Baker Hill Prosper 2017 - CECL – Now That the Dust is Settling, What is Going to be Required
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presented by John Robertson and co-presented by Noah Coonce of Emprise Bank In this session, we discussed the evolving CECL requirements and expectations that have emerged since the regulation was announced. We discussed steps that have been taken and steps yet to come as financial institutions prepare for the change.
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Baker Hill Prosper 2017 - CECL – Now That the Dust is Settling, What is Going to be Required
- 1. CECL – NOW THAT THE DUST IS SETTLING, WHAT’S REQUIRED? John Robertson – Baker Hill Noah Coonce – Emprise Bank
- 2. Confidential & Privileged Document Where it’s been • GAAP required using an “incurred loss” methodology • Delayed recognition until it is probable a loss has been incurred • GAAP restricted recording credit losses but not yet meet the “probable” threshold
- 3. Confidential & Privileged Document The dilemma • 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
- 4. Confidential & Privileged Document Where it’s going • CECL is built on the same foundation of information as the incurred (aka historical) loss model • For CECL, these historical losses must be adjusted beyond the reporting date, looking forward according to what is ‘reasonable and supportable’ • If can’t reasonably support it, revert to historical averages but don’t expect the regulators to accept it in the future • Reactive to predictive – Banks will have to estimate risk through life of loan simulations • Proactive view of portfolio losses – Bankers will reserve for a loss from day one
- 5. Confidential & Privileged Document Implementation challenges • Clarity around acceptable interpretation of the CECL model externally and internally • Level of coordination between finance, credit, risk, IT, and others to execute the implementation • Availability of data • Capability to design, build, and test new models with limited internal resources • Capability to plan and execute a program of this size in parallel with other current initiatives
- 6. Confidential & Privileged Document What options are there • Determine the appropriate credit loss measurement method and how it compares to the institution’s credit and risk analysis process – Be prepared for this to evolve over time • Different methods include – Regression analysis – Probability of default estimates – Credit migration analysis – Tracking defaults and loss severity patterns – Vintage analysis by like-kind products
- 7. Confidential & Privileged Document What data would I expect to collect • Historical defaults, attrition, and recovery data • Risk grades • Delinquency data • Internal indicators of likelihood to pay • Prepayments • Collateral information • Forward-looking economic scenarios • Macroeconomic indexes
- 8. Confidential & Privileged Document Next steps – data integrity • Examine and compare • Ensure your data is segregated • Review historical data • Document your initial assumptions • Document what can and can’t be managed
- 9. Confidential & Privileged Document Next Steps - segmentation • Compare apples to apples – Pool your loans • Risk rating • Classification • Risk score • Geography • Days past due – Loss rate by loan type – Loss patterns by loan type
- 10. Confidential & Privileged Document Next steps – risk assessment • Identify the credit risk indicators • Analyze collateral values • Analyze aging, charge-off and recovery data • Perform a gap analysis • Examine underwriting processes
- 11. Confidential & Privileged Document What drivers to consider • Correlate key economic metrics and associated losses • Identify any historical credit quality changes • Identify loss patterns • Review prepayments • Find/use applicable economic factors that can act as telltales
- 12. Confidential & Privileged Document Drivers - credit metrics • Current delinquencies • Loan-to-value ratios • Impaired loans • Annual charge-offs or annual loss rates • Troubled debt restructurings (TDRs)
- 13. Confidential & Privileged Document Drivers – macroeconomic • Unemployment rate • Real median income • Changes in GDP • Change in housing prices • Change in used auto prices • Changes in real estate values • Housing starts
- 14. Confidential & Privileged Document Document • Through every phase of developing CECL implementation plan validate your selections and exclusions • Regulators will want to know why you chose certain factors and excluded others
- 15. Confidential & Privileged Document Next steps – policies and systems • Examine your current ALLL policies, processes and procedures • Document internal controls over your processes and procedures • Assess current capabilities to identify necessary system changes • Reconcile to final CECL compliance required
- 16. WORK IN PROCESS – EMPRISE BANK
- 17. Confidential & Privileged Document Work in process – Emprise • Where we began • Where we are • What has yet to be done
- 18. Confidential & Privileged Document Emprise Bank - where we began • Early 2015 formed a team to evaluate options to comply with CECL. – Final guidance was expected to be issued late 2015 with effective date in 2018. • Using the initial guidance we recognized: – Need for additional origination data we were not capturing in the core. – Need to begin capturing loan data to create an adequate historical database. – Need to determine further segmentation in our loan pools. – Process would become more complex and time consuming.
- 19. Confidential & Privileged Document Emprise Bank – steps we took to begin • Determined purchasing a solution to provide expertise and guidance was most efficient. – Reviewed two solutions Sageworks and Mainstreet Technologies (MST) – Chose MST – Loan Loss Analyzer
- 20. Confidential & Privileged Document Emprise Bank - where we are • Final guidance issued in June of 2016 set effective date in 2017 for our institution. – Placed project testing on hold while completed core system conversion. • Selected method for additional segmentation. – Filtering first by Product Codes then Risk Rating. • Recently resumed validating historical data imports.
- 21. Confidential & Privileged Document Emprise Bank - what still needs done • Full data import to run CECL model parallel with current ALLL methodology. • Go “live” by 9/30/17.
- 23. Confidential & Privileged Document You must know the past to know the future • Learn • Discuss • Review • Identify • Plan • Test, Test, Test
- 24. THE DUST CONTINUES TO SETTLE. STAY AHEAD OF IT. Presenter Contact Info John.Robertson@bakerhill.com
Editor's Notes
- CECL is the most discussed subject in banking since Dodd-Frank – and likely will have just as much impact on the bank’s bottom line. Financial institutions are facing significant changes in the manner in which risk is measured with the latest regulations. The question FI’s should be asking themselves is “Are we ready?”. The discussion will be centered around “Where should we be in preparation?”. Accountants and auditors agree that CECL will have significant effect on capital and capital planning; CECL could result in a 20 to 50 percent increase in the allowance requirement at some banks. If for no other reason than capital, planning is a two- to three-year process.. We are starting to get a glimpse of what may be required.
- Current generally accepted accounting principles (GAAP) require an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. Both financial institutions and users of their financial statements expressed concern that current GAAP restricts the ability to record credit losses that are expected, but do not yet meet the “probable” threshold. The global financial crisis underscored those concerns because users analyzed credit losses by utilizing forward-looking information to assess an entity’s allowance for credit losses on the basis of their own expectations. Consequently, in the lead-up to the financial crisis, users were making estimates of expected credit losses and devaluing financial institutions before accounting losses were recognized, highlighting the different information needs of users from what was required by GAAP. Similarly, financial institutions expressed frustration during this period because they could not record credit losses that they were expecting but had not yet met the probable threshold.
- FASB’s CECL model requires entities to recognize lifetime expected credit losses for all assets, not just those that have had a significant increase in credit risk since initial recognition. Stated differently, CECL follows a single credit-loss measurement approach, whereas IFRS 9 follows a dual credit-loss measurement approach in which expected credit losses are measured in stages to reflect deterioration over a period of time.
- The first criteria in determining the appropriate credit loss measurement method is how it conforms to the bank’s credit and risk analysis processes. The amount of “expected loss” in a portfolio should be driven by that credit analysis and not merely a calculation made to comply with GAAP. While some believe certain methods may be applied best to certain consumer loan portfolios, and other methods are better for commercial portfolios, ABA staff believes different methods and analysis provide different aspects of a more comprehensive credit risk analysis. For example: Methods may likely differ by product type and even within those categories Vintage analysis of charge-offs may best enable analysts to observe how underwriting standards and the economic cycle impact a current loss expectation. A credit migration analysis (which shows how loans of a certain credit rating or delinquency status result in historical losses) may help analysts observe how deteriorating credit performance may provide risk not yet perceivable in an analysis that solely includes charge-off data. Tracking defaults and loss severity patterns may help analysts estimate exposure in collateralized loans and also supplement observations from credit migration analysis. Such analysis may also assist evaluating whether temporary trends warrant long-term credit loss rate adjustments. With this in mind, bankers should also remember that current practice in the ALLL estimate has evolved over forty years. It is likely that CECL practice will evolve, so excluding certain specific methods at the outset may be regretted later. It is important to have open and frequent communication with your board of directors, your regulators, and your auditors to discuss any planned methods or analysis. Therefore, ABA recommends that all measurement options be left open at this time.
- Gap analysis to assess available data for various modeling options and document what can and can’t be managed given your available data Develop a timeline to accomplishing your identified goals in route to CECL implementation
- Pooling analysis to balance your loan pools for manageable sizes and to minimize volatility under CECL
- Commercial. CRE, Construction, and consumer have similar influences but very different ones as well. Examine underwriting processes, methodologies and change history to understand where changes in underwriting standards have occurred and how they impact quality and comparability of data
- Examine your current ALLL policies, processes and procedures to ensure a clean, efficient, reconcilable methodology in place to run your allowance systems Obtain assistance with documentation of internal controls if need be Examination of your current available data: the quality and quantity of your data and data fields to ensure you have data appropriate for pooling segmentation Assess current capabilities of internally-developed and/or third-party technology to identify necessary system changes or upgrades
- Learn and become familiar with the new standard Discuss with board and audit committee Review existing allowance and credit risk management process that can be leveraged Identify data needs and system changes including Gap analysis Plan with a cross-functional effort and determine the impact on capital 2017 determine methods and options to try in order to implement CECL 2018-2019 Test, test, test
- Financial institutions are now familiar with the CECL standard and considering what to do. As you think about data input, think about accuracy, consistency and auditability. You might have a lot of fields of historical data but how comfortable are you with someone looking at them? And how consistent is your data? And how can it be proven that it’s right? The main objective is to understand your history first. Then sit down with your lenders, credit and data folks and determine your risk drivers. Most people are doing that now. They haven’t moved to the forward looking phase. You need to get your historical view clear, then figure out the most appropriate model based on that: input, process and output.