Clearing up some CECL confusion
Jul 21, 2016
American Banker’s recent webinar, How to live with the New CECL and ALLL loan loss rules, featured FASB Member R. Harold Schroeder and FASB Assistant Director Matthew Esposito. In this presentation, Schroeder discussed who is affected by the new guidance and when it will be effective. A key point was the clarification that CECL doesn’t change the amount lost on loans, but only the timing of the recognition of those losses. Additionally, Matthew Esposito presented the “top ten truths” of CECL, listed below.
- The allowance for credit losses is one factor in an equation used to present the “net amount expected to be collected.” The equation is simplified to A-B=C:
Amortized cost (A) – allowance (B) = Amount expected to be collected (C).
- Expected credit losses shall be measured either collectively or individually. Measurement on a collective (pool) basis if the assets share similar characteristics for risk with other assets, or individually if the asset doesn’t have similar risk characteristics with other assets.
- The CECL standard does not specify the method to use. It is up to each institution to decide what method(s) may be best for them and best reflects the institution’s expectations of credit losses. The standard is very flexible and some methods used today may be used tomorrow, however the inputs will change to reflect the shift from incurred to expected loss.
- Expected credit losses shall be measured over the contractual term of the loan. When a TDR is anticipated, that will be considered in the terms of the loan. This aspect of TDRs is a new element of CECL methodology not in current GAAP.
- Historical, current and future information will be used. Information will be key, and both internal and external info may be considered. External data doesn’t have to be used if it is not relevant. Institutions will have the flexibility to decide what should be incorporated from a data perspective. Also, historical credit loss information will still be key. Data sets may be adjusted in order to provide a basis for assessing collective pools. For example, you may use internal or external data to supplement a four-year history to make it reflect a five-year term.
- Any approach to estimating collectability is inherently subjective. Credit risk is managed differently by different entities, thus various methods are permitted. Estimates will be different for different entities. There will be a range of acceptable outcomes. Estimates may also use qualitative adjustments. Qualitative adjustments will be inherently subjective – just as qualitative adjustments used under current GAAP contain subjectivity.
- For periods where forecasts are not supportable – entities should revert to historical credit loss information that is reflective of the contractual term. Reversion techniques shall not be used if the entity is able to forecast over the life of the loan. Institutions may use a rational and systematic basis for making decisions about when to use historical reversions.
- Expected credit losses shall be measured, even if remote. There could be fact patterns where no loss is expected. The expectation can’t be solely based on current value of collateral. The FASB did not explicitly state specific financial assets where nonpayment may be zero.
- Expected credit losses for off-balance sheet credit exposures shall be measured over the period the entity is exposed to credit risk via a present contractual obligation unless unconditionally cancellable by the issuer.
- Collateral-dependent financial assets – where repayment is expected substantially through operation or sale of collateral when a borrower is experiencing financial difficulty. Practical expedients for expected credit losses are measured by comparing fair value of collateral to amortized cost.
Esposito, Matthew. (2016, July 14). How to live with the New CECL and ALLL loan loss rules [Webinar]. Hosted by American Banker. Retrieved from https://sageworks.wistia.com/medias/zth7a12kvd
Watch the full presentation: https://sageworks.wistia.com/medias/zth7a12kvd