Small businesses are often the canary in the coal mine for new financial and accounting regulations. They are the first to feel the impact of policies that may not necessarily affect larger businesses to the same extent. CECL is the latest accounting standard issued by the Financial Accounting Standards Board. Small businesses and institutions will have to navigate the new regulatory environment in light of this new standard, and small businesses will have to be wary of the new, more stringent requirements to qualify for loans. Loans often get a bad rap for plunging people and businesses into debt, but used correctly, they can give your small business a beneficial boost.
What is CECL?
CECL is an abbreviation for Current Expected Credit Losses. The accounting standard was drafted as a replacement for the Allowance for Loan and Lease Losses Standard. CECL is distinguished by its focus on future expected losses during a loan's tenure. Future expected losses will be calculated using the borrower's credit history, conditions at the time of borrowing, and the business's predicted performance.
Methods Will Depend on Institutions
Each institution will handle its application of the CECL standard differently. Currently, experts believe that most lending institutions will use one of three loss evaluation methods to determine the suitability of a loan. These compliant loss methods include the Vintage Method, the Open Pool Method, and the Remaining Life Method.
-
The Vintage Method uses loans similar to the potential loan in tenure, origination period, and risks to predict the expected losses for future loan periods.
-
The Open Pool Method starts with analyzing an entire loan portfolio at a specific point in time, and then consistently follows the development of the portfolio until the loans are resolved.
-
The Remaining Life Method combines an analysis of the remainder of the loan's tenure with average yearly charge-off rates.
-
Qualifying for Loans Under CECL
It might become more difficult for small businesses to be approved for long-term loans under the CECL regime. It is easier for lenders to calculate expected losses for short-term loans. Even if lenders continue to offer long-term loans, it is anticipated that interest rates will rise. Small business owners should also anticipate the emergence of new loan products to facilitate CECL compliance.
The CECL impact won't be felt until after December of this year. Until then, its consequences can only be predicted. It will take several lending cycles for analysts to know the full extent of CECL's impact on small businesses. Only then will small businesses be completely prepared to adapt to the CECL standard.