CECL updates for directors are critical for financial institutions transitioning to the current expected credit loss (CECL) standard in 2023.
After all, the board (or its designated committee) has oversight responsibility for the management and for activities related to the allowance for credit losses and provisions for credit losses. In addition, directors have oversight responsibilities for approving and monitoring loss estimation policies, among other bank or credit union activities. Keeping all directors informed and on the same page is good for corporate governance. It’s also beneficial for helping management secure buy-in from key operations involved in the transition.
Smooth CECL transition hinges on buy-in.
“Unified buy-in across the institution is critical,” says Regan Camp, Abrigo’s Managing Director of Advisory Services. “When we talk to financial institutions that have had success in the CECL transition or have struggled, it went more smoothly when they had buy-in. It didn’t when they didn’t have buy-in. There’s no better way to get buy-in than for the board to say, ‘We want everyone involved.’”
Ensuring the board and executive management remain aligned on CECL implementation starts with regular updates. Have CECL updates to the board read into the meeting minutes to memorialize the CECL committee’s progress and help document decision-making for auditors and regulators.
Areas to discuss in CECL board meetings
What are important topics to include in any CECL board update? Here are some areas that deserve focus, according to Camp:
Ongoing education about the project status, changes
“For most board updates, your goal is continuing education,” Camp said. “It’s ‘Here’s what we’ve done and here’s where we are in the process.’ At this stage, there are things that the board should be updated on regularly that are task-related.” As important as it is to describe to the board what’s already accomplished in the CECL transition, it’s also critical to make directors aware of what remains to be tackled, as board members likely need continued review of program requirements.
This is especially important considering the timeline for CECL implementation has been pushed out since the standard was first issued. Boards must be mindful of the limited time available to complete model selection, parallel testing, and everything else related to the transition.
‘Clock is ticking’
“As recently as the CARES Act, Congress gave filers an optional delay,” Camp said. “So financial institutions need to keep their ears open for potential changes in the timeline, but also not rest their hats on there being another delay. The clock is ticking, and this isn’t something [standard-setters are] going to pull.”
Financial institutions are going to be held accountable for what they did with the time they’ve had, he said. “We’ve had this standard since 2016, and while there have been bumps in the timeline, delays have not been to give people more time to procrastinate.”
Possible CECL impact on the financial institution
Another area to include in board updates is information on the expected impact of CECL on the bank or credit union. “We’ve heard a lot of feedback from the 2023 filers that there’s added emphasis from boards on parallel testing,” Camp said. ““They’re wanting a number sooner rather than later on what the impact is going to be.”
“In most cases, it’s probably not going to be a huge capital raise,” Camp said, “but we do have a lot of boards saying, ‘At least give us an idea so we can alleviate some of the anxiety.’”
Even if a financial institution isn’t yet able to begin parallel testing, management can begin to address this topic with the board.
Camp noted that a majority of SEC filers have already adopted CECL. “If we’re a 2023 filer, we have some advantage, because early adopters are already disclosing some of what they did,” he said. In addition to disclosing best practices for adopting CECL, these early adopters are shedding light on the potential impacts for financial institutions adopting CECL for 2023.
“While the impacts are varied, across the board there are some trends,” Camp said. One is that, while most institutions experienced an overall increase in their allowance for credit loss, it was those institutions with large amounts of acquired loans that were more likely to see the larger increases, he noted. Nevertheless, Camp added, “increases, in general, have not required significant capital raises.”
Model selection and the need for flexibility
CECL model selection is a third area to update the board on regularly. Discussing the model or models under consideration or being tested is vital due to the unique challenges the pandemic created for financial institutions, Camp said. Explaining the need to remain flexible is also helpful. “With COVID, there are things we didn’t have to consider before that we now need to consider,” he said. “We really need to be flexible, because some of those models are breaking.”
He explains: A lot of financial institutions went live with CECL models using assumptions and forecasts that were based on years of economic stability. “Then all of a sudden coronavirus hits and our ability to forecast changed, those assumptions changed, the reversion periods — everything changed,” Camp said. “As an example, unemployment went through the roof. But other influences have kept losses to a minimum so far, so the correlation of unemployment to losses was compromised.”
Calibrate models as necessary
“There really is no easy button to model selection, so we’ve got to get started sooner rather than later,” he said.
“We’ve got to be asking how these different models are going to be performing in different environments and calibrate those as necessary.”
Directors should understand that management needs resources and funding to start testing methodologies. But they should also understand, “the environment is always changing, and particularly today, when we’re seemingly coming out of a pandemic and still in an uncertain environment, we have to be flexible.”
Inform boards of data constraints and how that shapes model selection. After all, directors need to approve the model and understand it enough to explain at a high level what drives any change in the allowance. “If there is a material change in the allowance and material impact on capital, the expectation is that directors can explain to shareholders and regulators what some of the key drivers were behind that,” Camp said.
“The board ultimately is responsible for identifying holes and where the financial institution needs help. Directors need to be able to say, ‘This is something we’re making an investment in internal resources,’ or ‘Does it make sense to evaluate third-party CECL resources to get there faster?’”