CECL: preparations for compliance

May 2018  |  FEATURE  |  FINANCE & ACCOUNTING

Financier Worldwide Magazine

May 2018 Issue

Despite its scheduled implementation being more than 18 months away, preparations to comply with the Financial Accounting Standards Board’s (FASB) Current Expected Credit Loss (CECL) standard are (or should be) well underway, with US banks looking to plug any gaps in data and infrastructure.

Applicable to US Securities and Exchange Commission (SEC) filers for fiscal years beginning after 15 December 2019 (for all other entities, including certain not-for-profit and employee benefit plans, the date is a year hence), the new CECL measurement applies to financial assets measured at amortised cost, which includes loans, held-to-maturity debt securities, net investment in leases, and reinsurance and trade receivables, as well as certain off-balance sheet credit exposures, such as loan commitments.

“Banks that have not programmatically addressed any data and infrastructure gaps will find that CECL requirements may involve extensive changes and possibly deeper investment,” says Tom Kimner, director and head of global marketing and operations, risk management at ‎SAS Institute.

Challenges

In order to be fully prepared for CECL, there are a number of factors potentially affecting implementation which banks need to be aware of. “The CECL standard brings a significant change to the banking industry,” says Christian Henkel, a senior director at Moody’s Analytics. “The process for calculating an appropriate allowance for credit losses will be more complex, but it will also be more aligned with credit risk than the incurred loss model. Banks whose allowance for loan and lease losses (ALLL) is based upon annual historical charge-off experience will most likely need to revisit their credit portfolio segmentation and methodologies for quantifying expected credit loss (ECL) for financial instruments within each segment.”

According to Mr Kimner, regardless of where banks are in their CECL programme evolution, they all need to take the following steps: (i) review accounting standards; (ii) assess data completeness; (iii) review suitable model methodologies and coverage; (iv) determine appropriate segmentation; (v) evaluate reasonable and supportable scenarios; (vi) conduct an impact analysis of the methodologies, scenarios and segmentation; (vii) implement the selected methodologies, scenarios and segmentation; (viii) document data, methodologies and operating procedures; (ix) update policies including governance and controls; and (x) review and issue financial reports.

“For banks that are industrialising their loss estimation efforts and stress testing programmes, implementing the new accounting standards will be less burdensome but still may require significant effort,” suggests Mr Kimner. “This effort will focus on evaluating new or revised ECL models and understanding their bottom-line impacts, streamlining processes, and more deeply integrating risk and financial data and systems.”

Considerations

An immediate decision for banks is whether they should leverage existing processes or start from scratch. “Experience with stress testing implementations shows that banks generally want to begin with existing processes and extend them where needed,” says Mr Kimner. “This is understandable from the perspective of organisational familiarity and a desire to minimise upfront implementation costs.”

At this stage, banks should have already begun their implementation process and formed internal committees and work groups to ensure ownership and accountability. “A priority should be evaluating gaps within the current allowance process relative to the institution’s CECL ‘target state’ and defining when to enter a parallel run,” advises Mr Henkel. “Developing a roadmap and cross-functional work plan will help guide bank management toward compliance, while also ensuring that the right stakeholders are involved, both internal and external, such as regulators, auditors and vendors.”

Countdown

As the countdown to implementation continues, a CECL parallel run phase is in the offing, which many expect to begin in early 2019. “Banks need to ensure that material development activities are completed in time to allow for a parallel run phase of at least six months, although a full year is optimal,” suggests Mr Kimner. “During this time, assessments and evaluations of specific models will continue, additional infrastructure and supporting systems and data will be fine-tuned, and appropriate and necessary controls and governance will be instituted.”

In addition, banks may decide to break the overall CECL programme into multiple tracks that address several aspects of the new standard simultaneously. For example, one track could focus on model choices and assessing the loss estimates and implications for financial statements, while another could develop and evaluate a set of ‘reasonable and supportable’ scenarios that feed underlying expected loss models.

“Bank management should be determining how they will derive ECL estimates for each segment within their portfolio and the process by which they will implement,” says Mr Henkel. “Converting annual charge-off estimates into lifetime ECL measures that include current conditions and economic forecasts is far more than an accounting exercise. If they have not done so already, the first half of 2018 should be focused on vendor selection, where appropriate, and identifying gaps to readiness. The second half of the year will be more tactical, toward implementation and validation before commencing their parallel run.”

Considered to be the most impactful banking regulation since Dodd-Frank, the CECL accounting standard, once it comes into effect, will have an extensive, long-term, enterprise-wide impact on bank operations in the US.

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