CECL Q Factors BE READY TO ANSWER 3 QUESTIONS By Mary Ellen Biery, Senior Strategist & Content Manager, Abrigo What Happened to Q Factors Under CECL? Qualitative factors, or Q factors, play an important role in calculating the allowance for credit losses. But banks and credit unions have needed to adjust how they tackle developing these adjustments under CECL, the current expected credit loss standard. Q factors — more specifically, “What’ll happen to my Q factors under CECL?” was a popular topic among bankers before the final 2023 deadline for implementing the new accounting standard. Controls around Q factors remain important, since they are an area of attention from auditors and examiners. Before CECL, many financial institutions often relied on qualitative factors for a larger percentage of their reserve when calculating the allowance for credit loss (ACL). That practice evolved as several years of good credit quality put downward pressure on the quantitative portion of the estimate under the incurred loss method. Financial institutions adjusted the qualitative portion of the allowance in an effort to ensure sufficient reserves. As financial institutions transitioned to CECL, a central question among them was how the use of Q factors under the new standard would compare with existing practices. Another common question from institutions was what percentage of quantitative vs. qualitative components would be expected by auditors and examiners. Outside CECL experts weigh in on the topics. Understand the Quantitative Analysis While there’s no universal answer to either question because banks and their loan portfolios and loss experiences can differ so much from each other, CECL experts agree that the first step to applying Q factors under CECL is a solid understanding of the quantitative side of your financial institution’s CECL calculation. After all, said Garver Moore, Abrigo’s vice president of strategy, “The purpose of the qualitative factors is to address what’s not in the losses expected from the quantitative baseline analysis.” Graham Dyer, chief accountant and accounting principles partner at Grant Thornton LLP, has said those involved in the allowance should consider three questions as it relates to Q factors: 1. What is not captured by the model that requires you to make this adjustment? 2. Is the adjustment directionally consistent? 3. Is the adjustment quantitatively appropriate? Justify the Need for Qualitative Adjustments “Tell me what is not in that model — why you need an adjustment in the first place,” Dyer said. “Some methodologies necessitate the use of more Q factors than others,” said Regan Camp, vice president at Abrigo. “It really depends on the type of methodology you’re leveraging.” The COVID-19 pandemic illustrates this. Quantitative models incorporating loss-rate forecasts based on unemployment estimates were complicated by the impact of government stimulus payments and other factors. Documenting the reasoning behind adjustments tied to qualitative factors is important. “We continue to see clients making adjustments for things that we say, ‘Can you show me why that’s not captured by your model?’ And it’s not something they’ve considered,” Dyer said. Building that logic into the process of estimating the allowance is important. Colorado Banker 6
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