Written by Luis Valente, CEO LogiqTree
Community banks can start by evaluating their allowance for loan losses process, not just the computation itself, but also the identification and documentation of individual ‘troubled’ loans as well as the overall process.
If you are familiar with the popular books or the HBO series “Game of Thrones,” you are probably familiar with the phrase “Winter is coming.” In the show, the characters show their concern about the approach of winter with dread and doom from the inevitable dismay that this otherwise regular weather event will have on their lives.
Now, I am not suggesting that internal or external auditors or examiners will turn into White Walkers on the advent of the issuance of the new credit losses pronouncement, nor am I expecting to see, although slightly more probable, the accounting profession, the examiners and bankers involved in a convoluted plot to conquer the iconic iron throne from King’s Landing.
Yet, the phrase ‘CECL is coming’ does resonate with the sense of anguish and despair overheard through the financial services community. Yet, is this fear founded on logic? As humans, we tend to be frightened by the unknown, and the new credit losses pronouncement contains plenty unknowns. The exposure draft, more commonly known by its acronym CECL (Current Expected Credit Losses) was published and open for comment during 2013. My company, LogiqTree submitted our perspective on the proposed changes, found on the FASB website at http://bit.ly/banqlogixCECLopinion
Despite the expected improvements that CECL may bring, it also carries a series of uncertain consequences, potentially complex calculations, subjective estimates and burdensome documentation requirements. So what are banks to do? There is little that can be done specific to the individual calculations, at least until the FASB and the regulators provide more specific guidance on the matter. Certainly you could start developing a methodology based on the draft and while probably reasonable, the interpretation given to the authoritative guidance will either corroborate the methodology or highlight holes in it. If history has taught us anything is that the latter scenario tends to be the most realistic, especially for community banks burdened with the same set of heavy compliance requirements as large institutions but expected to be achieved with limited resources.
So what else can a community bank do? Community banks can start by evaluating their allowance for loan losses process, not just the computation itself, but also the identification and documentation of individual ‘troubled’ loans as well as the verall process. The new credit losses pronouncement removes the threshold of probable loss in its definition of impairment. Therefore,
it will fall on management’s determination to properly and consistently identify those troubled loans that require a specific impairment analysis compared to a pool based approach, if any. As part of that process management must ensure that its ocumentation is consistent, including documentation of completion, review and approvals. Further, that the process includes
sufficient controls to ensure proper classifications, maintain accurate version controls and consistency across the board.
Ultimately, because the economy continues to recover since the bottom of the recent economic crisis, the scrutiny over the ALLL process may have shifted to other areas of risk such as BSA, vendor management, Capital rules and IT security. However, the fact remains that once CECL arrives, the focus will be directed back to the allowance process and any potential weaknesses currently undetected or dormant at this stage will come to you with a vengeance. The old, “we’ve always done it this way and they never said anything” will not provide much protection.
Further, it is important to keep in mind that although the regulators may not harshly criticize your ALLL process nor make it the focus of a MOU, Consent Order or C&D, it does not mean that the process is adequate. The ALLL process may not be operating effectively or as efficiently as it should and it may be prone to issues or other inadequacies.
You can plan for the winter and take the time now to ensure your ALLL process is cohesive and efficient. It is important to be able to trust and rely on your officers handling the loans as your first line of defense. They should participate in the
ALLL process as an effective means to identify troubled loans. It is important to ensure your documentation standards are sound and that your information stands on its own to support every decision you make on the loan. This will allow you to focus on the computations and other uncertainties generated by the release of CECL and avoid being overwhelmed with the regulatory weaknesses that have been dormant for many years.
You cannot stop Winter, but at least you can prepare for it. CECL is coming.
Written by Luis Valente, CPA and Managing Partner of LogiqTree, LLC.
Luis started his career at the accounting firm PriceWaterhouseCoopers where he spent eight years specializing in the audit
of medium and large financial institutions. After that he led the finance functions at local and regional banks in Florida. Luis was the CFO of the Bank of Miami and then went to work at BankUnited and Florida Community Bank as their head of financial reporting and corporate controller. He guided the team on the complex accounting associated with FDIC assisted transactions. He then founded LogiqTree to develop software solutions and assist banks in optimizing their complex accounting processes. Luis earned his Master’s degree in Finance at the University of Tampa
For additional consultations and evaluation of your Troubled Loan and ALLL process please contact LogiqTree at
[email protected]