Guide to Selecting an Outsourcing Partner for the CECL Calculation

Learn about the benefits institutions are experiencing with CECL Advisory Services

Financial institutions seeking a partner for the transition to the current expected credit loss (CECL) model or ongoing preparation of the allowance for credit loss must carefully weigh the risks and benefits of moving this function outside their walls. When discussing taking on these functions with prospective clients, we must ensure that external process management is appropriate for the institution’s size and complexity. Banks and credit unions approach us for a variety of reasons, but the key drivers are usually some blend of:

• Forecasts
• The desire for CECL expertise not found within the institution
• The value of “industry-wide” optics on a problem from CECL practitioners that work with multiple institutions
• The drive to reduce executive distraction
• The reduced compliance risk by not “going it alone” on CECL methods and practices
• The difficulty in recruiting, training, and retaining specialist staff in their market

Introduction

Process outsourcing, including CECL, can help clients focus on growth and investment in their communities. However, outsourcing done poorly can present a trap with punch-out costs and risks above perceived initial value. In addition, when Abrigo works with clients to provide calculation, modeling, and process outsourcing services, we draw an obvious line: management can (and in many cases, should) outsource the doing, but management must not outsource the administration.

If a vendor takes on a business process, management must still have ultimate understanding and control. This document was developed with these considerations in mind to assist prospective clients of Abrigo and others as they evaluate a partner for CECL. The guide provides, in detail and drawing heavily from vendor management best practices, important factors when considering and negotiating with a process outsourcing partner.

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Risk Considerations

Performing CECL in-house has certain risks — the work might be done poorly, key staff might depart, or a malicious actor might interfere with the process. Partnering with a vendor can carry risk as well. Evaluating the partner’s maturity in the following areas — and documenting the evaluation — are critical.

DETERMINE THE PARTNER’S CONTROLS AROUND PERFORMED WORK.

• Evaluate the processes in place for reviewing work before and as it is delivered
• Determine if there is a durable system for access to allowance work papers and prior work
• Confirm there is a SOC in place. How frequently is it performed? Who performs it?

A CECL VENDOR WILL NEED ACCESS TO YOUR DATA .

• Determine how data will be transmitted
• Evaluate security and controls procedures in place for data in flight and data at rest
• Determine the data required by the vendor for the CECL calculation
• Evaluate how the partner plans to use data you provide
• Assess security of data storage
• Understand what access you will have to data created over the course of the engagement
• Evaluate data security protocols for potential vendors

A CECL PROVIDER WHO CANNOT CONTINUE SERVICES PRESENTS A RISK TO THE FINANCIAL INSTITUTION.

• Assess the potential provider’s commitment to the space, its financial strength, and its future goals
• Assess the degree of “key person” risk in the services you are evaluating and the strength and depth of the provider’s “bench”
• Assess contractual service levels for availability

Business Considerations
CECL resulted in Stepped-up expectations for Model Risk Management

There are many statutory and common-practice “tripwires” in this highly regulated industry. We work with clients that behave with a level of complexity that we would politely consider “aspirational” for their present asset size and market, and we work with others who tend toward an attitude of “getting through the quarter.” While we find the intersection of “wants to outsource a business process” and “wants to over-engineer the business process” to be mercifully low, management must assess whether a CECL vendor can solve today’s challenges and those that will arise in the future.

CONSIDERATIONS

Term of Engagement 

• Define the length of the engagement (one-time, annual, other)
• Clarify cost implications of scaling with future growth
• Understand any window for an option to extend the engagement

Handover to Management

• Understand the continuity plan for management to take the function back if the financial institution grows in complexity to the point where CECL outsourcing is no longer appropriate
• Consider how a provider may help or hinder such a transition. For CECL, this plan and approach for “handing over” the calculation must be seamless

Adjacency and Efficiency

• Consider efficiencies of scale — for example, if a provider is performing a CECL calculation service and a capital planning service, is there overlap in the underlying credit models? What is the level of effort to add more business functions to the relationship?

Managements Responsibility

• Determine any CECL processes for which the financial institution will be responsible and confirm that they are clearly communicated
• Confirm management is confident they can perform those responsibilities to ensure timely and quality delivery

Scope Flexibility

• Identify the mechanism and expectations for performing work outside the core scope of the engagement (e.g., work must be re-performed due to a client mistake)
• Ensure alignment of your and the vendor’s definitions of a successful outcome and contingencies for unsatisfactory outcomes
• Define the fee structure for out-of-scope services or other additions, such as help due to staff turnover

Value-Add Services
CECL typically brings major adjustments to qualitative adjustments

It is common for clients to work with Abrigo on the CECL transition or ongoing calculation and receive value-add deliverables within the broader orbit of that process. For example, the information, models, and data required to enable a CECL calculation enable functional reporting and benchmarking. Understanding a vendor’s capabilities beyond the core outsourced process can help differentiate it from other options.

CONSIDERATIONS

Reporting

• Explore additional data services that a partner can provide (industry data, benchmarking, etc.) using their data and yours
• Establish reporting criteria

Maintenance Services

• Explore “model maintenance” services:
  • client-specific back tests
  • periodic model redevelopment
  • other model risk management best practices

Process Enhancements

• Clarify the process to accept or decline process or data enhancements
  • Will you receive access to new features and capabilities for preparation of the allowance for credit loss over the course of the engagement?
  • How amenable is the partner to re-scoping an engagement as practices evolve, and what cost controls can they offer?

Additional Intelligence 

• Evaluate optional data sources, both public and proprietary, that may be available through your provider
• Determine the relevancy of external data sets to your financial institution’s allowance for credit loss
• Establish how are these data sources used in the delivery of the work
• Define controls on the use of proprietary data pools

Defensibility

Most of what a financial institution does intersects with regulatory or financial reporting standards, and outsourcing the allowance for credit loss preparation is no exception. The work performed by a provider should withstand not only your scrutiny but the scrying eyes of your external auditors and regulatory examiners. Working with a CECL vendor can be an immediate lift in this area, if only from standardization of approach to that used by other market participants. Still, the level of defensibility intended and provided by a vendor can vary widely in several important areas.

CONSIDERATIONS

Scope of Defense

• Determine which components of the work the vendor is willing to defend and what the vendor’s practice is for defending those components
• Establish the vendor’s track record in successfully defending their work to external audiences

Documentation

• Evaluate vendor deliverables for comprehensiveness, depth, and rigor
• Ensure the deliverables are sufficient to document the allowance practice When inputs or components of the process are proprietary, e.g., dependent on private data pools, determine what documentation of those aspects the vendor is willing to provide
• Ensure the vendors’ deliverables will represent conditions and information “as of” the statement date (e.g., not the quarter prior)
• Clarify that the vendor is capable of establishing the relevancy of their CECL calculation to your institution.

Model of Defense

• Ensure the vendor is committed to your understanding their practices — it does not give comfort to auditors or regulatory examiners when a financial institution must bring in a third party to explain what is happening

Prior Experience

• Determine whether the provider has experience with public institutions that have adopted the CECL standard
• Evaluate their lessons learned from implementation. The vendor must be able to explain how their practices for you converge and diverge with their practices with public institutions
• Ask providers for specific examples of how they have supported clients in the past in the face of regulatory and audit reviews for specific aspects of the CECL calculation
• Determine if a provider has experience and understanding of the nuances between different audit firms and understands the particular “house concerns” of major firms

Engagement Pattern

Vendors can provide CECL outsourcing in several ways. Abrigo’s pattern is typically “software-enabled.” That is, we provide summary deliverables and reporting, and the in-depth details of the underlying CECL calculation are delivered in our software platform to take advantage of its controls and validation pedigree and the ease of navigation of underlying information. How a CECL vendor delivers their work can significantly impact the ease of incorporating management input and particular client circumstances.

CONSIDERATIONS

Partner of Arms Length

• Determine whether your vendor is offering to outsource the function or outsource the thought behind the function. The less input management has into the process, the more critical it is to be comfortable with the vendor approach
• If the vendor has a standardized way of performing the function, challenge them to convince you of its benefits and relevancy to your institution. If the vendor’s approach is highly customizable, determine whether that thwarts the advantages of standardization
• Understand exactly where the delivery will be tuned to your particulars and where the process will be standardized, and be comfortable with both

Timing

• Obtain a clear understanding of the timing of the vendor’s responsibilities and yours in the engagement process
• Determine the degree to which management will have a ‘preview’ of the work for planning purposes and give feedback and input
• Assess whether leadership will be time-pressed to provide meaningful feedback or if delivery timing will allow management to absorb and deliberate

Length of Input

• Identify within the contract, statement of work, or engagement letter the stages of work during the CECL transition or the ongoing CECL calculation that will require management input and feedback
• Ensure the level of input is appropriate. In other words, the engagement details should create confidence that management is making decisions the institution is uniquely qualified to make, and the vendor is making decisions they are uniquely qualified to make. The vendor’s feedback and ability to provide market optics for management’s consideration is a critical value-add in working with a partner
• Assess how and when management will provide input for adjustments to forecasts, qualitative components, or individually analyzed (e.g., impaired) loans

About Abrigo Advisory Services

Abrigo’s in-house consulting organization helps financial institutions implement best practices across various service lines, including credit loss modeling for CECL and stress testing, valuation, asset/liability management (ALM), budgeting and planning, loan review, information security, model validation, loan and deposit pricing and profitability, analytics and market intelligence, and monitoring, investigation, and reporting of potential financial crimes. Abrigo’s work helps clients get the most optimization from using our suite of software tools; in other cases, we operate in a “software-enabled” outsourcing model wherein clients receive work through our integrated platform.

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Garver Moore

Managing Director, Advisory Services

[email protected]

Garver Moore is Managing Director of Advisory Services at Abrigo, leading a team engaged with hundreds of community financial institutions to provide valuation, credit loss modeling (stress testing & CECL), and strategic services. Prior to joining Abrigo, Garver worked with C-suite executives on technology strategy and delivery as a Managing Partner of the Orange Advisory Group and was a Technical Consultant with Accenture. He earned his bachelor’s degree in electrical and computer engineering from Duke University

Ease Your Transition to CECL

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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. Make Big Things Happen. Get started at abrigo.com.