By Larry Sherrer, Senior Examiner, Banking Supervision and Regulation Division, Federal Reserve Bank of St. Louis and Ty Lambert, SVP, Bancorp South.
Larry, can you please tell the Risk Insights readers a little bit about yourself, your experiences and what your current professional focus is?
Most of my 35 years of industry experience has been in the field working as an examiner on a wide variety of assignments at regional and community banks. I have extensive experience on problem assignments including the recent financial crisis of 2008-2010. Currently, I am the examiner in-residence for the St. Louis Fed’s Supervisory Policy and Research unit where I analyze risks facing financial institutions in the Federal Reserve’s Eighth District. My responsibilities also include serving as the district liaison to the Federal Reserve’s Current Expected Credit Loss (CECL) implementation team.
Ty, can you please tell the Risk Insights readers a little bit about yourself, your experiences and what your current professional focus is?
I joined BancorpSouth in 2006 and have served in a variety of roles including portfolio management, asset-liability management, investor relations, and model development/systems integration. My team is currently responsible for asset-liability management, liquidity risk management, credit risk analytics, and capital stress testing. In addition, I play an active role in strategic planning with respect to corporate budgeting and capital deployment. I have been a featured speaker at industry conferences and have served on American Banker’s Advisory Board for Stress Testing. Prior to joining BancorpSouth, I was a portfolio manager for retail clients. I received my bachelor and MBA degrees from Mississippi State University and the University of Mississippi, respectively.
At the CECL Congress 2018, you will be taking part in a panel discussion on, ‘CECL from regulators’. Why is this a key talking point in the industry right now?
Larry: Many institutions are now past the awareness phase of preparing for the transition to CECL and are looking at the more technical aspects of the standard. Bankers are making important decisions regarding the selection of methodology and how they will collect, organize and analyze their data. I think bankers are interested in what regulators are communicating about the standard as well as information that could impact regulatory reporting. The more information that bank management considers at this phase, the more confident they are in their decisions regarding implementation.
Ty: As with any new rule, there is a fair amount of uncertainty in the industry currently in terms of the expectation for CECL, particularly in regard to the level of sophistication for institutions of varying size and complexity. In contrast to stress testing, CECL will impact institutions of all sizes, which creates more opportunity for discussion around the interpretation and application of CECL across the broader financial industry. While there will continue to be clarification on the expectations of CECL as the industry approaches adoption, it may take an extended period of time before best practices are recognized.
What, in your opinion, is the best practice for meeting CECL data requirements?
Larry: This depends on the complexity of the bank’s credit portfolio and also choices that management makes regarding methodology. CECL is not ‘one-size fits all’ so data requirements differ among institutions. In general, best practices flow out of having a solid plan for transition. Banks need to collect and organize data in a way that they can determine how relevant the data is to their credit portfolio risk. That process needs to result in organizing the data in a manner that allows analysis and documentation. A good first step is to know what data the institution currently has and identify gaps that might need to be filled. Then we encourage banks to begin maintaining the applicable data going forward. Banks also need to keep in mind disclosure requirements when collecting data.
Ty: There are really two aspects to evaluating data for purposes of satisfying CECL. First, there is data collection from a reporting aspect. Second, there is data collection from a modeling perspective. These concepts can be considered collectively or mutually exclusive. For example, CECL requires reporting by vintage, but an institution may choose not to build any credit models on the basis of vintage. It seems logical to suggest that the reporting aspect of CECL, at least from a data standpoint, will be easier to satisfy than the modeling aspect. Robust model development requires a comprehensive repository of historical data, which will likely be a limitation for many institutions. This notion places emphasis upon vended data, and in turn, the burden of proof that vended data is a sufficient proxy for what an institution may be lacking with internal data alone. In an effort to address these concerns, institutions may wish to keep the modeling process simple and reduce the immediate need for extensive amounts of data. More sophistication can be implemented in the modeling process (if needed) as additional data is collected over time.
What are the key considerations that need to be made when demonstrating results to regulators and external auditors?
Larry: Regulators do not want to be leading practice; however, with that said, there are things to keep in mind with CECL as with any regulatory reporting requirement. This is a principle-based standard, so transparency is important. Management needs to feel comfortable they can explain their methodology and the impact it has on the credit loss estimates. Steps to ensure that underlying data and assumptions are documented and available for review will be necessary for auditors and regulators. There should be a logical connection between credit portfolio risks and methodology.
Ty: The key to supporting your CECL methodology is having a thoughtful development and implementation process accompanied with the appropriate level of governance. Development and implementation should cross functional lines as CECL overlaps Credit with Finance in a similar fashion to an institution’s stress testing program. In addition, the governance process should include representation from Risk and Internal Audit and should extend to a Company’s Board of Directors.
What would you say is the key regulatory challenge with CECL implementation? And how should Financial Institutions deal with this?
Larry: Listening to what banks, auditors, vendors and others are saying about the challenges they are experiencing in implementing the standard. The transition period is long, so monitoring industry progress is a regulatory challenge as well but is necessary.
Finally, what challenges do you foresee with CECL implementation over the coming years?
Larry: Maintaining consistent momentum and progress will be as much of a challenge as will the technical aspects of the standard. It’s a good idea to approach adoption of the standard like a project management effort. Form a CECL transition team and develop a plan that can be used to maintain progress but also allow appropriate time for testing and reassessments. Accountability should be established with timelines. Plan up front for the necessary resources and training of staff. I think periodic reporting to the directors is also a good idea.
Ty: A key challenge in the world of CECL is the expedited timeline in which results have to be refreshed on an ongoing basis to align with quarterly reporting requirements. Even for institutions that have been conducting stress tests, the timeline for conducting these analyses is longer than what will be required for purposes of estimating a quarterly loan loss reserve. As such, operational efficiencies are paramount to producing credible results on a timely basis.
Legal Disclaimer – The opinions expressed by Mr. Sherrer are intended for informational purposes and are not formal opinions of, nor binding on, the Federal Reserve Bank of St. Louis or the Board of Governors of the Federal Reserve System.