CECL: Don t Panic - Prepare

Transcription

1 CECL: Don t Panic - Prepare Regan Camp Managing Director - MST Advisory Services September 25, 2017

2 Speaker Introduction 2

3 Speaker Introduction Regan Camp is the Managing Director of MST Advisory Services, leading a team of subject matter experts who assist financial institutions nationwide in accurately interpreting and applying federal accounting guidance. He has established himself as a nationally recognized speaker, writer, thought leader and trusted advisor, with a primary focus on the Allowance for Loan and Lease Losses (ALLL) and Credit Risk. Having worked closely with hundreds of financial institutions nationwide of varying sizes and complexities, Regan offers his clients a unique combination of experience and perspective, as he works closely with each institution in developing sound and defensible methodologies, policies and procedures. His lauded ability to simplify the complex has especially contributed to the appreciation and success of those with whom he has worked. Beginning his career as a Commercial Loan Officer at a $2.1 Billion institution, Regan went on to join Deloitte and Touch LLP in their federal advisory practice, represented the FDIC in managing the day-today operations and eventual liquidations of failed financial institutions, as well as managed private consulting teams in assisting financial institutions with the administration of FDIC Loss Share Agreements, the establishment of special asset divisions, and the resolution of troubled portfolios. Most recently, Regan has spent the past 5+ years leveraging his specialized experience and expertise in contributing to the development and implementation of industry leading financial software products, while serving as a key relationship manager, subject matter expert and principal consultant. Regan is a magna cum laude graduate of Brigham Young University s Marriott School of Business, where he studied Business Management and Finance. In addition to his work experience, Regan also passionately serves his communities through his leadership and volunteer efforts, while lovingly supporting his beautiful wife and three children. 3

4 Agenda Introduction CECL Overview Why the Panic? Where Should I Get Started? CECL Examples Q&A 4

5 CECL Overview 5

6 CECL Overview X Primary Components of the ALLL Cecil CECL Current Expected Credit Loss model Accounting Standards Update (ASU) No , Financial Instruments Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments FASB s response to the Financial Crisis A move from an incurred loss approach to estimating credit losses to an expected or life of loan approach 6

7 CECL Overview What s in Scope? When is a Loss Recognized? How Much of a Loss is Recognized? What Information Set is Used to Determine a Loss? Basis of Approach Current GAAP Varies across multiple standards When loss is probable or incurred The amount of loss that has been incurred Past events + current conditions All loans are good loans, until proven otherwise CECL Proposed Financial assets measured at amortized cost (e.g.; Financing receivables, HTM debt securities, etc.) No recognition threshold updated at each reporting date The current estimate of cash flows not expected to be collected Past events + current conditions + reasonable & supportable forecasts All assets are originated with some measurable risk of default 7

8 Why the Panic? 8

9 Why the Panic? We Fear Change Most significant accounting change ever? FAS 5 (ASC ) and FAS 114 (ASC ) have been around since Mar 1975 and May 1993, respectively. Even SOP 03-3 (ASC ) has been around since Dec No precedent has been set No best practices to look to What s the flow of traffic? 9

10 Why the Panic? The Effect on the Allowance Could Be Significant There is no question that implementation of the FASB proposal will require most banks to boost their allowance perhaps in the neighborhood of 30 to 50 percent system-wide if applied today. Thomas J. Curry Comptroller of the Currency (AICPA Conference - 9/6/2013) While initial estimates indicated 30-50% increases in the ALLL would result from CECL implementation, independent estimates since then have been significantly lower, as the CECL estimate is largely dependent on a company s forecast of future economic conditions. ABA - FASB s Current Expected Credit Loss Model for Credit Loss Accounting (CECL): Background and FAQ s for Bankers June

11 Why the Panic? One Word: DATA Quantity AND Quality both are important What is available today? Is it held in a dynamic form?? What do we need to start capturing? Chicken or the Egg? Do we match our data to a methodology, or Do we match our methodology to our data What about peer and industry data? 11

12 Why the Panic? New and Increased Reporting and Disclosures Requirements Documentation and transparency will be critical to support the estimate Does a forward looking methodology introduce increased subjectivity and, thus, additionally required support? Many of the existing disclosures are carried forward New disclosures (e.g.; disaggregate credit-quality indicators by vintages) 12

13 Why the Panic? How Do We Predict the Future? Determining a reasonable and supportable forecast Will this require the use of new models/methodology that many are unfamiliar with (e.g.; Vintage Analysis, Migration Analysis, PD/LGD, DCF, etc.)? Or 13

14 Why the Panic? Complications = Preparation and Audit Costs Increased complication generally equates to increased costs to comply This standard is expected to have a huge impact on the costs to prepare and audit the ALLL, how investors analyze the ALLL, and how banks manage their capital. American Bankers Association 1 The Auditors and Examiners are still learning this new guidance themselves As you plan/implement, be certain to document everything! Will have to be an iterative process plan with flexibility in mind 1 American Bankers Association - FASB s Current Expected Credit Loss Model for Credit Loss Accounting (CECL): Background and FAQ s for Bankers June

15 Why the Panic? Time is running out Mandatory adoption date (calendar year entities): Early Adoption...Q SEC Registrants.Q Non SEC PBE s...q All others...ye 2021 Example Timeline: Plan Build, Implement Parallel Production The next two (2) years are absolutely critical to the transition to CECL 15

16 Why the Panic? Early Adoption: A shift from Why? to Why Not? *Remember No staged early adoption. Anyone can early adopt for periods after December 15, 2018, regardless of institution type. Reason #1: We re ready, so why wait? Reason #2: We would like to set the pace Reason #3: CECL is an improvement over incurred loss, so why wait? Reason #4: CECL can justify our current reserve levels 16

17 Why the Panic? We Don t Know Where to Start Nothing diminishes anxiety faster than action. -Walter Anderson 17

18 Where Should I Get Started? 18

19 Where Should I Get Started? 19

20 Where Should I Get Started? Become Familiar With the Standard (ASU ) READ THE STANDARD (Accounting Standards Update No , Financial Instruments Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments) Countless interpretations/explanations are already out there May consider leveraging third party experts Keep your pulse on potential forthcoming revisions Take comfort in the fact that we re all still learning/processing the Standard 20

21 Where Should I Get Started? Form Your CECL Steering Committee CECL will require significant collaboration across multiple functional areas Include representation from Finance, Accounting Policy, Lending, Risk and IT Ensure strong executive partnership/buy-in Level-set and educate on specific changes required by CECL Responsible for developing an expectation of project scope, high-level phasing and timing 21

22 Where Should I Get Started? Start With What You Know and Have Today The Board expects that an entity can leverage its current systems and methods for recording the allowance for credit losses. However, the inputs used to record the allowance for credit losses generally will need to change to appropriately reflect an estimate of all expected credit losses and the use of reasonable and supportable forecasts. (ASU ) 22

23 Where Should I Get Started? Formulate a Project Plan What is your CECL Blueprint? Current State Data Methodologies Pooling Reporting Implementation 23

24 Where Should I Get Started? Gap Analysis / Readiness Assessment The identification and analysis of the gap between Current State (current GAAP) and Future State (CECL), including an analysis of existing data, process and methodology (models) against the expected guidelines. Current State (Current US GAAP) (The Gap) Future State (CECL) 24

25 Where Should I Get Started? While Getting Started, A Few Things to Note Reminder: This will be an iterative process proceed with flexibility in mind This must be a collaborative effort, with strong executive sponsorship The standard intentionally does not prescribe certain aspects of the CECL estimate (e.g.; specific methodology to be used, how to determine reasonable & supportable forecast, etc.) There are A LOT of resources available to you You ll never get where you re going, if you never start moving You can be an institution that sets the pace, or one that s left trying to catch up 25

26 Where Should I Get Started? 26

27 CECL Examples 27

28 CECL CALCULATION APPROACH... an entity shall consider available information relevant to assessing the collectability of cash flows. This information may include internal information, external information, or a combination of both relating to past events, current conditions, and reasonable and supportable forecasts. Historical Life of Loan Loss Experience Adjustments for Current Economic Conditions Adjustments for Reasonable and Supportable Forecasts Estimate of Current Expected Credit Losses The standard does not prescribe certain aspects of the credit loss estimate, including: The specific methodology to be used; How to determine the reasonable and supportable forecast period; How to revert to historical losses beyond the reasonable and supportable forecast period; and How to determine historical losses 28

29 CECL EXAMPLE: LOSS RATE APPROACH Loan Pool- 5 year amortizing, $20 million in loans The Facts Historical lifetime credit loss- 1.5% based on last 5 periods Key factors that affect collectability- real estate values and unemployment rates Current economic factors- real estate values unemployment rates 29

30 CECL EXAMPLE: LOSS RATE APPROACH (Continued) Real estate values 10bp incremental increase in loss Unemployment 15bp incremental increase in loss Allowance for Expected Credit Losses $350,000 Total Loss Rate 1.75% 30

31 CECL EXAMPLE: VINTAGE APPROACH The Facts Institution originates loans with 4 year amortization Institution tracks loans and losses by year of origination Year of Year 1 Year 2 Year 3 Year 4 Total Expected Origination 20X X X X X X ??? 20X ??? 20X ??? 20X ??? 31

32 CECL EXAMPLE: VINTAGE APPROACH The Facts Losses most significant in years 2 and 3 Expected losses based on current economic conditions and historical losses by year Year of Origination Year 1 Year 2 Year 3 Year 4 Total Expected 20X X X X X X X X X Expected Credit Losses $1,060 32

33 CECL EXAMPLE: VINTAGE APPROACH The Facts Reasonable and Supportable Forecast Period determined to be 2 years Revert to unadjusted historical averages beyond Forecast Period Year of Origination Year 1 Year 2 Year 3 Year 4 Total Expected 20X X X X X X X X X Expected Credit Losses $1,000 33

34 Questions? 34

35 THANK YOU 3225 Piedmont Rd Seven Piedmont Center, Ste 300 Atlanta, Georgia www. 35

36 Update on CECL Transition Resource Group, FASB & DIEP Activities B. Gabe Nachand, Partner

37 Community Banking Conference Most Recent TRG Meeting June 12, 2017 Issue #1 Discounting Expected Cash Flows Using an Entity s Effective Interest Rate Issue: use of the Effective Interest Rate ( EIR ) and prepayments impacts the measurement of the allowance; the expectation of prepayments will always increase the allowance for financial assets held at a premium (vice versa for a discount) - considered an issue because of the misalignment between contractual life and estimated life does not appropriately isolate credit risk. Conclusion: Entities should be given the choice, through an accounting policy election whether they use an adjusted EIR (adjusted for prepayments). Policy election should be at the class of financing receivable level (subset of portfolio segment). No further discussion or work planned on this issue.

38 Community Banking Conference Most Recent TRG Meeting June 12, 2017 Issue #2 Scope of Purchased Financial Assets with Credit Deterioration Guidance for Beneficial Interests within Subtopic Issue: Difference in views about how an entity might determine a purchase credit deteriorated (PCD) beneficial interest s contractual cash flows, which would impact the determination for the criteria applied to determine if PCD accounting should be followed. [Note: scope of PCD for BI s subject to ASC considerations] View A: Contractual cash flows should not consider credit losses or prepayments. View B: Contractual cash flow should not consider credit losses but should consider prepayments that are expected to occur. Question: How should contractual cash flows be determined when assessing whether a beneficial interest meets the criterion in paragraph A(a)? Conclusion: Follow View B for determining contractual cash flows and if PCD accounting should be applied. No further work or discussion planned on this issue.

39 Community Banking Conference Most Recent TRG Meeting June 12, 2017 Issue #3 Transition Guidance for Pools of Financial Assets Accounted for under Subtopic Should and entity apply the election to maintain pools at the time of adoption only (View A), or both at the time of adoption and on an ongoing basis (View B)? View A: After adoption, only maintain the pools to the extent the risk characteristics of the underlying assets are similar ( ). Allocation of allowances and discounts on an individual asset basis. View B: Maintain through adoption and ongoing, for all applicable areas of accounting, which may include: credit loss measurement, interest income recognition, write-off determination, and TDR identification. For interest income, apply the gross up at pool level and freeze the effective interest rate of the pool. Removal from pools for only payoffs, write-offs, or sales.

40 Community Banking Conference Most Recent TRG Meeting June 12, 2017 Issue #3 Transition Guidance for Pools of Financial Assets Accounted for under Subtopic continued Conclusion: Either method acceptable; FASB clarified which provisions of would be needed in order to apply View B after the adoption date as well. Election should be determined on a pool-by-pool basis. Consider disclosure of the accounting policies in place for these pools that are different from other assets held by the entity. View B should consider disclosure of qualitative and quantitative information that may be necessary to understand size and nature of pools. No further discussion or work planned on this issue.

41 Community Banking Conference Most Recent TRG Meeting June 12, 2017 Issue #4 Accounting for Troubled Debt Restructurings (TDRs) Issues: Should entities forecast all types of reasonably expected future TDRs on a portfolio basis and include the effect of those reasonably expected TDRs in the calculation of expected credit losses? Is the impact of TDRs already in the loss history? Differences in estimates by models used (DCF explicitly considers interest rate and term concessions; loss rate methods do not) do all types of concessions need to be considered? Should specific methodologies be required? Deferred to September FASB Meeting (see next slide).

42 Community Banking Conference Most Recent FASB Meeting September 6, 2017 Guidance on Troubled Debt Restructurings FASB guidance will not result in a formal amendment to ASU No ; the board plans to publish a memo about its discussion of the guidance for restructured loans. The accounting board agreed that lenders must identify and measure the effects of the restructuring when the individual troubled loan is reasonably expected. In some circumstances, such as when restructuring information is not available, banks can apply what the FASB called a portfolio-level approach making estimates based on known historic data. When a bank carries out the loan restructuring, it may make an additional adjustment if there is a difference between the loss it expected and the actual loss it incurred.

43 Community Banking Conference Most Recent FASB Meeting September 6, 2017 Guidance on Troubled Debt Restructurings continued The FASB also agreed to not specify a particular method for calculating the loss from a restructured loan, although the method must capture the concession (e.g. DCF is necessary for an interest rate concession). If an entity uses DCF on their performing portfolio, any effects of TDRs that are incremental to what is embedded in historical loss data should not be incorporated into the DCF model until individually identified. It should be noted that the expectation of a TDR is the one situation where you could forecast beyond the contractual life of the financial asset.

44 Community Banking Conference Most Recent TRG Meeting June 12, 2017 Issue #5 Determining the Estimated Life of a Credit Card Receivable Initial issue: what is the life of a credit card? This led to questions on payment allocation (considered the key determinant in estimating the life) and determination of future payments for forecasting purposes. Two views on the payment allocation: should principal payments expected to be received after the measurement date (after finance charges and fees are paid) be applied to the credit card receivable balance at the measurement date until that balance is exhausted or should those payments be allocated in some manner between the measurement date balance and future credit card receivables expected to be originated through subsequent usage of the unconditionally cancellable loan commitment associated with the credit card account? Conclusion: Either is acceptable, but follow CARD Act requirements (payment prioritization), and don t reserve for losses on balances that aren t outstanding yet. No further discussion or work planned on payment allocation; FASB intends to discuss how future repayment amounts should be determined at the October Board Meeting.

45 Community Banking Conference Most Recent DIEP Activity August 2017 Zero Expected Credit Losses Discussion Paper written by DIEP and provided to the regulatory agencies for review and comment Discussion Paper proposed US Treasuries, GNMA MBSs, & FNMA and FRMC MBSs have an expectation of nonpayment of zero. Initial feedback from regulators: Concerned the conclusions in the Paper might be used as a safe harbor or threshold when all debt securities should be reviewed and conclusions documented. Concerned about analogizing to other GSEs (e.g. FHLB or Federal Farm Credit Banks Funding Corporation)

46 Community Banking Conference Most Recent DIEP Activity August 2017 Zero Expected Credit Losses Discussion Paper written by DIEP members and provided to the regulatory agencies for review and comment continued Regulators Suggest: Discuss more prominently the requirement to adjust historical credit information for current conditions and reasonable and supportable forecasts (e.g. higher political uncertainty, heightened government budgetary concerns, and widening credit default swap spreads in liquid markets). Include the expectation that when determining credit loss estimates, underlying assumptions should be consistent with other internal analyses at the bank (unless there is documented explanation justifying any differences). See paragraph 37 and 83(e) of the Basel guidance on credit risk and accounting for expected credit losses

47 Community Banking Conference Most Recent DIEP Activity September 2017 Other topics to keep track of Issues currently being contemplated: Narrow issue related to transfers from HFS to HTM/HFI could potentially be double-counting CECL reserve if a prior write-off is taken and PCD accounting is applied. Variable rate instruments if using DCF, could be a mismatch between interest income recognition and expected credit loss measurement for various instruments. Freestanding Credit Insurance ignore for CECL reserve; FASB to provide guidance on timing of recognition of recovery, as well as measurement. Collateral maintenance provisions confusion regarding additional considerations in the ASU and the practical expedient.

48 Community Banking Conference The material appearing in this presentation is for informational purposes only and should not be construed as advice of any kind, including, without limitation, legal, accounting, or investment advice. This information is not intended to create, and receipt does not constitute, a legal relationship, including, but nor limited to, an accountant-client relationship. Although this information may have been prepared by professionals, it should not be used as a substitute for professional services. If legal, accounting, investment, or other professional advice is required, the services of a professional should be sought. Assurance, tax, and consulting offered through Moss Adams LLP. Wealth management offered through Moss Adams Wealth Advisors LLC. Investment banking offered through Moss Adams Capital LLC.