Pub. 6 2018 Issue 1

25 Spring 2018 The Community Banker CECL IMPLEMENTATION – STEP BY STEP By Debi Ferguson, SVP, Regional Manager - Northwest L ately, bankers may find that they are more dedicated to loan loss calculations than before, as everyone tries to get their hands around the Current Expected Credit Loss (CECL) standard. CECL will require you to calculate reserves based on expected losses for the life of the loan, which is different from the Incurred Credit Loss (ICL) standard. To help address some of the pieces of something as large and complex as CECL, we offer these step by step suggestions: Inventory & Analyze Your Data. Though CECL is a depar- ture from your current method of loan accounting, you most likely already have most of the infor- mation you need. Knowing this, start to review and take inventory of your data. Sort Your Data. Basically, data can be broken down into three primary groups for CECL. The first is descriptive data, which is the purpose and nature of the loan. The second is per- formance data, which includes loan/risk grade, charge-offs and recoveries. The final piece is cash flow descriptive data, which is needed to determine how repayment will occur over the life of the loan. Here, it is crucially important to include the impact of prepayments. Assess & Evaluate Meth- ods. Now that you have your data, you will need to start looking at suitable methods to use. There are several options, so be sure to choose the one to suit the data, not the other way around. For example, static closed pool method works well for very homogenous loans, while closed pool vintage and vintage default curves may work well for amortizing loans with shorter maturity structures and similar balance sizes. Remember Where We Are. When it comes to choosing which method to use, know that most banks currently use open pool. This may work well under CECL, but it is important to note that the Great Recession was an anomaly. So, if that is the only economic cycle you have results for, you may need to search back further in time to “dial down” these results to “normal” levels. Get More Math-y. Grade migration and PD/LGD methods will typically better reflect current credit quality than other meth- ods, especially if your lookback period is over the Great Reces- sion. Recall that there were more classified loans held during this time, which causes other meth- ods to skew higher. You can also consider using discounted cash flows. These can lower reserves, but also require more work when dealing with recoveries. Test, Retest & Then Act. As you work along, take a close look at your evaluation method. Seek to understand how the method will work now AND as economic conditions change over time. As you refine things down, ensure that your auditors, examiners, bank executives and board are all on the same page. For more information on CECL, contact Debi Ferguson. Phone: (206) 271-2523 dferguson@pcbb.com www.pcbb.com To read more about CECL, checkout www.pcbb.com/prod- ucts/cecl/. Dedicated to serving the needs of community banks, PCBB’s comprehensive and robust set of solutions includes: cash management, international services, lending solutions and risk management consulting services, including CECL. Guest Article