CECL Model Prep Kit

Mar 23, 2015

While you won’t be needing an emergency radio or a first aid kit, it would be wise to equip yourself with the knowledge needed to effectively transition to an expected loss model. Anticipated to be released in 2015, the Financial Accounting Standards Board’s (FASB’s) Current Expected Credit Loss (CECL) model will represent one of the largest changes bankers have seen in decades with respect to how they account for reserves.

To learn about and prepare for the CECL model, download this CECL Prep Kit. The focus of this kit is to provide you with resources that strengthen your knowledge about CECL, including recorded webinars, whitepapers and infographics. In addition, the kit contains a complimentary registration link to a “CECL Webinar” that will dissect the guidance and provide insight into how to manage the transition once CECL is released.

THE BASICS OF THE CECL MODEL:

Life of loan concept: Anticipated as the largest change from how institutions currently calculate the ALLL, the CECL model will require banks to account for expected credit losses throughout the contractual life of the loan.

Data: Given the transition to life of loan analysis, the ALLL calculation will require significantly more data for each quarter end, including new data components such as: risk rating by individual loan, loan duration, individual loan balance, individual loan charge-offs and recoveries (partial and full), and individual loan segmentation.

New calculation: All of these data components will be integrated into what the FASB views as a more comprehensive (albeit more complex) ALLL calculation, inclusive of forecasting future macroeconomic conditions. System upgrades and sophisticated models are likely to be a byproduct of the complexities of the new calculation.

30-50% increase in ALLL levels: Because institutions currently account for probable and estimable losses over the first year of a loan, the move to a life of loan model will inherently raise ALLL levels. The OCC’s Thomas Curry has been on the record stating, “There is no question that implementation of the FASB proposal will require most banks to boost their allowance; perhaps in the neighborhood of 30-50% system-wide if applied today.” While an improving economy may reduce that percentage slightly, a material increase to the ALLL seems to be the only likely scenario.

One-time capital adjustment: Sometimes a point of confusion, institutions should realize that the one-time increase to ALLL levels will not come in the form of a provision expense, as most adjustments are made under the incurred loss model. Rather, this one-time adjustment will be directly from capital. This has far reaching implications for capital adequacy, thus institutions must strategically plan for the increase to ensure they maintain appropriate capital levels as they transition to an expected loss model. Many institutions will use tools which support scenario building in order to observe their figures under present day circumstances, then under a “CECL” scenario. This allows them to analyze the difference in their figures, more accurately plan for the transition to CECL, and take any capital measures that may be needed to maintain “comfortable” levels, or adequacy at a minimum.

While all signs point toward the FASB releasing its CECL model in 2015, institutions will likely have two to three years to transition to this new model. Institutions should start to plan for this transition on the board level now to get out in front of changes and be positioned to mitigate the risks associated with transitioning to a new model.