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CECL: 2021 Mid-Year Review

This whitepaper details updates to key data points and analysis from 12/31/2020 (shown in prior publications) through 6/30/2021. We also discuss how the industry responded to credit loss reserving through the first half of calendar year 2021, our expectations for the future reporting periods of 2021, and key items that institutions required to adopt ASC as of 1/1/2023 should be focused on. As in the prior study, we continue to focus on both geographic region (Defined by U.S. Census Bureau Region) and Total Asset Size (aggregated into 4 categories – Less than $10 Billion, between $10-$25 Billion, $25-$100 Billion, and greater than $100 Billion).

Introduction

In 2020, Valuant released a study titled, “CECL: First Year in Review” containing key data statistics and insights around the US Regional and Community Banking sectors as it relates to the adoption of ASC 326, commonly referred to as “CECL”. The study included an analysis of 137 banks that adopted ASC 326 as of 1/1/2020. These banks included regulated financial institutions whose stock traded on a Major Public Exchange (NYSE, NASDAQ, OTC) and had total assets of less than $400 Billion as of 12/31/2019. For the updated study, we continue to use these thresholds but have updated the population to be based on these statistics as of 12/31/2020.

This whitepaper will detail updates to key data points and analysis from 12/31/2020 (shown in prior publications) through 6/30/2021. We will also discuss how the industry responded to credit loss reserving through the first half of the calendar year 2021, our expectations for the future reporting periods of 2021, and key items that intuitions required to adopt ASC as of 1/1/2023 should be focused on. As in the prior study, we continue to focus on both geographic region (defined by U.S. Census Bureau Region) and total asset size (aggregated into 4 categories –less than $10 Billion, between $10-$25 Billion, $25-$100 Billion, and greater than $100 Billion).

Study Data Overview

Data was sourced from SEC Form 10-K and 10-Q to identify the most accurate values and allow for review of detailed commentary. While CECL applies to both unfunded commitments and Held to Maturity Securities, our study focuses on Loans Receivable. Furthermore, tax impacts are not considered within the study. Our current study population is updated to source the population as of 12/31/2020. As discussed above, the prior study included 137 institutions. The population in our updated study includes 173 institutions and encompasses the following changes detailed below and shown in the chart. 30 banks were added that previously delayed adoption through the CARES act but adopted as of 1/1/2021.

It should also be noted that 7 of the banks that were previously delayed through the CARES Act are now planning to adopt 1/1/2022 based on further provisions outlined in the Consolidated Appropriations Act. 6 banks were added that had fiscal year ends in 2020 that were not 12/31 and therefore adopted CECL after 12/31/2019.

It should also be noted that of the 173 institutions that were included as of 12/31/2020, 3 sold
during the first 2 quarters of 2021 and therefore would not be included in the statistics for all
periods during 2021.

For the 30 banks included in the updated study that have delayed adoption through the CARES
Act provision, all were less than $25 billion in assets. This is logical given that smaller institutions may
have benefited the most from the delay, both operationally and in terms of the capital impact.
Furthermore, the delay may have allowed these companies to divert further resources to fund loans
through the Paycheck Protection Program (“PPP”). The chart below details the composition by Region and Asset Size for these banks.

The graphic below details the same statistics but includes the entire population of institutions
included in the updated study.

2020 Adoption Overview

Before reviewing 2021 statistics, we should first recap 2020 reporting periods. It’s reasonable to assume that one of the most significant challenges for 2020 adopters was the Reasonable and Supportable Forecast component of the CECL standard. While not only challenging to decide upon and document, the variation among consensus and scenario forecasts changed rapidly during 2020. Furthermore, the flexibility that the CECL standard offers through the Reasonable and Supportable Forecast element makes comparability among institutions more difficult than under the Incurred Loss Model.

Lastly, the method upon which organizations adjusted for changes in the forecast between
quarters could be very different. Common methods may have included but are not limited to the following items:

  • Weighting scenarios differently from quarter to quarter (i.e. for adoption 100% weighting
    to a baseline scenario and moving to a 50% weighting during Q2)
  • Removing scenarios from consideration
  • Adjusting for changing economic environments through qualitative overlays
  • Changing forecast periods
  • Changing reversion periods

As shown above, the flexibility within the standard can lead to a point of great confusion for some
preparers and modelers within the space. Furthermore, the options available give the need for enhanced documentation for all decisions that are made.

Prior to adoption, the average ACL Coverage Ratio (Defined as total allowance over total loans) was .82%. The average adoption ACL Coverage Ratio was 1.07% or an increase of around 37%. As was expected, allowances increased when CECL was adopted. As we moved throughout the year, reserve
levels steadily climbed until reaching their peak of 1.49% in both Q3 and Q4. The graph below shows the average coverage ratios for all periods of 2020.

In many cases, the overall coverage ratio was muted given the large impact of PPP loans for the bank’s contained within our study. Most banks reserved little to none against the PPP population as they were fully guaranteed by the Small Business Administration (SBA). For some intuitions, these loans made up more than 10% of their total loan portfolio at their peak and thus masks the comparability for the later time periods in 2020.

Unprecedented government stimulus programs entered the mix beginning March 2020. This includes the latest bill, which was enacted on March 11, 2021, and named the “American Rescue Plan”, allocating over $5.3 trillion in funds. A chart from the Peter G. Peterson Foundation shows a summary of where these bills’ funds were allocated.

In total, this resulted in over $1 trillion in direct support of small business and over $1.6 trillion in individual taxpayer support. Due to these measures and a reopening of the economy, we saw labor markets sharply rebound.

The chart below shows the trend of the coverage ratios for the 2020 data set as compared to the National Unemployment Rate. As can be seen, directional divergence in the trends began during Q3 2020. However, given the amount of government support, pandemic risks, and payment holidays that were in place during the early part of the year, reserve levels held somewhat steady over the back half of the year. As the industry moved into 2021 reporting periods, a vast amount of uncertainty remained.

03.31.2021 Reporting

As we moved into the first quarter, 36 institutions entered the study as discussed above. Including these institutions, the overall reserve ratios dropped from an average of 1.49% at 12/31/2020 to 1.41% as of 3/31/2021. This was most expected and telegraphed during various earnings calls and SEC filings
delivered throughout the back half of 2020. The following chart displays these coverage ratios by region and by asset size.

It should be noted that due to the population change as discussed in the opening section of the document, prior period ratios may change due to movement in certain identifying data as of 12/31/2020 rather than 2019. This impact has been lessened by removing the consideration of prior period data points for the bank’s that did not adopt during 2020.

In most cases, the larger institutions continued to hold higher coverage ratios. This is mainly related to the compositions of their loan portfolios and less of a percentage being made up of PPP loans. Overall, the Midwest region of the US has the highest average reserve ratio at 1.56% followed by the West at 1.50%. Evaluating based on asset size, the greater than $100 Billion population carried an average coverage ratio of 1.59% followed by the $10-$25 Billion group at 1.49%. The full data set is shown in the following table.

In most cases, the larger institutions continued to hold higher coverage ratios. This is mainly related to the compositions of their loan portfolios and less of a percentage being made up of PPP loans. Overall, the Midwest region of the US has the highest average reserve ratio at 1.56% followed by the West at 1.50%. Evaluating based on asset size, the greater than $100 Billion population carried an average coverage ratio of 1.59% followed by the $10-$25 Billion group at 1.49%. The full data set is shown in the following table.

Of the 173 banks included in the 2021 update, 109 of these showed negative provision expenses during the 3/31/2021 reporting period. Another 14 showed provision expense of zero for the quarter. In total, this represented over 70% of the population. As economic conditions continued to improve and economies continued to reopen, concerns shifted to tightness in the labor markets and inflation. Furthermore, while most loans that were granted deferrals during 2020 had moved back to their regular payment schedules, concerns still existed around the ability for these borrowers to continue to service debt. As one banker described it, government stimulus and deferrals may have not changed the underlying condition of a business.

6.30.2021 Reporting

Moving to 6/30/2021, reserve levels continued to fall from 1.41% at 3/31 to 1.35% at 6/30/2021. When considering the average adoption coverage ratio of 1.07%, this meant that reserves were approximately 25% higher at 6/30/2021 than at adoption. In commentary observed through earnings calls and other publicly available information, expectations were that reserve levels would continue to move down in the following quarters until reaching adoption levels by year- end 2021. Most consensus economic forecasts showed macroeconomic data points supporting these levels. Comparing to provisions in Q1 2021, 127 banks in the dataset showed negative provision expense amounts during the 2nd quarter. Another 16 banks recorded a provision expense of zero. While 70% of the banks recorded zero or negative provision expense in the prior quarter, this increased to over 82% of the data set in June. The graph below details the averages by both region and asset size and the table presents the underlying data points.

Trends for the entire time periods forbank’s reporting under CECL shows this movement over calendar year 2021. The first graphic shows the trend based on asset size and the second based on geographic region.

As seen above, the most significant movement occurred in the largest institutions. However, all asset size groupings are showing a tight correlation for the movement downward from Q4 2020 to Q2 2021. The lowest average ratio is shown in the $25-$100 Billion grouping at 1.29% and the highest in the greater than $100 Billion at 1.44%. While the smallest three asset groupings showed tight comparability throughout 2020, the largest asset grouping has mostly fallen back into the grouping with the lower asset tiers as of 6/30/2021. While difficult to do, inferences could be made that perhaps the larger institutions had a more adverse reaction to the forecast scenarios than their smaller peers. However, it serves to consider the PPP composition of the smaller tiers thus muting the impacts as well as their asset class composition with a lower overall weighting to long term consumer and credit card debt.

The next graphic displays the same time series data trend but grouping by region rather than asset class. Interestingly, the Midwest regions showed a break from their 2020 trends. The Midwest Region showed an increase in average coverage ratio during Q1 2021 before moving back to the same average as that shown at Q4 2020. It should be noted that the population change with 36 banks adopting during 2021 is the reason for this. The Midwest represented the largest portion of these at 13 banks , over 1/3 of the population. The West region had only 2 additional banks adopted during 2021 and represented the lowest percentage of new adopters based on region.

Future Reporting Periods

As can be seen through the review of the first half of 2021, economic conditions continue to improve. While reserve builds were adjusted significantly through 2020, the runoff of these reserves has come down more slowly than previously anticipated. Heightened uncertainty as it relates to inflation concerns, labor market shortages, and COVID outbreaks continue to be focus points within the Banking space. As we migrate to the end of 2021, expectations are largely that reserve rates will approximate those at the earliest adoption date of 1/1/2021. Most economic forecasts show unemployment being back under 5% by late 2021 to mid-2022.

Although frameworks have been established and more vetted throughout the first 6 reporting periods under CECL, each reporting period brings its own unique challenges. The industry at large has become more educated on the process, but the forecasting element is one that is ever-evolving. Institutions are challenged with constantly monitoring the performance of previously concluded inputs and model parameters while also operating their current process. Resource allocation is in most cases higher than what was previously estimated. This may lead to consideration for most institutions to have an internal resource dedicated solely to the allowance process. This person may present themselves as the Allowance for Credit Loss Manager/Director or Credit Analytics Manager/Director.

While the position has historically been reserved for large financial institutions, smaller organizations are beginning to see the need for this resource as increased regulatory and audit scrutiny comes into effect.

Most believed that the need for a dedicated resource may pass after initial adoption but have quickly learned it is an ever-evolving process That requires significant oversight and support for both internal and external stakeholders.

As smaller institutions move closer to the required implementation date, some consideration is being given to early adoption. These institutions spent a significant amount of time gathering data and reviewing initial model runs and estimation techniques during the 2018-2019 timeframe.

In many cases, the institutions may have slowed down their implementation efforts after the delay was passed in late 2019 for Smaller Reporting Companies (essentially those with less than $100 million in revenue or less than $250 million in public float). However, they are greatly ahead of the curve and therefore adoption at 1/1/2022 is a reality.

For others, they are focused on beginning implementation efforts for a 1/1/2023 adoption date. As outlined within this document and the prior installment of this series, there is a significant amount of information to consider.

For those that have not yet adopted, the industry is at large more educated and experienced in the process of CECL. Fortunately for this group, they have other institutions that while larger and perhaps more complex, give them industry information to help with implementation efforts that were not there previously.

These guidelines in conjunction with the industry analysis outlined within the study should prove meaningful for benchmarking and readiness techniques for the largest population of CECL adopters.

About the Authors

Derek Hipp, CPA, Chief Operating Officer

Derek is a Co-Founder of Valuant and leads the Client Service division. Valuant assists financial institutions with various financial modeling and data analytical services including Acquisition Accounting, Valuation, and Credit Risk Analysis (Current Expected Credit Loss or “CECL”) through delivery of a proprietary suite of Software as a Service(SaaS)solutions, ValuCast™. The Client Service team assists customers with onboarding, training, and execution of these products and services. Derek is also a member of the Valuant leadership group focusing on team development, business development, product delivery, software feature development and exploration, and other strategic initiatives.

Madison Kalmanowicz, Consultant

Madison has over four years of accounting and consulting experience with financial institutions ranging in asset size from $300 Million to $19 Billion.Her primary responsibilities include Day 1 valuation and due diligence services for whole bank acquisitions and branch purchases, ALLL and CECL implementation, as well as ongoing allowance advisory consulting. Madison earned her Bachelor of Science in Finance and Entrepreneurial Management from the University of South Carolina, where she was also a member of the Capstone Scholars program.

Additional Resources

We hope that our content is useful to you. Valuant’s team of Subject MatterExperts are available to answer your questions. Contacts us atinfo@bevaluant.com to schedule a call.

Listen to our Webinar, CECL: First Year in Review, Click Here.

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Data used in this presentation is from financial institutions’ annual form 10-K or quarterly form 10-Q filings. Data was compiled using both the S&P Global Market Intelligence Database and the U.S.Securities and Exchange Commission (SEC)’s EDGAR database.

For more information on the dataset used in this paper, please contact info@bevaluant.com.

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As part of an annual study that began in 2020, Valuant conducts analysis on ASC 326, commonly referred to as “CECL”. The study contains key data statistics and insights around the US Regional and Community Banking sectors and the impact CECL has on their Allowance for Credit Loss (ACL) Coverage Ratios.

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