LIFE AFTER “CECL”

If you have not heard…”CECL” stands for Current Expected Credit Loss, and is a “new” accounting standard (ASC 326-20) for estimating losses due to credit risk on financial assets held at amortized cost. CECL was effective for most financial institutions as of January 1, 2023.

But now that CECL has “come and gone”, below are key considerations and potential impacts your institution should be focusing on or should already have in place going forward as it relates to your CECL model:

C – Corporate Governance

With any model, overall corporate governance and model governance is critical to ensure integrity in the process as well as the outcomes. Institutions should have a framework in place to govern this process and the overall model, including the examination of model documentation, internal control processes and polices, and Board/Management oversight. Examples of governance examiners and auditors may expect include: a Board-approved CECL policy, documented internal control framework including identification of key controls, Board oversight (including periodic review and analysis of model outcomes), management’s ongoing analysis of model output, and documented back-testing and stresstesting scenarios.

E – Expectations

As previously noted, examiners and auditors will focus on key attributes of your CECL Model, including:

1. Model and Corporate Governance,

2. Model Design and Assumptions, and

3. Model Execution

While these functions are the responsibility of management and the Board, an independent CECL model validation will provide an objective assessment of overall model design, output, and internal control processes supporting the model. As a general rule, internal audit scoping is more limited in scope, focusing on internal controls and polices rather than a comprehensive evaluation of the model.

Institutions should be familiar with the Federal Reserve’s Model Risk Management (MRM) guidelines (SR 11-7). Recent (April 2023) Interagency guidelines also strongly recommend an institution’s CECL model be validated on an on-going basis. While frequency is not prescribed in the guidance, a 12-24 month timeframe may be considered reasonable assuming no major assumptions or model changes were implemented since the last validation. For significant changes to model design or methodology, management should consider the need for an updated model validation.

C – Continuous Training

For adoption of any new major accounting or regulatory standard, on-going training for those involved is critical. While initial training on the CECL accounting standard and model has been a common industry practice leading up to adoption, regular and consistent training is essential to ensure well-functioning model utilization. As your institution’s CECL implementation progresses, your model will likely undergo periodic updates and create the need for on-going training. Just as CECL is based on a life of loan concept, why not have training over the life of the model?

L – Limitations

Institutions need to be aware of limitations within their model. The accounting standard does not prescribe a specific methodology at the institution or segment level. As such, all methods should be considered, and ultimate selection based on the nature and profile of the institution’s loan portfolio.

Possible limitations institutions should consider within their CECL model include:

1. Does the model have a Held-to Maturity (HTM) investment module to estimate lifetime losses of the portfolio?

2. Does the model require significant manual overrides and inputs?

3. Does model access, documentation, and support facilitate independent evaluation and/or validation?

4. Does the model have a built-in forecast module, or is the institution required to provide their own forward looking adjustments/projections?

In conclusion, CECL implementation calls for a robust system of Corporate governance, addressing Expectations related to accounting, audit, and regulatory guidelines, adopting a program of Continuous training, and understanding the inherent Limitations specific to your model and methodology.

Andrew Shear, CPA,

Engagement Manager Brown Edwards