CECL Initial and Subsequent Measurement A Practical Approach

Transcription

1 CECL Initial and Subsequent Measurement A Practical Approach June 8, 2017 Neekis Hammond, CPA Principal - Advisory Services 1

2 Loan portfolio and risk management solutions More than 1,000 financial institution clients Risk management thought leader for institutions and examiners Regularly featured in national and trade media Founded in

3 ASU (Topic 326/CECL) Key Principles : Loss estimate must include expected credit losses over the contractual term of the financial asset(s) 3

4 ASU (Topic 326/CECL) Key Principles : Loss estimate must include expected credit losses over the contractual term of the financial asset(s) : Prepayment behavior must be explicitly or implicitly addressed 4

5 ASU (Topic 326/CECL) Key Principles : Loss estimate must include expected credit losses over the contractual term of the financial asset(s) : Prepayment behavior must be explicitly or implicitly addressed : Extension and/or renewal assumptions are not allowed except for Troubled Debt Restructurings 5

6 ASU (Topic 326/CECL) Key Principles : Loss estimate must include expected credit losses over the contractual term of the financial asset(s) : Prepayment behavior must be explicitly or implicitly addressed : Extension and/or renewal assumptions are not allowed except for Troubled Debt Restructurings : Analyzing assets on a collective or pooled basis is required unless unique risk characteristics exist 6

7 ASU (Topic 326/CECL) Key Principles : Loss estimate must include expected credit losses over the contractual term of the financial asset(s) : Prepayment behavior must be explicitly or implicitly addressed : Extension and/or renewal assumptions are not allowed except for Troubled Debt Restructurings : Analyzing assets on a collective or pooled basis is required unless unique risk characteristics exist : Institutions (PBEs and SEC filers) must prepare a vintage disclosure by presenting the amortized cost basis within each credit quality indicator by year of origination (that is, vintage year) 7

8 ASU (Topic 326/CECL) Key Principles : Internal information, external information or a combination of both may be used for analyzing past events and current conditions, as well as in the creation of reasonable and supportable forecasts 8

9 ASU (Topic 326/CECL) Key Principles : Internal information, external information or a combination of both may be used for analyzing past events and current conditions, as well as in the creation of reasonable and supportable forecasts : Adjustments to historical loss information may be quantitative and/or qualitative in nature 9

10 ASU (Topic 326/CECL) Key Principles : Internal information, external information or a combination of both may be used for analyzing past events and current conditions, as well as in the creation of reasonable and supportable forecasts : Adjustments to historical loss information may be quantitative and/or qualitative in nature : Adjustments may be based on reasonable and supportable forecasts. For periods beyond a reasonable forecast, reverting to historical loss information immediately, on a straight-line basis, or using another rational and systematic basis is acceptable 10

11 ASU (Topic 326/CECL) Key Principles : Internal information, external information or a combination of both may be used for analyzing past events and current conditions, as well as in the creation of reasonable and supportable forecasts : Adjustments to historical loss information may be quantitative and/or qualitative in nature : Adjustments may be based on reasonable and supportable forecasts. For periods beyond a reasonable forecast, reverting to historical loss information immediately, on a straight-line basis, or using another rational and systematic basis is acceptable : A liability for credit losses on off-balance-sheet credit exposures over the contractual life must be recorded 11

12 ASU (Topic 326/CECL) Key Principles SEC Filers SAB No. 74 (Topic 11-M): Disclosure of the impact that recently issued accounting standards will have on the financial statements of the registrant when adopted in a future period. 12

13 ASU (Topic 326/CECL) Key Principles SEC Filers SAB No. 74 (Topic 11-M): Disclosure of the impact that recently issued accounting standards will have on the financial statements of the registrant when adopted in a future period. ASU , Revenue from contracts with customers 13

14 ASU (Topic 326/CECL) Key Principles SEC Filers SAB No. 74 (Topic 11-M): Disclosure of the impact that recently issued accounting standards will have on the financial statements of the registrant when adopted in a future period. ASU , Revenue from contracts with customers ASU , Leases (Topic 842) 14

15 ASU (Topic 326/CECL) Key Principles SEC Filers SAB No. 74 (Topic 11-M): Disclosure of the impact that recently issued accounting standards will have on the financial statements of the registrant when adopted in a future period. ASU , Revenue from contracts with customers ASU , Leases (Topic 842) ASU , Measurement of credit losses on financial instruments (Topic 326/ CECL ) 15

16 ASU (Topic 326/CECL) Key Principles SEC Filers SAB No. 74 (Topic 11-M): Disclosure of the impact that recently issued accounting standards will have on the financial statements of the registrant when adopted in a future period. 16

17 ASU (Topic 326/CECL) Key Principles SEC Filers SAB No. 74 (Topic 11-M): Disclosure of the impact that recently issued accounting standards will have on the financial statements of the registrant when adopted in a future period. A brief description of the new standard, the date that adoption is required and the date that the registrant plans to adopt, if earlier. 17

18 ASU (Topic 326/CECL) Key Principles SEC Filers SAB No. 74 (Topic 11-M): Disclosure of the impact that recently issued accounting standards will have on the financial statements of the registrant when adopted in a future period. A brief description of the new standard, the date that adoption is required and the date that the registrant plans to adopt, if earlier. A discussion of the methods of adoption allowed by the standard and the method expected to be utilized by the registrant, if determined. 18

19 ASU (Topic 326/CECL) Key Principles SEC Filers SAB No. 74 (Topic 11-M): Disclosure of the impact that recently issued accounting standards will have on the financial statements of the registrant when adopted in a future period. A brief description of the new standard, the date that adoption is required and the date that the registrant plans to adopt, if earlier. A discussion of the methods of adoption allowed by the standard and the method expected to be utilized by the registrant, if determined. A discussion of the impact that adoption of the standard is expected to have on the financial statements of the registrant, unless not known or reasonably estimable. In that case, a statement to that effect may be made. 19

20 ASU (Topic 326/CECL) Key Principles SEC Filers SAB No. 74 (Topic 11-M): Disclosure of the impact that recently issued accounting standards will have on the financial statements of the registrant when adopted in a future period. A brief description of the new standard, the date that adoption is required and the date that the registrant plans to adopt, if earlier. A discussion of the methods of adoption allowed by the standard and the method expected to be utilized by the registrant, if determined. A discussion of the impact that adoption of the standard is expected to have on the financial statements of the registrant, unless not known or reasonably estimable. In that case, a statement to that effect may be made. Disclosure of the potential impact of other significant matters that the registrant believes might result from the adoption of the standard (such as technical violations of debt covenant agreements, planned or intended changes in business practices, etc.) is encouraged. 20

21 ASU (Topic 326/CECL) Key Principles SEC Filers SAB No. 74 (Topic 11-M): Disclosure of the impact that recently issued accounting standards will have on the financial statements of the registrant when adopted in a future period. A brief description of the new standard, the date that adoption is required and the date that the registrant plans to adopt, if earlier. A discussion of the methods of adoption allowed by the standard and the method expected to be utilized by the registrant, if determined. A discussion of the impact that adoption of the standard is expected to have on the financial statements of the registrant, unless not known or reasonably estimable. In that case, a statement to that effect may be made. Disclosure of the potential impact of other significant matters that the registrant believes might result from the adoption of the standard (such as technical violations of debt covenant agreements, planned or intended changes in business practices, etc.) is encouraged. 21

22 ASU (Topic 326/CECL) Strategic Considerations Reasonable (Financial Considerations) Costs: Initial, subsequent and recurring Benefits: Variance, materiality and managerial insight Risks: Modeling, volatility and sensitivity 22

23 ASU (Topic 326/CECL) Strategic Considerations Reasonable (Financial Considerations) Costs: Initial, subsequent and recurring (build vs. buy) Benefits: Variance, materiality and managerial insight Risks: Modeling, volatility and sensitivity 23

24 ASU (Topic 326/CECL) Strategic Considerations Reasonable (Financial Considerations) Costs: Initial, subsequent and recurring Benefits: Variance, materiality and managerial insight Risks: Modeling, volatility and sensitivity Supportable (Levers and Elections) Segmentation: Structure, term and credit risk Methodology: Alignment, strengths/weaknesses and data constraints Forecast: Source, sensitivity and data constraints 24

25 ASU (Topic 326/CECL) Strategic Considerations Reasonable (Financial Considerations) Costs: Initial, subsequent and recurring Benefits: Variance, materiality and managerial insight Risks: Modeling, volatility and sensitivity Supportable (Levers and Elections) Segmentation: Structure, term and credit risk Methodology: Alignment, strengths/weaknesses and data constraints Forecast: Source, sensitivity and data constraints Applicable (Accuracy and Meaningfulness) GAAP: Compliance and auditability Regulatory: Adequate and transparent Strategic: Cross application and managerial insight 25

26 ASU (Topic 326/CECL) Tactical Considerations Data Adequacy Retention Process 26

27 ASU (Topic 326/CECL) Tactical Considerations Data Adequacy Retention Process Contractual Life/Prepayment Calculation Support 27

28 ASU (Topic 326/CECL) Tactical Considerations Data Adequacy Retention Process Contractual Life/Prepayment Calculation Support Segmentation Flexibility Comparability Support 28

29 ASU (Topic 326/CECL) Tactical Considerations Data Adequacy Retention Process Contractual Life/Prepayment Calculation Support Segmentation Flexibility Comparability Support Methodologies Flexibility Comparability Support 29

30 ASU (Topic 326/CECL) Tactical Considerations Data Adequacy Retention Process Contractual Life/Prepayment Calculation Support Segmentation Flexibility Comparability Support Methodologies Flexibility Comparability Support Forecasting and Adjustments Flexibility Comparability Support 30

31 ASU (Topic 326/CECL) Tactical Considerations Data Adequacy Retention Process Contractual Life/Prepayment Calculation Support Segmentation Flexibility Comparability Support Methodologies Flexibility Comparability Support Forecasting and Adjustments Flexibility Comparability Support Documentation Completeness Auditability Efficiency 31

32 ASU (Topic 326/CECL) Tactical Considerations Data Adequacy Retention Process Contractual Life/Prepayment Calculation Support Segmentation Flexibility Comparability Support Methodologies Flexibility Comparability Support Forecasting and Adjustments Flexibility Comparability Support Documentation Completeness Auditability Efficiency 32

33 ASU (Topic 326/CECL) Tactical Considerations Data Adequacy Retention Process Contractual Life/Prepayment Calculation Support Segmentation Flexibility Comparability Support Methodologies Flexibility Comparability Support Forecasting and Adjustments Flexibility Comparability Support Documentation Completeness Auditability Efficiency 33

34 Data - Adequacy Interagency Guidance December 19, 2016 Specifically with regard to data, to implement CECL, an institution should collect and maintain relevant data to support its estimates of lifetime expected credit losses in a way that aligns with the method or methods it will use to estimate its allowances for credit losses. As such, the agencies encourage institutions to discuss the availability of historical loss data internally and with their core loan service providers because system changes related to the collection and retention of data may be warranted. Depending on the estimation method or methods selected, institutions may need to capture additional data and retain data longer than they have in the past on loans that have been paid off or charged off to implement CECL. 34

35 Data - Adequacy Interagency Guidance December 19, 2016 Specifically with regard to data, to implement CECL, an institution should collect and maintain relevant data to support its estimates of lifetime expected credit losses in a way that aligns with the method or methods it will use to estimate its allowances for credit losses. As such, the agencies encourage institutions to discuss the availability of historical loss data internally and with their core loan service providers because system changes related to the collection and retention of data may be warranted. Depending on the estimation method or methods selected, institutions may need to capture additional data and retain data longer than they have in the past on loans that have been paid off or charged off to implement CECL. 35

36 Data - Adequacy Interagency Guidance December 19, 2016 Specifically with regard to data, to implement CECL, an institution should collect and maintain relevant data to support its estimates of lifetime expected credit losses in a way that aligns with the method or methods it will use to estimate its allowances for credit losses. As such, the agencies encourage institutions to discuss the availability of historical loss data internally and with their core loan service providers because system changes related to the collection and retention of data may be warranted. Depending on the estimation method or methods selected, institutions may need to capture additional data and retain data longer than they have in the past on loans that have been paid off or charged off to implement CECL. 36

37 Data - Adequacy Interagency Guidance December 19, 2016 Specifically with regard to data, to implement CECL, an institution should collect and maintain relevant data to support its estimates of lifetime expected credit losses in a way that aligns with the method or methods it will use to estimate its allowances for credit losses. As such, the agencies encourage institutions to discuss the availability of historical loss data internally and with their core loan service providers because system changes related to the collection and retention of data may be warranted. Depending on the estimation method or methods selected, institutions may need to capture additional data and retain data longer than they have in the past on loans that have been paid off or charged off to implement CECL. 37

38 Data - Retention 4-year 3-year 2-year 5-year 4-year 3-year 2-year 38

39 Data - Process

40 ASU (Topic 326/CECL) Tactical Considerations Data Adequacy Retention Process Contractual Life/Prepayment Calculation Support Segmentation Flexibility Comparability Support Methodologies Flexibility Comparability Support Forecasting and Adjustments Flexibility Comparability Support Documentation Completeness Auditability Efficiency 40

41 Contractual Life (Attrition) Average Life (years) WORKING CAPITAL LOC EQUIPMENT VEHICLE CREDIT CARD CONSTRUCTION SBA 41

42 Contractual Life (Attrition) 42

43 Contractual Life (Attrition) 43

44 Contractual Life (Attrition) 44

45 Contractual Life (Attrition) 45

46 Contractual Life (Attrition) 46

47 Contractual Life (Attrition) 47

48 Contractual Life (Attrition) Application Cumulative/Static Pool Analysis Migration Probability of Default & Loss Given Default (PD & LGD) Roll Rate Markov Chain Monte Carlo (MCMC) 48

49 15% 20% 20% 25% 30% Prepayment (CPR/SMM) Conditional Prepayment Rate (CPR) EQUIPMENT VEHICLE CREDIT CARD CONSTRUCTION SBA 49

50 Prepayment (CPR/SMM) 50

51 Prepayment (CPR/SMM) 51

52 Prepayment (CPR/SMM) 52

53 Prepayment (CPR/SMM) 53

54 Prepayment (CPR/SMM) Application DCF (Discounted Cash Flow) 54

55 ASU (Topic 326/CECL) Tactical Considerations Data Adequacy Retention Process Contractual Life/Prepayment Calculation Support Segmentation Flexibility Comparability Support Methodologies Flexibility Comparability Support Forecasting and Adjustments Flexibility Comparability Support Documentation Completeness Auditability Efficiency 55

56 Segmentation Cumulative Loss & Migration 56

57 Segmentation Cumulative Loss & Migration 57

58 Segmentation DCF Risk-Level (Top) & DCF Risk-Rating (Bottom) 58

59 Segmentation DCF Risk-Level (Top) & DCF Risk-Rating (Bottom) 59

60 ASU (Topic 326/CECL) Tactical Considerations Data Adequacy Retention Process Contractual Life/Prepayment Calculation Support Segmentation Flexibility Comparability Support Methodologies Flexibility Comparability Support Forecasting and Adjustments Flexibility Comparability Support Documentation Completeness Auditability Efficiency 60

61 Methodologies DCF Risk-Level Migration Risk-Level PD & LGD 61

62 Methodologies Cumulative Loss 62

63 0.25% 0.33% 0.42% 0.79% Methodologies Life-of-Loan Loss Experience DCF RISK-LEVEL MIGRATION RISK-LEVEL PD & LGD RISK-LEVEL CUMULATIVE LOSS 63

64 Methodologies The allowance for credit losses may be determined using various methods. For example, an entity may use discounted cash flow methods, loss-rate methods, roll-rate methods, probability of default methods, or methods that utilize an aging schedule: Loss-rate-method: Net charge-offs/average balance is of little worth. Cumulative loss rates are appropriate. For more information: Roll-rate-method: Net change in balances assumed to indicate migration through default to loss Vintage: Suitable for installment loans; not for revolving credits. Migration: Observed loss experience at the subsegment-level over n periods. Misalignment between the life of the asset and the migration/loss experience is a common error in logic. PD & LGD: Probability of defaulting over n periods. Misalignment between the life of the asset and the probability that a loan will default is a common error in logic. DCF: Inputs prior to executing amortization schedules require models as well; loss-rate or probability-of-default, prepayment, loss-given-default, recovery lag, etc. 64

65 Transition/Execution As institutions search for solutions that are both cost-effective and accommodating, understanding critical capabilities will lead to a more successful investment. Building peripheral spreadsheet-based models, purchasing data to derive and support material inputs and assumptions, limiting methodology options and manually compiling supporting documentation and/or disclosures can lead to dissatisfaction and can prove costly. The following items must be understood/evaluated: Data fit/gap analysis and a clear understanding of data-driven limitations Data remediation assistance Adequate training, support, and advisory services Life-of-loan and prepayment calculations Rapid segmentation elections 65

66 Transition/Execution The following items must be understood/evaluated (continued): Multiple methodology options available at the pool-level Forecast creation, support, and application capabilities Supporting documentation and disclosure preparation Clear developmental roadmap commitments and contractual obligations to remain compliant 66

67 CECL Summary Strategic Considerations Reasonable (Financial Considerations) Costs: Initial, subsequent and recurring Benefits: Variance, materiality and managerial insight Risks: Modeling, volatility and sensitivity 67

68 CECL Summary Strategic Considerations Reasonable (Financial Considerations) Costs: Initial, subsequent and recurring (build vs. buy) Benefits: Variance, materiality and managerial insight Risks: Modeling, volatility and sensitivity 68

69 CECL Summary Strategic Considerations Reasonable (Financial Considerations) Costs: Initial, subsequent and recurring Benefits: Variance, materiality and managerial insight Risks: Modeling, volatility and sensitivity Supportable (Levers and Elections) Segmentation: Structure, term and credit risk Methodology: Alignment, strengths/weaknesses and data constraints Forecast: Source, sensitivity and data constraints 69

70 CECL Summary Strategic Considerations Reasonable (Financial Considerations) Costs: Initial, subsequent and recurring Benefits: Variance, materiality and managerial insight Risks: Modeling, volatility and sensitivity Supportable (Levers and Elections) Segmentation: Structure, term and credit risk Methodology: Alignment, strengths/weaknesses and data constraints Forecast: Source, sensitivity and data constraints Applicable (Accuracy and Meaningfulness) GAAP: Compliance and auditability Regulatory: Adequate and transparent Strategic: Cross application and managerial insight 70