Takeaways from the July 30, 2018 Ask the Regulators Webinar – Part 3
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
Question 2: Supervisory Expectations under CECL.
What can community institutions expect during 2018 examinations relating to CECL? Do examiners have a standard set of expectations for community institutions?
The agencies want you to be ready for CECL early enough to be able to test your CECL solution. “FAQ #22” from the December 2016 release, Frequently Asked Questions on the New Accounting Standard on Financial Instruments – Credit Losses is another resource for determining the agencies’ expectations. MST has been advising our clients that the most sensible testing method is to run parallel incurred loss and CECL estimates. Some institutions will run parallel for a full year before implementation; others not as far along in their preparations will want at least two quarters running parallel, not only to test the applicability of their chosen methodologies but to compare outcomes and understand the impact of CECL.
The agencies will want you to have identified the steps you are taking and the timing of those steps leading up to your implementation date. To get to that point, everyone on your preparation team should understand CECL so you can build out your process with those people. You will need to have the resulting process reviewed internally, then discuss it with your auditors and examiners.
The agencies added that the FDIC, the Fed and the CSBS are partnering to develop a plan to evaluate CECL preparedness. They stressed that they are not examining for CECL compliance at this time, rather on CECL readiness, as is the OCC. How ready do they expect you to be? The answer differs from lender to lender. Just know that you must have a plan in place as to how you are going to achieve full, compliant CECL implementation.
Question 5: Charge-offs and recoveries.
When determining historical loss rates to use in the calculation for the ACL, how should recoveries be considered in the charge-offs (i.e., net or gross of recoveries)?
The agencies noted that recoveries must be included in your calculations, and referenced the language in the standard: “Recoveries shall be included when received.” They pointed to a discussion at the June 11 meeting of the Transition Resource Group confirming that expected recoveries should be implied consistently. That is, imply your normal or usual recovery rate to the upcoming year in your forecasting.
Question 9: Qualitative factors.
What qualitative factors would be considered reasonable when using a loss rate method to calculate the ACL?
As per the Standard, qualitative factors are intended to be leveraged to adjust historical loss information, as necessary, to reflect current conditions and reasonable and supportable forecasts not already reflected in the historical loss information. This, or course, is not a new concept in calculating an appropriate allowance, as the concept prevails from current U.S. GAAP governing the incurred loss approach of today. Accordingly, the regulators have pointed institutions to those factors listed in the Standard itself, as well as in the 2006 Interagency Policy Statement, as example factors that may still be considered under CECL, noting that not all listed factors may apply to any given institution and certainly do not represent an all-inclusive list of those factors that should be considered.
Throughout MST’s experience in guiding institutions through their CECL preparations, the identification of appropriate qualitative factors tailored to the specific institution, the structuring of a framework through which the appropriate magnitude of these adjustments will be determined, and the identification of how these adjustments will be incorporated into each adopted model/methodology have each proven to be critical steps in preparing to produce a reasonable and supportable CECL estimate.
Question 11: Reasonable and supportable forecasts.
What are the agencies’ expectations regarding the use of economic forecasts? Do the agencies expect institutions to use multiple scenarios when developing reasonable and supportable forecasts?
Your regulators will neither require nor preclude the use of multiple scenarios for reasonable and supportable forecasts. It is strictly at management’s discretion. The AICPA’s Depository Institutions Expert Panel has been preparing a whitepaper on the subject, which should be a point of reference. However, the Association has yet to announce a publishing date. The agencies do not plan at this time to issue guidance on the topic.
MST’s reading is that the agencies are providing a lot of flexibility on how institutions can approach reasonable and supportable forecasting. However, documentation will be key. Institutions should document their forecasting process in as much detail as possible.
Question 24: Troubled debt restructuring (TDR).
Does determination and measurement of expected losses on TDRs remain the same under CECL?
There are two main points of discussion about TDRs: identification and measurement. As to how to identify a TDR, there is no change under CECL to the way TDRs are determined under the incurred loss model. As to measurement, while TDRs are currently evaluated individually, banks will be able to estimate TDRs on a pool basis under CECL, as long as, like other pools, the TDRs in a pool exhibit similar risk characteristics. As well, CECL will allow the use of other loss methods than discounted cash flow (DCF), as long as the methodology can pick up concessions. If not, you will have to use a DCF method to estimate TDRs, or a method that can be reconciled to a DCF method.