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CECL Q&A - PD/LGD & discounted cash flow

Posted by David Kistler
CECL Q&A - PD/LGD & discounted cash flow

The FASBs Current Expected Credit Loss (CECL) model presents unique challenges for banking professionals. 

To help institutions prepare, Sageworks launched a CECL webinar series covering data, segmentation, methodology and forecasting requirements broken down by loan type. A key component of the series is allowing participants to ask their CECL-related questions and below are several questions with answers relating to different methodologies; specifically, we take a look at common questions for running a probability of default & loss given default (PD/LGD) analysis and discounted cash flow analysis.

PD/LGD:

One way banks and credit unions can potentially improve their methodology is to employ a more robust analysis in the general reserve loss rate estimate. A probability of default/loss given default (PD/LGD) approach is widely recognized as one such type of analysis for determining portfolio loss estimates.

We subscribe and/or calculate the probability of default at our institution. Can we use our current PD model?

If you are using a 1-year PD model then you need to change it to the current life of the asset you are estimating losses on.

Discounted Cash Flow:

We’re approaching $10B and are looking for a solution for DFAST and CECL. Which approach is ideal for cross application?

If we think about DFAST the principle is, at a point in time and with clarity. Not just losses, but growth and revenue. A DCF would provide the period level results that are needed and could be correlated to the FED tables to inform you DCF schedule.

Our institution is only $500M, we don’t need to do complex modeling such as DCF, correct?

That can be true, if you do not have access to your historical data or if that data is not viable. Without viable data that’s shows the life of the asset then a DCF model may be the most applicable approach and with the right tools, it is not a cumbersome exercise.

If you are interested in more answers to CECL, watch the on-demand webinar, “CECL Methodology Q&A".


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