CECL ORIGINS
CECL appears to be the largest, most painful item on the horizon. This new method for future loan loss accounting has been pushed upon the banking industry by FASB, an accounting group. This is the third or fourth revision in estimating loan losses from governing bodies. All are estimates or guesses. I think this method could cost more for well run banks to implement than their actual loan losses without our help.
The main problem with FASB formulating new rules in this area is their background. I have an accounting background, but I was also a commissioned bank examiner. Prior to being an examiner I had no ability to determine which loans were problems or fully collectible. This position gave me the ability to determine problem loans, classify them, and form a write up that justifies the classification. There are multiple factors that contribute to classifications and loan losses present and in the future.
The models I have seen paint a partial picture of the possibility of a future loss, but all of them miss major contributors to classification and losses. The top two factors for loan losses and bank failures according to the OCC Failed Bank Study are nowhere to be found in the models I have reviewed.
We were featured in CIO Outlook in 2018. The article describes where we were two years ago. We enhance and refine the entire system every day internally. Moving forward to CECL 2.0 gives us the new abilities listed below.
GOOD NEWS FROM BAD
Once the entire picture is viewed in our model I found a significant pattern that could work to the bank’s advantage. If you have a loan that has a CECL percentage of 8% it is better than all loans in the bank with a higher percentage.
The first advantage is since the prior rule is true automated grading can be implemented in a system based on a range of CECL percentages.
The next advantage is the bank can help junior lenders along their learning curve by setting a maximum CECL percentage of X. No loan can be considered or funded if it exceeds that percentage threshold.
Our model can run the CECL calculation and grade the entire portfolio in seconds. Once graded we can refer to the factors contributing to the total CECL percentage and generate write ups.
STREAMLINES LOAN REVIEW
A reviewer checks the grades and write ups once they are generated. They appear as recommended grades and the reviewer can accept or edit the findings. Reports are also available that feature any loan with grade changes. Duplication of effort is eliminated. This should save the bank thousands in review expenses and might uncover a surprise sooner rather than later. This will give the bank more time to resolve or reduce the exposure on any problem debt which could save the bank thousands to millions.
EXAMINER CREDIBILITY
CAMELS – this is another tool in our arsenal to improve or stop deterioration in this rating in a possible down economy. We have had two clients improve their rating by two in eighteen months in a down economy. As an examiner I have never seen this happen. This was without the CECL model and automated grading tools we are rolling out now. Other established LQAS features get the recognition of improved bank ratings.
Over eighty percent of our clients were ranked four or above on Bankrate at the height of the great recession.
CECL IMPLEMENTATION EXPENSES
The cost of implementing CECL varies from system to system. Everything mentioned above is a standard feature of our system. We did not increase our prices, therefore CECL is free to all of our customers. All LQAS clients received the CECL model in a prior update and automated grading is rolling out soon again at no extra cost.
Another cost factor is the labor involved to load the model. All needed core data is available every morning in our system. Most other factors are determined by the system based on data it has been tracking for years. According to several sources the accounting required for CECL did not exist a year or two ago if it exists now. The major areas needed to operate the model have been in LQAS for twenty years. A demonstration of the system will show loan examples with data going back to 2000 including historical and migration losses. This is the major reason why we are not charging for CECL or automated grading. The system had the data needed to run the model for years if not decades.
CECL IMPLEMENTATION TIMING
The latest deadline for most community banks has been postponed to January 1, 2023. This also helps everyone. We finished our model early to assist the banks in playing what if in the model before going live. The banks that are planning to solve this problem at the last minute could have an excessive adjustment to the reserve if the model dictates this amount. Historical information will also be required. We have taken as much of the pain out of this step as possible, but banks that are live now will have history loaded by the system as changes come from the core or review. A high percentage of all data needs from the model is calculated by LQAS once the rules are setup by the bank. Think of it as auto pilot.
Demonstration of all above features are available now. Email ccrawford@lqas.com to schedule.