CECL Case Study: From In-House to Outsourced (Micro-cast)

Nancy Ozawa (00:00): Hi, I am Nancy Ozawa, I’m Senior Vice President of Marketing here at PCBB. And I was just talking to one of our CECL customers who had originally planned to perform CECL in-house, but decided to outsource and partner with PCBB instead. So, I have invited Michael Kerr, Chief Credit Officer at First Federal Bank in Dunn, NC to share his story. Michael, I appreciate you spending the time to talk about CECL, I understand that your team initially was planning to do CECL in-house, possibly with SCALE. Can you share your CECL journey and the main motivators that helped you make the decision to change course from in-house and decide to outsource it. Michael Kerr, CCO, 1st Federal Bank (00:38): Well, we started looking at CECL back in '18. We wanted to kind of run in parallel a model for three years. And, I had looked at several different vendors, and we had even looked at an in-house or in-house core provider, and for a bank our size, it was going to be very costly to run the CECL model through these other vendors. We were looking to have them just run it and we would just kind of verify the results. But anyway, to make a long story short, it went on the back burner. our bank felt like maybe this might go away. Then COVID struck and that delayed it even more. And last year, probably in late summer into the fall, it came back up again and my president had been on a Zoom call and they talked about the SCALE method for CECL, And around November he said, "Let's look at the SCALE method." We looked at it. We sat down by a conference call with the OCC. We kind of ran it through a little bit. We started to implement it. And we got probably about halfway through it and then Michael Davies, He's been the one running this. And Michael is very, very smart, very, very analytical, very, very, sharp individual. He said to me, "I've got a lot of concerns about this. I can't defend or support the calculations using the scale method." But just from an audit and examiner perspective, being able to pick the right model and then being able to support and defend your decision and your judgment as to why you chose it and the numbers you're using to the methodology to support that. That's the biggest thing. I was down in Charlotte yesterday and we were meeting with the OCC and they talked a little bit about the SCALE method and they put it up there and it looks very easy to do, but when you get into it and you put it together and you have to support. And there are banks using it that I know of. Have they had the models validated and have they been tested by auditors? That I don't know. Have they taken early adoption? I don't think they have. I think they've been kind of running with it. They're our size and smaller, so it maybe fairly good for them, but not for us. And he had been working on it for probably about three or four months, putting it together. And the clock is ticking on us. And, I had a friend of mine who's at another bank, Coastal Bank, and He said, "Who are you using?" and he said “Well, I'm using PCBB." And I said, "Okay." And I said, "Are you happy with it?" He said, "Yes, it's been very good to us." And I said, why don't we reach out to PCBB and see if they can get us in and what they can do for us and what's involved." So, Frank, And Janet, they were fantastic. We explained what we were running into, SCALE method. And I said, "Well let's talk with my president, my CFO and tell them what the situation is, tell them how the SCALE method, while it looks very simple from a hundred thousand, 50,000 feet, when you boil down to it, you have to support it to auditors or examiners." It's going to be very, very difficult for us to do that. And I don't want to get us in a position where we get in trouble with that, where we may not necessarily set aside enough reserves or we over reserve, whatever it may be. Nancy Ozawa, SVP, Marketing, PCBB (04:07) Michael, as you know PCBB works hard to ensure a smooth onboarding process. Can you share what your experience was like working with PCBB? Michael Kerr, CCO, 1st Federal Bank (04:17) Everything worked really, really well. Everybody was very helpful. We got the contract, I think within a couple days. We've got a relationship with PCBB. We know them. They're not some fly by night group." It was extremely well priced and reasonable, which was another attractive thing that helped me get my president to go along with this. It made sense. Frank knew the predicament we were in and his relationship, his support really helped us move forward faster. And we started probably in late April, we got you guys the information for the first quarter for calendar year 2022, which we're on a June 30th fiscal year end. That was our third quarter of our fiscal year. Y'all got that finished up in August. We got our first number and then about a week and a half, two weeks ago, we got our second number for the year end. It moved really quick, I just reported to our board last month that we are now fully implemented. I reported our first CECL parallel run from March 30th and then June 30th, We're looking forward to doing now the September quarter ending number, which we should have probably in the next two weeks. Ideally, I think you probably want to have two to three years running in parallel. But we'll probably have about five to six quarters worth of parallel information. And the big thing about it with us is our losses since 2012 have been very, very minimal. Our reserves, if anything, we've been probably a bit over reserved. This will put a lot more perspective to help us out going forward. Nancy Ozawa, SVP, Marketing, PCBB (05:54) Michael, are there any tips you might share with your peers who are in a similar situation and are planning to do CECL in-house? Michael Kerr, CCO, First Federal Bank (06:02) I think if you want to kind of look at the SCALE method that's up to y'all. I think you need to have the professional help with folks like PCBB who have the ability, who have the expertise and have the access to the data needed to support and defend your qualitative factors, your methodologies. It's very, very difficult for a bank, somebody like us, we're not a First Citizens. We're not a BofA or a Truist or anything like that where I'm sure they've created their own models. There's a lot of time involved with making sure that the model is correct, your methodology is the right one, accessing the data, collecting the data, if you can even access the data. And a bank our size just doesn't have that capability. we don't have the time or the manpower to have a full time person dedicated just to CECL. I think the other thing is, there's so much accounting involved with this. As Michael Davies and I were talking, he kind of said, "I wish I had majored in accounting now rather than finance," because this model is all about accounting. And you really have to have that expertise and we don't have that expertise. And if we could have somebody to help us out with that, it makes a big difference. I don't have to lose sleep at night worrying about this calculation or how to defend that calculation. While I'm responsible for it and defending it and explaining why we did what we did I know I can rely on you guys to help us out and guide us along the way. PCBB was able to really boil it down to layman's terms and helped me understand that a lot better, There's things out there that you just don't even think about that you guys have the expertise to know and say, "You need to think about this, you need to think about that." The kind of help and support that was really helpful. You guys have been extremely helpful, friendly, very supportive, very extremely knowledgeable Nancy Ozawa, SVP, Marketing, PCBB (07:44) Perfect. Well thank you so much for sharing your story. I really appreciate it and suspect that your peers listening have benefited from hearing your story and your CECL journey. For our listeners, I’d like to let you know that if you have questions about CECL or your approach to doing it in house. Feel free to reach out and call us or even email us to have a no-pressure casual conversation with one of our advisors and we can have them provide advice and share our perspective on key aspects to consider when getting ready for CECL, and getting ready to having those discussions with your auditors and regulators.