The Issue of Disclosures and the Proposed ASU – Codification Improvements – Financial Instruments

This is the third installment in a series of blog posts about the proposed ASU for codification improvements to ASU 2106-13, better known as the CECL standard. Click here to see the initial post in the series and to read some background on the proposed ASU. Issue 5A: Vintage Disclosures - Line-of-Credit Arrangements Converted to Term Loans One of the new disclosures required by the CECL standard is the disclosure of the carrying value of loans disaggregated on both their credit quality indicator as well as the vintage, or year of origination. The entity would have to produce this disclosure with columns for term loans originated in the last five years, as well as separate columns for term loans originated prior to the last five years and revolving loans. See the below illustrative example directly from the guidance: An issue that was discussed at the November 1st meeting of the CECL Transition Resource Group was how loans should be treated in the vintage disclosure that had previously fallen into the revolving category but at some point since have converted to term loans. A variety of scenarios were raised, including revolving loans where an eventual conversion to term was written into the original agreement, or loans where the lender performs a new underwriting and converts the existing revolving loan to a term loan. This also might include loans that are restructured as part of a Troubled Debt Restructure (TDR) agreement. Opinions seemed to differ on what the correct treatment of these loans would be for disclosure purposes: whether they should be included in the column based on their origination date, included in the column the based on the date they converted to term loans, left in the revolving column even after the conversion to term, [...]

2019-02-15T16:51:45+00:00February 15th, 2019|Blog, CECL, CECL Accounting|

Shadow Loss Analysis: Running Parallel Methodologies

Many thanks to Nathan Kelly, SVP, Credit Risk & Reporting Officer, United Bank, and David Jaques, FVP, Credit Analytics Manager, Valley National Bank, for discussing their CECL journey and how partnering with a third party, Abrigo (formerly MST), and running parallel methodologies using the MST Loan Loss Analyzer’s “Shadow Loss Analysis” module are helping them determine which CECL models will best suit their institutions. Automating the Allowance Process Nathan Kelly on the impact of automating the allowance process . . . We moved from Excel to automation in 2015 to improve the efficiency of our existing process. We chose MST at that time, now Abrigo, and our partnership has grown over time as we needed to respond to the increasing complexity of our incurred loss estimations. One of the benefits of converting to an automated solution early has been the warehousing of our data. We also use Abrigo Advisory Services as a trusted resource to address issues that have come up during transition. I think a financial institution needs to focus on a partnership as opposed to just an automated solution. We have found it valuable to bring various bank departments onto our transition team, to better understand the impact CECL is going to have on the bank and capital. We’ve got a lot of bench strength, people who’ve been with the bank a long time.  We have used the Advisory team as a sounding board all along the way. They are professionals with real life experience, including at large audit firms. David Jaques on the impact of automating the allowance process . . . We went live with the MST Loan Loss Analyzer in 2016. It has allowed us to compile a data warehouse for our 149,000+ loans. CECL implementation is critical [...]

2019-02-13T18:29:11+00:00February 8th, 2019|Blog, CECL|

FASB CECL Roundtable Recap – from January 28

On January 28, 2019, the FASB hosted a public roundtable on CECL intended to cover one main topic as well as a secondary topic. A large group was in attendance, with representatives from banks of various sizes, regulators, representatives from audit firms, as well as bank stock analysts and other readers of financial statements. Bank Policy Institute Proposal The primary topic was a letter containing a proposal made by the Bank Policy Institute (BPI) to FASB on November 5 identifying their concerns with CECL, as well as some proposed changes to address these concerns. The BPI is a banking trade group whose membership includes over 30 of the largest and most influential banks in the country. The first part of the letter asked for a delay in the implementation timeline as well as a more comprehensive study to be done to assess the “systemic and economic risks posed by CECL.”  The BPI’s proposed change to the standard is to essentially split the impact of CECL into three categories: Non-impaired financial assets Loss expectations within the first year would be recorded to provision for loan losses in the income statement Loss expectations beyond the first year would be recorded to Accumulated Other Comprehensive Income (AOCI) Impaired financial assets would have expected losses recorded entirely in earnings The entire proposal can be read here. If this splitting of the total expected losses sounds familiar, it may be because this proposal has a lot in common with the “three bucket approach” that was proposed back when FASB and IASB were attempting to converge on expected loss standards, and in fact has some elements in common with IFRS-9, IASB’s expected loss standard that went into effect in 2018. The BPI points to both the negative capital [...]

2019-02-13T18:29:56+00:00February 1st, 2019|Blog, CECL, Regulators|

The Issue of Recoveries and the Proposed ASU – Codification Improvements – Financial Instruments

This is a second in a series of blog posts about the proposed ASU for codification improvements to ASU 2106-13, better known as the CECL standard. Click here to see the initial post in the series and to read some background on the proposed ASU. Issue 1C: Recoveries The issue of the treatment of recoveries of previously charged off amounts has been an ongoing topic of discussion. It was discussed at the June 11 TRG meeting, discussed again at a subsequent August FASB board meeting, then discussed again in the November 1 TRG meeting. Two main issues were brought up and deliberated around this: Inclusion of Recoveries in the ACL Estimate Some preparers did not feel that the standard was clear on if recoveries should be included in the estimate of expected credit losses. Many financial institutions use net charge-off rates today, that is, loss rates that include both the charge-offs as well as any subsequent recoveries, which theoretically produces an allowance that is net of those amounts today. There were also some questions about which types of recoveries should be included in the estimate, and if recoveries were required to be considered, or if that was optional. Some of these questions were based on the difficulty in obtaining data related to recoveries. Negative Allowances Related to the question above, if recoveries are included in the estimate of credit losses, then this could result in allowance amounts at either the loan or segment level that could at times be negative. Examples were given of banks who had very high levels of losses during the financial crisis where the subsequent recoveries of these amounts resulted in net recoveries in the years following the crisis. Preparers felt that clarification was necessary considering this definition [...]

2019-02-13T18:31:07+00:00January 28th, 2019|Blog, CECL, CECL Accounting, CECL Education|

Proposed ASU – Codification Improvements—Financial Instruments – What’s New on the CECL Front?

When FASB released the CECL ASU in June 2016, the defining theme through the ASU was the flexibility given to preparers with regard to the new expected losses standard. Since this time, there have been many discussions and buckets of ink spilled on the interpretation of the guidance released, but no new ASUs released that actually changed the guidance. While ASU 2018-19 was issued in late 2018, all this really did was make some clarifications and changes around the effective date of the standard for private companies, essentially extending the adoption date for those companies to Q1 2022. However, the first proposed ASU with substantial changes to the codification has now been proposed as of November 19th, 2018 with a comment period ending on January 18th, 2019. This ASU addressed many of the issues that have been brought up and discussed in the Transition Resource Group (TRG) formed by FASB to look at the implementation of the standard, as well as other issues brought up by stakeholders to FASB. We’re going to spend the next series of blog posts looking at a few of these issues and how they will affect the implementation of the standards for financial institutions. For reference, the proposed ASU can be found on FASB’s website here under the title 11/19/18: Proposed Accounting Standards Update—Codification Improvements—Financial Instruments. The issues are numbered in the update, and we will use the same number scheme to be consistent. Issue 1A: Accrued Interest One of the issues that came up at the June 11, 2018 meeting of the TRG was the issue of Accrued Interest. In CECL, the estimate of credit losses is to be based on the amortized cost basis of the asset. This is defined in the glossary of the ASU [...]

2019-02-13T18:30:31+00:00January 18th, 2019|Blog, CECL, CECL Accounting|

Short on New Years’ Resolutions? We’ve Got a Few Suggestions.

What were your New Year’s resolutions? With our sole focus being the allowance, you might guess that ours are all about getting you ready for CECL. So if you’ve come up short on resolutions for 2019, we’ve got a few suggestions. CECL New Year's Resolutions From Senior Advisor Paula King With a “go-live” date of Q1 2020, SEC registrants should be well on their way to CECL compliance. Resolve to spend 2019 parallel testing your incurred loss model against your preliminary CECL model(s) and pooling structure(s), making adjustments each quarter as you test. While 2018 was a year for determining methodologies and loan segments, 2019 should be a time to focus on tweaking, and on structuring your qualitative factor framework and forecast component (identification of pertinent economic indicators, correlation analysis, etc.). As you walk through the testing phase and determine qualitative and forecast adjustments, begin developing your accompanying documentation (e.g. narrative or memo) to support your CECL calculation. Writing down your process will not only solidify your understanding of your model, it should provide insight into any necessary changes. Spending 2019 as a “practice” session will minimize surprises on Day 1 of CECL. From Data Analyst Zach Langley Financial institutions that haven’t done s0, should be developing their data “wish list.” This wish list is comprised of data fields that they are not capturing today but will need for their CECL model, or fields they are capturing today but haven’t done so historically and will begin capturing and maintaining historically starting in 2019. From Senior Advisor Tom Flournoy Early in 2019, institutions should make a thorough assessment of where they are in their CECL transition process. SEC banks should be preparing to run parallel models and tweaking the results. Public business entities [...]

2019-01-11T10:25:11+00:00January 11th, 2019|Blog, CECL|

BPI Proposal Seeks to Soften CECL’s Impact on Earnings

With mandatory conversion to CECL from the present incurred-loss allowance model set to begin Jan. 1, 2020, financial institutions and their representative associations are alternately calling for delays in required implementation dates and changes in the standard that will ease the anticipated blow to their earnings. On November 5, an advocacy group of bank corporations under the banner Bank Policy Institute (BPI) penned a letter to FASB Chairman Russell Goldman proposing a re-structured approach to CECL that “would retain the CECL methodology’s intent of establishing an allowance for the lifetime of an asset on the balance sheet, but recognize the provision for credit losses in three parts.”  The letter listed the three parts as “(1) for non-impaired financial assets, loss expectations within the first year would be recorded to provision for losses in the income statement with (2) loss expectations beyond the first year recorded to Accumulated Other Comprehensive Income ("AOCI'') and (3) for impaired financial assets, lifetime expected credit losses would be recognized entirely in earnings.” The expressed intent of the BPI proposal is to reduce the impact of CECL on bank earnings at its inception date – that is, keep the expected future losses and changes in expected future losses from impacting earnings (or spread them).  Moreover, a problem related to CECL as it currently stands that they would seemingly like to avoid is the earnings hit both from booking new loans and from an increase in expected future losses. They want to avoid these hits to earnings and capital as well as the pro-cyclical effect of booking big losses in earnings when the economy is going into a depression. However, they would also have to convince the regulators to ignore the resulting large debit to OCI when computing regulatory [...]

2018-12-21T09:28:34+00:00December 21st, 2018|Blog, CECL|

Transitioning Your Incurred Loss Methodology to CECL

Notes from the 2018 National CECL Conference session with Hans Pettit, Horne; Anthony Porter, Moss Adams; and Garry Rank, MST Regulators have urged institutions to leverage their current methodology for the allowance in transition to CECL but make changes to it, primarily in respect to life-of-loan and forecasting requirements. The FASB expects the transition to be scalable, but that “the inputs to the allowance estimation methods will need to change to properly implement CECL.” Compared to current GAAP, which requires you to reasonably estimate the amount of loss that has been incurred (upon meeting the probable requirement), CECL is more about what cash flows you expect not to collect at origination. And while current GAAP sees all loans as good until proven otherwise, under CECL, all loans are originated with some measureable risk of default. CECL requires loans to be pooled or segmented according to shared risk characteristics for measurement. Start that process by looking at how you are analyzing your risk segments now and how they will line up for CECL. Most institutions are using a call report structure on which to base their pooling. CECL will require a more granular approach than that, but you can start there as call codes contain much useful information. Your initial pooling decisions are likely to change as you move through the process, like your methodology choice and Q-factors. You will have to continue to ask yourself if your pooling structure remains appropriate given your risk profiling. Things that may bring about a change in pooling structure are new products, changes in underwriting and standards, and loan acquisitions. The way you look at risk under CECL is going to change. CECL will force you to peel the onion back to understand why a loan went bad and that will give you a clearer picture of your risk categories. Most banks haven’t been accumulating the data they’ll need for CECL, so by year four or five you will [...]

2018-11-30T10:57:59+00:00November 30th, 2018|ALLL, Blog, CECL|

ALLL / CECL Glossary

Banking with all of the various acronyms can be quite confusing, not to mention when you add in terms and acronyms from the FASB. To make it easier, we've developed this glossary of allowance and CECL terms. ALLL (Allowance for Loan and Lease Losses) – Originally referred to as the “reserve for bad debts,” a valuation reserve established and maintained by charges against a bank’s operating income. It is an estimate, calculated according to the incurred loss estimation model, of noncollectable amounts used to reduce the book value of loans and leases to the amount a bank can expect to collect. ACL (Allowance for Credit Losses) – Replaces the ALLL as a reference to the allowance under CECL. ACL is a more accurate term than ALLL under CECL, as CECL applies to a broader array of financial instruments than did the incurred loss model. Amortized Cost - The sum of the initial investment less cash collected less write-downs plus yield accreted to date. Amortized Cost Basis - The amortized cost basis is the amount at which a financing receivable or investment is originated or acquired, adjusted for applicable accrued interest, accretion, or amortization of premium, discount, and net deferred fees or costs, collection of cash, write-offs, foreign exchange, and fair value hedge accounting adjustments. ASU 2016-13 – The FASB update establishing a new accounting standard for estimating the allowance for credit losses (ACL). This ASU represents a significant change in the incurred loss accounting model by requiring immediate recognition of management’s estimates of current expected credit losses (CECL) throughout the lifetime of the loan. Back-Testing- A term used in modeling to refer to testing a predictive model on historical data. Systems that quantify risk ratings in terms of default probabilities or expected [...]

2018-11-20T12:34:36+00:00November 20th, 2018|Blog, CECL|

Don’t You Forget About Me: The Impact of CECL on Debt Securities

Notes from the 2018 National CECL Conference session with Gordon Dobner, BKD; John Griffin, BKD; and Dale Sheller, The Baker Group The impact of estimating credit losses for debt securities for most community financial institutions is relatively minor, certainly not as impactful as for loans. Guidance for estimating held-to maturity securities (HTM) follows the CECL standard like loans. There are fairly minor changes relative to assets-for-sale (AFS) debt securities, a modified version of today’s OTTI model. In addition for AFS and HTM securities, you’re buying after their original issuance, you have to consider whether they will fall into the PCD category. The biggest impact is determining the rigor with which you have to approach this. Typically you wouldn’t expect any losses, but the standard says to document. You don’t have to have a loss measurement if the expectation is zero at default – anything issued by the federal government that are backed, like U.S. treasuries, has a zero loss expectation. The expectation is that for most institutions the impact of CECL on HTM will be on municipals and corporate bonds. You could get to an expectation of zero if there is insurance or some other type of guarantee. You could also call it close to zero and immaterial, eliminating the need for a reserve. It is not as simple as just feeling you won’t have losses, you will have to document it. Municipal defaults over 30 years are at .15 percent, very rare, much more rare than corporate defaults, which could support your documentation of zero credit loss or immateriality. If you don’t believe zero is the answer, there will be pooling considerations, and a need to pull out securities where there might be a specific identified loss issue and analyze those [...]

2018-11-16T09:48:18+00:00November 16th, 2018|Blog, CECL|