Artisan Unfiltered #11: Making Sense of CECL

The latest episode of our Artisan Unfiltered podcast series, “Making Sense of CECL,” is now available for download. It focuses on the important and timely topic Current Expected Credit Losses, or CECL. A credit loss accounting standard that was issued by Financial Accounting Standard Board in 2016 that replaced the Allowance for Loan and Lease Losses accounting standard, CECL has been a long time coming and it’s finally here. What does it mean for you?  We put together a great panel of experts to help you make sense of CECL.

Kyle Manny is a partner in the financial services sector at Plant Moran in Chicago, and specializes in proactively addressing risk to protect and build shareholder value and minimize the risk of regulatory criticism. He supervises assurance, tax, and risk management engagements and provides holistic services to his clients that include community banks, specialty finance lenders, as small as 100 million in assets, and large regional and national brands.

Peter Fotopoulos, Managing Director at Artisan Advisors has served as an executive level management consultant with Artisan Advisors since 2011. His areas of expertise in client service include strategic planning, financial management, operational analysis, profit improvement, asset liability, ACL methodology and implementation, and regulatory response management.

Jeff Voss is a founder and a Managing Partner of Artisan Advisors.  Since 2009, Jeff has advised and assisted C-suite level officers and their boards of directors on a variety of management, financial, operational and regulatory matters, with an emphasis on strategic planning, financial forecasting, risk management practices and capital planning.

Transcript

[00:00:00] Jim Adkins: Welcome to Artisan Unfiltered, a series of podcasts that focus on current topics in the banking industry. Today's discussion will focus on an important topic, CECL, or Current Expected Credit Losses. the risk of stating what is obvious to most bankers, CECL is a credit loss accounting standard that was issued by Financial Accounting Standard Board, uh, on June 16th, 2016. replaced the Allowance for Loan and Lease Losses accounting standard. CECL standard focuses on an estimation of expected losses over the life of the loan, while the old ALLLL standard relied on incurred losses. My name is Jim Atkins. I'm here with my co host Jeff Voss, and we're pleased to have Kyle Manning, a partner with Plant Moran in Chicago, and Peter Fotopoulos, Managing Director at Artisan Advisors. background on Kyle. is a partner in the financial services sector. specializes in proactively addressing risk to protect and build shareholder value and minimize the risk of regulatory criticism. He supervises assurance, tax, and risk management engagements provide holistic services to his clients. of whom are financial institutions and specialty lenders focused on commercial finance. Clients include community banks, specialty finance lenders, as small as 100 million in assets to large regional and national brands. With more than 15 years at Plant Moran, Kyle has been a trusted advisor for his clients, playing a significant role in capital raises and business combinations over the years. Kyle frequently speaks at industry conferences about topics such as CECL and cybersecurity. He also participates in various CEO roundtables providing updates to regulatory and financial accounting requirements. As a licensed CPA, Kyle is a member of the AICPA and the Illinois CPA Society. He is active with the Illinois Bankers Association, the Wisconsin Bankers Association, and the Financial Managers Society. Kyle received his bachelor's degree in accounting from Hope College, which he is a proud graduate of. Now to Pete, give you a little background on Pete. Pete has served as an executive level management consultant with Artisan Advisors since 2011. areas of expertise in client service include strategic planning, financial management, operational analysis. Profit Improvement, Asset Liability, ACL Methodology and Implementation, and Regulatory Response Management. Pete has more than 30 years of financial and operational management experience. Pete has held various executive roles over the course of his career, including chief executive officer, president, chief of operating officer, chief financial officer. He's also served as a member of the board of directors in a privately held bank and holding company. Pete earned his bachelor's of science degree in accounting and MBA from DePaul. And I just want to welcome you fellas to the podcast. Thanks for being here.

[00:02:54] Peter F.: Good afternoon,

[00:02:56] Jim Adkins: So, Jeff, why don't you tell us how we got here?

How did the road lead to CECL? Why don't you give us a little background

[00:03:01] Jeff Voss: I mean, so, um, you know, you mentioned the date when it was originally implemented back in 2016. So not implemented, but, but, um, brought up by SASB. So it's been eight years. Hard to believe it's been the newest, the newest standard, eight years old. Um, financial crisis back in 2007 and eight, it demonstrated that the allowance for the loan release loss accounting, uh, really didn't allow for timely adjustment of reserves, you know, based on the reasonable expectation of future conditions.

Um, it, it relied on what, on losses that had been incurred, but not yet realized. Um, when it, when it was known that some expectation of future cash flows, or when it was known that some future expectation of cash flows would not be collected. During the crisis, negative outlook on the economy was not explicitly taken into account for all calculations.

So, you know, as a result, reserves were not being adjusted for future losses. FASB reviewed the standard and replaced it with CECL. CECL requires expected losses to be estimated over the remaining life of loans as opposed to incurred losses of the then current standard. Um, so that it's, it's been a long road in terms of implementation, lots of sessions, lots of seminars that bankers went to, um, lots of discussion about how to go about and implement it.

And we're finally here. Um, I know the publicly traded companies, publicly traded companies were. Implemented a couple, few years ago, we're actually probably forced to deal with some of the current then, uh, current issues at that time, dealing with COVID, how to, how to factor in COVID into the picture as well.

Um, at the time to the office of the controller of currency 30 and 50%. Um, companies that, that, um, have adopted so far. You know, one of the questions. Jim, I don't know if you're going to get to this, but one of the questions that I'd like to throw out there would be, have you seen, with those banks that have implemented, have you seen, um, increases in reserves, decreases in reserves, everybody's holding steady, that they're Excess reserves or shortages remained about the same.

What, what have you guys seen? And sorry, Jim, I kind of jumped in there and took that first. But,

[00:05:44] Jim Adkins: Good question.

[00:05:45] Jeff Voss: and, and Kyle, I'll throw it out to you first.

[00:05:50] Kyle Manny: Sure. So, know, I think the question is interesting. In general, we all thought the standard come out like we thought there should be a one way elevator. Um, if we're thinking about the conceptually incurred losses, and then we're transitioning to expected losses. Well, can only go up to go to expected.

We can't expect less than what has been incurred. So we kind of thought at that point in time, there really should only be an increase to the loan loss reserve. So our general position at the firm is that the allowance in general should go up when adopting the standard. on the flip side of that, you know, I have another colleague of mine that especially with the community banks that we work with tell you that. A lot of the community banks have had a CECL reserve really ever since the Great Recession. been using qualitative factors and other subjective conclusions to adjust their historical losses that have effectively been zero for the last decade to get to an allowance percentage that they consider reasonable at all. material respects and that instance, they've been using subjective factors to bolster the reserve to kind of get to what they expect because they felt really that they got burned during the great recession. So I tell you in general, we're still seeing most of our clients increase the loan loss reserve with the adoption. Some of our clients are making, taking the position that holding flat was a reasonable approach. Um, but in general, it's been an increase to the loan loss reserves.

[00:07:31] Jim Adkins: You know, I, my, my thoughts are, you know, we've had such a low problem credit. Environment for the last, you know, 67 years, six years, whatever it's been and how can we really, you know, we won't really know the story until something bad happens. And not that I'm hoping that will happen. But isn't that so? I mean, don't we really need a an environment that challenges the bank's credit quality?

And who knows? I mean, I'm seeing little blips here and there and some of our clients where there's some credit issues popping up. It's not anything that you got to go home and, and you know, about, but it's still, I see a difference in a number of situations. Do we really need to test this thing in a real live environment now under live fire?

[00:08:22] Kyle Manny: So let me take that one too. And so I would tell you that, we saw that play out. So the large SEC filers adopted the standard on January 1st, 2020. In their date of adoption, the pandemic was nothing. It hadn't happened yet. And so they adopted the standard in the first quarter, subsequent to. adoption.

They needed to figure out what in the world do we need to do about this? The world literally just shut down in March of 2020, so they were reporting in April on March of 2020, and we saw huge increases to the loan loss reserves by those, by those banks based on anticipated losses. Those only increased in the second quarter as the pandemic really was, was in full bore, then they kind of maintained at a certain level and then dropped down. Did those losses ever come? No. And for whatever reason, I'm not sure what folks's politics are, but certainly the federal government stepped up and provided a lot of relief, um, to borrowers and therefore those losses that those big banks were anticipating to come never actually came.

[00:09:34] Jim Adkins: So Kyle, let me, let me ask a follow up on that. So we had modified loans, right? At that point in time. you know, that was really... Uh, an effective way of dealing with past dues when you can call it something else, right? And that's what we basically did, was call loans that were supposedly affected by, uh, the, uh, um, the pandemic, we called them modified and we didn't have to deal with them as we would have.

How did that modified accounting approach, did that affect the, those banks that had implemented CECL at that time?

[00:10:10] Kyle Manny: Congress actually changed the accounting rules. I'm not sure who kind of gave them the authority to do so, but Congress. suspended the TDR rules at the time. In the event those rules were in place, the banks would have had to or should have had to account for and measure the allowance for credit losses in a special way for those loans. Because they modified that accounting treatment, Jim, they really didn't. And, and by the time that that suspension off from a legislative standpoint, that suspension of that accounting standard, if not all of those loans, those modifications have returned to full payment status given all of the, the, the cash infusion by the federal government.

So what I'm telling you is. think it worked. The standard work people were anticipating losses. We saw very large increases to the loan loss reserves. And then when it was clear, and we can now expect that those losses were going to come, banks really did start start to ramp down their their A.

C. L. S. In the 3rd, 4th quarter of 2020 and into 2021 as it became apparent that the estimates they had made had been But you know, proven untrue. And that's, it's just a big estimate. And at some point we're going to be right. And at some point we're going to be wrong. We're going to probably miss on both sides.

[00:11:31] Jeff Voss: So, so the publicly traded banks were forced to deal with it in a kind of an overt way that the privately held banks Um, it didn't adopt CECL, still accounted for it in a very similar manner, I believe. I mean, they adjusted their, their qualitative factors in a significant way, adding a factor for COVID, if you will.

And what I saw was huge increases in those reserves, even though they hadn't adopted CECL at that point in time. And like you said, afterward, watched them reduce those reserves when losses went up. We're not materializing. The situation has changed. I guess my, my one question to follow up on Jim's and your comment was, so did the federal government change gap or did the federal government change regulatory reporting and somehow we were able to reconcile regulatory reporting gap?

[00:12:33] Kyle Manny: So the federal government actually suspended a component of GAP.

[00:12:37] Jeff Voss: Wow.

[00:12:38] Kyle Manny: actually suspended ASC 310 20, if I'm remembering correctly. they suspended that 2021. If I'm not mistaken, it's been a while, Jeff.

[00:12:50] Jeff Voss: Yeah.

[00:12:50] Kyle Manny: remember the exact dates, but yeah, the expend is they suspended the accounting for TDRs.

[00:12:56] Jim Adkins: Pete, that would have been, uh, when Pete and I, we've done a lot of workout stuff and had workout banks. It would have been nice if they would have suspended some of that accounting, uh, that appraisal work back into Great Recession.

[00:13:08] Peter F.: I, I was going to say it might, it might have helped back

[00:13:10] Jeff Voss: We, we might still have been bankers.

[00:13:13] Jim Adkins: you know, you know, the, the, uh,

[00:13:14] Jeff Voss: Everything worked out

[00:13:16] Jim Adkins: yeah, the mark, the mark to market, you know, with an appraisal, it would have been nice to say back in the recession, hey, why don't we take these over three years or something like that?

But,

[00:13:26] Peter F.: Well, in the, uh, in the, uh, 1980s, uh, I believe with the savings and loans, were given the savings and loans, regulatory goodwill that were was able to keep some of them float afloat. Uh, eventually they came back and took away regulatory goodwill, and that created another situation. Um, I wanted to touch a little bit on the earlier question about the, the adjustments that were made in March. Uh, in preparation for our conversation today, uh, I pulled some statistics off of S& P Global information. And just looking at privately held banks, according to S& P, which were about 7, 3, 800 banks. Uh, looking at the statistics, 25 percent of those banks had uh, had an adjustment that increased their December 31st reserve. Uh, 16 percent actually had reduced, had a negative adjustment to their December 31st, this shocked me. 59%. Had no change. So basically almost 60 percent of the banks didn't report any change. So I think that kind of goes back to what Kyle was suggesting. Uh, reserves had been bulked up over time. when the CECL implementation came along, wasn't any adjustment being made. And the majority of those banks are under, uh, under a billion of the 3, 800 banks. That are privately held according to the statistics there. So, um, so, and all those changes less than 25%, uh, or down that were made. So, it almost seems like there was minimal impact to the privately held banks. Possibly the, you know, they're not regulatory filers with the, I, I would let Kyle speak to that. the, if the standards and the risks are more with SEC filers, and they're obviously with privately held companies.

[00:15:42] Kyle Manny: Yeah, certainly earnings is more of a topic that's, that's sensitive in a public company environment kind of because those, those, that information could be used to, to execute investment decisions, um, and likely for a private company, that's not as much. So earnings are less volatile. in that case, the, the impact on. Community banks is generally and auditors are a little bit more tolerable to, um, unallocated reserves or large qualitative components that aren't really supported by history or probabilities of fault and that kind of stuff. And that's really been consistent across the country. We've seen the private 2008 9. 10 recession. Um, those ones predominantly failed the banks that kind of bu have been concerned about not knowing what's going tell you that's that's pr Um, not surprised on the stats that you gave and kind of supports one of my colleagues often comments that lot of the community banks have maintained CECL reserves since that great recession.

[00:17:03] Jeff Voss: so. At, at the end of 2022, the end of, you know, the all calculation, um, most, what we saw in our community base, significant number of, I might say 95 percent of the banks that we work on that have, have us do some all related, or had us do some all related work, they were supported primarily by Q Factors. I mean, you, the historical losses going back.

For five year horizon, four, three, two, one, whatever it was, there wasn't enough loss history out there to be able to support a reserve. Banks absolutely refused to lower the reserves at that time and maintain these relatively high reserves and, you know, I'd say peer level type reserves. Is the same thing happening with CECL?

Are you seeing that the reserves are still supported by the Q factors themselves or? Is it, is it now because we can open it up to go back to the Great Recession with loss history that when they use some of the more simplistic models, they can pull in loss history from back during the last Great Recession?

What are you, what are you seeing, Kyle?

[00:18:30] Kyle Manny: So I, Jeff, I think it really depends on the method and model chosen by each of our banking clients. Um, our smaller clients that have chosen to use scale. the Fed scale model really is just a pure comparison to the end result of banks over a billion dollars. In that case. Those loss rates that are used as a proxy for the loss rates that our clients are using really use a lot of qualitative factors because baked into those proxy loss rates are the other of the pure banks loss rates, their expectations of the future and their qualitative factors, and so they haven't had to use qualitative factors as much to support. The allowance for credit losses flip that to banks that have used their own Warm model weighted average remaining maturity model or they've used. Um, Discounted cash flow pd lgd whatever other models are out there Some built internally many have have chosen to use a service provider Um, in those instances, we're still seeing the use of qualitative factors being least a significant component of the reserve, um, certainly probably less than they were under the incurred loss method, but still a significant component of how they're estimating their ACL.

[00:19:56] Jim Adkins: you know, Pete, what, what are the. What's the pros and cons of the scale Model B? I mean, what do you, what do you see? You know, you're a data dog. You like data. You like to go in and get through things and understand the numbers. What is the, what's the good and bad about it?

[00:20:11] Peter F.: do. Well, you know, going back to in time, um, I would say the early 2000s, you know, the, everybody was kind of saying our reserve is going to be one and a quarter of our loan portfolio. Everybody's kind of using an approach. The regulators to be okay with, having, uh, watching the industry trends. And using peer data and such, and then at, at some point, they started emphasizing using more bank specific data that you should build your reserve around your specific circumstances. And time, those kind of changed, but now I think it's going to come back. Uh, with the clients that we've done work for, we've always emphasized. You know, from a risk management perspective and from, you know, and a better handle on your particular bank situation, you really need to look at your specific data. And I will tell you, recently, within the last week or so, I heard that, there was a bank that went through, um, I believe they had a recent regulatory exam, and, uh, it went okay, but the emphasis Was that when we, uh, that they would prefer that the bank focus, and I think the bank was using scale, uh, they would prefer the focus be more bank specific as opposed to using the scale method. Now, that's just 1 instance, I think as time goes on and more banks go through their exams, we'll be getting more feedback. Uh, in general, I, I don't particularly think that the scale is, um. A method that is an accurate depiction of a specific bank. Um, over time, can build your reserve around your specific circumstance.

Obviously, you have to keep an eye on economic activity and what's going on around you. But, you know, looking at something where it's focused on banks over 10 billion, or is it, I forget, either a billion or 10 billion, how is that reflective of a bank that's 300 million or 500 million? So again. We're always, we're always emphasizing using bank specific data and, you know, for work that we've done with clients, um, that's the general, uh, that's the type of work we've done for them is developing, uh, models or work that will deliver, uh, the calculations based on their specific

[00:22:46] Jim Adkins: Was the scale, you know, and we've all been in boardrooms. We've all, you know, banks and been, you know, in, in the presence of executive management teams. And was, was the scale, was that just the easy decision? You know, are there going to be a lot of banks that they go in, they use scale, and then they maybe graduate to something more specific to their circumstance?

[00:23:07] Peter F.: Well, well, scale is something that the Federal Reserve Bank Came up with not the regular, not the regulatory side of the Fed. The F and I don't think I ever heard that the OCC or the FDIC blessed particular one. I think it was just another methodology out there. And until the exams happen this year, next year, we're not really, we'll find out what the examiners. thinker of, uh, the implementation.

[00:23:39] Jeff Voss: Well, what, what if you don't have the data? I mean, as we went through. Eight years of, of instructing banks to collect data, collect all your loan data, um, a lot of these smaller institutions didn't do it. And, and so scale seems to be the easiest option for them, probably the one method, um, in order to avoid having to deal with detailed data itself.

[00:24:10] Peter F.: I agree. Fortunately, for the, for clients that we've done work for, either had the data or we've helped them assemble the data, search for it and build it. Uh, but you're right, without having at least five years worth of data, three to five years worth of data, the, it's challenging to do something, but like you said, if, if, you know, going forward, banks can, you know, pull that data and utilize it if they need to.

[00:24:41] Jeff Voss: So the,

[00:24:41] Kyle Manny: I,

[00:24:42] Jeff Voss: the simplicity, one of the advantages of scale is obviously the simplicity of it. And the ease at which you can comply with an accepted, at least what appears to be an accepted methodology out there, you know, is from what I can see. Um, I, I guess the, uh, the proof, as you said, will be when the examiners get in there and look at everything.

Um, we'll talk more about the examiners in a few minutes too, I'm sure.

[00:25:11] Peter F.: Yeah, and I think somebody commented earlier, one of the biggest challenges is for the last few years, there really haven't been losses or charge offs. Of any significance of materiality. in terms of backtesting or proving this out, um, there isn't, you don't have the charge offs.

[00:25:31] Jeff Voss: Well, what's one of the things that I've seen some banks do is going back to their. You know, the worst times back in the last recession, you know, 2009, 10, 11, and those are the statistics that they're using loss rates, you know, on their portfolio, their various portfolios, call report based portfolios, rather than going back only five years where there is no loss history, so they're taking that.

And Kyle, are you seeing that too, where they're, they're taking kind of the worst case scenario and building into the model?

[00:26:08] Kyle Manny: I've seen them use the data in different ways, Jeff. So Okay. They may go back and look at lost data and loan behavior for that period of time. I think that would be appropriate, um, in the event that you understand that you're using that and you may have different types of qualitative adjustments than you would if you're only using data from the last three or five years. Where I'm seeing it used more effectively is when banks try to identify. The degree losses that could come in how they're applying qualitative factors. not necessarily just coming up with an arbitrary scale that they're saying if things are getting a little worse, we're going to apply a 25 basis point adjustment to a certain portfolio, or a 50 basis point adjustment, or 100 basis points. They're using that data to develop the scale based on What's been the worst it's ever been

[00:27:05] Jeff Voss: Okay. Yeah.

[00:27:06] Kyle Manny: and in the event that you know, we're seeing really bad economic data Maybe we'll change those scales to increase them or decrease them, but it's been a nice basis to help identify The goalposts that we're working with when we're making those subjective conclusions

[00:27:22] Jeff Voss: I didn't, I didn't even think about that. That's a great way to frame it up of you can use your worst case scenario as a goalpost in order to, uh, create that, that, that, um, matrix, if you will, to multiply your Q factors out with. It makes a lot of sense. You know, we're still using his story. In many cases, we're still using historical data.

In order to prognosticate future losses again.

[00:27:57] Peter F.: the,

[00:27:57] Jeff Voss: know how you

[00:27:57] Peter F.: the 1,

[00:27:58] Jeff Voss: ever get around that. Yeah.

[00:28:00] Peter F.: the 1 thing we've seen with, with, with our clients that we've done work for, um, a lot of their portfolios are, have been originated more recently within the last 5 to 6 years. That's, at least with our, with our clients, you, you look at their loan portfolio and 85% of the portfolio has been originated, uh, within the last five to six years. So it's been underwritten to new standards. So, you know, when you look at the worst case scenarios and back in the two, late two thousands, is that really relevant to today's underwriting standards? Could be, but but they're different. You have a pool of loans. That have been underwritten to more recent, uh, credit underwriting.

[00:28:52] Kyle Manny: at Pete I think that's a great point and and let me play the devil's advocate to that because I do as an auditor I'm a paid skeptic Um, I appreciate that. I hope bankers learn their lesson during the Great Recession, and I know all of my clients did because they're great bankers, but I have, you recall, during the pandemic and during all of the fiscal policy changes that were made, were overloaded with deposits folks had liquidity up the wazoo and folks were really searching for Loan demand commercial borrowers were paying down lines with all the fiscal stimulus that they got So there was really pressure from lenders to go out and deploy the liquidity that was in the system So well, I agree with you.

I think that underwriting in general has gotten better since since the late 2000s I would tell you don't take your eye off the ball. I certainly heard about a lot of banks down the street offering bad structure on deals giving up guarantees that would have existed giving up On loan of value giving up certain things and again, none of them admitted to doing it themselves But everyone wanted to tell me about the bank down the street that was doing crazy things so I it might be different types of Stresses that were being done that was done in the late 2000s But I do think there was pressure in the last three to five years on

[00:30:21] Peter F.: Oh, that's a good

[00:30:22] Jim Adkins: Yeah. And you know, you look at the rates, you know, just a few years ago, a 4 percent rate was not unheard of right for a good borrower. Some were even lower than that. And now you're looking at rates that are pushing 10%. And the renewal risk is significant. And, you know, we are, as I mentioned earlier, we are seeing evidence of deals that just don't underwrite like they did three years ago. And, you know, certainly that's going to play a big part in Thank you. You know, CECL and our reserve levels and things like that, I would think,

[00:30:57] Jeff Voss: So I'm going to switch directions here a little bit. I'm going to start with saying, so we talked about scale in this, I'll call it the simplicity of that model. Banks also have the ability to customize and do things internally. Um, what, what are the pros and cons of doing customization of their, their modeling?

And then I'm going to take one more question deeper in that. Are you seeing banks use different methodologies for different portfolios? You know, that was one of the big things back when we were learning about CECL, that you could tailor your methodology. It wasn't a one, one method requirement like it was under, under the all method.

Here we had the ability to tailor our method, methodology. So first customization. Pros and cons, and then are you seeing that with whatever methodology is these customization, are they using different methodologies? Whoever wants to take it.

[00:32:06] Peter F.: Um, from what we, from our clients that we've seen, um, they use the same methodology across the board. The, we're talking about community banks that don't have, they're more of a vanilla type lending. Um, so they use one approach across the board. The only, the only item that they will do different is for accrual status. Uh, they will a separate pool from them and do a direct, you know, impairment analysis to come up with a reserve for those. But other than that, they'll use 1 methodology across the board. Um, again, they don't have sophisticated portfolios or something that would materially drive them to try to do. types of, uh, methodologies within their, within their loan portfolio.

[00:32:58] Jim Adkins: you know, having said that, Pete, know, we have a lot of clients that are interested in FinTech and we have some, you know, community, I don't know, community bank, I don't know if you describe as community bank, but large community banks or banks that are probably at the higher end of the community bank scale that are going hard into FinTech, you know, and originations of different products and things like that. I wonder how you have to take your FinTech strategy and, and, and in that consider CECL, because, you know, a lot of these loans are national loans that, you know, people are originating things not in their backyard anymore, and there's, there's a little more risk in the system. How does CECL, is that supposed to be picked up in CECL in some way? These strategic moves to these other products that are. Somewhat fintech based.

[00:33:49] Peter F.: I, I would think you'd want to create, uh, different segmentation as much as you can for unique characteristics. You know, if you have a, loan pool versus an originated pool, you probably want to look at that on a, on a, as a separate segment when you're assigning qualitative factors to it you're determining historical loss. off of that because it's a unique, you know, it's a unique, uh, feature there. So when, uh, you know, for most of our clients, we've done based on a call report classification. And I would suspect most of the banks out there, it's probably the most simplistic thing, but we do have clients that have some unique products or they purchased pools of unique products. And they will create a separate segment and do calculations for that specific segment so that it's not blending in with, uh, you know, if they have a CNI pool they purchased some CNI credits, them out because you have different characteristics and, it gives you a better handle in terms of risk.

I always look at stuff that the banks are doing. Are you doing something that'll help you with the risk management as well, or reporting that. You can understand what's happening in your portfolio as opposed to consolidating everything together, uh, and you don't get as much information out of it. But again, that goes back to having the data or the ability to capture the data or you're segmenting it through your general ledger or through your loan system to be able to capture that information.

[00:35:25] Jim Adkins: mean, Kyle, I don't know if I'm sure you've seen this as well, but of times when we go in and we look at, you know, the information, the fields that the banks are using to populate their. Their data files and things like they just not capturing enough data and that's always a struggle. I don't know if you've seen that as well, but it seems like it is.

[00:35:48] Kyle Manny: Yeah, I think what I've seen, Jim, honestly, is, um, and we were one of the firms that was squawking early on in 2016, 17, 18, collect more data, collect more data, because we candidly weren't sure how banks were going to pool their loan portfolios. And at one point we thought, all right, maybe we're going to look at, CNI loans with debt service coverage from 1.

2 to 1. 5 and that was going to be a pool and then one above two was going to be a pool below one was going to be a pool, but we needed the data to find that I don't have a single client that segments their loan portfolios like that. So some of that data that wasn't readily available really isn't. Used by any of my clients What the nice thing has been and p alluded to it earlier It's been common that most banks have defined most of their loan pooling by call report code And they've done that in a lot of ways in a lot of reasons But one of the biggest reasons is the under the accounting standard you're allowed to use peer data to support your loss rates if you don't have sufficient data to get there.

So like you're alluding to here, if you have a FinTech partner that's providing paper, can go out and find significant auto lenders and look at their loss data, look at their delinquency data way back as far as call reports were segmented that deeply. So there is ways now to seek and find data to apply to new types of lending that may be Brought in through a new fintech relationship that is all of a sudden available to you You may not have the data, but it's out there. Um, Jeff, I think your question on pros and cons of kind of these these

[00:37:33] Jeff Voss: Custom. Yep.

[00:37:35] Kyle Manny: Yeah, I I like to refer to them as more quantitatively complex models because is just not complex, but many of the customized models are more complex. I think there's the con on it, I'll start, which is the pro for scale is that one, it's not simple. And two, if you don't think examiners are coming in and comparing you against your peers already, you're crazy. And so what scale does is it just takes, all right, we're just going to compare to these guys down the street. We're going to book to what they book to and we're going to be done and generally most examiners are going to say, yep, good enough. I think it's kind of the easy button in terms of setting the reserves. So that's the, that's the pro for scale. It's the, it's

[00:38:23] Jeff Voss: Efficiency. Yep.

[00:38:25] Kyle Manny: a quantitatively challenging model because you don't have that easy button to click with the examiners. The pros on those quantitatively challenging models. Um, biggest one is for those banks that would ever consider selling those banks that are trying to compare themselves and understand how a purchaser would look at their loan portfolio, I think it's a much better representation of what buyer would expect to receive or what they would expect to lose. And you could really try to push. Any sort of acquirer on this is the mark that you should put on our loan portfolios because this is what we've seen historically on default rates. Here's how we're thinking based on Moody's forecast based on Fed forecast based on who's ever forecast. Here's how those default rates are lost.

Given default rates will change based on those forward forecasts. So you can really drive folks understanding your portfolio far better. that has historically done in due diligence where people are applying really broad industry loss rates and you can't really challenge them.

[00:39:37] Jeff Voss: Yeah. It's a great point.

[00:39:38] Kyle Manny: may say you're getting a point in a quarter a, on a credit mark. When in reality, you haven't taken a point in a quarter in the last decade. So it's been really hard to challenge those things, but with CECL, a quantitatively challenging model, you may be able to push folks a little bit more than you have in the past on what that initial credit mark should be. think that is a, an advantage for some banks.

They may say that's not, I don't really care about that. Um, and then in that case, I, you know, it's hard for me not to recommend scale to folks that just don't care,

[00:40:11] Jeff Voss: Yeah.

[00:40:11] Kyle Manny: and appreciate that easy button.

[00:40:13] Jeff Voss: Yeah. Yeah.

[00:40:14] Jim Adkins: Well, I think Jeff, you said, you know, we're going to see more and more exams coming through and we'll get more feedback as time, time goes on as to you know, the scale up with a more. Specific thing. And as you said, Kyle, it may come down to the model that your bank is, is employing in the marketplace.

And, know, if you're just a standard bank and you know, why take the risk? But if you've got some interesting things going on, there might be a little kickback or not kickback. That's probably the wrong word in a financial discussion. There might be a little, uh, resistance from the regulators on

[00:40:52] Jeff Voss: Yeah.

[00:40:53] Jim Adkins: like that.

[00:40:54] Peter F.: Well, you know, for banks also there, there's cost considerations, you know, scale is a relatively low cost option. I'm sure that Kyle has seen very high end options, but cost of acquiring or utilization is, uh, more significant. So,

[00:41:14] Jeff Voss: Yeah.

[00:41:15] Jim Adkins: see

[00:41:16] Jeff Voss: let me, let me ask one more.

[00:41:17] Jim Adkins: question.

[00:41:18] Jeff Voss: Yeah, I'm going to ask

[00:41:19] Jim Adkins: All right, go.

[00:41:20] Jeff Voss: one more question. So you guys have been both through implementations with all your clients and seeing how they've been implementing. What are the pitfalls, some of the things that have not happened well in the implementation at these institutions?

Are you seeing things that they need to do to make sure when the regulators come in, um, you know, they're going to get a pass? Um, I've, I'll just say, I think the banks that I've gone, that I work on, that have gone through exams, regulators have given it a glossy look, and what they're waiting for is Kyle and his troops to come in and give them the thumbs up, because that's going to give them more assurance that, you know, they're complying with GAAP, because I don't think they really, understand it yet themselves, some of these examiners.

But I'd like to know your thoughts on what do banks need to do to shore up their situation today? And I, I've got some ideas myself too, but you'll probably touch on.

[00:42:36] Peter F.: um, well, from my perspective, what I, what I've seen, uh, a client that's gone through, uh, through, uh, an audit or uh, documentation, um, And making sure that your documentation covers the, what you need in it so that it's understood by your auditors. It's understood by your board, it's understood by your examiners. so that's what I've seen is everybody's been racing

[00:43:06] Jim Adkins: And finally,

[00:43:07] Peter F.: something

[00:43:07] Jim Adkins: Kakaigloss in Form Pit, because we don't actually have the letter, so we need to find some form pit

[00:43:12] Peter F.: it probably is more in his bailiwick. an

[00:43:14] Jim Adkins: donators

[00:43:16] Kyle Manny: Yeah, Pete, you stole my thunder on documentation. I think the one, the one challenging thing with this is the accounting standard and frankly, the regulatory response to

[00:43:26] Jim Adkins: to help us

[00:43:26] Kyle Manny: standard is There isn't a prescribed methodology doing the allowance for credit losses. They left it very open ended and the examiners haven't given us the next 2006 interagency policy yet on the allowance for credit losses. They've really left it up to banks to come up with initial methodology and how to, uh, how to apply the standard. from my vantage point. Making sure you understand your methodology, whether you built it yourself,

[00:43:56] Jim Adkins: with our lung cancer

[00:43:57] Kyle Manny: you're using

[00:43:58] Jim Adkins: Duodenum

[00:43:58] Kyle Manny: or whether you're using a third party service

[00:44:01] Jim Adkins: enil

[00:44:01] Kyle Manny: that. What we've identified is, especially in those situations where people are thinking they're clicking the easy button by hiring someone to do it. Um, and, and one of the probably the most often used ones would be Abrigo,

[00:44:15] Jim Adkins: is

[00:44:15] Kyle Manny: is they don't understand. The levers that they're pulling in the

[00:44:20] Jim Adkins: what this

[00:44:20] Kyle Manny: And when we look at those levers and we look at correlations and we look at things and

[00:44:24] Jim Adkins: That's the problem.

[00:44:26] Kyle Manny: they don't really have a good answer.

[00:44:28] Jim Adkins: And, uh,

[00:44:29] Kyle Manny: the more you can document not only what you're doing, but why you're doing it is a reasonable and supportable

[00:44:39] Jim Adkins: Um, Um, Um, Um, Um, Um, Um, Um, Um, Um, Um, Um, Um,

[00:45:00] Kyle Manny: I think, but I, overall, I think in general, our clients have been doing a really good job of coming up with a good, supportable, reasonable range. And then I think we're going to work out the details over time, but to get ahead of that, Jeff, it's document, not only what you're doing, but why you did it.

[00:45:18] Jeff Voss: Yeah, I, you know, this is going to sound goofy, but,

[00:45:22] Jim Adkins: Um,

[00:45:23] Jeff Voss: as simple as make sure the terminology you're using is current with the current standard. I can't tell you how many people still use a triple L. in their policies that I see when it's not A triple L anymore, right? It appears on their financial statements and like, guys, it's A C L now.

You got to use the right, right terminology.

[00:45:45] Jim Adkins: Hey, people still say fast five.

[00:45:49] Jeff Voss: Yeah, yeah.

[00:45:50] Jim Adkins: It's still that's been going on for for a long time.

[00:45:53] Jeff Voss: So anyway, that, that

[00:45:55] Jim Adkins: I

[00:45:55] Jeff Voss: was my final question.

[00:45:57] Jim Adkins: that was a good question. So, uh, we're, we're out of time. Uh, the old clock on the wall, or maybe I should say, since we're all very current, the Apple is saying that we're out of time. I want to thank Kyle and Pete for sharing their expertise today. Yeah, Kyle is a fantastic accountant and we love working with him and Plant Moran. If you would like to contact Kyle, you can reach out to him via his email. Kyle, you want to give that if someone wants to talk?

[00:46:27] Kyle Manny: Sure. It's kyle. mannyatplantmoran. com.

[00:46:32] Jim Adkins: Perfect. And of course, if you want to reach out to Jeff, Pete, or me, just go to our website artisan advisors. com and our contacts are there. until next time, this is Jim Adkins. Thanks for listening and happy banking.