CECL's main provisions—what they mean to you

Benchmarking doesn’t need to be time and resource consuming. Read on for four simple steps you can take to improve efficiency and maximize resources.

Stop us if you’ve heard this one before (from your Board of Trustees or Finance Committee): “I wish there was a way we could benchmark ourselves against our competitors.”

Have you ever wrestled with how to benchmark? Or struggled to identify what the Board wants to measure? Organizations can fall short on implementing effective methods to benchmark accurately. The good news? With a planned approach, you can overcome traditional obstacles and create tools to increase efficiency, improve operations and reporting, and maintain and monitor a comfortable risk level. All of this can help create a competitive advantage — and it  isn’t as hard as you might think.

Even with a structured process, remember that benchmarking data has pitfalls, including:

• Peer data can be difficult to find. Some industries are better than others at tracking this information. Some collect too much data that isn’t relevant, making it hard to find the data that is.
   
• The data can be dated. By the time you close your books for the year and data is available, you’re at least six months into the next fiscal year. Knowing this, you can still build year-over-year trending models that you can measure consistently.
   
• The underlying data may be tainted. As much as we’d like to rely on financial data from other organization and industry surveys, there’s no guarantee that all participants have applied accounting principles consistently, or calculated inputs (e.g., full-time equivalents) in the same way, making comparisons inaccurate.

Despite these pitfalls, benchmarking is a useful tool for your organization. Benchmarking lets you take stock of your current financial condition and risk profile, identify areas for improvement and find a realistic and measurable plan to strengthen your organization.

Here are four steps to take to start a successful benchmarking program and overcome these pitfalls:

1. Benchmark against yourself. Use year-over-year and month-to-month data to identify trends, inconsistencies and unexplained changes. Once you have the information, you can see where you want to direct improvement efforts.
2. Look to industry/peer data. We’d love to tell you that all financial statements and survey inputs are created equally, but we can’t. By understanding the source of your information, and the potential strengths and weaknesses in the data (e.g., too few peers, different size organizations and markets, etc.), you will better know how to use it. Understanding the data source allows you to weigh metrics that are more susceptible to inconsistencies.

3. Identify what is important to your organization and focus on it. Remove data points that have little relevance for your organization. Trying to address too many measures is one of the primary reasons benchmarking fails. Identify key metrics you will target, and watch them over time. Remember, keeping it simple allows you to put resources where you need them most.

4. Use the data as a tool to guide decisions. Identify aspects of the organization that lie beyond your risk tolerance and then define specific steps for improvement.

Once you take these steps, you can add other measurement strategies, including stress testing, monthly reporting, and use in budgeting and forecasting. By taking the time to create and use an effective methodology, this competitive advantage can be yours. Want to learn more? Check out our resources for not-for-profit organizations here.

Read this if your CFO has recently departed, or if you're looking for a replacement.

With the post-Covid labor shortage, “the Great Resignation,” an aging workforce, and ongoing staffing concerns, almost every industry is facing challenges in hiring talented staff. To address these challenges, many organizations are hiring temporary or interim help—even for C-suite positions such as Chief Financial Officers (CFOs).

You may be thinking, “The CFO is a key business partner in advising and collaborating with the CEO and developing a long-term strategy for the organization; why would I hire a contractor to fill this most-important role?” Hiring an interim CFO may be a good option to consider in certain circumstances. Here are three situations where temporary help might be the best solution for your organization.

Your organization has grown

If your company has grown since you created your finance department, or your controller isn’t ready or suited for a promotion, bringing on an interim CFO can be a natural next step in your company’s evolution, without having to make a long-term commitment. It can allow you to take the time and fully understand what you need from the role — and what kind of person is the best fit for your company’s future.

BerryDunn's Kathy Parker, leader of the Boston-based Outsourced Accounting group, has worked with many companies to help them through periods of transition. "As companies grow, many need team members at various skill levels, which requires more money to pay for multiple full-time roles," she shared. "Obtaining interim CFO services allows a company to access different skill levels while paying a fraction of the cost. As the company grows, they can always scale its resources; the beauty of this model is the flexibility."

If your company is looking for greater financial skill or advice to expand into a new market, or turn around an underperforming division, you may want to bring on an outsourced CFO with a specific set of objectives and timeline in mind. You can bring someone on board to develop growth strategies, make course corrections, bring in new financing, and update operational processes, without necessarily needing to keep those skills in the organization once they finish their assignment. Your company benefits from this very specific skill set without the expense of having a talented but expensive resource on your permanent payroll.

Your CFO has resigned

The best-laid succession plans often go astray. If that’s the case when your CFO departs, your organization may need to outsource the CFO function to fill the gap. When your company loses the leader of company-wide financial functions, you may need to find someone who can come in with those skills and get right to work. While they may need guidance and support on specifics to your company, they should be able to adapt quickly and keep financial operations running smoothly. Articulating short-term goals and setting deadlines for naming a new CFO can help lay the foundation for a successful engagement.

You don’t have the budget for a full-time CFO

If your company is the right size to have a part-time CFO, outsourcing CFO functions can be less expensive than bringing on a full-time in-house CFO. Depending on your operational and financial rhythms, you may need the CFO role full-time in parts of the year, and not in others. Initially, an interim CFO can bring a new perspective from a professional who is coming in with fresh eyes and experience outside of your company.

After the immediate need or initial crisis passes, you can review your options. Once the temporary CFO’s agreement expires, you can bring someone new in depending on your needs, or keep the contract CFO in place by extending their assignment.

Considerations for hiring an interim CFO

Making the decision between hiring someone full-time or bringing in temporary contract help can be difficult. Although it oversimplifies the decision a bit, a good rule of thumb is: the more strategic the role will be, the more important it is that you have a long-term person in the job. CFOs can have a wide range of duties, including, but not limited to:

• Financial risk management, including planning and record-keeping
• Management of compliance and regulatory requirements
• Creating and monitoring reliable control systems
• Debt and equity financing
• Financial reporting to the Board of Directors

If the focus is primarily overseeing the financial functions of the organization and/or developing a skilled finance department, you can rely — at least initially — on a CFO for hire.

Regardless of what you choose to do, your decision will have an impact on the financial health of your organization — from avoiding finance department dissatisfaction or turnover to capitalizing on new market opportunities. Getting outside advice or a more objective view may be an important part of making the right choice for your company.

BerryDunn can help whether you need extra assistance in your office during peak times or interim leadership support during periods of transition. We offer the expertise of a fully staffed accounting department for short-term assignments or long-term engagements―so you can focus on your business. Meet our interim assistance experts.

Read this if your company is considering outsourced information technology services.

For management, it’s the perennial question: Keep things in-house or outsource?

For management, it’s the perennial question: Keep things in-house or outsource? Most companies or organizations have outsourcing opportunities, from revenue cycle to payment processing to IT security. When deciding whether to outsource, you weigh the trade-offs and benefits by considering variables such as cost, internal expertise, cross coverage, and organizational risk.

In IT services, outsourcing may win out as technology becomes more complex. Maintaining expertise and depth for all the IT components in an environment can be resource-intensive.

Outsourced solutions allow IT teams to shift some of their focus from maintaining infrastructure to getting more value out of existing systems, increasing data analytics, and better linking technology to business objectives. The same can be applied to revenue cycle outsourcing, shifting the focus from getting clean bills out and cash coming in, to looking at the financial health of the organization, analyzing service lines, patient experience, or advancing projects.  

Once you’ve decided, there’s another question you need to ask
Lost sometimes in the discussion of whether to use outsourced services is how. Even after you’ve done your due diligence and chosen a great vendor, you need to stay involved. It can be easy to think, “Vendor XYZ is monitoring our servers or our days in AR, so we should be all set. I can stop worrying at night about our system reliability or our cash flow.” Not true.

You may be outsourcing a component of your technology environment or collections, but you are not outsourcing the accountability for it—from an internal administrative standpoint or (in many cases) from a legal standpoint.

Beware of a false state of confidence
No matter how clear the expectations and rules of engagement with your vendor at the onset of a partnership, circumstances can change—regulatory updates, technology advancements, and old-fashioned vendor neglect. In hiring the vendor, you are accountable for oversight of the partnership. Be actively engaged in the ongoing execution of the services. Also, periodically revisit the contract, make sure the vendor is following all terms, and confirm (with an outside audit, when appropriate) that you are getting the services you need.

Take, for example, server monitoring, which applies to every organization or company, large or small, with data on a server. When a managed service vendor wants to contract with you to provide monitoring services, the vendor’s salesperson will likely assure you that you need not worry about the stability of your server infrastructure, that the monitoring will catch issues before they occur, and that any issues that do arise will be resolved before the end user is impacted. Ideally, this is true, but you need to confirm.

Here’s how to stay involved with your vendor
Ask lots of questions. There’s never a question too small. Here are samples of how precisely you should drill down:

• What metrics will be monitored, specifically?
• Why do the metrics being monitored matter to our own business objectives?
• What thresholds must be met to notify us or produce an alert?
• What does exceeding a threshold mean to our business?
• Who on our team will be notified if an alert is warranted?
• What corrective action will be taken?

Ask uncomfortable questions
Being willing to ask challenging questions of your vendors, even when you are not an expert, is critical. You may feel uncomfortable but asking vendors to explain something to you in terms you understand is very reasonable. They’re the experts; you’re not expected to already understand every detail or you wouldn’t have needed to hire them. It’s their job to explain it to you. Without asking these questions, you may end up with a fairly generic solution that does produce a service or monitor something, but not necessarily all the things you need.

Ask obvious questions
You don’t want anything to slip by simply because you or the vendor took it for granted. It is common to assume that more is being done by a vendor than actually is. By asking even obvious questions, you can avoid this trap. All too often we conduct an IT assessment and are told that a vendor is providing a service, only to discover that the tasks are not happening as expected.

You are accountable for your whole team—in-house and outsourced members
An outsourced solution is an extension of your team. Taking an active and engaged role in an outsourcing partnership remains consistent with your management responsibilities. At the end of the day, management is responsible for achieving business objectives and mission. Regularly check in to make sure that the vendor stays focused on that same mission.

More and more emphasis is being put on cybersecurity by companies of all sizes. Whether it’s the news headlines of notable IT incidents, greater emphasis on the value of data, or the monetization of certain types of attacks, an increasing amount of energy and money is going towards security. Security has the attention of leadership and the board and it is not going away. One of the biggest risks to and vulnerabilities of any organization’s security continues to be its people. Innovative approaches and new technology can reduce risk but they still don’t prevent the damage that can be inflicted by an employee simply opening an attachment or following a link. This is more likely to happen than you may think.

Technology also doesn’t prepare a management team for how to handle the IT response, communication effort, and workforce management required during and after an event. Technology doesn’t lessen the operational impact that your organization will feel when, not if, you experience an event.

So let’s examine the human and operational side of cybersecurity. Below are three factors you should address to reduce risk and prepare your organization for an event:

1. People: Create and maintain a vigilant workforce
   Ask yourself, “How prepared is our workforce when it comes to security threats and protecting our data? How likely would it be for one of our team members to click on a link or open an attachment that appear to be from our CFO? Would our team members look closely enough at the email address and notice that the organization name is different by one letter?”
    

   According to the 2016 Verizon Data Breach Report, 30% of phishing messages were opened by the target across all campaigns and 12% went on to click on the attachment or link.

   Phishing email attacks directed at your company through your team range from very obvious to extremely believable. Some attempts are sent widely and are looking for just one person to click, while others are extremely targeted and deliberate. In either case, it is vital that each employee takes enough time to realize that the email request is unusual. Perhaps there are strange typos in the request or it is odd the CFO is emailing while on vacation. That moment your employees take to pause and decide whether to click on the link/attachment could mean the difference between experiencing an event or not.
   
   So how do you create and cultivate this type of thought process in your workforce? Lots of education and awareness efforts. This goes beyond just an annual in-service training on HIPAA. It may include education sessions, emails with tips and tricks, posters describing the risk, and also exercises to test your workforce against phishing and security exploits. It also takes leadership embracing security as a strategic imperative and leading the organization to take it seriously. Once you have these efforts in place, you can create culture change to build and maintain an environment where an employee is not embarrassed to check with the CFO’s office to see if they really did send an email from Bora Bora.

2. Plan: Implement a disaster recovery and incident response plan 
   Through the years, disaster recovery plans have been the usual response. Mostly, the emphasis has been on recovering data after a non-security IT event, often discussed in context of a fire, power loss, or hardware failure. Increasingly, cyber-attacks are creeping into the forefront of planning efforts. The challenge with cyber-events is that they are murkier to understand – and harder for leadership – to assist with.
   
   It’s easier to understand the concept of a fire destroying your server room and the plan entailing acquiring new equipment, recovering data from backup, restoring operations, having good downtime procedures, and communicating the restoration efforts along the way. What is much more challenging is if the event begins with a suspicion by employees, customers, or vendors who believe their data has been stolen without any conclusive information that your company is the originating point of the data loss. How do you take action if you know very little about the situation? What do you communicate if you are not sure what to say? It is this level of uncertainty that makes it so difficult. Do you have a plan in place for how to respond to an incident? Here are some questions to consider:
    
   1. How will we communicate internally with our staff about the incident?
   2. How will we communicate with our clients? Our patients? Our community?
   3. When should we call our insurance company? Our attorney?
   4. Is reception prepared to describe what is going on if someone visits our office?
   5. Do we have the technical expertise to diagnose the issue?
   6. Do we have set protocols in place for when to bring our systems off-line and are our downtime procedures ready to use?
   7. When the press gets wind of the situation, who will communicate with them and what will we share?
   8. If our telephone system and network is taken offline, how we will we communicate with our leadership team and workforce?

By starting to ask these questions, you can ascertain how ready you may, or may not be, for a cyber-attack when it comes.

3. Practice: Prepare your team with table top exercises  
   Given the complexity and diversity of the threats people are encountering today, no single written plan can account for all of the possible combinations of cyber-attacks. A plan can give guidance, set communication protocols, and structure your approach to your response. But by conducting exercises against hypothetical situations, you can test your plan, identify weaknesses in the plan, and also provide your leadership team with insight and experience – before it counts.
   
   A table top exercise entails one team member (perhaps from IT or from an outside firm) coming up with a hypothetical situation and a series of facts and clues about the situation that are given to your leadership team over time. Your team then implements the existing plans to respond to the incident and make decisions. There are no right or wrong answers in this scenario. Rather, the goal is to practice the decision-making and response process to determine where improvements are needed.
   
   Maybe you run an exercise and realize that you have not communicated to your staff that no mention of the event should be shared by employees on social media. Maybe the exercise makes you realize that the network administrator who is on vacation at the time is the only one who knows how to log onto the firewall. You might identify specific gaps that are lacking in your cybersecurity coverage. There is much to learn that can help you prepare for the real thing.

As you know, there are many different threats and risks facing organizations. Some are from inside an organization while others come from outside. Simply throwing additional technology at the problem will not sufficiently address the risks. While your people continue to be one of the biggest threats, they can also be one of your biggest assets, in both preventing issues from occurring and then responding quickly and appropriately when they do. Remember focus on your People, Your Plan, and Your Practice.

On June 16^th the FASB issued the final standard for credit losses. We’ve analyzed the new standard and pulled together some key items you’ll need to know:

It looks like you should be able to implement CECL without purchasing expensive third-party models, if your institution is able to get adequate historical data from your core system and has the personnel available to crunch the numbers. Following is one approach that should pass muster with regulators (and, hopefully, the PCAOB):

1. Determine loans for which specific reserves are appropriate, much as you are currently doing. The notion of “impaired” loans goes away; a loan should be evaluated specifically if the institution becomes aware of loan-specific information indicating it has an exposure to loss that differs from other loans it would otherwise be pooled with. In practice, we think that’ll be largely the same loans that are currently being identified as impaired.
2. For the rest of the portfolio: Group loans by common characteristics – same as you’re doing now.
   1. For each group, create subgroups for each origination year. It looks like current year and previous four years are the critical ones to focus on; anything older than five years could probably be lumped together.
   2. For each subgroup, establish economic and other relevant conditions for the average term of loans in the subgroup. This includes actual conditions from year of origination to the present, forecasted conditions for the near future, and long-term historical conditions for the remaining average loan term
      • Select an historical loss period that best approximates the conditions established in (b) above.
      • Determine average lifetime chargeoffs for that historical loss period for each loan type
      • Adjust that average for any current or expected conditions that you believe are different from this historical data.  Such adjustments should be based on the institution’s chargeoff experience when similar conditions occurred in the past.  An example might be an actual or expected decline in real estate values that you believe is more pronounced than in the historical loss period chosen.

While not specifically mentioned in the guidance, we believe a modest unallocated allowance is still supportable, especially since imprecision is certainly higher when factoring in expected losses in addition to incurred losses.
 

Other points that caught our eye:

1. The guidance applies to purchased loans with credit deterioration, as well as originated loans. That will create more comparability in terms of the allowance as a % of loans for institutions that have done acquisitions vs. those who haven’t. An interesting twist, though – for acquired loans that have experienced a more-than-insignificant deterioration in credit quality since origination, the allowance established is simply an adjustment to (ultimately) the premium or discount, while for other loans acquired in the transaction, an allowance is established with an offset to loan loss expense at acquisition. 
2. The guidance applies to held-to-maturity debt securities, and there’s specific guidance that affects the accounting for available-for-sale debt securities as well. These will likely only come into play for institutions with private-label mortgage-backed securities and/or corporate bonds. However, some of the CECL disclosure requirements apply to securities as well; in particular, the one that caught our eye was the requirement in ASC 326-20-50-5 to disclose credit quality indicators (e.g., S&P ratings) for securities as well as loans.
3. Surprisingly, you continue to assume no change in future interest rates for purposes of establishing expected credit losses for specific variable rate loans. We think FASB may have missed the boat on this one, as resetting ARMs were one of the factors that led to the 2008 crisis that CECL is intended to be responsive to.
4. There will obviously be much, much more dialogue about these new rules, and we’ll need to begin the process of helping you understand them and prepare for implementation sooner rather than later.

Please call us if you have any questions.

As we begin the second year of Uniform Guidance, here’s what we’ve learned from year one, and some strategies you can use to approach various challenges, all told from a runner's point of view.

A Runner’s Perspective

As I began writing this article, the parallels between strategies that I use when competing in road races — and the strategies that we have used in navigating the Uniform Guidance — started to emerge. I’ve been running competitively for six years, and one of the biggest lessons I’ve learned is that implementing real-time adjustments to various challenges that pop up during a race makes all the difference between crossing — or falling short of — the finish line. This lesson also applies to implementing Uniform Guidance. On your mark, get set, go!

Challenge #1: Unclear Documentation

Federal awarding agencies have been unclear in the documentation within original awards, or funding increments, making it hard to know which standards to follow: the previous cost circulars, or the Uniform Guidance?

Racing Strategy: Navigate Decision Points

Take the time to ask for directions. In a long race, if you’re apprehensive about what’s ahead, stop and ask a volunteer at the water station, or anywhere else along the route.

If there is a question about the route you need to take in order to remain compliant with the Uniform Guidance, it’s your responsibility to reach out to the respective agency single audit coordinators or program officials. Unlike in a race, where you have to ask questions on the fly, it’s best to document your Uniform Guidance questions and answers via email, and make sure to retain your documentation.  Taking the time to make sure you’re headed in the right direction will save you energy, and lost time, in the long run.    

Challenge #2: Subrecipient Monitoring

The responsibilities of pass-through entities (PTEs) have significantly increased under the Uniform Guidance with respect to subaward requirements. Under OMB Circular A-133, the guidance was not very explicit on what monitoring procedures needed to be completed with regard to subrecipients. However, it was clear that monitoring to some extent was a requirement.

Racing Strategy: Keep a Healthy Pace

Take the role of “pacer” in your relationships with subrecipients. In a long-distance race, pacers ensure a fast time and avoid excessive tactical racing. By taking on this role, you can more efficiently fulfill your responsibilities under the Uniform Guidance.

Under the Uniform Guidance, a PTE must:

• Perform risk assessments on its subrecipients to determine where to devote the most time with its monitoring procedures.
• Provide ongoing monitoring, which includes site visits, provide technical assistance and training as necessary, and arrange for agreed-upon procedures to the extent needed.
• Verify subrecipients have been audited under Subpart F of the Uniform Guidance, if they meet the threshold.
• Report and follow up on any noncompliance at the subrecipient level.
• The time you spend determining the energy you need to expend, and the support you need to lend to your subrecipients will help your team perform at a healthy pace, and reach the finish line together.

Challenge #3: Procurement Standards

The procurement standards within the Uniform Guidance are similar to those under OMB Circular A-102, which applied to state and local governments. They are likely to have a bigger impact on those entities that were subject to OMB Circular A-110, which applied to higher education institutions, hospitals, and other not-for-profit organizations.

Racing Strategy: Choose the Right Equipment

Do your research before procuring goods and services. In the past, serious runners had limited options when it came to buying new shoes and food to boost energy. With the rise of e-commerce, we can now purchase everything faster and cheaper online than we can at our local running store. But is this really an improvement?

Under A-110, we were guided to make prudent decisions, but the requirements were less stringent. Now, under Uniform Guidance, we must follow prescribed guidelines.

Summarized below are some of the differences between A-110 and the Uniform Guidance:

While the process is more stringent under the Uniform Guidance, you still have the opportunity to choose the vendor or product best suited to the job. Just make sure you have the documentation to back up your decision.

A Final Thought
Obviously, this article is not an all-inclusive list of the changes reflected in the Uniform Guidance. Yet we hope that it does provide direction as you look for new grant awards and revisit internal policies and procedures.

And here’s one last tip: Do you know the most striking parallel that I see between running a race and implementing the Uniform Guidance? The value of knowing yourself.

It’s important to know what your challenges are, and to have the self-awareness to see when and where you will need help. And if you ever need someone to help you navigate, set the pace, or provide an objective perspective on purchasing equipment, let us know. We’re with you all the way to the finish line.

When last we blogged about the Financial Accounting Standards Board’s (FASB) new “current expected credit losses” (CECL) model for estimating an allowance for loan and lease losses (ALLL), we reviewed the process for developing reasonable and supportable forecasts for use in establishing the ALLL. Once you develop those forecasts, how does that information translate into amounts to set aside for loan losses?

A portion of the ALLL will continue to be based on specifically identified loans you’re concerned about. For those loans, you will continue to establish a specific component of the ALLL based on your estimate of the loss ultimately expected on the loans.

The tricky part, of course, is estimating an ALLL for the other 99% of the loan portfolio. This is where the forecasts come in. The new rules do not prescribe a particular methodology, and banking regulators have indicated community banks will likely be able to continue with their current approach, adjusted to use appropriate inputs in a manner that complies with the CECL model. One of the biggest challenges is the expectation in CECL that the ALLL will be estimated using the institution’s historical information, to the extent available and relevant.

Following is just one of many ways  you can approach it. I’ve also included a link at the end of this article to an example illustrating this approach.

Step One: Historical Loss Factors

1. First, for a given subset of the loan portfolio (e.g., the residential loan pool), you might first break down the portfolio by the number of years remaining until expected payoff (via maturity or refinancing). This is important because, on average, a loan with seven years remaining until expected payoff will have a higher level of remaining lifetime losses than a loan with one year remaining. It therefore generally wouldn’t be appropriate to use the same loss factor for both loans.
    
2. Next, decide on a set of drivers that tend to correlate with loan losses over time. FASB has indicated it doesn’t expect highly mathematical correlation models will be necessary, especially for community banks. Instead, select factors in your bank’s experience indicative of future losses. These may include:
   • External factors, such as GDP growth, unemployment rates, and housing prices
   • Internal factors such as delinquency rates, classified asset ratios, and the percentage of loans in the portfolio for which certain policy exceptions (e.g., loan-to-value ratio or minimum credit score) were granted
      
3. Once you select this set of drivers, find an historical loss period — a period of years corresponding to the estimated remaining life of the portfolio in question — where the historical drivers best approximate those you’re expecting in the future, based on your forecasts. For that historical loss period, determine the lifetime remaining loss rates of the loans outstanding at the beginning of that period, broken down by the number of years remaining until payoff. (This may require significant data mining, especially if that historical loss period was quite a few years ago.
    
4. Apply those loss rates to the breakdown derived in (a) above, by years remaining until maturity.

   Step Two: Adjustments to Historical Loss Rates

   The CECL model requires we adjust historical loss factors for conditions that may not be adequately captured by the historical loss period analysis we’ve just described. Let’s say a particular geographical subset of your market area is significantly affected by the economic fortunes of a large employer in that area.  Based on economic trends or recent developments, you might expect that employer to have a particularly bright – or dim – future over the forecast period; accordingly, you forecast loans to borrowers in that area will have losses that differ significantly from the rest of the portfolio.

   The approach for these loans is the same as in the previous step. However:

   These loans would be segregated from the remainder of the portfolio, which would be subject to the general approach in step one. As you think through this approach, there are myriad variations and many decisions to make, such as:

   Our intent in describing this methodology is to help your CECL implementation team start the dialogue in terms of converting theoretical concepts in the CECL model to actual loans and historical experience.

   To facilitate that discussion, we’ve included a very simple example here that illustrates the steps described above. Analyzing an entire loan portfolio under the CECL model is an exponentially more complex process, but the concepts are the same — forecasting future conditions, and establishing an ALLL based on the bank’s (or, when necessary, peers’) lifetime loan loss experience under similar historical conditions.

   Given the amount of number crunching and analysis necessary, and the potentially significant increase in the ALLL that may result from a lifetime-of-loan loss model, it’s safe to say the time to start is now! If you have any questions about CECL implementation, please contact Tracy Harding or Rob Smalley.

   Other resources
   For more information on CECL, check out our other blogs:

   CECL: Where to Start
   CECL: Bank and Branch Acquisitions
   CECL: Reasonable and Supportable

   To sign up to receive notification of our next CECL update, click here.

   • In substep (c), you would focus on forecasted conditions (such as unemployment rate and changes in real estate values) in the geographical area in which the significant employer is located.
   • You would then select an historical loss period that had actual conditions for that area that best correspond to those you’ve just forecasted.
   • In substep (d), you would determine the lifetime remaining loss rates of loans outstanding at the beginning of that period.
   • In substep (e), you would apply those rates to loans in that geographic area.
   • How to break down the portfolio
   • Which conditions to analyze
   • How to analyze the conditions for correlation with historical loss periods
   • Which resulting loss factors to apply to which loans

Recently, federal banking regulators released an interagency financial institution letter on CECL, in the form of a Q&A. Read it here. While there weren’t a lot of new insights into expectations examiners may have upon adoption, here is what we gleaned, and what you need to know, from the letter.

ALLL Documentation: More is better

Your management will be required to develop reasonable and supportable forecasts to determine an appropriate estimate for their allowance for loan and lease losses (ALLL). Institutions have always worked under the rule that accounting estimates need to be supported by evidence. Everyone knows both examiners and auditors LOVE documentation, but how much is necessary to prove whether the new CECL estimate is reasonable and supportable? The best answer I can give you is “more”.

And regardless of the exact model institutions develop, there will be significantly more decision points required with CECL than with the incurred loss model. At each point, both your management and your auditors will need to ask, “Why this path vs. another?” Defining those decision points and developing a process for documenting the path taken while also exploring alternatives is essential to build a model that estimates losses under both the letter and the spirit of the new rules. This is especially true when developing forecasts. We know you are not fortune tellers. Neither are we.

The challenge will be to document the sources used for forecasts, making the connections between that information and its effect on your loss data as clear as possible, so the model bases the loss estimate on your institution’s historical experience under conditions similar to those you’re forecasting, to the extent possible.

Software may make this easier… or harder.               

The leading allowance software applications allow for virtually instantaneous switching between different models, permitting users to test various assumptions in a painless environment. These applications feature collection points that enable users to document the basis for their decisions that become part of the final ALLL package. Take care to try and ensure that the support collected matches the decisions made and assumptions used.

Whether you use software or not there is a common set of essential controls to help ensure your ALLL calculation is supported. They are:

• Documented review and recalculation of the ALLL estimate by a qualified individual(s) independent of the preparation of the calculation
• Control over reports and spreadsheets that include data that feed into the overall calculation
• Documentation supporting qualitative factors, including reasonableness of the resulting reserve amounts
• Controls over loan ratings if they are a factor in your model
• Controls over the timeliness of charge-offs

In the process of implementing the new CECL guidance it can be easy to focus all of your effort on the details of creating models, collecting data and getting to a reasonable number. Based on the regulators’ new Q&A document, you’ll also want to spend some time making sure the ALLL number is supportable.  

Next time, we’ll look at a lesser known section of the CECL guidance that could have a significantly negative impact on the size of the ALLL and capital as a result: off-balance-sheet credit exposures.