© 2017 RSM US LLP. All Rights Reserved. © RSM US LLP. All ... · Purchase of Non PCD asset illustration • Same assumptions as preceding slide however the asset is not PCD. The

© RSM US LLP. All Rights Reserved. © 2017 RSM US LLP. All Rights Reserved.

© RSM US LLP. All Rights Reserved.

CECL

Community Bankers of Washington – 27th Annual Convention

09/15/2017


Speaker Today

Assurance Services | RSM US LLP

Steven Marsden

Senior Manager

3


OVERVIEW OF THE CREDIT LOSSES STANDARD


Overview of the Credit Losses Standard

• ASU 2016-13, Measurement of Credit Losses on

Financial Instruments was issued June 16, 2016

− Creates ASC Topic 326

• Subtopic 326-20 applies to financial assets measured at

amortized cost (Current expected credit losses or CECL

Model)

• Subtopic 326-30 applies to AFS debt securities

− Supersedes impairment guidance on ASC 310 on

receivables/loans and ASC 320 on debt securities

(amongst other changes)


Effective dates of the credit losses standard

• SEC filers – fiscal years beginning after 12/15/19 (including interim periods) – 2020 for CYE

• Public Business Entities that are not SEC filers –fiscal years beginning after 12/15/20 – 2021 for CYE

• All others – fiscal periods beginning after 12/15/20 (interim periods beginning after 12/15/21) – 2021 for CYE

• Early adoption is permitted for fiscal years beginning after 12/15/18 – 2019 for CYE

• Adopt through a cumulative effect adjustment to retained earnings− Special rules for OTTI, PCD assets and beneficial

interests


APPLICABILITY AND MAJOR PROVISIONS OF CECLSubtopic 326-20, Financial assets measured at

amortized cost


Applicability of CECL

• The following are in-scope:− Financial assets measured at amortized cost (AC)

including:• Financing receivables (loans)

• Held to maturity debt securities

• Receivables from revenue transactions with customers and other income

• Reinsurance receivables

• Receivables related to repo and securities lending agreements

− Net investment in leases

− Off-balance-sheet credit exposures• Loan commitments

• Standby letters of credit

• Financial guarantees/similar instruments


Applicability of CECL, cont.

• The following are out of scope:

− Financial assets measured at fair value (FV)

• Available for sale securities and loans held for sale

• Other

− Loans made to participants by defined contribution

employee benefit plans

− Policy loans receivable of an insurance entity

− Promises to give (pledges receivable) of a not-for-

profit entity

− Loans and receivables between entities under

common control


Audience Participation

CECL is pretty much the same as fair value.

A. True

B. False


Major provisions of CECL

• Recognize expected (rather than incurred) credit losses− Through allowance for recognized financial assets

(including HTM debt securities)

− Through liability for off balance sheet exposures

− Results in day 1 life of asset expected loss recognition• Exception: PCD assets (Assets that as of the date of

acquisition have experienced a more-than-insignificant deterioration in credit quality since origination –“Purchased with credit deterioration”)

− Changes in the allowance (plus and minus) are recorded immediately through credit loss expense


Major provisions of CECL, cont.

• Estimate credit losses over the contractual

term

− Consider prepayments

− Do not extend for expected extensions, renewals or

modifications

• Unless there is a reasonable expectation of a troubled

debt restructuring (TDR) with the borrower


Major provisions of CECL – Collateral based expedients

• Collateral dependent practical expedient (PE)

available when:

− Borrower is experiencing financial difficulty

− Repayment is expected substantially through the

operation or sale of the collateral

• Base estimate of credit loss on amortized cost

less fair value of collateral

− Adjust for selling costs if expect repayment through

sale of collateral

• Must be used if foreclosure is probable


Major provisions of CECL – Collateral based expedients

• Collateral maintenance provisions PE− Borrower required to continually adjust the amount

of collateral as a result of fair value changes in the collateral

− Limit allowance to excess of amortized cost of asset over fair value of collateral

• Through PEs only, could conclude expected loss is zero solely on the basis of the current collateral value. Absent PE, would need to consider potential future changes in collateral value and historical loss info for assets with similar collateral


What is not CECL?

• CECL is not annual loss rate x remaining life

− Current calculation shows 0.8% annual loss rate in

portfolio

− Expected life is 3 more years

− 0.8% x 3 years = 2.4%


Major provisions of CECL – How to estimate losses

• Measure expected losses on a pool basis

whenever similar risk characteristics exist

• No one method required. Some examples:

− Discounted cash flows

− Loss rate methods

− Roll-rate methods

− Probability of default methods

− Based on an aging analysis


Major provisions of CECL – How to estimate losses, cont.

• Consider relevant available information (internal and/or external) when estimating expected losses

• Don’t rely solely on past events – Adjust historical loss information for− Differences in current asset specific risk

characteristics

− Circumstances when historical info is not reflective of contractual term

− Current conditions

− Reasonable and supportable forecasts


Major provisions of CECL – How to estimate losses, cont.

• When estimating losses for periods beyond reasonable and supportable forecast, revert to historical loss information− Input level or based on the entire estimate

− Immediately, straight line basis or another rational and systematic basis

• Include measure of expected risk of loss even if remote− May reach conclusion expected credit loss is zero if

justified based on historical loss info adjusted for current conditions and reasonable and supportable forecasts


ACQUISITIONS


Example - Purchase of PCD asset (ASC 326-20-55-64)

• Assume a PCD asset with a par amount of $1 million is

purchased for $750,000. At the time of purchase, the

allowance for credit losses on the unpaid principal

balance is estimated to be $175,000. The acquisition-

date journal entry is as follows.

Loan—par amount $1,000,000

Loan—noncredit discount $75,000

Allowance for credit

losses

175,000

Cash 750,000

Loan A/C is $925,000

Expense is zero


Purchase of Non PCD asset illustration

• Same assumptions as preceding slide however the asset

is not PCD. The acquisition-date journal entry is as

follows. (Alternatively, the entity could wait until the

reporting period end to compute/record the allowance)

Loan—par amount $1,000,000

Credit loss expense 175,000

Loan - discount 250,000

Allowance for credit

losses

175,000

Cash 750,000

Loan A/C is $750,000

Expense is $175,000


DISCLOSURESSubtopic 326-20, Financial assets measured at

amortized cost


Major provisions of CECL- Disclosures

• Allowance disclosures and rollforward as well

as disclosures of past due and non-accrual

assets will continue to be required and now

also apply to HTM securities

• Collateral dependent financial assets

− Describe the type of collateral

− Qualitative description of the extent of collateral

− Significant changes in collateral coverage


Major provisions of CECL- Disclosures, cont.

• Disclosures by credit quality indicator will be required for HTM securities as well as most other assets within the scope− Further disaggregation by year of origination required for

net investment in leases and financing receivables (with certain exceptions)

− Detail for most recent five years

• Non-PBEs can omit

• Transition ramp up for non-SEC filers that are PBEs

− Acquisitions go back to origination (not purchase)

− Use existing guidance to determine if a modification / renewal constitutes a new origination (ASC 310-20-35-9 through 35-12)


Example – credit quality disclosures by origination year (ASC 326-20-55-79)

As of December 31, 20X5 Term Loans Amortized Cost Basis by Origination Year

20X5 20X4 20X3 20X2 20X1 Prior Revolving Loans Amortized Cost Basis

Total

Residential Mortgage:

Risk Rating

1-2 Internal grade $ XX $ XX $ XX $ XX $ XX $ XX $ XX $ XX

3-4 Internal grade XX XX XX XX XX XX XX XX

5 Internal grade XX XX XX XX XX XX XX XX



Total residential mortgage loans

$ XX $ XX $ XX $ XX $ XX $ XX $ XX $ XX

Residential Mortgage loans:

Current-period gross writeoffs

$ XX $ XX $ XX $ XX $ XX $ XX $ XX $ XX

Current-period recoveries XX XX XX XX XX XX XX XX

Current-period net writeoffs $ XX $ XX $ XX $ XX $ XX $ XX $ XX $ XX

Similar disclosures would be required for the other

loan classes


AFS DEBT SECURITIESSubtopic 326-30, Available-for-sale debt securities


Major provisions for AFS debt securities

• Assess impairment at individual security level

• Recognize impairment related to credit losses through an allowance− Debit expense except initial allowance on PCD AFS securities

(add to purchase price)

• Credit loss = Amortized cost – PV of cash flows expected to be collected (discounted at effective rate) − Estimated based on past events, current conditions and

reasonable and supportable forecasts

• Changes in the allowance (plus and minus) are recorded immediately through credit loss expense

• Allowance is limited to excess of amortized cost over fair value. Can’t be reversed below zero


Major provisions for AFS debt securities

• Can’t use length of time to avoid loss recognition

• Not required to consider volatility and post-balance sheet changes in fair value

• If intent or more likely than not requirement to sell exists, write off allowance and write security down to fair value through expense− Expected cash flows in excess of amortized cost

should be accreted in to interest income

• Current disclosures substantially retained plus allowance rollforward


PLANNING FOR IMPLEMENTATION


Planning for implementation

Understand impact

Collect dataAnalyze

data

Review gap assessment and develop

roadmap


Planning for implementation, cont.

• Analyze standard/understand where you are

versus where you need to be

• Develop multidiscipline implementation team

− Finance

− Credit/Credit Admin

− Lending

− Risk Management

− Operations

− IT

− Internal Audit



• Data considerations/collect data− For each loan segment, how far back is data available

− Ability to further brake down by:

• LTV

• Risk rating

• Region

− Average until legacy loans refinance (prepayment assumptions)

− Loss data

• Correlation of historical losses to various economic environments, underwriting conditions, etc

− Quality of loans by loan officer

• Analyze data and review gaps



• Weigh benefits of modifications to existing

approaches/systems/applications versus

investing in new

− Several vendors providing outsourcing options,

however…

− Regulators have communicated institutions could use

existing approaches/systems/applications to develop

calculation in house



• Develop detailed implementation plan/timeline

• Monitor progress

• Decide how to obtain or develop reasonable

and supportable forecasts and how to adjust

historical information as a result of forecasts

• Discuss plans with regulators and auditors



• Develop new processes and internal controls, particularly as they relate to previously unaudited information

• Monitor regulatory and other developments in how the ASU is interpreted and applied

• Manage investor expectations and prepare to disclose the impact of adoption

• Consider if any changes to credit extension or investment philosophy are warranted

• Consider impact on forecasting, budgeting and capital planning


Implementation roadmap

36

Model selection

Data organization and mapping

Document processes and procedures

Parallel testing

On-going monitoring and validation


MODEL EXAMPLES


Challenges with examples

• Every portfolio and circumstance is unique and will require assumptions− May be fine for Portfolio A, but not for Portfolio B

− May be fine for Client A, but not for Client B

• Consider variability in current methodologies

• Very difficult to publish a complete example that would be helpful− May be more complex than necessary

− May set unnecessary expectations

• Requires implementation custom to each portfolio


Example – Estimating losses by vintage year (ASC 326-20-55-30)

Year of

Originati

on

Loss Experience in Years Following Origination

Year 1 Year 2 Year 3 Year 4 Total Expected

20X1 $ 50 $ 120 $ 140 $ 30 $ 340 -

20X2 $ 40 $ 120 $ 140 $ 40 $ 340 -

20X3 $ 40 $ 110 $ 150 $ 30 $ 330 -

20X4 $ 60 $ 110 $ 150 $ 40 $ 360 -

20X5 $ 50 $ 130 $ 170 $ 50 $ 400 -

20X6 $ 70 $ 150 $ 180 $ 60 $ 460 $ 60

20X7 $ 80 $ 140 $ 190 $ 70 $ 480 $ 260

20X8 $ 70 $ 150 $ 200 $ 80 $ 500 $ 430

20X9 $ 70 $ 160 $ 200 $ 80 $ 510 $ 510


Example – Probability of Default/Loss Given Default

General Ledger

Balance PD

Q factors

adjustmentTotal PD

Loss Given

Default

Q factors

adjustmentTotal LGD

Blended

loss rateReserve

Commercial Real Estate

Owner Occupied RE - Pass 327,000,000 3.00% -0.20% 2.80% 28.00% -0.30% 27.70% 0.78% 2,536,212

Watch 800,000 4.40% -0.20% 4.20% 45.00% -0.30% 44.70% 1.88% 15,019

Marginal - 9.00% -0.20% 8.80% 57.00% -0.30% 56.70% 4.99% -

Substandard - 19.00% -0.20% 18.80% 69.00% -0.30% 68.70% 12.92% -

Non Owner Occupied RE 113,200,000 6.20% -0.20% 6.00% 37.00% -0.30% 36.70% 2.20% 2,492,664

Watch 2,700,000 8.00% -0.20% 7.80% 49.00% -0.30% 48.70% 3.80% 102,562

Marginal 1,100,000 11.00% -0.20% 10.80% 68.00% -0.30% 67.70% 7.31% 80,428

Substandard 300,000 21.00% -0.20% 20.80% 70.00% -0.30% 69.70% 14.50% 43,493

Commercial & Industrial Loans - Pass 117,000,000 8.00% 0.10% 8.10% 57.00% 0.18% 57.18% 4.63% 5,418,949

Watch - 12.00% 0.10% 12.10% 71.00% 0.18% 71.18% 8.61% -

Marginal - 19.00% 0.10% 19.10% 76.00% 0.18% 76.18% 14.55% -

Substandard 180,000 27.00% 0.10% 27.10% 82.00% 0.18% 82.18% 22.27% 40,087

Total 562,280,000 10,729,414

© 2017 RSM US LLP. All Rights Reserved. © 2017 RSM US LLP. All Rights Reserved.

41


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© 2017 RSM US LLP. All Rights Reserved. © RSM US LLP. All ... · Purchase of Non PCD asset illustration • Same assumptions as preceding slide however the asset is not PCD. The