For many financial services organizations, 2023 was the first year of adoption for the new credit loss accounting standard (CECL). While many organizations have already spent years researching and testing vendors, updating policies and procedures, and comparing calculated reserves to those under legacy methods, the need to continue to evaluate and refine their current calculations does not go away.
These efforts are even more imperative as auditors, regulators and other stakeholders become more familiar with the new standard. Financial services organizations must ensure they continue making appropriate changes as needed and continue enhancing their existing processes to align with industry best practices.
Actions to Take
Following are some of the lessons learned over the past year, including recommendations for board members and management:
- Ensure appropriate internal controls — including policies and procedures, assumptions, and review of data input — are in place. While many existing controls were applicable to CECL, updates are needed to ensure significant new areas are being addressed and monitored appropriately.
- For some organizations, documentation of reserves for held-to-maturity investments and unfunded commitments needed to be enhanced or considered. While the reserve for these two areas was often immaterial, management is required to have documentation supporting that determination. Additionally, the assumptions in these calculations — specifically, the expected usage of unfunded commitments — should continue to be reviewed and challenged.
- Strengthen documentation of qualitative factors used (or the lack of a factor) to ensure the documentation captures any risk (or lack of risk) in an institution’s portfolio that is not included in historical loss data. Changes made to factors during a period should be formally documented with the appropriate rationale and support for the change.
- Document supporting methodology decisions and validate the accuracy of the raw data and modeling outcomes. This is important because reliance on third-party vendors and applications doesn’t diminish management’s responsibility. This documentation should be reviewed and updated regularly to ensure the current vendor and methodologies are appropriate for the organization. A robust analysis should be performed and documented, supporting the decisions made in the continued use of a vendor and methodology.
The Bottom Line
Internal controls are more important than ever, and board members ultimately have oversight responsibility. Consider the consistency and accuracy of manual processes for data compilation and input, as well as the consistent application of model settings for calculations. Carefully review the accuracy and reasonableness of assumptions in model settings, such as portfolio segmentation, lookback and forecast periods, prepayment projections and economic factors. Challenge your current methodology to ensure it is appropriately capturing the current and expected losses over the life of your loan portfolio.
As CECL continues to evolve, make sure you have the procedures and controls in place to evolve with it.
For a detailed review of your financial institution’s policies and customized guidance on steps that will strengthen not only CECL compliance but also the resilience of your portfolio, contact Kevin Frank at [email protected] or talk with your Rehmann advisor.
