4/18/17 - Preparing for the FASB’s CECL Standard
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4/18/17 - Preparing for the FASB’s CECL Standard

How well does your bank understand its options? Do you have the data and a plan for meeting the requirements?

The Financial Accounting Standards Board’s new reporting standard for current expected credit losses will come into effect in 2020 for banks registered with the Securities and Exchange Commission and in 2021 for banks not registered with the SEC. Financial institutions can also adopt the CECL model early, beginning in 2019.

In contrast to current incurred-loss provisioning — which is event-driven, with provisions based on realized, highly probable, or reasonably likely losses — the new standard requires statistical, or dynamic, provisioning based on forecasts and longer-term expectations for portfolio losses. The new standards also align with the general goals of regulators, encouraging prudent risk management and the building of countercyclical capital buffers to lessen the impact of the next economic downturn on a firm’s capital. The concept of incurred losses and the high-probability threshold are eliminated.

Why It Matters to Banks:

  • These new requirements will likely cause the ALLL for unimpaired assets to rise significantly, with a one-time increase for existing assets (the transition impact) upon implementation and an ongoing impact from new assets (day-one loss expectations) after implementation. The impact goes beyond the loan portfolios to include other accounting effects (for troubled-debt restructurings, purchased credit-impaired loans, etc.).
  • The ability for management to provide forward-looking views and greater objectivity in their judgments will depend on banks’ ability to collect and maintain better data — e.g., on the history of loan-level vintage losses — and to assess the portfolio by appropriate segments and risk classes.
  • Banks can draw on their current systems, internal data, and general approach to credit risk management, but they will likely need to invest in the collection of additional data, development of CECL models, and improvements in key systems and reporting.
 

Under the CECL approach, the allowance for loan and lease losses will be expected to reflect:

  • Current estimates of all contractual cash flows expected to go uncollected
  • Lifetime losses inherent in the portfolio but not yet realized (from day one of a new loan)
  • Losses expected based on supportable economic forecasts of the future

Banks using CECL models will be expected to forecast and predict economic conditions over the entire lifetime of their assets — a time horizon that poses a challenge for many banks. Management will still use its judgment, but will need to ensure its decisions are well-justified and ‑documented.

Banks Have Flexibility

Banks with less complex balance sheets may not necessarily need to develop complex models and can choose from one or more of several methods — including those for forecasting loss rates, roll rates, and probability of default, and those that use a provision matrix based on loss factors or discounted-cash-flow modeling. Lenders can also use different approaches for different portfolios.

Banks Face Several Challenges in Adopting CECL

  • The models must be capable of forecasting over the life cycle of the asset, and the method must be applied consistently over time.
  • More complex estimation methods and judgments will likely require:
    • Robust and comprehensive historical credit data
    • Better and possibly different types of ALLL analytics
    • Strong internal governance, controls, documentation, and model risk management
    • A sound and defensible approach to “reasonable forecasts” and improved reporting

Banks of all sizes that begin work now on their CECL ALLL programs will best prepare themselves for the likely economic impact and challenges associated with implementing a CECL approach to ALLL provisioning. Firms can begin with education and training on the FASB’s CECL requirements, an assessment of the various CECL modeling options, a data gap analysis, and an overall impact assessment — and end with a plan for implementing the framework over time.

Scope of Our Services

Promontory, an IBM Company, provides cross-disciplinary expertise in accounting, finance, data, and technology to assist banks in preparing for the FASB’s CECL standard in a thoughtful, phased manner. Our team helps clients leverage key current capabilities and align enhancements with other key bank activities, such as asset-liability management and stress testing.

Our approach is holistic, offering services for CECL-related training, methodology selection, impact analysis, plan development, and model estimation and validation.

Education and Training

  • Briefing the board and executive management
  • Tailoring training programs to fit client size and complexity

Planning

  • Selecting the most appropriate methodologies
  • Identifying points of synergy with current stress testing
  • Identifying other opportunities to draw on existing programs
  • Assessing data requirements, availability, and quality
  • Developing strategies for data collection
  • Developing road maps and project plans

Impact Analysis

  • Estimating the range of expected impacts on the allowance
  • Assessing the ability to make use of existing models

Model Development

  • Calibrating existing models
  • Determining segmentation
  • Determining best methodologies
  • Designing and estimating new models
  • Developing regulatory-compliant model documentation

Model Validation

  • Performing independent validations of bank and third-party models

Why Promontory

Promontory offers expertise in ALLL reporting, loss reserving, credit-loss modeling, and data aggregation. We are an ideal partner in helping banks plan and implement enhancements that suit their organization. Our professionals have unparalleled regulatory and practitioner experience and insight, and provide our clients with frank, proactive advice informed by best practices and regulatory expectations. Our unique domain expertise, combined with IBM’s world-class technology, allows us to resolve critical issues, particularly those with a regulatory dimension.

Contact Us

David Samuels
Managing Director and Global Head of Stress Testing Practice
dsamuels@promontory.com
+1 212 542 6776

Joseph Sergienko
Director
jsergienko@promontory.com
+1 202 370 0408