1 Insight. Oversight. Foresight.® Florida l Michigan l North Carolina l Texas
Ready, Set, CECL! Navigating the New Model
November 4, 2016
Region 2
Presented by:
Robin D. Hoag, CPA, CGMA, CMC
Shareholder / Practice Leader
2
Financial Institutions
Group
Can you provide us with a summary
overview of the CECL standard and the
effective dates?
Question #1
3
Financial Institutions
Group
• Current accounting requires a loss threshold that is
both probable and reasonably estimable.
• This causes a delay in loss recognition.
• Financial Crisis of 2008
• Losses were not being recognized timely.
• ALLL balances were 30%-60% deficient.
• FASB formed Financial Crisis Advisory Group to research
alternatives to current model.
Background and Overview
4
Financial Institutions
Group
Source: Callahan & Associates
Background and Overview
5
Financial Institutions
Group
Current Expected Credit Loss (CECL) Model
• Calculates expected losses over the remaining life of the
financial asset.
Amortized Cost
Allowance for credit
losses
Amount expected
to be collected
• An ALL that includes all expected losses over an asset’s
remaining life, allows loans to members net of the
allowance to be presented on the balance sheet at the
amount expected to be collected.
Background and Overview
6
Financial Institutions
Group Transition Rules and Guidance
• For all non-public companies (e.g., credit unions),
amendments are effective for fiscal years beginning after
December 15, 2020 (e.g., January 1, 2021), and interim
periods with fiscal years beginning after December 15,
2021.
• Early adoption is permitted as of the fiscal year beginning
after December 15, 2018.
• Amendments will be applied through a cumulative-effect
adjustment to retained earnings as of the beginning of the
first reporting period in which the guidance is effective.
7
Financial Institutions
Group
CECL Model
What are some of the key differences
between the CECL model and the
current expected loss model?
Question #2
8
Financial Institutions
Group CECL Model
Historical Events
Current Conditions
Reasonable and Supportable Forecasts
9
Financial Institutions
Group
FICO Score & Delinquency Matrix
FICO Score <30 ≥ 30 and <60 ≥ 60 and <90 ≥ 90
720 -850 1.97% 2.13% 2.33% 5.49%
690 -719 2.19% 3.19% 4.45% 6.49%
660 -689 2.28% 3.58% 5.24% 7.91%
620 -659 2.71% 5.62% 9.32% 15.30%
600 -619 4.16% 12.54% 23.13% 40.31%
1 -599 4.16% 12.54% 23.13% 40.31%
2.74% 10.68% 18.92% 34.59%
Delinquency
Data Example (Historical Events) - Loss Severity
Historical Events
• Historical loss experience of similar assets
• Delinquency analysis
• Credit ratings - Consumer
• Risk ratings - Commercial
• Loan to Values (LTV)
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Financial Institutions
Group
CECL Model - Data Example (Current Conditions)Credit Grade Loan Characteristics
Credit Number Current % of Wtd Rmg Wtd Wtd
Grade Low High of Loans Balance Balance Term Yrs Score Rate
A+ 720 850 9,041 86,737,039$ 28% 9 772 6.17%
A 690 719 3,311 26,519,234 9% 7 704 7.66%
B 660 689 4,057 32,636,289 11% 7 670 7.77%
C 620 659 5,909 34,548,057 11% 7 641 10.54%
D 600 619 3,476 17,203,445 6% 5 610 12.13%
E 1 599 18,225 80,972,997 26% 5 540 13.36%
TDR 0 0 414 29,542,362 10% 17 589 3.17%
44,433 308,159,423$ 100% 8 653 8.89%
Credit Score Range
Current Conditions
• Underwriting standards
• General economic environmental factors
• Bankruptcy filings by region or nation
• Changes in: Delinquency analysis; Credit ratings (Consumer);
Risk ratings (Commercial); LTV
• Factors specific to the borrower (individually evaluated loans)
11
Financial Institutions
Group
CECL Model - Data Example (Reasonable & Supportable) Peer Data
RATIO PERFORMANCE
Asset Quality
Delinquent Loans / Total Loans 1.41% 1.53% 1.75% 1.49% 1.70% 1.65% 1.49%
Net Charge-Offs / Average Loans 2.15% 2.27% 2.58% 0.94% 1.16% 1.10% 0.94%
Earnings
Return on Assets 0.99% 0.40% 0.72% 0.79% 0.29% 0.57% 0.79%
Special Lending Ratios
Losses as a % of TDRs and
Modifications 2.15% 2.27% 2.58% 1.75% 1.16% 1.10% 0.94%
Historical Actuals Peer Data
2019 2020 12/31/21 Current 2019 2020 12/31/21 Trend/
Forecasted
Reasonable & Supportable Forecasts
• Changes in prepayment speeds
• Changes in collateral values
• Geographic location, etc.
• Disaggregated at the portfolio segment level
• Expected credit losses using a discounted cash-flow model
• Internally and externally developed forecasted economic data
12
Financial Institutions
Group
Can you please explain the practical
expedient that can be used when
creating reasonable and supportable
forecasts?
Question #3
13
Financial Institutions
Group
What types of models/methodologies are
acceptable in the CECL standard?
Will that, along with the different types of
data that are acceptable under the new
CECL guidance, cause inconsistency and
comparability issues among peers?
Question #4
14
Financial Institutions
Group
Potential Estimation Methodologies
FASB guidance identified several potential estimation
methodologies
• Expected Loss Rate: Lifetime historical loss rates applied to
financial assets with similar key risk characteristics. Historical
loss information can be internal, external, or both. The
institution needs to select a reasonable period to base it’s
historical loss rate information. A reasonable period should
consider have similar underwriting standards and contractual
terms in comparison with the current portfolio.
15
Financial Institutions
Group
• Vintage Analysis: Vintage refers to the date of origination. A
vintage analysis is similar to the expected loss rate approach,
except it further segments the portfolio by date of origination.
Segmenting by origination will reveal the timing of historical
loss experience.
• Probability of Default and Loss Given Default Modeling:
Statistical-based calculation that uses risk parameters;
contains two components:
• Probability of Default: Probability that asset in a segment will
default.
• Loss Given Default: Percentage of defaulted loan balance that is
charged off.
Potential Estimation Methodologies
16
Financial Institutions
Group
• Discounted Cash Flow: Calculates future cash inflow based on
financial instrument’s effective interest rate. Contractual cash
flows are adjusted for voluntary prepayments, defaults, and
loss severity.
• Migration Analysis: Tracks performance of financial assets over
time, based on risk characteristics.
Credit unions should select appropriate model based on their
individual portfolio.
Potential Estimation Methodologies
17
Financial Institutions
Group
Loss Rate Approach
Simple to create and understand
Similar to current ALLL approach for most institutions
May show historically irrelevant
data points
Auditor and regulator expectations might
not be met
Vintage Analysis
Simple to create and understand
(variation of loss rate approach)
Method is useful as a forecasting tool
Establishes relationships to environmental
factors
Long-term historical data required
PD and LGD
Improves credit risk management
process
Deeper insight into loss driving factors
Significant amount of data required
Complexity- difficult to verify results
Discounted Cash Flow
Provides both market value and
loan portfolio
Analyze a large volume of loans
Complex to create
Only as good as assumptions used
Overview of Approaches: Pros and Cons
18
Financial Institutions
Group
TRANSITION TITLE HERE
Data Retention
Question #5
How many years of historical data do
we need to retain?
19
Financial Institutions
Group Preparing for Implementation
How far back should historical look-back data go?
• The ASU does not require a specific look-back period: • “An entity may use historical periods that represent
management’s expectations for future credit losses. An entity
also may elect to use other historical loss periods, adjusted for
current conditions, and other reasonable and supportable
forecasts.”
• As a rule of thumb, look-back time period should be at least
equal to the average remaining life of the portfolio/segment.
• A longer look-back period that includes various economic
cycles may be useful when forecasting the effect of future
changes in economic conditions.
20
Financial Institutions
Group
Origination Data Current Data Historical Data
Credit rating/score Credit rating/score Date of charge-off
Balance Balance Charge-off amount
Loan term Remaining term Date of recovery
Interest rate Interest rate Recovery amount
LTV LTV
Date (vintage) Delinquency status
Product type
Preparing for Implementation
• Data needs will be dependent on model selected and key risk
characteristics of portfolio.
• The following data is required for most models (not all
inclusive):
21
Financial Institutions
Group
Data Considerations:
Data
Location
Storage
Access
Quality
Preparing for Implementation
22
Financial Institutions
Group
Do you currently have a process in place to
retain the data needed for the CECL model?
Group Question #1
23
Financial Institutions
Group
TRANSITION TITLE HERE
Question #6
What level of detail is appropriate when
developing loan portfolio segments for the
new model?
24
Financial Institutions
Group CECL Model
• Collective basis: Assets with similar risk characteristics, i.e.,:
• Credit score/ risk ratings
• Vintage
• Collateral type
• Term
• Geographical location
• Individual basis: Unique risk characteristics
• Do not share similar risk characteristics
• Delinquent loans.
• Collateral-dependent approach is still an option.
• Expected credit losses shall be measured on either a collective
basis or individual basis (Similar to current accounting)
25
Financial Institutions
Group
TRANSITION TITLE HERE
Question #7
When should we start planning for
implementation??
26
Financial Institutions
Group
2016 2017 2018 2019 2020 2021
Preparing for Implementation
Planning:
• Form an
Implementation
Committee
• Collect data
• Develop appropriate model
• Test model-
run parallel
to incurred
loss model
• Make
necessary
adjustments
• Go live with
model
• Going forward,
monitor
27
Financial Institutions
Group
TRANSITION TITLE HERE
Question #8
What departments should be involved in
implementing CECL?
28
Financial Institutions
Group
• In order to assure a
smooth transition, an
Implementation
Committee should be
formed.
• An effective CECL Model
relies on cross-
departmental
communication.
Credit
Finance
Accounting Technology
Risk
Implementation Committee
29
Financial Institutions
Group Implementation Committee Resources
• Auditors and industry experts
• Regulators
• Other credit unions and financial institutions
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Financial Institutions
Group
TRANSITION TITLE HERE
Group Question #2
Has anyone formed a CECL planning
committee?
31
Financial Institutions
Group
TRANSITION TITLE HERE
Question #9
Can the credit union internally handle the
level of data examination/sorting or will most
outsource the calculation or parts of the
calculation to a third party?
32
Financial Institutions
Group
TRANSITION TITLE HERE
Question #10
What will the impact be on the ALL balance
on day one and going forward?
How will this impact net worth?
33
Financial Institutions
Group
33
Impact Expected for ALLL
• Losses would be recognized sooner than under the
incurred loss model. A financial institution would not
wait for a loss event to occur.
• ALLL balances will generally be higher under the
CECL than they are now.
• Impact will be influenced by how regulators, investors
and auditors interpret the CECL model.
34
Financial Institutions
Group
Impact on ALLL and Regulatory Capital
NCUA Statement
“While NCUA's risk-based capital rule, which takes effect
January 2019 and covers credit unions with assets of $100
million or more, allows 100 percent of a credit union's ALLL to be
included in the numerator of the RBC ratio, which is positive,
having to increase the ALLL - if necessary - as a result of the
new accounting standards may be increasingly problematic for
some, as we near implementation of FASB's new accounting
standards.”
35
Financial Institutions
Group
A credit union’s
capital
classification is …
Net worth
ratio
Risk-based capital
ratio also applicable
if complex
And subject to following
condition(s) …
Well Capitalized 7% or greater And 10% or greater
Adequately
Capitalized 6% or greater And 8% or greater
Does not meet the criteria to
be classified as well
capitalized
Undercapitalized 4% to 5.99% Or Less than 8%
Significantly
Undercapitalized 2% to 3.99% N/A
Or if “undercapitalized at < 5%
net worth and (a) fails to timely
submit, (b) fails to materially
implement, or (c) receives
notice of the rejection of a net
worth restoration plan
Critically
Undercapitalized Less than 2% N/A
Table 1 TO §702.102 – Capital Categories
Impact on ALLL and Regulatory Capital
36
Financial Institutions
Group
TRANSITION TITLE HERE
Group Question #3
Is your Board aware of this new accounting
pronouncement and its potential financial
impact?
37
Financial Institutions
Group
TRANSITION TITLE HERE
Question #11
How much more time is the ALL analysis
going to take as compared to the current
methodology?
38
Financial Institutions
Group
TRANSITION TITLE HERE
Question #12
How will CECL impact TDR accounting?
39
Financial Institutions
Group Troubled Debt Restructuring (TDR)
• Risk of re-default based on expected credit losses.
• Economic concession, such as interest rate reduction
or principal forgiveness, recorded through allowance.
• Discounted cash flow method is not required, but still
acceptable.
40
Financial Institutions
Group
TRANSITION TITLE HERE
Question #13
Are there going to be new disclosure
requirements as a result of CECL?
41
Financial Institutions
Group Disclosures
• Description of how expected losses are developed.
• Factors that influenced the current estimate of CECL.
• Reasons for significant changes in the amount of write-offs.
• Amount of significant purchases and sales of debt instruments
during each period.
• Amount of any significant sales or reclassifications to held for
sale for financial assets during each period.
• For collateral-dependent assets: qualitative discussion of the
type of collateral, extent to which collateral secures financial
assets, and any changes that impacted how much collateral
secures the asset.
42
Financial Institutions
Group Disclosures
• Policy for charging off uncollectible debt instruments.
• Changes to accounting policies or methodology from
the prior period.
• Policy for accounting for nonaccrual financial assets.
• Reconciliation between purchase price and par value
of PCD assets.
• Prospective transaction approach for PCD assets.
• Roll-forward of the allowance for credit losses.
43
Financial Institutions
Group Disclosures
Not required for non-public entities (e.g., credit unions)
• Credit quality indicators by vintage.
• Need not exceed more than five annual reporting periods.
• All periods prior to fifth annual reporting period will be shown in
aggregate.
44
Financial Institutions
Group Key Takeaways: Do’s and Don’ts
Do: • Start planning today
• Form an Implementation Committee
• Discuss data considerations
• Consult with your accounting professionals
• Consider future capital impact
• Evaluate budget
• Educate your board
Don’t: • Wait
• Implement model today
• Current accounting is still effective, therefore, increasing
ALLL beyond incurred loss model to mitigate CECL impact is
not allowed.
45
Financial Institutions
Group
• External financial audits
• Regulatory compliance
audits
• IT Assurance
• Controls reviews
• Vulnerability
assessments
• Penetration testing
• Mergers & consolidations
• ALLL validation/TDR accounting
• Internal audit
• Real estate/Commercial loan reviews
• Enterprise Risk Management systems
• Compliance auditing
Financial Institutions Group Services
46
Financial Institutions Group
Sample Methodology
Calculations
47
Financial Institutions
Group
XYZ Credit Union has decided to use the loss rate approach to calculate its expected credit loss.
• Loan portfolio- 7 year amortizing loans, all with similar risk characteristics. (evaluated collectively)
• Amortized cost- $100,000,000
• Historical lifetime credit loss rate- 2%
• Current conditions and reasonable and supportable forecasts:
• Unemployment rate increased in industry served
• Real estate values have decreased significantly
• Conditions are expected to worsen over the next three years, but cannot be reasonably forecast
past three years, and immediately reverts to historical loss rate.
Loss Rate Approach
Calculation of allowance:
Historical loss rate
2.00%
Adjustments:
Unemployment increase
Decrease in real estate values
0.06%
0.14%
Loss rate adjusted for current conditions and reasonable and supportable forecasts 2.20%
Amortized cost basis of the portfolio $ 100,000,000
Allowance for credit losses $ 2,200,000
48
Financial Institutions
Group
Vintage Year Approach
XYZ Credit Union has decided to use the vintage year approach to calculate its expected credit loss.
• Loan portfolio- 4 year amortizing loans, all with similar risk characteristics. (evaluated collectively)
• XYZ Credit Union tracks loans on the basis of the calendar year of origination.
• Conditions are expected to worsen over the next two years, but cannot be reasonably forecast past two
years, and immediately reverts to historical loss rate.
Loss Experience in Years Following Origination
Year of
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
Allowance for credit losses $1,260
49 Insight. Oversight. Foresight. SM
Questions?
50 Insight. Oversight. Foresight. SM Michigan l Texas l Florida
Thank You!
Robin D. Hoag, CPA, CGMA, CMC
Shareholder / Practice Leader
Office: (248) 244-3242
Cell: (248) 709-1270
Email: [email protected]
Co-Creation / Research Team:
David D. Ritter, CVA, MBA, Shareholder, Strategic Advisory Group
Jeanine LaBarbera, Audit Supervisor
Stephen LaBarbera, CPA, Audit Supervisor
Rafael Guijarro, CPA, Senior Auditor