Is CECL a big effort?
By Chris Galloway, MBA and Geoffrey Oliver, CPA, CFF, CMB
The American Bankers’ Association has called the new Current Expected Credit Losses model (CECL) “the most sweeping change to bank accounting ever.” If you offer credit, then you should be getting ready to implement the new rules on accounting for credit losses. The Financial Accounting Standards Board’s (FASB) new standard introduces the Current Expected Credit Loss (CECL) methodology for estimating the allowances for credit losses. It requires that the “life of loan” losses to be recorded at the time of loan origination and recognizes potential losses based on historical or expected loss trends. As a result, loan losses will no longer be recognized “after the loss has occurred.”
The impact of the FASB’s Current Expected Credit Loss (CECL) requirements will be significant, with projected credit loss reserves anticipated to increase by as much as 30-50 percent by some estimates.
Some of the most important questions for any bank will be:
- Can bank management explain to the auditors the analysis performed to calculate the loss experience for the various types of loans in their portfolio?
- Will the bank have sufficient data and documented analysis to support the proposed CECL policy, procedures, loss calculations and accounting entries?
- Does the bank understand the complexity and time intensive steps required to capture the appropriate data, define the portfolio segmentation (and how poor segmentation can dramatically affect the losses for different loan types) and
- What effort will be needed to “dig out loan loss information” by loan type over an extended period of time?
- A well-documented database will need to track the information needed for banks to have a reasonable basis for its estimates of expected losses over the life of the loan?
- Continued updates to the CECL assumptions and calculations will be needed to address changing loss patterns. Loss levels on existing loans may change and new loss events may occur that are short term and/or are from specific, non-recurring loss events.
The industry knowledge needed to analyze losses, the data to collect and use, the database capabilities and the economic/industry factors that affect the various concentrations of borrowers are all critical for a bank to be able to implement CECL properly.
Hilltop has established a template that organizes the implementation of CECL and identified key steps to take for the implementation:
- identifying the types of data by loan type that is available,
- assessing the database capabilities that are already in place and identifying what will be needed,
- identifying the parameters for loan loss data to be collected,
- research and begin to model historical and anticipated losses by loan type (which may be different than the bank’s own portfolio),
- determining what loan and loss experience data the Bank has available (and if not available-how to create such) and what needs to be completed,
- identifying the method of segregation for various loan types,
- identifying inputs (borrower risk level, payment history, risk rating, other internal information feeds), delinquency and loss data and economic and industry forecast information that will be used in the calculations,
- identifying the integration steps for loan loss data with the inputs noted above,
- create a “mock” analysis that will use the above information and potential policy decisions that provides a range of possible life of loan losses,
- finalizing the implementation of CECL should include the following steps:
- approving the design of an acceptable accounting policy that will meet the needs of the external auditors and federal examiners,
- implementing a workplan that addresses how all of the components come together: the data, the analytics, loss calculations and final policy decisions regarding the losses per loan type that will be booked to meet CECL requirements,
- creating the final supporting policy and procedural documentation for identifying life of loan losses for each loan type,
- approving the analytics that need to be completed,
- identifying the Bank personnel with the appropriate skills to perform testing of the methodology, assumptions, data analytics, calculations, amount to be booked for CECL and determining if the methodology will pass the accounting requirements.
As noted above, CECL is not a “one and done” rule implementation, lenders will need to continually assess (in the same manner as outlined herein) the change in the lending and borrower marketplace:
- subprime mortgage loans came and went but CECL would have required recording losses at origination and then continually update loss assumptions based on bank portfolio and market trends,
- commercial/multifamily loan growth may increase loss experience for these loan types,
- increases in defaulted loans (temporary or permanent changes),
- non-QM mortgage loans may have their own credit loss dynamics,
- increases in losses from fintech loans because the origination process and borrower types are different,
- more data continues to be available about borrowers – this is likely to foster more complex loan loss analytics given the additional data and subsequent default patterns, and
- of course – the quality, completeness and accuracy of the data used for borrower and loss analyses is critical to ensuring that the life of loan losses are calculated correctly.
To contact the authors:
Chris Galloway Jeff Oliver
Senior Director CEO
703-356-3350 ext. 217 703-356-3350 ext. 201
cgalloway@thehilltopcompanies.com gaoliver@thehilltopcompanies.com
