Accounting Update. John Rieger, Deputy Chief Accountant, Federal Deposit Insurance Corporation, Washington, DC

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1 A Regulatory Update John Rieger, Deputy Chief Accountant, Federal Deposit Insurance Corporation, Washington, DC Caren Hill, CPA, Western District, Office of the Comptroller of the Currency, Denver CO Tullus Miller, Partner, Financial Services Group Leader, Moss Adams LLP

2 Accounting Update John Rieger, Deputy Chief Accountant, Federal Deposit Insurance Corporation, Washington, DC

3 Agenda 3 CECL Updating FAQs on CECL TRG Meeting June 12, 2017 Topics Bank Activities Qualitative Factors Factors to Consider for Collectibility Reasonable and Supportable Forecast / Reversion to Historical Zero Estimates Planning- Message for Examiners and Banks PBE Rules FAQs Flowchart HEDGE ACCOUNTING ASU

4 4 CECL

5 Basics of Standard Replaces the current incurred loss model triggered by the Probability of Default over the next 12 months Introduces the current expected credit loss (CECL) which requires a determination on day one of the expected amount to be collected on a pool of originated loans over the life of the loan The difference between the originated loan amount and expected amount to be collected over the life of the loan is the day one allowance Records on day one the expected loss that an institution would have on a pool of loans 5 The intent is to report a more accurate balance sheet value for loans and leases It forces the recording of all the expected losses of a loan or lease that would be experienced over the life of the loan upfront Attempts to satisfy the criticism of too little too late

6 6 CECL Effective Dates

7 FAQ Update A new set of FAQs have been issued (insert date). The focus is on: PBE definition and clarification Qualitative factors PCD Assets 7 Transition Call report Fiscal year institutions Use of collateral dependent assets

8 Transition Resource Group Meeting held June 12, Topics: Discounting Expected Cash Flows Using Entity s Effective Interest Rate vs Contract Rate (accounting policy choice) Scope of PCD Assets for Beneficial Interest (consider prepays) Transition for Pools of PCI/PCD loans- keep pool or not (allow as a policy choice) Accounting for TDRs (unresolved) 8 Credit Cards life of loan determination (unresolved)

9 Large Bank CECL Activities 1Q: Implementation plan and key milestones, and governance structure 2Q: Updates on plan and key challenges 3Q: Status on quantitative impact analysis and preliminary key assumptions 9 (overall and by portfolio) 4Q: Preliminary discussion around potential models and assumptions (broadly by portfolio)

10 Bank CECL Activities Preparation TIMELINE AND KEY MILESTONES FOR IMPLEMENTATION ANY CRITICAL ISSUES OR CHALLENGES THAT MAY DELAY TIMELINE? INDEPENDENCE AND INTEGRATION WITH STRESS TESTING, BASEL MODELS AND IFRS 9 Governance: CURRENT CONTEMPLATED GOVERNANCE STRUCTURE FOR IMPLEMENTATION GROUPS WHO WILL BE INVOLVED 10 BOARD AND SENIOR MANAGEMENT OVERSIGHT Data and Approach Considerations WHAT IS YOUR ANALYSIS OF THE AVAILABILITY OF NECESSARY DATA FROM CURRENT APPROACH? LIFE OF LOAN ANALYSIS AND CONSIDERATIONS FOR DIFFERENT PORTFOLIOS (E.G. REVOLVING CREDIT FACILITIES, CREDIT CARDS, MORTGAGES ETC.) WHOLESALE SEGMENTATION ANTICIPATION OF NEEDING TO BUILD NEW MODELS (HIGH LEVEL) ANY SPECIFIC AREAS WHERE GUIDANCE WOULD BE HELPFUL?

11 Possible Methods CECL DOES NOT PRESCRIBE THE USE OF SPECIFIC ESTIMATION METHODS. ALLOWANCES FOR CREDIT LOSSES MAY BE DETERMINED USING VARIOUS METHODS THAT REASONABLY ESTIMATE THE EXPECTED COLLECTABILITY OF FINANCIAL ASSETS AND ARE APPLIED CONSISTENTLY OVER TIME. FOR EXAMPLE, ACCEPTABLE METHODS INCLUDE: LOSS RATE, ROLL-RATE, VINTAGE ANALYSIS, DISCOUNTED CASH FLOW, 11 PROBABILITY OF DEFAULT/LOSS GIVEN DEFAULT METHODS. NEITHER A VINTAGE NOR A DISCOUNTED CASH FLOW METHOD IS REQUIRED FOR ESTIMATING EXPECTED CREDIT LOSSES. AN INSTITUTION MAY APPLY DIFFERENT ESTIMATION METHODS TO DIFFERENT GROUPS OF FINANCIAL ASSETS. TO PROPERLY APPLY AN ACCEPTABLE ESTIMATION METHOD, AN INSTITUTION S CREDIT LOSS ESTIMATES MUST BE WELL SUPPORTED.

12 Historical Loss Standard requires reversion to historical loss rate (not reversion to the mean) Historical loss should include defaults/tdrs/prepayments/recoveries 12 An entity shall not adjust historical loss information for existing economic conditions or expectations of future economic conditions for periods that are beyond the reasonable and supportable period What historical loss rate period to use? What qualitative adjustments are required?

13 Reversion Standard requires reversion to historical loss rate (not reversion to the mean) For periods beyond which the entity is able to make or obtain reasonable and supportable forecasts of expected credit losses Reversion may be at the input level or based on the entire estimate Reversion may be immediately, on a straight-line basis, or using another rational and systematic basis 13 That is reflective of the contractual term of the financial asset or group of financial assets. Length of Reasonable and Supportable may impact level of CECL ALLL

14 Qualitative Adjustments Ability to make scheduled payments Remaining payment terms, time to maturity, timing and extent of prepayments Nature and volume of financial assets Volume and severity of past due financial assets Value of underlying collateral Entities lending practices Quality of credit review system 14 Experience, ability, and depth of management Environmental factors of borrower Regulatory, legal, technological Changes in general market conditions (geographical or industrial) Changes in economic and business conditions (international, national, regional or local)

15 Zero Estimates An estimate of expected credit losses shall include a measure of expected risk of credit loss even if risk is remote An entity is not required to measure expected credit losses on a financial asset (or group of assets) in which historical credit loss information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that nonpayment is zero 15 Except for circumstances described in to 6, an entity shall not expect nonpayment of the amortized cost basis to be zero solely on the basis of the current value of collateral securing the financial asset(s) but, instead, also shall consider the nature of the collateral, potential future changes in collateral values, and historical loss information for financial assets secured with similar collateral

16 Observations Consider the type of loan product (Retail or Wholesale, Amortizing, Bullet, Renewal) Loan and loss volumes should be considered when selecting a method. Lower loan volumes may not be appropriate for use with Vintage due to higher degree of volatility Selection of an appropriate historical period is often the most significant input WAL should be sensitive to the terms of the loans Impact of amortizing loans need to be considered 16 Credit performance drivers may be hard to isolate (they may also be imbedded into the loan segmentation)

17 Planning Questions Read and become familiar with the new standard Determine the effective date requirement for your institution Preliminary communication with senior management/board Develop a preliminary timeline with due date deliverables based on effective date for the specific institution 17 Identify team members for the CECL project including project lead (team members will likely include accounting, credit, IT, methodology modelers, business line product representatives Data and system assessment (how much data is already available and how much additional data will be required) What additional data requirements to determine historical loss If all historical data is not available, how will the institution fill in the data gaps?

18 Planning Questions-Continued Will existing product segmentation using current credit criteria work or will the CECL segmentation need to be different What additional IT requirements if any Determine if the current core system will provide necessary data or if a third party vendor should be considered Determine and estimate additional resource requirements and capital (timing and cost) 18 Establish what a reasonable and supportable forecast is for each segment and when/if the forecast will convert to the historical loss Consider a period of time for a parallel run before complete conversion Consider operational efficiency and adequate controls and documentation. Reasonable and supportable forecasts represent an estimate that will require senior management/board reviews and approvals

19 19 PBEs

20 Public Business Entities a. It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing). b. It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC. 20 c. It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer. d. It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market. e. It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including footnotes) and make them publicly available on a periodic basis (for example, interim or 6 annual periods). An entity must meet both of these conditions to meet this criterion.

21 Public Business Entities Is an insured depository institution that is subject to Section 36 of the Federal Deposit Insurance Act and Part 363 of the FDIC s regulations, Annual Independent Audits and Reporting Requirements (commonly referred to as the FDICIA requirement), considered a PBE? [August 2017] The fact that an IDI is subject to the FDICIA requirement does not in and of itself mean the IDI is a PBE. An IDI subject to the FDICIA requirement that is not an SEC filer would need to evaluate each criterion in the definition of a PBE listed in the response to question 30 to determine whether it is a PBE. If the IDI is a subsidiary of a holding company, the IDI and the holding company should separately evaluate each of the PBE criteria to determine whether each entity is a PBE. For example, assume an IDI subject to the FDICIA requirement is not an SEC filer and does not meet any of the first three criteria listed in the response to question 30. The final criterion in that response includes two conditions, both of which must be met for the IDI to be a PBE. These conditions are: 21 The entity has one or more securities that are not subject to contractual restrictions on transfer, and the entity is required by law, contract, or regulation to prepare U.S. GAAP financial statements and make them publicly available on a periodic basis. An IDI subject to Section 36 and Part 363 is required to prepare audited annual U.S. GAAP financial statements, which the IDI must include in a report that it files with the FDIC, its primary federal regulator (if other than the FDIC), and the appropriate state banking regulator (if applicable). The IDI must make this report, including the U.S. GAAP financial statements, publicly available. Thus, an IDI subject to the FDICIA requirement meets the second condition in the criterion above and needs to determine if it meets the first condition in that criterion to conclude whether it is a PBE..

22 Public Business Entities Is an insured depository institution that is subject to Section 36 of the Federal Deposit Insurance Act and Part 363 of the FDIC s regulations, Annual Independent Audits and Reporting Requirements (commonly referred to as the FDICIA requirement), considered a PBE? [August 2017] When an IDI is subject to Section 36 and Part 363, the IDI s only securities outstanding are common stock, and the IDI is not an SEC filer, the IDI should consider whether contractual restrictions on transfer exist on its common stock. If the common stock of the IDI is wholly owned by a holding company, an implicit restriction on the transfer of the IDI s common stock is presumed to exist. Therefore, the IDI would not meet the first condition in the criterion above, and, thus, the IDI is not a PBE. If there is no holding company or the holding company owns less than 100 percent of the IDI s common stock, and the IDI determines that no contractual restrictions on transfer exist on its common stock, the IDI would be a PBE under the final criterion listed in the response to question 30, as it meets both conditions under that criterion (i.e., conditions 1 and 2 above). 22 The FDICIA requirement to prepare and make U.S. GAAP financial statements publicly available on a periodic basis is not part of the Securities Exchange Act of 1934 or the rules promulgated thereunder. Therefore, when an IDI is subject to the FDICIA requirement, this does not cause the IDI to be an SEC filer. The FDICIA requirement applies to an IDI with $500 million or more in consolidated total assets as of the beginning of its fiscal year. The FDICIA requirement does not apply directly to holding companies, but an IDI can satisfy the audited financial statement requirement of Section 36 and Part 363 at the consolidated holding company level if certain conditions are met. Even if the IDI satisfies the audited financial statement requirement of Section 36 and Part 363 at the consolidated holding company level, the IDI meets the second condition in this criterion because the IDI is the entity subject to the requirement to prepare and make publicly available U.S. GAAP financial statements.

23 CECL Call Report Effective Date Decision Tree 23 Disclaimer: This decision tree is an instructional tool. It is not supervisory guidance and is not a supervisoryrequirement. 1 For non-calendar year-end banks, the first quarter of your fiscal year beginning after December 15, For noncalendar year-end banks, the first quarter of your fiscal yearbeginningafter December15, For non-calendar yearendbanks, thelast quarter of yourfiscal year that beginsafter December 15, 2020 Office of the Comptroller of the Currency

24 24 Hedge Accounting

25 Hedge Accounting Summary 1. Permit an entity to measure the change in fair value of the hedged item on the basis of the benchmark rate component of the contractual coupon cash flows determined at hedge inception, rather than on the full contractual coupon cash flows as required by current GAAP. 2. Permit an entity to measure the hedged item in a partial-term fair value hedge of interest rate risk by assuming the hedged item has a term that reflects only the designated cash flows being hedged. Current GAAP does not allow this methodology when calculating the change in the fair value of the hedged item attributable to interest rate risk. 3. For prepayable financial instruments, permit an entity to consider only how changes in the benchmark interest rate affect a decision to settle a debt instrument before its scheduled maturity in calculating the change in the fair value of the hedged item attributable to interest rate risk For a closed portfolio of prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments, permit an entity to designate an amount that is not expected to be affected by prepayments, defaults, and other events affecting the timing and amount of cash flows (the last-of-layer method). Under this designation, prepayment risk is not incorporated into the measurement of the hedged item.

26 Hedge Accounting Comments Early application is permitted in any interim period after issuance of the Update. All transition requirements and elections should be applied to hedging relationships existing (that is, hedging relationships in which the hedging instrument has not expired, been sold, terminated, or exercised or the entity has not removed the designation of the hedging relationship) on the date of adoption. The effect of adoption should be reflected as of the beginning of the fiscal year of adoption (that is, the initial application date). ASU allows banks to adopt as early as Q3 2017, retrospectively to January Would Regulators require, if material, an early adopting bank to re-file the March and June Call Reports? 26 Response: No. Institutions will reflect cumulative effect of adjustment in the call report quarter in which they adopt it.

27 Moss Adams Community Banking Conference Office of the Chief Accountant Caren Hill, CPA Western District, Denver CO. September 25, 2017

28 Accounting Update Agenda Upcoming Accounting Standards Revenue Recognition Leases ALLL Incurred Loss Model 28

29 Revenue Recognition 29

30 Revenue from Contracts with Customers Core Principle: A company will recognize revenue when it transfers promised goods or services to customers in an amount that the company expects to be entitled in exchange for those goods or services. Issued May 2014 Convergence project with IASB Replaces nearly all existing GAAP guidance on revenue recognition ASU provided one year delay in effective dates Public Business Entities 12/15/2017 Non public Business Entities 12/15/2018 Early adoption permitted 30

31 Revenue from Contracts with Customers Entities will apply a 5 step model to determine when to recognize revenue and at what amount Current GAAP: Revenue is recognized when it is realizable and earned New GAAP: Revenue is recognized based on the transfer of control 31

32 Accounting for Seller Financed OREO Transfers Amended ASC will become primary accounting guidance for transfers of foreclosed real estate and will eliminate existing methods of accounting for such transfers in ASC Glossary entry for Foreclosed Assets in Call Report instructions updated in March 2017 to incorporate the effect of the revenue recognition standard on seller financed OREO transfers See also March and June 2017 Call Report Supplemental Instructions Both available at 32

33 Leases 33

34 Leases Key Objective: To increase transparency and comparability by recognizing lease assets and liabilities on the balance sheet and disclosing key information Lease categories similar to current GAAP: capital and operating Lessee will record a right of use asset (ROU) and a lease obligation liability (for both capital and operating types) ROU based on the present value of rent, initial direct costs and deductions for lease incentives Amortization of ROU will result in a single straight line average rent pattern. Election available for short term operating leases to treat the same as operating leases under current GAAP. Final standard to be issued in mid February Effective for Public Companies: Annual periods beginning after December 15, 2018 and interim period therein. Early adoption permitted. 34

35 Leases June 2017 Call Report Supplemental Instructions provide guidance on how lessee institutions should treat right of use (ROU) assets recorded in accordance with ASC 842, Leases, for regulatory capital purposes following adoption of this new standard Treat ROU assets arising from leases of tangible assets as a tangible asset not subject to deduction from regulatory capital Risk weight ROU assets at 100 percent and include in total risk weighted assets Include ROU assets in lessee s total assets for leverage capital purposes Applies to ROU assets from both operating and finance leases under ASC 842 Consistent with lessee s current regulatory capital treatment for capital lease assets under existing ASC 840, Leases 35

36 ALLL 36

37 The ALLL. What is the allowance? Is institution specific Includes probable and incurred losses as of the balance sheet date An incurred loss for accounting purposes precedes a Loss Rating/Charge off Is an estimate and, therefore, inherently imprecise Should be directionally consistent with credit risk 37

38 The ALLL is NOT A risk mitigation tool Capital Intended to capture losses that might happen in the future Merely a percent of past dues + nonaccrual loans or total loans Applicable to: Loans carried at fair value Loans held for sale Off balance sheet credit exposures General or unspecified business risks 38

39 39

40 ASC : RED FLAGS Loan segmentation is too broad or too narrow No allowance for segments of pass credits Frequent lengthening or shortening of the lookback period Q factor adjustments that are not directionally consistent Caps and floors Target percentages Unallocated balances Lack of documentation and support 40

41 OCC Publications Resources Available Interagency Policy Statement on the Allowance for Loan and Lease Losses, Guidance and Frequently Asked Question on the ALLL December 2006 Policy Statement on Allowance for Loan and Lease Methodologies and Documentation for Banks and Savings Institutions July 2001 Bank Accounting and Advisory Series (BAAS) CECL Frequently Asked Questions (BankNet) Joint Statement on the New Accounting Standard on Financial Instruments Credit Losses 41

42 Caren Hill (720)