Overcoming Organizational Obstacles in Transitioning to CECL
Who owns the present Allowance for Loan and Lease Losses (ALLL) and the new Allowance for Credit Losses (ACL) processes in your financial institution? The Chief Financial Officer (CFO)? The Chief Credit Officer (CCO)? The Chief Lending Officer (CLO)? Perhaps it is a shared function. In my 40 years in banking, I have seen the responsibility fall to each of these roles.
In late 2017 and early 2018, as a CFO in a Florida bank, I was collaborating with our CCO on planning our transition to the new Current Expected Credit Loss standard. Working together on the process was important for two reasons: for one, it meant we realized that we shared ownership of the CECL transition. In my previous 20 years as a bank CFO and now as an advisor to financial institutions on their CECL transitions, I’ve witnessed situations where the CFO and CCO or CLO roles do not cross paths; where they have different agendas; and more often, where they do not understand their counterpart’s processes as they relate to the ALLL. Which leads to reason number two: you can’t do CECL without the pulling together. Each department has responsibility for practices and processes that will impact your CECL model and its effect on all bank operations.
Typically, responsibilities and knowledge related to the ALLL, and now CECL are as follows:
- Planning and budgeting the allowance
- Economic forecasting (includes consideration of Q-factors for the allowance)
- The financial performance of the institution (expense provision for the allowance)
- The allowance’s impact on capital adequacy and capital ratios
- Interaction with external auditors (CECL footnotes to audited financial statements)
- Board of director interactions (explaining CECL)
- CECL methodology determination (effects on magnitude of the allowance)
CCO or CLO:
- Loan pooling and loan type structure (due to knowledge of loan systems)
- Loan product offerings, loan growth, loan pricing, loan structure
- Loan data, including loan types, system coding, structure of reporting
- Lending regulatory oversight (working directly with regulators)
- Lending policy
There are responsibilities in these lists that overlap or where there can be territorial conflict, and will require a cooperative effort and approaches to run CECL compliantly and for the institution’s benefit. For example, Loan Operations is a department that is critical to the CECL transition process due to their understanding of the loan system platform. This department might report up through the CFO in some financial institutions and up through the CLO or CCO in others. The need for and allocation of that department’s time is critical for CECL implementation. Both the CFO and the CCO/CLO must recognize that.
Other examples where issues can arise in CECL transition and recommendations for dealing with them
Issue: Loan Pooling – An institution might pool its loans by call report codes but manage them differently, for example, a managed portfolio of small business loans with varying call report codes.
Recommendation: Early in the CECL process, hold group meetings between Accounting/Finance and Lending/Credit to fully understand the pooling or classification practices of the institution’s portfolio, including how loans are grouped for call report purposes.
Issue: Loan Maturities – The CFO might favor shorter loan maturities given CECL’s life-of-loan loss estimation requirement. But the institution’s current loan product offerings, pricing and portfolio might lean toward longer maturities, especially if competitive factors are leading customers to lock in lower interest rates.
Recommendation: It is critical that both the CFO and the CCO/CLO understand the financial results of the CECL methodology(s) selected for the organization. This will occur during the parallel running of the old and new models. Additionally, CECL’s impact on capital should be addressed in the ALM setting, including comparing the impact of shortening loan maturity positions over time to extending loan maturities thru ALM modeling software.
Issue: Loan System – Often Accounting/Finance has limited knowledge of the loan system, such aspects as coding, reports and loan types. This tends to be more prevalent when Loan Ops reports through Credit or Lending.
Recommendation: It is essential that the CFO and Accounting group fully understand the architecture of the loan system in order to participate in determining CECL methodologies and pooling structures. Educational meetings should be held early in the CECL preparation process.
Issue: External auditors vs. regulators – It is the CFO’s initiative to ensure the financials are accurate and the external auditors are satisfied with the CECL methodologies and disclosures. The lending function is more focused on what the regulators will say and do when they come into the institution, because regulators spend most of their time on the lending function during their exams.
Recommendation: All CECL Implementation teams should consist of senior level managers from both Credit and Accounting/Finance to ensure that both objectives above are addressed.
A thorough CECL transitioning process usually spans 18 to 24 months. We’re running out of time, and how institutions are organized, how responsibilities are divided between the CFO and the CCO or CLO, and the level of understanding of all parties can present obstacles and cause delays. The CECL transition committee needs high-level representation from both functions to complete its transition on schedule and in a manner that will best suit the institution and its overall goals.
About the Author
Tom Flournoy | Senior Advisor
Tom Flournoy brings a long and distinguished career in banking to his role with MST Advisory Services, where he joins a team of subject matter experts assisting financial institutions in accurately interpreting and applying federal accounting guidance, currently and more specifically, in their transition to estimating the allowance under the new current expected credit losses (CECL) standard.
Tom offers MST Advisory clients the expertise of more than 30 years in community bank leadership – in Finance/Accounting, Audit and Risk, Operations and Information Technology. Most recently he was executive vice-president and chief financial officer of CBC National Bank in Fernandina Beach, Fla., where he was responsible for the Treasury, Accounting, Operations and Human Resources divisions. From 2009 to 2015, he served as CFO of First Bank of Georgia in Augusta, ranked as one of the top banks in Georgia during the economic crisis and acquired by State Bank and Trust Company in Atlanta.