cecl: are you where you need to be?

CECL: Are you where you need to be?What you need to know in preparing for the current expected credit loss

John Robertson- Senior Business Process Consultant, Advisory Services John Closs- Executive Vice President - MST

CECL is built on the

same foundation of

information as the

incurred (aka historical)

loss model.

CECL basics

For CECL, these historical

losses must be adjusted

beyond the reporting date,

looking forward according

to what is ‘reasonable and

supportable.’

CECL basics

Why the change?

GAAP requires an “incurred loss” methodology. Delayed recognition until it is probable a loss has been incurred. GAAP restricts recording credit losses but not yet meet the “probable” threshold. Users analyzed credit losses by utilizing forward-looking models. FI’s could not record credit losses that had not yet met the “probable” threshold. Age old problem - conflict between safety and soundness and taxable income.

What will change under CECL?What you should expect:

Banks will have to predict future losses.

Bankers will reserve for a loss from the day a loan is issued.

What can I do now?

Consider the data collection needs. Single most important is the process of capturing and storing

loan-level detail and transactional information on a regular

basis.

Assemble data on two primary levels…

Key to CECL is assembling data on two primary levels

Data on a loan level of losses over time

Loss rate by loan type.

Loss patterns by loan type.

Correlations with key economic metrics

and associated losses.

Data on a loan level of duration

Loss patterns under different economic

and interest rate environments.

Prepayments under different economic

and interest rate environments.

Gathering the information and saving it

Financial institutions with insufficient amounts of data.

Turn to call reports as a starting point even if it’s not be loan level data.

Start gathering that information in detail right now.

Have your service provider start saving the data.

Having detail gives you flexibility.

Historical data requirements for CECL are expected to be five years or more.

Loan data surrounding historical losses

Probability of default stats Loss given default stats Loan-level detail for net losses Loan rating/grade Was a loan TDR? Or impaired? Delinquency status Loan to value Prepayment experience Information on unique products or loan structures Date info, like first past due, first classified as non-accrual, etc.

Economic ForecastingSteps to develop a “reasonable and supportable” forecast.

1)Identify the relevant economic metrics that drive losses for different segments of loans.

2) Identify economic forecasts for the selected metrics.

3) Translate to loss information using correlations and lags identified in historical data.

Economic metrics to consider

Real gross domestic product Nominal gross domestic product Nominal disposable personal

income Unemployment rate Commercial real estate prices

CECL Implementation: Seven Steps to Consider

Data Management

Data Interfaces

Transparency

User Acceptance

Systems/ Methodology Controls

Solid foundation from which to move forward

Incurred Loss 2020 - 2022

Automation

Implement a Shadow Loss solution

Begin testing pool segments based on vintage and other cohorts

Project loss with migration analysis or other method based on historical data

Correlate default and loss data economic information

Apply forecasts

Run quarterly and reconfigure as needed

Go live 2019 - 2022

Modeling

“We anticipate modeling for CECL to take us one year.”

Muneera CarrComerica, EVP & CAO

2016 MST National ALLL Conference

Reports: governance & oversight

New model/ methodology Policy

Establish Document

Execution Responsibility Owner Oversight

Output

Consistency between actual and documentation

3DevelopReports

Rewriting/ documenting policies What is the method? How does the model work? Who is responsible? What department?

Define model controls

Use of outside resources

Models break

Excel just reports a bad number

4Document

Process

Loan originations will create immediate accounting events

Develop and validate disclosures

Disclose Segment method and rationale Forecast (correlations and duration)

5Assess

Impact on ICFR

“Preparing for CECL now will bring greater value to your institution, it will be a lot easier to start testing different types of models…giving you the

flexibility to determine what might work and what might not.”

Dan HarachWestern Alliance Bank, VP Portfolio Management

MST 2016 National ALLL Conference

Possible allowance increase impacts all corners of institution

Profile change and loan portfolio

Lifetime losses may dictate product offerings

Future loss estimates may impact capital planning

Variations in reserves based on forecasts need to be explained

6Capital

Planning

Comprehensive understanding/ practice of guidance

Pre-planning

Who or what departments are delegated with responsibility

Historical data, correlations (forecasts), external data

Parallel for a reasonable timeframe

Oversight and adherence

Auditors and regulators will guide and not recommend

7Audit &

Regulatory Approval

CECL Implementation – Deadline“The extension will raise expectations for

success.”

Rahul Gupta(former) FASB CECL Project Manager

MST 2016 National ALLL Conference

May 22, 2016Conference Poll

March 16, 2016 Webinar Poll

December 2015 Email Poll

67%63% 58%

Respondents who have not begun preparing for CECL.

Do you plan to use Excel or a 3rd party software to estimate your allowance under

May 22, 2016 Conference Poll

76%82% 58%

Is your financial institution ready? Start collecting data now Ensure key data are gathered and governed Coordinate credit risk management metrics with CECL Understand the impact of the forward-looking requirement and vintages

Don’t wait!

THANK YOU

Optimize,

Change, Innovate#BHCM16@bakerhill

For more information, visit our Solutions Showcase, or, contact your presenter at John.Robertson@bakerhill.com

APPENDIX

Respondents indicating they will need more than 8 years of historical data.

Most were unsure48% Was not

Respondents who expect their allowance to increase under CECL.

80%73% 74%

Do you use Excel or software to estimate your allowance today?

55%56% Was not asked

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