2017 CECL Survey of Financial Institutions Lenders Find Transitioning. to CECL a Complex Process. By: Shane Williams Senior Advisor MST Advisory

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1 2017 CECL Survey of Financial Institutions Lenders Find Transitioning to CECL a Complex Process By: Shane Williams Senior Advisor MST Advisory John C. Closs EVP MST

2 2017 CECL Survey of Financial Institutions Ever so surely, the CECL deadline approaches. Publicly traded lending institutions will start estimating their allowances under the new current expected credit loss accounting standard for fiscal years beginning after December 15, 2019, privately held, December 15, FASB provided such considerable time to prepare for implementation because of the challenges involved famously stating, this is not a tweak and lenders who have started addressing the transition understand it is neither a simple nor easy process. FASB Timeline of CECL Implementation Dates For Fiscal Years Beginning After: Dec Early Adoption permitted Dec Effective Date: PBEs that are SEC filers Dec Effective Date: PBEs that are not SEC filers and all others Mar Regulatory reporting for early adopters Mar Regulatory reporting for PBE SEC filers Mar Regulatory reporting for PBEs that are not SEC filers Dec Regulatory reporting for Non-PBE Non-SEC *Assuming calendar year filer. Rather, it is complex and burdensome, starting with developing a CECL implementation plan, then assessing the available amount and quality of data needed for estimating expected losses, then pooling loans, then choosing one or more estimation methodologies that accommodate the institution s lending products and portfolios and limit its financial, operational and regulatory exposure. It is a demanding task, timeconsuming and not inexpensive. So how are banks and credit unions progressing in their journey toward CECL compliance? Allowance solution provider MST used its annual lender survey to find out. Distributed in February 2017 and responded to by financial institutions collectively doing business in all U.S. states and territories, the survey reveals that almost all institutions, 95 percent of the respondents, have started doing something to prepare for CECL. However, few have yet to make substantial progress. In our 2015/2016 survey we learned that lenders were assessing how to prepare for CECL, looking for the direction they need to get started, noted MST CEO Dalton T. Sirmans. Now they have started the process, if only the earliest stage, meeting internally with the people and departments expected credit loss will impact to discuss their transition and plan their path to CECL compliance. Respondents to the MST 2017 CECL Survey run the institutional gamut, evenly split between public and private, more than half in the $1-5 billion in assets category with another 20 percent with greater assets. Almost all market a wide range of loans commercial, consumer, CRE, construction, land development, nonoccupied real estate the biggest percentages offering CRE and commercial, 97 and 93 percent respectively. 2

3 Respondent Demographics What is the total asset size of your financial institution? Institutions doing business in all 50 U.S. states and Puerto Rico and U.S. Territories Over 50 billion $ 20 billion to $50 billion Under $1 billion 3.16% 4.21% $10 billion to $20 billion 25.26% 8.42% 5.26% $5 billion to $10 billion 53.69% $1 billion to $5 billion Who is your primary regulator? NCUA How is your institution classified as a business entity? FED 10.42% Private Public 17.71% 48.96% 38.78% 42.86% OCC 22.91% FDIC Non - PBE 18.36% 3

4 Loan Segmentation For the purpose of estimating the allowance, how are your loans segmented? By loan product type 82.80% By collateral type 50.54% By risk rating 48.39% By geography 20.43% By origination vintage 11.83% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 4

5 Loss Emergence Period Do you use a Loss Emergence Period (LEP)? Yes 31% No 69% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Under CECL, the use of a Loss Emergence Period should go away because you are looking at the entire life of the loan. Chris Emery, MST Senior Advisor If you use a LEP, for what loan types? Commercial loans 93.10% CRE loans 96.55% Multi-family loans 75.86% Commercial leases 41.38% A & D loans 68.97% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 5

6 Progress Towards CECL How would you describe your progresss in preparation for and transition to CECL? We have yet to begin preparation 5.10% We are having internal discussions/ meetings 86.73% We are testing potential CECLcompliant methodologies 15.31% We are evaluating third parties to assist us with CECL 36.73% We have completed our transition process and are ready for our first CECL allowance estimation 1.02% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Clearly, by now, the public companies should be building and testing CECLcompliant methodologies Dorsey Baskin, MST Senior Advisor 6

7 In 2016 the number of respondents not preparing for CECL was 23% versus 5% in 2017, so there is forward momentum in CECL preparations. Engagement by Asset Size Asset Size Internal meetings Looking at 3rd parties Testing methodologies Haven t started Ready to go < $1B 87% 39% 17% 9% 0% $1-5B 86% 31% 14% 4% 2% $5-10B 100% 50% 0% 25% 0% $10-20B 100% 50% 0% 9% 0% $20B-$50B 67% 33% 100% 0% 0% 7

8 What departments of the financial institution are involved in your CECL preparations? Accounting 91.40% Audit 34.41% Board of Directors 24.73% Chief Administrative Officers 40.86% Lending 68.82% Operations 31.18% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Discussion regarding possible concerns for CECL implementation, education, and allowance impacts will be a starting point for identifying those who will be involved. Dorsey Baskin, MST Senior Advisor 8 CECL s impact will extend well beyond the allowance so institutions should organize a committee with representatives from affected departments to study CECL s impact. A CECL Steering Committee should be a multi-functional group, though the departments involved will vary from institution to institution. The vast majority of survey respondents, 86.6 percent, are in the earliest stage of CECL preparation, that is, meeting internally, bringing together individuals and departments that will be impacted by CECL, including some who never before concerned themselves with the allowance, to discuss CECL s implications and begin charting a path toward compliance. Those meetings universally include accounting and lending personnel. A third of responding institutions have invited people in operations and auditing into their discussions. But only 41 percent include a chief administrative officer and less than one-fourth, a director. Thirty-seven percent said they are evaluating third parties for help en route to a CECL solution.

9 Data for CECL Estimating CECL will require more historical data than required by the incurred loss standard. Where is your institution in collecting and assessing the data? We currently have sufficient data 19.39% We are compiling internal data and will work with what we have at implementation date 30.61% We are compiling internal data and assessing the quality of our in-house data to see if we have sufficient good data 53.06% We will need more or better data than we currently have or can compile by implementation date We are unsure if we have sufficient quantity and quality of data to estimate under CECL 17.35% 19.39% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Not having the data is an enormous issue since you analyze the data to forecast the future. If you have a small amount of data or only a short period of data and there is an unusual event, you end up with a distorted forecast due to that unusual event. Lender Voices. There may be some consideration for pricing/ term trade-offs to customers. A shorter term may get a rate discount. 9

10 Types of Data Being Collected by Respondents Name Responses Origination date 97.8% Loan type 95.7% Loan number 94.6% Charged-off principal 94.6% Current unpaid balance 93.5% Current interest rate 92.5% Loan maturity date 91.4% Maturity date 91.4% Borrower name 88.2% Balance at origination 87.1% Charge-off & recovery information (loan number, transaction date, charge-off amount, recovery amount) 87.1% Commitment amount at origination 87.1% Collateral code 86.0% Current book balance 86.0% Current days past due 84.9% Interest rate type (fixed or variable) 83.9% Risk rating (all changes and dates of changes) 83.9% Renewal date 80.6% Current undisbursed commitment amount 77.4% Interest rate at origination 76.3% NAICS industry codes 71.0% Number of times delinquent (30+ days, 60+ days, 90+ days, etc.) 71.0% LTV (original, current, date of last change) 69.9% Purpose code 68.8% Call report code 67.7% Borrower number 64.5% Date to non-accrual 64.5% Non-accrual interest applied to principal 63.4% Property type 63.4% Extension date 61.3% Credit score (all changes and dates of changes) 59.1% Government guaranteed balance 52.7% Class code 51.6% Default information (loan number, date of default, default reason, balance at default) 47.3% DSC (original, current, date of last change) 38.7% NOI (original, current, date of last change) 30.1% Group code 26.9% 10

11 How many years will you go back to gather data? 1 year 1.02% 2 years 6.12% Comparison of 2016 / 2017 Responses 2016 Responses 2017 Responses 5-7 years 29% 36.73% 3 years 8.16% 8+ years 14% 27.55% Unsure 25% 12.24% 4 years 5-7 years 8-10 years 8.16% 21.43% 36.73% As CECL inches closer, more financial institutions see the need to increase the length of their look back periods: 64% foresee greater than 5 years compared to 43% indicating more than five years in our 2016 MST survey. More than 10 years 6.12% Not sure 12.24% 0% 10% 20% 30% 40% Much of the talk about CECL has focused on the data a lender will need to support a CECL compliant methodology not just more data but better quality data, more accurate and more consistent. Only 20 percent of respondents said they currently possess sufficient data; more than half are trying to find out; 18 percent already know their data is insufficient. Safe to say, institutions must assemble data in many fields, substantially more than required to comply with the current incurred loss estimation model. And from substantially farther back in their loan histories. Responses also indicate how complicated the data gathering process can be. More than half of the 41 data fields listed in the survey were being targeted by more than half of the respondents. 11

12 Expected Outcomes Do you think CECL will increase or lower your reserves? Stay about the same 29.90% Lower 4.12% 65.98% Increase Comparison of 2016 / 2017 Responses 2016 Responses 2017 Responses Increase 93% 65.98% Decrease 7% 4.12% Stay about the same 29.9% Is it wistful thinking or more knowledge about the new accounting standard that is making lenders more hopeful than they were in 2016 that CECL will not change their reserve amount? Institutions of $10-20 billion in assets are more hopeful than smaller lenders in that 37 percent predict CECL won t cause a change in their allowances. But overall only 4 percent of respondents said they thought their reserves would decrease with the implementation of the new standard as compared to 7 percent in Lender Voices. While costs will increase initially, the improved information will reduce loss exposure in the future. 12

13 How else do you expect CECL to impact your institution? Increase cost of compliance 68.37% Increase complexity of compliance 84.69% Increase demand on internal resources, including staff 83.67% Change the types of loans we make 9.18% Have substantial negative impact on profitability 6.12% CECL will reduce our loan losses 4.08% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Institutions with under $1 billion in assets are the most concerned about the cost and complexity of complying with CECL. While institutions $1 billion to $5 billion are equally concerned with complexity and demand on internal resources. Lender Voices. I m concerned that capital will be more volatile. 13

14 Methodologies What ALLL methodology do you currently use? Historical Loss 88.54% Migration Analysis 26.04% Cash Flow Analysis 7.29% PD/LGD 12.50% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 14

15 What reserve methodology are you considering for use under CECL? Historical Loss 45.36% Migration Analysis 44.33% Cash Flow Analysis 14.43% PD/LGD 37.11% Vintage 36.08% Cohort 12.37% Haven t identified potential methodologies yet 35.05% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% The ultimate goal in preparing for CECL is the implementation of one or more expected credit loss methodologies. Most lenders are not far enough along in their transitions to make such choices, but survey responses indicate choosing will be more difficult than how they decided on an incurred loss methodology. Nine of ten respondents currently employ a historical loss approach as their sole or primary methodology. But with CECL, the options range far wider with respondents considering a mix of historical loss, migration analysis, probability of default/loss given default, vintage and cohort methods. Lender Voices. Concerned that there will be more arguments with auditors unfamiliar with the process. 15

16 Tools for the Allowance Which of the following is the primary tool you currently use to estimate the ALLL? Which of the following will be the primary tool you plan to use to estimate the allowance under CECL? 100% 100% 90% 90% 80% 80% 76.53% 70% 66.33% 70% 60% 60% 50% 50% 40% 33.67% 40% 30% 30% 23.47% 20% 20% 10% 10% 0% Excel Software solution 0% Excel Software solution 16

17 Sixty-seven percent of respondents use Excel to estimate their allowances under current GAAP; 76 percent say they will employ a software solution other than Excel to comply with the new CECL standard. Conclusion The ABA Journal says, bank regulators have described CECL as the biggest change to bank accounting ever. And financial institutions are beginning to take that to heart. Estimating the allowance based on expected credit losses is something very different from the way allowances are calculated today, but most lenders aren t yet sure how their processes will change or what will result from their first CECL estimation just a few years from now. Most institutions have at least begun internal discussions of how to go about getting ready and are reviewing and compiling data. Lenders show the most concern with increased complexity of compliance and increased demand on resources, including staff. 17

18 Further Reading FASB Issues Final Loan Loss Accounting Standard, June 16, 2016 ABA Journal Seven Steps 2.0- whitepaper detailing seven steps to CECL-compliance 4 Methodologies to Consider under CECL 18

19 About the Authors John C. Closs is EVP of Atlanta-based MST (MainStreet Technologies, Inc.) developer of loan portfolio risk management software and leader in education on the allowance for banks and credit unions. Shane Williams is Senior Advisor for Modeling with Atlanta-based MST Advisory Services providing a comprehensive set of ALLL and CECL advisory services and software solutions. Tailored to the financial institution s needs, Advisory Services address all aspects of the allowance, including projects required for a successful, efficient transition to estimating under the Current Expected Credit Losses (CECL) standard. About MST Since 2005, MST has implemented technology solutions and provided subject matter expertise to help financial institutions simplify and sophisticate the way they manage loan portfolio risk. MST is the leader and pioneer in allowance software solutions, advisory services and education. Financial institutions across the U.S. employ MST to address their allowance requirements, including their transition to and ongoing compliance with the CECL accounting standard. MST solutions are tailored to meet lender-specific data management needs and integrate with core and other data and risk management systems to exponentially improve efficiencies. **The information contained in this and other MST white papers is intended to provide insight and support the financial institution s efforts to make appropriate ALLL determinations. However, it does not constitute regulatory policy, nor is intended to replace the exercise of appropriate judgement and analysis of actual circumstances by financial institution management. Copyright MST (MainStreet Technologies). All Rights Reserved. 19

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