Considerations for Post-CECL Adoption

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Over the last 10 years, banks have discussed and debated the current expected credit loss, or CECL, accounting standard. Many of the larger banks adopted the standard in 2020, with the majority of smaller banks adopting on Jan. 1, 2023.

While the industry has adopted CECL, here are some items to consider in 2023 to position your institution for success in your next regulatory exam or external audit.

Prepare a CECL Adoption “Package”
When your regulators and auditors arrive in 2023, they will likely ask about your CECL implementation process. One way to address their questions is to prepare a package that  includes:

  • Board-approved allowance for credit losses, or ACL, policy.
  • The initial adoption calculation.
  • The consideration of unfunded commitments, which are recorded as a liability on the bank’s balance sheet, and debt securities, both available-for-sale and held-to-maturity.
  • The bank’s narrative that supports its CECL calculation, which should include a summary of the selected model and methodology, assessment of qualitative factors and forecasting and a summary of any individually evaluated loans.
  • The initial adoption journal entry, a reconciliation to your CECL calculation and documentation of a review and approval of the journal entry.
  • Third-party vendor management documentation and CECL model validation.

Third-Party Vendor Management
If your bank is using a third-party vendor for its CECL calculation, be sure to document the vendor management considerations over this calculation annually in accordance with your bank’s vendor management policies and your primary regulator’s guidance.

Make sure this documentation includes procedures the bank has taken to gain comfort over the third party’s calculation, obtaining a service organization controls (SOC) report for the calculation and a CECL model validation for the third-party calculation. Your institution may need to get support from the vendor to assist with articulating the math behind the calculation and a recalculation of the ACL on an individual loan basis.

Perform Back Testing in 2023
As the bank’s CECL model “ages” in 2023, management should document back testing of the model to verify it is functioning as expected. Back testing can aid the bank in understanding the model and how estimates and varying economic results impact it.

As your bank develops its back testing procedures, consider comparing estimated data points to actual results, including prepayment speeds, loan charge-offs and recoveries, economic data points and loan balances. Additionally, management should consider sensitivity or stress testing of the model, including analysis of various scenarios or assumptions and their impact on loss estimates.

Add CECL to the 2023 Internal Audit Plan
The CECL model, like the historic incurred loss model, should be subject to the bank’s internal audit plan. This internal audit program can include reviewing the policies and procedures, gaining an understanding of the model, reviewing the assumptions in the model for reasonableness and consistency with other assumptions and reviewing the model access. It should also include procedures to verify calculations are appropriately reviewed by management and governance.

CECL Model Validation
As bank regulators discussed in the 2020 interagency policy statement on the allowances for credit losses, model validation is an essential element to a properly functioning process for a bank, and should be completed annually. Validation activities for a bank include evaluating and concluding on the conceptual soundness of the model, including developmental evidence, performing ongoing monitoring activities, including process verification and benchmarking and analyzing model output, according to the interagency statement.

The CECL model validation, which is a frequently overlooked part of CECL implementation, should be performed by an individual or firm that is independent from the model’s design, implementation, operations and ownership. Additionally, the interagency statement states the external auditor of the bank may impair independence if they also perform the CECL model validation.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CliftonLarsonAllen) to the reader.

CLA exists to create opportunities for our clients, our people, and our communities through our industry-focused wealth advisory, digital, audit, tax, consulting, and outsourcing services. CLA (CliftonLarsonAllen LLP) is an independent network member of CLA Global. See CLAglobal.com/disclaimer. Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor.

How Banks Can Leverage Continuous Auditing, Continuous Monitoring

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Continuous auditing and continuous monitoring are one of the most misunderstood and under-utilized concepts in business. While continuous auditing and continuous monitoring, or CA and CM, may be two distinct concepts, they operate under the same development umbrella. When institutions design, build and implement them correctly, both can deliver targeted and dynamic results.

To leverage the power of this methodology, bankers should start by understanding the overlooked differences between the two approaches. Continuous auditing and continuous monitoring are two distinct disciplines.

The first key difference between the two is frequency. A confusing aspect of the CACM methodology is the name. Everyone hears the word “continuous” and believes this type of work goes on forever, without any consideration. That could not be further from the truth. Continuous auditing has a distinct start and finish; in contrast, continuous monitoring can be started and stopped at any time and has no set length of execution.

Like any type of formalized testing, a CA program must contain a time frame in which the work will be performed so a conclusion on the control effectiveness for the same period can be made. Conversely, a CM program can be started, stopped and restarted again for any length of time because it is not being executed to provide a conclusion on the control environment. Rather, it delivers an indication that a specific control or set of controls produces the expected results within acceptable performance limits.

The second key distinction is the testing specifics. The CA approach has detailed control process descriptions that provide information to develop the corresponding steps to be reperformed — in order to confirm the results. In contrast, the CM approach selects a control or controls and verifies the outcomes are within the acceptable limits of the business process requirements. At no time does a CM review, examine or reperform the control steps to validate results. The only information obtained and examined in the CM review is the result. If those results are within the acceptable control parameters, there is no additional verification performed. The CA approach provides a more comprehensive validation of the control environment compared to the CM approach.

Common Uses for the CACM Methodology
One of the most appealing aspects of the CACM methodology is that it can be applied to any business process in any industry. However, there are considerations to include in the evaluation process before selecting your target business processes. The most effective way to communicate these considerations is not by telling you the best business processes to target, but providing you with the business areas that should be avoided when developing your CACM methodology.

This does sound contradictory, but to avoid methodological pitfalls, there are limitations to consider when selecting a target CACM area. While you can apply the CACM methodology to any process, in any industry, it is important to consider using a new methodology to proactively validate your existing control environment and identify potential future challenges.

To do that, there are two areas to avoid when selecting your target CACM business processes: complexity and judgment. Regarding complexity, the methodology is going to ask you to identify the most critical control or controls in the process that directly impact the outcome. It will be difficult, if not impossible, to identify one or two critical controls in any complex business process. With judgment, the process allows for overrides, which potentially creates false positives in the CACM. Even with detailed approval guidelines, the subjective nature of the process makes it a challenging selection for a CACM.

At Baker Tilly, we recommend banks incorporate CACM into their compliance business process. Most compliance processes have very specific, detailed and documented process requirements with almost zero judgment. Compliance rules and regulations do not provide a significant amount of grey area. Those types of processes make it easier to incorporate your CACM process because the business requirements are clear and you will have an easier time selecting the most critical control points.

Continuous auditing and continuous monitoring provides organizations with a proactive review approach that help identify potential control breakdowns. This proactive approach allows organizations to enhance their current control environment, strengthen their compliance processes, mitigate risk and build a stronger business culture to mitigate risk and potentially eliminate future losses.

Highlights From CECL Adoption

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On Jan. 1, 2020, approximately 100 SEC financial institutions with less than $50 billion in assets across the country adopted Accounting Standards Update 2016-13, Financial Instruments—Credit Losses (Topic 326) Measurement of Credit Losses on Financial Statements.

More commonly referred to as “CECL,” the standard requires banks to estimate the credit losses for the estimated life of its loans — essentially estimating lifetime losses for loans at origination. Not all banks adopted the standard, however. While calendar-year SEC filers that are not considered to be smaller reporting companies or emerging growth companies were set to implement the standard at the start of 2020, the Coronavirus Aid, Relief, and Economic Security Act and subsequent Consolidated Appropriations Act, 2021, allowed them to delay CECL implementation through the first day of the fiscal year following the termination of the Covid-19 national emergency or Jan. 1, 2022. Of the publicly traded institutions below $50 billion in assets that were previously required to adopt the standard, approximately 25% elected to delay.

Highlights from the banks that adopted the standard could prove very useful to other community banks, as many work toward their January 2023 effective date. A few of the relevant highlights include:

  • Unfunded commitments had significant effects. It is important that your institution understands the potential effect of unfunded commitments when it adopts CECL. The new standard has caused significant increases in reserves recorded for these commitments. At institutions that have already adopted the standard, approximately 20% had a more significant effect from unfunded commitments than they did from funded loans.
  • Certain loan types were correlated with higher reserves. When comparing the reserves to loan concentrations at CECL adopters with less than $50 billion in assets, institutions with high levels of commercial and commercial real estate/multifamily loans experienced larger increases in reserves as a percentage of total loans for the period ended March 31, 2020.
  • Certain models were more prevalent in banks with less than $50 billion in assets. Approximately 60% of the banks with less than $50 billion in assets indicated they used the probability of default/loss given default model in some way. Other commonly used models were the discounted cash flow model and loss rate models. Less than 10% of adopters so far have disclosed using the weighted-average remaining maturity (WARM) model.
  • One to 2 years were the most commonly used forecast periods. The new standard requires banks to use a reasonable and supportable economic forecast to guage loss potential, which demands a significant amount of judgment and estimation from management. Of the banks that adopted, more than half used 1 year, and approximately a quarter used 2 years.
  • Acquisitions impacted the additional reserves recorded at adoption. Of the 10 CECL adopters with the most significant increases in reserves as a percentage of loans, nine had completed an acquisition in the previous year. This is due to the significant changes in the accounting around acquisitions as a part of the CECL standard. The new standard requires reserves to be recorded on purchased loans at acquisition; the old standard largely did not.
  • Reserves increased. Focusing on banks that adopted CECL in the first quarter that have less than $5 billion in assets (21 institutions), all but one experienced an increase in reserves as a percentage of loans. Approximately 70% of those institutions had an increase of between 30% and 100%.

The CECL standard allows management teams to customize the calculation method they use, even among different types of loans within the portfolio. Because of that and because each bank’s asset pool will look a little different, there will be variations in the CECL effects at each institution. However, the general themes seen in these first adopters can provide useful insight to help community banks make strides toward implementation.

This article is for general information purposes only and is not to be considered as legal advice. This information was written by qualified, experienced BKD professionals, but applying this information to your particular situation requires careful consideration of your specific facts and circumstances. Consult your BKD advisor or legal counsel before acting on any matter covered in this update.

Solve the Right Problem: The Path to Remediation Success

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At some point, your bank will find an operation or process isn’t working or failing on intent. When that happens, don’t fall prey to the impulse to fix the wrong problem without looking below the surface for the root cause.

No matter the scenario, your best position is always to self-identify an issue and kick off remediation before a customer or regulator reports a problem. Once external forces step in, the stakes run even higher; you really can’t afford a misstep. Without question, the most common way that banks err is by starting on the wrong foot.

In my front-line experiences, I’ve seen financial institutions work ambitiously on remediating issues only to have regulators assign a failing grade. While no bank wants to be under a regulatory finding’s shadow, working smart and rejecting shortcuts is the only way to deliver the right solution and minimize future risk. With compliance costs expected to more than double and reach 10% of revenue spend by 2022, banks can’t afford to get it wrong.

Here are the steps for an effective remediation:

1.Take a breath — then dive into the deep end
Too often, companies fix what they think is the problem, only to learn that they’ve missed the mark and broken other things along the way. Not understanding the crux of the issue wastes a bank’s time, energy and resources.

If you’re dealing with a regulatory finding, be sure to engage your legal and compliance teams to ensure you understand the issue and solve for exactly what’s at risk, especially for issues with broader scope and breadth. Those leading your remediation plan should dig deeper into root problems by asking “why?” up to five times, peeling off another layer each time as you strive toward the core issue. Apply those questions to your business problem until you’ve identified the precise thing that needs to be fixed.

2. Know how to get from Point A to Point Z
Develop a roadmap to move effectively and efficiently from understanding the issue and identifying root causes to implementing solutions. From aligning on stakeholder engagement to technology resources, no solution happens overnight. Some regulatory remediation activities can take 12 to 18 months to resolve.

3. Make sure everyone’s on the same journey
Nothing derails remediation more than missed consensus on its direction and end goal. Remain focused on actions to fix your root issue, ease regulator or auditor concerns  and reduce customer complaints. Engage the right people in the right roles. Involving too many people can water down intent, while involving too few means you might miss capturing relevant insights from key parts of your business.

4. Document your journey
A comprehensive action plan can take time to execute. During that time, people in key roles might leave and business processes, and objectives, technology or regulations could change. Thorough and complete documentation keeps a record of execution activities, action plan or intent changes, and provides evidence of key decisions.

5. You’re not finished until you get an official pat on the back
Did your action plan include time to validate your work? Whether you have a third-line audit, loan review finding or a regulatory ruling, the issuer will return to confirm you solved the right problem completely. Build in solid testing to validate your solution fulfills on its intent, with no side effects that disrupt other processes. Also, if possible, check in with third-line partners regularly or when hitting major milestones to prevent surprises.

Remediation success comes with both the assessor’s endorsement, as well as sustained results from your action plan as evidenced by reporting and monitoring put into place. More importantly, don’t overlook this moment to repurpose your team’s learnings and experiences as the foundation for a repeatable remediation framework. When the next issue arises — and it will — your bank will already have a strategy and blueprint for smart action with minimal risk.

An Audit Expert Explains What’s Changed

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An audit committee seat can one of the biggest challenges — and one of the greatest responsibilities — for a bank director, even without a global pandemic and economic recession. The audit committee sets the tone at the top for the bank. How does its role change in a pandemic? It’s an increasingly important responsibility, says Jon Tomberlin, managing partner in Dixon Hughes Goodman LLP’s financial services practice, participating in a panel discussion focusing on audit matters at Bank Director’s BankBEYOND 2020 experience. “There’s a lot of risk and difficulty in being on the audit committee,” he says. “They are one of the most important elements of the bank.” The audit committee creates and maintains an conditions and expectations that support the integrity of the bank’s financial controls — an environment that may have altered or become strained under the pandemic’s forceful impact or the severe economic fallout. Tomberlin says he sees many roles for audit committee in this turbulent environment, overseeing and challenging the appropriateness of internal controls and management’s risk assessment. Joining Tomberlin in this conversation with Bank Director’s Editor-At-Large Jack Milligan were Michael Ososki, a partner at BKD LLP, and Mandi Simpson, a partner at Crowe LLP. You can access all of the BankBEYOND 2020 sessions by registering here.

Banks Have Started Recording Goodwill Impairments, Is More to Come?

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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.”

Audit Hot Topics: Internal Controls

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Bank boards and executive teams face a number of risks in these challenging times. They may need to adapt their strong internal controls in response, as Mandi Simpson and Sal Inserra — both audit partners at Crowe — explain in this short video. You can find out more about the audit and accounting issues your bank should be addressing in their recent webinar with Bank Director CEO Al Dominick, where they discuss takeaways from the adoption of the current expected credit loss model (CECL) and issues related to the pandemic and economic downturn, including the impact of the Paycheck Protection Program and concerns around credit quality.

Click HERE to view the webinar.

Common Themes in Banks’ Critical Audit Matters

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Beginning in 2019, auditors of large accelerated filers that file with the U.S. Securities and Exchange Commission were required to communicate critical audit matters, or CAMs, in their audit opinions. An analysis of Form 10-K filings for U.S. depository institutions for reporting periods covering June 30, 2019, through Dec. 31, 2019, reveals common themes of interest to bankers. The 10-Ks of large accelerated filers with a Dec. 31, 2019 year-end represent the first time these required communications appeared in a significant amount of bank filings.

Banks that are classified as large accelerated filer might wonder how their CAMs compare to those of other banks; SEC filers that do not have the designation might wonder what to expect in their own audit opinions for fiscal years ending on or after Dec. 15, 2020.

Background
In 2017, the Public Company Accounting Oversight Board (PCAOB) adopted Auditing Standard 3101, which requires auditors to communicate CAMs in their audit opinions for audits of large accelerated filers with fiscal years ending on or after June 30, 2019.

The PCAOB defines a critical audit matter as “any matter arising from the audit … that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective, or complex auditor judgment.” CAMs are intended to provide insight beyond the boilerplate audit opinion and share important information with investors.

Each CAM included in the audit opinion should include:

  • What: Identification of the CAM.
  • Why: Principal considerations that led the auditor to determine the matter was a CAM.
  • How: A description of how the CAM was addressed in the audit, including a description of one or more of the following: (1) the auditor’s response or approach most relevant to the matter; (2) a brief overview of the audit procedures performed; (3) an indication of the outcome of the audit procedures; (4) key observations with respect to the matter.
  • Where: The relevant financial statement accounts or disclosures that relate to the CAM.

Number of CAMs
Crowe specialists analyzed the audit opinions of U.S. depository institutions that are large accelerated filers and filed directly with the SEC (“issuers”) with year-ends between June 30 and Dec. 31, 2019, using data from Audit Analytics.

In 2019, 150 depository institutions reported CAMs; and all depository institutions that both file with the SEC and are large accelerated filers reported at least one CAM. The average number of CAMs per issuer was just shy of 1.5. Approximately two-thirds of issuers reported just one CAM, while just under 10% of issuers reported more than two CAMs. Four CAMs was the maximum observed in any one depository institution, with only one institution reporting that number (Exhibit 1).

CAMs per issuer

CAM themes
Auditors of the 150 bank issuers reported a total of 221 CAMs. Unsurprisingly, the most common CAM was related to the allowance for loan and lease losses. This CAM appeared in every bank issuer’s opinion and constituted 68% of the total CAMs reported by bank auditors. In addition to the 150 CAMs specific to the allowance, eight CAMs were specific to the disclosure around the pending adoption of the Accounting Standards Update (ASU) 2016-13 (Accounting Standards Codification 326), commonly referred to as current expected credit losses accounting standard.

The second most common CAM topic — business combinations — appeared 35 times across 32 issuers’ opinions. Nearly three-fourths (27) of the business combination CAMs were specific to certain acquired assets and liabilities, most commonly loans and identifiable intangible assets. Six CAMs were more general in nature and covered entire acquisition transactions. Two CAMs were specific to Day 2 acquisition accounting.

Twenty-eight CAMs were outside of the common topics of the allowance, CECL and business combinations. These CAMs spanned topics including goodwill impairment, servicing rights valuations, deferred tax asset valuation allowances, contingencies, level three fair values and revenue recognition, among others (Exhibit 2).

Banking CAM topics

The number and nature of CAMs will vary over time, but the most frequently observed topics appearing in 2019 CAMs will likely always be prevalent in bank audit opinions. As more institutions adopt CECL, the incidence of CECL as a CAM almost certainly will increase.

The prevalence of CAMs related to business combinations likely will be directly related to the level of bank acquisitions that occur in a given period. Other CAM topics such as goodwill impairment, deferred tax asset valuation allowances, and fair value considerations might increase or decrease based on market conditions.

Coronavirus Considerations for Goodwill Impairment

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Given the recent impact of Covid-19 on the economy, unemployment and operations, discussions around potential goodwill impairment — and the related testing — is a hot topic for many financial institutions as the March 31 quarter ended.

Goodwill is defined as an asset representing the future economic benefits arising from other assets acquired in a business combination. Financial institutions record goodwill as a result of a merger or an acquisition. Accounting Standards Codification (ASC) 350, Intangibles – Goodwill and Other, states that entities must evaluate their goodwill for impairment at least annually. However, during interim periods, a goodwill impairment analysis could be necessary if the entity has an indication that the fair value of a reporting unit has fallen below carrying value, defined by the guidance as a triggering event. Determining whether a triggering event has occurred is challenging for many financial institutions.

Under the guidance of ASC 350, impairment testing for goodwill is required annually and upon a triggering event. Private entities electing the accounting alternative are only required to test upon a triggering event. Here are some examples of goodwill triggering events, according to ASC 350-20-35:

Macroeconomic conditions: deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates or other developments in equity and credit markets. 

Industry and market considerations: deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (consider in both absolute terms and relative to peers), a change in the market for an entity’s products or services, or a regulatory or political development. 

Overall financial performance: negative or declining cash flows, or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods.

Other entity-specific events: changes in management, key personnel, strategy or customers; contemplation of bankruptcy or litigation.

Events affecting a reporting unit: a change in the composition or carrying amount of its net assets, a highly probable expectation of selling or disposing of all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.

A sustained decrease in share price: to be considered in both absolute terms and relative to peers.

It is clear that Covid-19 has global impacts on some macroeconomic conditions. Financial institutions may want to assess whether they have experienced a triggering event; if they conclude there has been such an event, they will need to proceed to a goodwill impairment test. Assessing whether there has been a triggering event, as defined by ASC 350, involves judgment.

When it comes to a decline in stock price, the guidance in ASC 350 does not define what “sustained” means. In isolation, a decrease in share price is not an automatic indicator of a triggering event. The guidance suggests comparing the relative decrease to peers — if it is consistent among the industry, one may conclude that the decrease is related to general economic events and not specific to the institution individually. Banks may determine that an overall decline in the market could be indicative of macroeconomic conditions that impact the value of the company. Entities should consider forecasts and projections to determine whether the situation is expected to be temporary, and the reduction in stock price is reflective of short-term market volatility rather than a long-term, sustained decline in fair value.

The guidance does not suggest that the existence of one negative factor results in a triggering event. Rather, the guidance requires companies to assess various factors to determine whether it is probable that the company’s fair value is less than its carrying value. One way to consider the factors mentioned in the guidance is to weight them by their impact on the entity’s fair value. If the company concludes that a triggering event has occurred, then an impairment analysis should be performed to determine if in fact goodwill is impaired.

The determination of a triggering event, or lack thereof, involves judgment; management’s analysis and conclusion should be thoroughly documented. As the economic environment and resulting impacts of Covid-19 continue to shift and evolve, companies should revisit goodwill impairment triggers on a regular basis.

CECL Delay Opens Window for Risk Improvements

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The delay in the current expected credit loss accounting model has created a window of opportunity for small banks.

The delay from the Financial Accounting Standards Board created two buckets of institutions. Most of the former “wave 1” institutions constitute the new bucket 1 group with a 2020 start. The second bucket, which now includes all former “wave 2 and 3” companies are pushed back to 2023 — giving these institutions the time required to optimize their approach to the regulation.

Industry concerns about CECL have focused on two of its six major steps: the requirement of a reasonable and supportable economic forecast and the expected credit loss calculation itself. It’s important to note that most core elements of the process are consistent with current industry best practices. However, they may take more time for banks to do it right than previously thought.

Auditors and examiners have long focused on the core of CECL’s six steps — data management and process governance, credit risk assessment, accounting, and disclosure and analytics. Financial institutions that choose to keep their pre-CECL process for these steps do so at their own peril, and risk falling behind competitors or heightened costs in a late rush to compliance. Strategically minded institutions, however, are forging ahead with these core aspects of CECL so they can fully vet all approaches, shore up any deficiencies and maintain business as usual before their effective date.

Discussions over the impact of the CECL standard continue, including the potential for changes as the impacts from CECL bucket 1 filings are analyzed. Unknown changes, coupled with a three-year deadline, could easily lead to procrastination. Acting now to build a framework designed to handle the inevitable accounting and regulatory changes will give your bank the opportunity to begin CECL compliance with confidence and create a competitive advantage over your lagging peers.

Centering CECL practices as the core of a larger management information system gives institutions a way to improve their risk assessment and mitigation strategies and grow business while balancing risk and return. More widely, institutions can align the execution across the organization, engaging both management and shareholders.

Institutions can use their CECL preparations to establish an end-to-end credit risk management framework within the organization and enjoy strategic, incremental improvements across a range of functions — improving decision making and setting the stage for future standards. This can yield benefits in several areas.

Data management and quality: Firms starting to build their data histories with credit risk factors now can improve their current Allowance for Loan and Lease Losses process to ensure the successful implementation of CECL. Financial institutions frequently underestimate the time and effort required to put the required data and data management structures in place, particularly with respect to granularity and quality. For higher quality data, start sourcing data now.

Integration of risk and financial analysis: This can strengthen the risk modeling and provisioning process, leading to an improved understanding and management of credit quality. It also results in more appropriate provisions under the standard and can give an early warning of the potential impact. Improved communication between the risk and finance functions can lead to shared terminologies, methods and approaches, thereby building governance and bridges between the functions.

Analytics and transparency: Firms can run what-if scenario analysis from a risk and finance perspective, and then slice and dice, filter or otherwise decompose the results to understand the drivers of changes in performance. This transparency can then be used to drive firms’ business scenario management processes.

Audit and governance: Firms can leverage their CECL preparations to adopt an end-to-end credit risk management architecture (enterprise class and cloud-enabled) capable not only of handling quantitative compliance to address qualitative concerns and empower institutions to better answer questions from auditors, management and regulators. This approach addresses weaknesses in current processes that have been discovered by audit and regulators.

Business scenario management: Financial institutions can leverage these steps to quantify the impact of CECL on their business before regulatory deadlines, giving them a competitive advantage as others catch up. Mapping risks to potential rewards allows firms to improve returns for the firm.

Firms can benefit from CECL best practices now, since they are equally applicable to the current incurred loss process. Implementing them allows firms to continue building on their integration of risk and finance, improving their ALLL processes as they do. At the same time, they can build a more granular and higher quality historical credit risk database for the transition to the new CECL standards, whatever the timeframe. This ensures a smoother transition to CECL and minimizes the risk of nasty surprises along the way.