Nine and a half times out of 10, you don’t eat the entire pie during dessert. Instead, you opt for a slice – maybe two.
It’s the same with financial institutions and their services.
Most banks don’t originate every type of loan or allow customers to open every type of account in the market. But when they are in need of a specific capability, such as banking as a service capabilities or acquisition, development and construction financing, it can be difficult to find a solution that does only that.
In certain cloud-hosted environments, however, banks can create the exact solution they need for their business and customers.
In this episode of Reinventing Banking, a special podcast series brought to you by Bank Director and Microsoft Corp., we speak to Robert Wint, senior product director at Temenos, a cloud-based banking technology solutions provider.
Wint describes how Temenos’ cloud banking focus is helping financial institutions spin out specific, individual technologies and launch them as stand-alone solutions. He brings to the table some impressive case studies, and introduces a potentially new term to our American audience: composable banking.
Temenos reports that its technology is used to bank over 1.2 billion people. Listen to find out how.
This episode, and all past episodes of Reinventing Banking, are available on FinXTech.com, Spotify and Apple Music.
Faster financial reporting means executives have more immediate insight into their business, allowing them to act quicker. Unfortunately for many businesses, an understaffed or overburdened back-office accounting team means the month-end close can drag on for days or weeks. Here are four effective strategies that help banks save time on month-end activities.
1. Staying Organized is the First Step to Making Sure Your Close Stays on Track
Think of your files as a library does. While you don’t necessarily need to have a Dewey Decimal System in place, try to keep some semblance of order. Group documentation and reconciliations in a way that makes sense for your team. It’s important every person who touches the close knows where to find any information they might need and puts it back in its place when they’re done.
Having a system of organization is also helpful for auditors. Digitizing your files can help enormously with staying organized: It’s much easier to search a cloud than physical documents, with the added benefit of needing less storage space.
2. Standardization is a Surefire Way to Close Faster
Some accounting teams don’t follow a close checklist every month; these situations make it more likely to accidentally miss a step. It’s much easier to finance and accounting teams to complete a close when they have a checklist with clearly defined steps, duties and the order in which they must be done.
Balance sheet reconciliations and any additional analysis also benefits from standardization. Allowing each member of the team to compile these files using their own specific processes can yield too much variety, leading to potential confusion down the line and the need to redo work. Implementing standard forms eliminates any guesswork in how your team should approach reconciliations and places accountability where it should be.
3. Keep Communication Clear and Timely
Timely and clear communication is essential when it comes to the smooth running of any process; the month-end close is no exception. With the back-and-forth nature between the reviewer and preparer, it’s paramount that teams can keep track of the status of each task. Notes can get lost if you’re still using binders and spreadsheets. Digitizing can alleviate some of this. It’s crucial that teams understand management’s expectations, and management needs to be aware of the team’s bandwidth. Open communication about any holdups allows the team to accomplish a more seamless month-end close.
4. Automate Areas That Can be Automated
The No. 1 way banks can save time during month-end by automating the areas that can be automated. Repetitive tasks should be done by a computer so high-value work, like analysis, can be done by employees. While the cost of such automation can be an initial barrier, research shows automation software pays for itself in a matter of months. Businesses that invest in technology to increase the efficiency of the month-end close create the conditions for a happier team that enjoys more challenging and fulfilling work.
Though month-end close with a lack of resources can be a daunting process, there are ways banks can to improve efficiency in the activities and keep everything on a shorter timeline. Think of this list of tips as a jumping off point for streamlining your institution’s close. Each business has unique needs; the best way to improve your close is by evaluating any weaknesses and creating a road map to fix them. Next time the close comes around, take note of any speed bumps. There are many different solutions out there: all it takes is a bit of research and a willingness to try something new.
A growing number of banks may need to record goodwill impairment charges once the coronavirus crisis finally shows up in their credit quality.
A handful of banks have already announced impairment charges, doing so in the first and second quarter of this year. Some have written off as much as $1 billion of goodwill, dragging down their earnings and, in some cases, dividends. Volatility in the stock market could make this worse in the second half of the year.
“It was a very hot topic for all of our financial institutions,” says Ashley Ensley, a partner in DHG’s financial services practice. “Everyone was talking about it. Everybody was looking at it. Whether you determined you did … or didn’t have a triggering event, I expect that everyone that had goodwill on their books likely took a hard look at that amount this quarter.”
Goodwill at U.S. banks totaled $342 billion in the first quarter, up from $283 billion a decade ago, according to the Federal Deposit Insurance Corp.
Goodwill is an intangible asset that reconciles the premium paid for acquired assets and liabilities to their fair value. It’s recorded after an acquisition, and can only be written down if the subsequent carrying value of the deal exceeds its book value. Although goodwill is an intangible asset excluded from tangible common equity, the non-cash charge can have tangible consequences for acquisitive banks. It immediately hits the bottom line, reducing income and, potentially, even capital.
Several banks have announced charges this year. PacWest Bancorp, a $27.4 billion bank based in Beverly Hills, California, took a charge of $1.47 billion. Great Western, a $12.9 billion bank based in Sioux Falls, South Dakota, took a charge of $741 million. And Cadence Bancorp., an $18.9 billion bank based in Houston, Texas, recorded an after-tax impairment charge of $413 million.
Boston-based Berkshire Hills Bancorp announced a $554 million charge during its second-quarter earnings that wiped out all its goodwill. The charge, combined with higher loan loss provisions, led to a loss of $10.93 a share. Without the goodwill charge, the bank would’ve reported a loss of only 13 cents a share.
“The primary causes of the goodwill impairment were economic and industry conditions resulting from the COVID-19 pandemic that caused volatility and reductions in the market capitalization of the Company and its peer banks, increased loan provision estimates, increased discount rates and other changes in variables driven by the uncertain macro-environment,” the bank said in its quarterly filing.
Goodwill impairment assessments begin by evaluating qualitative factors for positive and negative evidence — both internally and in the macroeconomic environment — that could cause a bank’s fair value to diverge from its book value.
“It really is not a one-size-fits-all analysis,” says Robert Bondy, a partner in Plante Moran’s financial services group. “Just because a bank — even in the same marketplace — has an impairment, it’s hard to cast that shadow over everybody.”
One reason banks may need to consider impairing their goodwill is that bank stock prices are meaningfully down for the year. The KBW Regional Banking Index, a collection of 50 banks with between $9 billion and $63 billion in assets, is off by 33%. This is especially important given the deceleration in bank deals, which makes it hard to evaluate what premiums banks could fetch in a sale.
“[It’s been] one or two quarters and overall markets have rebounded but bank stocks haven’t,” says Jay Wilson, Jr., vice president at Mercer Capital. “You can certainly presume that the annual impairment test, when it comes up in 2020, is going to be a more robust exercise than it was previously.”
Banks could also write off more goodwill if asset quality declines. That has yet to happen, despite higher loan loss provisions — and in some cases, banks saw credit quality improve in the second quarter.
The calendar could influence this as well. Wilson says the budgeting process and cyclical cadence of accounting means that annual tests often occur near year-end — though, if a triggering event happens before then, a company can conduct an interim test.
That’s why more banks could record impairment charges if bank stocks don’t rally before the end of the year, Wilson says. In this way, goodwill accumulation and impairment mirror the broader economy.
“Whenever the cycle turns, banks are inevitably in the middle of it,” he says. “There’s no way, if you’re a bank to escape the economic or the business cycle.”
The suspension of accounting rules on modified loans is
another dramatic measure that regulators and lawmakers have taken in the struggle
to limit pandemic-related loan defaults.
The question of how — and increasingly, whether — to
account for, report and reserve for modified loans has taken on increasing
urgency for banks working to address borrowers’ unexpected hardship following
the COVID-19 outbreak.
Regulators homed in on the treatment for troubled debt restructurings, or TDRs, in late March, as cities and states issued stay-at-home orders and the closure of nonessential businesses sparked mass layoffs. The intense focus on the accounting for these credits comes as a tsunami of once-performing loans made to borrowers and businesses across the country are suddenly at risk of souring.
“The statements from regulators and the CARES Act are trying
to reduce the conversations that we have about TDRs by helping institutions
minimize the amount of TDR challenges that they’re dealing with,” says Mandi Simpson,
a partner in Crowe’s audit group.
TDRs materialize when a bank offers a concession on a credit
that it wouldn’t have otherwise made to a borrower experiencing financial
difficulties or hardship. Both of those prongs must exist for a loan to be
classified as a TDR. Banks apply an individual discounted cash flow analysis to
modified credits, which makes the accounting complicated and tedious, Simpson
“You can imagine, that could be pretty voluminous and
cumbersome” as borrowers en mass apply for modifications or forbearance, she
Late last month, federal bank regulators provided guidance on TDRs to encourage banks to work with borrowers facing coronavirus-related hardship. Still, Congress intervened, broadening both the relief and the scope of eligible loans.
The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, which went into effect on March 27, suspended the requirements under U.S. generally accepted accounting principles for coronavirus loan modifications that would have otherwise been categorized as TDRs. It also suspended the determination that a loan that has been modified because of the coronavirus would count as a TDR, “including impairment for accounting purposes.” This applies to any loan that receives a modification that was not more than 30 days past due as of Dec. 31, 2019.
The law encourages banks to record the volume of modified loans.
It also specified that bank regulators can collect data about these loans for
Bank regulators issued their revised interagency statement on April 7 to align with Congress’ rule. Bankers should maintain appropriate allowances and reserves for all loan modifications. It adds that examiners will exercise judgment when reviewing modifications and “will not automatically adversely risk rate credits that are affected by COVID-19.”
Importantly, the U.S. Securities and Exchange Commission’s chief accountant issued an opinion accepting the CARES Act treatment of TDRs as GAAP on April 3. The statement reconciled U.S. accounting policy and federal law, and spared auditors from issuing modified opinions for institutions that adopt the TDR relief.
accounting relief could create longer-term issues for banks, says Graham Steele,
staff director of the Corporations and Society Initiative at Stanford Graduate
School of Business. He previously served as minority chief counsel for the
Senate Committee on Banking, Housing and Urban Affairs and was a member of the
staff of the Federal Reserve Bank of San Francisco.
He understands the imperative to provide forbearance and flexibility, but he says the modifications and concessions could lead to diminished cash flows that could erode a bank’s future lending capacity. He points out that it’s also unclear what would happen to balance sheets once the national emergency ends, and how fast those modifications would be reclassified.
like an ‘extend and pretend’ policy to me,” he says. “Congress and regulators
have offered forbearance, but they’re changing mathematical and numerical
conventions that you can’t just assume away.”
Simpson says that as part of the tracking of modified loans, institutions may want to consider those credits’ risk ratings and how their probability of default compares to performing loans. She is encouraging her clients to consider making appropriate and reasonable disclosures to share with investors, such as the amount and types of modifications. The disclosures could also give bank executives a chance to highlight how they’re working with borrowers and have a handle on their borrower’s problems and financial stress.
“I think proactively helping borrowers early on is a good move. I know banks are challenged to keep up with the information, just I am, and the timing is challenging,” Simpson says. “They’re needing to make very impactful decisions on their business, and you’d like to be able to do that with a little bit more proactivity than reactivity. Unfortunately, that’s just not the place that we find ourselves in these days.”
Bank buyers preparing to review a potential transaction or close a purchase may encounter unexpected challenges.
For public and private financial institutions, the impending accounting standard called the current expected credit loss or CECL will change how they will account for acquired receivables. It is imperative that buyers use careful planning and consideration to avoid CECL headaches.
Moving to CECL will change the name and definitions for acquired loans. The existing accounting guidance classifies loans into two categories: purchased-credit impaired (PCI) loans and purchased performing loans. Under CECL, the categories will change to purchased credit deteriorated (PCD) loans and non-PCD loans.
PCI loans are loans that have experienced deterioration in credit quality after origination. It is probable that the acquiring institution will be unable to collect all the contractually obligated payments from the borrower for these loans. In comparison, PCD loans are purchased financial assets that have experienced a more-than-insignificant amount of credit deterioration since origination. CECL will give financial institutions broader latitude for considering which of their acquired loans have impairments.
Under existing guidance for PCI loans, management teams must establish what contractual cash flows they expect to receive, as well as the cash flows they do not expect to receive. The yield on these loans can change with expected cash flows assessments following the close of a deal. In contrast, changes in the expected credit losses on PCD loans will impact provisions for loan losses following a deal, similar to changes in expectations on originated loans.
CECL will significantly change how banks treat existing purchased performing loans. Right now, accounting for purchased performing loans is straightforward: banks record loans at fair value, with no allowance recorded on Day One.
Under CECL, acquired assets that have only insignificant credit deterioration (non-PCD loans) will be treated similarly to originated assets. This requires a bank to record an allowance at acquisition, with an offset to the income statement.
The key difference with the CECL standard for these loans is that it is not appropriate for a financial institution to offset the need for an allowance with a purchase discount that is accreted into income. To take it a step further: a bank will need to record an appropriate allowance for all purchased performing loans from past mergers and acquisitions that it has on the balance sheet, even if the remaining purchase discounts resulted in no allowance under today’s standards.
Management teams should understand how CECL impacts accounting for acquired loans as they model potential transactions. The most substantial change relates to how banks account for acquired non-PCD loans. These loans first need to be adjusted to fair value under the requirements of accounting standards codification 805, Business Combinations, and then require a Day One reserve as discussed above. This new accounting could further dilute capital during an acquisition and increase the amount of time it takes a bank to earn back its tangible book value.
Banks should work with their advisors to model the impact of these changes and consider whether they should adjust pricing or deal structure in response. Executives who are considering transactions that will close near their bank’s CECL adoption date not only will need to model the impact on the acquired loans but also the impact on their own loan portfolio. This preparation is imperative, so they can accurately estimate the impact on regulatory capital.
A debate is raging right now as to whether the new loan loss accounting standard, soon to go into effect, will aggravate or alleviate the notoriously abrupt cycles of the banking industry.
Regulators and modelers say the Current Expected Credit Loss model, or CECL, will alleviate cyclicality, while at least two regional banks and an industry group argue otherwise. Who’s right? The answer, it seems, will come down to the choices bankers make when implementing CECL and their view of the future.
CECL requires banks to record losses on assets at origination, rather than waiting until losses become probable. The hope is that, by doing so, banks will be able to prepare more proactively for a downturn.
This debate comes as banks are busy implementing CECL, which goes into effect for some institutions as early as 2020.
Last year, internal analyses conducted by BB&T Corp. and Zions Bancorp. indicated that CECL will make cycles worse compared to the existing framework, which requires banks to record losses only once they become probable.
Both banks found that CECL will force a bank with an adequate allowance to unnecessarily increase it during a downturn. Their concern is that this could make lending at the bottom of a cycle less attractive.
The increase in provisions would “directly and adversely impact retained earnings,” wrote Zions Chief Financial Officer Paul Burdiss in an August 2018 letter, without changing the institution’s ability to absorb losses. BB&T said that adjusting its existing reserves early in a recession, as called for under CECL, would deplete capital “more severely” than the current practice.
BB&T declined to comment, while Zions did not return requests for comment.
The Bank Policy Institute, an industry group representing the nation’s leading banks, said in a July 2018 study that the standard “will make the next recession worse.” CECL’s lifetime approach forces a bank to add reserves every time it makes a loan, which will increase existing reserves during a recession, the group argued.
“The impact on loan allowances due to a change in the macroeconomic forecasts is much higher under CECL,” the study says.
And in Congressional testimony on April 10, JPMorgan Chase & Co. Chairman and CEO Jamie Dimon said CECL could impact community banks’ ability to lend in a recession.
“I do think it’s going to put smaller banks in a position where, when a crisis hits, they’ll virtually have to stop lending because putting up those reserves would be too much at precisely the wrong time,” he said.
Those results are at odds with research conducted by the Federal Reserve and firms like Moody’s Analytics and Prescient Models. Some of the differences can be chalked up to modeling approach and choices; other disagreements center on the very definition of ‘procyclicality.’
Moody’s Analytics believes that CECL will result in “easier underwriting and more lending in recessions, and tighter underwriting and less lending in boom times,” according to a December 2018 paper. The Federal Reserve similarly found that CECL should generally reduce procyclical lending and reserving compared to the current method, according to a March 2018 study.
Yet, both the Fed and Moody’s Analytics concluded that CECL’s ability to temper the credit cycle will vary based on the forecasts and assumptions employed by banks under the framework.
“The most important conclusion is that CECL’s cyclicality is going to depend heavily on how it’s implemented,” says Moody’s Analytics’ deputy chief economist Cristian deRitis. “You can … make choices in your implementation that either make it more or less procyclical.”
DeRitis says the “most important” variable in a model’s cyclicality is the collection of future economic forecasts, and that running multiple scenarios could provide banks a baseline loss scenario as well as an upside and downside loss range if the environment changes.
The model and methodology that banks select during CECL implementation could also play a major role in how proactively a bank will be able to build reserves, says Prescient Models’ CEO Joseph Breeden, who looked at how different loan loss methods impact an economic cycle in an August 2018 paper.
A well-designed model, he says, should allow bankers to reserve for losses years in advance of a downturn.
“With a good model, you should pay attention to the trends. If you do CECL right, you will be able to see increasing demands for loss reserves,” he says. “Don’t worry about predicting the peak, just pay attention to the trends—up or down—because that’s how you’re going to manage your business.”
In the final analysis, then, the answer to the question of whether CECL will alleviate or aggravate the cyclical nature of banking will seemingly come down to the sum total of bankers’ choices during implementation and execution.
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.
Since the 1970s, there has been an inevitable march toward a macro, quantitative assessment of credit quality. Technology and big data ensured its emergence to complement the more traditional, transactional counterpart of credit risk management.
Since the adoption of the 2006 allowance for loan and lease losses (ALLL) guidance, and the ferocity of loan losses during the great recession, we have seen the growing confluence among credit, accounting, regulatory and investor constituencies attempting to answer the same age-old questions: How much loss is embedded in the loan portfolio? How much is this portfolio worth?
While having comparable goals, each level of management has its priorities, biases and specialized methodologies for answering those questions. For directors, there may be a need to connect the dots to determine the objective of these measures.
Today’s ALLL The current loss methodology was also used in 2006, prior to the massive, mainly real estate, credit losses from the great recession. The 2006 methodology included pool, formula-driven and specific impairment loss estimates. The incurred loss bias of the current methodology–often known as a “run-rate” approach–inflates the most recent credit quality performances. With no significant losses prior to the crisis, the industry was largely pushed into the abyss with low loss reserves–unable to raise reserves for forecasted losses. Given the relatively benign state of credit currently, it could be said that we are back to the future, having to defend ALLL levels, largely with qualitative justifications.
Tomorrow’s CECL The soon-to-be implemented current expected credit loss (CECL) methodology is the inevitable reaction to the roller coaster nature of today’s ALLL. Some even consider it a fall back to the failed bid, about eight years ago, to impose mark-to-market valuations on the entirety of banks’ loan portfolios. Regardless of the pejorative “crystal ball” moniker often describing CECL–not to mention estimates of significant Day One implementation increases in reserves–its integration of historical losses, current conditions and reasonable forecasts is designed to be the more holistic, life-of-loan estimation of losses.
There is a high presumption in CECL that quantitative measures, such as discounted cash flows or probabilities of default (PDs)/loss given defaults (LGDs), overlaid by recovery lags, will be used to project future losses. In theory, it may be a more reliable estimate than the current guidance; however, its greatest hindrance is the perception that it is yet another de facto variant layer of capital buffer mandated by the Dodd-Frank Act, and Basel III.
Exit Price Notion This accounting-based fair value measure disclosure (ASU 2016-01), often referred to as fair value/exit pricing, is new for 2018 and specifies the method by which public financial institutions calculate the fair value of their loan portfolios for purposes of disclosure. Fair value is the amount that would be received to sell an asset or paid to transfer a liability at the measure date. The estimate of fair value must be supported through specified protocols of valuation and calculation. Credit-based assessments, coupled with ties to loan review and risk grade migrations, will be key to justifying a reasonable, point-in-time fair value calculation.
Credit Mark in Mergers & Acquisitions (M&A) Speaking of fair value, in M&A, it is truly in the eye of the beholder. How skeptical is the buyer? How much does the buyer want the deal? Determining a credit mark, or rational estimate (or range) of discounts to be applied to a prospective purchased loan portfolio, is very much a credit-based, symbiotic marriage between a traditional, more qualitative loan review and the more quantitative metrics of PDs, LGDs, risk grade migrations, yield marks, recovery lags and probabilistic modeling. Using one approach, without the informing nature of the other, is problematic and increases inaccuracies. What is sacrosanct in credit mark, is that an institution never wants to undershoot the estimates. Accounting plays a greater role when the deal-negotiated credit mark is refreshed at the deal’s completion, known as Day One accounting.
The credit discipline has often described as a qualitative decision stacked on an array of quantitative metrics. That remains an apt description for transactional credit–where it all begins. However, the new frontier in managing credit risk, even at smaller financial institutions, is in the ever-evolving, mostly mandated, macro, quantitative measures–some of which are described above. Each of these, not unlike a Venn diagram, has similarities and overlapping portions, but each has separate purposes, as well. Directors, like credit officers, need to understand and embrace these quantitative measures, which will, in turn, lead to better decision making for the bank.
By now, most community bankers are familiar with the Current Expected Credit Loss standard (CECL), which was issued by the Financial Accounting Standards Board in June of 2016 as a new standard for the recognition and measurement of credit losses for loans and debt securities. However, your bank may be struggling with applying its theoretical concepts. We’ve put together a few simple steps to help you start your implementation process.
Form an implementation team. CECL implementation cannot be the responsibility of just one or two people. It requires a team that should include:
A chief financial officer or equivalent who has knowledge of loan loss accounting and basic modeling capabilities;
A chief audit executive or equivalent to identify key controls necessary to the new process;
A chief credit officer with deep knowledge of the loan portfolio and related documentation;
And a chief technology officer to assist with data gathering and retention.
We advise documenting the members of your team, and briefly summarizing their skill sets and roles in implementing CECL.
Confirm your implementation deadline. The deadline for implementation of CECL is based on whether or not the bank is considered a Public Business Entity (PBE), unless the institution is a Securities and Exchange Commission registrant. It is important to periodically re-evaluate, document, and receive concurrence from auditors and regulators regarding the bank’s status as a PBE. The American Institute of Certified Public Accountants’ (AICPA) Technical Questions and Answers (TQA) document can help institutions with this determination. Based on this document, most non-SEC registrants will not qualify as a PBE, so most institutions will be expected to implement CECL by December 31, 2021. For SEC registrants, the standard will go into effect one year earlier, in December 2020.
Establish a simple project plan. A CECL project plan does not need to be voluminous in order to be effective. Start with a single page implementation timeline as a foundation. Next, break the project into manageable segments. For near-term deadlines, record specific tasks and dates. Assign broader timeframes to latter segments to allow sufficient time in the event that there are changes in the bank’s operations, such as an acquisition or PBE classification updates.
Understand CECL’s impact. It is important to quantify the impact of CECL by understanding industry reserve levels compared to current accounting rules. For the historical loss component of the allowance, which will be the base component for this new standard, current industry data shows the following:
Most financial institutions use between a three- and five-year average annual loss rate to compute the historical loss component of the allowance.
Based on quarterly call report data, the average three-year net charge-off rate for all bank loans from December 31, 2014 to December 31, 2016 was 0.49 percent. The average five-year net charge-off rate was 0.68 percent.
The percentage of allowance to loans for the historical loss component for all banks over $1 billion in assets was 1.24 percent as of September 30, 2017.
Under current accounting rules, this data would suggest that the industry believes incurred losses in the loan portfolio are 0.56 percent to 0.75 percent worse than the average of the last three to five years of actual charge-offs. This could indicate there may be some excess in current reserve levels, which could reduce your previous expectation of the impact of CECL on your institution.
Start retaining available data and use it for modeling. Consider what models can be built with information that is readily available to most community banks, such as a standard loan trial balance, the history of net charge-offs by loan number and a watch list for set periods of time. Starting with a limited number of data points and simple models can help banks gain familiarity with modeling basics, and identify modeling flaws and potential additional data point requirements.
Effective models such as discounted cash flow, vintage analysis, migration analysis and static pool analysis can be built with these limited reports. The important step in data retention is to ensure core system reports are maintained for a period of time. This will ensure when you begin your modeling efforts, you will have the data necessary to start to build your model.
Even though the implementation date is a couple years away, it is important for institutions to get started with data collection and modeling efforts, as there will be unforeseen challenges along the way. The sooner an institution begins its modeling efforts, the sooner it can identify potential additional data requirements, and the potential impact of this new standard to the balance sheet and income statement.
For small businesses and freelancers, successfully performing work for customers and clients is only half the battle. Oftentimes, businesses wait up to 90 days to receive payment for their outstanding invoices. This delayed cash flow can create a variety of problems, especially when it comes to covering overhead expenses like rent and payroll.
That’s why Eyal Shinar developed the Fundbox software service, to help small businesses fix their cash flow problems as it relates to outstanding invoices. Fundbox is the leading cash flow optimization platform for small businesses, and who better to start a fintech company focused on this problem than someone who learned it at his mother’s knee? Shinar’s mother was a small business owner, so growing up he saw the pain and frustration that delayed payment of invoices can cause. According to a recent report, 82 percent of small businesses fail due to poor cash management. Where some see problems, others see solutions, and that’s where Fundbox comes in.
The process is straightforward. Business owners simply connect their existing accounting software to Fundbox and submit their outstanding invoices for immediate reimbursement. The business owner incurs a small fee for this service and they are given up to 24 weeks to pay Fundbox back.
For banks looking to offer new or better services to small business clients and freelancers, though, is Fundbox a good partner? Let’s look a little closer.
Small business accounts are a much coveted group for banks, so providing new tools to improve service and/or relationships with this group should be of interest area to most any financial institution. The fact that Fundbox already has some traction in the small business space should be a good indicator for banks that the service they provide—instant cash flow—is a needed service for this group.
Once a small business owner submits an invoice to the Fundbox platform, they are typically paid within one to two days. Fundbox connects easily with most existing accounting platforms that small businesses are already using, such as QuickBooks, Freshbooks, Xero, Wave and Sage One, so there is very little to do in terms of importing data. Fundbox connects with a few simple clicks and pulls any outstanding invoices that business owners might want to turn into cash. Also, when the user signs up for their account, Fundbox uses big data and algorithms to quickly determine the consumer’s financial health rather than putting them through a lengthy application and approval processes.
The pricing model is simple and transparent. For an invoice of $1,000, the fee is $48 per week over 24 weeks, or $89 per week over 12 weeks. Fees are reduced if the business pays back what it owes prior to the deadline, which is a good incentive to keep Fundbox’s own cash flow looking good, although they have no shortage of funding—another point that might give banks some comfort in partnering with the company.
While the Fundbox fee structure is quite straightforward and transparent, it’s also relatively expensive and can really add up over time, especially for businesses that regularly choose the 24-month financing option. After you do the math, the annual percentage rate for Fundbox repayments can range anywhere from 13 percent to 68 percent. Fundbox also places a $100,000 limit on invoices that it will fund, so it isn’t an option for companies seeking to turn accounts receivable for amounts larger than that into cash.
While Fundbox is compatible with most of the common accounting software mentioned earlier, small businesses that use less common accounting packages or Excel spreadsheets can’t utilize its service. Other drawbacks are that Fundbox doesn’t provide cash for past-due invoices, and the approval process for credit limit increases can take some time. So while the service is helpful in many use cases, it certainly doesn’t match every situation. Finally, Fundbox is rolling out additional credit products as well, which could increase its presence as a possible competitor in the banking space.
OUR VERDICT: FOE
Fundbox offers an important service to small businesses and entrepreneurs, and does so more conveniently than most banks do today. At a time when so much emphasis is being placed on the customer experience, banks should be taking notice of this heavily-funded bank alternative. If an entrepreneur has outstanding invoices and needs cash to keep the lights on, their only option with traditional banks is to apply for a small business loan, or to go to their credit card company, which charges even higher rates than Fundbox. Furthermore, between the application process, credit checks and agreeing upon collateral, it can be weeks or months before businesses see a penny of the cash they need. For this reason, I applaud what Fundbox is doing, and I think it is certainly a —friend’ to many entrepreneurs in their times of need.
As Fundbox encourages more and more small business owners to come to them for cash, though, this obviously chips away from the bank’s importance and its relationship with their small business clients—a relationship they certainly don’t want to lose. And to date, Fundbox cannot boast of any existing bank partnerships or list banks as an area of interest. Of course, if this was to change, we might reconsider our foe designation.
In the meantime, banks would be wise to understand why entrepreneurs are using services like Fundbox, and how they might better address this particular need, whether it’s partnering with fintech companies, investing in new solutions or building them internally. In short, business owners have enough things to worry about, and getting paid on time doesn’t have to be one of them. Who can blame small business owners for looking outside their banking relationship for help?