The CECL Model: Update and Implementation Considerations. Steve Merriett Deputy Associate Director and Chief Accountant Board of Governors

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Clara Bradford
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2 The CECL Model: Update and Implementation Considerations Steve Merriett Deputy Associate Director and Chief Accountant Board of Governors 2

3 Disclaimer The opinions expressed in these presentations are intended for informational purposes and are not formal opinions of, nor binding on, the Federal Reserve Bank of Kansas City or the Board of Governors of the Federal Reserve System. 3

4 Likely Timeline of the Proposed Standard Finalized standard expected to be issued by the Financial Accounting Standards Board (FASB) in December Possible implementation date of January 1, 2018, though likely to be later. 4

5 Key Elements of the Proposed Standard Allowances are to be based on CECL model: CECL is applicable to loans and debt instruments held at amortized cost, as well as receivables, lease receivables, and loan commitments. Expected credit losses are defined in the exposure draft as current estimate of all contractual cash flows not expected to be collected. : No triggers, no thresholds. Quicker recognition of losses is an expected outcome: Changes in allowance balances reflect changes in credit quality and flow through bank earnings. 5

6 Measurement of Expected Credit Losses A current estimate of all contractual cash flows not expected to be collected should incorporate: Internally and externally available information. Information about past events, current conditions, and reasonable and supportable forecasts. Quantitative and qualitative factors specific to borrowers and the economic environment, including underwriting standards. Unadjusted historical lifetime loss experience for past events and current conditions for reasonable and supportable forecasts Estimate of expected credit losses 6

7 Measurement of Expected Credit Losses (Continued) Choice of methods include: Loss-rate methods, Probability of default methods, Discounted cash flow methods, Roll-rate methods, Provision matrix method using loss factors. Any reasonable approach may be used, provided it reflects that some risk of default, however small, always exists and that zero allowance for loan and lease losses would be rare. Entities should leverage current internal credit risk management approach and systems to measure expected credit loss. 7

8 Unadjusted Historical Lifetime Loss Experience Many small banks currently use a historical loss rate method to estimate allowances and have processes in place to collect and analyze annual charge-off data. Existing data collection processes will require changes under the CECL model. Vintage analysis is just one way of collecting and analyzing historical loss data. Unadjusted historical lifetime loss experience for past events and current conditions for reasonable and supportable forecasts Estimate of expected credit losses 8

For Past Events and Current Conditions Assess how current economic conditions compare to conditions that impacted historical loss experience.

9 For Past Events and Current Conditions Assess how current economic conditions compare to conditions that impacted historical loss experience. Adjust for changes in bank policies and underwriting standards. Unadjusted historical lifetime loss experience for past events and current conditions for reasonable and supportable forecasts Estimate of expected credit losses 9

For Reasonable and Supportable Forecasts Existing accounting standards do not allow consideration of future conditions and include a probable threshold for recognition.

10 For Reasonable and Supportable Forecasts Existing accounting standards do not allow consideration of future conditions and include a probable threshold for recognition. Practical expedients for periods beyond a reasonable and supportable forecast period will be allowed. Unadjusted historical lifetime loss experience for past events and current conditions for reasonable and supportable forecasts Estimate of expected credit losses 10

11 Supervisory Approach Financial institutions are being encouraged to: Become familiar with the proposed changes, Involve all relevant business lines in preparation for the implementation of the CECL model, Discuss the proposed CECL model with industry peers and external auditors, Begin collecting actual loss data required for the implementation of the CECL model. Community banks are not expected to need complex models. 11

12 12 Questions?

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