Risk Management & Analytics: CECL methodology will become part of bank M&A due diligence by mid-2019

CECL methodology will become part of bank M&A due diligence by mid-2019

After many quiet years, merger and acquisition (M&A) activity at banks has been on the rise in 2018, and several favorable trends will likely sustain the momentum through the remainder of the year.

By the middle of 2019, as banks evaluate acquisition opportunities, they likely will add a new component to their customary due diligence: an exploration and understanding of the target company’s Current Expected Credit Loss (CECL) methodology.

That’s a likelihood envisioned by Jeff Prelle, Managing Director and Head of Risk Modeling at MountainView Financial Solutions, a Situs company. Prelle is also the author of CECL’s Impact on Acquired Loans, a white paper published by Situs.

“The new accounting standard goes into effect in 2020 for banks that are SEC filers, but in the middle of next year it will become common practice for an acquirer to do deep-dive research into how the target is planning to measure credit losses for CECL,” said Prelle. “You’ll not only want to consider your capital requirements in the post-CECL era, but you’ll want to compare your target’s estimation methods to your own so that you know how the provision for loan losses post-acquisition is likely to impact your capital requirements in 2020.”

CECL, by design, affords financial institutions the flexibility to model their own reasonable assumptions and loss calculations as they deem appropriate. This means there will likely be a significant disparity in the allowance for loan losses between the two banks.

Situs’ white paper discusses how CECL in total will change purchase accounting rules, including changes in fair value determination and loss estimation for both loans that are performing and loans that are impaired as of the transaction date. The impact is one of many that banks are scrambling to get their arms around as they continue to plan to implement CECL.

Technologically transforming credit risk management

Credit risk is the risk of default on the part of a bank borrower or counterparty to meet the credit obligations or pay debt as defined in pre-agreed terms. Banks and corporates are under tremendous pressure in the wake of challenging economic circumstances to deal with credit risk management in a more effective and risk-averse fashion. The new regulations such as Basel III and Solvency II have introduced tighter rules on risk management, including credit risk. Within such situations, managing credit risk revolves around reducing credit risk exposure within acceptable limits to make sure that even in a situation of a default the damage will not jeopardize the organization’s core business operations and activities.

Management of credit risks begin with the understanding of risk within the financial organization. An extensive knowledge of all internal elements that can influence credit risk exposures and identification of assets of the organization that are exposed to credit risk is a primary concern.

Financial institutions need to bring effective solution in place to appropriately monitor and measure credit risk in relation to their counterparties. This is where technology steps in to aid organizations in streamlining the process of managing credit risks. Automation of business operations and compliance practices to monitor each action against risk will enable organizations in ensuring enhanced auditability and mitigating credit risk. Implementation of a business process management (BPM) system will help financial institutions to effortlessly construct efficient processes and design the necessary strategic measures to ensure proper performance and minimize operational risk. Once the stage for technological support for measuring financial exposure is set, limits to automatically track and calculate credit risk in agreement with pre-defined requirements can be defined.

Read more: CIO Review

How Brexit could affect finance, real estate and the global economy

As the date for Britain’s exit from the European Union inches closer, the U.K. is in turmoil over how exactly that withdrawal will look.

Since July, two high-profile pro-Brexit leaders, David Davis and Boris Johnson, have quit the cabinet and British Prime Minister Theresa May released a white paper outlining the government’s vision for its post-Brexit relationship with the European Union.

The renewed risk of a “no-deal Brexit,” in which Britain would leave the EU without having reached an agreement on its ties to the rest of Europe, has become “uncomfortably high,” Bank of England Governor Mark Carney told the BBC last week.

And while the deadline for Britain’s withdrawal is March 29, 2019, negotiators reportedly see the next two to three months as crucial, naming October as the time by which a deal must be finalized so it can be ratified by the exit date.

Read more: Forbes

China’s softer approach to debt doesn’t mean easy ride for banks

China’s top regulators are signaling that they’re not about to go soft on overseeing the nation’s $40 trillion financial industry, even as an economic slowdown gives them reason to relax their campaign against debt.

The Financial Stability and Development Committee, headed by Vice Premier Liu He, emphasized last week that that it will continue to crack down on wrongdoing and illegal financial institutions. That statement is backed up by record fines against market malpractice in recent months and stronger cooperation between law enforcement and financial regulators, pointing to determination to corral the sector’s excesses.

While a recent easing of an ongoing anti-leverage campaign may have suggested a more relaxed posture by the government, regulators are showing that their years-long attack on risk taking and threats to the system remains in place. New capital rules governing an asset swap program also surprised investors last week with their toughness.

Read more: Bloomberg

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