February 25, 2019

CECL Might Revolutionize Lending -- Here's How

Excerpt

The new CECL accounting standard may cause lenders to move toward shorter-term loans and higher interest rates going forward.

Post

Banks are beginning to indicate that the Current Expected Credit Loss (CECL) standard required by the Financial Accounting Standards Board (FASB) will change the conditions under which loans are originated and their terms, according to American Banker.

Interest rates on loans could rise due to the impact of CECL.

Concerns About New Standard

The most controversial part of the CECL is the requirement that lenders project the lifetime credit losses of a loan when the loan is originated versus the current standard, which recognizes loan losses when they become probable. 

CECL is designed to reduce the risks banks faced during the 2008-2009 financial crisis by mandating that lenders look at their past records and market conditions to forecast expectations and capital reserves. The CECL model requires financial institutions to take a more forward-looking approach to estimating losses, relying on their own historical data and market information to develop forecasts. The idea is to build in more potential warning of worsening conditions, according to Compliance Week.

Bankers widely consider CECL one of the most significant changes in accounting standards ever enacted. Banks that are publicly traded currently have until January 1, 2020 to convert to CECL from current standards. Privately held banks and credit unions have until 2021 and 2022, respectively.

The new accounting standard was rolled out to make credit lending standards more forward-looking.

Short-term Loans, Higher Rates Likely

If CECL is implemented as planned, the requirement that losses be forecast upon origination is especially likely to change the way banks and finance companies do business. They may focus more on short-term loans and higher interest rates, as well as tougher standards.

Higher interest rates would allow lenders to offset the needed reserves that must be placed on the books.

Observers note that they could also provide less guaranteed financing at the beginning. In a $100 million deal, for example, only the initial 10% may be funded immediately, to reduce CECL’s effect.

Lenders may also be weighing options on mortgages and commercial real estate lending.

Subprime lending is likely to be reduced, quickly and perhaps significantly.

How a Seasoned Loan Sale Adviser Can Be on Your Side

While it isn’t known what shape or form CECL will ultimately take, this much is clear: lenders need to actively manage the purchase and sale of loans on their balance sheet. If your business is moving to short-term loans and high rates, a seasoned loan sale adviser, such as Garnet Capital, can help you stay ahead. 

Our expertise and reach can be critical in helping to manage portfolios as the effect of CECL unfolds. Sign up for our newsletter today.