In our first article of this series, we compared the pros and cons of the two main types of CECL approaches: non-causal modeling and causal modeling. In this article, we offer some criteria to consider when evaluating a CECL solution provider, along with some of the less obvious, “hidden costs” of CECL that institutions should examine before selecting the best partner to fit their needs.
After a several-year delay, the Financial Accounting Standard Board (FASB) is now requiring non-SEC-filers and non-public business entities (PBEs) to report under the Current Expected Credit Loss (CECL) standard beginning with the fiscal year following December 15, 2022. This means that most affected institutions must comply as of the first quarter of 2023.
Although many community banks and credit unions fall within the non-filer category and have benefitted from the FASB’s delay in implementation of the standard, the time to begin preparing is now.
Fortunately, banks and credit unions are not alone in this journey. Since the standard was first introduced, numerous CECL compliance solutions have come on the market. The industry has learned from the experience of early filers, and today organizations can select from numerous CECL solutions to support their specific needs, from fairly simple implementations to more rigorous deployments to support those institutions with diverse asset profiles.
Evaluating a CECL vendor
With so many CECL solution providers, methodologies and frameworks to choose from, vendor selection can seem daunting. It is particularly difficult to objectively evaluate these vendors side-by-side, especially when pricing structures vary so widely.
To help you in this selection process, here are criteria to consider in making an informed decision:
» Assets covered: Institutions must calculate their CECL exposure for various asset types across their loan, lease, and securities portfolios. It’s imperative to ensure the solution you select covers all the types of assets your institution has on the books.
» Segments: Financial institutions are required to produce CECL estimates for all segments in their loan portfolio, including commercial and industrial (C&I), commercial real estate (CRE), and consumer segments. Making sure your preferred vendor covers all the relevant segments you have in your portfolio today is critical.
» Methodologies: Many loss assessment methodologies and frameworks can now be used to produce CECL estimates, and the list continues to grow. These methodologies span from simple approaches like Weighted Average Remaining Maturity (WARM) to much more precise approaches, like Probability of Default (PD) and Loss Given Default (LGD). Ensure that the methodologies your chosen vendor provides out of the box align with your regulatory, audit, and management requirements.
» Models: The choice of model is a critical step toward accurately computing the expected loss of an exposure. A model can use an aggregated, less granular framework that runs at the pool level, or be highly specialized and segmented – not just by asset class but by industry, location and other criteria. The specialization is especially relevant if an institution has concentrations in specific segments or other areas.
» Calibration: Institutions can choose to calibrate their CECL model to align with either aggregated industry loss history or their own unique experience. Models calibrated to the institution’s experience will provide more accurate estimates for loss, but are dependent on being able to fully capture and analyze historical data.
» Forecasting: Calculating the loss estimate using a "reasonable and supportable" forecast is a key component to CECL compliance. Institutions must adjust the loss estimates for future outcomes and provide commentary on their forecasts. Some vendors provide built-in forecasting while others may rely on the organization’s judgement to make appropriate adjustments to loss calculations.
» Hosting: Perhaps less obvious, it is also important to determine whether your CECL solution will be remotely hosted in the cloud, or require on-premises servers and hardware, which may demand additional expense and resources for setup as well as ongoing maintenance.
» Reporting: There is a big difference between obtaining full control over CECL estimation versus only an output report. Top vendors will work with you to provide all the necessary reporting you require to demonstrate compliance, provide insights to
your management team, and add operational lift to your regulatory reporting process.
» Validation: Ask whether the model you are deploying is fully validated and includes documentation. If standard documentation is not provided by the vendor, it may put additional demands on your internal teams to conduct the proper due diligence.
Assessing the “hidden costs” of CECL
The cost and complexity of implementing the CECL standard varies widely from vendor to vendor. It’s important to recognize that the disclosed up-front costs don’t tell the whole story. Selecting the solution that appears cheaper on paper can often result in a later surprise from hefty advisory expenses, validation costs, or technology support on the back end.
Institutions can anticipate and should budget for a variety of expenses during their CECL journey, including:
» Subscription fees: This is the recurring fee the institution pays to the vendor on an annual or monthly basis for access to the chosen solution set.
» Setup fees: A setup fee is often assessed as a one-time expense to cover initial implementation, conversion, training and consulting services.
» Forecasting: Some vendors charge for the forecast data they provide, assessed separately from the loss estimation. If your initial solution does not provide this then you may need to source this from a second vendor separately.
» Advisory fees: Occasionally, a provider may assess a fee for the advice they provide in helping you select, develop and document the best CECL approach for your institution’s needs.
» Cloud hosting: Some vendors charge a separate recurring fee for hosting the solution in the cloud, on top of the regular monthly or annual subscription fees. The inverse is also true; if you have to host this yourself then you incur the technology
expenses to establish and maintain the infrastructure this sits on.
» Validation and audit documentation: These artifacts document your decisions and selections for regulatory and audit purposes. If a vendor does not provide validation and audit documentation as part of their standard solution package, they may charge additional fees to support this effort for you. Alternatively, the institution may be forced to obtain validation and documentation on its own, burdening the team with additional allocations of time, effort and expense to comply with SR11-7.
» Internal staffing: Employee and resource commitments may vary based on whether the solution is maintained in-house, and if additional effort is required for execution, forecasting, and documentation.
As you begin your assessment of potential CECL solution providers, be sure to keep these factors in mind as you allocate your budget. Moody’s Analytics credit risk data, models, economic forecasts, advisory services, and infrastructure solutions have already helped many financial institutions of all sizes successfully implement CECL. To learn more about our offerings and whether we may be the right fit for your institution, reach out now.
