CECL Preparation: Do This, Not That
**The FASB issued the final CECL standard on June 16, 2016. For up-to-date information and resources, access the updated CECL Prep Kit.
Understandably, financial institutions of all sizes have numerous questions about how they will implement the FASB’s proposed current expected credit loss model, or CECL, once the standard is finalized. At the 2015 Risk Management Summit, a panel of banking industry experts provided tips for bank and credit union professionals to put their institutions in a better position for transitioning from the incurred-loss model when the time comes. At the same time, experts also cautioned against certain actions that might be premature and trigger scrutiny by regulators or auditors.
Below are summaries of some of the “Do this, not that” recommendations from the panel, which featured Graham Dyer, senior manager of Grant Thornton’s National Professional Standards Group; Todd Sprang, principal in CliftonLarsonAllen’s financial institution’s group; Ben Hoffman, director in KPMG’s Financial Risk Management practice; and Tim McPeak, executive risk management consultant at Abrigo.
Capture data. Dyer said that the top advice for financial institutions to prepare for CECL is to begin gathering loan-level data on historical losses in their portfolios. Very few institutions already have the granular data on historical losses that will be needed, he and others said. Sprang said institutions that begin gathering data today could benefit from what he hopes will be a lengthy implementation period – perhaps as long as five years. “If you started gathering some data today on current losses and tracked information on those losses, it would give you five-six years’ worth of data going forth,” he noted.
Focus on internal controls. Banks that are public or have assets topping $1 billion, in particular, should be focusing on internal controls that will be needed in the transition. “Bringing the rigor of a model validation process — even if that’s not a full-on regulatory requirement — may become important from an internal control perspective for a forward-looking model like this, so that’s probably something to start thinking about,” said Dyer. “How will we validate this?” Also important for providing evidence of internal controls will be showing that the data feeding into the model is complete and accurate, as well as reviewing the output of the model to make sure it is functioning consistently with the standards. “Someone has to verify it’s working,” Hoffman said.
Develop cross-functional teams. Make sure staff with credit knowledge and staff with accounting knowledge are involved early on in the process of implementing the expected loss model. “The point is, don’t say you can or can’t do something until you ask the person who has to do it,” Dyer said. Developing cross-functional teams for CECL implementation may also help to ensure that assumptions and inputs that go into developing the allowance aren’t in conflict with those that go into conducting stress tests.
Look for reasonable, supportable forecasts. Given the nature of the expected credit loss model, chances are that estimates for factors that correlate to losses in loan segments will change or sometimes be incorrect, panel members said. The key will be using consistent, external forecast sources and, if internal forecasts used deviate from external forecasts, it will be important to support why that internal forecast makes the most sense.
In addition to recommending financial institutions “do this” in certain areas, panelists cautioned institutions about the following:
Don’t expect a watered-down CECL standard by the time it is implemented. Panelists said they see no evidence that a less arduous application of CECL will be adopted, even for smaller institutions. “What the regulators stress is that they need everyone playing by the same set of rules so that when they look at capital standards they have one set of rules that apply to everyone,” Sprang said. He and other panelists said, however, there could be some variation in how regulators enforce the standards, in how they require institutions to accomplish the standards, or in how long they give institutions to implement the standards.
Don’t adjust ALLL levels early. Several panelists said banks and credit unions shouldn’t inflate the ALLL in anticipation of CECL implementation – even if they’re hearing examiners suggest doing so. Nor should they release reserves in anticipation that future reserve requirements will be higher. “The message from the top is you are under the incurred model and will remain there until later,” Sprang said.
Don’t change your current ALLL methodology to be more CECL-esque. McPeak said some institutions feel pressure to “almost jump the gun from a model standpoint,” so that they can be more ready for the transition. That’s equally as dangerous as avoiding negative provisions now in anticipation of higher allowances under the new model, he said. “That said, if you’re enhancing your model to be more granular with loan level data and you’re still GAAP compliant today, that’s great,” McPeak said.