Henry.