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Revise Don’t Replace

August 18, 2017
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When the Financial Accounting Standards Board (FASB) introduced the new accounting standard for credit losses, Current Expected Credit Loss, which we now know commonly by its acronym “CECL,” many were quick to suggest that financial institutions would need to replace their current incurred loss ALLL methodologies of today with much more sophisticated and/or data-intensive methodologies for CECL of tomorrow.  These suggestions have caused many institutions to panic and question whether or not they’re prepared for such an overhaul. One need not look further than within the FASB standard itself, however, to find that this was never the FASB’s intended consequence.  In fact, the FASB explicitly states, “the Board expects that an entity can leverage its current systems and methods for recording the allowance for credit losses. However, the inputs used to record the allowance for credit losses generally will need to change to appropriately reflect an estimate of all expected credit losses and the use of reasonable and supportable forecasts.”

Accordingly, as institutions begin preparing for their transitions to CECL, may I suggest it most appropriate and in accordance with the standard itself that, instead of looking to “recreate the entire wheel,” institutions begin by considering what might be leveraged from your current methodologies of today, while giving consideration to how you might simply revise your current approach to accommodate the more forward-looking CECL requirements. After all, the most direct and cost-efficient route to CECL compliance is likely to start with this current state assessment – your allowance tools, your data, your current policies and processes, etc. The work to determine a CECL methodology starts with understanding what you have in terms of ALLL assets today, then doing what you need to fill the gaps. You want to leverage and appropriately revise what you have already invested in; you shouldn’t have to entirely replace it all.

With that said, institutions should still not underestimate the challenges and complexity of converting to estimating your allowance under the CECL accounting standard. As the FASB, your regulators, bank auditors and accounting experts have said from the beginning, this is no simple task. It takes time and resources.

In our advisory work with lenders, we assess the institution’s current state and determine what can be leveraged and what changes need to be implemented to be ready for the future – what data gaps need to be filled, if loan pools need to be broken down differently, what tools are needed to address CECL, then whether the existing model can be modified to address CECL or a different model is required.  We review reporting practices and determine what additional disclosure and management reports will be needed. And we work with the lender to develop a plan to bridge all those gaps.   

Consider this:  about 80 percent of the process you employ to estimate reserves under CECL will be unique to your institution – your loan portfolio, your pools, your data, your processes. As Grant Thornton Partner Graham Dyer told attendees at the May 2017 MST National ALLL Conference, “There is no off-the-shelf solution for CECL.” And no one methodology suitable for all.

 

 

About the Author

Regan Camp is the Managing Director of MST Advisory Services, leading a team of subject matter experts who assist financial institutions nationwide in accurately interpreting and applying federal accounting guidance. He has established himself as a nationally recognized speaker, writer, thought leader and trusted advisor, with a primary focus on the Allowance for Loan and Lease Losses (ALLL) and Credit Risk. Having worked closely with hundreds of financial institutions nationwide of varying sizes and complexities, Regan offers his clients a unique combination of experience and perspective, as he works closely with each institution in developing sound and defensible methodologies, policies and procedures. His lauded ability to simplify the complex has especially contributed to the appreciation and success of those with whom he has worked.

About Abrigo

Abrigo enables U.S. financial institutions to support their communities through technology that fights financial crime, grows loans and deposits, and optimizes risk. Abrigo's platform centralizes the institution's data, creates a digital user experience, ensures compliance, and delivers efficiency for scale and profitable growth.

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