Preparing For CECL: What Procedures Need To Change?

by Mary Ellen Biery

7 considerations to ensure effective implementation of the major change in estimating losses.

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While most non-public business entities aren’t required to implement the current expected credit loss (CECL) model for the allowance for loan and lease losses (ALLL) until after Dec. 15, 2020, many institutions have begun the transition to ensure effective implementation of this major change in estimating losses. An actionable step banks can take to prepare for CECL is to identify how the new model will require modifications to ALLL procedures and map out the steps and individuals needed to run the new activities. Some reasonable steps to take now include examining: 

Methodology selection

As financial executives are preparing their institutions for CECL, keep in mind that the new model is aimed at reporting expected credit losses over the life of the loan portfolio, rather than reporting incurred losses as under the current accounting standard. This means that credit losses need to be effectively reported at origination. Reliance on the most recent years of pooled loan data will likely be insufficient under the new standard.  There is not a single method for measuring expected credit losses. Institutions should use their best judgment to develop estimation methods that are well documented, applied consistently over time and faithfully estimate the collectability of financial assets by applying the principles in the new accounting standard. 

Methodologies that will be available to most institutions include vintage analysis, historical loss to migration analysis, probability of default/loss given default and discounted cash flow. Identifying the methodology options for an institution bas­ed on its portfolio makeup will help clarify the needed data points and data history that will be required for the allowance calculation. This analysis will also shed light on the material inputs and assumptions that the bank may need to finalize. 


Proper loan pool segmentation, already a critical issue in the incurred-loss method of calculating the allowance, is expected to have even more importance under CECL. Various methodologies for forecasting expected credit losses will require specific kinds of segmentation in order to execute them.

Institutions must analyze assets on a collective or pooled basis unless unique risk characteristics exist. If risk characteristics do exist, the assets should be evaluated on an individual level. Designated pools should be relatively granular while maintaining statistical significance. If choosing to prepare with a third party, vendor models should easily illustrate pool size and offer a variety of segmentation and sub-segmentation elections based on customizable and dynamic logic. The model should allow institutions to automatically and manually identify and separate loans for individual analysis.

Qualitative adjustments

Q Factors or qualitative factor adjustments have been a part of the allowance calculation for a while, but the inputs may need to be adjusted and become more quantitative in nature. Q Factor procedures will most likely need to change under CECL to ensure the reserve is reflective of real loss experience. Q Factors are already a common point of scrutiny from auditors who are reviewing a bank’s quarterly allowance calculation. Although Q Factors are unlikely to go away with the approach of CECL, auditors will likely recommend that financial institutions rely more on industry data when making qualitative adjustments.   


The CECL model incorporates an institution’s expectations for how future conditions might affect losses. The measurement of expected credit losses is not only based on historical experience and current conditions, but also centered on reasonable and supportable forecasts. Financial institutions are not required to develop forecasts over the contractual term of the asset or group. The standard at 326-20-30-9 says: “For periods beyond which the entity is able to make or obtain reasonable and supportable forecasts of expected credit losses, an entity shall revert to historical loss information.” It is not recommended to adjust historical loss information due to existing or future conditions for periods that are not reasonable and supportable. A likely scenario is that forecasting will be closely tied to methodology selection. 

Documentation and reporting

Documentation and reporting is an area that is often the most time-consuming exercise in today’s allowance processes. The new standard will require more inputs, assumptions and analysis at the pool level. Tracking, consolidating and displaying all information necessary to review, support and recalculate will be a critical function of any homegrown or vendor-based solution. Financial executives should consider what level of transparency and auditability is offered by any third-party solution under consideration, and take into account costs associated with model risk and/or time spent preparing documentation and support.

Additionally, banks may end up with multiple methodologies (one for auto loans, for example, and another for 1-4 multifamily loans). As those become apparent, banks will consider what components and material inputs should be documented in order to be able to defend the calculation for each pooled analysis. This may require implementing data management systems to make that reporting more efficient 

Workflow changes

Understanding more about the bank’s historical loss calculations, qualitative adjustments and documentation/reporting needs will prompt discussions about changes that might be needed to the workflow. Certain steps may take longer than before, require different reports to be built, require sign-off from different teams at the bank or create new steps (such as life of loan calculations) that haven’t yet been important.

Specifically, both the credit and finance teams at a bank will need to collaborate in order to tackle CECL as efficiently as possible. Both departments currently have different roles within the allowance calculation for the incurred loss model. The expected loss model will likely require more collaboration between the two teams. Both team liaisons should build a list of discussion points to review as part of the transition, including data sources, methodology elections, reporting and disclosure requirements, audit considerations and capital planning. 

Additional department inputs 

Cross-functional discussions will also help determine whether other departments already have some of the missing data inputs in some form or whether remediation assistance from a third party may be needed. Once these discussions are had, institutions should have a clear understanding of responsibilities and costs specific to calculating and supporting material inputs. It is also important to understand the availability, expertise and costs/fee structure related to any training, advisory services and technical support.

Mary Ellen Biery, Research Specialist at Sageworks.