CECL: Where Do We Go From Here? June 26, 2017 11:45 to 12:45 Presented by: Speaker Name Debbie Scanlon, Partner Gordon Dobner, Partner BKD, LLP 2800 Post Oak Boulevard Suite: 3200 Houston, TX 77056 P: 713-499-4600 E: dscanlon@bkd.com gdobner@bkd.com
Key Takeaways Understand the CECL standard Grasp current regulatory expectations Strengthen understanding of the CECL implementation process Understand how loss rate methods may change under CECL Now is the time to start
Overview of the CECL Standard
New Impairment Guidance Incurred/Probable Expected/Lifetime
Comparison to Existing Guidance Current Guidance Topic ASC 450-20 (FAS 5) Scope Contingencies- Loss Contingencies ASU 2016-13 Topic ASC 326-20 Scope Financial Instruments-Credit Losses- Amortized Cost (CECL) ASC 310-30 Receivables- Loans & Debt Securities - Acquired with Deteriorated Credit Quality ASC 326-30 Financial Instruments- Credit Losses- AFS Debt Securities ASC 310-10 Receivables- Overall ASC 320-10 Investments- Debt Securities
CECL Scope Included Financing receivables Held to maturity debt (no more OTTI) Loan commitments, guarantees, standby L/C Lease receivables Reinsurance receivables Receivables on repurchase & securities lending agreements Excluded Financial assets at fair value Available for sale debt (updated model) Participant loans defined contribution benefit plans Insurance policy loans NFP pledges receivable
CECL Calculation By Loan Pool Historical Lifetime Credit Loss Current conditions adjustment Forecast adjustment Current expected credit loss
Purchased Assets with Credit Deterioration Modifies the definition of what were previously known as purchased credit-impaired (PCI) Acquired financial asset or acquired groups of financial assets with similar risk characteristics that have experienced a more-than-insignificant deterioration in credit quality since origination, based on the buyer s assessment.
Purchased Assets with Credit Deterioration Same approach as originated assets Initial allowance for credit losses will be added to the purchase price rather than being recorded as a credit loss expense in the income statement Subsequent changes in the allowance for credit losses for PCD assets will be recorded as a credit loss expense in the income statement
Regulatory Expectations
Formal Regulatory Guidance Joint Statement on the New Accounting Standard on Financial Instruments - Credit Losses (June 2016) Frequently Asked Questions on CECL (December 2016)
Key Takeaways New standard will be scalable to all institutions Smaller and less complex institutions will be able to adjust their existing allowance methods to meet the requirements of the new standard without the use of costly and/or complex modeling techniques. Inputs to allowance estimation methods currently used will need to change to properly implement CECL requirements Institutions can continue to leverage credit risk management practices in their qualitative and quantitative factors. Institutions may apply different estimation models to different groups of financial assets or loan pools. Won t require institutions to engage third-party vendors to assist in implementing and calculating allowances within CECL Institutions may need to capture additional data and retain data longer to meet CECL data requirements
CECL Readiness and Implementation
CECL Readiness and Implementation Process Planning and Readiness Implementation Create committee and timeline Pool segmentation and credit risk identification Data inventory and gap analysis Model(s) selection and development Model(s) finalization and parallel run Modify policies, procedures, controls and disclosures
Overall Implementation Considerations Document conclusions and process followed in selecting models and complying with the standard There will be setbacks and roadblocks. Accept that fact and be adaptable The overall implementation process will be scalable based on size and complexity of institutions Make sure you have an executive sponsor and appropriate expertise involved
Implementation/Steering Committee Highly recommend using an implementation committee including senior management from the following: Accounting/Finance Credit Risk Operations IT Audit
Implementation/ Steering Committee Responsibilities should include: Develop an understanding of the standard and regulatory guidance Communicate with executive management and those charged with governance Monitor regulatory guidance and industry trends Designation of project(s) manager to track status Determine if outside vendors are needed and follow third party risk management guidance Consider potential impact on capital and capital planning Outreach with external auditor and regulators Consideration of impact of future events such: Acquisitions New product lines (lack of loss history) System conversions
Implementation timeline example Non-SEC PBE Create timeline and committee Data assessment and pool and risk analysis complete Model development and update of policies and controls complete Implementation 2016 2017 2018 2019 2020 2021 2022 Phase I Finalization of planning process and model selection complete Model finalization and parallel run including testing controls Phase II Test run of required annual disclosures Phase III Finalize annual disclosures
Implementation timeline considerations Public Business Entity (PBE) determination Consideration of events that may impact timing Early adoption?
Pool Segmentation and Credit Risk Identification Before selecting models its important to document the appropriateness of loan pools based on common risk characteristics as this may drive different CECL model options: Consider if current pooling can be leveraged Document the shared credit risk drivers of your loan pools Consider level of granularity (more or less) How homogenous are your loan pools (term, collateral, prepayment risk, etc.) Use this time to perform the following: Inventory all current policies, procedures, processes and controls over the incurred loss rate model Determine lives of pools (contractual adjusted for prepayment) Create a preliminary list of models you will consider for each pool based on risk drivers
Data Inventory Create an inventory of where all historic loan information is maintained: Look for detailed loan trial balances, loan level charge-off and recovery activity, loan origination activity Need basic loan level data (loan number, origination balance, maturity, current balance, interest rate, payment terms) Need segment pooling characteristic (i.e. call code) Also risk indicators such as risk rating, LTV, FICO, DSCR, industry, property type Consider the following sources for historic data: Loan applications (core systems) ALLL spreadsheets/software ALM software Network drives Other
Gap Analysis Based on models you are considering what data gaps do you have? Data needs are highly dependent on model selection Chicken or the egg question? Choose a method and then find the data you need or; Find the data you have and then choose a method? Necessary data points and are they available for an adequate historical time frame to get meaningful results Sources for future economic forecast information National vs regional Federal Reserve DFAST and CCAR Don t forget HTM securities and off-balance sheet commitments
Gap Analysis Completeness and accuracy of the data: Are data sets complete and can you prove it? Is information from disparate systems in the same format? Is information input timely and accurately (risk ratings, LTV, FICO, etc)? Accuracy of data input at origination and ongoing updates (updated risk ratings, renewed loans, LTV, etc) Consider results of internal audits and loans review on data input accuracy What controls will need to be put in place to ensure this data is verified on a regular basis going forward to help ensure the completeness and accuracy of your data
What to Do About Data Gaps? Begin warehousing data on a monthly or quarterly basis in a usable format: Detailed loan trial balance Loan level charge-off and recovery detail Loan level origination activity Other information as necessary for models Modify or increase the attributes input at the loan level Modify controls over data input for accuracy Consider the need for external data
Model Selection Specific model approach is not mandated, however start by considering what is used currently Institutions can leverage existing credit risk management systems & allowance methods, including: Loss rate methods Roll rate method Probability of default Discounted cash flow
Model Selection Considerations Likely different models are selected for different pools Certain models work better for certain portfolios Consumer vs commercial Amortizing vs non-amortizing Amount of loss experience Population sizes No model is perfect and this is an estimate and inherently imprecise Understand the pros and cons of the models you are considering Data limitations may not allow certain models to used at implementation, but institutions can work toward those models in the future Check in with regulators and auditors for feedback
Model Selection Considerations Will need to also consider how the following will be addressed: What loans will be analyzed individually TDR s Collateral-dependent loans Other loans not sharing similar risk characteristics Adjusting for changes in current conditions and reasonable and supportable future forecasts Will vary based on size and complexity of institution Likely to build from current Q factor process Should be aligned with your strategic plan How will reversion be handled after reasonable and supportable forecast period? LC17 #-#
Transitioning Loss Rate Models to CECL Examples Open pool loss rate models Closed (static) pool loss rate models Open pool at segment level Vintage model (subsegment by origination)
Open Pool Loss Rate Models Freezes all the loans in a segment pool at a particular point in time, then tracks the loss history on those loans over the remaining lives.
Open Pool Excel Example
Pros Less complex model Data collection less complex (no origination data) Similar pooling methodology to current practice Q factor adjustment process will be similar to current practice Cons Assumes historical pool has same credit risk and terms as current pool Q factor & forecast adjustments are harder to support
Closed Pool (Static) Loss Rate Models Closed pool models consider the life cycle of the loan pools. Vintage is the most commonly discussed, which is typically based on year of origination. However static pool analysis can be based on any type of shared pooling criterion and assets originated in a similar time period (i.e. loans originated from 2008 to 2013 based on FICO bands)
Vintage Analysis Example
Pros Can help isolate changes in economic conditions, collateral value and underwriting Improved ability to forecast as more historical data is collected Eliminates changes in portfolio growth Methodology can be leveraged in other models or assumptions (prepayment, PD/LGD) Cons More extensive data requirements May require tracking of more loss pools If loan pools are not homogenous may become onerous
Model Development Once models are selected, model development and buildout occurs Determine if this will be done in-house or through an outside vendor This process should also include modification and development of internal controls over financial reporting (ICFR)
Model Finalization and Parallel Run Perform a parallel run (parallel to the existing incurred loss model) prior to implementation to monitor results and refine the model and forecasts as necessary This includes not only the model but disclosures and governance as well Perform tests of controls related to the ICFR around the CECL models and related reporting before implementation
BKD at a glance Clients Private & publicly-traded companies, government entities, not-for-profit organizations & individuals Total Personnel Approximately 2,400 Partners & Principals Approximately 260 Founded 1923 Locations 34 offices serving clients in all 50 states & internationally International Delivered through Praxity, AISBL*, a global alliance of independent firms in approximately 100 countries *Praxity, AISBL, is a global alliance of independent firms. Organised as an international not-for-profit entity under Belgium law, Praxity has its executive office in Epsom. Praxity Global Alliance Limited is a not-for-profit company registered in England and Wales, limited by guarantee, and has its registered office in England. As an Alliance, Praxity does not practice the profession of public accountancy or provide audit, tax, consulting or other professional services of any type to third parties. The Alliance does not constitute a joint venture, partnership or network between participating firms. Because the Alliance firms are independent, Praxity does not guarantee the services or the quality of services provided by participating firms. 37
BKD Office Locations Erie, PA Chicago, IL Pittsburgh, PA Joplin, MO Kansas City, MO Springfield, MO Des Moines, IA Decatur, IL Omaha, NE St. Louis, MO Cincinnati, OH Lincoln, NE Wichita, KS Fort Wayne, IN Indianapolis, IN Denver, CO Colorado Springs, CO Bloomington, IN Evansville, IN Tulsa, OK Enid, OK Oklahoma City, OK Branson, MO Louisville, KY Bowling Green, KY Rogers, AR Nashville, TN Dallas, TX Waco, TX Little Rock, AR San Antonio, TX Houston, TX Fort Smith, AR Jackson, MS 38
BKD national financial services Group Clients Approximately 1,200 financial clients Total Personnel Approximately 420 professionals in BKD National Financial Services Group One of the top 5 largest public banking audit practices nationwide Broad technical expertise to help you meet your strategic goals Best practice recommendations gained from working with hundreds of similar clients to help you maintain your competitive edge 39
Questions?