Banks fought hard for assurances that they could use existing methods to comply with a new accounting standard for forecasting credit losses.
Still, it might not hurt to look at applying new techniques as the Financial Accounting Standards Board’s deadline for implementing the Current Expected Credit Loss, or CECL, standard nears.
One bank, First Commonwealth Financial in Indiana, Pa., is already making a change. The $6.7 billion-asset company recently concluded that using Excel to calculate its loan-loss allowances no longer made sense, and it is set to switch to a Sageworks program it hopes will slash hundreds of hours off the time required to determine an appropriate allowance.
“These are fairly complex spreadsheets and there are a number of spreadsheets that feed into the model,” said Tony Kallsen, First Commonwealth’s senior credit officer. “The process of calculating the result, and checking to make sure it is the result we intended to have, has taken a tremendous amount of time.”
First Commonwealth is on the cutting edge of a trend that will affect many more banks in its size class, said Ethan Heisler, a former Citigroup managing director who writes Heisler’s Quality Letter and Analysis, a monthly newsletter focused on banking issues that include accounting.
Banks with $2 billion to $10 billion of assets are “in a different kind of world” than smaller institutions, Heisler said. He expects more banks of that size to look into upgrading their analytical tools.
Though Excel remains the predominant tool for calculating allowances at small banks, Michael Gullette, vice president for accounting and financial management policy at the American Bankers Association, said he has worked with banks significantly smaller than First Commonwealth that are considering switching to third-party providers.
While regulators have provided assurances banks can continue using Excel, Heisler said larger community banks will likely be scrutinized more closely if they continue to rely on Microsoft’s spreadsheet software.
Examiners are apt to push bankers to use enhanced programs, if nothing else to speed up the process, Heisler said.
First Commonwealth decided to scrap Excel for multiple reasons. In addition to an increasingly lengthy preparation process, Excel’s open architecture made human error a constant concern, Kallsen said.
“There are no inherent controls” with Excel, Kallsen said. “It literally allows anybody to go in and change any formula. … We have a number of redundant controls to make sure it is calculating the result we expect. That takes a lot of effort, and in some cases producing multiple versions of the same model just as a check and recheck.”
Sageworks’ software will allow First Commonwealth to limit the number of individuals allowed to make changes. Managers will also be able to track all the alterations that are made.
“That’s just not possible in Excel,” Kallsen said.
Allowance calculations are a sticky subject for banks, regardless of the methodology used.
Several banks, including Central Pacific in Honolulu and Webster Financial in Waterbury, Conn., have in recent weeks have reported material weaknesses in their financial reporting that reflected issues with how they documented changes to their allowances. Using a third-party provider has its own set of risks, industry experts said.
CECL, which was finalized by FASB in June, will radically change the way financial institutions calculate loan-loss allowances. Discarding the incurred-loss model, which requires waiting for a loss to materialize before recording provisions, bankers will be expected to use historical and market data to estimate credit losses as soon as they book a loan. They will also have to update projections as conditions change.
“CECL isn’t just about performing a calculation,” Gullette said. “It’s about taking a new approach to credit risk. … Banks are seeing a need to get a grip on much larger amounts of data and to hold it longer.”
Public companies that file with the Securities and Exchange Commission must implement CECL for full-year and quarterly reports beginning in 2020. Public companies that do not file with the SEC are slated to implement the new standard a year later. All other companies can wait until 2022.
Given the magnitude of change embedded in the new standard, Kallsen said First Commonwealth didn’t want to wait too long to adjust to a new framework.
“We were really looking for something that was much more scalable than what we have now,” Kallsen said. “We anticipate as we get close to CECL we will have to evolve our framework.”
Most banks haven’t been as forward thinking as First Commonwealth, Heisler said.
“This is low down on the totem pole of priorities,” Heisler said. “It’s out there, but it’s a 2020 thing. It’s not urgent – yet. It will be, eventually, but not now.”
First Commonwealth is significantly ahead of other banks when it comes to selecting a solution for CECL, Gullette said.
“I think there’s kind of a paralysis going on,” Gullette said. “In some cases banks just don’t know where to start. … Even the big banks are still working things out.”