Update on the ALLL and FASB’s “CECL” Model
GABE NACHAND, PARTNER
Disclaimer
The material appearing in this presentation is for informational purposes only and should not be construed as advice of any kind, including, without limitation, legal, accounting, or investment advice. This information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant‐
client relationship. Although this information may have been prepared by professionals, it should not be used as a substitute for professional services. If legal, accounting, investment, or other professional advice is required, the services of a professional should be sought. Content is not all inclusive.
Agenda
• Highlights of the Redeliberated CECL Model
• Modeling Options/Strategies
• Key Takeaways
CECL – Redeliberated Model
• User support for CECL Model is very high ( 3–1 margin)
• Fatal flaw review recently completed (approx. 25 parties reviewed)
• Approx. 950 comments on the most recent “draft” (“draft” was not released publicly)
• Technical Resource Group Meeting tomorrow, 9/30 (only 3 FASB Board Members will be present –
therefore meeting doesn’t have to be public)
• Expected date of issuance: 4Q2015? 2016?
FASB CECL Model
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Single measurement objective replaces (multiple) existing impairment models in current U.S. GAAP:
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Simplifies the accounting for purchased credit deteriorated (ASC 310‐30/SOP 03‐3) assets
Included in scope:
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Each reporting date, the allowance will measure the assets at the amount an entity expects to collect
All debt instruments (e.g. debt securities and loans) except AFS debt securities and FV‐NI securities
Receivables that result from revenue transactions
Reinsurance receivables
Lease receivables recognized by a lessor
Loan commitments
Financial guarantees
Excluded from scope:
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Equity instruments
Equity method investments
Derivatives
Related party loans
Receivables between entities under common control
CECL “Model” Options
Measuring Current Expected Credit Losses
• Estimate of expected credit losses represents contractual amounts that an entity does not expect to collect over the contractual life of the asset
• When determining the contractual life of the asset:
• Consider expected prepayments
• Do not consider extensions, renewals, and modifications unless entity “reasonably expects” to execute a TDR
• Allowed to pool assets when similar risk characteristics exist; otherwise assess individually
• Management’s expectations should consider all relevant internal and external information including:
• Past events
• Current conditions
• Reasonable and supportable forecasts (how far in the future?)
• Revert to unadjusted historical loss average experience for future periods beyond which the entity is able to make reasonable and supportable forecasts
Measuring Current Expected Credit Losses
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The estimate of expected credit losses must not be a best case scenario (or worst case) and must always reflect the risk of loss, even when that risk is remote
Not required to recognize a loss on a financial asset in which the risk of default is greater than zero yet the amount of loss would be zero
• Don’t expect FASB to define this, but a possibility would be: even though probability of default/nonpayment can’t be zero (i.e., PD > 0), the amount of the loss can be estimated as $0 (LGD can be = 0 due to, for example, substantial collateral)
• Treasuries and GSE’s likely to qualify; expected to be in limited circumstances otherwise •
Practical expedients in measuring credit losses provided for:
• Collateral‐dependent financial assets
• Financial assets for which the borrower must continually adjust the amount of securing collateral
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Variety of methods to develop an estimate of current expected credit losses are permitted (e.g., regression, DCF, PD/LGD, loss rates/provision matrix, etc.) Recognizing Current Expected Credit Losses
• No minimum threshold for recognition of impairment losses
• At each reporting date, expected credit losses would be recognized as an allowance
• Similar to current GAAP for loans
• Changes existing practice for HTM debt securities (no longer a direct write‐down – i.e. current OTTI accounting changed)
• The amount required to adjust the allowance from prior period to current period calculation is the provision for credit losses, recognized in earnings • Expect guidance in final standard on “charge‐offs” definition and no specific guidance (or no change to current guidance) on “non‐accrual”
Modified Financial Instruments – TDRs
• For TDRs:
• Currently confusion on the calculation, but essentially you will compare pre and post modification cash flows, and calculate a difference
• The difference/change in contractual cash flows is written off (or potentially recovered) at time of modification (the “basis adjustment”); amortize basis adjustment (except if a principal concession was granted) • Future expected credit losses are calculated and recorded under CECL as an allowance
Purchased Credit Deteriorated (PCD) Assets (CECL Gross‐Up)
• Definition:
• Asset that has experienced “more than an insignificant deterioration in credit quality” (different from existing U.S. GAAP definition; expect more guidance)
• Initial recognition
• Expected credit losses are recognized as an allowance through a gross up to the balance sheet (no Day 1 P&L impact)
• Measurement of impairment
• Use CECL for loans and HTM debt securities similar to if they are not PCD
• Use securities model for AFS debt securities
• Subsequent recognition
• Increases/decreases in expected credit losses recognized immediately in earnings as a provision for credit losses (same as “non‐PDC” CECL/securities impairment models)
• Interest income recognition based on Day 1 expected cash flows
Bottom Line on PCD Transitional guidance anticipated • Expected to be a gross up of the nonaccretable difference (convert it to an allowance), and continue interest income recognition based on yield as of the adoption date • Loans that are accounted for as PCI (under 310‐30) will be considered PCD under the new model
• Loans that are not accounted for as PCI will not be considered PCD under the new model
• No changes to PCI population as a result of adoption
• Do existing pools need to be maintained? Believe the transition guidance will say “Yes”, but pool integrity concept will matter much less going forward given that Day 2 accounting for PCD mirrors non‐PCD accounting Purchased assets should be evaluated for credit deterioration • If purchased asset is deemed credit deteriorated – no “day one” P&L from provision as Allowance is established via a balance sheet gross‐up
• If purchased asset is not deemed credit deteriorated – “Day One” P&L impact to establish an Allowance
PCD asset acquired as part of a Business Combination
• ASC 805, Business Combinations, intended to be modified so that PCD assets that are part of the assets acquired in a transaction considered to be a business combination will be subject to the CECL guidance for PCD assets
AFS Debt Securities (Impairment Revised)
• Apply the existing model, revised as follows:
• If faire value < cost, recognize expected credit losses as a loss reserve/allowance (contra‐asset to AFS debt securities)
• No direct write‐off of the security
• As credit losses change over time (increases or decreases), the loss reserve is adjusted through earnings (i.e. credit reversals are permitted)
• Changes in FV due to interest rates recognized in OCI • Do not consider the duration of fair value < cost
• When estimating credit losses, do not consider recoveries or additional declines in fair value after the balance sheet date
• No OTTI in vocabulary, but similar concept with allowance instead of direct write‐down
Credit Losses – Proposed Disclosures
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Methods used to estimate expected credit losses for periods beyond which the entity is able to make reasonable forecasts (methods for reverting to unadjusted historical credit loss experience)
Policies for uncollectible receivables charge‐offs and the placing of financial assets on nonaccrual status and the accounting for nonaccrual financial assets
Allowance rollforward
• Period‐to‐period rollforward of its allowance for expected credit losses, both for financial assets measured at amortized cost and FV‐OCI
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Vintage analysis
• Tabular disaggregation of credit quality indicators, for all classes of financing receivables (excluding revolving lines of credit, such as credit cards) that are disclosed under current GAAP
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By year of origination (i.e. vintage), but limited to no more than five annual reporting periods (aggregate older vintages) For interim reporting, include a YTD originations column
Credit Losses – Proposed Disclosures
• TDRs • New: disclose the write‐offs • Disclosures for collateral‐dependent financial assets
• The type of collateral
• The extent to which collateral secures the financial assets
• The significant changes in the extent to which collateral secures the financial assets, whether because of a general deterioration or some other reason
• Previous impaired loan table with and without allowance is expected to be eliminated • Disclosures about past due status of financial assets:
• Disaggregation by portfolio segment
• Required for HTM debt securities (new) and held for investment loans
Modeling Options/Strategies
• Potential models used in forecasting: •
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Discounted cash flow Provision matrices Risk Migration (pooling – open vs. closed) Static Pool/Vintage PD/LGD
Regression Analysis (18 different models) Combinations of the above…
Remember: many of these models are designed to analyze the past, in order for you to forecast the future expected losses; the models themselves don’t give you the future losses
Needs/Challenges Related to Models
• Your Data • Data fields available, frequency of updating, “connectivity” of the data, and overall history available • Regression requires approximately 30 to 40 data point observations and no gaps in data, no zeros and no $ signs • Have you updated data fields along the way (and lost historical info)? • Do you have multiple data sets in a single data field? • What historical data do you have from your mergers? • PD/LGD doesn’t work without collateral values • Bad data quality requires more correlation/forecasting • Be very careful with using risk ratings in your CECL modeling – may be too subjective/qualitative and diverge from your segmentation that will likely be more useful • External Data
• Accuracy, timeliness, availability (national vs. regional vs. local) Needs/Challenges Related to Models
• Life of Loan/Prepayments • What’s the life of a credit card? 1 month or 10 years? How does your renewal process impact the life? • If you want to use a 7 year life for a 10‐year term loan, do you think you will be able to arbitrarily assign that shorter life? NO! • TDRs • Depends heavily on how you are using your system – have you shortcut the process and lost historical data? • Specific Model Issues
• PD/LGD – FASB doesn’t currently define “default” – use Basel definition? Need Collateral values; not useful for unsecured loans
• Segmentation
• Term loans (fixed vs. variable); balloon, interest only, lines of credit, credit cards
• Further segmentation by credit metrics (DSC/liquidity/past due status); rate tiers; possibly geography? CECL: How Are You Going To Segment Your Portfolio? Aggregate CRE
CRE ‐ total
C & I
Residential
Consumer
Base Case Loan Balance 4,750 1,250 850 150 7,000 Change in Loan Mix; no Change in Loss Rates
Historical
Loss Rate
0.56%
0.85%
0.25%
2.50%
0.61%
1 Year
Losses
26.50 10.63 2.13 3.75 43.00 Loan Balance 4,500 1,400 850 250 7,000 Historical
Loss Rate
0.56%
0.85%
0.25%
2.50%
0.65%
1 Year
Losses
25.20 11.90 2.13 6.25 45.48 CECL: How Are You Going To Segment Your Portfolio? More Detailed CRE
CRE ‐ construction
CRE ‐ owner occupied
CRE ‐ non‐owner occupied
CRE ‐ other
CRE ‐ total
C & I
Residential
Consumer
Base Case Loan Balance 500 2,000 1,500 750 4,750 1,250 850 150 7,000 Change in Loan Mix; no Change in Loss Rates
Historical
Loss Rate
1.15%
0.40%
0.55%
0.60%
0.56%
0.85%
0.25%
2.50%
0.61%
1 Year
Losses
5.75 8.00 8.25 4.50 26.50 10.63 2.13 3.75 43.00 Loan Balance 250 3,000 1,000 250 4,500 1,400 850 250 7,000 Historical
Loss Rate
1.15%
0.40%
0.55%
0.60%
0.49%
0.85%
0.25%
2.50%
0.60%
1 Year
Losses
2.88 12.00 5.50 1.50 21.88 11.90 2.13 6.25 42.15 CECL: How Are You Going To Calculate
Your Allowance?
Selected National Statistics Date
Q1 2001
Q2 2001
Q3 2001
Q4 2001
Q1 2002
Q2 2002
Q3 2002
Q4 2002
Q1 2003
Q2 2003
Q3 2003
Q4 2003
Q1 2004
Q2 2004
Q3 2004
Q4 2004
Q1 2005
Q2 2005
Q3 2005
Q4 2005
Q1 2006
Q2 2006
Q3 2006
Q4 2006
Q1 2007
Q2 2007
Q3 2007
Q4 2007
Q1 2008
Q2 2008
Q3 2008
Q4 2008
Dow Jones House Commercial Price Real estate Total Stock 3‐month 10‐year Real DGP Un‐employment Treasury Treasury Market Index Index Price Index (Level)
(Level)
(Level)
yield
rate
Growth
rate
‐1.1
4.2
4.8
5.3
10645.9
113.2
139.5
2.1
4.4
3.7
5.5
11407.2
115.2
138.6
‐1.3
4.8
3.2
5.3
9563.0
117.5
141.0
1.1
5.5
1.9
5.1
10707.7
119.8
135.6
3.7
5.7
1.7
5.4
10775.7
122.1
137.4
2.2
5.8
1.7
5.4
9384.0
125.4
135.8
4.5
7773.6
128.7
138.7
2.0
5.7
1.6
0.3
59.0
1.3
4.3
8343.2
131.3
142.5
2.1
5.9
1.2
4.2
8051.9
134.1
147.9
137.0
149.2
3.8
6.1
1.0
3.8
9342.4
9649.7
141.1
147.3
6.9
6.1
0.9
4.4
10799.6
146.0
145.7
4.8
5.8
0.9
4.4
2.3
5.7
0.9
4.1
11039.4
151.8
152.9
3.0
5.6
1.1
4.7
11144.6
158.0
160.4
3.7
5.4
1.5
4.4
10893.8
163.4
171.8
3.5
5.4
2.0
4.3
11951.5
169.4
175.8
11637.3
177.6
175.8
4.3
5.3
2.5
4.4
2.1
5.1
2.9
4.2
11856.7
185.0
182.3
5.0
3.4
4.3
12282.9
190.8
187.1
3.4
12497.2
195.5
195.4
2.3
5.0
3.8
4.6
4.9
4.7
4.4
4.7
13121.6
198.7
200.0
1.2
4.6
4.7
5.2
12808.9
197.8
209.0
0.4
4.6
4.9
5.0
13222.5
196.5
218.6
3.2
4.4
4.9
4.7
14215.8
196.5
217.3
0.2
4.5
5.0
4.8
14354.0
194.0
227.1
3.1
4.5
4.7
4.9
15163.1
189.1
236.4
2.7
4.7
4.3
4.8
15317.8
183.6
249.1
4.8
3.4
4.4
14753.6
178.1
251.5
1.4
‐2.7
5.0
2.1
3.9
13284.1
171.2
239.9
4.1
13016.4
163.9
223.9
2.0
5.3
1.6
‐1.9
6.0
1.5
4.1
11826.0
157.3
233.4
‐8.2
6.9
0.3
3.7
9056.7
149.2
222.5
Selected National Statistics Date
Q1 2009
Q2 2009
Q3 2009
Q4 2009
Q1 2010
Q2 2010
Q3 2010
Q4 2010
Q1 2011
Q2 2011
Q3 2011
Q4 2011
Q1 2012
Q2 2012
Q3 2012
Q4 2012
Q1 2013
Q2 2013
Q3 2013
Q4 2013
Q1 2014
Q2 2014
Q3 2014
Q4 2014
Q1 2015
Q2 2015
Q3 2015
Q4 2015
Q1 2016
Q2 2016
Q3 2016
Q4 2016
Dow Jones House Commercial Real 3‐month 10‐year Total Stock Price Real estate DGP Un‐employment Treasury Treasury Market Index Index Price Index Growth
rate
rate
yield
(Level)
(Level)
(Level)
‐5.4
8.3
0.2
3.2
8044.2
143.1
208.9
‐0.5
9.3
0.2
3.7
9342.8
142.9
178.5
1.3
9.6
0.2
3.8
10812.8
144.1
154.0
3.9
9.9
0.1
3.7
11385.1
145.0
155.2
1.7
9.5
0.1
3.9
12032.5
145.5
149.8
3.9
9.6
0.1
3.6
10645.8
144.4
164.5
2.7
9.5
0.2
2.9
11814.0
141.3
166.9
2.5
9.6
0.1
3.0
13131.5
140.0
172.7
‐1.5
9.0
0.1
3.5
13908.5
138.1
179.6
2.9
9.1
0.0
3.3
13843.5
137.3
177.0
0.8
9.0
0.0
2.5
11676.5
137.3
177.0
8.6
0.0
2.1
13019.3
137.1
188.4
4.6
2.3
8.2
0.1
2.1
14627.5
139.3
188.2
1.6
8.2
0.1
1.8
14110.2
142.5
189.4
2.5
8.0
0.1
1.6
14894.7
145.4
196.6
0.1
7.8
0.1
1.7
14834.9
148.9
198.3
2.7
7.7
0.1
1.9
16396.2
153.8
203.2
1.8
7.5
0.1
2.0
16771.3
158.7
212.4
4.5
7.2
0.0
2.7
17718.3
162.6
222.8
3.5
7.0
0.1
2.8
19413.2
166.4
229.2
‐2.1
6.7
0.0
2.8
19711.2
169.7
227.6
4.6
6.2
0.0
2.7
20568.7
170.8
233.0
3.1
6.1
0.0
2.5
20458.8
172.1
236.0
‐3.9
6.9
0.1
0.9
17133.5
169.5
238.9
‐6.1
8.0
0.1
1.0
12498.5
164.0
230.2
213.6
‐3.9
8.8
0.1
1.2
10190.1
157.6
‐3.2
9.5
0.1
1.3
8770.7
150.7
195.1
‐1.5
9.9
0.1
1.5
8606.3
144.3
177.6
1.2
10.0
0.1
1.5
9087.3
138.4
164.4
1.2
10.1
0.1
1.3
9607.2
133.4
157.4
3.0
10.0
0.1
1.8
10480.7
130.4
154.4
3.0
9.9
0.1
1.9
11521.4
128.4
154.6
Key Takeaways
• Data
• Preserve what you have (stop the data purges)
• Develop a more formal data and document management process
• What data can you recover quickly without significant cost?
• What “kind” of data do you have? • What are you missing that you need (cost to acquire)? • How does your data “connect”? (renewals/refi’s – new loans in the system?)
• How are you storing info like FICO scores and collateral values? • Risk ratings – if a “pass” rating never moves and then you have a charge‐off, how good do you think your risk ratings are for migration purposes?
• Improve quality of guarantor data Key Takeaways
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DATA – National Statistics Being Considered in Migration: •
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Real GDP Growth
Nominal GDP Growth
Real Disposable Income Growth
Nominal Disposable Income Growth
Unemployment Rate
CPI Inflation Rate
3‐Month Treasury Rate
5‐Year Treasury Rate
10‐Year Treasury Rate
BBB Corporate Yield Mortgage Rate (30 year)
Prime Rate
Dow Jones Total Stock Market Index House Price Index Commercial Real Estate Price Index
Market Volatility Index Key Takeaways
• Models • Multiple options – different models for different segments? • Correlation of industry/economic data to your losses varies by segment and model?
• Forecast needs to be reasonably consistent with other modeling (ALM, Capital Stress Testing, etc.) • How will you define the “historical loss period”? Key Takeaways
• Prep for additional disclosures – particularly the vintage disclosure (how does your CECL segmentation impact this going forward?) • Updated Policies, Procedures, Controls around all the new data
• Better understanding of credit risk needed at origination/purchase
• Regulatory Position: “CECL is more than a tweak”; “CECL is an integrated approach to credit risk management”; “No early adoption, so don’t build up reserves ahead of time” • FRB outreach webcasts: “Ask the Fed” on CECL schedule for 10/22/2015 Questions? B. Gabe Nachand
Partner
(503) 471‐1277
gabe.nachand@mossadams.com