How community banks, credit unions can prepare for CECL
To some bankers, the Current Expected Loss Standard (CECL) might as well be a reboot of Y2K. Remember? That was when computers were supposed to go haywire around the turn of the 21st Century. Of course, once the clock struck 12:00 a.m. Jan. 1, 2000, the anticipated tech apocalypse never arrived.
And so the good news: CECL is not, nor will be, the end of the world. In fact, it’s widely expected to revolutionize the way banks and credit unions report losses. But until another Jan. 1 arrives—this one in 2022—bankers find themselves in a tizzy as they work to set aside greater reserves.
JPMorgan Chase, for example, which holds more than $2.6 trillion in assets, says it may have to increase its reserves by $5 billion on the first day of CECL rollout. Yet for community banks and credit unions, which may not have access to an army of consultants, the process will prove rough sledding—especially if they’re unprepared.
“This is the biggest change in loss reserve accounting in a generation,” observes John Reedy, director, financial management advisory services for Grant Thornton LLP. Although there are no reliable estimates, Reedy says “most are seeing (reserve) increases of 10-20 percent, but some could see up to 40 percent.”
One for the books
CECL emerged from a new set of standards issued by the Federal Accounting Standards Board (FASB) in 2016. While regulators were hoping to head off the kind of draconian losses incurred in previous banking financial crises, the standards will apply to all banks, savings institutions, credit unions and bank holding companies.
Since CECL will impact how institutions report and forecast credit losses, it will likely have a dramatic impact on how they keep their books.
With credit unions, for example, “CECL may result in a decrease in net worth upon implementation of the standard,” according to a statement from the National Credit Union Association. “To assist with this, we will add a new ratio to the Financial Performance Report to illustrate net worth differences prior to and after implementation of CECL.”
David Bakke, a writer for the Money Crashers blog, suggests credit unions “need to decide what data will be collected and the process as to how it will be done. The main things you’ll need will be loan-to-deposit ratio, debt-to-income ratio, and credit score.”
More complex loans and needs “will require a more comprehensive model,” Bakke notes. “And finally, your data collection decisions and how they’ll be processed will need to be tested and investigated. What you’re looking for are answers from an analytical standpoint that match for the most part your expectations from a risk standpoint. If they don’t line up, some adjusting could or should be in order.”
Deadlines and red lines
How are institutions preparing for the CECL compliance deadlines? Many banks and credit unions have adopted software solutions while others have built internal teams.
“Try to reverse engineer expectations and get close to the pin,” advises Garver Moore, managing director for advisory services for Abrigo, a company that helps community financial institutions manage risk. “You have an opportunity to make the process easy and meaningful. If you’re going to go through the exercise, you might as well do it right.”
By setting up an “early warning system” on potential losses, Moore says it will give institutions a chance to adjust their models since institutions will have to boost their reserves.
Reedy is concerned, though, that many fail to take a comprehensive view of all of the impacts, “such as changes to reporting and control processes and potential impacts to capital and portfolio management.”
CECL readiness beyond the rules
Getting ready for CECL also involves more than just following the rules: It means teeing up a workable business process. As an organization, you’ll need to ask some key questions, such as those suggested by Grant Thornton:
- What data will you need to reconcile to ensure integrity of data processes?
- How will risk management processes integrate with CECL processes?
- What data will you need to produce accounting templates?
- Will your CFO need supplemental information to perform attestation of financial statements?
The bad news, for those who hope artificial intelligence will ramp up in the meantime, is that most CECL-related problems won’t be solved with a piece of software. Reedy says institutions should follow guidelines that include:
- Adopt best practices. Integrate cross-functional teams early and iterate through quick decision making.
- Closely involve management. Have the team provide governance and effective challenge throughout.
- Focus on an end-state goal. This also should document needs for future reporting, disclosures and process.
- Have an effective plan to address challenges. Include time to test new activities.
If you think you’ll need more guidance—especially if you’re at the community bank level—you’re definitely not alone. This 22-page transcript from the webinar “Current Expected Credit Loss (CECL): Questions and Answers for Community Institutions” includes actionable advice from representatives of six regulatory bodies.
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John F. Wasik has written 17 books and contributed to The New York Times, Wall Street Journal, Forbes, Financial Planning, Bloomberg and Reuters. His firm JK Enterprises provides editing and writing services for financial services firms. He has spoken about investing, innovation and creativity across North America.