Regulators, smaller banks still need to sweat the details on CECL

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The implementation of the new Current Expected Credit Losses accounting standard, known as CECL, has proven to be difficult to understand for banks of all sizes — and smaller institutions have proven to be the slowest to get started getting prepared. But it’s crucial that they do.

In January of this year, the CEO of a smaller community bank in the Midwest told me: “I am in a group of some 25 CEOs of local community banks, and we all agreed that we weren’t going to do anything about CECL until the Federal Deposit Insurance Corp. or the state tells us we have to.”

Until federal regulators hosted a February webinar for smaller community banks on adopting the standard, the general message from the banking agencies had been that the standard is scalable for smaller institutions and shouldn’t require much in the way of additional time or resources. As a result, most are just gathering industry information about CECL, attending vendor webinars, wondering and worrying about what they may have to do in 2021 to be compliant.

But the February webinar — featuring speakers from the FDIC, the Federal Reserve, the Conference of State Bank Supervisors, the Financial Accounting Standards Board and the Securities and Exchange Commission — offered a different picture for the more than six thousand banks, vendors and other interested parties who joined the call.

While most of the speakers in that webinar tried to convey an understanding that there are lower expectations of smaller community banks for their CECL implementation than for larger banks, several of their comments actually indicated that CECL compliance was still going to be difficult and costly for even the smallest institutions.

The regulators noted, for example, that a bank can do the actual CECL loss rate calculations many different ways, and some banks may be or may not able to use various spreadsheet models to do so. They offered that a bank could choose to use a vendor supplied model, but that it wasn’t a requirement — it was the bank’s decision. They also explained that most smaller banks will need to have some type of data warehousing to hold and manage in a controlled fashion the data needed for CECL. Moreover, a smaller bank’s internal data will most often be insufficient for CECL loss modeling and smaller banks will probably need to acquire third-party or peer data to complete their calculations. The regulators underscored that no bank, no matter how small, is or will be exempt from CECL.

This information — coming directly from the regulatory agencies — should have been a call to action for smaller community banks. Given how much needs to be done, they should be starting now. Unfortunately, it appears that the collective reaction to this wake-up call has been more like a yawn.

What can the smaller banks do? For starters, banks can begin to pull together a database of aggregate historical portfolio performance data for their peer group to be able to justifiably estimate credit losses under the new standard using publicly available data from the FDIC and elsewhere. The speakers from the agencies fell short of suggesting to smaller banks that it would be acceptable to use their existing model structures and publicly available data to become CECL compliant. Can they use their existing regulatory asset category and FDIC peer data to augment their own loss history? If they truly believe the CECL standard is scalable and should not be onerous on smaller less complex institutions, then these are important points to make.

On a go-forward basis, the institution can do a much better job creating justifiable historical loss patterns and loss curves by creating and collecting more granular underlying risk-driver data like borrower financial ratios, risk ratings and credit scores at origination. As these data practices become the “new normal,” even the smallest banks will have the ability to use enhanced internal historical data for CECL loss modeling. As the years pass, the oldest and least specific data from the FDIC call code database will fall away and be replaced with newer, better internal data by the 2021 implementation deadline.

To be sure, there are a number of real concerns surrounding using a methodology like this for CECL compliance. For example, at this point no audit firm or regulatory agency has commented on whether using a blend of publicly available and internal loss data at the call code level will be an acceptable near-term solution for data-challenged, resource-strapped community institutions.

Smaller community banks know they need to collect more data. But those who oversee the implementation of CECL also have a responsibility to help banks prepare themselves — and to establish practical guidelines and best practices that are readily achievable without undue cost.

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