Items to Consider with the New CECL Requirements
With the new CECL requirements coming into effect for the majority of our Community Banking clients, (for non-public business entities the standards are effective as of January 2021), we have begun to receive numerous questions related to potential implementation changes. Some items to consider when reviewing these changes may include the following:
- Implementation Software
- Estimation Methods
- How Much Data?
- CECL Templates
Virtually all regulatory authorities from the FED, FDIC and the OCC have publicly stated repeatedly that the new complexity and sophistication of the CECL analysis, when implemented, should be consistent with the complexity and sophistication of the financial institution itself. However, implementation software from outside vendors is not a requirement. In fact, many presentations by regulatory personnel state that current loan loss methodologies and calculations performed within Microsoft Excel could be based on Excel spreadsheets. Therefore, if a financial institution does not want to absorb the cost of additional software, there is no requirement to purchase outside software.
CECL does not require any one specific estimation method. The overall guidance mentions acceptable methods that could include analysis of loss rates, migration analysis, roll-rates, vintage analysis, discounted cash flow, and probability of default/loss given default methods. However, none of these methods are specifically required for estimating expected credit losses under the new methodology. Certain methods will require additional resources to develop their respective calculations.
We recommend you begin by examining at a variety of different options to determine the analysis you would like engage to fully implement CECL. Then focus on the methods and analysis that are consistent with the complexity and sophistication levels within your institution.
Off-balance credit exposures and troubled debt restructurings have to be evaluated under CECL implementation. For troubled debt restructurings, the new accounting standards require:
- The value of concessions made by the creditor in a TDR to be incorporated into the allowance estimate; and
- The pre-modification effective interest rate to be used to measure credit losses on a TDR when applying the discounted cash flow method.
How Much Data?
Currently, there is no established period of time on how much loss data will be required under CECL. The Basel Committee issued a document in 2015 that stated regulators will generally expect to see one economic cycle of data maintained. However, changes in underwriting standards, management, and loan concentrations may dictate a different approach to the amount of time to be analyzed. Ultimately, bank management and the board of directors will need to determine what seems to be a reasonable period of time to collect and analyze loss data for the new CECL methodology. Be sure to document your decision, illustrate the facts and circumstances for why your approach has been determined.
The new CECL methodologies will require certain future forecasts, which banks believe, will affect their loan portfolios. Although there is no set period to forecast, many experts have stated that at least the next 12-24 months will need to be incorporated into the new modeling.
Qualitative factors will still be required to be incorporated under the new CECL methodology. Current qualitative factors will serve as a good starting point, but additional factors will likely need to be included to reflect the unique factors within each specific institution. New factors will not only be based upon current conditions, but also reflect expectations for upcoming economic projections.
FBLG is currently developing a variety of basic CECL templates to distribute to clients and friends within the banking industry. We will continuously update the templates as we collect feedback from bank regulators and other experts. If you would like to use our templates as starting point in developing your own specific analysis, please contact us.