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Results from the latest survey on preparations for CECL, or the current expected credit loss standard, show that financial institutions across the board are making progress as the Q1 2020 compliance date nears for SEC-filers.

Abrigo, the technology provider behind Sageworks ALLL and MST’s Loan Loss Analyzer, recently released results from its third annual CECL Survey, which found that nearly half of survey participants (and a majority of SEC filers) have already collected and validated data. This is important, because collecting and validating data for the loan loss calculation is typically one of the more significant bottlenecks and challenges in CECL implementation.

In addition, more than a third (and at least half of SEC filers) are testing potential CECL-compliant methodologies for calculating their allowance for credit losses. Identifying which methodology or methodologies to use is another important step in the CECL implementation process.

However, other financial institutions are not moving fast enough to implement an accounting change that could affect not only earnings but also capital available for dividends, lending, and other growth initiatives, according to CECL experts who reviewed the Abrigo CECL survey results.

“The clock is ticking,” said Regan Camp, Senior Director of Advisory Services at Abrigo, (formerly MST, Sageworks, and Banker’s Toolbox). “While many financial institutions are taking the necessary steps to make sure they are prepared for this important change in accounting for credit losses, it’s clear that others are falling behind their peers.”

 

cecl survey results

 

One area of concern is how infrequently lenders from SEC-filing institutions reported that they are now producing parallel calculations – i.e., calculating the allowance for credit losses both under current GAAP and under the CECL standard.

“The glaring concern in these SEC-filers’ responses is the seemingly limited number of institutions that have actually produced meaningful results and are already running parallel in preparation for a 2020 adoption,” Camp said.

Institutions have been broadly encouraged to plan for at least four quarters of parallel execution in order to offer enough time to observe a series of results and appropriately calibrate their models. However, only 14 percent of SEC registrants surveyed are running parallel allowances. Even more concerning: 3 percent of SEC filers acknowledged having yet to begin CECL preparations at all.

“Allowing enough time to do a walk-through of your models will point to areas that may need to be adjusted and give the institution the opportunity to make those adjustments prior to their CECL compliance date,” said Abrigo Senior Advisor Paula King, a former bank CFO and co-founder. Financial institutions may need to adjust their loan segments and methodologies for determining CECL estimates based on the testing results. In addition, the walk-through provides time to prepare for loan loss reserve levels and to create supporting documentation, she noted.

Overall, 6 percent of survey respondents reported their financial institutions are already running parallel allowances, and the same percentage reported their institutions have yet to begin CECL preparations.
While SEC registrants face a 2020 deadline to begin reporting the allowance for credit losses under the CECL accounting standard, all other financial institutions have until 2021 or later.

To learn more, download the 2019 Survey, “CECL: Where Are We Now?

Financial institutions across the U.S. are grappling with the many changes required to implement the current expected credit loss, or CECL, model. The extensive time, resources, and staff involved in a successful transition from the incurred loss model can make even the process of getting started feel daunting. Data, methodology, and pooling decisions may seem overwhelming if institutions are not properly prepared.

However, having an effective plan in place can make it easier to implement a compliant CECL model in an efficient manner. Financial institutions can build out their models faster by learning the key decisions peer institutions have made ahead of the transition to help create that framework.

In a recent webinar, representatives from Great Southern Bank and the bank’s Advisory team at Abrigo shared their experiences with CECL so far, the decisions they have made, and their expectations for the future. Great Southern operates out of Springfield, Mo., and has total assets of approximately $4 billion. Great Southern is an SEC filer and has a Q1 2020 compliance deadline.

The Great Southern CECL team works closely in regulatory, SEC, and board reporting. At their institution, they have strong support for the process by their CEO and board group. Their CECL team has involved other departments in the bank in training and responsibility to ensure compliance. Other key players include the bank’s Chief Credit Officer, Chief Production Officer, IT, internal audit, compliance, and loan operation teams.

“We currently have a quantitative component or reserve amount based on the cohort method, and we are testing the methodology,” Debbie Flowers, VP and Director of Credit Risk Administration at Great Southern said on the webinar regarding the current status of their CECL transition process. “ for inclusion in our SEC reporting.”

Choosing a methodology

Great Southern first consulted with Abrigo in mid-2018 to assist with their CECL planning. To begin their transition process, they started evaluating the methodology options available to them under the new accounting standard. After analyzing their unique data situation, Great Southern decided on a cohort approach.

The Cohort methodology, also referred to as “snapshot” or “open-pool analysis,” relies on the creation of cohorts to capture loans that qualify for a particular segment at a specific point in time. Cohort methodologies then track those loans over their remaining lives to determine their loss experience.

“Cohort seemed most like our current incurred model and the premise of tracking historical loss rates made sense to us,” said Tammy Bauricther, VP/Controller at Great Southern Bank. “Our loan portfolio is a traditional one and we believe that the perfect knowledge derived from this model is a good representation of how our loan portfolio will continue to behave in terms of losses.”

Learn more about navigating the CECL transition.

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Analyzing their unique data situation

“You really can’t stress the importance of data enough when building out a CECL model. Methodologies and pooling alike, they need to be approached based on what data fields are available and the time frame that they are available,” said Zach Langley, Advisory Analyst at Abrigo.

When conducting CECL engagements with Great Southern, Langley focused on depth, breadth, and integrity of data during their gap analysis. Breadth is the amount and type of data fields that financial institutions should capture. “Breadth means looking at how wide a data set can be,” said Langley. “Some questions to answer are what are we bringing in and what are we capturing? Moreover, of those things, what are the critical data elements that we are also capturing to run CECL-compliant methodologies? For example, data to run a discounted cash flow looks very different than data that is needed to run a cohort or open pool model.”

Depth is reflective of how far back the data goes. When meeting with Great Southern, Langley considered options for the life of loan of each segment and took note on whether that analysis should come from the segment’s contractual life, or from a weighted average remaining maturity, etc. Ways to calculate the “life of the loan” can vary among institutions – it is dependent on what the institution is comfortable defending.

To analyze the integrity of data, a financial institution can look back to see if they have consistent and correct coding historically, as well as consistent and correct application. For example, if a loan has a collateral code of one and that means unsecured, is that loan unsecured in practice? Is the financial institution applying their coding consistently?

Segmenting into appropriate risk characteristics

During the webinar, the consultants highlighted that the first step for creating an effective segmentation strategy should be to find similar risk characteristics of appropriate pools. These segments should be meaningful and not too granular to produce relevant results. Pools should calibrate to whatever methodology that a financial institution chooses. It is important to understand what is being analyzed so that the segments can reflect that.

Great Southern has lending activity spread throughout multiple locations across the U.S. Because of this, geographical considerations were important when defining their segments. “It is important for us to be able to pinpoint areas of greater risk by market areas as that information becomes available,” said Flowers.

Segmentation can be challenging for institutions approaching the CECL transition. Indeed, Great Southern found this to be an obstacle as they were building out their model.

“One of the challenges we faced was limiting the number of pools while still trying to segment our risk,” said Delynne Geary, Senior Credit Risk Analyst at Great Southern Bank.  “We ended up with 26 pools. Initially, we started with call report categories and expanded to areas of credit and market risk.”

For more information about the beginning phase of Great Southern Bank’s CECL implementation process, please watch the on-demand webinar, “How a Financial Institution is Getting CECL Ready: Key Decisions and Steps in the CECL Transition.”

 

This is a second in a series of blog posts about the proposed ASU for codification improvements to ASU 2106-13, better known as the CECL standard. Click here to see the initial post in the series and to read some background on the proposed ASU.

Issue 1C: Recoveries

The issue of the treatment of recoveries of previously charged off amounts has been an ongoing topic of discussion. It was discussed at the June 11 TRG meeting, discussed again at a subsequent August FASB board meeting, then discussed again in the November 1 TRG meeting.

Two main issues were brought up and deliberated around this:

Inclusion of Recoveries in the ACL Estimate

Some preparers did not feel that the standard was clear on if recoveries should be included in the estimate of expected credit losses. Many financial institutions use net charge-off rates today, that is, loss rates that include both the charge-offs as well as any subsequent recoveries, which theoretically produces an allowance that is net of those amounts today. There were also some questions about which types of recoveries should be included in the estimate, and if recoveries were required to be considered, or if that was optional. Some of these questions were based on the difficulty in obtaining data related to recoveries.

Negative Allowances

Related to the question above, if recoveries are included in the estimate of credit losses, then this could result in allowance amounts at either the loan or segment level that could at times be negative. Examples were given of banks who had very high levels of losses during the financial crisis where the subsequent recoveries of these amounts resulted in net recoveries in the years following the crisis. Preparers felt that clarification was necessary considering this definition in the ASU:

326.20.30.1 The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net amount expected to be collected on the financial asset. At the reporting date, an entity shall record an allowance for credit losses on financial assets within the scope of this Subtopic. An entity shall report in net income (as a credit loss expense) the amount necessary to adjust the allowance for credit losses for management’s current estimate of expected credit losses on financial asset(s).

In the definition, the allowance is defined as a valuation account that is deducted from the amortized cost basis of the asset. It wasn’t clear if that could include negative amounts that would be essentially added to the amortized cost basis rather than deducted.

Response in the Proposed ASU

Much of the clarification in the proposed ASU is around the second issue of Negative Allowances. The FASB appears to have mostly believed that there was not much clarification necessary on the inclusion of recoveries in the estimate, as the existing guidance was clear, particularly this paragraph:

326-20-30-7 When developing an estimate of expected credit losses on financial asset(s), an entity shall consider available information relevant to assessing the collectability of cash flows. This information may include internal information, external information, or a combination of both relating to past events, current conditions, and reasonable and supportable forecasts. An entity shall consider relevant qualitative and quantitative factors that relate to the environment in which the entity operates and are specific to the borrower(s). When financial assets are evaluated on a collective or individual basis, an entity is not required to search all possible information that is not reasonably available without undue cost and effort. Furthermore, an entity is not required to develop a hypothetical pool of financial assets. An entity may find that using its internal information is sufficient in determining collectability.

In this paragraph, institutions are asked to “consider all available information relevant to assessing the collectability of cash flows”, which would include information on expected recoveries. It also addresses that institutions are “not required to search all possible information that is not reasonably available without undue cost and effort”, which should address the questions for recovery data that is difficult to acquire. For negative allowances, the proposed ASU states that they are acceptable in this new addition to paragraph 326-20-30-7:

Recoverable amounts included in the valuation account shall not exceed the aggregate of amounts previously written off and expected to be written off by the entity.

There is also similar language added to the collateral dependent practical expedient, that those individual loans may also carry negative allowances as long as they do not exceed amounts previously written off.

Abrigo’s Take

For the most part, the clarifications addressed in this portion of the proposed ASU related to recoveries should require minimal change to ongoing implementation efforts at community financial institutions. Most institutions were already planning to include recoveries in their allowance estimate and likewise include them in their modeling for developing this estimate. As for the possibility of negative allowances, we feel these situations are likely to be extremely rare at the pool level, but may become more common for some individual loans, particularly for institutions who are very conservative with their initial charge-offs. However, institutions who may wish to carry negative allowances on individual collateral dependent loans should make sure that they have all their documentation and justification prepared, as the regulatory scrutiny that will be applied to these loans will likely be quite high.

On January 28, 2019, the FASB hosted a public roundtable on CECL intended to cover one main topic as well as a secondary topic. A large group was in attendance, with representatives from banks of various sizes, regulators, representatives from audit firms, as well as bank stock analysts and other readers of financial statements.

Bank Policy Institute Proposal

The primary topic was a letter containing a proposal made by the Bank Policy Institute (BPI) to FASB on November 5 identifying their concerns with CECL, as well as some proposed changes to address these concerns. The BPI is a banking trade group whose membership includes over 30 of the largest and most influential banks in the country. The first part of the letter asked for a delay in the implementation timeline as well as a more comprehensive study to be done to assess the “systemic and economic risks posed by CECL.”  The BPI’s proposed change to the standard is to essentially split the impact of CECL into three categories:

The entire proposal can be read here. If this splitting of the total expected losses sounds familiar, it may be because this proposal has a lot in common with the “three bucket approach” that was proposed back when FASB and IASB were attempting to converge on expected loss standards, and in fact has some elements in common with IFRS-9, IASB’s expected loss standard that went into effect in 2018. The BPI points to both the negative capital and earnings impacts of the current CECL standard as well as claiming that CECL, as written, would be significantly more procyclical than the current incurred loss standard, and that procyclicality could lead to an unintended tightening in lending during an economic downturn. The letter and proposal were signed by around 20 banks within the BPI’s membership, although notably absent were the signatures of some of the very largest banks in the country: JPMorgan Chase, Bank of America, Wells Fargo, Citigroup, and TD Bank, who are all members of the BPI.

Discussion during the roundtable consisted primarily of the various signatories of the BPI proposal explaining and answering questions from FASB board members and staff, as well as other stakeholders around the table. It was clear that the position of the signatories was that the proposal, while substantial, was simply meant to lay out a framework, and not intended to be a fully mature accounting standard on its own. They also expressed praise for FASB’s deliberate standard-setting process and felt that some of the issues being address regarding the proposal would be able to be more fully addressed in that process. Discussion for this topic extended for nearly three hours, with FASB board members and staff in particular appearing to be eager to get into the details of the proposal and better understand it. Support among banks for the proposal was far from universal, with several of the banks in attendance expressing views in opposition to the proposal. FASB staff is committed to doing more research on the proposal and bring more information to the board later in Q1.

Abrigo’s Take

It seems hard to imagine that the FASB would take up the proposal without changing adoption timelines for CECL. The change, including the associated costs, for banks who are already well down the road on their CECL implementation would be significant, to the point of potentially having to go completely back to the drawing board in the most extreme cases. FASB was giving the proposal a fair hearing, but they are also holding their cards pretty close to their chest, as CECL has become something of a political football at this point. Hopefully this becomes clearer when FASB staff presents to the board later in Q1.

Vintage Disclosure Discussion

The secondary topic of discussion at the roundtable was an interesting disclosure issue related to the new credit quality vintage disclosure that exists in the new CECL standard. The background of this issue is that the illustrative example of this disclosure in the guidance contains lines for “current period gross write-offs and recoveries”, but this requirement was not outlined in the text of the ASU itself, leading to some confusion among banks and analysts as to if it was part of the disclosure of not.

This issue was discussed at the 11/7 board meeting and then again at the 12/18 board meeting. Conclusions reached were essentially that the gross write-offs and recoveries were intended to be part of the disclosure requirement; however, FASB was sympathetic to the operational challenges to adding the requirement so late in the implementation process and, therefore, asked the staff to do more research and outreach on the issue. The inclusion of the topic at this roundtable was part of that outreach.

Early in the discussion, one of the issues brought up by analysts was that they desired this information to be the cumulative gross write-offs and recoveries against a particular vintage of loans, which was even more than the illustrative example in the ASU outlined. Banks expressed that is would be extremely difficult to go back to get the cumulative losses and recoveries against vintages of loans for the last five years, as would be the requirement based on this desire. A few bankers also expressed that they do not use this information in this way today for managing credit risk and questioned the value of disclosing information that is not even used by management.

Abrigo’s Take

It seems likely that this will end in a compromise with both analysts and banks having to move from their current positions: banks not wanting to provide the information at all, and analysts wanting to have cumulative write-offs and recoveries against the last five vintage years. The logical compromise, which FASB board members seemed to propose, was requiring only the current period write-offs and recoveries, and then leaving it to the analysts to build the cumulative amounts over the next few years of disclosures. What is less clear is if any update to this disclosure will have the same rapidly approaching adoption date as the rest of the ASU, or if it will be split into a separate update with a different adoption date.

To learn more about Abrigo and our ABA Endorsed CECL Solutions, click here.

The number of jobs created in January as revealed in the February 1 Bureau of Labor Statistics’ Employment Situation report could only be characterized as strong. The national economy added 304,000 jobs, approaching double the expectation of about 170,000. Strength in hiring was widespread. Construction, manufacturing, and leisure and hospitality stood out as job gaining sectors, but most other sectors also saw increases. Only wholesale trade, financial activities, and information technology were essentially flat.

The report comes on the heels of a similarly strong report for December, although it did include a downward revision of December’s numbers of 90,000, leaving that month’s job creation number at 220,000, still well beyond what had been expected.

The headline unemployment rate, U3, ticked up 0.1 percentage point to 4 percent. The broader labor underutilization measure, U6, which counts individuals not formally included in the narrow definition of “unemployed” but available for full-time work, jumped from 7.6 to 8.1 percent.

The two sets of numbers – job creation and unemployment rates – are generated in different surveys; the partial government shutdown, for technical reasons, was expected to have an impact on the “household survey,” which produces the unemployment rates.  This seems to be the case. Expectations were that headline unemployment would be unchanged, but might tick up a bit due to the shutdown, which, indeed, is what happened.

January’s job creation report, even given the revision to December’s numbers, indicates, at least as measured by the labor markets, that the U.S. economy remains strong and on firm footing.

 

About the Author

Tom Cunningham holds a Ph.D. in economics from Columbia University and was senior economist with the Federal Reserve Bank of Atlanta from 1985 to 2015. Mr. Cunningham serves as a consultant to MST in the creation and ongoing development of the MST Virtual Economist and is the MST Advisory economics specialist

Why should lenders consider the monthly jobs report?

As employment is a key factor in projecting loan portfolio performance, current employment statistics and longer term trends are likely to be primary considerations for most banks and credit unions as they incorporate forward-looking economic factors in their ALLL estimations under the CECL accounting standard. 

How can lenders consider economic factors in estimating their reserves?

Under the new accounting standard, CECL, financial institutions will be required to consider economic factors in estimating their reserves. The MST Virtual Economist is an efficient, automated way to evaluate qualitative economic factors and project their impact on the institution’s loss rate, find new variables that impact the loss rate and determine the relevance of the economic factors you are already using to make qualitative adjustments. Click here for more information or to schedule a demonstration.

One of the challenges bankers often cite about implementing the current expected credit loss (CECL) accounting standard is knowing where to begin the process. Controllers, senior credit analysts and administrators, and others involved in calculating the allowance for loan and lease losses (ALLL) have heard and read about the changes to the standard for accounting for credit losses for more than half a decade, and yet “CECL paralysis” is a primary hurdle for many involved in the transition efforts.

Having a CECL action plan that lays out steps to prepare for and comply with the Financial Accounting Standards Board’s (FASB) methodology for estimating allowances is one way to help overcome that paralysis. The action plan provides a road map that can be adjusted for your institution based on its size, staffing, and deadline for compliance. The updated accounting standard is effective in less than a year at banks with the earliest deadlines. Nevertheless, many other banks know that gathering years of loan data, selecting a loss methodology, and refining their estimates will take long enough that CECL is on the agenda in board rooms across the country.

CECL training helps transition

Another sound option for lenders looking to kick-start CECL implementation is to attend hands-on training that provides the opportunity to dig into the standard and move beyond simply reading about it. Having the chance to evaluate different loan segmentation options and loss rate methodologies and to discuss various ideas about the best way to implement CECL can set off lightbulbs and perhaps avoid missteps.

John Richardson, Credit Administration Analyst at Bank of Washington in the St. Louis area, says his financial institution was already using software that automates the allowance calculation under current U.S. GAAP and is capable of running the estimate under CECL when he attended a CECL Transition Workshop in November. However, he had not really dived head first into implementing CECL beyond spending a significant amount of time attending webinars and seminars and reading up on the various guidance that has come out about CECL.

“A lot of what I’d been reading and hearing was very theoretical, so I was having trouble wrapping my head around the notion of ‘Here’s how it works in your world,’ ” he says. “Before I went to the seminar, we read a lot about CECL and talked a lot about CECL, but we hadn’t really been able to translate that research into practice.”

Abrigo, the technology provider behind Sageworks ALLL and MainStreet Technologies (MST)’s Loan Loss Analyzer, will host CECL Transition Workshops in six locations this year that will provide the same caliber of hands-on case studies and training that Richardson received. The workshops are relevant for institutions regardless of whether the institution subscribes to Sageworks ALLL, MST’s Loan Loss Analyzer or neither.

The workshops combine a morning panel discussion about approaches to CECL with an afternoon of attendees working together (in some cases, working on laptops pre-loaded with CECL solutions and case studies) to discuss the inputs, assumptions, and decisions required for producing an allowance for credit losses. One change this year to the workshop setup is that registrants will receive a short survey upon registration to help determine which agenda track would best fit his or her financial institution. The goal is to make sure participants get the kind of training and advice out of the workshop that is most beneficial to their particular situations.

CECL training makes abstract concepts tangible

Regan Camp, Abrigo’s Senior Director of Advisory Services, says CECL Transition Workshops help demystify CECL for those bankers who have been reading and hearing about it for so long that they have gotten a “Chicken Little” mentality: That the sky is falling and they don’t know where to run. The workshops will also, he says, keep bankers focused on the relevant aspects of implementation so they don’t get caught in “analysis paralysis,” where they get caught up in less important details at the expense of making progress on implementation.

“It’s one thing to understand all of the basic conceptual approaches” related to CECL implementation, Camp says. “However, there’s often a disconnect between the theory of it and the practical application of it. There are a number of different inputs, assumptions, and decision points that institutions need to make to actually implement it that are rarely discussed” in CECL educational programs.

Richardson says that the November workshop really helped to make the abstract concepts of CECL much more tangible. “The case study materials provided were helpful, because they walked us through step-by-step and encouraged discussion within the groups. Consultants and other staff were walking around to provide assistance for the times when our group got stuck or had questions,” he says. “I really enjoyed the fact that we were able to work as a team to process through some of the subjective questions, too, because so much of CECL is subjective. In fact, one of the things they said in the panel discussion was that so much of this implementation is going to be how we document the decisions we make as we implement the standard. So we discussed as a group: Which of these outlier readings can we remove, and how do we justify that? What factors do we apply here? What forecasts do you think are reasonable? Just thinking through that process was very beneficial.”

Banking regulators have repeatedly said that financial institutions should document their processes for determining their methodologies and for changing their methodologies, as well as documenting their process for determining the amount of the allowance.

Abrigo’s CECL Transition Workshops begin Feb. 26 in Kansas City, Mo. Additional workshops will be held:

• Feb. 28 in the Los Angeles area.
• March 12 in Nashville
• March 14 in Dallas
• May 14 in Minneapolis
• May 16 in Boston

For information and registration, learn more here.

When FASB released the CECL ASU in June 2016, the defining theme through the ASU was the flexibility given to preparers with regard to the new expected losses standard. Since this time, there have been many discussions and buckets of ink spilled on the interpretation of the guidance released, but no new ASUs released that actually changed the guidance. While ASU 2018-19 was issued in late 2018, all this really did was make some clarifications and changes around the effective date of the standard for private companies, essentially extending the adoption date for those companies to Q1 2022.

However, the first proposed ASU with substantial changes to the codification has now been proposed as of November 19th, 2018 with a comment period ending on January 18th, 2019. This ASU addressed many of the issues that have been brought up and discussed in the Transition Resource Group (TRG) formed by FASB to look at the implementation of the standard, as well as other issues brought up by stakeholders to FASB. We’re going to spend the next series of blog posts looking at a few of these issues and how they will affect the implementation of the standards for financial institutions. For reference, the proposed ASU can be found on FASB’s website here under the title 11/19/18: Proposed Accounting Standards Update—Codification Improvements—Financial Instruments. The issues are numbered in the update, and we will use the same number scheme to be consistent.

Issue 1A: Accrued Interest

One of the issues that came up at the June 11, 2018 meeting of the TRG was the issue of Accrued Interest. In CECL, the estimate of credit losses is to be based on the amortized cost basis of the asset. This is defined in the glossary of the ASU as:
The amortized cost basis is the amount at which a financing receivable or investment is originated or acquired, adjusted for applicable accrued interest, accretion or amortization of premium, discount, and net deferred fees or costs, collection of cash, writeoffs, foreign exchange, and fair value hedge accounting adjustments.

Issues Preparers of Financial Statements Found in ASU

Preparers of financial statements, particularly of regulated financial institutions, as well as other stakeholders brought up a few main issues with this. The TRG Memo No. 9 covers these in depth, as well as the meeting minutes following that TRG meeting in Memo No. 13. In short, preparers brought up a few issues:

  • Preparers pointed out the operational difficultly involved with reporting accrued interest as part of the amortized cost basis of the asset, as it is typically common practice to report that amount as an accrued interest receivable separate and apart from the loan balance itself.
  • Currently, the allowance recorded by most institutions does not include any allowance related to accrued interest amounts, as they are generally reversed directly on the income statement and not against the allowance when a loan moves into nonaccrual status, this is done when a loan reaches 90 days past due with very few exceptions.

FASB's Response to Concerns

To address these concerns, FASB made a few updates to the codification. They basically do three things:

  • Allow an entity to make an accounting policy election to not measure an allowance on the accrued interest receivable if the entity writes off the accrued interest in a timely manner. This should be consistent with the practice of most regulated financial institutions today and will likely not require any major changes in systems or processes if they make this election.
  • Allow an entity to make an accounting policy election (separate from above) to write off accrued interest either by reversing interest income expense or by recognizing credit loss expense. Again, if most regulated financial institutions elect to follow current practice and write accrued interest amounts off on the income statement, this will likely require very little change.
  • Allow an entity to elect to disclose the amount of accrued interest receivable separately from the amortized cost balance of the financial assets. As with the other two changes, this will result in very little change to current practice for institutions that make this election.

Abrigo’s Take

These should be welcome changes for most community financial institutions, especially for an issue that has largely gone under the radar for many. These updates were targeted to reduce operational costs and burden at those regulated institutions by allowing them to maintain practices very similar to the ones they have today with regard to accrued interest. Our expectation would be that most community financial institutions will avail themselves of all three policy elections outlined here to streamline the adoption process and not make significant changes to systems and processes.

As many community banks continue loosening underwriting standards for commercial real estate (CRE) and regulators heavily scrutinize CRE portfolios, it’s a good time for financial institutions to review their CRE loan portfolio management.

So says Robert Ashbaugh, Executive Risk Management Consultant at Abrigo, formerly Sageworks, Banker’s Toolbox, and MST. After all, billions of dollars on the balance sheets of community banks are at stake, considering banks are still looking to grow CRE portfolios and there isn’t any assurance that the 10-year U.S. economic recovery will continue, Ashbaugh told bankers recently during the American Bankers Association Conference for Community Bankers.

Ashbaugh and Roger Shumway, Executive Vice President and Chief Operating Officer of Bank of Utah in Ogden, Utah – an Abrigo customer – were the headliners of a new CRE educational track during the ABA Conference for Community Bankers, the premier event developed for – and by – community bank CEOs. Ashbaugh and Shumway will provide a repeat of the speech Feb. 26 at 2 p.m. ET during the Abrigo webinar, “CRE Lending Market Simplified: Key Insights for 2019.”

Regulators are asking about stress testing practices related to CRE portfolios, the strength of risk rating practices, underwriting guidelines, bank policies and procedures related to CRE lending, and institutions’ reporting on CRE concentration, Ashbaugh said. This focus will continue, he predicted, even though banks in recent quarters have shaved CRE growth rates as they contend with rising delinquencies and stiffer competition from non-bank lenders.

“You want to make sure you’re managing the risk, that you’re always evaluating the portfolio and making sure you know where the risk is,” Ashbaugh said. “And once you’ve identified it, you want to make sure you’ve mitigated that risk. Banks have to ask, ‘Am I adding additional covenants for debt service recovery, for getting additional financials, have I priced and risk rated it appropriately?’ ”

In addition to providing information on best practices for CRE portfolio management and stress testing CRE, Ashbaugh and Shumway’s session at the conference also included an update on the upcoming shift to the current expected credit loss model, or CECL.

Attendees were advised that the two biggest issues to consider as it relates to CRE and CECL might be the segmentation of loans and the average life/remaining life of loans in the portfolio. Data quality and utilizing accurate risk ratings and risk-based pricing are also important considerations that were discussed during the session.

More than 1,100 banking and financial services professionals were slated to attend the four-day national conference in San Diego.

Register for the Abrigo webinar, “CRE Lending Market Simplified: Key Insights for 2019,” to learn more about CRE loan portfolio management.

 

Additional Resources

Webinar: Risk Rating: The Cornerstone of Credit Risk Management.
Webinar: Navigating Loan Pool Segmentation Under CECL.

This is the third installment in a series of blog posts about the proposed ASU for codification improvements to ASU 2106-13, better known as the CECL standard. Click here to see the initial post in the series and to read some background on the proposed ASU.

 

Issue 5A: Vintage Disclosures – Line-of-Credit Arrangements Converted to Term Loans

One of the new disclosures required by the CECL standard is the disclosure of the carrying value of loans disaggregated on both their credit quality indicator as well as the vintage, or year of origination. The entity would have to produce this disclosure with columns for term loans originated in the last five years, as well as separate columns for term loans originated prior to the last five years and revolving loans. See the below illustrative example directly from the guidance:

 

 

An issue that was discussed at the November 1st meeting of the CECL Transition Resource Group was how loans should be treated in the vintage disclosure that had previously fallen into the revolving category but at some point since have converted to term loans. A variety of scenarios were raised, including revolving loans where an eventual conversion to term was written into the original agreement, or loans where the lender performs a new underwriting and converts the existing revolving loan to a term loan. This also might include loans that are restructured as part of a Troubled Debt Restructure (TDR) agreement. Opinions seemed to differ on what the correct treatment of these loans would be for disclosure purposes: whether they should be included in the column based on their origination date, included in the column the based on the date they converted to term loans, left in the revolving column even after the conversion to term, or allow an entity to make a policy election for which of these approaches to take.

Ultimately, the approach FASB landed on was twofold:

An example of the new disclosure can be seen below:

 

 

Abrigo’s Take: In this case, it seems like FASB found a pretty elegant solution to this tricky issue. By basing the inclusion in the term loans column on a subsequent credit decision, this should allow institutions to utilize data fields they are already tracking for other purposes (Last Renewal Date, for example) to also track which vintage year column the loan should appear in for this disclosure. However, institutions may have to look closely at what types of products they have that would fall into the new category outlined here, and make sure that those products are able to be identified for proper placement in this disclosure. Once those product types are identified, it should be simply a matter of combining those product types with whatever revolving indicator is already being used to determine what term loans should fall into this category.

This is a second in a series of blog posts about the proposed ASU for codification improvements to ASU 2106-13, better known as the CECL standard. Click here to see the initial post in the series and to read some background on the proposed ASU.

Issue 1C: Recoveries

The issue of the treatment of recoveries of previously charged off amounts has been an ongoing topic of discussion. It was discussed at the June 11 TRG meeting, discussed again at a subsequent August FASB board meeting, then discussed again in the November 1 TRG meeting.

Two main issues were brought up and deliberated around this:

Inclusion of Recoveries in the ACL Estimate

Some preparers did not feel that the standard was clear on if recoveries should be included in the estimate of expected credit losses. Many financial institutions use net charge-off rates today, that is, loss rates that include both the charge-offs as well as any subsequent recoveries, which theoretically produces an allowance that is net of those amounts today. There were also some questions about which types of recoveries should be included in the estimate, and if recoveries were required to be considered, or if that was optional. Some of these questions were based on the difficulty in obtaining data related to recoveries.

Negative Allowances

Related to the question above, if recoveries are included in the estimate of credit losses, then this could result in allowance amounts at either the loan or segment level that could at times be negative. Examples were given of banks who had very high levels of losses during the financial crisis where the subsequent recoveries of these amounts resulted in net recoveries in the years following the crisis. Preparers felt that clarification was necessary considering this definition in the ASU:

326.20.30.1 The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net amount expected to be collected on the financial asset. At the reporting date, an entity shall record an allowance for credit losses on financial assets within the scope of this Subtopic. An entity shall report in net income (as a credit loss expense) the amount necessary to adjust the allowance for credit losses for management’s current estimate of expected credit losses on financial asset(s).

In the definition, the allowance is defined as a valuation account that is deducted from the amortized cost basis of the asset. It wasn’t clear if that could include negative amounts that would be essentially added to the amortized cost basis rather than deducted.

Response in the Proposed ASU

Much of the clarification in the proposed ASU is around the second issue of Negative Allowances. The FASB appears to have mostly believed that there was not much clarification necessary on the inclusion of recoveries in the estimate, as the existing guidance was clear, particularly this paragraph:

326-20-30-7 When developing an estimate of expected credit losses on financial asset(s), an entity shall consider available information relevant to assessing the collectability of cash flows. This information may include internal information, external information, or a combination of both relating to past events, current conditions, and reasonable and supportable forecasts. An entity shall consider relevant qualitative and quantitative factors that relate to the environment in which the entity operates and are specific to the borrower(s). When financial assets are evaluated on a collective or individual basis, an entity is not required to search all possible information that is not reasonably available without undue cost and effort. Furthermore, an entity is not required to develop a hypothetical pool of financial assets. An entity may find that using its internal information is sufficient in determining collectability.

In this paragraph, institutions are asked to “consider all available information relevant to assessing the collectability of cash flows”, which would include information on expected recoveries. It also addresses that institutions are “not required to search all possible information that is not reasonably available without undue cost and effort”, which should address the questions for recovery data that is difficult to acquire. For negative allowances, the proposed ASU states that they are acceptable in this new addition to paragraph 326-20-30-7:

Recoverable amounts included in the valuation account shall not exceed the aggregate of amounts previously written off and expected to be written off by the entity.

There is also similar language added to the collateral dependent practical expedient, that those individual loans may also carry negative allowances as long as they do not exceed amounts previously written off.

Abrigo’s Take

For the most part, the clarifications addressed in this portion of the proposed ASU related to recoveries should require minimal change to ongoing implementation efforts at community financial institutions. Most institutions were already planning to include recoveries in their allowance estimate and likewise include them in their modeling for developing this estimate. As for the possibility of negative allowances, we feel these situations are likely to be extremely rare at the pool level, but may become more common for some individual loans, particularly for institutions who are very conservative with their initial charge-offs. However, institutions who may wish to carry negative allowances on individual collateral dependent loans should make sure that they have all their documentation and justification prepared, as the regulatory scrutiny that will be applied to these loans will likely be quite high.