As we reflect on the experience of the first 350 institutions to adopt the current expected credit losses (CECL) standard and prepare for the remaining 10,000 institutions to adopt over the coming years, it appears CECL may be achieving the results for which it was designed. While it’s difficult to distinguish the impact of CECL adoption from that of the pandemic, it appears the standard has allowed institutions to be more responsive to ongoing uncertainty than was common under the incurred loss method. As we’ve worked with institutions that have adopted the standard and others that are working toward adoption, we’ve identified two areas on which your institution should consider focusing. Understanding your model We’ve seen institutions design models to estimate credit losses where the resulting reserve conceptually didn’t make sense, even though the individual decisions made in developing the model were well supported. This could result from not understanding how the model works or certain assumptions having unexpected impacts. To combat this, we suggest taking a moment to assess your model and results from a high level and qualitatively evaluate what you’re seeing. Do you have minimal loss history and yet, with almost no adjustments to that history, are projecting a large reserve? Are you expecting an improvement in the economic environment over the next year, but your model is using loss rates that exceed the historical average? The results of these reflections, at a minimum, support the effective challenge of the model and could even lead to some significant adjustments to how you approach establishing a reserve. Establishing model documentation Estimating expected credit losses under CECL inherently requires a significant amount of judgment – judgment that will need to be explained to stakeholders such as management and regulators throughout the use of your CECL model. Because of this, we can’t stress the importance of establishing and maintaining clear and thorough documentation of decisions made during the development and ongoing operation of the model. While many vendors provide white papers and other technical discussions of the theories underlying third-party models, this documentation should be supplemented with a discussion of how management is applying the model and the related decisions, assumptions, and limitations. As each institution is in a different stage of addressing the new standard, we’ve outlined additional considerations for those who have already adopted and those yet to adopt below. CECL: Where we’ve been and where we’re going By Ryan Abdoo, Partner Kate Krones, Senior Manager Plante Moran 2.20 2.00 1.80 1.60 1.40 1.20 1.00 0.80 Dec-18 Dec-19 Mar-20 Jun-20 Sep-20 Dec-20 Mar-21 Jun-21 Sep-21 Incurred loss CECL Coverage ratio, excluding PPP loans coloradobankers.org 18
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