Many financial institutions are well on their way in their transition to a CECL allowance estimate. They are reviewing and refining results, operationalizing their process preparing documentation and engaging with auditors. With the adoption date less than two months away, here are some additional key considerations to finalize.
- Give yourself time to refine results.
Financial institutions may be surprised by some of their initial CECL results. As now publicly reported, some institutions with shorter-term portfolios are experiencing a decrease in their CECL estimate when compared to an incurred loss estimate. Some have found that they did not have the requisite data to support initial intended segmentation or segment-level methodology elections. These circumstances required additional time for a bank to iterate through different options—often switching to less granular segmentation or simpler methodologies. Results will take longer to analyze, understand and substantiate. It will be necessary to understand all the assumptions that drive the CECL allowance (e.g., lookback period, reasonable and supportable forecast period, reversion period, prepayment assumptions, and contractual life) and how these interact. Bottom line—leave yourself time to get comfortable with your own results.
- Finalize approach for less material or non-mainline loan asset classes in your overall process.
Most of a bank’s time throughout the last year has likely been spent determining and analyzing CECL methodologies and the potential impact for larger and more material asset classes. But since the CECL adoption date is less than two months away, institutions should make sure to broaden their focus to include their less material or non-mainline asset classes as well. A simplified approach may be suitable for these assets; however, these less material or non-mainline assets still need to be integrated into the bank’s core CECL process to satisfy internal controls, analytical reporting, financial reporting, etc.
- Own your model calculations.
Financial institutions will need to be able to stand behind their methodology elections and model calculations. In addition to explaining detailed calculations and data used to develop the CECL estimate, this also means internally documenting why certain models or methodologies are most appropriate for their bank and for their specific portfolios, how key assumptions were ascertained, and what internal processes are in place to validate and monitor model performance. Auditors and regulators will require the same level of scrutiny whether a bank chooses to use an internally developed model, a vendor model (including industry-leading vendor models), or to purchase peer data. Financial institutions may require more specialized resources or additional internal governance and oversight to help aid this process.
- Know Your Qualitative Adjustments.
Qualitative adjustments will likely look different when transitioning from an incurred loss to an expected loss allowance estimate. Institutions will require a deep understanding of their portfolios and how their concentration of risk has changed over time. It will also be necessary to have an in-depth knowledge of any models and model calculations used to determine the CECL allowance to understand which specific portfolio credit characteristics and macro-economic variables are contemplated by their models, and which are not. This will inform the need for additional qualitative adjustments.
- Anticipate stakeholder questions.
With the adoption of CECL, most institutions are going to take a one-time capital charge that will require explanation to internal as well as external stakeholders. Moving from a rate versus volume attribution to a more complex set of drivers to the allowance estimate, including the incorporation of forecasted conditions, will require the production of additional analytics. Financial institutions will need to have the proper reporting framework and structure in place to produce analytics at the portfolio, segment and ultimately, loan level.
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For more insight into these considerations or to ask a question on your CECL journey, contact us.