According to Walt Disney, “Times and conditions change sorapidly that we must keep our aim constantly focused on thefuture.”

As many credit union executives have likely heard, the current expected credit loss model is a new FinancialAccounting Standards Board accounting rule. According to NCUALetter No. 16-CU-13, CECL is not effective until Dec. 31, 2021, butthe NCUA writes, “…your credit union needs to take steps in advanceto ensure effective implementation of the standard. The board ofdirectors and senior management of your credit union should becomefamiliar with the new accounting standard to assess how the newstandard differs from the existing incurred loss model.” Thestandard changes how credit unions account for credit losses ontheir loans and on debt securities in their investmentportfolios.

In a nutshell, the purpose of CECL is to address delays in the recognition ofcredit losses. In effect, CECL will require credit unions torecord, at the time of origination, credit losses that are expectedduring the life of loans and Held-to-Maturity securities. This isdifferent than the “incurred loss” accounting methodology usedtoday in which losses are recorded by credit unions when it'sprobable that a loss already has occurred.

Some information has been written about the effect of CECL onloans, but very little about its effect on credit union investmentsecurities. Currently, debt securities at purchase are designatedas either Trading, Held-to-Maturity or Available-for Sale. Theaccounting treatment is different for each designation, as are theapplications of CECL and related FASB amendments. Changes may becoming, but here's a quick summary of what we know so far inconnection with CECL's application to debt securities in creditunion investment portfolios:

Securities designated “Trading” are accountedfor monthly on a mark to market basis and the adjustment in valueis recorded to income. Credit losses are accounted for immediately.CECL does not impact securities designated “Trading.”

HTM securities accounting is performed monthlyon a book basis. Valuation changes are not recorded to income orequity. Currently, losses or Other Than Temporary Impairment arerecorded to income when it is determined that a loss has or willsoon occur. HTM is primarily used to reduce volatility to equity.HTM securities will be subject to CECL. CECL will require anallowance on these HTM debt securities for lifetime expected creditlosses, determined by adjusting historical loss information forcurrent conditions and reasonable and supportable forecasts. Theforward-looking evaluation of lifetime expected losses will beperformed on a pooled basis for bonds that share similar riskcharacteristics. These allowances for expected losses must be madeby the holder of the HTM debt security when the security ispurchased. So, when credit unions buy HTM securities, they will berequired to look in the rear-view mirror and also squint down theroad through the windshield to determine whether the new securitywill encounter trouble. If so, the expected trouble must beaccounted for at the time of purchase.

AFS securities accounting isperformed monthly on a book basis. Valuation change is not recordedto income but is recorded to equity in the form of OtherComprehensive Income. Currently, losses or OTTI are recorded toincome when it is determined that a loss has or will occur. Theincome adjustment is recorded as a reduction in the security's costbasis. Recovery of a previously recognized impairment is recordedin interest income prospectively over time. The FASB decided thatCECL should not apply to AFS debt securities. Instead, targetedamendments were made to the existing AFS debt security model. Underthe new guidance, an allowance will be recognized for credit lossesrather than as a reduction in the cost basis of the security.Subsequent improvements in credit quality, or reductions inestimated credit losses, will be recognized immediately as areversal of the previously recorded allowance, which aligns theincome statement recognition of credit losses with the reportingperiod in which changes occur. Consequently, the guidanceeliminates the theory of OTTI, and instead emphasizes determiningwhether an unrealized loss is credit-related, or due to otherfactors. Specifically, the length of time the security has been inan unrealized loss position will no longer be used to determinewhether a credit loss exists. Impairment must be evaluated at theindividual security level, at each reporting period, through acomparison of the present value of expected cash flows from thesecurity with the amortized cost basis of the security.

In addition to most existing disclosurerequirements, disclosure of an allowance roll-forward, bymajor security type, for both HTM and AFS debt securities will berequired. For HTM debt securities, by major security type,disclosure of credit quality information and allowance for creditlosses and management's estimation process will be required. Also,for AFS debt securities, disclosure of the accounting policy forrecognizing write-offs will be required.

Although CECL may not inspire us to whistle while we work, wecan take heart in the words of Disney's Mary Poppins who sang, “Inevery job that must be done there is an element of fun.”

Heather A. Funsch, CPA is Principal for Rehmann.She can be contacted at 989-797-8393 or [email protected].

David G. Barnes is Chairman, President/CEOfor Heber Fuger Wendin, Investment Advisors. He can becontacted at 248-258-6866 or [email protected].