Current expected credit losses (“CECL”) is likely the biggest change to hit the banking industry in the last 40 years. The new CECL standard impacts your earnings, capital and pricing of loans. The level of new data required for CECL is cumbersome at best, and burdensome as more banks and credit unions realize they must seek the right software or develop a new internal model. Do it wrong and you could hurt your institution for many years to come.
To better understand your needs for CECL compliance, we’ve put together 10 Reasons to Implement a CECL Solution Now. You can download the pdf here.
You need to run side-by-side calculations of the allowance for loan losses (“ALL”) under various methods of calculating CECL so that over time, you can decide what method or combination of methods work best for your institution.
The level of data needed is going to be cumbersome and you will need or should have at least 5 years of data to support your historical charge-off calculations by vintage (year the loan was originated), prepayment assumptions, and will need to be able to break your loan portfolio down in more loan types that you typically have used in the past. This will mean going through prior year loan subsidiary records and a data scrub of your existing loan portfolio.
Why are more loan types good? Because it will allow you to isolate net charge-offs to a lower portion of your loan portfolio. If you are going to use the probability of default / severity of loss or migration analysis method, you will also need to break your year-end balances of loans and net charge-offs down even further for this prior year data.
If you plan is to rely on purchasing national data which is allowable, you could be transferring loss percentages from portions of the country that tend to experience higher losses in economic downturns onto your loan portfolio. Additionally, over time regulators and auditors will expect you to develop better data that is more reflective of your specific institution’s situation and lending practices. Why start over 2 to 3 years down the road? Do it right the first time.
You should be considering the impact of CECL when you establish interest rates for longer term loans (loans that will likely still be outstanding when the new standard becomes effective). If you don’t, it will negatively impact your future operating results.
You need to educate board members, senior management, and other leaders in your organization. Don’t be that guy! The one everyone is pointing at and saying, “Why didn’t you tell me?”
Most industry experts expect CECL to increase ALL balances. You need to prepare for this and consider the impact on your future growth, dividend, and capital planning efforts. Be prepared!
Your auditors and regulators will be asking you what you have done to plan for CECL and may even start asking for projections of the impact of CECL on your future capital position.
CECL will require your institution to better track and segment your loan portfolio. This will upset some but, in the long run this will make many institutions better at managing risk in their loan portfolios. Boards and senior management should be able to finally have the information they need to make appropriate strategic decisions on how you deploy your limited capital and where you focus your marketing and growth efforts.
Because CECL is not going away. Yes, we realize there are industry groups that are lobbying or campaigning to make this go away for smaller institutions or credit unions. This has been a long time in the making and has been supported publicly by all the various federal regulators for both banks and credit unions.
Implementing CECL takes careful analysis. It will impact your earnings, capital, and pricing of loans. Don’t wait until the end and rush it. Not doing this right could hurt your institution for many years to come.