The CECL Ripple Effect

By Julie Knudson

With the Current Expected Credit Loss standard for loan loss accounting set to go into effect starting in 2020 for SEC registrants (and in 2021 for all other banks), financial institutions still have time to consider where CECL’s ripples will appear across their operational areas. Better integration between functions such as accounting, risk management and data analysis is just one of several priorities emerging as CECL’s effective date draws closer. For institutions looking to get ahead of the curve, data management may rise to the top as a near-horizon priority.

Data retention, storage take center stage

Banks already possess much of the data covered under CECL. But whether it’s housed in the right system or saved in the right form—or whether it’s available at all—needs to evaluated. “The systems and the collection of data that a bank would use to measure credit risk either doesn’t exist, or it’s been written over or, in many cases, it’s been purged,” explains ABA SVP Michael Gullette, the association’s lead expert on CECL. Information may have originally been gathered and used for loan underwriting, for example, but not for overall analysis of portfolio risk. These data sets likely weren’t subjected to the strict quality oversight that will now be expected under CECL. “You have to track those things you did during your underwriting process, which never had those controls,” Gullette says of existing data. Information integrity is one area that will become key as banks make their data ready for CECL review.

Jim Rives, senior director at FTI Consulting in Washington, D.C., says he sees CECL’s implementation as an opportunity to get banks’ data management houses in order. “As we look at the entire credit lifecycle, from underwriting through loss mitigation, a lot of times banks of all sizes have very disparate data repositories and applications,” he explains. To a large degree, CECL will require institutions to bring those standalone platforms into a more holistic, connected grouping. “It’s really about having the various systems talk to each other,” Rives says. Risk rating platforms illustrate this point. They may be housed within a bank’s core system but sometimes they’re simply an Excel spreadsheet on a desktop computer. By pulling everything together in advance of CECL, Rives says organizations will have better insight into where data gaps and duplication exist.

Banks should also consider that historical information takes on new life once CECL’s requirements go live. “Think of a simple instrument like a mortgage, which is typically 25 or 30 years,” says Jimmy Yang, managing director of credit and operational risk analytics at the Bank of Montreal’s U.S. headquarters in Chicago. “The lifetime losses for a 30-year note are much more difficult to evaluate without data to back it up.” Some banks don’t have the look-back data that may be called out for review. “Going forward, the lesson learned is that really you need to pay special attention to data, and also the quality of the data,” Yang says.

Other operational areas also likely to feel CECL’s effects

CECL won’t just change how data storage and analysis are handled. Credit decisions and risk management will also evolve under CECL. On the surface, Rives says he expects credit will slow, but he’s quick to add that he actually sees CECL’s implementation as a good time to regroup. “I think it’s going to make the credit function smarter,” he says. “When banks are getting better information and refining it, they’ll be able to price their loans better.” Price will become more closely aligned with risk, something Rives says doesn’t necessarily happen now. “CECL will help banks better price their products,” he explains. Rather than pricing schemes based on factors such as what a bank’s competitors are doing, Rives says the institution’s own cost of funds would be a better measure. “You don’t want the last financial crisis where you’re over-lending,” he says.

Other considerations are also going to come into the picture once banks have reliable access to data that is more granular and robust. Better historical comparisons can be made, more accurate long-term outlooks developed—and a number of operational areas are likely to benefit as a result. “It could be ‘What kind of money did we leave on the table? Or what price are we giving up based on the deals we’re getting?’” Gullette says.

Although calculations may be at the heart of bankers’ focus as they gear up for CECL compliance, Gullette says, “it’s really a larger picture about managing the company.” Capital management, risk and credit decisions—even programs such as incentive compensation—could soon be feeling CECL’s impacts. Bankers must be ready to communicate the upcoming changes, not just to a board that may not be familiar with the nuances of how portfolio risk is analyzed, but also to consumers and employees who need to understand loan pricing determinations and incentive package structures.

Implementation and timeline concerns

The looming implementation timeline may create some near-term data management challenges for banks. Ensuring the availability of credible models and predictions is one, which is closely linked to another—infrastructure. “In the old days, banks could do it with Excel,” Yang says. “Going forward, they’ll need something more sophisticated.” The governance process will also need to evolve. “You’ll need to have economic forecasts,” Yang explains. Unless the bank has a department to cover that function, outside vendor partnerships may need to be cemented soon to help fill that role.

With what Gullette describes as a potentially “large contingency of community banks” surmising that the Financial Accounting Standards Board may withdraw or amend the standard, he worries some organizations aren’t preparing for CECL as thoroughly or as promptly as they should be. “The main thing is to start collecting data,” he urges. In-house systems can get the process rolling but future upgrades should already be on the radar. “The problem is that bankers say, ‘It’s non-complex, I can do it on a spreadsheet,’” Gullette says. It’s a sentiment that worries him. “Just because it’s non-complex doesn’t mean there isn’t a lot more processing needed to manage it.” Unless institutions begin the transition toward systems capable of higher-level analysis, providing CECL-compliant documentation could quickly become problematic.

Another challenge hindering progress is difficulty getting the right people together to address the issues. “Someone from the CIO group, or even a CIO’s equivalent or divisional sub-CIO, have to be part of the stakeholder group for an enterprise-wide approach to CECL implementation,” Rives says. Identifying areas that require improvement should be one of the team’s top priorities, along with developing a longer-term strategy for compliance. “At least identify and map out what your systems are and where you need to get information from on a recurring basis,” Rives says. He stresses that it will be a dynamic, ongoing process. “It will have to happen every quarter, it’s not a one-time spend. You’ll be constantly tweaking this.”

Julie Knudson is a freelance financial writer and frequent contributor to the ABA Banking Journal.

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