Any big accounting change—especially one as large as CECL (current expected credit loss)—is bound to cause some pain. But, there are ways to make sure your bank is not making the challenge bigger than it has to be. Here are five tips on selecting a calculation methodology that’s compatible with your institution.
1. Consider the complexity.
Banks can choose from several methodologies that range in complexity. The more complex the methodology, the more data needed—and the more inherent risk of error. Both the Financial Accounting Standards Board (FASB) and regulators have consistently indicated that complex CECL models aren’t required. Nevertheless, some community institutions seem to be choosing more complex methodologies over simpler solutions that can decrease cost and reduce risk.
Overall, the choice of a more complex methodology can impose additional costs and risks to a bank. If a community bank is going to use a complex methodology, it should go into it with clear understanding of the cost and risk involved.
2. Select your methodology first.
Regulatory agencies — including the Securities and Exchange Commission and the FASB — have continually discussed how Excel is an acceptable tool for fulfilling CECL requirements. As a general rule, the more complex the methodology, the more likely you’ll need new software. Industry participants are becoming aware that they can use, with some adapting, methodologies similar to those they use today. That means they can continue to use Excel.
CECL software does have its advantages. For example, there’s functionality for quickly disaggregating the portfolio to a finer degree and the ability to explore various methodologies, which could be beneficial. But, new software won’t eliminate all of the hard work of making estimates requiring a managerial decision.
3. Don’t panic about the reasonable and supportable forecast requirements.
The accounting standard provides a framework for incorporating a reasonable and supportable forecast. The standard doesn’t require fancy and sophisticated forecasting techniques with regression equations. Using charts with historical economic information compared to long-term trend lines can be a way to reasonably support a forecast. This framework is illustrated within the accounting standard and consists of comparing the general direction of two economic indicators (unemployment and real estate values) and using historical loss periods with similar directional trends as a basis for qualitative adjustments.
4. Start with what makes sense and add complexity as needed.
The more complex the methodology, the more historical, loan-level data will be required. Many institutions won’t have accurate and complete data from several years ago readily available. They could do a tremendous amount of work right now to obtain that historical data. A better solution might be for those institutions to start changing their processes for the current year, so that going forward, they’ll have the correct data. In the meantime, they can use a less complex methodology that’s acceptable to regulators, such as the weighted average remaining maturity that doesn’t require loan-level information.
5. Ignore the hype and do what’s right for your institution.
Much of the focus in the industry now is on the big banks that are closest to adoption. A big, complex institution will require a complex CECL solution, so much of the dialogue in the industry relates to those complex methodologies. But, what’s good for your bank? Much of the industry buzz around advanced methodologies and CECL software has little to do with the needs of community institutions. The adoption deadline for community banks, which is still a couple of years away and simpler than that for large banks, is not an argument for procrastination. Rather, it’s a reminder that community institutions can craft solutions appropriate to their own needs that are efficient, effective, and economical.
Some community banks are still not working on CECL with necessary diligence and speed. Others are introducing complexity that makes the process more difficult than it has to be. An approach that recognizes there’s work to do—but understanding it can be minimized—is the right CECL strategy for the large majority of banks.