Caveat Emptor: The Pitfalls of a SaaS Approach to CECL

By Adam Mustafa, Invictus Group CEO


Software can be wonderful. It can provide a spike in efficiency and automate a host of processes and problems that were previously solved manually in painstaking fashion. As a result, it is no surprise that many community banks have deployed or are strongly considering a software as a service (SaaS) approach to implementing CECL.

But as many community banks that have already started down the CECL path can attest, software can create far more problems than it solves. A CEO of one Nebraska bank told me, for instance, that the bank got hit with unexpected implementation costs. Another CFO of a Wisconsin bank realized his CECL results would not pass muster with accountants, let alone regulators.  A CFO of a New York bank didn’t trust the loan loss reserve calculations, but had no one to consult with at the SaaS vendor.

The purpose of this article is to summarize the not-so-obvious pitfalls that many community banks have fallen into with their SaaS CECL implementations. Any community bank scheduled to adopt CECL in 2023 but has not yet decided on a CECL solution should read this very carefully.

SaaS Pitfall #1:  Forgetting that Once You Purchase the Software, You’re Still on Your Own!

Once you purchase the software, and your data is successfully uploaded, the real work often begins. You’ll have to make tough decisions, including how to customize the software to your unique institution, what methodologies to use, what assumptions to make for those methodologies, and how to support those assumptions.  In addition, documentation must be written, and somebody needs to explain to auditors, model validators, and regulators what is going on in the model.

These tough decisions and tasks are not one-time events, and the reality is you are left on your own to figure them out. Your initial attempt at a CECL calculation will likely come up with a result that may not feel right. It may be too large or too small, or one pool has a much higher loss rate than you expect while another pool has a much lower one. You will then have to figure out why that is the case and what adjustments you need to make.  This is a reiterative process founded upon learning and adjusting.

Then once you think you know the answers, you may be thrown a curve ball, such as a once-in-a-lifetime pandemic. COVID-19 broke every model, which previous CECL filers know all too well. Can you imagine what some of these models were spitting out when GDP cratered by over 30 percent and the national unemployment rate reached 15 percent in the second quarter of 2020?  Events like this can create massive volatility and uncertainty in your reserve, and software doesn’t solve this for you. You are left to your own devices to figure out how to adapt to this type of situation.

Larger banks that have a dedicated person or even a dedicated department are far better equipped to handle these issues. They have the two critical prerequisites to successfully deploy CECL software while also making the tough decisions: (1) technical skills and (2) time.

Unfortunately, the average community bank is in a different situation. Most are relying on someone in their finance and/or credit department to be the “CECL person,” but that person usually is left on an island. That person often has more than enough talent to handle CECL, but also has 500 other pressing tasks on his or her plate. In fact, that person is usually viewed as a star internally, and as a result, is often leaned on by many senior executives within the bank, which further diminishes their capacity. One person simply cannot not have enough time to dedicate to CECL once he or she figures out that the software the bank just purchased is not the panacea that management was expecting.

SaaS Pitfall #2:  Failure to Budget for those Unexpected Consulting Fees. 

Perhaps you bought software after seeing a presentation from your regional SaaS sales rep that showed how easy and affordable CECL can be. The annual fee seemed reasonable. But then you fall into Pitfall#1 described above. You contact your sales rep who sends you a bunch of white papers and user manuals and suggests you attend the next regional training session in your territory, which is often not included in the cost. Helpful, but not really. You go ahead and ask for more help. The answer is often the SaaS consulting group, which can help with implementation, but of course, that was NOT included in the cost and they are not cheap.

The consultants may give you guidance on methodology selection, and often point you toward either the Weighted Average Remaining Maturity (WARM) method or the Discounted Cash Flow (DCF) method.  This is often poor advice. You are often left with something that is too simple that you could have easily done yourself in an excel spreadsheet, or too complex using assumptions that you do not understand (giving a nod to those using Frye Jacobs for their LGD assumptions feeding their DCF) and will be in a poor position to defend their results with the auditors and regulators.

Many consultants are often also brought in on a one-time basis to help a bank ‘stand up’ their CECL models. Unfortunately, CECL is still in its infancy, and it will take a while for best practices to emerge, especially with the economy in transition from the pandemic. CECL requires consistent evolution and improvement over a long period of time. Quick fixes can also mean quick shelf lives.

And at the end of the day, a SaaS company doesn’t have a vested interest in you having a successful outcome. After all, the software can do “anything.” It’s your fault for not manipulating it correctly if an audit blows up in your face, you find yourself slapped with an MRA, or perhaps worst of all, you find your bank grossly over-reserved.

SaaS Pitfall #3:  Welcome Back to Q-Factor Penitentiary. 

OK, now you’ve spent vast amounts of unbudgeted dollars paying consultants to help you calibrate the software. Yet after all of this, you find yourself exactly in the same position you were in during incurred-loss land, which is having to rely on good ole q-factors to drive your reserve. Reliance on q-factors really means having to err on the side of over-reserving and/or having a weak hand to defend your reserve with auditors and regulators. And then you realize that all you got for your investment was an extra 10 or 15 basis points of your bank’s reserve quantified under CECL versus the incurred loss method you used before. Yikes. Let me be clear. If you cannot quantify 75 percent or more of your reserve in CECL, your model is hot garbage. You may (barely) win the battle by having the auditors and regulators accept your q-factor infested model, but you will lose the war (via excessive over-reserving draining shareholder value).

Wrap UP

Software as a service is a highly tempting solution for community banks to deal with CECL. It appears to be both easy and cost effective. Unfortunately, not everything is what it seems. The reality is that the banks best positioned to utilize SaaS solutions are the largest banks and the smallest banks. Large banks have the internal resources, both in terms of capacity and technical expertise, to unlock full value from the purchased software. Small banks can get away with the easiest methods for CECL and require little customization and complexity. All the banks in between are most at risk to encounter the pitfalls mentioned in this article.

CECL has a lot of similarities to doing your taxes. There are plenty of software solutions out there for filing your tax returns, most notably Turbo Tax. Some people do their taxes on their own and allow these software packages to guide them. But these individuals are highly unique. They tend to be people who are very technical, have time on their hands, and have enough conviction in their own situation to understand the end-product. Or they have very simple tax profiles.

But most of us do not. We still prefer to hire a CPA to do our taxes because we fear making a mistake or simply do not have the time. Some people also have more complex tax situations and require more customized solutions, such as having to itemize deductions or merge multiple income sources.

When the Trump Administration pushed through tax reform in 2018, most of us didn’t just go out and purchase TurboTax 2019 and call it a day.  In fact, we relied on our CPAs even more to guide us through the nuances and make sure we did not over or under pay.

With CECL, what many banks really need is a partner that brings technology, expertise, leadership, and manpower to the process. And unfortunately, SaaS only checks some, but not all, of those boxes.