By Bruce Richter
August 30, 2017
With the passing of the one-year anniversary of the current expected credit loss model (CECL), the financial institution industry has had time to digest the contents of CECL and its potential impact. While the implementation date for the new standard will be after December 2020 for smaller financial institutions, the timeframe between now and the implementation date should be used wisely. Planning early for CECL will result in better decision making and design of a CECL approach that better serves your financial institution.
Here are five important steps financial institutions should consider as they work through their implement of CECL:
This is the group that will guide the institution through the process. They will need to educate themselves on the requirements of CECL, identify the options available, pick an approach that meets the entity’s needs, determine and gather information that will be needed for implementation, set time frames for completion of each critical phase, perform dry runs of the method selected and guide final implementation. Key personnel that should be considered include operations, IT, the senior credit officer and the chief financial officer. The institution should have started this process by now along with documenting their progress.
Review CECL Options
The standard does not dictate a particular model or method that must be used. The standard provides some basic guidelines along with examples, but otherwise it is pretty wide open. Some of the more common approaches being discussed include migration analysis, discounted cash flow, probability of default/loss given default (PD/LGD) and vintage analysis. The institution can use one method or multiple methods, but for smaller institutions one method would be preferable. Most all CECL approaches for smaller entities will involve three parts:
The historical loss experience is numerical with little judgement involved. Current conditions and reasonable and supportable forecasted data may start out with numerical data, but judgement will be needed to interpret the data and apply it to the institutions historical loss experience.
Selecting a Method
This will prove somewhat challenging as there are several methods and versions of the same method that could be used. Selecting the right one that fits your institution’s needs will take time. The method that is ultimately selected may be driven by data available, ease of use, cost, time commitment, what is most relevant, availability of support and the complexity of your institution. Visiting with your accountant, auditors or others knowledgeable on the topic will make the selection easier. For many smaller institutions, a vintage approach maybe more practical because the information needed to use this approach is more readily available and the method is simpler to use.
Some of the guidance being communicated on implementing CECL indicates institutions need to start gathering data to be used in implementing CECL. To a certain extent this is appropriate; institutions want to make sure historical data is not being purged, overwritten or replaced by new data. However, to begin collecting a lot of other data without selecting the CECL approach first may be wasted time, as some of the data collected may not be needed for the approach selected, or the appropriate data has not been gathered for the method chosen. Basic data that should be considered for early gathering include, origination date and amount, prepayment dates and amounts, maturity date, date and amounts of write-offs, dates and amounts of recoveries, date restructured as a TDR and payment dates along with amounts.
Once the method has been chosen and the data gathered the institution should begin trial runs. This will identify weaknesses in the calculation process and data collection. Refinement of the approach may be needed based on initial calculations and as experience is gained.
By starting early in the implementation phase, financial institutions will be better prepared for implementing CECL by having early feedback as to the potential impact the new guidelines will have on their earnings and capital structure.