The transition to the current expected credit loss (CECL) standard is just around the corner for larger SEC filing institutions, but for many institutions, there are still many questions surrounding the new standard. Hal Schroeder, a Financial Accounting Standards Board (FASB) board member, led a presentation, “Roadmap to the Future: Fact vs. Fiction (on CECL and Other FASB Standards),” at the 2019 ThinkBIG conference in September. During the presentation, Schroeder addressed many CECL questions, shedding light on the nuances of the standard.
Top CECL Questions Answered
Cost-benefit analysis: What is the FASB’s process, and how much of that information is public?
Some CECL critics have called upon FASB to undertake a cost-benefit analysis of CECL to address and better understand the financial implications of the standard. Schroeder explains that a cost-benefit analysis is not something that just happens at the end of the process; rather, it’s embedded throughout each step.
“Usually, a problem is either brought to us, or we identify a problem. Then, we have a set of rules or procedures that deal with the identification of problems,” Schroeder said. Problem identification is an important part of the FASB’s analysis into issues that arise. “Aspects of that problem identification is taken on as part of the agenda for the board to debate. There must be at least one viable, cost-effective solution to address that issue,” he noted.
For CECL, Schroeder explained, the board looked at a range of solutions, from ignoring losses to fair value, and examined each solution to determine if it was operable, understandable, and auditable. This brings us to cost-benefit. “We’re constantly balancing the scales, particularly between the preparers and the users,” Schroeder said. Each board member is asked, “Do you think that the benefits justify the cost,” and then each member votes. A summary of this discussion is available here.
How to lessen the impact of CECL on smaller community banks
Many smaller community financial institutions are driving the conversation of cost vs. benefit regarding CECL. Some bankers fear that the standard will present onerous operational challenges and pose a disproportional financial burden to smaller community financial institutions. This particular argument is one of the reasons the weighted average remaining maturity (WARM) Model was added to the Q&A document, Schroeder noted.
“WARM was geared specifically to community banks. It’s a great approach for less complicated portfolios and for smaller, less complicated banks,” Schroeder said. Like any method, WARM may not be suitable for the entire institution; rather, it should be considered on a pool-by-pool basis. “A smaller bank might have 10 different pools, and it might be appropriate for 9 of them, but there may be one portfolio that is really the backbone of the lending operation, and it may require something more. It’s not a blanket, ‘I’m going to use WARM and that’s it,’” Schroeder said.
Some smaller community banks have also expressed concern that reserves won’t change, leading auditors to question whether or not the institution was accurately calculating it in the past, but Schroeder says that he wouldn’t worry about this and would focus more on the future.
In order to be successful at business lending, it’s important for credit unions to focus on areas that it does have control over: Processes. Digitizing and automating the business lending process allows for credit unions to drastically improve time- and cost-savings. From online loan applications to automated loan decisioning, today’s technology enables credit unions to make lending decisions quickly and support greater loan volumes.
If all loans require the same amount of time – regardless of size – your credit union has very little incentive to make small business loans. For some credit unions, a $20,000 loan and a $2,000,000 loan may go through largely the same origination process, resulting in the cost to originate the loan to outweigh the benefit. Technology allows for credit unions to streamline their lending process by electronically spreading tax returns, reducing and eliminating manual data entry, automatically scoring and decisioning loans, and more. Business loans can be some of the most paperwork-intensive loans offered, and these technologies allow for credit unions to scale business loans in order to make them profitable investments for their members.
Technology isn’t just important for making business loans more efficient. A key area of digitization in increasing business lending is a customer relationship management (CRM) system. Members want decisions fast, and in this day and age, instant gratification outweighs a member’s loyalty to his/her credit union – you can’t wait on a member to come to you. Relationship management software enables credit unions to capture a 360-degree view of each member and loan. Rather than waiting for member business loan applications, your CRM system can empower lenders to identify cross-sell opportunities on their own.
Gaining clarity on reversion periods and relationships with auditors
Reversion periods, or the period of time after the reasonable and supportable forecast periods, have become a point of contention for many smaller financial institutions. Specifically, whether or not institutions need a reversion period and how to support the length of reversion. In an Accounting Standards Update (ASU), the FASB gave financial institutions the flexibility to determine the expected credit losses and does not require the institution to develop a reasonable and supportable forecast for the entire expected remaining life of a loan, such as a 30-year mortgage. According to the FASB’s Q&A document, when a financial institution is reverting to historical loss information, it should “consider whether the historical loss information is still relevant to estimating expected credit losses…and not adjust historical loss information in the reversion period and post-reversion periods for existing economic conditions or expectations of future economic conditions.”
For institutions that are struggling with determining the difference between a 24-month and a 20-month reversion period, the idea of “reasonableness” can seem lost. Schroeder credits his background as a CFO and writing the firm’s audit approach for giving him the advantage to have more meaningful conversations with auditors. “I was able to say, ‘No, that’s not required and here’s why,” Schroeder said.
A key component of successfully navigating the CECL transition is aligning expectations with examiners and auditors.
“If I had a concern about CECL, it wouldn’t be community banks’ ability to do it,” Schroeder said. Rather, he would be focused on the adequacy of documentation. Schroeder suggests working with bank auditors and regulators to ensure they understand the strategy and plan for implementing the standard. It’s important for community bankers to fully understand the standard and ensure they’re “armed with the right information” to know how to support their assumptions. “You have a say in this,” Schroeder told the audience.
There are many resources available to help guide your institution in the transition to CECL. If your institution would like more information, reach out to Abrigo today. Stay up-to-date on next year’s ThinkBIG conference here.