The Board, Investors, and Expected Credit Loss
To govern effectively, a financial institution board needs to understand the CECL standard. And an effective CECL implementation process involves educating the board and investors on the nuances and system-wide impact of CECL. This general session at the National ALLL Conference in May addressed the challenges involved in education, reporting and ongoing governance.
Here are some of the highlights of the panel discussion with Garry Rank of MST Advisory Services, Chad Kellar of Crowe Horwath, Ben Hoffman of KPMG, Walter McNairy of DHG Financial Services, and Mike Gullette of ABA.
• A good practice is to present your board with some crude numbers, some CECL-based calculations rooted in your history that will make them aware of how it might affect capital, how meaningful an impact it will have.
• You should have decided on your methodologies at least one year before implementation and understand that by year three, following implementation, many of the assumptions from your initial CECL estimates will have changed as you have learned more about the impact of your methodology.
• The provision is going to evolve over the years and it is important that your board understands that. Also you will need to explain to your board why your expectations are different from your peer institutions.
• The definition of a Public Business Entity (PBE) has changed. It is critical to know if it applies to your institution for several reasons, including that the CECL
implementation date for PBEs is a full year earlier than privately held institutions.
• Due diligence for an acquisition requires you to understand the history and trends of that institution over time to calculate an appropriate CECL reserve. If you buy a smaller institution, it is likely the quality of its data will not be as good as yours.
• It is important to have day-one data on acquired loans as that will be needed for a compliant CECL estimate. If you’re a seller you might want to adopt early, or at least
be well down the road toward transition so you can share the expected impact on your portfolio with your acquirer.
• One of the challenges to assembling the data needed for CECL is the low number of charge-offs and lack of losses in recent years.
• It will be challenging to understand how your provision will evolve over the year based on growth, acquisition, changes in economic factors, etc. Explaining the volatility of your provision to board members, investors, and all stakeholders will be difficult.
• Retaining comparability of financial statements will be a significant challenge.
• Examine how a recession will impact your reserves. Your numbers won’t be precise, but they will give the board a good idea of how a recession will impact your provision. It will help them understand how the new model affects your bottom line during a downturn.
• For the additional data you need, look to peer groups as your guardrails for investors. But also look to public companies because by the third quarter of 2019 they will have done a lot of that work. Regulators are also likely to have data on potential trends.
The National ALLL Conference Digest is now available. The digest is filled with articles and videos on the allowance, the transition to CECL, and related topics.
Many thanks to Garry Rank of MST Advisory Services, Chad Kellar of Crowe Horwath, Ben Hoffman of KPMG, Walter McNairy of DHG Financial Services, and Mike Gullette of ABA for their participation and insights.