For most publicly traded financial institutions, the Current Expected Credit Loss (CECL) is halfway through year 4 post implementation. For non-publicly traded banks and credit unions, many have been living with the new CECL standard for more than a year, and those with non-calendar-based fiscal year ends are rapidly approaching the year mark.

As the new standard simply becomes “the allowance” again, and each month or quarter becomes routine, it’s important for institutions to set time aside to evaluate the model inputs on a regular basis to avoid complacency.

Items to review include:

Loan Portfolio Characteristics: Changes in the composition of your loan portfolio (e.g., loan types, creditworthiness of borrowers) necessitate adjustments to model inputs. Loan to Value and Debt Service Coverage ratios are moving in a material fashion, and expenses for businesses continue to climb. As these variables continue to adjust, there needs to be an accompanying move in the allowance models, whether quantitatively or qualitatively.

Macroeconomic Data: Unemployment data, interest rates, economic growth expectations, and other economic metrics that can impact your borrowers continue to be volatile. Questions to ask include “are there any sector-specific risks on the horizon? Are there potential disruptions in supply chains or commodity prices that could affect your borrowers’ businesses?”

Default or Past Due Activity: Monitor trends in loan delinquency rates (past due payments) to identify early warning signs of potential credit losses. Are there any particular loan types or borrower characteristics exhibiting a rise in delinquencies? Is there a geographic concentration of past due loans? Understanding the root causes of these trends can help you refine your loss forecasting models and take targeted actions to mitigate risk.

While CECL implementation may have initially felt like a whirlwind, for many institutions, it’s settling into a familiar rhythm. As the new standard becomes the norm, there’s a risk of complacency setting in. However, it’s important to resist this urge and maintain a proactive approach to CECL, setting time aside on a recurring basis (monthly, quarterly, or annually) to review your current inputs.

Remember, the accuracy of your allowance hinges on the quality of your model inputs. Regularly evaluating these inputs is essential to ensure they continue to reflect the evolving risk profile of your loan portfolio and the broader economic landscape. This ongoing evaluation process is vital for maintaining the integrity of your CECL calculations and supporting your financial reporting. By adapting your models as needed, you can ensure CECL continues to serve its purpose: providing a more accurate picture of your expected credit losses.

Zach Englert, Senior Consultant, Empyrean Solutions

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