The painstaking regulatory and reporting burden that has plagued consumer and mortgage lending for decades is coming to the world of commercial lending fast—and its name is CECL (Current Estimated Credit Losses, pronounced like the name “Cecil”).
The name Cecil means “blind,” which is ironic, because FASB’s upcoming guidance will push FIs to clarify the future performance of their loan portfolios by using models to predict CECL of all loan portfolios. Achieving this objective for commercial portfolios is virtually impossible, however—in the short term, at least—due to the lack of useable data to produce any model with statistical relevance.
The key word here is “useable.” Banks have data on their commercial portfolios, it’s just not useable because:
Banks need to establish plans to ensure that they maximize the value of the CECL effort. Approaching CECL from a singular vision of estimating credit losses on commercial loans for just Allowance for Loan and Lease Losses (ALLL) reporting is a waste of time. While banks will work to comply with the FASB guidance, this major effort has the opportunity to be much more far-reaching and provide greater vision and overall benefit in risk assessment and forecasting than ever before.
The typical formula to estimate future credit losses is as follows:
PD (Probability of Default)
X EAD (Exposure at Default)
X LGD (Loss Given Default)
= Current Expected Credit Loss
In addition to CECL, this model can be beneficial for:
The bank’s credit group needs to lead two concurrent efforts: 1) collect the data, and 2) develop the model framework.
It’s a framework because without sufficient data, banks are left to make educated guesses as to which factors to include and the overall weight of each of the factors in calculating future estimated losses.
As banks start the data collection process, they will quickly realize that, in the commercial line of business, data is stored in Microsoft platforms (Word, Excel, Access), financial statement spreading platforms (Moody’s, Baker Hill), ticklers in core accounting system, and in paper files.
This makes it virtually impossible to export the data into a single platform or data warehouse. To make matters worse, banks need to link the information not only to individual borrowers but to related entities (such as guarantors, owners, and affiliated companies).
In order to incorporate the model into the daily operations, banks need to associate the CECL model with a commercial loan origination platform. That’s no easy task, either.
Loan origination platforms differ greatly in terms of functionality regarding CRM, statement spreading, loan documentation, and other functions. CECL adds another level of required functionality.
Banks need to challenge their vendors to develop capabilities for CECL data collection, modeling, and analytics. Banks undergoing commercial loan origination system selections should make sure CECL is part of the requirements. For banks not planning on a new commercial LOS, 2016 might be a good year to start the process given this could become the foundation for all things CECL.
The worst thing a bank can do about CECL is wait. Don’t wait for CECL to become adopted; don’t wait for some point in the future where you might have more capacity. Don’t wait for some miracle technology platform to appear that will suddenly have all the data you need. Open your eyes and get started on the hard work of data standardization and model development!
Cornerstone Advisors can help. We’ve guided hundreds of financial institutions through technology assessments, system selections, and system conversions, and we have the vendor knowledge and expertise to help you make educated decisions about your commercial loan origination systems.
Contact us today to learn more.