CECL: Are you where you need to be?
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CECL is the new credit loss model that will replace the existing incurred loss model. Under CECL, banks will have to predict future credit losses from the day a loan is issued by adjusting historical losses for reasonable and supportable forecasts. To prepare, banks need to improve data collection, particularly loan-level data and transaction details over time, as well as gather data on loan losses and durations under different economic conditions. Banks also need to identify relevant economic metrics, develop forecasts for those metrics, and translate the forecasts into expected loss estimates using correlations identified in historical data. Proper implementation will require changes to processes, controls, reporting, and capital planning.
CECL: Are you where you need to be?
- 1. CECL: Are you where you need to be? What you need to know in preparing for the current expected credit loss model John Robertson- Senior Business Process Consultant, Advisory Services John Closs- Executive Vice President - MST
- 2. CECL is built on the same foundation of information as the incurred (aka historical) loss model. CECL basics
- 3. For CECL, these historical losses must be adjusted beyond the reporting date, looking forward according to what is ‘reasonable and supportable.’ CECL basics
- 4. Why the change? GAAP requires an “incurred loss” methodology. Delayed recognition until it is probable a loss has been incurred. GAAP restricts recording credit losses but not yet meet the “probable” threshold. Users analyzed credit losses by utilizing forward-looking models. FI’s could not record credit losses that had not yet met the “probable” threshold. Age old problem - conflict between safety and soundness and taxable income.
- 5. What will change under CECL? What you should expect: Banks will have to predict future losses. Bankers will reserve for a loss from the day a loan is issued.
- 6. What can I do now? Consider the data collection needs. Single most important is the process of capturing and storing loan-level detail and transactional information on a regular basis. Assemble data on two primary levels…
- 7. Key to CECL is assembling data on two primary levels Data on a loan level of losses over time Loss rate by loan type. Loss patterns by loan type. Correlations with key economic metrics and associated losses. Data on a loan level of duration Loss patterns under different economic and interest rate environments. Prepayments under different economic and interest rate environments.
- 8. Gathering the information and saving it Financial institutions with insufficient amounts of data. Turn to call reports as a starting point even if it’s not be loan level data. Start gathering that information in detail right now. Have your service provider start saving the data. Having detail gives you flexibility. Historical data requirements for CECL are expected to be five years or more.
- 9. Loan data surrounding historical losses Probability of default stats Loss given default stats Loan-level detail for net losses Loan rating/grade Was a loan TDR? Or impaired? Delinquency status Loan to value Prepayment experience Information on unique products or loan structures Date info, like first past due, first classified as non-accrual, etc.
- 10. Economic Forecasting Steps to develop a “reasonable and supportable” forecast. 1) Identify the relevant economic metrics that drive losses for different segments of loans.
- 11. 2) Identify economic forecasts for the selected metrics. Economic Forecasting Steps to develop a “reasonable and supportable” forecast.
- 12. 3) Translate to loss information using correlations and lags identified in historical data. Economic Forecasting Steps to develop a “reasonable and supportable” forecast.
- 13. Economic metrics to consider Real gross domestic product Nominal gross domestic product Nominal disposable personal income Unemployment rate Commercial real estate prices
- 14. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary CECL Implementation: Seven Steps to Consider
- 15. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary
- 16. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary Data Management Data Interfaces Transparency User Acceptance Systems/ Methodology Controls Solid foundation from which to move forward Incurred Loss 2020 - 2022 1 ALLL Automation
- 17. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary Implement a Shadow Loss solution Begin testing pool segments based on vintage and other cohorts Project loss with migration analysis or other method based on historical data Correlate default and loss data economic information Apply forecasts Run quarterly and reconfigure as needed Go live 2019 - 2022 2 CECL Modeling
- 18. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary “We anticipate modeling for CECL to take us one year.” Muneera Carr Comerica, EVP & CAO 2016 MST National ALLL Conference
- 19. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary Reports: governance & oversight New model/ methodology Policy Establish Document Execution Responsibility Owner Oversight Output Consistency between actual and documentation 3 Develop Reports
- 20. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary Rewriting/ documenting policies What is the method? How does the model work? Who is responsible? What department? Define model controls Use of outside resources Models break Excel just reports a bad number 4 Document Process
- 21. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary Loan originations will create immediate accounting events Develop and validate disclosures Disclose Segment method and rationale Forecast (correlations and duration) 5 Assess Impact on ICFR
- 22. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary “Preparing for CECL now will bring greater value to your institution, it will be a lot easier to start testing different types of models…giving you the flexibility to determine what might work and what might not.” Dan Harach Western Alliance Bank, VP Portfolio Management MST 2016 National ALLL Conference
- 23. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary Possible allowance increase impacts all corners of institution Profile change and loan portfolio Lifetime losses may dictate product offerings Future loss estimates may impact capital planning Variations in reserves based on forecasts need to be explained 6 Capital Planning
- 24. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary Comprehensive understanding/ practice of guidance Pre-planning Who or what departments are delegated with responsibility Historical data, correlations (forecasts), external data Parallel for a reasonable timeframe Oversight and adherence Auditors and regulators will guide and not recommend 7 Audit & Regulatory Approval
- 25. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary
- 26. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary CECL Implementation – Deadline “The extension will raise expectations for success.” Rahul Gupta (former) FASB CECL Project Manager MST 2016 National ALLL Conference
- 27. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary May 22, 2016 Conference Poll March 16, 2016 Webinar Poll December 2015 Email Poll 67%63% 58% Respondents who have not begun preparing for CECL.
- 28. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary Do you plan to use Excel or a 3rd party software to estimate your allowance under CECL? May 22, 2016 Conference Poll March 16, 2016 Webinar Poll December 2015 Email Poll 76%82% 58%
- 29. Is your financial institution ready? Start collecting data now Ensure key data are gathered and governed Coordinate credit risk management metrics with CECL Understand the impact of the forward-looking requirement and vintages Don’t wait!
- 30. THANK YOU
- 31. Optimize,Change, Innovate #BHCM16 @bakerhill For more information, visit our Solutions Showcase, or, contact your presenter at [email protected]
- 32. APPENDIX
- 33. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary Respondents indicating they will need more than 8 years of historical data. May 22, 2016 Conference Poll March 16, 2016 Webinar Poll December 2015 Email Poll Most were unsure 48% Was not asked
- 34. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary Respondents who expect their allowance to increase under CECL. May 22, 2016 Conference Poll March 16, 2016 Webinar Poll December 2015 Email Poll 80%73% 74%
- 35. Copyright © 2016 Baker Hill Solutions LLC – Confidential & Proprietary Do you use Excel or software to estimate your allowance today? May 22, 2016 Conference Poll March 16, 2016 Webinar Poll December 2015 Email Poll 55%56% Was not asked