CFO Corner — “ALLL” about CECL
In this occasional feature, CFOs from financial institutions share their approaches to the ALLL and to the CECL transition, as well as advice for keeping the board informed about related matters. Here, Ronald S. Ohsberg, Senior Executive Vice President, Chief Financial Officer and Treasurer of The Washington Trust Company shares advice from his institution.
CSBS offers CECL readiness tool
The Conference of State Bank Supervisors (CSBS) released a readiness tool for Accounting Standards Update (ASU) 2016-13, Financial Instruments—Credit Losses (Topic 326). The tool is a downloadable resource that institutions can use to their expected loss implementation planning.
CECL Transition Workshops to Kick Off in March
As part of a three-pronged approach to help Sageworks’ clients transition to the excepted loss accounting standard, Sageworks will kick off in March 2018 a series of CECL Transition Workshops to take place across the country. These events will be open to all financial institutions, not just those who subscribe to the company’s ALLL solution.
Segmenting the Loan Portfolio
he extent of segmentation recommended for a bank or credit union depends on the size of the institution and the nature, scope and risk of its lending activities (new products, significant changes to underwriting, origination in new markets, etc.). Guidance suggests the loan portfolio should be segmented into homogenous pools based on similar attributes, “stratifying the portfolio into segments that have common risk characteristics or sensitivities.” But, be sure that the segmentation reflects the segmentation risk within your institution’s portfolio. Segmentation strategy should be tailored to each institution to address its specific circumstances and needs.
FASB’s CECL Model: Navigating the changes
Final deliberations by the FASB on the impairment of financial instruments are drawing to a close, and the board is expected to issue a final standard in 2015. Prior to deciding to issue a final standard, the board will ask themselves whether re-exposure is warranted. While the deliberations are not yet complete, the CECL model removes the “probable” threshold that exists today and requires the development of an estimate of all contractual cash flows not expected to be collected. Given the pervasive impact, many financial institutions are beginning to think about the impact the new model is likely to have on their allowance methodologies.
The two D’s of the ALLL: Data and documentation
One critical component of the ALLL is data-gathering and documentation. The reserve is more than simply a calculation of funds, and a lack of or insufficient data and/or documentation is often a sore spot for many banks and credit unions. Whether an institution assesses the ALLL monthly or quarterly, collecting portfolio-level and loan-level data is often the most time-consuming aspect of the process, but a crucial one.
What credit unions need to know about CECL
Over the course of the next several years, any number of aspects of the financial industry can change. Information security could become tighter to better protect a financial institution’s sensitive data, or restrictions could relax allowing more credit union members access to lines of credit for mortgages or auto loans. One critical change in the landscape, though, isn’t member-facing – transitioning from the incurred loss model to the expected credit loss model in a credit union’s allowance for loan and lease losses (ALLL).
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."
Life of Loan Concept
The more forward-looking CECL model will require institutions to adopt a methodology that takes into account the lifetime of the loan. This will require institutions to gather significantly more data components in order to perform the calculation.
qualitative scoring matrix
Justification of Qualitative and Environmental (Q/E) Considerations
As required by regulatory and accounting guidelines, historical loss experience is the starting point for estimating future loss expectations. In a stable environment without significant changes in process, personnel, or portfolio concentration, historical experience offers a reasonable approximation of expected future losses. However, a constantly changing environment requires management to assess how changes may affect future losses.
How FANB readies its ALLL data
A past due loan report is used to review loans needing a downgrade due to days past due or days past due in combination with history. Commercial loans over 90 days past due are placed on non-accrual. Consumer loans, including home loans, are typically assigned non-accrual at 90 days but in some cases where a workout is in process or collateral value exceeded the fair market value less cost to sell & the loan is in collection, non-accrual is not assigned until 120 days past due.
Peer data can be useful for de novo institutions, but should no longer be used when institutions have a substantive amount of data on their portfolio to perform a historical loss methodology.
It is vital to ensure data integrity before performing the actual calculation. Institutions must validate that the numbers they have on their books are up-to-date in order to derive an accurate output on the ALLL calculation.
Before an institution can begin on the ALLL calculation, it must first gather and prepare the necessary data. This may require collecting data from disparate sources and converting the data from an illegible core output to a ready-to-use format. If an institution uses an automated solution that integrates with its core, this step in the process may not be necessary.
With the transition to the CECL model, institutions will likely need to rely on archived loan-level detail. This could include individual loan segmentation, individual charge-offs and recoveries, risk ratings by individual loan, loan balances and duration.