CECL Time to Start Will Neeriemer, Partner DHG Financial Services. financial services

Transcription

1 CECL Time to Start Will Neeriemer, Partner DHG Financial Services 1

2 About DHG DHG Financial Services, a national practice of Dixon Hughes Goodman, focuses on publicly traded and privately-held financial services companies across the U.S. Our professionals provide in-depth industry knowledge and a wide range of assurance, tax and advisory services 2

3 Agenda The New Rules Estimation Methods Implementation Communication 3

4 The New Rules ASU Effective for SEC registrants for years beginning after , effective for most others for years beginning after Early adoption is permitted 4

5 The New Rules Must recognize life-time expected credit losses at date of origination or acquisition of a loan Removes the thresholds that were present in current GAAP (probable and measurable) Will incorporate information about past events, current conditions and reasonable and supportable forecasts of the future 5

6 The New Rules What does lifetime mean? Contractual maturity Do not assume extensions/renewals (unless a TDR is probable) Shorten for expected prepayments Must pool assets with similar risk characteristics. Assess assets with unique characteristics separately. 6

7 The New Rules The allowance will measure the difference between the amortized cost of the asset and the amount expected to be collected Historical loss experience is still relevant; however: Likely need loan level data Pools will likely be different Length of historical period used should reflect expected life 7

8 The New Rules Qualitative factors Needed to adjust for current conditions Needed to adjust for differences from historical period Needed to adjust for reasonable and supportable forecasts If the life of the asset extends beyond a reasonable forecast then entity should revert to historical average 8

9 The New Rules Reasonable and supportable forecasts Length will be different for each entity Can use either internal or external data, depending on which is most relevant and reliable Items that may be forecasted: Unemployment Housing price index Interest rates 9

10 The New Rules Reasonable and supportable forecasts NOT required to search all possible information Shall consider available information relevant to assessing collectability. Internal information may be sufficient What does it mean to revert to historical loss information? 10

11 The New Rules Assets acquired with a more than insignificant credit deterioration will receive a gross up of the allowance and the fair value of the loan upon origination Allowance will be measured in the same manner as originated assets Assets acquired with only insignificant credit deterioration will be treated similarly to originated assets (record allowance at acquisition through the income statement) 11

12 The New Rules Will measure CECL on off-balance sheet exposures Consider likelihood of funding Consider amount expected to be funded Consider impact on lines of credit, revolving loans and letters of credit If credit availability can be canceled at any time then do not measure CECL on unfunded amounts (credit cards) Collateral dependent loans can be measured based on fair value of collateral 12

13 Estimation Methods The new standard does not prescribe a particular method FASB expects that multiple methods will be used, and that results will vary widely Range of acceptable outcomes rare that there would be only one acceptable choice Method should vary based on: Way the entity manages credit risk Complexity of portfolio and sophistication of entity 13

14 Estimation Methods Loss Rate Cumulative loss rate over expected life Vintage Predictable losses based on seasoning PD/LGD Dual risk rating DCF Combine PD/LGD with present value Migration Statistical analysis 14

15 Modeling Options Cumulative loss rate NOT simply adding historical loss rates Is observing total losses over the life of a historical portfolio and dividing it by the original amount of the loan to calculate a rate May be a good option for smaller institutions with limited losses and small portfolios Cumulative Loss Rate Illustration Cumulative losses / original pool balance = cumulative loss rate Cumulative loss rate X outstanding balance = CECL reserve 15

16 Modeling Options Cumulative loss rate - advantages Simple method, easily calculated using tools available (Microsoft Excel) Easy to explain, support and audit Cumulative loss rate disadvantages For larger loan portfolios, data gathering may limit ability to utilize 16

17 Modeling Options Vintage analysis example Year of Loss Experience in Years Following Origination Origination Year 1 Year 2 Year 3 Year 4 Total 20X1 0.50% 1.20% 1.40% 0.30% 3.40% 20X2 0.60% 1.20% 1.60% 0.50% 3.90% 20X3 0.40% 1.10% 1.50% 0.30% 3.30% 20X4 0.60% 1.10% 1.50% 0.40% 3.60% 20X5 0.50% 1.30% 1.70% 0.50% 4.00% 20X6 0.70% 1.50% 1.80% 4.60% 20X7 0.80% 1.40% 4.80% 20X8 0.70% 5.00% 20X9 5.10% 17

18 Modeling Options Vintage analysis Tracking losses over life of asset Useful for loans with terms and factors that influence risk are generally homogenous Advantages Relatively simple model Can accommodate unseasoned portfolios Disadvantages Not appropriate for pools with mixed loan terms Difficult to apply to new products 18

19 Modeling Options Probability of default and loss given default (PD/LGD) example Probability of Default Loss Given Default Expected Loss 1-4 Family 1.00% 40% 0.400% Multi-family 0.75% 50% 0.375% CRE NOO 2.00% 35% 0.700% CRE OO 1.50% 50% 0.750% C&I 1.70% 90% 1.530% Consumer 3.00% 30% 0.900% 19

20 Modeling Options PD/LGD is useful when: Loan terms are unique within pools Loan grading system is robust and actively managed PD/LGD advantages Allows for loan specific loss estimation Leverage for regulatory stress testing Can leverage to acquired loans PD/LGD disadvantages Heavy data requirements and modeling capabilities Application of forecast when loan life is longer than forecast period 20

21 Modeling Options Discounted cash flow (DCF) Project cash flows including assumptions about: Prepayments Defaults (timing) Recoveries (amount and timing) DCF is a good option for: Individual credit analysis 21

22 Modeling Options DCF advantages Most closely aligns with fair value measurement techniques Allows flexibility related to the timing of expected losses DCF disadvantages Accuracy of timing expectations Forecasting period (if you can predict the timing of the loss, should you also be able to predict other events at that date?) Timing related noise 22

23 Modeling Options Migration analysis Using statistical methods to predict the migration of a loan from origination to loss Migration analysis is useful when: You have large amounts of historical loss data Migration analysis advantages Defensible modeling theory Can eliminate some management bias by providing mathematical insight into actual loss performance 23

24 Modeling Options Migration analysis disadvantages Complex, heavy data driven models Changes in pools (either through acquisition of loans or re-segmentation) can disrupt the logic of the model and require recalculation of historical information 24

25 Implementation Timeline 2016 Implementation committee and data 2017 Data and pro-forma modeling 2018 Implement and test model 2019 Validate and refine model January 1, 2020 Go Live! 25

26 Implementation Committee Credit Finance CECL Committee Technology Risk 26

27 Implementation Committee Basic requirements of the implementation committee Have cross-functional membership Have a champion with appropriate organizational authority Have ability to dedicate sufficient time to the project Must be open to change and willing to innovate 27

28 Implementation Committee Implementation Committee Tasks 2016 Read and discuss new standard Create a timeline for adoption Educate board and key stakeholders on new standard Evaluate data needs: What do we have? What do we need? Where will we store it? How will we access it? 28

29 Implementation Committee Implementation Committee Tasks 2017 Continue with data evaluation and gathering Perform high level modeling to estimate impact of different methods Define loan pools and segments Select model(s) for adoption 2018 Continue with data Run selected models in test phase Build policy and process documentation Model impact on capital plan, strategic plan 29

30 Implementation Committee Implementation Committee Tasks 2019 Perform model validation and challenge Finalize policies and procedures Report on expected impact to internal stakeholders (more detail) Discuss impact to external stakeholders (less detail) 2020 Adopt!! Continue to refine model and inputs 30

31 Communication Board of Directors Make sure that they are educated on the general concepts and change from current practice Update them on implementation plan Explain impact on: Risk assessments Internal controls Strategic plan Capital plan 31

32 Communication Regulators Implementation plan (calendar year 2017) Impact on level of allowance Transition issues, particularly related to acquired loans Impact on capital levels and earnings (consider doing a lookback if possible) Stress your model 32

33 Communication Auditors Communicate implementation timeline Discuss methodologies and get consensus Discuss inputs, particularly the time horizons that you plan to gather data to use in your model Share policies and procedures Plan with internal audit for audit procedures 33

34 Communication Investors In year prior to adoption, consider disclosing rough magnitude of impact, particularly if you believe it will be material As impact gets closer, indicate the changes in disclosures and financial statements that should be expected upon adoption Introduce new relationships between KPIs and levels of ALLL Standard requires significant disclosures in year of adoption 34

35 Questions & Contact Information Will Neeriemer Partner Dixon Hughes Goodman LLP Related articles from DHG: Preparing for CECL, by Adam Thomas & Walter McNairy The Wait is Over: Planning for Day 1 of CECL, by Sean Prince & Will Neeriemer 35