Pub. 8 2017 Issue 2

www.wvbankers.org 28 West Virginia Banker V ery soon, CECL will fundamen- tally change how the financial industry accounts for loan loss reserves. Currently, institutions can’t record ex- pected losses until deemed “probable.” Because of this limitation, they were inadequately reserved before the 2008 financial crisis. To avoid a disastrous repeat, the Fi- nancial Accounting Standards Board’s (FASB) Current Expected Credit Loss (CECL) approach to the Allowance for Loan and Lease Losses (ALLL) goes into effect between 2020 and 2021. The following guide takes your institu- tion through implementation, one step at a time. Step 1: Initiate Education and Planning If you haven’t already done so: 1. Assign a team leader and assem- ble a team Identify a strong candidate with experience in such areas as credit risk or accounting. The CECL leader should build a team representing key affected areas, including senior management, loans, credit under- writing, risk management, account- ing and internal audit. 2. Educate the team and board Review CECL and explain its implications to your board and key stakeholders. Start by reviewing these interagency documents about CECL: Joint Agencies State- ment and Frequently Asked Ques- tions. 3. Create a project plan Your detailed project plan should manage system and policy changes, provide training and communica- tion, and account for contingencies. 4. Communicate with your core provider CECL relies on historical data on life of loan or life of portfolio loss rates, key portions of which reside within your core system. So, contact your provider to make adjustments to the current closed-file destruction schedule. Step 2: Address Key Decision Points The CECL project team must determine your institution’s best course of action. 1. Data identification Institutions must anticipate col- lecting the following data—at a minimum—for individual loans, and assess the need for more granular detail: risk rating, loan duration, origination date, maturity date, loan balance, key charge-off or recovery information, and loan segmentation. 2. Data gathering Gather individual loan data for existing loans to build the histori- cal picture and vintage disclosures CECL requires, including data from: • Core system: determine the data available, and plan for accessing it. • Loan accounting and servic- ing systems: determine how to retrieve data points captured within these systems. • Loan files and credit memos: certain data points may only be available within the loan file or credit memo. • Other databases: search other resources, like customer relation- ship management systems, to complete customer profiles. 3. Process adjustment The project team must adjust existing loan processes and sys- tems to capture the CECL data more cost effectively. This includes creating consistent codes for data fields, eliminating duplicate fields, ensuring data can be accessed and transitioning to digital-collection methods. 4. Data analysis Decide where to store the data, be it in an Excel spreadsheet or a com- plex, secure database—and deter- mine a cost-effective way to analyze that data. CECL: Your Step-by-Step Guide to Compliance by 2020-21 By Keith Monson, CSI Summer 2017 29 West Virginia Banker KeithMonson serves as CSI’s chief risk officer. In this role, Monson maintains an enterprise-wide compliance framework for risk assessment and reporting, as well as other key components of CSI’s corporate compliance program. 1. Portfolio Segmentation The Federal Reserve advises to “identify the portfolio segmentation needed to implement the proposed CECL model, such as grouping as- sets with similar risk characteristics.” 2. Economic Variables Institutions also must include nation- al and local economic data when calculating CECL. Those that are readily available, including unem- ployment rates, housing prices and commercial real estate prices, will prove the most helpful. 3. CECL Methodology FASB doesn’t require that a specific methodology be used to calculate the ALLL under CECL. The inter- agency joint statement explains “allowances for credit losses may be determined using various methods. Additionally, institutions may apply different estimation methods to dif- ferent groups of financial assets.” Methodologies include: • Average charge-off method • Vintage analysis • Static pool analysis • Roll-rate method or migration analysis • Probability of default • Regression analysis • Discounted cash-flow analysis Step 3: Validate and Test Your Decisions Follow the change management best practice of Plan, Do, Check, Act. 1. Validate chosen methodology Ensure your methodology meets all CECL requirements and provides the most accurate reserve estimates. The former will indicate your insti- tution’s compliance readiness; the latter helps minimize the financial impact from CECL. 2. Run parallel ALLLs Calculate both the current ALLL model and the newly devised CECL version through the transition peri- od, to help with budget decisions in preparation for CECL’s effective date. 3. Estimate capital impact The Federal Reserve suggests institutions “be proactive in esti- mating the potential impact to their regulatory capital ratios to assess whether they will have sufficient cap- ital at the time that the CECL model goes into effect.” Step 4: Transition to CECL by 2020-21 Institutions that follow this multi-step plan, making use of system-driven re- sources, will reap many benefits, includ- ing balancing CECL-related tasks with other responsibilities, streamlining data analysis and ensuring their CECL rollout meets regulatory expectations. Using this background information and our four-step plan, you have the tools to determine how to implement CECL based on your institution’s size, loan complexity and budget. 