CECL: Uniting Two Views on Risk

A major challenge organizations face with FASB's Current Expected Credit Loss (CECL) standard is that both the quantitative and qualitative sides of risk are necessary for successful adoption. Organizations must look not only at the data, but at the story the data tells.

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“Risk is in the eye of the beholder,” says Fiserv’s John Dalton. Dalton, who serves as the financial services technology provider’s Director of Product Strategy Management for Financial and Risk Management Solutions, and Rick Martin, Product Manager for Financial and Risk Management Solutions, sat down with FEI Daily to discuss the attention paid to the standard by bank executives, congress, and even the Federal Reserve Board Chairman, the evolving challenges, data gaps, and where organizations should be in their implementations.

FEI Daily: What are your thoughts on the FASB’s recent rejection of the proposal on loan losses?

John Dalton: The FASB decision was consistent with prior actions from the board, and we continue to work with our bank and credit union clients to prepare for CECL requirements.

FEI Daily: Congress doesn't typically pay close attention to accounting regulation, but in this case it's a little bit different. Why do you think that is?

Rick Martin: If you watch the Congressional Financial Oversight Board discussion, they did talk about their concern that CECL would create procyclicality of any economic environment that did exist. So, in other words, it would double down on an economic downturn. 

There was discussion [at the hearing] about some legitimate concerns that might decrease lending in under-served environments. But, again, it would be procyclical. If there was an economic downturn, the banks would get away from certain types of lending instruments, specifically longer term mortgages, because, under CECL, they're going to have to put aside larger reserves for those loans, and that's not financially advantageous for financial institutions [(FIs)]. There was even a bill introduced designed to prevent regulators from enforcing CECL.

FASB oversees GAAP and they had a round table discussion as a follow-up to the congressional concern. For about five hours, in fact, FASB addressed a lot of the concerns and suggestions that the banks had. It's currently being taken under advisement as to whether or not they're going to incorporate those.

Dalton: One thing that's interesting about FASB's response to the congressional concern is that within that five hours of round table discussion, they spent 20 minutes, and even preceded the round table, by distributing a 16-page document that was a timeline of the hundreds of outreach opportunities that they had made, and all of the previous exposure drafts, and the changes that they had made to best align with the accounting community.

FEI Daily: You recently presented at the CECL 2019 conference. What were some of the landmines you heard from attendees and other speakers?

Martin: Gaps in data. The pronouncement itself is, by design, non-prescriptive. So, there's judgment required in determining what is a reasonable and supportable timeframe to be doing projections. What the economy's going to look like and how it's going to affect their risk and their banks. So, a lot of that is specific to individual banks.

Sharing some of those practices and how they're determining those things in their individual environments is what they were talking about.

FEI Daily: As we are getting closer to the deadline, are you hearing that the challenges have changed from a year ago? Or are you hearing different concerns?

Dalton: We had breakfast with a number of large FIs. It was unanimous that they had all decided that they had been humbled by the challenge of bringing all the data together. And collaborating in a way that creates a stable and sustainable CECL model. We expected that would be a big challenge for smaller institutions with smaller staffs, so that was a little surprising to see.

The good news, though, is that a lot of the thought leadership and outreach from industry periodicals like yours have made the point that, across the board, FIs have to capture their data. So, now a year advanced, I'm happy to report that that's been a good thing. 

American Banker, not too long ago, covered the congressional hearings, and said that even though no changes had been made to the accounting standard or the implementation thereof, about fifty percent of CECL adopters had done nothing more than capture the additional data.

Much work remains. And I'm not assigning that work to any one group of people. Much work remains for all of us. The technology providers too.

Martin: To add for context, that fifty percent is almost entirely the national institutions that aren't going to have to comply until 2022. But, yes, the large banks are well on their way towards solving CECL.

FEI Daily: Most people see CECL as a standard for banks.  How do you think this standard will affect non-banking companies? Are their challenges the same? 

Dalton: Well, the application remains the same. Obviously, banks and credit unions are  flocking together to compare notes and come up with things that are  consistent, though since it's principles-based, everybody has to make up their own implementation on their own, which makes people a little nervous.

But for the non-regulated FIs, one good example that's gotten a lot of press lately is payment companies or credit card companies.

A credit card is a payment device. We all carry it. In the past you might stratify those based on size of line of credit or by credit rating, but we need a lot more granularity now, and particularly around the behavior. The industry, not FASB, but the industry is starting to develop some new vocabulary. The important terms that the industry is coming up with is revolvers versus transactors. So, do you use a credit card as a transaction device and then you pay it off? Do you use it for the points or just to not use your own debit card or expose your own accounts? Or you do carry a balance and treat it like a revolving line of credit? 

That risk behavior would also apply to the retail industry, who are also card issuers. Where I think the retailers who are issuers have an advantage over the broader,  market would be that they have more behavior that's available. More data around spending habits, particularly around their own retail vertical. The question is what's the entire body of knowledge around our asset base that I can bring to bear here?

The good news is there's lots of data available. The bad news is neither FASB nor the regulatory agencies are going to tell you exactly what's needed.

There are people who are embracing this idea of homework that’s been assigned. We can either go for bare minimum or we can use this as an opportunity and embrace the challenge, bringing people together within their organizations that probably weren't spending time together in a joint risk management capacity. So, there are a handful of people who are bright-eyed and actually excited about the opportunity.

FEI Daily: Who in the organization leads CECL implementation? Who should make up the team?

Dalton: It really depends. 

Martin: It varies because you're marrying risk and accounting now. And those two groups had previously worked autonomously.

FEI Daily: And how about IT?

Martin: Yep. We're bringing them in.

FEI Daily: Because of the data element?

Martin: Oh, absolutely. And all the governance and the new internal controls they're going to have to implement to oversee IT with all this new data.

FEI Daily: Have you seen that done successfully? What's the recipe that works?

Martin: There's not a recipe, unfortunately. It depends on the size of the institution, where the risks are and the culture of the institution.

The first step is put your team together and bring in IT and even marketing, because you're going to have changes in strategic direction based on the results, likely. And the costs associated in accounting and risk. 

Dalton: It’s the human factor. It's social. The CECL concept is evolving beyond the data and people are realizing that risk is in the eye of the beholder. Often times, your financial risk folks will go to what they're comfortable with. A quantitative analyst is going to build a model and is going to solve for as much of the risk as possible. You have economic forecasts and so forth, but they'll take a confidence interval, and build scenarios, and weigh those scenarios, and do lots and lots of math, and come out with a number or a range of numbers.

But others, like your reporting risk folks - it might be your controller side, the people who are pulling your financial statements together - think in terms, not just of the data but also of the disclosures. How do I account for everything that my company has done in a way that's transparent and consistent and compliant?  There is a lot of room for narrative and qualitative adjustments. The neat thing about CECL and the challenging thing about CECL is that both are required.

In prior events, where you had the stress testers, they could take all their data in a room with some bags of Cheetos and Red Bull and create a stress test, and come out with some numbers. Hand it to management and they would run the organization. Meanwhile, the credit and accounting risk folks would go in a different room. They would take the input of that data, think through how to tell the story in a way that resonates with investors and other stakeholders like their bank or other issuers of credit to the company. And then, they would create their disclosure. 

Now, you have the quantitative piece of your reserve and a qualitative piece. Because we've been in a growth economy for almost an unprecedented length of time, many of these institutions don't have enough losses in their history to generate a sizable quantitative piece. And even if they have the 15 years of history, they go back before the '08 downturn, you have to test you assumptions there and ask, ‘Is the last one really going to be like the next one?’

And so, that quantitative piece is only a portion of your whole reserve. But if you ask a quantitative person, they're going to say, ‘These are my assumptions. This is my confidence interval. This is my answer. If you ask a credit officer or a reporting risk person, they'll say, ‘This is my story.’

Socially, you had people with different biases walk into a room to talk about risk. They're using the same word, but their backgrounds lend themselves to be good at different parts of it. Some team building is probably in order. 

Martin: There were half a dozen Federal Deposit Insurance Corporation (FDIC) regulators at the conference. During one of the presentations, they were actually asked, ‘Do you think you could lend some insights here?’ And they said, ‘Thanks, no. We're here to learn too.’ So, the regulators are learning right along with the rest of us. And the auditors, too. It’s symbiotic. The banks are sharing what they learn with the auditors. The auditors are learning and re-sharing that. It's a fascinating process.

FEI Daily: Do you think non-banking companies are giving CECL the attention that it deserves? Last year certain industries may have been in denial about CECL affecting them.

Martin: Five stages of grief? Something along those lines? I think the folks that have a financial focus are paying attention. We've got guys in insurance companies and credit card firms. But it's GAAP accounting, so it's going to apply to every company that adheres to GAAP. If you've got credit on your balance sheet, you have to comply with CECL.

Dalton: Word is getting out and I think people are picking up on this.

Martin: It's not going to impact them to the level that it impacts FIs, because that's where we make our living. But, yes, they're going to have to comply, and they're going to have to address CECL.

FEI Daily: Would you say that, generally speaking, organizations are where they should be in their implementations?

Martin: The short answer is no. The large SEC public filers, especially the ones that have gone through IFRS 9 have a pretty good handle. They're beginning to run parallel calculations. They're pivoting, and modifying, and tweaking based on those results.

The smaller financial institutions and the non-FIs that'll have to comply have a long way to go. Hopefully, they're storing their history now so that they'll be more prepared when these details actually get thrashed out. 

FEI Daily: I know a big issue is aggregating all of the data you need. Is data quality an element of this? 

Martin: Well, we've discovered that approximately 100% of our clients have gaps in their data. Troubles with their data history.

Dalton: Give or take.

FEI Daily: The gaps in data could be a symptom of disparate systems? Any other reasons?

Dalton: There’s also the human element of data. If you combined three or four entities, one may have a highly organized, detail-oriented history accumulating chief credit officer, and they might have 15 years of lots and lots of detailed data about every one of their instruments. While another, in some of the older institutions, you may even have paper files. Whenever you acquire a company, you have the cost benefit analysis to figure out.

You have to think of all of the history that brought each piece of the company, and the leaders of that history, and the circumstances that brought that company in. It’s complicated. But the good news is, we are where we are. Capture from here, identify where you have those gaps, work with people.

Martin: And the examiners are going to want to see activity toward resolving gaps. Not a clean bill of health, but they understand that.

FEI Daily: Are organizations turning to outside resources and vendors or are they pretty capable on their own?

Martin: The large banks have the resources to do it. They have PhDs on staff to do quantitative analytics going forward. They've got archives of data going back 20 years with data warehouses. But, to fill those gaps, they may still be looking for certain types of information. 

Certainly, the smaller financial institutions are going to need to be filling those data gaps with external data, and reaching out to the Federal Reserve for economic data, or to third parties to supplement their projections. 

We’re tasked with taking this large CECL animal and scaling it to make it palatable for smaller financial institutions, which is the lion's share of the Fiserv customers: the non-public business entities.

The smaller guys will certainly be using third-party help. But the bigger guys, in my experience, have the resources to go and do it internally.

FEI Daily: Any advice you want to offer those who are falling behind?

Martin: Get started early, err on the side of gathering more information rather than less, especially when it comes to loss history, and  keep strategic use of that data in mind as the long-term goal. 

Dalton: I would say keep an eye on the human factor, also. Because every organization probably has the root skillsets to solve this, but they can't solve it in the silos. When you bring those silos together to collaborate, be conscious of their biases as they come to the table, and also be conscious of their fears. The math isn't enough. You have to have the narrative to explain how you got there and where you think you’re going. As we get more people engaged, and they come from different backgrounds, those differences will yield collaboration and a better final answer.