Accounting for Financial Instruments Impairment Current Expected Credit Losses ( CECL ) By Candy Wright & Vincent Milano, P&N

Size: px

Start display at page:

Download "Accounting for Financial Instruments Impairment Current Expected Credit Losses ( CECL ) By Candy Wright & Vincent Milano, P&N"

Russell Andrews
5 years ago
Views:

1 The Unique Alternative to the Big Four Accounting for Financial Instruments Impairment Current Expected Credit Losses ( CECL ) By Candy Wright & Vincent Milano, P&N

2 Presentation Agenda Project Status Current Situation Effective Dates Project Summary April 1 Transition Resource Group Meeting Transition Method Comparison of Current GAAP and CECL Tentative Board Decisions Measurement and Disclosure Possible Models Implementation 2

3 Project Status The final pronouncement will be issued any day now The originally announced effective dates have been deferred by one year as set forth later in this presentation FASB has a transition resource group (TRG) ahead of issuing the final pronouncement (unusual for FASB) The FASB has hosted 8 public roundtables, fifteen preparer workshops and met with more than 200 users of financial statements The first public roundtable was held February 4, 2016 and was very contentious with the ICBA leading the charge The first TRG meeting was held on April 1, 2016 and was considered a breakthrough meeting as summarized later in this presentation 3

4 Current Situation During economic downturns, loan growth becomes non-existent and loan losses increase Most of these losses are from loans made during good economic conditions During good economic times, the current impairment model does not support higher reserves and, when banks do provide higher reserves, they are very difficult to substantiate Many believe that there is a need for a new impairment standard that allows banks to reserve in good times for the inevitable bad times and visa versa This is the objective in the CECL project 4

5 Effective Dates For Calendar Year-end Institutions FASB created a new subgroup of smaller public business entities (PBE) This new Smaller PBE subgroup does not meet the definition of an SEC filer (they don t file periodic reports with the SEC) The Smaller PBEs meet FASB definition of a public entity and are generally privatelyheld FDICIA banks (assets > $500 million) Supplementary Call Report Instructions for Q3 of 2015 contain a discussion of public entity 5

6 Effective Dates, Calendar Year Institutions, continued PBE - SEC filers 2020 and interim periods within that year (includes disclosures of vintages) PBE Small 2021and interim periods within that year All others 2021 year end and interim periods beginning in 2022 Early adoption will be permitted for 2019, including interim periods of that year The FASB will also permit a phase-in approach for vintage disclosures of non- SEC banks that begins in the year of adoption but includes originations years 2019 and

7 Project Summary Measuring Current Expected Credit Losses (CECL) Estimate of expected credit losses represents contractual amounts that an entity does not expect to collect over the contractual life of the asset Incorporates more forward looking information Reduces but does not eliminate reliance on projections of historical loss statistics Will probably lengthen the historical loss projection period to match the expected duration of the existing portfolio segments Results in a life-of-portfolio view Environmental factors will likely have a more prominent role in the calculation of the allowance 7

8 Project Summary, continued Measuring Current Expected Credit Losses (CECL), cont. Further disaggregates existing disclosures to incorporate vintage disclosures (the handouts include two examples of vintages) Incorporates the need for more granular information about the portfolio Since CECL is an origination model expected credit losses are booked when loans are made (or acquired in a business combination), then updated as more information becomes available ( day 1 loss ) 8

9 April 1, 2016 FASB Transition Resource Group (TRG) Meeting TRG has 16 members including financial statement users, auditors, preparers (two community banks and a credit union) Banking regulators and some accounting firms were also present The FASB unexpectedly distributed a current working draft of the CECL pronouncement (Draft) Most attendees agreed that the Draft was a vast improvement from earlier versions and it was scalable for smaller banks 9

10 April 1, 2016 TRG Meeting, cont. The Draft included additional examples addressing specific community banking concerns raised in the February meeting The Draft clearly states that banks can determine the ALLL using various methods and continue to evaluate loans individually Bank regulators in attendance commented that the Draft language is flexible operational for smaller banks ICBA noted the increased flexibility including continued use of spreadsheets 10

11 Transition Measuring Current Expected Credit Losses (CECL) Transition method Cumulative effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective 11

12 Comparison of Current GAAP and CECL When is a Loss Recognized? How Much of a Loss is Recognized? What Information Set Used to Determine a Loss? Current GAAP When a loss is probable or incurred Recognize the amount of loss that has been incurred Past events & current conditions CECL Proposal No recognition threshold, updated at each reporting period Recognize the current estimate of cash flows not expected to be collected -Past events & current conditions -Reasonable & supportable expectations about the future 12

13 Tentative Board Decisions Regarding Measurement An entity should consider available information relevant to assessing the collectability of contractual cash flows, including information about past events, current conditions, and reasonable and supportable forecasts, when developing an estimate of expected credit losses on financial assets When determining the contractual cash flows and the life of the related financial assets An entity should consider expected prepayments An entity should not consider expected extensions, renewals, and modifications unless the entity reasonably expects that it will execute a troubled debt restructuring 13

14 Tentative Board Decisions Regarding Measurement, continued An entity should revert to unadjusted historical credit loss experience for future periods beyond which the entity is able to make or obtain reasonable and supportable forecasts For collateral-dependent financial assets, there is a practical expedient where an entity would measure the allowance for expected credit losses as the difference between the collateral s fair value (adjusted for selling costs, when applicable) and the amortized cost basis of the asset 14

15 Tentative Board Decisions Regarding Disclosures An entity should disclose in the notes to the financial statements, the method applied to revert to historical credit loss experience for periods beyond which the entity is able to make or obtain reasonable and supportable forecasts An entity would not be explicitly required to disclose the time period covered by its reasonable and supportable forecasts of credit losses An entity should disaggregate the credit quality indicators by year of the asset s origination (that is vintage year). The disaggregation by vintage year would be limited to no more than five annual reporting periods, with the balance for financing receivables originated before the fifth annual reporting period being shown in the aggregate 15

16 Tentative Board Decisions Regarding Disclosures, continued For the purpose of determining the vintage year for disaggregated credit quality disclosures, an entity would use the guidance for determining a new loan resulting from loan refinancing or restructuring in current GAAP as set forth in paragraphs through (Receivables Nonrefundable Fees and Other Costs Loan Refinancing or Restructuring) 16

17 Possible CECL Models The final pronouncement will have several examples of various methods to calculate expected losses The FASB and banking regulators say that banks do not need to spend thousands on vendor supplied software to comply The move toward vendor software may take place if migration analysis becomes the preferred calculation technique Vendor solutions could become more prevalent in community banks if they can be scaled to fit banks of various sizes Larger institutions will probably want something more controlled than spreadsheet models 17

18 CECL - Implementation Get to know the standard, especially the guidance on vintages and the transition to vintage disclosures Get to know your data by developing a plan around gathering historical data Life-of-loan concept means that the need to isolate loan duration, average life, risk ratings, loan charge-offs and recoveries and portfolio cohorts will create a level of data granularity that previously did not exist Banks will need to understand the various components of their losses such as probability of default and loss given default 18

19 CECL Implementation, cont. Environmental (qualitative) factors will become more important than quantitative factors, especially when applying forecasts about the impact of expected future events The use of forecasted information will change what we previously thought about directional consistency of environmental factors Identify internal and external information for use in developing a reasonable and supportable forecast After the pronouncement is issued, the FASB Transition Resources Group will continue to issue new guidance or new examples as necessary Regulators and banks will be learning at the same time 19

20 Questions? 20

Webinar: Latest Developments on CECL and Upcoming Changes to the Allowance for Credit Losses. September 8, 2016

Webinar: Latest Developments on CECL and Upcoming Changes to the Allowance for Credit Losses September 8, 2016 An Introduction CECL What s Changing? What s not Changing? Acceptable Methods Myths vs Facts