As U.S. financial institutions start to implement a new loan-loss accounting guideline this week, Jefferies Equity Analyst John Hecht forecasts higher lending costs down the road.
The Current Expected Credit Losses (CECL) model, introduced by the Financial Accounting Standards Board in 2016, outlines how banking institutions account for and reserve against loan losses. Early adoption of the new model started Jan. 1, and public companies filing with the SEC must adopt CECL in December.
Under CECL, lenders will need to use historical information, current conditions, and reasonable forecasts to estimate the expected loss over the life of the loan. This is compared to the previous standard, which required lenders to reserve against loans that should have a high probability of defaulting in the next period.
The biggest difference between the two models is the forward-looking view of loss expectations. “Now, the moment lenders originate a loan, they have to reserve for the expected loss of the loan, for the entire life of the loan,” said Moody’s analyst Michael Vogan. Lenders with a large concentration of long-term loans are likely to feel the biggest impact, because the longer the loan, the higher the expected loss, Vogan added.
Hecht pointed out that the CECL accounting standards may pump up borrowing costs in the coming years. “Because lenders, in effect, have to hold a bit more capital for every loan they make, it’s possible that over time, general lending costs go up,” Hecht said, adding those costs will likely be passed on as higher costs to borrowers.
This year will be a “mad dash” for lenders to figure out what models to use and the processes and procedures around how they are going to implement the CECL accounting standard, Vogan said. “It really affects how much lending volume [lenders] are able to originate, how much money they have to lend,” he said. As lenders continue to solidify these models, which take much more data than the older, incurred risk model, they will learn how to adapt lending strategies and reassess how much risk they are willing to take on.Like This Post