“The journey of a thousand miles begins with one step.” — Lao Tzu
We know the Current Expected Credit Loss model (CECL) will be effective starting in 2020 for public institutions and 2021 for all other institutions, and we know it will be a significant change to the current process each institution uses to estimate its allowance for loan losses. The real question is, How do we implement a new model that is so different from what we are accustomed to seeing and using?
As is the case with any complex project, the most important step is planning. Even if you can’t see the finished product today, you can begin laying the foundation for moving forward. An effective plan can lead your management team through the process and guide decisions it will need to make along the way.
Need for Action
Many institutions are not motivated to start the implementation process since the effective dates are years in the future; however, delaying the inevitable will only make it that much more difficult to be ready. Some executives have said they believe CECL will be rescinded before it becomes effective, but we have seen no evidence this will happen. The Financial Accounting Standards Board (FASB) has given no indication it intends to make any significant amendments to the standard, much less rescind it, and communication from federal regulators has been around CECL implementation, not “let’s wait and see what happens.” Believing the standard will be rescinded appears to be wishful thinking, not unlike retirement strategies that depend on winning the lottery.
CECL will have an impact on regulatory capital. Although the adoption of CECL will not impact net income upon adoption, it will reduce retained earnings. The size of the impact will vary among institutions, but it will be important to understand the potential impact and how this might affect your capital planning. If management estimates the impact today, it will have more time to address capital needs before the effective date.
Finally, because this is such an enormous undertaking, planning for CECL now will give you more time to identify and implement the processes and methodologies that make the most sense for you rather than settling for something that does not meet the needs of your institution.
Select Your Team
Before getting too far down the road, it will be vital to identify the team members at your institution who will work on CECL. The implementation process should not be left solely to accounting. The team should also include members from loan operations, credit administration, IT, and senior management.
Once management has identified your implementation team, it should make sure the team has time and resources set aside. Block some time off on calendars for regular meetings and completion of tasks. If team members will end up with too much work, train some employees to help the team members with their other jobs. Asking employees to figure out CECL without giving them the means to do so will only lead to stress and trouble.
Set Some Milestones
On a difficult journey, it is much easier to focus on a series of shorter legs rather than the final destination. Here are a few milestones and some possible deadlines your implementation team members should consider as they begin the journey:
- Investigate different CECL methodologies available (internal and third party) – Now through Fall 2017
- Segregate your loan portfolio into appropriate pools based on shared risk characteristics – Fall 2017
- Select the ideal methodologies to use for each loan pool – December 2017
- Identify data collection requirements for each methodology – Spring 2018
Begin Collecting Data
Even though you may not know what methodologies you will be using, there are certain data elements that will be necessary for any methodology, including the following loan-specific information:
- Loan origination date
- Loan origination amount
- Charge-off (recovery) date
- Charge-off (recovery) amount
- Loan principal at each reporting date (quarter-end)
- Loan duration
Right now, you should try to gather as much loan data as possible (without incurring too much cost) since you won’t know exactly what data you need until the methodologies are selected. Possible ways to gather this data may include archiving the following as of each month-end or quarter-end:
- Detailed loan trial balance report
- Standard regulatory download of data fields
- Loan charge-off schedules
- Risk rating schedules
- Other schedules that include loan quality factors that are not normally included in the loan system
As you archive this data, consider the format it is being archived in. Adobe files cannot be easily accessed by other software, so it is better to save the files in Excel or text files. If a text file format is used, make sure the downloaded files can be accurately imported into Excel or some other software.
Take Your First Step
Although it may seem daunting, the CECL implementation process can begin with the simple steps outlined above. If you feel like you could use some more help, please contact Brett Schwantes or your Wipfli relationship executive, and we will be happy to help you get started on this journey.
Check out our recent articles on CECL:
- Measuring Credit Impairment of Financial Instruments (Sept 2016)
- Investigating CECL Methodologies (Nov 2016)
- CECL Governance (Jan 2017)