Currently, within companies, trade publications and the halls of government in Washington, D.C., a lot of attention is being paid to a new accounting standard called the current expected credit loss model (CECL). There are armies of accountants and analysts just waiting to help you adapt to CECL, and numerous trade associations are lobbying to push back the effective date of the standard. Companies filing with the Securities and Exchange Commission will need to adopt CECL for fiscal years beginning December 15, 2019.
So, what does this mean?
CECL will have a material impact on the Allowance for Loan and Lease Losses (“ALLL”) for lenders that hold loans in a portfolio. Instead of reserving for losses on an incurred basis, lenders will be forced to post a reserve against the lifetime expected credit loss on Day 1. This will directly impact:
- how loans are priced
- how much capital is allocated to a portfolio lending strategy
- which products are offered to consumers
- net income, since changes to the ALLL impact pre-tax operating income
The impact from CECL extends further because lenders will also have increased costs related to loss forecasting and reporting, especially as they continue to update estimated loss reserves over the life of the assets. What’s more, this isn’t going to just impact future production – it’s going to impact every loan on a balance sheet. Naturally, lenders are concerned.
Thankfully, there is a bit of a silver lining.
Lenders who have utilized traditional primary loan-level mortgage insurance (MI), either borrower- or lender-paid, can use that coverage as an offset against their CECL reserving requirements. By insuring that loan production, a lender can escape the volatility that CECL introduces, and even offset the impact to pricing and financial statements.
While there are other forms of credit enhancement out there, they generally won’t be given credit under CECL. Pool insurance, credit default swaps, and other “freestanding” contracts are not acceptable under CECL because they can be separated from the loan and exercised independently.
When it comes to traditional MI, there are several options. A lender could utilize borrower- or lender-paid (BPMI or LPMI) coverage, and have a choice to pay a single premium up front, or go with an ongoing premium type such as MGIC’s monthly premium plan. The right premium plan depends on a lot of factors, such as the cancelability of the MI, prepayment speeds and the actual rate charged. In some cases, a split premium, with a portion of the premium paid up front and the balance in monthly installments, may be the right choice.
The first step to get ready for CECL is to make sure your current production is being insured. If your current production is not insured, then it is possible that there could be more costs and volatility in earnings when it comes to adopting CECL. MGIC’s Portfolio Playbook suite of insurable loan products is a good starting point for evaluating current loan portfolio offerings. If you have not reviewed the impact of CECL and some potential mitigants, I encourage you to engage your MGIC Account Manager to help determine a plan of action.
If you haven’t been insuring your current production, you are probably sitting on a portfolio of loans that may benefit from MI. MGIC has a channel dedicated to insuring seasoned portfolio loans, and we’re ready to discuss your needs.