Takeaways from the July 30, 2018 Ask the Regulators Webinar – Part 5
This is the final in our five-part series discussing the 27 questions addressed by the regulators in their most recent joint webinar on CECL.
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 U.S. 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 16. Renewal loans at the ACL.
How should renewed loans be considered in the calculations of ACL? For example, if a loan pool has an average life of five years and a loan is renewed at the end of five years, does the renewed loan start a new five-year period or should it remain in the original five-year pool?
The regulators referenced paragraph 326-20-30-6 of the Update stating that “an entity shall not extend the contractual term for expected extensions, renewals, and modifications unless it has a reasonable expectation at the reporting date that it will execute a trouble debt restructuring with a borrower.” As such, you do not include the renewal period in your original pool’s calculation of credit losses. Rather, the renewal is treated as a new loan. In fact, the amendments made for CECL did not amend the guidance for determining whether a loan is a new loan, and lenders will continue to make that determination according to the guidance in Subtopic 310-20.
In helping institutions transition to CECL, MST consultants are advising our clients on the importance, in particular, of restricting the loan number and origination date to the original loan. Retaining the same number or origination date for the renewal could result in artificially – and incorrectly – dragging out the life of the loan. MST Senior Advisor Paula King says, “If the bank is not currently tracking renewal dates, the transition to CECL is an opportune time for your loan operations area to begin including procedures to track renewal dates going forward.”
Question 20. Transitioning methods over time.
Is it appropriate to use one loss rate method (e.g., open pool or WARM) and then transition to another loss rate method (e.g., vintage) at a later time when the institution has collected a sufficient amount of data?
The regulators confirmed your right to change methodologies, but stressed that any change must be well documented and substantiated. Changing methodologies is considered an uncommon event, and changing simply to change the result of the calculation is not an acceptable reason. There is guidance on switching methodologies in the 2006 interagency policy statement.
Several MST clients are opting to set up a “day one” CECL methodology based on the data they have at their disposal and the processes they are familiar with. Such an approach is consistent with regulators’ oft-repeated directive to “start with what you have now.”
Question 21. Supervisory expectations.
Will agencies object to institutions’ use of the Weighted Average Remaining Maturity Methods, commonly referred to as WARM?
The regulators reminded us that the CECL Standard does not require a specific methodology. As long as a model complies with GAAP, it is acceptable. A “weighted average” or “remaining life” methodology could be appropriate for smaller and less complex institutions. For more on WARM, read MST’s Regan Camp’s article, “Methodologies for Small Institutions: Agencies Make Recommendations”.
Question 22. Public company financial statement disclosure.
Is there a requirement to disclose the quantitative impact of the adoption of CECL on capital in the financial statements (e.g., Form 10-K)?
Depending on the impact to capital upon adoption of the Standard, the entity should provide quantitative disclosures, the regulators noted. They will expect more complete disclosures the closer the institution gets to its CECL implementation date. They pointed institutions to Staff Accounting Bulletin (SAB), Topic 11M or SAB 74 for more information on this topic.
As with any material impact on financial statements, your disclosures should be detailed and sufficient enough for the reader to gain a better understanding of your financial condition.
Question 25. Risk ratings.
How do loan risk ratings impact the calculation of the ACL under CECL?
CECL requires loans to be pooled based on similar risk characteristics. Risk ratings are a common way to pool by risk characteristics. Generally, loans with risk ratings indicating a higher risk profile should be pooled separately.
Many MST clients currently pool based on risk ratings and will continue to use risk ratings for CECL pooling. However, an institution must have sufficient metrics substantiated by proper documentation and an appropriate risk rating framework and meaningful rating review process to employ risk ratings.
Read part 4 of the series covering segmentation, life of loan, credit cards and individual impairment.