The CECL Workshop Series Part I: Crafting Your Implementation Plan
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The document presents guidance on implementing the Current Expected Credit Loss (CECL) model, emphasizing the need for financial institutions to adapt their loan loss reserve calculations to reflect forward-looking data. It outlines key steps such as building a cross-departmental committee, assessing data requirements, and modeling potential CECL scenarios while highlighting the project's complexity and the necessity of collaboration across various business units. Additionally, it discusses common pitfalls and the importance of ongoing communication with senior management and the board regarding changes in loan loss provisioning.
The CECL Workshop Series Part I: Crafting Your Implementation Plan
- 1. P R E S E N T E D B Y Tim McPeak Sageworks Todd Sprang CliftonLarsonAllen Tom Danielson CliftonLarsonAllen
- 2. • Ask questions throughout the session using the GoToWebinar control panel • We will answer as many questions as we can at the end of the presentation 2
- 3. • Risk management thought leader for institutions and examiners • Featured in national and trade media 3 • Loan portfolio and risk management solutions • More than 1,000 financial institution clients • Founded in 1998
- 4. 4 • A professional services firm with three, distinct business lines » Wealth Advisory » Outsourcing » Audit, Tax, and Consulting • Nearly 4,000 employees • Offices coast to coast • Serve more than 1,450 financial institutions Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC.
- 5. This presentation may include statements that constitute “forward-looking statements” relative to publicly available industry data. Forward-looking statements often contain words such as “believe,” “expect,” “plans,” “project,” “target,” “anticipate,” “will,” “should,” “see,” “guidance,” “confident” and similar terms. There can be no assurance that any of the future events discussed will occur as anticipated, if at all, or that actual results on the industry will be as expected. Sageworks is not responsible for the accuracy or validity of this publicly available industry data, or the outcome of the use of this data relative to business or investment decisions made by the recipients of this data. Sageworks disclaims all representations and warranties, express or implied. Risks and uncertainties include risks related to the effect of economic conditions and financial market conditions; fluctuation in commodity prices, interest rates and foreign currency exchange rates. No Sageworks employee is authorized to make recommendations or give advice as to any course of action that should be made as an outcome of this data. The forward-looking statements and data speak only as of the date of this presentation and we undertake no obligation to update or revise this information as of a later date. 5
- 6. Executive Risk Management Consultant Sageworks 6 TIM MCPEAK Principal CliftonLarsonAllen TOM DANIELSON Principal CliftonLarsonAllen TODD SPRANG
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- 8. • Factors your institution should consider when crafting a CECL implementation plan • Example timelines for CECL implementation planning • Important data components, and how to future-proof your ALLL • The pitfalls of repurposing historical loss calculations for CECL • Auditor concerns 8 CRAFTING YOUR IMPLEMENTATION PLAN
- 9. • FASB released proposal December 2012 • Current expected credit losses (CECL) • What’s changed from Incurred Loss Model? » Forward-looking requirements » “Probable loss” threshold removed • “No triggers, no thresholds” (“Fed Perspectives,” 2015) » Need for accessible, loan-level data » Longer loss horizon » Makes ALLL more institution-wide calculation • Purpose: Quicker recognition of losses. Changes in ALLL reserve balances will reflect changes in credit quality and flow through bank earnings (“Fed Perspectives,” 2015) 9
- 10. Auditors Regulators Peers In-house Experts Outside Consultants Vendors 10 When it comes time for implementation, institutions will have a number of resources to consider: • Regulators, industry experts, thought leadership • All institutions will be going through the same process, your institution is not alone • Leverage in-house knowledge in your committee • External assistance from consultants and vendors
- 11. “CECL implementation is, in many ways, a project management challenge that will affect most parts of your business to one degree or another.” (“Fed Quarterly Conversations,” 2015) “The CECL model represents the biggest change – ever – to bank accounting.” (“ABA Letter to the FASB - CECL,” 2016) 11 Figure adapted from “Current Expected Credit Loss (CECL) Model: Answers to Your Questions,” by the Federal Reserve Bank of St Louis, 2015, Quarterly Conversations, Live from Eagle Bank and Trust Little Rock, AR. Retrieved from: https://bsr.stlouisfed.org/conversations/includes/resources/November%202015%20Quarterly%20Conversations%20(CECL)_FINAL.pdf Operational Credit Legal/Compliance •Credit Business Lines •Mergers & Acquisitions •Counter-parties •IT Systems •Vendor Management •Regulatory Reporting •Tax •Financial Reporting
- 12. • Forming your committee: » Look at how the allowance calculation flows through your institution and how many business areas touch it » Strive for senior level representation across all departments • Define the roles of the committee » Set initial objectives and timelines » Determine responsibilities and scope out resource requirements » Provide regular updates to senior management and board • Create project plan » Document your roadmap as well as possible » Meet regularly, as defined by the plan 12 CECL Committee CFO Chief Risk Officer Audit Technology Workout Head of Credit /Lending
- 13. • Must first evaluate your current process and methodology » From data gathering to reporting/disclosures » Often a few key individuals perform most of the work • CECL will require significant collaboration across functional areas » Committee members must understand the role their areas will play going forward » Assumptions used for ALLL will need to be consistent across other bank functions and models (ALM & Stress Testing) » Active committee creates checks and balances • Opportunity to improve the ALLL process » Not starting from scratch, but close to it 13 CECL Committee CFO Chief Risk Officer Audit Technology Workout Head of Credit /Lending
- 14. 14 Methodology Changes Data Requirements Capital Adjustment Communication Projected Impact Historic loss to migration, PD/LGD, vintage analysis “Reasonable and supportable forecasts” Life of loan expected loss versus one year incurred loss Model validation Internal controls External provider
- 15. 15 Methodology Changes Data Requirements Capital Adjustment Communication Projected Impact Building and maintaining a data warehouse (new storage device / server) Assessing availability and quality of historical data Determining key data needed for calculation Data validation process Report building process
- 16. 16 Methodology Changes Data Requirements Capital Adjustment Communication Projected Impact Need to raise additional capital? Shareholder communication Regulatory communication Timing consideration
- 17. 17 Methodology Changes Data Requirements Capital Adjustment Communication Projected Impact Socialization of CECL with board and senior management Periodic meetings Documents read into the minutes
- 18. 18 Methodology Changes Data Requirements Capital Adjustment Communication Projected Impact Earnings projection due to changes in provision Peer comparisons will change Asset and liability management Stress testing Loan pricing Underwriting guidelines Segment lending limits
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- 23. • Determine data requirements » Build and house data (warehouse, report builder, data tools, reports) » Work with core provider to extract data » Start gathering and storing data » Data validation • CECL » Review finalized CECL language / leverage available resources » Review potential loss methodologies versus available data » Begin modeling potential CECL scenarios 23 Key Action Items • Build committee • Set project plan • Review final CECL language • Inform board & management of committee/ALLL changes • Examine data/current processes
- 24. • Continue modeling CECL scenarios / run multiple scenarios » Begin running potential CECL models in parallel with current calculation » IT testing (test data, validation, etc.) » Internal and external audit review of ongoing model building • Ensure accurate data by developing formal data validation process • Identify if CECL calculations will require capital adjustment • Provide management with regular reporting showing comparison of current ALLL versus proposed CECL calculation, as well as whether additional capital will be needed 24 Key Action Items • CECL scenario modeling • Test methodologies • Develop data validation process • Identify any capital issues • Update board/management
- 25. • Identify final CECL model » Audit approval, regulatory feedback, board approval • Regular management and board reporting showing differences between ALLL and CECL » Potential impact on ratios, earnings, capital purchase, shareholders and investor relations • Incorporate model and reserve data into current portfolio management » Pricing, reporting, stress testing 25 Key Action Items • Identify final CECL model • Incorporate model & reserve data into current portfolio management • Capital adjustment • Update board/management
- 26. • Fine-tune the new ALLL process and other related processes » Ensure everyone is performing their duties » Refine risk ratings » Fine-tune loan pricing • Regular management and board reporting for strategic planning to include new CECL numbers 26 Key Action Items • Fine-tune new process • Monitor ALLL levels • Fine-tune risk ratings • Fine-tune loan pricing • Update board/management
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- 30. 30 - Individual loan charge-offs - Individual loan recoveries - Individual loan balances - Individual loan pool segmentation - Individual loan duration MigrationAnalysis Historical Loss VintageAnalysis - Individual loan origination dates - Individual loan origination amounts- Individual loan risk classification - Migration of loans between classifications • This is a data-driven exercise • Don’t cheat yourself out of using a methodology due to a lack of information • Gather industry information » Shape of loss curves » Prepayment assumptions » Projected lifetime losses for various types of loans by loan vintage
- 31. • Ensuring that you are capturing the proper data will give you more flexibility in the methodologies you can consider • This is a data-driven exercise • Don’t cheat yourself out of using a methodology due to a lack of information • Gather industry information » Shape of loss curves » Prepayment assumptions » Projected lifetime losses for various types of loans by loan vintage 31 - Individual loan charge-offs - Individual loan recoveries - Individual loan balances - Individual loan pool segmentation - Individual loan duration MigrationAnalysis Historical Loss VintageAnalysis - Individual loan origination dates - Individual loan origination amounts- Individual loan risk classification - Migration of loans between classifications
- 32. Probability of default (default can be defined various ways) • Days past due • Accrual/restructure status • Charge-off activity • Bankruptcy 32 Loss given default (LGDs can be measured various ways) • Product/loan type • Industry/geography • Collateral type Exposure at default • Loan balance Other Considerations • Adjustments for current conditions • Adjustments based on reasonable and supportable forecasts • Historical data for period beyond forecast • Credit risk information
- 33. • Not technically prohibited • ‘It typically would be inappropriate’ for long-term assets according to the exposure draft • Ease seems to be the only advantage • May create unwanted results for long-term assets • May be appropriate for short-term loans 32
- 34. 825-15-55-24 It typically would be inappropriate to estimate the expected credit losses for a long-term asset by multiplying an annual loss rate (that is, the net amount written off in a 12-month period divided by the average amortized cost) by the remaining years of the asset’s contractual term because loss experience is often not linear. That is, for certain types of lending, credit losses are low shortly after origination, rise rapidly in the early years of a loan, and then taper to a lower rate until maturity. When estimating expected credit losses under this Subtopic, the loss rate should be commensurate with the current credit risk of the financial asset. 33
- 35. Existing Calculation CECL Calculation Increase of 100% Loan Type Loan Balance Historical Factors Q Factors Allocation for Historical Losses Allocation for Q Factors Total Allocation Commercial Real Estate $100,000,000 1.25% 0.25% $1,250,000 $250,000 $1,500,000 Example: Commercial real estate portfolio with a remaining life of four years Date Year End Loan Balance Avg Balance Loss Rate + Q Factors ALLL 12/31/X0 $100,000,000 12/31/X1 75,000,000 87,500,000 1.50% 1,312,500 12/31/X2 50,000,000 62,500,000 1.50% 937,500 12/31/X3 25,000,000 37,500,000 1.50% 562,500 12/31/X4 - 12,500,000 1.50% 187,500 $3,000,000 34
- 36. • Depending on the shape of the loss curve, the necessary reserves might be 25% less than the $3 million shown on the previous slide • Large increase in reserves for long-lived assets • Discourages making long-term loans • Doesn’t account for loss curves » Low losses early » Losses rise quickly » Losses tail off as loans season • Discouraged by standard setters 35
- 37. • Familiarity • Ease • Information is readily available » Still need to gather information on expected life of loan 36
- 38. • Avoid the temptation of simply adapting your current methodology • CECL seems to encourage other methods • CECL expressly allows financial institutions to use multiple methods • Learn about other methods • Start gathering information needed 37
- 39. 39 • Reasonable and supportable forecast » Time period the forecast covers » Documenting forecast assumptions • Documenting the economic cycle » Cycle term » Current point on the cycle • Evaluating assumptions » What is the definition of a default? » Is the financial institution’s probability of default reasonable? » Is the financial institution’s loss given default assumption reasonable? • Proper use of industry data (when allowed) » Everyone thinks they are above average » Applying national data to a regional/local portfolio
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- 41. 41 • Topics include: » CECL » Current ALLL best practices » Stress Testing • Speakers from CliftonLarsonAllen, Grant Thornton, Sageworks and more • sageworks.com/summit
- 42. 42 TIM MCPEAK Executive Risk Management Consultant Sageworks Tim.mcpeak@sageworks.com Ph. 919.242.2642 TODD SPRANG Principal CliftonLarsonAllen todd.sprang@CLAconnect.com Ph. 630.954.8175 TOM DANIELSON Principal CliftonLarsonAllen thomas.danielson@CLAconnect.com Ph. 612.376.4795
- 43. • CLAconnect.com – Learn more about CliftonLarsonAllen • Sageworksanalyst.com – Learn about Sageworks risk management suite • ALLL.com – Everything ALLL, including news articles, whitepapers and peer discussions • ALLL Forum for Bankers – LinkedIn group for ALLL news & discussion • CECL Post-release webinar - panel-style webinar with thought leaders from top accounting firms • Interested in talking with a specialist? » Email us now: sales@sageworks.com 43
- 44. • Federal Reserve Bank of St Louis, (2015). Current Expected Credit Loss (CECL) Model: Answers to Your Questions. Quarterly Conversations, Live from Eagle Bank and Trust Little Rock, AR. Retrieved from: https://bsr.stlouisfed.org/conversations/includes/resources/November%202015%20Quarterly%20Conv ersations%20(CECL)_FINAL.pdf • Merriett, S., Wakim, J., Satwah, S., (2015). An overview of the current Expected Credit Loss Model (CECL) and Supervisory Expectations. Fed Perspectives. Retrieved from: https://bsr.stlouisfed.org/perspectives/ • Nichols, Rob, (2016). Re: CECL. A letter to Russell Golden. Retrieved from: http://www.aba.com/Advocacy/LetterstoCongress/Documents/RussellGolden-FASB-011316.pdf • Stackhouse, J., Sherrer, L., Ciluffo, S., (2015). Current Expected Credit Loss (CECL) Model: Answers to Your Questions. Fed Quarterly Conversations. Retrieved from: https://bsr.stlouisfed.org/conversations/ 44