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Takeaways from the July 30, 2018 Ask the Regulators Webinar – Part 2

August 17, 2018
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The July 30 installment of the “Ask the Regulators” series included speakers from the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Securities and Exchange Commission (SEC), the Conference of State Bank Supervisors (CSBS), and the Financial Accounting Standards Board (FASB). The goals of the session were to:

  • Share the agencies’ perspectives on 27 questions submitted by community institutions
  • Demonstrate a consistency of views across agencies
  • Share common challenges faced by community institutions about implementing CECL

This is the second in a series of blogs intended, in total, to summarize – and where appropriate, comment on – the agencies’ responses to each of the 27 questions:

 

Question 1: “Small and less complex.”

Is there a definition of “small and less complex” or a set of factors to consider in determining whether an institution fits that description? Would most institutions under the FDIC’s $10 billion threshold for “large and highly complex” qualify? 

The agencies’ response is consistent with the answer provided in the December 2016 document from the Board of Governors of the Federal Reserve System, “Frequently Asked Questions on the New Accounting Standard on Financial Instruments – Credit Losses.” CECL is scalable, the agencies have repeatedly said, and have declined to provide an exact definition of “small and less complex.” As such, there is no asset threshold to define size. Large institutions don’t always qualify as complex. Consider a $30 billion institution with a portfolio made up strictly of agricultural loans: a large institution but offering one type of loan. Similarly, a $500 million institution that lends across states and markets could be considered complex. The agencies noted that institutions will not be required to use a discounted cash flow (DCF) methodology, and that a small, less complex institution could use parts of its current methodology as long as it incorporated life-of-loan expectations and appropriate forecasting and assumptions. 

Question 6: Peer data for CECL.

Is it acceptable to use data from various regulatory reports (e.g., FFIEC Call Reports)? What types of peer data are available as a reference for historical loss experience? 

Peer data is acceptable and might be necessary, in particular for institutions with relatively new portfolios and without much historical loss data. The agencies stress that using your own data is preferable to using peer data, and that the institution should move toward gathering and reconciling its own data as its portfolio matures. For example, a lender that recently started offering mortgage loans might use the OCC mortgage metrics report for that loan segment. The uniform bank performance report (UBPR) could be used to determine average loss rates for different types of loans where the institution has an insufficient amount of its own data or call reports for peer group averages. To reiterate, while peer data is available and acceptable early on in CECL implementation, a lender’s own data is preferable, and an institution should seek to move away from peer data as time goes on.

 

Question 8: Low historical loss experience and the ACL.

What guidance is available for institutions with zero to extremely low historical loss experience? To what extent may institutions rely on qualitative adjustments to determine the appropriateness of the ACL? 

The agencies answered this question much like they did Question 6. The prevailing concept is that regulators are not going to require a certain threshold of losses – no allowance benchmarks – but that institutions are responsible for their CECL allowance results even if they have to be substantiated with Q-factor adjustments.

 

Question 10: Reasonable and supportable forecast period for CECL.

Is there a minimum preferred range for the reasonable and supportable forecast period? How can institutions estimate losses if the reasonable and supportable forecast does not cover the entire contractual life of the loan? 

The regulators stress that each institution’s forecast period will be whatever is appropriate for its portfolio and credit products. Management must use its judgment. As advisors to many institutions on their transition to CECL, MST advisors have seen an average of one-to-two years. It is difficult to look farther out as predicting the future is problematic, especially in today’s volatile economic environment. To help institutions estimate loan performance into the future, MST developed the Virtual Economist, software that provides institutions with economic trends for forecasting purposes.

Question 18: Methods for CECL.

Some have suggested that the vintage method will be the minimum standard required to implement CECL (i.e., other types of loss rate methods will not be acceptable). Is this accurate? 

While estimating life-of-loan losses requires the institution to know the vintages of its loans, it does not mean it must employ a vintage methodology. Public Business Entities (PBEs) are required to have vintage disclosures, and will have to track loans by vintage year, but again, that does not mean they are required to use the vintage method. In fact, many institutions have portfolios that are not conducive to a vintage methodology, as a vintage methodology requires a considerable amount of reconciled historical data and are homogenous types of financial assets that follow patterns or loss curves that are predictive and comparable for subsequent generations (e.g.; indirect auto loans, credit cards, etc.). Loss Rate, Roll Rate, and DCF methodologies may be more appropriate depending on the portfolio and institution.   

The agencies are not mandating any specific methodologies. ASC 326-20-30-3 provides a list of methodologies appropriate for CECL and examples of how to employ them. View the MST webinar “Practical Modeling Examples for CECL” with Regan Camp, Managing Director of MST Advisory Services.

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