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Forecasting might not be top of mind as you prepare for CECL. Understanding the standard, deciding whether to handle the transition internally or engage third party assistance, gathering data, pooling, choosing a methodology – those issues drive our concerns well before we encounter a “reasonable and supportable” forecast.
The forecasting piece is, in large part, what makes CECL different from incurred loss estimating. The Great Recession revealed the insufficiency of being able to reserve only for a probable or already incurred loss event; those years proved the incurred loss model “too little, too late.” The FASB determined we needed a forward-looking component to be prepared for an economic downturn when it comes – and not only a Great Recession, but a local economic jolt, like the closing of a factory that employs a significant portion of the local population. CECL allows us to do that, even to the extent of reacting to a rumor, be it from a credible source.
Ultimately we are forecasting why the future is different from the past, be it better or worse. We do that using economic factors. External factors can be broad in scope, such as political turmoil or a trade war. Or they can be local, such as a weather event or the opening of a new business that will increase employment in your area. And they can reflect internal factors, like losing a quality loan officer to another institution, or signing new loan talent, or the closing of a competing institution.
Here are a few things to consider when developing the forecasting piece of your CECL process:
Where you determine causation, seek out the data you’ll need to support your forecast. You can do that yourself or look to external sources for forecasting. For example, for unemployment rates or GDP, consult the reports of the Federal Open Market Committee or an economic agency in your state or a local university. There’s a lot of free data available, as well as more expensive services. As to your internal factors, of course, that information comes from your own experience – product lines or changes in the lending team, for example.
One common and justified concern we often encounter throughout our wide-spread advisory engagements is how far in advance institutions should forecast. Your forecast is limited to the contractual life of the assets and generally further reduced to how far into the future these forecasts can be reasonably supported. Most institutions are using a one- to two-year period and reverting to history beyond that forecast able period.
Remember few “experts” predicted the Great Recession – at least the magnitude to which it was experienced. Most of the economic gurus of the day missed it. So can you be any better at predicting the future? Your regulators won’t expect you to have a crystal ball. It’s always better to acknowledge that you don’t know instead of acting like you do know then being proven that you didn’t.
Regan Camp is Abrigo’s Senior Director of Advisory Services, leading a team of subject matter experts who assist financial institutions in accurately interpreting and applying federal accounting guidance. He began his career in financial services as a commercial loan officer at a $2.1 Billion institution. He then worked with Deloitte and Touche in their federal advisory practice, represented the FDIC in managing the day-to-day operations and eventual liquidations of failed financial institutions, and managed private consulting teams in assisting financial institutions with the administration of FDIC Loss Share Agreements, the establishment of special asset divisions and the resolution of troubled portfolios. At Abrigo, he provides Advisory Services clients a unique combination of experience and perspective as he works closely with each institution to develop sound and defensible allowance methodologies, policies, and procedures. Regan is a nationally recognized speaker, writer, thought leader, and trusted advisor, specializing in the ALLL, the CECL standard, and credit risk. Regan earned his undergraduate degree from Brigham Young University, where he studied business management and finance.
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