Economic forecasting will be an important part of predicting future losses under CECL. At the 2015 National ALLL Conference in the session entitled “Transitioning to CECL”, Graham Dyer of Grant Thornton proposed three steps to developing a “reasonable and supportable” forecast:
- Identify the relevant economic metrics that drive losses for different segments of loans, which must be supported by documentation of not just the metrics selected but of other metrics considered but not selected.
- Identify economic forecasts for the selected metrics. Documentation must include reasons a specific forecast was chosen and other metrics considered but not selected.
- Translate to loss information using correlations and lags identified in historical data.
“Under the coming CECL model, institutions will have to base their allowance estimate on ‘reasonable and supportable’ forecasts,” pointed out MST CEO Dalton T. Sirmans in a recent whitepaper. MST is developing an economic analysis tool to help its clients identify and gather economic data pertinent to their allowance estimation process.”
“As the factors which determine the production, distribution and consumption of goods and services, economic data is critically important,” Sirmans explained. “Economics-based decisions typically consider a large amount of data for quantifiable estimates. As such, economic data provides measurable, objective information. And while regulators and FASB always include economic considerations in their guidance, few banks have an economist on staff or access to available economic expertise.”
While banks will need to vet economic data for pertinence to their businesses and communities, Sirmans shared five key measures:
- Real gross domestic product
- Nominal gross domestic product
- Unemployment rate
- Nominal disposable personal income
- Consumer price index
And four sources for aggregate measures of financial conditions:
- S&P/Case-Shiller U.S. National Home Price Index or House Price Index
- Commercial real estate prices
- CBOE Volatility Index
- Dow Jones Industrial Average, S&P 500, Russell 2000
One way to begin preparing for CECL is collecting economic data and reviewing correlations between losses and economic triggers such as the five listed above.
Download the entire whitepaper, CECL: Ready, Set . . . Go?