Ready, Set, CECL! - Association of Credit Union Internal ... Session 8 - Ready Set CECL!.pdf9...

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


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


Group

Source: Callahan & Associates


5


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.


6


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


Group

CECL Model

What are some of the key differences

between the CECL model and the

current expected loss model?

Question #2

8


Group CECL Model

Historical Events

Current Conditions

Reasonable and Supportable Forecasts

9


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)

10


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


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


Group

Can you please explain the practical

expedient that can be used when

creating reasonable and supportable

forecasts?

Question #3

13


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


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


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.


16


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.


17


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


Group

TRANSITION TITLE HERE

Data Retention

Question #5

How many years of historical data do

we need to retain?

19


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


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


Group

Data Considerations:

Data

Location

Storage

Access

Quality


22


Group

Do you currently have a process in place to

retain the data needed for the CECL model?

Group Question #1

23


Group


Question #6

What level of detail is appropriate when

developing loan portfolio segments for the

new model?

24


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


Group


Question #7

When should we start planning for

implementation??

26


Group

2016 2017 2018 2019 2020 2021


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


Group


Question #8

What departments should be involved in

implementing CECL?

28


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


Group Implementation Committee Resources

• Auditors and industry experts

• Regulators

• Other credit unions and financial institutions

30


Group


Group Question #2

Has anyone formed a CECL planning

committee?

31


Group


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


Group


Question #10

What will the impact be on the ALL balance

on day one and going forward?

How will this impact net worth?

33


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


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


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


Group


Group Question #3

Is your Board aware of this new accounting

pronouncement and its potential financial

impact?

37


Group


Question #11

How much more time is the ALL analysis

going to take as compared to the current

methodology?

38


Group


Question #12

How will CECL impact TDR accounting?

39


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


Group


Question #13

Are there going to be new disclosure

requirements as a result of CECL?

41


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


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


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


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


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


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


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

Ready, Set, CECL! - Association of Credit Union Internal ... Session 8 - Ready Set CECL!.pdf9...

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