Pub. 11 2021-2022 Issue 3-1

November • December 2021 17 in-house capabilities. Compare the degree of automation and flexibility available for each option. 2. Methodologies The CECL model is not prescriptive, meaning banks and credit unions can determine the best methodology or methodologies to use based on their loan portfolio. With seven different methodologies to choose from, some financial institutions have “analysis paralysis” trying to determine the right approach for their institution. Once an institution determines the methodology best suited for its portfolio, it should consider the costs for developing and maintaining the methodology in-house compared to a vendor’s costs. How automated and flexible is the solution? Can the institution easily calculate, evaluate, and change methodologies? Finally, when weighing the pros and cons of building or buying a CECL solution, banks and credit unions should consider the advisory assistance and support they may need and what resources will be available to them as they work through their methodologies. Transparency and Auditability Forecasting and Documentation are Key to a Successful CECL Solution 3. Forecasting and Adjustments Unlike the incurred loss model, the CECL model is forward-looking, estimating loans’ lifetime losses using reasonable and supportable forecasts. For periods beyond an established forecast, reversion to average historical experience is required. The subjective factors of CECL can make the new standard more daunting – another reason institutions may be at a “standing Kylee Wooten Media Relations Manager, Abrigo start.” Qualitative adjustments have played an important role in calculating the allowance under the incurred loss method, and these adjustments will continue to be significant under the CECL model. Models should allow for quick inclusion and exclusion of all observable analysis periods and provide forecasting intelligence, support, and application. Ideally, management should be able to evaluate all observed loss rates, make any documented exclusion/ inclusion decisions, including forecasted conditions, and see those decisions reflected in the estimated reserve level. 4. Model Risk and Auditability Documentation and support are an area that is often the most time- consuming exercise in today’s allowance process under the incurred loss model. CECL will require more inputs, assumptions, and analysis at the pool level. Tracking, consolidating, and displaying all information necessary to review, support, and recalculate will be a critical function of any in-house or third-party solution. Consider the level of transparency and auditability offered by any vendors under consideration and take into account costs associated with model risk or time spent preparing documentation and support. There are financial and resources costs associated with building an in-house solution and purchasing a vendor’s solution. Irrespective of the decision to build or buy, banks and credit unions should carefully consider the impact that these four points will make on their model to ensure a successful transition to the CECL standard. Remember, testing, discussing, and deciding does not happen overnight. Be sure to get your solution in place as quickly as possible to be ready for the 2023 effective date. There are financial and resources costs associated with building an in-house solution and purchasing a vendor’s solution.