What you can do now to prepare for CECL

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Community banks won’t have to implement current expected credit losses, or CECL, standards until 2023, but it’s never too early to start getting ready. Here’s what industry experts say you should know about preparing for CECL.

By Kelly Pike

Many community banks have been granted a reprieve from implementing current expected credit losses (CECL) accounting standards thanks to a one-year extension that pushed the date to Jan. 1, 2023—but that doesn’t mean they can put preparing for CECL on the back burner.

The Financial Accounting Standards Board (FASB) delayed implementation for private and small public companies in 2019, acknowledging smaller financial institutions needed more time to adopt the accounting changes. It’s another win for ICBA and community banks; they pushed back against FASB’s initial proposal, which would have been far more complicated and expensive.

But that doesn’t mean preparing for CECL is without its challenges. Industry experts note that even some megabanks with massive resources wish they had more than three and a half years to prepare for CECL implementation, which began Jan. 1 of this year for large SEC filers.

Be proactive on CECL

CECL requires community banks to add a forward-looking component to their allowance for loan and lease losses (ALLL) calculation, projecting future losses forward into the future as long as reasonably possible and then reverting to historical loss experience. To do this, banks will need to gather new data from core and data processing systems so they can build and test models and then include the data in footnote disclosures in financial statements.

The good news for community banks—especially those with fewer than $1 billion in assets, straightforward business models and limited loan loss experience—is that they should be able to rely on existing loss estimation techniques like Microsoft Excel-based systems, says James Kendrick, ICBA’s first vice president of accounting and capital policy. These community banks should be using this time to prepare for forward loss estimation and begin running parallel systems to demonstrate preparedness with the accounting change.

“For [the] vast majority [of community banks, they] won’t have to make exhaustive changes,” he says. “I would argue they have already been utilizing CECL and didn’t know it.”

“For [The] vast majority [of community banks, they] won’t have to make exhaustive changes. I would argue they have already been utilizing CECL and didn’t know it.”
–James Kendrick, ICBA

Larger community banks can expect more scrutiny due to their size and more commoditized lending. Those with more than $1 billion in assets and standardized residential and commercial lending offerings will need more complex systems and should be thinking about whether they need to adopt a new solution and what that should look like.

Community banks with $5 billion or more in assets should be looking at bringing in internal or external expertise, including independent accountants or advisors, Kendrick says. “They are expected to make changes to their systems and really document a lot more of what controls are in place to make the right estimate and understand how that estimate is changing over time,” he adds.

Most community banks already have a good process in place that has served them well and should enhance that calculation for both quantitative and qualitative forward-looking factors, according to Tim Zimmerman, CEO at $991 million-asset Standard Bank in Monroeville, Pa., a past ICBA chairman and a CPA who serves on FASB’s Transition Resource Group for Credit Losses. Yet gathering data for analysis and disclosure is one of the most complicated elements of the process.

While all community banks will need to look at the impact of key factors of their loan loss estimates, including unemployment, models need to be attuned to local conditions, Kendrick says. For example, Midwest ag banks will care a lot more about crop prices and crop loss estimates than an East Coast bank that serves urban and suburban communities. Community bankers should be having conversations with their core providers about developing ways to pull data out of the system and test the results.

One roadblock is that many community banks’ core systems aren’t able to store a lot of data, limiting the availability of historic data, especially for banks with recent merger or acquisition activity, says Robby Holditch, director, SME and accounting solutions at Moody’s Analytics, which is based in New York City. Alternatives to homegrown data include call reports and purchasing peer data.

Since 2018, $406 million-asset The Fountain Trust Company in Covington, Ind., has been gathering loan-level data on a monthly basis and entering it in the community bank’s core provider’s data management system so it has historical data, says president Lucas White. Later this year, The Fountain Trust Company plans to segment its loan portfolio and then choose a methodology.

“There are so many unknowns from the segmentation as to how you use peer data,” says Curt Allison, chief lending officer at The Fountain Trust Company. “What Q factors are applicable to our specific loan portfolio? A big challenge, frankly, is most community banks, at least in Indiana, are experiencing historically low loan losses, so we don’t have anything to go off of the last four to five years.”

Most smaller financial institutions are starting with historical loss methodology, which most closely mirrors the current incurred loss calculations and result, says Danny Baker, vice president of market strategy, financial and risk management solutions at Fiserv, which is based in Brookfield, Wis. He says it’s also likely that banks may find themselves using different methodologies for different parts of the portfolio.

“CECL compliance will be an iterative process, so institutions should remain agile in their use of models and methodologies,” he says, “and in their ability to gather the associated required data.”

Learning from early adopters

One benefit of the CECL implementation extension for community banks is having the chance to learn from the disclosures of the big banks that were required to implement it this year. “We can learn a lot from watching what they do and see what will be acceptable for footnote disclosures under CECL and see the impact with ALLL calculations in terms of adjustments they’ve made,” says Tim Zimmerman, CEO of Standard Bank in Monroeville, Pa.

Robby Holditch, director, SME and accounting solutions at Moody’s Analytics, has seen increases in reserves between under 10% and 65% among public disclosures released as of March 2020. One $35 billion-asset bank has considered deleveraging its jumbo mortgage portfolio after calculating CECL estimates.

Community bankers who are working through CECL now are reporting much smaller adjustments to loss reserves. In preparing for CECL as an SEC-reporting company, Standard Bank found its ALLL calculation was “pretty good” and “probably won’t cause a significant change in reserve amounts,” Zimmerman says.

Regulators aren’t waiting until 2023 to begin asking community banks for CECL documentation, says James Kendrick, ICBA’s first vice president of accounting and capital policy. He says they want to know how banks will adopt these changes and whether they’re hiring an outside vendor, using Excel or new systems, making policy enhancements and how they will use various tools to calculate reserves.

“You need to get ready now and ask the right questions,” Kendrick says, “so when examination teams come in with questions about reserves and CECL, you’re prepared to give solid, straightforward answers.”

CECL as a strategic opportunity

While many community bankers see CECL as a compliance hassle, they would be well-served to look at CECL as a strategic opportunity, Baker says.

According to Baker, data is an increasingly valuable commodity, and the more data a community bank has, the more models are available, giving them the potential to uncover insights that help make decisions about what products to offer, where they should be offered and what price.

“There is so much opportunity here for those that will think of it from an AI and analytics type of thinking,” Baker adds.

“There is so much opportunity here for those that will think of it from an ai and analytics [perspective].”
–Danny Baker, Fiserv

Zimmerman suggests the most valuable CECL resource a community bank has is its independent certified public accountant. They are the CECL experts who will review the calculations and disclosures and render an opinion on the financial statements.

“You don’t necessarily have to go out and hire consultants and spend a lot of money,” Zimmerman says. “You don’t want to overengineer it.”

A CECL to-do list

  • Determine what disclosure methodology your community bank will use
  • Figure out what data your bank needs
  • Talk to your bank’s core data processing provider about how to collect and analyze data
  • Collect and test data
  • Start calculating CECL estimates
  • Upgrade your bank’s allowance for loan and lease loss calculation (ALLL)
  • Prepare disclosures

Kelly Pike is a writer in Virginia.