As the holidays approach, so does something of a CECL anniversary – or pre-anniversary. As of December 15, institutions classified as “public” will have just two years before they begin accounting for their loan loss allowances according to the CECL standard; most other lenders, just three years.
As “C-Day” approaches, most lenders are at some point in their preparations, testing new methodologies, assessing their data and pools, or at least assembling CECL steering committees. Moreover, as they take the steps required to ready their institutions for CECL, they are finding it no simple task, that it will take considerable time and resources to accommodate an accounting change of enterprise-wide impact – all the way to the bottom line.
Many lenders are being proactive, some pacesetters even planning to early adopt, which they can do as of December 15, 2018. Still others are delaying for reasons that range from cost, putting off the expense involved in making the change as long as possible, to a wait-and-see approach: wait and see what their peers do, or wait and see if the regulators roll back the implementation dates, or wait for additional guidance that will tell them exactly what to do to comply. Some believe they still have plenty of time to get started, that they can kick the can down the road another year or so before they need to consider making adjustments for CECL. Unfortunately, none of those reasons appear in the best interests of lenders; none certainly are garnering any support from auditors, regulators or acknowledged allowance experts.
“There’s general concern for some lenders that seem to have a false sense of security, that they can wait another year or so and then react,” noted Regan Camp, Managing Director of MST Advisory Services, which is consulting lenders on their CECL transition process. “But when you think of the sequence of the transition and all that involves, two years out is about as late a start as you want to get.”
“Getting started, determining priorities and learning what information you will need and how you will get it is imperative,” MST Advisory’s Shane Williams added. “If you put it off, it’s going to be expensive, both in terms of securing the resources and support to make the transition as well as from the perspective of CECL’s impact on your earnings and capital.”
CECL transition process
That transitioning to CECL is a drawn out process is evident from an examination of the various steps required:
1. Form a steering committee. Typically, the committee will involve members from various bank departments: more than just credit – all departments involved with lending or establishing lending guidelines, as well as those concerned with capital, and, of course, senior executives responsible for keeping the board and shareholders informed of the impact of CECL on operations, capital, profits and more.
2. Establish a transition budget. Can the institution handle this internally, or does it need third-party support? What other resources are associated with the commitment required by this project?
3. Assess loan data. Everyone knows by now that estimating loan loss allowances under CECL will require more data and data fields than today’s incurred loss model. The institution need assess its data not only for quantity but for the quality, that is, accuracy and consistency, that forward-looking estimations will require. Most institutions are finding they are lacking on both counts. How will they supplement their data stocks? Where will that data come from? Where will it be captured and stored?
4. Examine pooling. Most institutions will need to restructure their loan pools to more appropriately group loans for estimating life-of-loan losses.
5. Implement a software platform. If the institution is using Excel spreadsheets to estimate their reserves under the incurred loss model, will that be sufficient to address CECL’s more complex, sophisticated calculations? Will internal control over the process and spreadsheets be adequate? Software platforms play a key role in the CECL transition process itself.
6. Select one or more CECL methodologies. What CECL methodology will best serve the institution’s interests? Will the bank be able to modify its existing methodology for CECL or need another methodology, or different methodologies for different pools?
7. Shadow loss analysis. Lenders should run parallel CECL and incurred loss estimations for multiple quarters to reconcile and understand the impact of their potential CECL methodologies. Plan for at least six months, more likely a year or longer to work out the kinks.
“One of the key questions lenders have to ask themselves is whether or not they have both the expertise and bandwidth to do this on their own,” Camp pointed out. “And even if the answer to both is ‘yes,’ is that the best use of their time?”
If third-party support is the answer, those who delay could find themselves in yet another difficult position.
“There is a limited supply of external expertise available for both the process and the technology,” Economist Tom Cunningham warned. “As the implementation deadline approaches, demand for that expertise will increase, and we all know what happens when supply is limited and demand is surging. The technical answer is that as a deadline approaches, demand becomes more price inelastic, so the increase in demand results in a larger proportionate increase in price than earlier. How much costs increase depends on the shift in elasticity and the shift in demand.”
Waiting on peers
Some institutions are waiting to see what their peers will do. Following their lead, they reason, will be the surest and most efficient route to a compliant methodology. According to MST Advisory’s Garry Rank, such a line of reasoning won’t work this time around.
“Under incurred loss, 80 percent of your allowance is similar to other banks and 20 percent is unique,” said Rank, whose more than three decades in the industry includes auditing the allowance practices of hundreds of banks. “With CECL 20 percent will be similar and 80 percent unique.”
“CECL will change your expectations and you will be asked why your expectations changed,” noted Dorsey Baskin, Grant Thornton partner emeritus. “You are entering a whole new era of second-guessing. If you don’t have good processes, the right people involved, and good documentation, it will be difficult to explain.”
“If you wait, you won’t have time to come up with a defense that what you are doing is right for your institution,” Camp added.
Nor is it advisable to wait for more guidance from the FASB. The Board has been steadfast in telling lenders it will not dictate a methodology or a process to determine a methodology. Nor is there any indication the FASB will delay implementation or offer additional guidance other than clarifying existing positions through its Transition Resource Group.
A costly tactic
Delaying preparations is a costly tactic, not only in dollars but in light of the chance of unanticipated repercussions.
“Waiting puts the institution in danger of having less or no time to run parallel allowance estimations and evaluate the causes of unexpected results from a CECL methodology,” Baskin pointed out. “As well, an incomplete or inadequate implementation could lead to financial statements with material misstatements and material weaknesses in internal control over financial reporting. And a lack of time for your external auditors to validate your methodology or for testing the results could lead to delays in issuing financial statements.
“Those types of problems could cause the board of directors, investors and regulators to lose confidence in management,” he continued. “Making choices about the implementation of new accounting standards is an important responsibility for management. Making good choices is a reasonable expectation of the board of directors, investors and regulators.”
“If I were a bank executive I’d want to know as soon as possible the kind of impact CECL’s going to have on such things as capital and retained earnings,” Camp observed. “Will there be a hit on capital and do you need to raise more capital? If so, that will take time.”
Finally, Camp proposed, delaying preparations for C-Day puts the bank in a precarious “what if” situation.
“To paraphrase CECL, what is a ‘reasonable and supportable forecast’ of your future? What if you lose a key employee or something else surfaces that demands your time? There’s no time like the present to tackle this issue.”