CECL represents one of the most significant changes in accounting principles to confront financial institutions in years, and its effects are likely to be significant. While the business impacts of CECL will vary depending on each organization’s asset portfolios, market and other conditions, most organizations expect to see an increase in reserves. Estimates of that increase vary considerably, with expectations ranging from the single digits to more than 30%. The most significant impact is expected with banks and financial institutions holding longer-term assets.
Banks are struggling to dedicate efforts to CECL implementation, and time is running out, especially if parallel runs are a consideration. SEC filers must adopt CECL for fiscal years ending after Dec. 15, 2019, with other public business entities following closely behind in fiscal years beginning after Dec. 15, 2020.
Industry experience points to five areas of challenge–and we have a practical view on how to tackle those.
End-to-end data management
- Focus on managing the right data. To satisfy CECL requirements, banks need to develop risk analytics and models to determine their current credit expected losses during the life of the asset (e.g., loans, securities, etc.). Effective implementation requires data, and lots of it.
- Internal historical loan data. The characterization of forecasted loan performance will require substantial and accurate historical loan data. Origination data fields that include loan types, balances, term structure, collateral and borrower creditworthiness are crucial. Loan performance data on payment history (delinquency, defaults, credit line usage, etc.) will also be needed. Banks will need to track the percentage of their loan portfolio that is comprised of revolving credit products, including utilization percentages and historical performance.
- External market and economic data. The forecast horizon requires a bank to identify and quantify external factors that will drive loan performance. They need to address how changes in the economic environment will impact borrower credit risk. For many smaller banks, local conditions could be more indicative than national or international indicators. For example, increases in oil prices could be good news for a bank in Houston with energy industry clients but bad news for a lender in the Midwest with manufacturing borrowers. Upon closer investigation, some institutions will need to define institution-specific scenarios that incorporate macroeconomic data as well as business intuition to properly quantify performance.
- Complementary data. CECL presents a unique opportunity to introduce non-traditional sources of data to estimate the allowance for credit losses (ACL). Chief Credit Officers may look to a borrower’s external credit obligations, industry indicators, relationship measures such as wallet-share and other forms of data that could be indicative of credit performance.
If you’ve made a recent merger or acquisition and if the acquired entity exercised different lending practices or followed different data retention policies, you will have to address potential inconsistencies in the data available from acquired portfolios. Also, CECL data sets and models will both need to be subjected to SOX financial controls review.
Systems and technology
“CECL’s forward-looking approach accentuates focusing on strategic business intents, and its implementation truly requires close coordination among business operations, risk, and finance.”
- Institutions will need to think carefully in order to determine estimation approaches that will produce reasonable and supportable forecasts. There’s good news and bad news when it comes to choosing modeling approaches for CECL implementation. The good news? CECL allows a wide variety of modeling options. The bad news? CECL allows a wide variety of modeling options. Different options could produce entirely different results or introduce volatility into the estimates. Potential modeling approaches include::
Most banks won’t be starting from scratch. Credit risk analytics and models already in place for computing ALLL, regulatory stress testing, and BASEL compliance are helpful starting points for CECL. Banks with a global footprint are already complying with IFRS 9 and can leverage methodologies and lessons learned in that process, customizing them to CECL specifications. In the end, institutions will likely have different models across different loan products and asset portfolios. Some questions to ask about your portfolio?
- Regression analysis
- Static pool analysis
- Discounted cash flow analysis
- Average charge-off method
- Probability of default method
- Migration analysis
- Vintage analysis
- Can certain products be grouped with others by risk factors?
- Do you have products with unique credit risk factors?
- How idiosyncratic is your portfolio?
- Can you reconcile the CECL outcomes when using different modeling methodologies?
Jose Molina, Principal, Operations Risk Services
Governance and operating model
“CECL is an evolutionary industry change presenting institutions with the unique opportunity to optimize business decision making on the end-to-end credit lifecycle and to integrate this with internal and external performance management and reporting.”
- For most institutions, CECL is going to require some level of automation and integrity in computing allowance on monthly, quarterly and annual bases. CECL creates an opportunity for organizations to evaluate their technology and platforms. CECL is going to place additional demands on bank IT systems, requiring new data and the ability to effectively integrate that data across functional boundaries within the bank. As a principles-based standard, it is likely that CECL will evolve over the coming years, impacting initial IT configurations and thus requiring technological flexibility to adapt to changes in industry practices. In addition, with organizations already facing pressure to close their books quickly, CECL is going to add to that workload. CECL requires significant new public disclosures that might not be easy to automate. As you consider your technical response, take a close look at your data analytics and reporting capabilities and look for opportunities to automate CECL processes.
Frank S aavedra-Lim, National Managing Director, Business Risk Services
Integrated processes and controls
“Organizations should think of CECL not as an exercise to calculate a number, but rather as a sustainable program that supports the risk strategy of the business.”
- Incremental governance is going to be required as part of the implementation of CECL. The incremental governance stems from the fact that the forecast element of the estimation introduces a number of dynamic factors that have to be estimated, monitored and frequently validated. The CRO or equivalent, heading a reasonably independent risk function, will play a key role in providing analytical, challenger and forward-looking perspectives on credit portfolio risk management and other related business operations exposures. The CFO will need to attest to the results and provide extra transparency in the language that interprets the allowance as well as increased details about the estimation processes and related disclosures. Any changes to sourcing of data, modeling methodology, reporting details and actual allowance values will need to be closely monitored and reported, as the CECL reserve outputs can have direct impacts on the institution’s financial valuation, stock price, external ratings and reputation. From an operating model perspective, satisfying all CECL stakeholders is an active balancing act, requiring much closer coordination between risk and finance, among other functions.
Graham Tasman, Principal, Financial Management
- Well documented CECL estimations will require integrated workflows that link business units, IT, risk, finance and regulatory reporting. These workflows may require the implementation of service level agreements, as well as the requisite overlay of internal control frameworks and appropriate management attestation of SOX effectiveness. The execution of ACL processes will need to be timely, consistent, and properly traceable, producing appropriate public disclosures and reasonable, supportable information within tight reporting timelines.
Grant Thornton offers broad experience working with organizations and institutions on the broad range of issues what will drive an effective CECL response.
Beyond regulatory-driven risk management
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Principal, Operations Risk Services
: +1 312 602 8330
Principal, Financial Management
: +1 215 376 6080
Managing Director, Operations Risk Services
: +1 704 926 0365