How CECL Can Make Your Bank Better

CECL was just the opportunity that Glen Stiteley was looking for.

Stiteley joined County Bancorp, an agricultural-focused lender with $1.5 billion in assets, as chief financial officer in August 2017. Like many community banks, Stiteley says the Manitowoc, Wisconsin-based bank could sometimes be “tools cheap” when it came to internal operations, relying on its core vendor and struggling to leverage its own data in decision-making. That included the loan-loss allowance, which had been calculated on an Excel spreadsheet.

By contrast, Stiteley is a self-described “data guy” and is always looking for ways that the bank can improve through information and software. CECL presented him with a challenge-but also an opportunity-to improve how the bank gathers and analyzes its data.

“I try to take advantage of things like [CECL] to say, ‘How can we do things better?’” he says. “We hadn’t analyzed our data very well and hadn’t used it very well.”

County Bancorp elected to upgrade the Excel spreadsheet to a vendor solution from Sageworks (which is now part of the technology company Abrigo), and has been grabbing and scrubbing its data for a year. Stiteley says CECL implementation showed him the gaps and limitations within County Bancorp’s analytics, and has positioned the bank for improved profitability.

The current expected credit loss standard, or CECL, is a demanding undertaking for banks. Executives are rightly concerned about the time and expenses associated with various aspects of the standard, including data quality, modeling and the impact on the bank’s allowance and potential reduction in capital. But CECL implementation allows banks an unusual opportunity to make significant improvements to their data, internal controls, analytics and modeling. The standard could be an opportunity for many institutions to upgrade legacy systems and approaches. It could also help banks better understand their risk, increase profitability and, of course, proactively reserve.

CECL will require banks to reserve for lifetime loan losses at origination rather than later, when a loan shows signs of impairment. To create a lifetime loss allowance, banks will need to analyze historical loss information to see how those assets perform throughout various economic cycles, and pair that with a future economic forecast that is reasonable and supportable from an audit perspective. The bank would reserve for future losses based on both this forecast and the historical losses for loan durations that go beyond the forecasting period.

Creating a lifetime estimate will require a lot of data. Many banks have mounds of historical loss information that could be useful but will require scrubbing, vetting and backfilling. Chad Kellar, a partner at Crowe LLP, says the firm is seeing a large push from banks to identify credit and data management systems that can aggregate information from different internal systems into a single source. The idea is that bankers can use credit and loss information within this repository to generate a robust portfolio analysis. Kellar says many community banks have adequate systems in place-like an underwriting platform, a credit administrative program or a servicing solution-but the programs and their data are siloed from each other.

“This has presented a big problem,” he says. “Once you work through it, it should be more informative and should produce more real-time risk assessments.”

Stiteley at County Bancorp describes CECL as a “big data grab” exercise and says the firm is going back as far back as it can to gather historical loss information. County Bancorp finished building the reporting templates that it will use to calculate the allowance and now needs to backfill those templates, month by month going back several years, with the relevant information.

“The good news is that myself and my head of [operations]-we’re very data-geeky and are always looking for ways to do things more efficiently,” he says. “This has helped us flesh out even more what we can do going forward. It’s going to take some time for people to change how they mine data and underwrite credit.”

The modeling and extensive use of forward-looking and historical data may motivate banks to add technology enhancements to their current allowance practices. Some community banks like County Bancorp are shifting from an Excel spreadsheet approach to a full vendor solution, which can be an expensive change. However, the additional cost could also provide an opportunity for executives to upgrade, improve or overhaul their data management systems, allowance approaches and internal controls. Crowe’s Kellar says some banks have spent “millions of dollars and invested significant employee time” implementing CECL and updating technologies to facilitate better reporting. He says these bankers take the approach that, “‘If we’re going to do it, we’re going to fix this issue that we’ve been dealing with for years through workarounds. We’re going to do this right.’”

Jonathan Prejean, a managing director at Deloitte, agrees: “You have to do this, so you might as well make the best of it.”

For now, most banks are focused on implementing CECL ahead of the standard’s effective date-which for some is as early as 2020-rather than a return on their investment of time and expenses. Many banks are wrapping up their data buildouts and are preparing for practice, or parallel, runs of their allowances under the CECL standard. Parallel runs will help banks generate their new allowance numbers and show executives how the new standard compares to current practice. Bankers can also use the parallel run to test the robustness of internal controls, make modifications to the methodology, close gaps they identify, and practice reporting and disclosing the new allowance.

Stiteley says County Bancorp is close to running its CECL models and does not expect the new standard to have a “huge” impact on current results.

Canfield, Ohio-based Farmers National Banc Corp. spent 2018 verifying its data and loading it into the model, says CFO Carl Culp. The bank, which had $2.36 billion in assets at the end of the first quarter, opted to use a CECL solution and is now nearing the start of its own parallel run. The bank chose MainStreet Technologies, which is now Abrigo, in part because it had already engaged the company to conduct a loan-loss analysis. (Both MainStreet and Sageworks were acquired by Banker’s Toolbox in 2018. The entire company rebranded as Abrigo earlier this year.)

Stiteley and Cope believe there are ways they can leverage their respective CECL processes to better serve customers and ultimately reward shareholders. Those benefits range from better data to stronger controls to potentially improved profitability.

Culp saw one benefit right away, as his bank created an interdisciplinary taskforce to lead implementation. Many institutions have formed these groups with members of finance, credit and accounting departments to share knowledge and collaborate on their efforts to comply with CECL. Culp says this group showed him the value of “bringing together some of the top people from the organization with different, diverse viewpoints” to share their expertise on CECL. He says they will use the approach for other projects in the future.

Banks also used CECL to enhance their data capabilities and build out better historical loss information. A lifetime allowance hinges on lifetime loss information; using their own data can help a bank save on expenses and potentially provide a more accurate figure, compared to buying the data externally.

CECL implementation showed County Bancorp executives that the institution needs to be better at mining its own information. For instance, Stiteley says the institution does not have a good system to export loan-to-value ratios out of its credit portfolio and is looking at underwriting solutions that will transfer that data to the core processor.

“I think every bank has to have a data champion now-somebody who knows how to get information, digest it and figure out how you can make the bank better by using it,” he says. “[Banks] can have access to so much good information that can make them more efficient.”

That benefit is not just limited to small community banks. Financial Accounting Standards Board member R. Harold Schroeder has heard from larger institutions that implementation of both CECL and the European loan-loss standard improved banks’ data, internal controls and estimation processes.

CECL implementation is also an opportunity for banks to improve the efficiency or accuracy of their allowance methodology. Determining the allowance is not an efficient process for many organizations because of a reliance on spreadsheets or other manual calculations, says Prejean, who works in accounting and reporting transformation. Banks that are shifting entirely to a vendor or are augmenting internal processes with technology have an opportunity to make the allowance more automated, which could improve accuracy.

The financial statements and call reports at Farmers National use asset quality data that was calculated manually on spreadsheets. Culp says CECL will reduce the manual inputs and automate the reporting, which will streamline the preparation of financial statements and improve their accuracy. At County Bancorp, Stiteley expects that efficiency gains will free up credit and finance employees for other responsibilities.

A more controlled, automated process could also strengthen internal controls and a bank’s governance process, Prejean adds. CECL is a principles-based standard, which means that there are many interpretations on how to apply it and “right answers” for banks, he says. Institutions will want to strengthen their controls around their allowance process to ensure there is appropriate documentation for the “reasonable and supportable” future forecast and reversion to historical losses.

“At the end of the day, it’s an estimate. As long as it’s reasonable, it’s hard to say that it’s wrong,” he says. “From a control perspective, if you have $5 extra to spend on CECL, spend it on controls.”

Banks could also use their improved, more comprehensive data sets to increase profitability, and better align pricing and credit risk. Profitability was a factor in Farmers National’s decision to use a vendor, Culp says.

“I think we are going to find that we’re going to be able to do a deeper dive into our various asset categories, and that will help us shape decisions about what type of lending we want to do in the future,” Culp says. “Maybe we wouldn’t have had that prior to adopting CECL.”

Understanding the bank’s profitability was also a concern for County Bancorp, Stiteley says. The CECL process revealed that the bank had little information about how profitable each of its clients were and that its core system was not designed for that kind of analysis. County Bancorp engaged Kaufman Hall for software that can be used for financial reporting, budgeting, incentive compensation and analyzing profitability at all levels of lending. “Going through this whole data exercise helped us identify things that we needed to do better,” he says.

Better data may also help banks assign more realistic pricing on loans based on their risk, says Saul Martinez, managing director of equity research at UBS Group AG.

“Banks have better models, more historical data, they’ve scrubbed the data and they have a more-granular assessment of how different loans perform in different economic environments,” he says. “I think there’s a case to be made that optimizing risk and returns might be an important outcome of CECL.”

Martinez covers the impact of CECL at the largest banks in the country, some of which have published initial allowance adjustments under the standard. He says there are some similarities between CECL and regulatory stress testing exercises required under the Federal Reserve’s Comprehensive Capital Analysis and Review program and the Dodd-Frank Act. Following years of stress testing, a number of large and mid-size banks made changes to their lending based on risk-adjusted returns or the risk weighting. He says other outcomes from the tests included improved systems, controls, data integrity and estimation processes.

CECL could have a similar effect for a broader swath of banks. However, this potential upside comes with costs-some of them quite high relative to previous spending-along with other possible consequences. Adding additional technology to calculate the allowance could grow noninterest expenses, a cost that might be permanent. And the lifetime allowance could lead to changes in business practices that could negatively impact clients. A bank that has experience in making profitable loans with higher than average risk and loss rates may change its business practices or exit the space if reserves and the capital strain under CECL prove to be too high to sustain, Martinez says.

Strong, consistent leadership and support will be vital for banks that are looking to maximize the time and money they spend on CECL implementation. Management needs to talk about the strategic benefits of better data and processes with the employees who are doing the work, says Deloitte’s Prejean. The earlier they do this, and the earlier they start implementing CECL, the better.

That can include attending the meetings. Culp says he told Farmers National’s chief credit officer that he did not need to keep attending the taskforce meeting. Still, the credit officer has not missed one, and told Culp that his attendance demonstrates to his group the importance of the CECL standard and the bank’s implementation.

“When employees see the CECL taskforce-the chief credit officer, the CFO and the chief risk officer attending all these meetings and leading the way through the process-I think that sets the tone at the top for the rest [of the employees] to say, ‘Okay, this really is something that we need to pay close attention to,’” he says.

Bank leadership will also need to have patience as they wait for their CECL investments to produce a return. The priority for most banks now is to meet the standard’s effective date; it may take some time for executives to discover how they can leverage their newly-created data sets and profitability analyses. The potential upside will also be smaller for the smallest institutions, advisors warn. It may not make sense for those community banks to make outsized investments in CECL solutions.

Regardless of any potential upside, all financial institutions need to comply with CECL. But some banks may be able to use the implementation process as an opportunity to strengthen their controls and make better decisions. Those institutions will need to keep their focus on getting a return out of CECL as they make their investments during this implementation period.