Where The Rubber Meets The Road

Posted on August 28, 2022 Published by

I grew up in the era of muscle cars. If you had a little bit of money and a little bit of mechanical ability, you could transform your pedestrian Chevelle, Camaro, Mustang, GTO or Road Runner into a fire-breathing, window-rattling, tire-shredding, asphalt-eating monster. Even today, I attend classic cars shows to refresh the dream.

The New Transformational Process

Credit professionals have been engaged in their own “transformational process” this year (or perhaps longer) to transition from a backward-looking, incurred-loss approach to the new forward-looking, Current Expected Credit Loss (CECL) standards as established under ASU Topic 326 and the Interagency Policy Statement on Allowances for Credit Losses.

In the previous two blogs (here and here), we looked at various stages of the implementation process. The first installment focused on the early implementation phase. We also talked about the necessity for a quality plan to complete the transition. This includes a drafting policies and procedures and approvals at the highest levels in the organization. In the second installment, the focus was on late-stage implementation including portfolio segmentation, model development, and the importance of data availability and integrity.

Where The Rubber Meets The Road

In this third and final installment, it is time for the “rubber to meet the road.” Like the muscle car we built in our youth, it is time to take a test drive of our new ACL methodology rather than have the transmission fail on the first “hole shot.” Now is the time to complete the model review process to assure your institution is ready for full implementation, including making any necessary adjustments.

A good place to start would be doing a parallel run of the new CECL model alongside the current ALLL methodology as of the same date. The “full practice” run using CECL would include running all “Collective” (Pool) and “Individual” expected loss calculations and conducting a complete and comparative review of the results. As an organization, you can gain operational practice on running the model and process.

What To Expect

It will allow you to identify issues that may arise before having to “go live”. As with any new model, expect some surprises in the model results. It is rarely possible to predict all issues in real time. You can also expect a few pain points in the first trial runs. Don’t be surprised if the ACL output differs from expectations, whether that be too high or too low. This may prompt a desire to run multiple scenarios to see varying results.

No doubt a comparison to the current ALLL methodology for the same period will raise a question or two. Review and comparison of results across both models may result in adjustments in inputs or process to your CECL methodology. This process helps produce an output that fully supports expected credit losses across the entire loan portfolio.

Are You Ready?

All this angst in the near term will help uncover issues. First, is your institution ready? If not, what are the remaining gaps? Given that the auditors and regulators will focus on the accuracy, reliability, and sufficiency of the model, and the documented policies and procedures, is the process documented well enough? Finally, are the results reasonable?

Review of the model and troubleshooting of issues that may arise will prepare your institution for full implementation. In addition, model validation by a knowledgeable outside third party that evaluates all aspects of the model and provides a final report in advance of a “go live” date will provide your institution with additional confidence when dealing with examiners and auditors after implementation.

Prepare For Ongoing Testing

Similar to risk ratings across the loan portfolio, CECL models require ongoing review and updating. Back-testing of the model results against actual losses over a specific time period will lead to “fine tuning” of the model. A continuous process of comparing ACL output to actual losses provides useful feedback to maintain model accuracy.

If significant variance between ACL output and actual losses occurs, an evaluation of model inputs and possibly processes would be appropriate. Inputs to CECL models increased significantly when compared to the incurred loss model. As inputs and methodology options increase, so do opportunities for output variance. Ongoing review and validation provide both confidence and readiness for the path ahead.

Time To Drive!

Like our vintage muscle car, it is not enough to have it look good in the driveway. It needs to be driven. And while testing and validating your new CECL model may not be as difficult as tuning a six-pack carburetor on a 440 Hemi, it will require constant evaluation where the “rubber meets the road.” The professionals at Enlighten Financial can certainly help you with the latter. We only dream about the former.


Richard Rudolph is Senior Consultant at Enlighten Financial, a specialized consulting firm that focuses on loan review and risk management services to community banks and credit unions. Enlighten Financial has made it our business to shed light on the complex financial landscape. We lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to Rick directly, please call: 920.445.8133.

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