CECL Dominates the Conversation at Annual ABA CFO Exchange

While the ABA CFO Exchange Conference covered a wide range of issues germane to the financial performance of community banks, it proved that chief financial officers are as concerned about and confused by CECL as are credit officers charged with preparing for and implementing the new ALLL accounting standard.

Once again, CECL, which will require banks to estimate their allowances based on future projections, was the elephant in the room. It bracketed the conference, the subject of a three-hour presentation to open the conference and a closing two-hour session.

CECL: Survive or Thrive?

“Survive or Thrive? The CECL Implementation Challenge” was actually billed as a pre-conference session, though nearly every registered CFO made it to Charleston for the Monday presentation, “the biggest turnout ever for a pre-conference session,” announced Conference Chair Tanya Sturm of First United Bank & Trust in Oakland, Md. MST CEO Dalton T. Sirmans was joined by Grant Thornton’s Graham Dyer, who has been involved with the evolution of the standard since its inception and now serves on FASB’s CECL Transition Resource Group, and Michael Gullette, ABA vice president of accounting and financial management who represented industry concerns throughout the development of CECL as a participant in FASB workshops and roundtables.

Beyond an overview of CECL and how it differs from the current incurred loss allowance estimation model, the trio looked to shed light on some of the standard’s most difficult and challenging aspects, and provided direction to bankers preparing for CECL compliance. Graham Dyer proposed a step-by-step process banks could use en route to implementation:

• Scoring – inventory financial assets at amortized cost and group according to similar risk characteristics into pools
• Measurement – consider each pool to determine an appropriate method for determining losses (banks are likely to use different methods for different pools)
• Data – determine historical loss experience for each pool and assess data for quality, completeness and accuracy
• Processes and Controls – consider implications for IT, the need to automate the estimation process and embed IVFR into relevant operational areas
• Governance – establish and document policies, procedures and reporting; adopt model validation as a formal process
• External Input – engage auditors and regulators in planning
• Optimization – extend information and processes built for CECL to other management activities

CECL Methods and Madness

The discussion included a review of several methodologies deemed by the presenters as the most likely to be adopted, including cohort, vintage, adjusted annual loss rate, and probability of default/loss given default. Each approach has its strengths and weaknesses, Dyer pointed out, and while FASB has steadfastly refused to recommend one methodology over others, he offered, “The vintage approach was what FASB had in mind when developing CECL.

“The annual loss rate has the same problem as the cohort approach,” he noted. “It’s going to assume losses are going to happen at that rate as they season, but that’s not necessarily true. The impact of seasonality and the run-off rate of the portfolio are two big challenges.”

He commented on the flexibility of PD/LGD: “The data you gather to conduct the PD/LGD estimate can be really useful for additional management purposes. If you are going to go through all this for CECL, you should look for other ways to use the data, ways to leverage that information.”

The discussion also addressed Q-factors, or “asset-specific factors” under CECL, the main difference between applying them in the different environments being, that under CECL, such factors are life of loan considerations, so adjustments will be made considering the end of the contractual term of the loan as opposed to the evaluation date.

Speaking of Data

“The poor quality of data will plague the transition to CECL if not addressed,” MST’s Sirmans told the audience.

“The main reason our data is not perfect is human error,” he pointed out, citing the Risk Management Association’s recent survey on data quality. “Data quality has become one of the most critical challenges confronting banks, the payback for decades of benign neglect. Studies prove that as an industry we do a very poor job of managing data.”

The studies reveal multiple reasons for data inaccuracy, Sirmans explained, including:

• inadequate senior management
• insufficient budgets
• lack of internal manual resources, internal communication and relevant technology
• inadequate relevant technology and data strategy

And most impactful of all, he noted, human error, reported as a problem by six of 10 community banks.

Sirmans translated the issues into three major areas that impact ALLL estimation and that haunt banks as they prepare for CECL: the incorrect assumption that the bank’s data is accurate; the lack of a data champion or experienced ALLL expert; and the use of Excel spreadsheets to estimate the ALLL.

“Eighty-eight percent of all spreadsheets contain errors,” Sirmans reported.

Such performance has earned Excel the reputation as “what might be the most dangerous software on earth,” according to industry observers. More on Excel.

To get to the heart of data accuracy issues, Sirmans suggested that banks examine how data are gathered and entered throughout the loan decision process. “Identify who’s involved; chart the departments and people. Then list the data elements involved at each step of the process. Then define the details of how data are entered, altered and updated.”

Concluding Panel: “Our Favorite Topic”

Following a brief overview of new call report guidelines, the concluding session of the 2016 ABA CFO Exchange conference, “Accounting Issues and What They Mean to Your Bank,” again turned to CECL, “our favorite topic,” ABA’s Gullette quipped. Gullette was joined by Jim Brannen of Federal Savings Bank in Dover, N.H., Todd Sprang, of CliftonLarsonAllen of Oak Brook, Ill., and John Rieger, deputy chief accountant of the FDIC’s Division of Risk Management and Policy.

How far along are banks in their CECL preparation initiatives? Gullette polled the audience to learn that very few of CFO attendees had yet begun to assemble a CECL preparation team. And of those indicating they had started, most then admitted their teams so far consisted only of themselves.

The banking agencies have spent much of their time and focus on CECL since its release, FDIC’s Rieger reported. “The three agencies have been meeting and working on getting our arms around CECL. We’ve been meting with examiners, state regulators, vendors and the PCOAB (Public Company Accounting Oversight Board).”

He shared his list of what he regarded as the regulators’ expectations of banks relative to CECL:

• Remove concept of probability and incurred
• Leverage existing credit risk practices
• No particular estimated method prescribed
• Small banks’ current methodologies will be allowed but will need added data for reasonable and supportable forecasts
• Allowance must be directionally consistent (with capital planning, budgeting, etc.)
• Examiners will look at segments and similar risk characteristics
• No benchmarks or floors
• Dialogue with examiners informally so you’re on the same page, working together
• That you have read the standard and reviewed your existing data and data accessibility
• That you have documented your assumptions

“The financial stakes are high,” Gullette warned. “The strategic implications are great.”

Read the CECL guidance in the MST Academy.

Want to get your bank or credit union on track for CECL implementation? Download the MST Seven Steps to a CECL-Compliant Model whitepaper.