The countdown that began June 16, 2016 is officially underway. The runway to CECL (Current Expected Credit Losses) compliance promises to be riddled with complexities. You don’t need to look much farther than the fact that FASB implementation dates are set several years out to get the sense of how important it is to take a long-term, multi-faceted approach to ensuring compliance.
To review—early adoption is permitted for all entities in fiscal years beginning after December 15, 2018. The standards are effective for fiscal years beginning after December 15, 2019 for Public Business Entities (PBE’s) that are SEC Registrants. For those that are not SEC Registrants, CECL must be in place for fiscal years beginning after December 15, 2020. All other entities (banks with assets less than $500 million and not subject to FIDICIA) have until December 15, 2021.
HORNE has offered a series of resources, including a webinar and visual eight step timeline with the intent to educate you about the standard, its impact on the banking industry, and what you need to do to prepare for the changes. Over the coming weeks, we will use the blog to look more closely at each of the individual steps. These are posts you will want to bookmark for reference so you can refer to the information as you get farther into the process.
We’ve provided an introduction to the eight steps here. They are:
- Analyze the Loan Portfolio
- Identify Relevant Credit Quality Indicators
- Select the Appropriate CECL Model(s)
- Assess Resource Capabilities and Needs
- Perform Model Simulations
- Evaluate Software
- Prepare Formal Policies & Procedures
- Set an Implementation Timeline
In this first post in the series, we examine Steps One and Two, both of which focus on clarifying the health of your loan portfolio so you are able to monitor and respond to changes with clarity and confidence.
Step #1 – Portfolio Segmentation Analysis
Credit risk is already a primary focus for your institution, but you should also be aware of the hidden concentration exposure within your loan portfolio. A thorough and segmented analysis is a critical first step to creating the necessary insights into your loan portfolio. It will also identify any gaps in your assessment of credit risk. The degree to which you dissect the portfolio will depend on the level of homogeneity in it. Remember that call codes are the regulatory framework for reporting loan segments, but even they provide only a limited glimpse into your concentration risks, which vary widely and can include:
- Borrower’s industry
- Credit score and rating
- Effective interest rate
- Loan purpose
Break your loan portfolio into specific pools or individual transactions. The segmentation will give you a deeper understanding of similar/like credit characteristics, positioning your institution to make wise decisions on new loans, emerging concentrations, credit pricing and roll-out of new lending products.
Step #2 – Identify Relevant Credit Quality Indicators
Once you have a sense of your risk factors, it’s important to ensure you have clarity about the credit quality indicators (CQIs) impacting your loan portfolio. This insight positions your institution to be able to assess eminent future portfolio losses and make informed pricing and credit decisions. It takes diligence but staying aware of relevant qualitative environmental and macroeconomic factors will keep your bank prepared to respond to any forecasting changes in credit quality. Regression and vintage analysis both are great resources to determine which CQIs correlate most directly to actual losses within your loan segmentation.
Once you have a firm grasp on the risk and quality indicators in your loan portfolio, you are ready to begin reviewing CECL models to determine which is most appropriate to forecast future losses. We will look at those models and how you should document and support your selections in the next post.
Remember that you can access our complimentary one-hour webinar anytime for more help with the steps and tactics involved in working toward CECL compliance. Watch the CECL: Turn Compliance into Opportunity on demand.