2017 CEO & Board University What Boards Need to Know About CECL

Transcription

1 2017 CEO & Board University What Boards Need to Know About CECL Jim McGough, CPA, CGMA MEMBER OFALLINIAL GLOBAL, AN ASSOCIATION OF LEGALLY INDEPENDENT FIRMS 2017 Wolf & Company, P.C.

2 Introduction Jim McGough, CPA, CGMA Senior Audit Manager 2

3 Agenda Overview CECL Transition Where to start Implementation Considerations Loan pools Appropriate methodology Historical loss data Reasonable and supportable forecasts Scope of CECL on Investments CECL for HTM securities 3

4 Overview Topic 326, Financial Instruments- Credit Losses Problem Too many accounting models for impairment Too little too late What changed? Life-of-loan loss period Impaired trigger is gone Group similar assets Forward looking requirement General observations ALL estimate is more complicated under CECL More judgment required for principle based model Scalable & Flexible Quicker recognition of losses 4

5 CECL Transition Where to Start 1. Learn the standard, and understand the basis for conclusions included therein. Principles-based standard Requirements of the standard and best practices will evolve Effective for calendar year entities: o o o 2020 for public business entities (PBE) that are SEC filers, including interim periods 2021 for other public business entities, including interim periods Dec 31, 2021 for all others 5

6 CECL Transition Where to Start 2. Establish your working group, including professionals outside the accounting function such as lending, IT, risk management. CECL is a critical estimate for the senior management team Delineation of roles and responsibilities for personnel involved in the estimation process When to involve internal audit? 6

7 CECL Transition Where to Start 3. Develop your project plan, including governance/oversight and milestone dates. Define responsibilities Assess data needs (build and test) Establish time frames and milestones Dry/parallel runs Determine implementation has appropriate resources and priority Key question for Board to ask: What mechanisms will give us timely knowledge of the ongoing status of implementation? 7

8 CECL Transition Where to Start 4. Incorporate internal control considerations along the way to achieve design effectiveness. Written policies and procedures Completeness and accuracy of data Management review and approval Process must hold up under a quarterly frequency Outsourced model might be in scope of supervisory guidance for model risk management Can the estimate be validated/audited? 8

9 CECL Transition Where to Start 5. Communicate with your auditor and primary regulator. Scalability of the model exposes the bank to regulatory interpretation Regulatory agencies will develop supervisory guidance to clarify expectations but will not provide an approved model or example calculation Best practices will evolve Conclude on PBE status with external auditor so there are no surprises with effective date 9

10 Implementation Considerations Determine loan pools (those with similar risk characteristics) Identify an appropriate methodology for each loan pool Obtain sufficient historical loss data Develop reasonable and supportable forecasts 10

11 Loan Pools Loan pooling is a critical decision point; impacting all subsequent actions Does not prescribe a unit of account, but does require pooling of assets with similar risk characteristics. Loan segments utilized for current GAAP or call report have to be reevaluated Excessive aggregation/disaggregation may be problematic 11

12 Loan Pools Risk Characteristics In evaluating financial assets on a collective (pool) basis, aggregate financial assets on the basis of similar risk characteristics, which may include any one or a combination of the following (the following list is not intended to be all inclusive): a. Internal or external (thirdparty) credit score or credit ratings b. Risk ratings or classification c. Financial asset type d. Collateral type e. Size f. Effective interest rate g. Term h. Geographical location i. Industry of the borrower j. Vintage k. Historical or expected credit loss patterns l. Reasonable and supportable forecast periods 12

13 Loan Pools Where to start Using your loan footnote consider the list of risk attributes in the ASU for each segment: Identify 2 to 3 primary risk characteristics and consider if these are generally consistent within the segment. Are actual losses significant? Other than ALL estimate, does management evaluate the loans at a different level? Is the loss emergence period known? Can expected loan life be estimated for the segment as is? 13

14 Loan Pools Exclude Certain Loans Estimated credit loss for an asset should be measured individually if there are no similar risk characteristics with other loans. Practical expedients (FV of collateral) exist for: Collateral-dependent loans (borrower experiencing financial difficulties and repayment expected through sale or operation of the property) Loans secured by collateral maintenance provisions 14

15 Appropriate Methodology GAAP requirement is explicitly scalable and allows preparers to develop estimation methods that are appropriate and practical for their circumstances. One impairment model but many methods. Methodology by loan segment should be determined early because relevant data and software needs may vary. 15

16 Appropriate Methodology FASB concluded that different outcomes for expected credit losses are acceptable, given different levels of complexity and sophistication. Principles based Scalable FASB provided examples that illustrate implementation in a noncomplex environment. (Example 1 in the ASU) 16

17 Appropriate Methodology Considerations for scalability: What is the entity s strategic plan and who will be relying on the financial statements now and in the immediate future? Does the primary banking regulator classify the entity as a smaller, less complex institution? Would the cost of a more complex methodology exceed the benefits? The result may not be better, and model/error risk may be elevated. Is a sophisticated model required or desired for any segment based on the nature of the loans and relevant loss history? 17

18 Historical Loss Data An entity s loss history loss remains as the starting point and generally provides a basis for expected credit losses. GAAP does not specify a particular methodology for determining historical credit loss experience. That methodology may vary depending on the size of the entity, the range of the entity s activities, the nature of the entity s financial assets, and other factors. [ASU ] The loan segment and the chosen method will determine the data needs. Historical data is still adjusted using qualitative factors. 18

19 Reasonable and Supportable Forecasts Identify risk drivers for each loan segment For example, real estate values and unemployment rates for mortgage loans Q-Factor analysis will document whether historical loss data requires adjustment based on the forecast for these drivers. Entities are required to adjust for reasonable and supportable forecasts of the future, by adjusting historical loss information for future expected events that are not reflected in historical losses. For periods where an entity is unable to support its forecast, it is required to revert to historical loss information. Consider consistency with other forecasts within the entity (ALM, risk management, MSR valuation, budget, capital planning, other loan segments). Some entities may begin with external forecasts (e.g. Federal Reserve) and adjust to what management foresees in its area of operations. 19

20 Reasonable and Supportable Forecasts The adjustments for current conditions and reasonable and supportable forecasts may continue to be qualitative, similar to the approach applied by many institutions today. More robust quantitative models and/or greater segmentation may result in a smaller qualitative component, depending on the circumstances. Q-Factor adjustments may be more significant because of the lifeof-loan measurement period. Qualitative analysis may not always be directionally consistent with current trends/events. For example, an increase in delinquency rates may have been previously considered/anticipated when estimating expected credit losses. 20

21 Scope of CECL on Investments Type Current New Equity Securities Topic 320 Carried at FV with changes through earnings no impairment analysis required (ASU ) AFS Debt Securities Topic 320 Topic HTM Debt Securities Topic 320 Topic 326

22 CECL for HTM Securities Evaluate securities on a pool basis (similar risk characteristics) Individual basis (if not similar risk characteristics) Consider qualitative and quantitative factors that relate to operating environment and specific to entity, both internal and external When determining contractual cash flows and life of related asset, should consider expected prepayments Should revert to unadjusted historical credit loss for future periods beyond which an entity can make reasonable forecast Estimate should always reflect risk of loss, even if remote

23 CECL Implementation Considerations Questions?

24 Thank you! Jim McGough, CPA, CGMA Senior Audit Manager 24