The implementation window for the new Current Expected Credit Loss (CECL) standard may seem plenty big enough, but there are loads of decisions to be made, such as “how will we calculate this?”
“Decide on methodology and start implementing as fast as you can,” advised Masha Muzyka, Senior Director, Regulatory and Accounting Solutions at Moody’s Analytics. She was part of a round-table discussion, held on January 10, 2018, about the transition to CECL. The webcast was organized by the Global Association of Risk Professionals (GARP).
The new CECL standard will bring significant changes, such as a spike in earnings volatility. “The day-to-day operation of banks is based on contractual yield. The CFO sees 3 to 5 years ahead, based on contractual yield, not volatility,” said Muzyka. CECL means the view will change to quarter over quarter, so volatility will appear to increase. Because it incorporates forward-looking information, CECL will exacerbate the volatility.
Banks are hard at work gearing up for the change. Something to bear in mind is “how will this solution help me with my initial pricing?” she said. “It’s bringing the back office in with the front office, in a more formalized way.”
Muzyka summarized where banks currently stand in their CECL preparations. “Big banks have preliminary estimates already done. Some trends, some estimates by asset class: they can see these and how they are driven by where we are in the economic cycle.”
Mid-sized banks started with a gap assessment and are now addressing specific deficiencies in their operations for estimating CECL.
“Purchase credit impaired (PCI) accounting brought a lot of challenges,” she noted. “It’s very different from regular portfolios, where the income is tied to the cash flow.” A purchased asset leads to the question of where it belongs. “To recognize a purchased asset as PCD, it does not have to be impaired,” she said. (Here, PCD refers to purchase credit deteriorated.) “Banks will have a challenge with how to deal with PCI pools under the new rules,” she predicted.
For each particular asset class, a further task is deciding how to proceed with models and data. “You need to have enough data to train the model,” Muzyka said, and for some banks that means turning to data from a third-party source. Even so, there’s work to do because “you must correlate that data with your bank’s experience.”
“Whatever you choose, make sure it is fit for purpose,” she said, and that it correlates with the assets you have on the books. “The challenge is operational,” she said, but it’s more than that. “When you are removing silos, there’s a lot of training and a cultural shift that needs to happen within the bank.”
During the Q&A session, Muzyka recommended that banks make a concerted effort to handle communications around CECL. “Before CECL goes live, consider making disclosures so there is no shock in the quarter right before or after,” she advised. “After CECL goes live, you want to communicate the drivers to your investors—what changed, and why it changed. Do an attribution analysis.”
When it comes to implementing any new standard, a bank should aim for consistency and a holistic view. ª
Click here to view the one-hour GARP Webcast- The Transition to CECL: Implementation and Strategic Considerations: http://bit.ly/2BoTGgX