Countdown to CECL: What SEC filers have learned about implementation
All eyes will be on the large SEC registrants in January as they become the first financial institutions to adopt the current expected credit loss model, or CECL. Regulators, investors and other stakeholders will be watching and listening for updates on the impact of the accounting change.
Even now, however, banks and credit unions with 2023 deadlines are seeking information about what the earliest adopters have learned so far in their implementation efforts.
During a recent webinar hosted by the American Bankers Association, an executive with an SEC filer under a 2020 CECL implementation deadline provided first-hand advice on the challenges and progress related to CECL adoption. During the webinar, Felicity Ours of Summit Financial Group, a $2.2 billion financial holding company headquartered in Moorefield, West Virginia, advised banks and credit unions with 2023 deadlines to:
- Start preparing early;
- Tackle the data gap analysis before selecting methodologies;
- Resist overcomplicating loan segmentation; and
- Remain flexible throughout the process (with forecasts and methodology).
Among attendees of “What SEC Filers Have Learned about CECL Implementation,” 62 percent said in a poll that their institution must comply with CECL in Q1 2023, 35 percent are set to comply in Q1 2020, and 3 percent of attendees said they were unsure of their CECL deadline.
Start on CECL early
Ours, who is senior vice president and director of credit administration of Summit and its 32-location bank subsidiary, Summit Community Bank Inc., said financial institutions must devote the appropriate resources to the CECL process.
“We started early in 2018, and we’re 24 months into the process, but I can’t stress enough that I still wish we had more time,” she said. “At the end of the day, we still have regular jobs and daily responsibilities, and this is added to that. We are very fortunate to have individuals with strong IT and data analysis skills to help with this process, but I believe that will be a challenge, especially for some smaller institutions, so the longer the timeline, the better.”
Paula King, a senior advisor at Abrigo, which has advised Summit and other SEC filers on CECL implementation and was a co-presenter on the webinar, agreed. “I don’t have any SEC clients at this point who have the calculation tied up with a bow,” King said. “Most are still in the testing phase. The majority of my SEC clients wish they had started sooner.”
Assess data first, then move to methodology
When asked about advice for 2023 filers regarding data now that they have additional time, Ours recommended that financial institutions conduct a data gap analysis to assess how far back they can go back in gathering quality data from the core provider and then analyze which CECL methodologies make the most sense for the institution. She noted that every institution is different, so Summit's experiences might not be the same as those of other banks or credit unions when it comes to choosing data or methodologies.
“Really, data is the key to the entire process, as the availability of data drives the methodology,” she said. “Not only having the data points, but the quality of data is important.” In Summit Community’s case, it has a large concentration of commercial and commercial real estate loans, so renewal dates were important in determining the weighted average expected life of the institution’s portfolio, given that those loans typically tend to be longer-term loans. However, Summit had not been tracking various renewal dates on the core system and had to build a workaround to get the information and begin tracking it going forward. Ours said each financial institution should assess its data in light of the various methodologies. If there are gaps, the bank or credit union will need to assess whether it makes sense to go back and gather data points or, in some cases, move forward with a different methodology. That’s another argument against procrastination, she said; having sufficient time to either gather the data or pivot to a different methodology will make the implementation easier.
Summit Community decided to use the cohort methodology, which is a loss migration approach. The choice came down to the availability of quality data. “We were able to go back and gather all the necessary data points for the cohort methodology back to 2010, which will give us a full decade of data by the implementation date,” said Ours. The bank originally considered mixing two methodologies — PD/LGD (probability of default/loss given default) and cohort — but due to a lack of risk-rating data, it would have only had data points for PD/LGD going back to 2012. The additional complexity of providing supporting documentation for multiple methodologies was also a factor, although Ours said the bank will definitely assess its CECL methodology at least annually going forward.
“I believe CECL will continue to evolve, especially as our loan portfolio mix, our complexity, our size — as all of it continues to evolve,” she said. “I don’t believe CECL is a one-and-done process.”
Don’t overthink segmentation
King reminded webinar attendees that while financial institutions want to segment loan pools according to similarities of credit risk, they should strive to have meaningful segment sizes. “One of the biggest hurdles you have to overcome, based on experience, is getting too granular on your loan pools,” she said.
Ours said Summit Community ran into that issue. Initially, the bank wanted to segment based on loan type and then sub-segment each pool by risk rating, particularly for commercial loan pools. A closer examination at the loss history revealed that approach would be too granular, she said.
“You have to be willing to keep an open mind and don’t overcomplicate it,” Ours said. “Try to step back from it and consider what makes sense. Just because you initially build out your pools one way, don’t be afraid to make the change when that no longer looks right.”
Be willing to change as needed
An overriding theme in CECL implementation has been flexibility, Ours said. The bank has already made changes in its methodology, its loan segments and in other areas related to CECL.
Summit Community currently expects to use a 12-month economic forecast for qualitative factors, basing the forecast on national economic data from the Federal Reserve’s Federal Open Market Committee and on subscription-based quarterly reports for its lending areas in Virginia and West Virginia. The forecast period could change, however. “Where we stand [in the economic cycle] plays a major role in the forecast period, and … we have to be willing to increase or shrink that forecast period as necessary,” she said.
King noted that feedback from other SEC filers has been that while they were originally looking at using 18 to 24 months as their economic forecast horizon, they are recently leaning toward shortening it. She advised financial institutions, “Ask yourself the question, ‘At what point would I consider changing the length of my horizon?’ Is it going from a stable to an unstable environment?”
Having an advisor to bounce ideas off and to keep things moving forward has helped throughout CECL implementation, Ours said. Summit Community has tweaked numerous aspects of CECL throughout implementation, even as it has been running parallel calculations to test its methodology.
“CECL is a new standard, and all of us are all learning what is expected together,” she said. “While the guidance hasn’t really changed since the beginning, the interpretation of that guidance continues to evolve. In addition, I think honestly, the biggest challenge is we really don’t know what we don’t know, and you learn as you go — as you move through the process of building out the model. Flexibility is key and that can be a challenge.”