The American Institute of Certified Public Accountants (AICPA) held its National Conference on Banks & Savings Institutions in National Harbor, Md. last month. Once again, SS&C Primatics had the honor of being a gold sponsor and participating in the speaker series on the Current Expected Credit Loss (CECL) model under ASC 326, Financial Instruments - Credit Losses as subject matter experts. The conference featured speakers from key regulatory agencies as well as respected industry thought leaders to discuss the primary area of focus at this year’s conference, CECL.
Among the recognized industry thought leaders was SS&C’s SVP of Product and Operations, John Lankenau, who kicked off day two of the conference with the session “CECL on the Eve of Adoption.” Lankenau spoke to a full house about how the industry’s view of the allowance under CECL has changed over time. His topic subtitled, “CECL Implementation: What Have we Learned and Where Are we Going?” dove into the biggest drivers of the success in the CECL process to date.
Attendees heard how financial institutions have implemented CECL, including the pain points along the way, and current thought leadership for the journey ahead. Lankenau outlined key lessons learned from the first wave of adopters, noting that the most successful CECL projects (both vendor and internal build) recognized that CECL is a cross-functional challenge encompassing data, model, reporting and controls. Those institutions that initially saw CECL as a purely modeling exercise had overambitious data plans or did not include the appropriate stakeholders, have struggled. As Lankenau reminded the audience, CECL is an accounting standard, not an economic modeling exercise, and all choices must be evaluated in that context.
Lankenau dug into the key variables driving the CECL reserve and the importance of the “life of loan” concept as the primary driver of the change in the reserve, even more so currently than the use of an economic forecast. Lankenau noted that longer duration portfolios or portfolios that had short loss emergence periods (LEPs) under the incurred loss model were primarily responsible for the changes in the reserve estimation. Generally, bank portfolios have seen the following impacts:
- Reserves for credit card portfolios are the most impacted under CECL due to very short LEPs under the incurred loss model, but much longer lives under CECL, given the application of payments based on the Credit Card Act and the requirement to not consider future draws among other assumptions.
- Reserves for commercial loan portfolios are generally flat or down due to longer LEPs under the incurred loss model, but have short lives under CECL due to the restrictions around consideration of term extensions.
- Reserves for mortgages, in general, have significantly increased under CECL due to their very long average lives compared to the traditional 1-2-year LEP.
Banks that have disclosed the estimated impact of CECL on their portfolios so far have noted these impacts. JPMorgan has seen a large increase in reserves due to a large credit card portfolio, whereas Wells Fargo has seen a decrease in the overall reserve driven by a large commercial portfolio.
Finally, Lankenau discussed where we are going as an industry now that the first wave of adopters is almost at the finish line. He noted that industry leaders are questioning what auditor and regulator comments will be, but even more importantly, there are questions about whether CECL will fundamentally change a bank’s lending business, how the investment community will react to results, and whether CECL will be effective in preventing another reserve/capital crisis when the economic and credit cycles turn.
From the standpoint of return on investment, banks should be considering how to leverage the time and money that has been allocated to CECL to running their business more effectively. Banks should ask themselves if they can turn to CECL processes and models for things like portfolio analytics, more robust forecasts, risk appetites and pricing, etc.
CECL has been a heavy investment of time, energy and resources. To make the most of this investment, banks should consider insights gained and how they can be applied to other areas of running their business.
