Automation has been used across banking systems to streamline data input, reduce duplication and make calculations more reliable. However, the Allowance for Loan and Lease Loss (ALLL) calculation has traditionally been a cumbersome process, combining complex data analysis with antiquated technologies. What once lived on a spreadsheet and was decipherable only by a few financial analysts, will no longer suffice under the proposed Current Expected Credit Loss (CECL) model for calculating ALLL. CECL will require sophisticated forecasting methodology that relies on extensive historical data – and this too can be enhanced by automation.
Interested in learning how to prepare for the changes ahead? Register now to attend a D+H-hosted webinar – ALLL and FASB’s CECL Model: Perspectives to Consider for Your Financial Institution – Wednesday, April 13th. Click here to register for this upcoming event.
A New ALLL Calculation Approach with Far-Reaching Impact
The proposed Accounting Standards Update, Financial Instruments—Credit Losses (Subtopic 825-15), would replace the existing incurred loss model with the CECL model for calculating the ALLL. This change from an impairment analysis to a forecast of life-of-loan losses is significant, and will potentially have a dramatic impact on the balance sheet and capital reserve requirements. The FASB (Financial Accounting Standards Board) is expected to finalize the standard in the first half of 2016 with an effective date of January 1, 2019, for public entities that are required to file reports with the SEC and January 1, 2020, for non-filers. Federal banking examiners are expected to issue guidance to financial institutions in advance of the effective date.
As one of the most impactful changes facing the industry, the FASB’s proposed adoption of the CECL model into generally accepted accounting principles (GAAP) will require financial institutions to compile and analyze enough historical data to support reliable predictions about future loan performance.
In anticipation of the issuance of a final standard, financial institutions must begin to assess where that data going to come from, how much data will be enough, and how that data can be applied to a forecasting methodology that will provide meaningful results.
Furthermore, the question looms as to how complex the forecasting methodology must be, and financial institutions must understand the point at which the cost of gathering this intelligence outweighs the benefit of a more accurate ALLL reserve. Guidance from regulators will be crucial to this determination and will hopefully address the issue of scalability.
How Will This Impact Your Business?
Once the new standard is implemented, there will most certainly be audit implications, including new supporting documentation and procedures that will increase the costs of audits overall. But even more important, is the ultimate impact on the financial institution’s bottom line – there is the potential that CECL will result in a significant increase in the ALLL requiring an increase in capital reserves. Add to that the confusion that will come with trying to explain the new accounting standard to the users of financial statements, and the snowball effect of CECL could flatten the unwary financial institution at the bottom of the hill.
Top 5 CECL Considerations
- Historical data – where is it coming from and how is it getting there?
- Forecasting methodology – how are reliable forecasts made using historical data and based on information about current conditions?
- Scalability – how complex is the process/methodology used in arriving at a reliable ALLL calculation?
- Audit implications – how is the ALLL calculation supported and explained to auditors and examiners?
- Impact on the bottom line – what is the impact on capital reserves and if it is significant, what’s next?
Don’t Know Much About History? You’ll Need To!
Although CECL is still in the proposed stage and mandatory implementation won’t come for some time, the issue of historical data must be addressed now. As we await the final standard and guidance from regulators, institutions should begin assessing their access to historical portfolio data and the systems that will be used to analyze that data.
Would you like to learn more about how to prepare for the changes ahead? D+H will be hosting a webinar on this timely topic – ALLL and FASB’s CECL Model: Perspectives to Consider for Your Financial Institution – on Wednesday, April 13th. Click here to register for this upcoming event.
Contributing author: Tammy Campbell