The current expected credit loss model (CECL) standard is now rapidly approaching for all financial institutions that have not yet implemented. The time between now and the implementation date should be used wisely.
But when it comes to planning, how do you know where to start?
CECL Effective Date Delayed
On November 15, 2019, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2019-10, which delayed the effective date for the CECL standard, ASU 2016-13. The ASU extends the effective dates of CECL for smaller public business entities and nonpublic business entities.
The FASB pushed back the effective date of CECL from January 2021 to January 2023 for smaller reporting companies as defined by the Securities and Exchange Commission (SEC) and from January 2022 to January 2023 for nonpublic companies. The determination of smaller reporting companies is based on the entity’s most recent determination as of November 15, 2019. The SEC defines a small reporting company as one with public float of less than $250 million or annual revenue of less than $100 million, and either no public float or a public float of less than $700 million.
Furthermore, The CARES Act signed into law on March 27, 2020, has specific wording that states financial institutions are not required to comply with ASU 2016-13 (CECL), through the termination of the national emergency related to COVID-19 or December 31, 2020—whichever is earlier. The Consolidated Appropriations Act, signed into law on December 27, 2020, extended that delay to the termination of the national emergency related to COVID-19 or December 31, 2022 — whichever is earlier. Large accelerated filers will have to weigh their options on whether they delay CECL for the short term or report and disclose under the CECL model before they are required to at the termination of the national emergency or December 31, 2022. If a decision to delay implementation of CECL is made, the financial institution would still be required to disclose the potential impact of CECL.
Tips for CECL Preparation
When it comes time to prepare for CECL implementation, there are three tips you can consider following to help you get ready.
- Lifetime Loss Approach
Many smaller financial institutions are using annual loss experiences to calculate the historical loss rate, but the annual loss rate can no longer be used for calculating historical loss experience under CECL. The new standard requires the loss rate to be based on some form of lifetime loss approach, and the method for calculating the lifetime loss rate is fairly open.
If the financial institution plans on piggybacking off their current method of loan loss calculation based on annual loss rate, modifications to the lifetime loss approach will be required. It is important to note the one exception to this—the WARM method. Under the Weighted Average Remaining Maturity (WARM) method, an annual loss rate is applied to the projected paydown of existing loans. This method is expected to be popular with small community banks. It’s important to stay compliant with loss calculations to ensure you are prepared for implementation. - The Three Elements to CECL
The allowance calculation under CECL is equal to: Historical Loss rate +/- Current Economic Conditions/Qualitative Factors +/- Reasonable Forecasted Economic Conditions. Many of the discussions on CECL focus on the historical loss calculation and not the current economic/qualitative factors and the forecasted economic elements of the CECL calculation. As part of the education process, you should look for information that covers all aspects of the CECL calculation process. - Historical Data
Obtaining historical loan data may be difficult, or it may be limited. In order to find this information, consider using previous monthly board reports that show loan information related to that month. From this info, your bank will be able to calculate the historical loss rate.
Implementation Steps
By starting early in the implementation phase, financial institutions will be better prepared for implementing CECL. Here are five important steps your financial institution can take as you work through CECL implementation:
Appoint an implementation committee.
This is the group that will guide your bank through the process. They will need to educate themselves on CECL requirements, identify available options, pick an approach that meets the bank’s needs, gather information for the implementation, set timelines for completion of each phase, perform dry runs of the selected method and guide final implementation. In other words, this crew has a lot of responsibility, so you will want to make your selections carefully. Consider personnel who work in IT, operations, the senior credit officer and the chief financial officer.
Review CECL options.
The standard doesn’t dictate a particular model or method that must be used. Instead, it provides basic guidelines along with some examples, but is otherwise wide open. Some of the common approaches being discussed include migration analysis, discounted cash flow, WARM method, probability of default/loss given default (PD/LGD), the Fed’s SCALE method and vintage analysis. Institutions can use one or more methods, but smaller institutions may prefer only one method.
Select a method.
This step can be a bit of a challenge as there are several methods and versions of the same method that could be used. Selecting the one that fits your bank can take some time. The method that is selected may be driven by available data, ease of use, cost, time commitment, relevancy, availability of support and your institution’s complexity. Visiting with your accountant or auditor can help make your selection easier. For smaller institutions, the WARM or SCALE method may be more practical because the information needed is more readily available and the method is simpler to use.
Gather data.
Some guidance on implementing CECL indicates banks need to start gathering data to be used in implementation. To a certain extent, this is appropriate; institutions want to make sure historical data isn’t being purged, overwritten or replaced. However, collecting data without selecting the CECL approach first may be a waste of time since some of the data collected may not be needed or correct. Basic data that should be considered for early gathering includes:
- Origination date and amount
- Prepayment dates and amounts
- Maturity date
- Date and amount of write-offs
- Dates and amounts of recoveries
- Date restructured as a TDR
- Payment dates and amounts
Conduct trial runs.
Once a method has been chosen and the data gathered, the institution should begin trial runs. This will help identify weaknesses in the calculation process and data collection and ideally would happen for a minimum of a few quarters prior to adoption. The approach may need to be refined based on the initial calculations and as experience is gained.
If you were a community bank that hasn’t started the process of building or purchasing a CECL solution, what piece of advice would be most helpful?
“Find a vendor you know and trust and look closely at their solution; trying to build something on your own is a huge time commitment and difficult. Find someone trusted and provide a starting point now, because it does take time to gather, input and adjust the data for your institution.”
- Jody Eddy, Cashier/Controller – Reliance Bank, Faribault, MN
Selecting Your Solution
When it comes time to make your selection, you want a solution that fits your institution’s unique needs. A customizable, easy to use CECL Solution with built in features, such as updated security and tools for analyzing economic trends, can help your bank succeed. By following the tips and steps above, you can have a successful CECL implementation.
If you’d like to hear the latest thoughts about various CECL models being used and what might be best for your bank or credit union, listen in on our recent presentation.
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