CECL implementation and associated challenges
Implementing a new system and processes is never an easy task at any financial institution. To avoid disruption to 'business as usual', a rigorous approach must be taken. While this is true in all cases, CECL being implemented across the full spectrum of smaller 'community' banks and credit unions creates specific challenges of its own.
The reason that a CECL implementation is more complex for smaller banks is simply that it is asking banks to generate reportable, auditable results that use processes that are currently not part of the banks' business model. CECL not only looks at current impairment levels but asks financial institutions to predict future credit losses, using methods and techniques normally only found in larger firms. There are options in the specific methods that can be used, including:
- Weighted Average Remaining Maturity (WARM)
- Discounted Cashflows (DCF)
- Probability of Default / Loss Given Default (PD/LGD)
- Roll Rate
- Vintage
Each of these methods has nuances and consequences. FIs must be conscious that selecting a single method for expediency and compliance reasons could leave them with larger reserve requirements than their counterparts and at a distinct competitive disadvantage. By maintaining the possibility of using all methods as appropriate by loan pool, they can turn this into a positive competitive advantage.
The end game for a CECL implementation must include:
- Loan by loan auditability
- Full choice of methods by designated loan pool
- Capacity to drill down to Expected Credit Loss (ECL) inputs and computation
- Ease of use and ability to export for reporting
- Low need for secondary system developments such as data cleansing and 'golden data' storage
Third-party data consistency
CECL takes, as a start point in most of the ECL methods, the current reported losses per pool. These can be accessed via the FFIEC or NCUA call reports. An issue is that programmatically building these links into a CECL program is far from simple. The call reports themselves do not guarantee the formatting consistency needed for automation.
- In 2022, the FFIEC report changed by a single line, throwing off many spreadsheet-based solutions.
- The NCUA also changed the pooling for credit union peer groups, resulting in difficulty comparing one period to another by pool, and potentially stranding assets out of calculable pools.
Internal data availability
Some ECL models use internal data such as credit scores and Loss Given Default ratios. These are used at loan origination but not always maintained as the loan runs through its life. Poorly maintained LGD numbers or any failure to record credit deterioration can result in ECL numbers being far too high or low. Solutions include:
- Change in process for maintaining credit scores against obligors linked to the loans
- Defaulting missing values for values such as LGD on mortgage portfolios
- Exclusion of certain methods for specific pools due to lack of data
Lack of benchmarking
Smaller financial institutions have not been required to run this type of analysis and have just the ALLL to base expectancy on. This makes User Acceptance Testing more difficult. Useful steps include selecting a small sample of loans, finding the current known ALLL, computing ECL for as many methods as possible, comparing results, and using that as the benchmark increase. As a rule of thumb, the range of increase should fall between 20% and 40% above the ALLL.
Lessons learned
CECL is a journey into the unknown for banks and credit unions. Success lies in rigor around data management, education on potential pitfalls, and monitoring expectations of the result. The ability to demonstrate attention to these details is just as important to creating a program that works as is compliance itself.
CECL Express can help…
CECL Express is a turnkey solution that fully satisfies all elements of the new CECL accounting standard. The system provides all non-loan data, including:
- Yield curves and Fed data
- Linked reports on losses from the FFIEC and NCUA
- PD and LGD curves
- Macroeconomic data
Banks and credit unions need to only provide the underlying loan details for the system to provide fully auditable ECL results for multiple calculation methods, including:
- Vintage
- Roll Rate
- Discounted Cashflow
- WARM
- PD/LGD
CECL Express provides more than valid ECL results. The system computes results for all methods and all loan pools, allowing the bank to optimize its CECL configuration and avoid the worst impacts of the new standard.