Five steps for starters.
While most non-public business entities aren’t required to implement the current expected credit loss model for the allowance for loan and lease losses until after Dec. 15, 2020, many institutions have begun the transition to ensure effective implementation of this major change in estimating losses.
Something credit unions can work on now to prepare for CECL is to identify how the new model will require modifications to ALLL procedures and to map out sequencing and ownership. To do this, credit unions will need to examine:
- Historical loss rate calculations
Identifying the methodology options for your credit union based on your portfolio makeup will help clarify the data points and history you are likely to need. This will also shed light on the material inputs and assumptions that you may need to finalize in order to utilize the methodology/methodologies chosen. These inputs and assumptions are calculations such as the expected life of each loan segment, prepayment rates and probability of default.
- Qualitative adjustments
“Q Factors” or qualitative factor adjustments have been a part of the allowance calculation for a while, but the inputs may need to be adjusted. How will Q Factor procedures need to change under CECL to ensure the reserve is reflective of loss experience?
- Workflow changes
Understanding more about the credit union’s historical loss calculations, qualitative adjustments and documentation/reporting needs will prompt discussions about changes that might be needed to the workflow. Certain steps may take longer than before, require different reports to be built, require sign-off from different teams or create new steps that haven’t yet been important, such as life of loan calculations.
- Additional department inputs
These discussions will also help determine whether other departments already have some of the needed data or inputs in some form or whether remediation assistance from a third party may be needed. For example, interagency guidance on CECL issued Dec. 19, 2016, noted that “Depending on the estimation method or methods selected, institutions may need to capture additional data and retain data longer than they have in the past on loans that have been paid off or charged off to implement CECL.” Remediation assistance might include gathering more data in terms of loan fields required to run calculations or helping to start building more historical data that will need to be stored.
- Documentation and reporting
Credit unions may end up with multiple methodologies (one for auto loans, for example, and another for mortgages on multi-family dwellings). As those become apparent, CUs will need to consider what components and material inputs should be documented in order to be able to defend the calculation. This may require implementing data management systems to make that reporting more efficient. Even outside of reporting, some of the procedural changes required by CECL may be significant enough that the credit union considers acquisition of a software solution to keep the calculation internalized but supported.
The transition from the incurred-loss model to one estimating expected losses will not be a seamless one, but there are several resources available to facilitate transition efforts. For most credit unions, the overarching challenge related to CECL implementation will be related to logistics. By taking steps now, credit unions will find themselves in a position to calculate a reasonable and supportable reserve.
Mary Ellen Biery is a research specialist at Sageworks, Raleigh, N.C., a financial information company that provides lending, credit risk, and portfolio risk solutions to over 1,200 financial institutions across the country. She is a veteran financial reporter whose work has appeared in the Wall Street Journal and on Dow Jones Newswires, CNBC.com, MarketWatch.com, Nasdaq.com and other sites. For more information on CECL preparation, download the whitepaper, “A Practical CECL Action Plan for Credit Unions.”
