Many financial institutions are starting the process for implementing the Current Expected Credit Loss model (CECL). Here are some helpful tips to consider as you begin your implementation.
Lifetime Loss Approach
Many smaller financial institutions are using annual loss experiences to calculate the historical loss rate. The annual loss can no longer be used for calculating the historical loss experience under CECL. The new standard requires the loss rate to be based on some form of lifetime loss approach. The method for calculating the lifetime loss rate is fairly open. If the financial institution plans on piggybacking off their current method of loan loss reserve calculation based on an annual loss rate, modifications to a lifetime loss approach will be required.
The Three Elements to CECL
The calculation of the allowance under CECL equals: Historical Loss Rate +/- Current Economic Conditions/Qualitative Factors +/- Reasonable Forecasted Economic Conditions. Many of the training sessions and discussions on CECL focus on the historical loss calculation and not on the current economic/qualitative factors and the forecasted economic elements of the CECL calculation. As part of the educational process, institutions should be looking for information that covers all aspects of the CECL calculation process.
Obtaining historical loan data maybe difficult or limited. In a recent CECL planning meeting for a small community bank, we recommended using previous monthly board reports that provided various loan information for the month. From this information, the bank was able to calculate its historical loss rate. This is an example of having to be creative in obtaining historical loan information that might not otherwise be available using the traditional loan accounting systems.
Financial institutions will have many questions during the process of implementing CECL, and it will be important to reach out to various individuals, groups, accountants, consultants and others to help you through the process.
Watch the Eide Bailly CECL Solution Demo