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Financial institutions across the U.S. are grappling with the many changes required to implement the current expected credit loss, or CECL, model. The extensive time, resources, and staff involved in a successful transition from the incurred loss model can make even the process of getting started feel daunting. Data, methodology, and pooling decisions may seem overwhelming if institutions are not properly prepared.
However, having an effective plan in place can make it easier to implement a compliant CECL model in an efficient manner. Financial institutions can build out their models faster by learning the key decisions peer institutions have made ahead of the transition to help create that framework.
In a recent webinar, representatives from Great Southern Bank and the bank’s Advisory team at Abrigo shared their experiences with CECL so far, the decisions they have made, and their expectations for the future. Great Southern operates out of Springfield, Mo., and has total assets of approximately $4 billion. Great Southern is an SEC filer and has a Q1 2020 compliance deadline.
The Great Southern CECL team works closely in regulatory, SEC, and board reporting. At their institution, they have strong support for the process by their CEO and board group. Their CECL team has involved other departments in the bank in training and responsibility to ensure compliance. Other key players include the bank’s Chief Credit Officer, Chief Production Officer, IT, internal audit, compliance, and loan operation teams.
“We currently have a quantitative component or reserve amount based on the cohort method, and we are testing the methodology,” Debbie Flowers, VP and Director of Credit Risk Administration at Great Southern said on the webinar regarding the current status of their CECL transition process. “ for inclusion in our SEC reporting.”
Choosing a methodology
Great Southern first consulted with Abrigo in mid-2018 to assist with their CECL planning. To begin their transition process, they started evaluating the methodology options available to them under the new accounting standard. After analyzing their unique data situation, Great Southern decided on a cohort approach.
The Cohort methodology, also referred to as “snapshot” or “open-pool analysis,” relies on the creation of cohorts to capture loans that qualify for a particular segment at a specific point in time. Cohort methodologies then track those loans over their remaining lives to determine their loss experience.
“Cohort seemed most like our current incurred model and the premise of tracking historical loss rates made sense to us,” said Tammy Bauricther, VP/Controller at Great Southern Bank. “Our loan portfolio is a traditional one and we believe that the perfect knowledge derived from this model is a good representation of how our loan portfolio will continue to behave in terms of losses.”
Analyzing their unique data situation
“You really can’t stress the importance of data enough when building out a CECL model. Methodologies and pooling alike, they need to be approached based on what data fields are available and the time frame that they are available,” said Zach Langley, Advisory Analyst at Abrigo.
When conducting CECL engagements with Great Southern, Langley focused on depth, breadth, and integrity of data during their gap analysis. Breadth is the amount and type of data fields that financial institutions should capture. “Breadth means looking at how wide a data set can be,” said Langley. “Some questions to answer are what are we bringing in and what are we capturing? Moreover, of those things, what are the critical data elements that we are also capturing to run CECL-compliant methodologies? For example, data to run a discounted cash flow looks very different than data that is needed to run a cohort or open pool model.”
Depth is reflective of how far back the data goes. When meeting with Great Southern, Langley considered options for the life of loan of each segment and took note on whether that analysis should come from the segment’s contractual life, or from a weighted average remaining maturity, etc. Ways to calculate the “life of the loan” can vary among institutions – it is dependent on what the institution is comfortable defending.
To analyze the integrity of data, a financial institution can look back to see if they have consistent and correct coding historically, as well as consistent and correct application. For example, if a loan has a collateral code of one and that means unsecured, is that loan unsecured in practice? Is the financial institution applying their coding consistently?
Segmenting into appropriate risk characteristics
During the webinar, the consultants highlighted that the first step for creating an effective segmentation strategy should be to find similar risk characteristics of appropriate pools. These segments should be meaningful and not too granular to produce relevant results. Pools should calibrate to whatever methodology that a financial institution chooses. It is important to understand what is being analyzed so that the segments can reflect that.
Great Southern has lending activity spread throughout multiple locations across the U.S. Because of this, geographical considerations were important when defining their segments. “It is important for us to be able to pinpoint areas of greater risk by market areas as that information becomes available,” said Flowers.
Segmentation can be challenging for institutions approaching the CECL transition. Indeed, Great Southern found this to be an obstacle as they were building out their model.
“One of the challenges we faced was limiting the number of pools while still trying to segment our risk,” said Delynne Geary, Senior Credit Risk Analyst at Great Southern Bank. “We ended up with 26 pools. Initially, we started with call report categories and expanded to areas of credit and market risk.”
For more information about the beginning phase of Great Southern Bank’s CECL implementation process, please watch the on-demand webinar, “How a Financial Institution is Getting CECL Ready: Key Decisions and Steps in the CECL Transition.”
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