What is the Cohort Methodology for CECL?

Noting the diversity in portfolio sizes, complexities, as well as practices of applying the current incurred loss methodology, the FASB’s guidance on CECL offers quite a bit of latitude to financial institutions (FIs). It encourages FIs to leverage their current methods and existing systems in the application of a CECL compliant methodology. The general modeling strategies around CECL must incorporate the lifetime losses calculation, segmentation (one of the three pillars of CECL), determination and impact of adjustments, and the integration forecasts. Cohort Methodology A particular area of flexibility is with the determination of methodologies for the calculation of the allowance.  One of the main methodologies FIs are using is the Cohort methodology, which, as with all methodologies, requires institutions to make rational and defensible decisions. The Cohort methodology, or “snapshot” or “open-pool analysis,” relies on the creation of cohorts to capture loans that qualify for a particular segment, as of a point in time. They then track those loans over their remaining lives to determine their loss experience. Segmentation The most essential step in the utilization of the cohort-based methodology is the determination of the cohort – which starts with appropriate segmentation. The Update states that an “entity should aggregate financial assets on the basis of similar risk characteristics” when evaluating financial assets on a collective basis. Those characteristics include, but aren’t limited to, internal or external credit score, risk ratings, financial asset, loan type, collateral type, size, effective interest rate, term, or geographical location. Benefits that come with segmentation include a reasonable way for institutions to identify their key vulnerabilities and assess how to manage those risks. Segmentation enables the institution to capture the unique behavioral characteristics that vary the degree of inherent risk or increase the likelihood of loss. The [...]

2018-11-09T09:45:28+00:00November 8th, 2018|Blog, Methodologies|

What is the Vintage Methodology for CECL?

The Vintage Methodology under CECL (Current Expected Credit Loss) measures the expected loss calculation for future periods based on historical performance by the origination period of loans with similar life cycles and risk characteristics. It’s advantageous to pool similar loans that follow comparable loss curves that may be predictive for future periods. There are a handful of characteristics you should look at when segmenting your loans with the Vintage methodology. The most important risk driver is that all loans share a common origination period. Contrasted to the cohort method, loans are only included in tracking historical losses in the period in which they originated. Upon renewal of a loan, a new vintage is created. Critical data elements needed to run Vintage include loan number, balance at origination, loan balance, maturity date, renewal date, and loss information. The loans in the pools for this methodology should have similar risk characteristics and can be sub-segmented by an optional risk driver, like risk rating, although many times pools will become too granular to use this optional driver. Loan pools should  have very similar weighted average lives because loss rates in year two of a three-year loan looks vastly different than year two of a seven-year loan. Vintage works well with indirect auto loans and other consumer loans, credit portfolios, etc. To determine loss rates with this methodology, start with historical loss rates for each vintage and examine any trends in recent vintage loss rates. Fill in loss rates for future periods based upon historical trends as well as factoring in any changes for current conditions and reasonable and supportable forecast periods where you anticipate these periods are different from historical. Depending on differences in the makeup of the vintages, different adjustment factors may be required for each vintage. Depending on forecasted conditions, adjustments could be either positive or negative. When future years are no longer reasonably forecastable, revert to adjusted historical averages. Re-evaluate your Q factors with shifts in the economic landscape. When figuring out [...]

2018-10-26T13:07:18+00:00October 26th, 2018|Blog, CECL, Methodologies|

What is the PD/LGD Transition Matrix Model for CECL?

The transition matrix model (TMM) determines the probability of default (PD) of loans by tracking the historical movement of loans between loan states over a defined period of time – for example, from one year to the next – and establishes a probably of transition for those loan types between different loan states. […]

2018-10-24T11:14:12+00:00October 19th, 2018|CECL, Methodologies|

Confessions of a Data Analyst

The implementation of CECL has been called the biggest change in financial institution accounting . . . ever. Under current U.S. GAAP, financial institutions account for losses based on historical events or incurred losses. Beginning in the first quarter of 2020, financial institutions must look at the past as well as the future over the full lifetime of a loan. […]

CECL Nears, Priorities Are Changing

As CECL nears, institutions must re-think their preparation processes.  Time marches on. And CECL lies in wait. And as the former grows shorter and the latter nearer, priorities are changing for the financial institutions that will be required to adhere to the new allowance accounting standard. […]

Prospective CECL Methodologies: Transition Matrix

Part of a MST Blog Series examining prospective CECL-compliant methodologies The road to CECL compliance ends in identifying the CECL methodology (or methodologies) that best suits your institution and your loan portfolios as well as complies with CECL guidance and your auditor and regulator demands. This MST Blog series is designed to help you examine prospective CECL-compliant methodologies.  […]

2018-10-25T11:59:21+00:00May 19th, 2017|CECL, Methodologies|