Rethinking Risk Ratings Ahead of CECL
Depending on the methodology elections an institution makes under the current expected credit loss (CECL) model, risk ratings can be an absolutely critical input for loss rate calculations. This is especially true for migration analysis. But even more broadly, risk ratings play an essential role in understanding, measuring and limiting credit risk to the institution. Consequently, the risk rating policy that defines measurement criteria, timing and use-cases is an important document under both incurred and expected loss models.
Making sense of CECL
In a July 2016 webinar with more than 220 bankers attending, executives at banks and credit unions spoke up with some of their most pressing questions related to the implementation of the current expected credit loss (CECL) model. Neekis Hammond CPA and senior risk management consultant at Sageworks addressed some of the questions during the webinar and archived the responses below for the ALLL.com audience.
Can You See Where Your Portfolio is Going?
Institutions range in sophistication with respect to assessing their portfolios; however, there are several fundamental principles that every institution, regardless of size, should deploy to soundly manage risk. This consists of a well thought out data gathering plan, a consistent, objective risk rating system, analytical tools to interpret data, and an action-oriented portfolio review. If you "commit to using data to make better decisions, rather than to rationalize guesses...you will find yourself better prepared to cope with the ugly surprises that come to all of us in this business."
Measures of Loss
When calculating the FAS 5 portion of the ALLL, various methodologies can be used. These consist of peer analysis (for financial institutions that may still be in de novo status), historical loss, migration analysis and PD/LGD.