Is Your Bank Ready for CECL?

CECL-12-28-16.pngConsidered by some bank accounting’s most significant change in 40 years, the FASB’s Current Expected Credit Loss (CECL) standard is inching toward reality.

Are you and your board colleagues studying the standard’s fundamentally new requirements for booking loan losses? Do you have a sense for its implications on reserves? Are you considering the penetrating questions to ask about management’s preparedness and processes to comply?

For some directors, the standard might seem straightforward: Build reserves to cover losses over the life of a loan. But it means much more: The timing of adding to the reserve has changed considerably. The entire expected lifetime losses must be booked in the quarter in which the loan is made.

Make no mistake; preparing to meet the demands of the standard, effective January 1, 2020, for most Securities and Exchange Commission (SEC) registrants, promises be a complex, time-consuming endeavor.

Other questions bank directors must ask themselves include whether they understand the standard’s implications and if they are confident that bank management is prepared for the formidable changes affecting modeling, data collection and analysis, calculation of losses, and information technology (IT) systems.

For some bank management teams, the answer may be a confident, “Yes.’’ For others, it might be a tentative, “Well … let us get back to you on that.’’

It is worth noting that 83 percent of bankers who answered a recent survey at the American Institute of Certified Public Accountants conference said they expected CECL to require substantial changes to banks’ policies, procedures and IT systems. Half said they were most concerned about how they would manage the amount of data needed to comply.

Consider this counterintuitive CECL scenario: the bank has a quarter it considers successful because of the number of new organically grown loans it made. But, it might show a quarterly loss because the bank must book expected losses for the entire life of those loans in the quarter in which the loans were made. Under current rules, banks book losses after they are incurred.

Further, when calculating expected losses under CECL, banks must incorporate reasonable and supportable forecasts in their loss evaluations. In other words, how strong are your bank’s modeling capabilities?

That forecast would include a bank’s expectation, for example, of the future yield curve and an expectation of the economic future over the life of the loan–and how these factors would impact the performance of each loan for the life of the loan.

For some banks, the timing issue could mean between now and 2020, they will need to add to their capital base through earnings. Capital planning considerations are most effectively dealt with when given sufficient lead time, especially if a number of institutions need to raise capital upon adoption of the standard.

Directors must prepare to challenge management’s process to meet the standard. That may mean that directors ask management if they’ve examined commercial loans by type or vintage, and if they’ve done preliminary lifetime loss calculations based on past experience and future economic considerations.

Consequently, directors need comfort that management has established a robust CECL planning process in order to know which data will be required. It’s no wonder, then, that for many directors, that standard looming on the horizon suddenly is getting closer.

John Depman

Mike Ohlweiler