The allowance for loan losses (ALLL) standard (ASU 2016-13) known as CECL (Current Expected Credit Losses) was released June 16, 2016. The standard was proposed in 2012 and has been deemed the “biggest change to bank accounting ever.” It’s adoption changes 40 years of standards related to how banks account for changes in their credit risk. It promises to pose significant compliance and operational challenges, and implementation is well underway for some institutions.
Early adoption is permitted for all entities in fiscal years beginning after December 15, 2018. The effective required adoption schedule is as follows. Keep in mind that the prevailing thought is that all banks greater than $500 million in assets and subject to FIDICIA are deemed to be a Public Business Entity (PBE).
- PBE’s that are SEC Registrants: CECL is effective for fiscal years beginning after December 15, 2019
- PBE’s that are not SEC Registrants: CECL is effective for fiscal years beginning after December 15, 2020
- For all other entities, the new standard is effective for fiscal years beginning after December 15, 2021
Why CECL Means Opportunity
As your bank works toward application of CECL, keep in mind that this tremendous compliance burden has equal potential to be a source of opportunities:
- Strengthen the ability of banks to anticipate losses and changes in credit risk
- Simplifying purchase accounting as an allowance is now allowed at the date of acquisition
- An allowance is now given for other than temporary impairment losses on securities, as opposed to a direct write-off, providing the opportunity for recoveries
- An allowance is now given for credit losses during a Troubled Debt Restructuring, as opposed to a cost-basis adjustment
Effective implementation is the key to creating and taking advantage of opportunities like these. As with so many things, a step-by-step approach can increase success and reduce friction during adoption and beyond. HORNE recommends banks take an 8-step process, spending the time during each to generate necessary insights and resources.
Step #1: Portfolio Segmentation Analysis
A thorough loan portfolio analysis is a critical first step to creating the necessary insights into your loan portfolio and identifying gaps in your assessment of credit risk.
Step #2: Identify Relevant Credit Quality Indicators
Clarify the credit quality indicators (CQIs) impacting your loan portfolio so you are positioned to understand eminent future portfolio losses and make informed pricing and credit decisions.
Step #3: Select the Appropriate CECL Model(s)
The new standard offers flexibility to allow entities to apply different approaches to different loan pools based on what fits best. Understand the multiple approaches to calculate the required reserve outlined by FASB and make sure you have documented and supported your selection(s).
Step #4: Assess Resource Capabilities and Needs
Evaluate your human and technological capabilities and needs, and then identify the external resources necessary to improve efficiency and internal controls impacted by CECL.
Step #5: Perform Model Simulations
Test potential CECL models for reasonableness by performing multiple scenario simulations, paying attention to the accuracy of the CQIs selected and CECL models applied to your specific loan pools.
Step #6: Evaluate Software
Work with a trusted software vendor to determine which software solution fits your needs based directly on the results of your first 5 steps.
Step #7: Prepare Formal Policies & Procedures
Clearly document every policy, procedure, and newly implemented internal controls to remain prepared for questions from auditors and regulators.
Step #8: Set an Implementation Timeline
While the effective date of the new guidance is 2020 at the earliest, starting your implementation now positions your institution for success. This is not to say you should begin adoption now. Moving into the CECL model will require time and a host of resources. Give yourself the time to test, troubleshoot, and build confidence that you have developed the right methodology for your institution.
Learn More and Build Your Action Plan
We’ve just provided a high-level summary of the path your bank should take to be successful at each step in this historic transition. HORNE Banking is offering a complimentary one-hour webinar to delve deeper into each step so you can build your roadmap to CECL compliance. There is opportunity cost in not starting now, so we hope you will join us.
Date: Tuesday, December 13
Time: 12:00 pm CST
CPE: 1 hour
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