Questions to ask when deciding your CECL Method

What the C-Suite should know about CECL and change management

Read this if you are at a financial institution. 

Some institutions are managing CECL implementation as a significant enterprise project, while others have assigned it to just one or two people. While these approaches may yield technical compliance, leadership may find they fail to realize any strategic benefits. In this article, Dan Vogt, Principal in BerryDunn’s Management and IT Consulting Practice, and Susan Weber, Senior Manager and CECL expert in BerryDunn’s Financial Services Practice, outline key actions leaders can take now to ensure CECL adoption success.  

Call it empathy, or just the need to take a break from the tactical and check in on the human experience, but on a recent call, I paused the typical readiness questions to ask, “How’s the mood around CECL adoption – what’s it been like getting others in the organization involved?” The three-word reply was simple, but powerful: “Kicking and screaming.”  

Earlier this year, by a vote of 5-2, the FASB (Financial Accounting Standards Board) closed the door to any further delays to CECL adoption, citing an overarching need to unify the industry under one standard. FASB’s decision also mercifully ended the on-again off-again cycle that has characterized CECL preparation efforts since early 2020. One might think the decision would have resulted in relief. But with so much change in the world over the past few years, is it any wonder institutions are instead feeling change-saturated?  

Organizational change

CECL has been heralded as the most significant change to bank accounting ever, replacing 40+ years of accounting and regulatory oversight practices. But the new standard does much more than that. Implementing CECL has an effect on everything from executive and board strategic discussions to interdepartmental workflows, systems, and controls. The introduction of new methods, data elements, and financial assets has helped usher in new software, processes, and responsibilities that directly affect the work of many people in the organization. CECL isn’t just accounting—it’s organizational change. 

Change management

Change management best practices often focus on leading from optimism—typically leadership and an executive sponsor talk about opportunities and the business reasons for change. Some examples of what this might sound like as it relates to CECL might include, by converting to lifetime loss expectations, the institution will be better prepared to weather economic downturns; or, by evolving data and modeling precision, an institution’s understanding and measure of credit risk is enhanced, resulting in more strategic growth, pricing, and risk management. 

But leading from optimism is sometimes hard to do because it isn’t always motivating—especially when the change is mandated rather than chosen.  

Perhaps a more judiciously used tactic is to focus on the risk, or potential penalty, of not changing. In the case of CECL, examples might include, your external auditor not being able to sign-off on your financials (or significant delays in doing so), regulatory criticism, inefficient/ineffective processes, control issues, tired and frustrated staff. These examples expose the institution to all kinds of key risks: compliance, operational, strategic, and reputational, among them.

CECL success and change management

With so much riding on CECL implementation and adoption going well, some organizations may be at heightened risk simply because the effort is being compartmentalized—isolated within a department, or assigned to only one or two people. How effectively leadership connects CECL implementation with tenets of change management, how quickly they understand, then together embrace, promote, and facilitate the related changes affecting people and their work, may prove to be the key factor in achieving success beyond compliance.  

One important step leaders can take is to perform an impact assessment to understand who in the organization is being affected by the transition to CECL, and how. An example of this is below. Identifying the departments and functions that will need to be changed or updated with CECL adoption might expose critical overlaps and reveal important new or enhanced collaborations. Adding in the number of people represented by each group gives leaders insight into the extent of the impact across the institution. By better understanding how these different groups are affected, leaders can work together to more effectively prioritize, identify and remove roadblocks, and support peoples’ efforts longer term.           

 
No matter where your institution is currently in its CECL implementation journey, it is not too late to course-correct. Leadership—unified in priority, message, and understanding—can achieve the type of success that produces efficient sustainable practices, and increases employee resilience and engagement.

For more information, visit the CECL page on our website. If you would like specific answers to questions about your CECL implementation, please visit our Ask the Advisor page to submit your questions. For more tips on documenting your CECL adoption, stay tuned for our next article in the series, revisit past articles, or tune in to our CECL Radio podcast. You can also follow Susan Weber on LinkedIn.

Read this if you are at a financial institution.

While documentation of your CECL implementation and ongoing practices is essential to a successful outcome, it can sometimes feel like a very tall order when you are building a new methodology from the ground up. It may help to think of your CECL documentation as your methodology blueprint. While others will want to see it, you really need it to ensure that what you are building is well-designed, structurally sound, appropriately supported, and will hold up to subsequent “renovations” (model changes or tweaks). To help you focus on what’s essential, consider these documentation tips:

Getting started

Like any good architect, you need to understand the expectations for your design—what auditors and regulators want to see in your documentation. Two resources that can really help are the AICPA Practice Aid: Allowance for credit losses-audit considerations¹, and the Interagency Supervisory Guidance on Model Risk Management². One way to actively use these guides is to take note of the various section/subject headers and the key points, ideas, and questions highlighted within each, and turn that into your documentation checklist. You’ll also want to think strategically about where to keep the working document, who needs access to it, and how to maintain version control. It is also a good idea to decide up-front how you will reference, catalog, and store the materials (e.g., data files, test results, analyses, committee minutes, presentations, approvals, etc.) that helped you make and capture final decisions. You can download our CECL Documentation checklist now.   

What to watch out for

What’s new under CECL are areas requiring documentation (e.g., broader scope of “financial assets,” prepayments, forecasts, reversion, etc.). But watch out for elements that seem familiar—they may now have a new twist (e.g., segmentation, external data, Q factors, etc.). It’s a good idea to challenge any documentation from the past that you feel could be re-purposed or “rolled into” your CECL documentation. Be prepared also to spend time explaining or customizing vendor-provided documents (e.g., model design and development, data analysis memos, software procedures, etc.). 

While this material can give you a running start, they will not on their own satisfy auditor and regulator expectations. Ultimately, your documentation will need to reflect your own understanding and conclusions: how you considered, challenged, and got comfortable with the vendor’s work; what validations and testing you did over that work, and how you’ve translated this into policies and procedures appropriate for your institution’s operations, workflows, governance, and controls. For more information on making the vendor decision, and for suggestions of vendor selection criteria, read our previous article “CECL Readiness: Vendor or no vendor?” 

Point of view

It is human nature, especially whenever entering new territory, to want to know how others are approaching the task at hand. Related to CECL, networking, joining peer discussion groups, researching what and how those who have already adopted CECL are disclosing, are all great ways to see possibilities, learn, and gain perspective. When it comes to CECL documentation, however, the most important point of view to communicate is that of your institution’s management. Consider the difference in these two documentation approaches: (a) we looked at what others are doing, this is what most of them seem to be doing, so we are too; or (b) this is what we did and why we feel this decision is the best for our portfolio/risk profile; as part of our decision-making process, we did this type of benchmarking and discovered this. Example b is stronger documentation: your point of view is the primary focus, making it clear you reached your own conclusions. 

Other elements for CECL documentation

Documenting your CECL implementation, methodology, and model details is critical, but not the only documentation expected as you transition to CECL. It has been said that CECL is a much more enterprise-wide methodology, meaning that some of the model decisions or inputs may require you use data and assumptions traditionally controlled in other departments and for other purposes. One common example of this is prepayments. Up to this point, prepayment data may have been something between management and a vendor and used for management discussion and planning, but not necessarily validated, tested, or controlled for in the same way as your loss model calculations. Under CECL, this changes specifically because it is now an input into the loss estimate that lands in your financial statements. As a result, prepayments would be subject to, for example, “accuracy and completeness” considerations, among others (for more information on these expectations, refer to our earlier articles on data and segmentation). Prepayments is just one example, but does illustrate how CECL adoption will likely trigger updates to policies, procedures, governance, and controls across multiple areas of the organization.    

One final note: There are some new financial statement disclosures required with CECL adoption. Beyond those, there may be other CECL-related information either you want to share, or your audit/tax firm recommends be disclosed. Consulting with your auditor at least a quarter prior to adoption will help make sure you aren’t scrambling last minute to draft new language or tables.  

Struggling with CECL documentation or other elements of CECL? 

No matter what stage of CECL readiness you are in, we can help you navigate the requirements as efficiently and effectively as possible. For more information, visit the CECL page on our website. If you would like specific answers to questions about your CECL implementation, please visit our Ask the Advisor page to submit your questions.

For more tips on documenting your CECL adoption, stay tuned for our next article in the series. You can also follow Susan Weber on LinkedIn.

¹You can find the AICPA Practice Aid here.
²The interagency guidance was released as OCC Bulletin 2011-12, FRB SR 11-7, and as FDIC FIL 22-2017
 

Read this if you are at a financial institution.

This article is part of our series on CECL implementation. You can read previous articles in the CECL series here. 

Segments, sub-segments, pools, cohorts—by whatever name you call it, grouping loans (and other financial instruments) for CECL¹ is kind of a big deal. Like choosing an inner circle of friends, creating effective loan pools can have a lot of influence over your CECL experience, from methodology decisions to your allowance estimates. As a CECL adopter, you are expected to evaluate, support, and document segmentation choices (no such requirement for your inner circle of friends!), even if you plan to use the same segmentation in place today. To do so successfully, consider these segmentation ABCD’s:

A: Accuracy and completeness of data

The accuracy and completeness of data used to determine the most appropriate segmentation under CECL covers a lot of ground – everything from what information you considered to be relevant and why, to where the data came from and how it was determined to be valid (aka accurate and complete). CECL requires loans sharing similar risk characteristics² to be pooled together for “collective evaluation”; examples include loans with similar terms and structures, lien position on collateral (e.g. first, or junior lien), or collateral use (e.g. owner-occupied or investment real estate). As a result, “accuracy and completeness” applies not only to the data you rely on to pool loans, but also to what you determined the common risk characteristics to be, why those, what others you identified but ultimately didn’t use, and why. Read our earlier article, CECL Adoption: The five W's of data, for more information on data considerations.

B: Balance between granularity and significance

Striking a balance between how many segments you create and the significance of doing so can be a little like trying to achieve the “just right” goal of Goldilocks. For example, is pooling all your consumer loans together most aligned with your past loss experience, or does the type of collateral also influence your risk of loss? How far is too far (real estate, cars, boats, RV’s, tractors)? At what point does it become difficult to consistently demonstrate or predict meaningful differences in risk of loss for each? Several sections of the standard address this need to balance detail with what is useful³. In this way pools should be small enough that the risk characteristics they share are relevant to estimating inherent risk, but not so small as to be confusing, misleading, or not able to be modeled consistently over time. Being aware of how small a pool is in terms of the number of loans it consistently contains may be one consideration for whether or not the segmentation is too granular. 

C: Controls over the selection of risk characteristics

Your segmentation choices will likely have far-reaching effects on other key decisions in your CECL methodology. Model selection, qualitative adjustments, and even if/what/how external or peer data may apply are examples of what could be impacted by your segmentation selection.  As a result, and in addition to the above, your auditors and regulators will want to see evidence the risk characteristics driving your segmentation choices were robustly reviewed, challenged, tested, and documented. Further, they will want to see that you have a similar systematic approach in place, and ongoing, to identify when a loan no longer shares the defined risk characteristics of its segment, resulting in its removal from the pool to be assessed individually.⁴  

D: Documentation tips

Documentation is like exercise—you know you should do it, but sometimes you don’t make it a priority. CECL opens the door for all kinds of documentation expectations, so coming up with a way to do this as you work through implementation can save you a lot of headache later. For segmentation, setting up a simple spreadsheet with the ABC’s to the left and columns to the right to list data, testing, key considerations, decisions, approvers, and even links to supporting evidence (data files, governance memos, etc.) is but one example of how you might keep track of these items as you work. Be sure to include any assumptions you had to make along the way (e.g. how you handled missing information on old or purchased loans), or aggregations (larger-level pools than you might have preferred) you accepted and why.

Finally, while you may be checking out what segmentation others in the industry are using—which will vary as it does today—what you’ll want to document most is why the choices you made are right for your institution.

For more tips on documenting your CECL adoption, stay tuned for our next article in the series on documentation. You can also follow Susan Weber on LinkedIn.

No matter what stage of CECL readiness you are in, our Financial Institutions team is here to help you navigate the requirements as efficiently and effectively as possible. If you would like specific answers to questions about your CECL implementation, please visit our Ask the Advisor page to submit your questions.

¹Current Expected Credit Loss (CECL) methodology as provided for in the Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) Financial Instruments-Credit Losses Topic 326, commonly referred to as FASB ASU 326. A copy of the standard is available for download from the FASB website.
²Refer to FASB ASU 326-20-55-5
³Examples include FASB ASU 326-20-50-3, 326-20-55-10, and 326-20-55-11 (for financing receivables)
⁴Refer to FASB ASU 326-20-30-2

Read this if you are at a financial institution.

Data. Statistics. Analysis. Modeling. Whatever happened to good old-fashioned experience? When it comes to CECL (current expected credit loss), it’s going to take a combination of both—data and experience—to help you design an effective methodology. While “experience” sounds like a fun day of reminiscing, getting the “data” side can feel like a never-ending journey in the fog. If, in your CECL readiness journey data has you feeling a little lost, let the five W’s of data be your guide.

What data: Knowing what data you need is like having a map for the journey ahead. Understanding how CECL is different—in scope, requirements, definitions, and techniques—is the first step. One approach is to make a list of the differences. To the right of the list (or insert a column to your spreadsheet), add what data you will need to fulfill this part of the standard. For example, a new requirement for CECL is making adjustments for prepayments (new on-going data need). Some methods may use a prepayment rate which is, itself, a calculation requiring data and assumptions. It’s okay if this initial list is incomplete as capturing what’s new and different is an important start, and one that you can build upon as you go.

Where data: Next, you need to know where to get the data you need (sometimes it’s about even knowing if the data exists). This is where having key people from departments across the organization on the team can be very helpful. Time to add a new column to that spreadsheet: identify the system, department, person, and/or vendor responsible for the data you need. Find out where and how the data is stored. For example, is the data in a core system as a data point already, or is it manually calculated and recorded in a monthly memo going back 15 years? Where the data is located may be a key factor in decisions you will make about allocating resources, changing processes, and ensuring good controls over data.    

When data: The next essential question is, 'when is the data going to be needed and used?' In this regard, data falls into two broad categories: periodic and always. Examples of periodic data include data used to make model selection(s), support segmentation, or data that help you choose among several available techniques. Periodic data may be in the form of analysis and testing. Always data is the kind needed on an on-going basis, most typically to directly support the allowance calculation. Examples of always data are prepayments (from our earlier example), and the codes in the core system that allow you to group loans into their proper segments. Knowing when data will be needed and used will help keep your implementation moving forward.  

Why data: Data is often imperfect; it can be historically incomplete, somewhat dated, messy to compile, and may even be biased. Recognizing this upfront and throughout the process will not only reduce your stress; it will also help you document why certain data may have needed to be adjusted, modified, transformed, or ignored. Being equally inquisitive about why the data is in the shape it’s in may lead you to discover important ways to improve its quality, integrity, and the efficiency and effectiveness of collection and validation processes. Ensuring management has a good understanding of why assumptions or adjustments to data had to be made will help them fulfill their oversight responsibilities, pose credible challenge questions, and build context for understanding results.    

Whose data: Finally, whose data are you using? There are options for considering and using external data in your CECL methodology. When thinking through what this ultimately means to you in this process, it’s helpful to define external data as data provided by outside parties. In our journey analogy, think of these as alternate routes and, like alternate routes, there may be trade-offs to taking them that you’ll need to assess. Probably two of the most recognizable external data examples are economic forecasts and peer data. They may also include any data of yours that a vendor may have transformed and returned to you—a common example of this being prepayments. It is important to understand that from an auditor and regulator perspective, you remain responsible for the integrity and use of this data in your methodology. 

Once you have the five W’s of data locked in, you are well on your way to CECL implementation. No matter what stage of CECL readiness you are in, our Financial Institutions team is here to help you navigate the requirements as efficiently and effectively as possible. If you would like specific answers to questions about your CECL implementation, please visit our Ask the Advisor page to submit your questions.

Read this if you are at a financial institution.

For some financial institutions, it’s only 11 months to CECL adoption and they haven’t yet decided on whether or not to use vendor model software for their CECL calculation. If this sounds familiar, then take a few minutes to consider these five key factors to making this decision so you gain traction on your CECL readiness efforts:

1. Criteria: Identify and list the specific criteria you and others will need to make the vendor/no vendor decision. Ask key decision-makers to weigh-in. Getting this consensus on the criteria up-front ensures you present enough of the right kind of information to make the final decision quickly.     
2. Time: Create a timeline of what has to happen between now and the CECL adoption date for your organization to be ready and confident in your chosen method(s). Identify the staff and hours required to accomplish it. Clarifying both the time commitment and time constraints will help you assess if additional support or trade-offs are required. Get tips on creating or revising your CECL implementation timeline here. 
3. Expertise: Define the level of expertise necessary to understand, develop, test, and document the new model(s). This work may involve model design, data flow, mathematical formulas, and the ability to document assumptions and limitations of each. If you’re not sure, ask others to help assess if the organization has the internal expertise necessary to do this work, understanding those resources may work in different departments. 
4. Technology: Determine if you have access to, or enough of, the technology needed for CECL model development and testing. In this context, technology may include systems, programs, analytical software, processing speed, and secure access. Knowing what your current technology capabilities are helps you identify any limitations you may need to address in advance.     
5. Risk: Understand the risks. Take time to think through the risks posed by using – and not using – vendor model software. For example, developing a model in-house may save you the cost of vendor software, but what risk does developing a model in-house pose to the organization in allocating the people resources to do so? Likewise, securing vendor software may reduce the strain on limited internal resources, but what risks to access, process, communication, and control are posed by having to manage the vendor? 

Questions about your CECL implementation?

No matter what stage of CECL readiness you are in, our Financial Institutions team is here to help you navigate the requirements as efficiently and effectively as possible. If you would like specific answers to questions about your CECL implementation, please visit our Ask the Advisor page to submit your questions. 

Read this if you are at a financial institution.

Feeling stuck, or maybe even frozen, in your CECL readiness efforts? No matter where you are in the process, here are three things you can do right now to ensure your CECL implementation is on track:

1. Create or re-visit your 2022 timeline
   With just under 12 months to the January 2023 CECL adoption date, it’s important to make every moment count. Consider CECL adoption your Olympic moment and, like every great Olympic athlete, you have interim events—a timeline of major milestones—to ensure you are ready for “Day 1” and beyond. One strategy to ensure you do not “run out of time” is to start at the end of your timeline and work backward.
   
   Tip: Whether it be 1/1/2023 (“Day 1” adoption), or the first date by which you want to start parallel runs, fix the date of that final must-hit milestone, and work backward. For example, in order to adopt CECL on 1/1/2023, what major milestone has to be achieved before then and how much time will you need for that? Setting milestones from the final date backward will help you fit the remaining major activities into the time you have left—you can’t “run out of time” this way!
   
   
   
    
2. Assess where you are, tactically, and fill in the gaps
   What would an Olympic athlete be without a training schedule, and coaches, trainers, and other professionals to guide and push them? In order to make the most of each event (or milestone) in the countdown to CECL adoption, let’s fill in our training schedule. What key decisions still need to be made or documented? Who has the authority to approve them? What’s the right time and venue to obtain that approval? Will these be one-to-one, small group, or committee/board meetings? Will meetings be set up as-needed, or is the meeting schedule (e.g. quarterly executive/board) already set? Who are you engaging for model validation and key control review? What is the date of that review work? 
   
   Tip: Add those key approval, review, and validation dates to your timeline, and make sure the meeting time you need with decision-makers is booked in their calendars now. Scheduling this time in advance is a transparent and tangible sign that you’ve charted the course, helps ensure decision-makers are available to you when needed most, and incremental progress is being consistently made toward your ultimate goal. 
3. Identify the top three tasks to complete this week, reserve the time in your calendar, and complete them!
   Like any athlete, you are now “in training”, and daily and weekly actions you take will ensure you reach your goal in as strong a position possible. Whether it’s scheduling those meetings, identifying subject matter experts you can rely upon for coaching, or putting the finishing touches on model documentation and internal control mapping, booking that time with yourself to complete these tasks is key to feeling prepared and ready for CECL adoption. 
   
   Tip: Set aside a few minutes at the end or start of each week to review your timeline/milestones and identify the next key actions to complete.

Would you like assistance with certain aspects of your CECL readiness efforts? Are you ready for some validation/review work, or need guidance on policy, governance, or internal/financial reporting controls?

Contact our Financial Institutions team. We'll help you get your CECL implementation over the finish line. 

Read this if your organization offers health insurance through a health insurance exchange.

When the Affordable Care Act (ACA) was passed in 2010, it contained a known gap which made healthcare premiums unaffordable for some families covered under Medicare or employer-sponsored health insurance plans. The gap in the law, commonly referred to as the family glitch, was formalized in 2013 as the result of a Final Rule issued by the IRS. 

The “family glitch” calculates the affordability of an employer-sponsored health insurance plan based on the cost for the employee, not additional family members. An article published in April 2022 on healthinsurance.org estimated that the cost of health insurance for a family covered by an employer-sponsored plan could end up being 25% or more of the household’s income, even if the plan was considered affordable (less than 9.61% of the household’s income) for the employee alone. Almost half of the people impacted by the family glitch are children.

The family glitch was allowed to stand in 2013 partly because of concerns that resolving the issue could push more people off employer-sponsored plans and onto marketplace qualified health plans, ultimately raising the cost of subsidies. Since then, several attempts have been made to fix the issue, which affects around five million Americans. The most recent attempt was an executive order issued by President Biden soon after taking office in January 2021. The Office of Management and Budget has been reviewing regulatory changes proposed by the Treasury Department and IRS, details of which were published in April 2022. 

These regulatory changes would alter the way health insurance exchanges calculate a family’s eligibility for subsidies when the family has access to an employer-sponsored health insurance plan. If the changes go into effect in 2023 as proposed, audits of the 2023 fiscal year will need to account for the new regulations and potentially conduct different testing protocols for different parts of the year. 

Our team is closely following these proposed changes to help ensure our clients are prepared to follow the new regulations. Earlier this week, we attended a public hearing held by the Treasury Department, where representatives of various groups spoke in support of, or in opposition to the proposed regulatory change. Supporters noted that families with plans that offer expensive coverage for dependents would benefit from this change through reduced costs and more coverage options, including provider networks that may more closely align with the family members’ needs. Those in favor of the change anticipate that families with children would see the most benefit. 

Those opposed to the change expressed that due to the way the law is currently written, they do not see the regulatory flexibility for the administration to make this change through administrative action. Additionally, concerns were raised that families covered by multiple health insurance plans could be faced with higher out-of-pocket-costs due to having separate deductibles that must be met on an annual basis. Lastly, not all families that have unaffordable insurance would see financial relief under this proposal. 

The Treasury Department is expected to announce its decision in time for open enrollment for plan year 2023 which is scheduled to begin on November 1, 2022. Our team will continue to monitor the situation closely and provide updates on how the changes may impact our clients. 

For more information

If you have more questions or have a specific question about your situation, please reach out to us. There is more information to consider when evaluating the effects these changes will have on the landscape of healthcare access and affordability, and we’re here to help.