CECL Results and Reality

To the extent of what they can, financial institutions have been processing the requirement demands being cast upon them with the new “Current Expected Credit Loss” (CECL) standard to be implemented. Through a process assessment, most institutions have slowly started to form a picture/plan of how to satisfy the requirements. The 2006 Interagency Policy Statement notes, “The loan loss allowance should take into consideration all available information existing as of the financial statement date, including environmental factors such as industry, geographical, economic, and political factors.”

Although guidance grants a considerable amount of leeway in making qualitative adjustments, the 2006 Interagency Policy Statement provided a great deal of direction in terms of the specific factors institutions should consider when making adjustments. The nine factors,’ as they are commonly referred to, are one framework institutions will have when trying to limit potential regulatory criticism related to qualitative adjustments. Institutions are not limited to these nine but are encouraged to include additional factors to more accurately reflect the probable and estimable losses inherent within the portfolio.

The most pressing challenge institutions face is how to make adjustments effectively to those factors and how to substantiate those adjustments with objective supporting data. Regardless of the loss rate method or quantitative method a financial institution uses coupled with the supportable loss adjustments considered, the financial institution face one more daunting hurdle. Will their auditors and examiners sign off on it?

Bear in mind, each financial institution have gone through the laborious process of getting their financial statements reviewed and approved by these third-parties. And let’s just say that after capturing the data, segmenting the portfolios, determining the methodology, and testing the results numerous times that the results support a reduction in the allowance. What do you think your auditors will say, much less the examiners? “Sure, reduce the reserve, we think your method is sound and justifies the reduction. We’ve been cautious in having you reserve that much based upon the past methods that we’ve advocated and supported”. I don’t think so. They too have reputations to consider.

The true influence of the new standard won’t prove itself out until an abundance of data has been obtained through various economic cycles in order to establish a probable and estimable basis for the reduction. The likely scenario would be for them to revert to peer equivalency and instruct the institution to reserve accordingly. Besides, we have been in a growth market for some time now and the economic climate has been favorable.

Or in the contrary, the resulting calculations require a substantial increase in the allowance which will immediately result in the institution reducing capital and placing them in an undercapitalized position subject to receivership or C&D. You think they will say, “Oops! Missed that one. Sorry “. No, I don't think so. The likely scenario would be for them to revert to peer equivalency and instruct the institution to gradually increase their reserve over time.

This is not to say as data is collected over the years and through various economic cycles the reserves won’t experience the potential for upward and/or downward adjustments as designed with the new standard. But initially, once the standard is in play, the reality is that the allowance for most financial institutions won’t change substantially.

Author Bio

John Robertson is part of the Advisory Services team at Baker Hill, specializing in pricing and profitability. With 26 years of experience in the banking industry, Robertson assists banks in developing and implementing technology for commercial lending that improves the efficiency of the lending process and the productivity of the lending officers. As a Senior Business Process Architect for Baker Hill’s Advisory Services, Robertson provides guidance to Baker Hill’s clients on profitability, specifically with strategies involving risk-based pricing and relationship profitability.

Prior to joining Baker Hill, Robertson served in various roles related to cash management, treasury, and asset/liability management. Previously, he served as assistant treasurer for three banks and was a member of various asset and liability committees. Additionally, Robertson has developed and implemented several programs during his banking tenure including a pricing and profitability system, a secondary marketing department and a treasury management group.

Robertson received his bachelor’s degree in business administration and accounting from the University of Houston.