Written By: Jim Rives
Now that you have the updated FAQs on the Financial Accounting Standards Board’s (FASB) Current Expected Credit Loss (CECL) Model from the regulators, what else should you be considering in preparation for examiners? On December 19, 2016, the Board of Governors of the Federal Reserve System (the Fed), Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corp. (FDIC), and National Credit Union Administration (NCUA) issued an 18-page, 23-question statement titled, “Frequently Asked Questions (FAQs) on the New Accounting Standard on Financial Instruments – Credit Losses,” to help their regulated entities prepare for and implement FASB’s new standard on credit losses (ASU No. 2016-13 – Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments). The FAQs are detailed and should be thoroughly read by CECL implementation committee team members and other stakeholders, as it covers the effective dates, application upon initial adoption, acceptable estimation methods and estimating credit loss on a pool basis.
If you are just getting started or want to quickly assess where you stand in your own implementation, FAQ #22 addresses what institutions should do to prepare for the implementation of CECL (also nicely captured in these resources: 10 Ways to Get Ready for CECL, ABA’s CECL Backgrounder). More importantly, the FAQ is one of several recent regulatory publications that your CECL implementation team should be mindful of in order to meet the technical accounting requirements and regulatory expectations of examiners before and after the effective date of the new standard. This FAQ, and its precursor, the “Joint Statement,” make it clear that additional FAQs as well as updates to existing FAQs will be forthcoming. The Agencies appear eager to provide assistance.
There have been several recent updates from the OCC that are worth noting when preparing for examiners. Additionally, it is highly probable that the other Agencies will be updating their examination procedures and other guidance in a like manner. For now, consider the following.
In December 2015, the OCC (see bulletin below) updated four key examination process handbooks which lay the foundation for the OCC’s examination manual and support the OCC’s supervisory framework. The primary objectives were to revise the definition of banking risk and harmonize the OCC’s risk assessment system (RAS) and Uniform Financial Institutions Rating System (aka “CAMELS”). Among other changes, the OCC added a characterization for examiners to evaluate how well a bank identifies, measures, controls and monitors its risks. Previously, examiners graded a bank’s risk management standards for specific risk categories (i.e., credit risk management) on a scale of strong, satisfactory and weak. Under the new RAS framework, examiners are now afforded the option of assigning an “insufficient” rating (better than weak but not as good as satisfactory) in determining the quality of (credit) risk management. It is likely that this new option for examiners may have, or has already had, a direct or indirect adverse impact on the management (“M”) CAMELS component rating. OCC Bulletin 2015-48 indicates:
“…examiners consider their assessments of risk management practices for each of the risk categories when assigning management component ratings… Using the RAS and the CAMELS rating system in this manner provides an important verification of planned activities and supervisory findings.”
In early November 2016, the OCC updated the Comptroller’s Handbook for Community Bank Supervision with a focus on its core assessment for asset quality which: 1) updates examination procedures for credit underwriting and concentration risk management; 2) updates guidance for stress testing for community banks; 3) enhances procedures for evaluating retail credit, appraisals, other real estate owned and credit review functions; 4) updates the standard request letter and asset quality references; and 5) enhances the examination procedures for the allowance for loan and lease losses (Allowance).
At a minimum, your institution’s CECL implementation team should review and conduct self-assessments, or request independent assessments, of how its CECL implementation aligns with these updated asset quality examination procedures. Examiners’ determination of the adequacy of the Allowance, both in methodology and balance, have a direct impact on their conclusions for the quantity of credit risk (high, moderate, low); the quality of credit risk management (strong, satisfactory, insufficient, weak); aggregate level of credit risk (high, moderate, low); the direction of credit risk (increasing, stable, decreasing); and the asset quality, earnings, capital, and management CAMELS ratings. In my experience, the outcome of these ratings may also have an impact on incentive or other forms of compensation programs.
As with your current Allowance methodology, your CECL process will need to remain dynamic and will require constant review. Incorporating data and other information from regulatory guidance, surveys, speeches and local/regional economic data that substantiate your “reasonable and supportable” forecasts are necessary to defend your CECL model against examiner scrutiny. At a minimum, read what the examiners are reading. Consider regular subscriptions to the Fed, OCC, FDIC, NCUA (and industry association publications), including but not limited to:
Interagency Statement on Prudent Risk Management for Commercial Real Estate Lending
Survey of Credit Underwriting Practices
Senior Loan Officer Opinion Survey
QRTLY CECL Webinar Series – OCC Regulated Entities Only!
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