CECL – Post Adoption Considerations

Over the last ten years, financial institutions have discussed and debated the Current Expected Credit Loss (CECL) accounting standard. Many of the larger financial institutions adopted the standard in 2020 with the majority of smaller, community financial institutions adopting on January 1, 2023. With adoption behind us, here are some items to consider during 2023 to position your financial institution for success in your next regulatory exam or external audit.

• Prepare a CECL Adoption “Package”

When your regulators and auditors arrive in 2023, they will likely be asking about your CECL implementation process. We recommend preparing a package to include the following:

• Board Approved Allowance for Credit Losses (ACL) Policy
  • Initial Adoption Calculation
    • Ensure this includes consideration of Unfunded Commitments (recorded as a liability on the financial institution’s balance sheet) and Debt Securities, both available-for-sale and held-to-maturity
    • Also include the financial institution’s narrative to support the CECL calculation, which should include a summary of the selected model/methodology, assessment of Qualitative Factors and Forecasting, and a summary of any individually evaluated loans
  • Initial Adoption Journal Entry – Ensure this is reconciled to your CECL calculation and the journal entry has been properly reviewed and approved.
  • Third-Party Vendor Management Documentation and CECL Model Validation – See below for more information.

• Third-Party Vendor Management

If your financial institution is using a third-party vendor for your CECL calculation, you should document vendor management considerations over this calculation annually in accordance with your financial institution’s vendor management policies and your primary regulator’s guidance. Your documentation should also include the procedures taken to gain comfort over the third-party’s calculation, obtaining a Service Organization Controls (SOC) report for the calculation, and a CECL model validation for the third-party calculation. We also recommend obtaining any support from the vendor to assist with articulating the math behind the calculation and a recalculation of the ACL on an individual loan basis.

• Perform Back-Testing during 2023

As the financial institution’s CECL model “ages” in 2023, management should document back testing of the of the model to ensure it is functioning as expected. This should include comparing estimated data points in the calculation to actual results – including prepayment speeds, loan charge-offs and recoveries, economic data points, and loan balances. The financial institution should consider sensitivity or stress testing of the model and analyzing how changes to various scenarios or assumptions would impact the loss estimates. Performing the above can aid the financial institution in understanding the model and how it is impacted by estimates and varying economic results.

• Add CECL to the 2023 Internal Audit plan

The CECL model, like the historic incurred loss model, should be subject to the financial institution’s’ internal audit plan. This internal audit program can include a review of the policies and procedures, gaining an understanding of the model, reviewing the assumptions in the model for reasonableness and consistency with other financial institution assumptions, and a review of the model access. It should also include procedures ensure the calculation is appropriately reviewed by management and governance.

• CECL Model Validation

As discussed in the Final Interagency Policy Statement on Allowances for Credit Losses (the Interagency Statement), a model validation is an essential element to a properly functioning process. Per the Interagency Statement, validation activities include evaluating and concluding on the conceptual soundness of the model, including developmental evidence, performing ongoing monitoring activities, including process verification and benchmarking and analyzing the model output. The CECL model validation should be performed by an individual or firm that is independent from the design, implementation, operations and ownership of the model. In addition, the Interagency Statement states the external auditor of the financial institution may impair their independence if they also perform the CECL model validation. 

During conversations with financial institutions over the last year, the CECL model validation topic is a frequently overlooked part of CECL implementation. If you would like to hear more about this topic on a deeper level, CLA is hosting a complimentary webinar on CECL model validations on March 8, 2023 at 11am CST.  You can register for this complimentary webinar here.

Completing the items listed above should set your institution up for success in your next exam or external audit.

How can we help?

CLA’s Financial Services Group is filled with experienced professionals, here to assist your institution with your pre and post CECL adoption needs. In addition, we did a full series of blog posts on CECL in 2021. See the first blog post from July 2021 here. As a reminder, don’t forget to register for our complimentary CECL Model Validation webinar on March 8, 2023.