COUNTDOWN TO CECL: IS YOUR FINANCIAL INSTITUTION ON TRACK?

Size: px

Start display at page:

Download "COUNTDOWN TO CECL: IS YOUR FINANCIAL INSTITUTION ON TRACK?"

Clyde Cross
5 years ago
Views:

1 COUNTDOWN TO CECL: IS YOUR FINANCIAL INSTITUTION ON TRACK? Presented by: Scott Deters David Klopfer Katie Schnieber

2 COUNTDOWN TO CECL: IS YOUR FINANCIAL INSTITUTION ON TRACK? Presented by: Scott Deters David Klopfer Katie Schnieber

3 CECL: WHAT IT IS & WHEN TO IMPLEMENT

4 Background of CECL ASU Financial Instruments Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments Primary Goal: quicker recognition of losses

5 Major Changes Forward-looking requirements Removes the probable loss threshold Requires additional disclosures Creates an allowance for debt securities Cumulative-effect adjustment through retained earnings in the year adopted

6 Background of CECL

7 WHAT S CHANGING & WHAT IT COVERS

8 What is Changing? Incurred Loss Model (Current GAAP) vs. CECL Forward-looking requirements Probable loss threshold removed Greater need for loan-level data Longer loss horizon FASB says CECL makes ALLL a more institution-wide calculation FASB s Proposed Purpose Quicker recognition of losses. Changes in ALLL reserve balances will reflect changes in credit quality and immediately impact institution earnings What Doesn t Change Existing write-off principle Nonaccrual practices Loans held for sale, which are already measured at lower of amortized cost or FV

9 What is Changing? Recognition CANNOT PHASE IN Initial entry to recognize accounting change will be through retained earnings o o No current year earnings hit Will effect capital Credit losses will not be based on triggering event Result will be credit impairment being recognized earlier and immediately after the financial asset is originated or purchased

10 What is Changing? The Difference Loans o Under current GAAP, credit impairment losses are determined using an incurred-loss model, which recognizes credit losses only when probable contractual cash flows will not be collected Debt securities o Credit impairment losses are recognized when the security s fair value is less than amortized cost and the impairment is other-than-temporary Purchased credit-impaired assets o If measured at amortized cost, an allowance for expected credit losses will be recorded upon acquisition and in subsequent periods

11 In Scope vs Out of Scope In Scope ASU creates ASC Topic 326, Measurement of Credit Losses on Financial Instruments Financing receivables, trade receivables, debt securities, loan commitments, stand-by letters of credit, financial guarantees, lease receivables recognized by a lessor, expectation of a TDR Out of Scope AFS securities other than debt securities, equity instruments, financial instruments measured at FV via current year earnings, loans and receivables under common control and expected extensions, renewals, modifications of financial assets Supersedes impairment guidance in ASC 310 on receivables/loans and ASC 320 on debt securities ASC Topic applies to financial assets measured at amortized costs, a.k.a. CECL ASC Topic applies to AFS debt securities

12 Initial Recognition & Lifetime Loss Measurement HTM Debt Securities Current GAAP security is initially acquired there is no recognition of credit losses because no losses have been incurred CECL HTM debt security acquired at FV will generally require an allowance and related provision for credit losses at the time it is purchased Debt securities on which OTTI had been recognized prior to the effective date will transition to the new guidance prospectively (i.e., with no change in the amortized cost basis of the security) Loans Current GAAP credit losses on loans are recognized at the date of recognition only when they are included in a collective pool CECL will require an allowance for all credit losses expected over the entire remaining life of the asset.

13 Initial Recognition & Lifetime Loss Measurement Purchase Credit Impaired Assets Current GAAP measured at FV based on discounted cash flows or other method measurements CECL actually a welcomed change to current GAAP o Lowers threshold that an asset would qualify as such - Assessment by acquirer at acquisition to determine if there is a more than insignificant deterioration in credit quality - Factors include collateral, credit rating, DSCR - Focus would be on assets delinquent, classified, impaired and/or on nonaccrual

14 Initial Recognition & Lifetime Loss Measurement Purchase Credit Impaired Assets (continued) Accounting for PCD assets o o o o o Allocation of a credit discount and noncredit discount/premium at time of acquisition Noncredit discount/premium is accreted/amortized into interest income over life of the asset Credit discount is presented as an allowance! Does not prohibit nonaccrual PCD assets acquired prior to effective date will be classified as PCD assets as of the effective date. For all PCD assets, institutions will be required to gross up the amount of the asset for its allowance for expected credit losses as of the effective date and will continue to recognize the noncredit discount or premium as interest income

15 Initial Recognition & Lifetime Loss Measurement Non-Purchase Credit Impaired Assets Day 1 no change from current GAAP Day 2 institution may be required to record credit loss expense if the amortized cost > amount expected to be collected under CECL model

16 Individually Evaluating Loans With CECL, concept of loan impairment no longer exists Individually evaluated loans would be due to risk classification or delinquency status Unless foreclosure or settlement through sale of collateral, the asset would be evaluated on the cash flow or loss-rate method

17 Historical Loss Calculations Historical loss rates will serve as the STARTING POINT for CECL measurements Historical loss rates will be determined from cumulative actual losses incurred over the lifetime of the assets, as opposed to annualized loss rates that are more commonly used today. Vintage analyses will become very important in loan pools Prepayments of assets will become important as institutions will need to estimate the timing and prepayments of both debt securities and loans Current GAAP generally does not consider this. Forecast Period vs. Look Back Period Institutions will be required to adjust historical loss rates for periods which they can prepare reasonable and supportable forecasts for future conditions.

18 Major Updates for AFS Debt Securities Institution must assess impairment at individual security level Impairment is recognized via credit losses through an allowance, not OTTI Credit loss = Amortized cost minus PV of cash flows Changes in related allowance are recognized immediately (both positive and negative) Allowance is limited to excess of amortized cost over fair value. Amount cannot be reversed below zero.

19 Major Updates for AFS Debt Securities There will be no such thing as length of time to avoid loss recognition An institution will not be required to consider volatility and post balance sheet changes in fair value If intent or more likely than not requirement to sell exists Write off allowance and write security down to fair value through expense Anticipated cash flows in excess of amortized cost should be accreted into interest income Current disclosures remain substantially the same however the allowance roll-forward is added

20 Changes in Disclosures Credit Quality Disclosures Largest change to disclosures, but only significant if SEC or PBE filer Should be disaggregated by class and vintage If risk ratings are used as indicator, a description of the indicator should be disclosed to understand likelihood of loss Allowance for Credit Losses Disclosures Disaggregated by segment and similar to current disclosure, which would include roll-forward of activity Past Due Status Disaggregated by class and similar to current disclosure TDR Disclosure by Class Disaggregated by class and similar to current disclosure Due to impaired loan guidance and disclosures being superseded by CECL, the amount of funds committed to be lent to borrowers that are current TDRs will be included

21 Changes in Disclosures Nonaccrual Status Would be disaggregated by class and look similar to current impaired loan disclosures Amortized cost would be presented for both beginning and end of each period Would include amount on balance sheet but also amount as of the beginning of the first year presented Amount of nonaccrual loans with no related allowance would be disclosed due to the impaired loan guidance and disclosures are superseded by CECL PCD Disclosures Reconciliation of the purchase price and par value of the assets including the purchase price, acquisition date allowance for credit losses, noncredit discount/premium and par value

22 Changes in Disclosures Off-balance sheet disclosures Disclosures are qualitative and can be accomplished with a short narrative Narrative would include accounting policy, methodology to measure allowance and provision to credit loss during the period, if any

23 CECL Model Result Balance sheet reflects management s current estimate of expected credit losses at the reporting date Per the FASB, allowances can be easily understood since it is based on a single measurement objective Income statement reflects changes in expected credit losses during the period Interest income measured using a decoupled approach; however accrual ceases when collection is not probable Disclosures provide insight into the credit quality of financial assets at each reporting date and illustrate credit deterioration occurring during the reporting period

24 IMPLEMENTATION

25 Methodology Long implementation period to allow gathering of information Collaborative approach Internal Auditors Compliance Loan Department Asset Liability Management Examiners External auditors Risk assessment Loan characteristics Structures Complex or Simple Prepayment Speeds Macroeconomic risks consider future and impact to portfolio

26 Implementation Discounted Cash Flow Analysis Average Charge-off Method Vintage Analysis Static Pool Analysis Migration Analysis Probability of Default Regression Analysis

27 Average Charge Off CECL requires losses be estimated for expected life of loan Longer historical life period o Supported by reasonable assumptions and data Segregation of loan pools with similar risk Age vintage analysis Credit score Location Collateral type Size

28 Average Charge Off Additional factors Similar to today except consideration is forward looking What is expected unemployment What are expected changes in real estate values Reasonable and supportable forecast o FDIC Quarterly economic data o Local Government forecasts o FNMA/FHLMC economist o Federal Reserve economist and meetings

Collateral Dependent Loan Can still be used as practical expedient when: Foreclosure is probable Repayment is expected to be provided substantially through operation or sale of collateral with

29 Collateral Dependent Loan Can still be used as practical expedient when: Foreclosure is probable Repayment is expected to be provided substantially through operation or sale of collateral with borrower experiencing financial difficulty If sale reduce by estimated cost to sell Recognize as allowance for credit losses More disclosures required on type collateral, extent by type of loan collateral secures loan, why changes in value occurred o General deterioration or other reason

30 QUESTIONS? Scott Deters, CPA Shareholder David Klopfer, CPA Principal Katie Schnieber, CPA Manager

31 THANKS FOR JOINING US. Scott Deters, CPA Shareholder David Klopfer, CPA Principal Katie Schnieber, CPA Manager

32 COUNTDOWN TO CECL: IS YOUR FINANCIAL INSTITUTION ON TRACK? Presented by: Scott Deters, David Klopfer & Katie Schnieber

Technical Line FASB final guidance

No. 2018-09 4 October 2018 Technical Line FASB final guidance What s changing under the new standard on credit losses? In this issue: Overview... 1 Key considerations... 2 Effective date and transition...