cecl jim mcgough, cpa, cgma - wolf & company, p.c. · pdf file ·...
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MEMBER OFALLINIAL GLOBAL, AN ASSOCIATION OF LEGALLY INDEPENDENT FIRMS © 2017 Wolf & Company, P.C.
2017 CEO & Board UniversityWhat Boards Need to Know About
CECL
Jim McGough, CPA, CGMA
Introduction
2
Jim McGough, CPA, CGMA
Senior Audit Manager
jmcgough@wolfandco.com
Agenda
Overview
CECL Transition – Where to start
Implementation Considerations
– Loan pools
– Appropriate methodology
– Historical loss data
– Reasonable and supportable forecasts
Scope of CECL on Investments
– CECL for HTM securities
3
Overview Topic 326, Financial Instruments-
Credit Losses
Problem
• Too many accounting models for impairment
• Too little – too late
What changed?
• Life-of-loan loss period
• “Impaired” trigger is gone
• Group similar assets
• Forward looking requirement
General observations
• ALL estimate is more complicated under CECL
• More judgment required for principle based model
• Scalable & Flexible
• Quicker recognition of losses
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CECL Transition – Where to Start
1. Learn the standard, and understand the basis for
conclusions included therein.
• Principles-based standard
• Requirements of the standard and best practices
will evolve
• Effective for calendar year entities: o 2020 for public business entities (PBE) that are SEC filers,
including interim periods
o 2021 for other public business entities, including interim periods
o Dec 31, 2021 for all others
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CECL Transition – Where to Start
2. Establish your working group, including
professionals outside the accounting function
such as lending, IT, risk management.
• CECL is a critical estimate for the senior
management team
• Delineation of roles and responsibilities for
personnel involved in the estimation process
• When to involve internal audit?
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CECL Transition – Where to Start
3. Develop your project plan, including
governance/oversight and milestone dates.
• Define responsibilities
• Assess data needs (build and test)
• Establish time frames and milestones
• Dry/parallel runs
• Determine implementation has appropriate
resources and priority
Key question for Board to ask: “What mechanisms will
give us timely knowledge of the ongoing status of
implementation?”
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CECL Transition – Where to Start
4. Incorporate internal control considerations along
the way to achieve design effectiveness.
• Written policies and procedures
• Completeness and accuracy of data
• Management review and approval
• Process must hold up under a quarterly frequency
• Outsourced model might be in scope of
supervisory guidance for model risk management
Can the estimate be validated/audited?
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CECL Transition – Where to Start
5. Communicate with your auditor and primary
regulator.
• Scalability of the model exposes the bank to
regulatory interpretation
• Regulatory agencies will develop supervisory
guidance to clarify expectations but will not
provide an approved model or example calculation
• Best practices will evolve
• Conclude on PBE status with external auditor so
there are no surprises with effective date
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Implementation Considerations
Determine loan pools (those with similar risk
characteristics)
Identify an appropriate methodology for each loan pool
Obtain sufficient historical loss data
Develop reasonable and supportable forecasts
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Loan Pools
• Loan pooling is a critical decision point; impacting all
subsequent actions
• Does not prescribe a unit of account, but does require
pooling of assets with similar risk characteristics.
• Loan segments utilized for current GAAP or call report
have to be reevaluated
• Excessive aggregation/disaggregation may be
problematic
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Loan Pools – Risk Characteristics
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In evaluating financial assets on a collective (pool) basis,
aggregate financial assets on the basis of similar risk
characteristics, which may include any one or a combination
of the following (the following list is not intended to be all
inclusive):
a. Internal or external (third-
party) credit score or credit
ratings
b. Risk ratings or classification
c. Financial asset type
d. Collateral type
e. Size
f. Effective interest rate
g. Term
h. Geographical location
i. Industry of the borrower
j. Vintage
k. Historical or expected credit loss
patterns
l. Reasonable and supportable
forecast periods
Loan Pools – Where to start
Using your loan footnote consider the list of risk attributes in
the ASU for each segment:
• Identify 2 to 3 primary risk characteristics and consider if these
are generally consistent within the segment.
• Are actual losses significant?
• Other than ALL estimate, does management evaluate the loans
at a different level?
• Is the loss emergence period known?
• Can expected loan life be estimated for the segment as is?
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Loan Pools – Exclude Certain Loans
• Estimated credit loss for an asset should be measured
individually if there are no similar risk characteristics with
other loans.
• Practical expedients (FV of collateral) exist for:
– Collateral-dependent loans (borrower experiencing financial
difficulties and repayment expected through sale or operation of the
property)
– Loans secured by collateral maintenance provisions
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Appropriate Methodology
GAAP requirement is explicitly scalable and allows
preparers to develop estimation methods that are
appropriate and practical for their circumstances.
• One impairment model but many methods.
• Methodology by loan segment should be determined
early because relevant data and software needs may
vary.
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Appropriate Methodology
FASB concluded that different outcomes for expected credit
losses are acceptable, given different levels of complexity
and sophistication.
Principles based
Scalable
FASB provided examples that illustrate implementation in a
noncomplex environment. (Example 1 in the ASU)
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Appropriate Methodology
Considerations for scalability:
What is the entity’s strategic plan and who will be relying on the financial
statements now and in the immediate future?
Does the primary banking regulator classify the entity as a smaller, less
complex institution?
Would the cost of a more complex methodology exceed the benefits? The
result may not be better, and model/error risk may be elevated.
Is a sophisticated model required or desired for any segment based on the
nature of the loans and relevant loss history?
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Historical Loss Data
An entity’s loss history loss remains as the starting point and
generally provides a basis for expected credit losses.
GAAP does not specify a particular methodology for
determining historical credit loss experience. “That
methodology may vary depending on the size of the entity,
the range of the entity’s activities, the nature of the entity’s
financial assets, and other factors.” [ASU 326-20-55-2]
The loan segment and the chosen method will determine the
data needs.
Historical data is still adjusted using qualitative factors.
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Reasonable and Supportable Forecasts
Identify risk drivers for each loan segment
For example, real estate values and unemployment rates for mortgage loans
Q-Factor analysis will document whether historical loss data requires adjustment
based on the forecast for these drivers.
Entities are required to adjust for reasonable and supportable forecasts of the
future, by adjusting historical loss information for future expected events that
are not reflected in historical losses.
For periods where an entity is unable to support its forecast, it is required to
revert to historical loss information.
Consider consistency with other forecasts within the entity (ALM, risk
management, MSR valuation, budget, capital planning, other loan segments).
Some entities may begin with external forecasts (e.g. Federal Reserve) and
adjust to what management foresees in its area of operations.19
Reasonable and Supportable Forecasts
The adjustments for current conditions and reasonable and
supportable forecasts may continue to be qualitative, similar to the
approach applied by many institutions today.
• More robust quantitative models and/or greater segmentation may
result in a smaller qualitative component, depending on the
circumstances.
• Q-Factor adjustments may be more significant because of the life-
of-loan measurement period.
• Qualitative analysis may not always be directionally consistent
with current trends/events.
For example, an increase in delinquency rates may have been
previously considered/anticipated when estimating expected
credit losses.
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Scope of CECL on Investments
Type Current New
Equity Securities Topic 320 Carried at FV with changes
through earnings – no
impairment analysis required
(ASU 2016-01)
AFS Debt Securities Topic 320 Topic 326-30
HTM Debt Securities Topic 320 Topic 326
CECL for HTM Securities
• Evaluate securities on a pool basis (similar risk
characteristics)
• Individual basis (if not similar risk characteristics)
• Consider qualitative and quantitative factors that relate to
operating environment and specific to entity, both internal
and external
• When determining contractual cash flows and life of
related asset, should consider expected prepayments
• Should revert to unadjusted historical credit loss for future
periods beyond which an entity can make reasonable
forecast
• Estimate should always reflect risk of loss, even if remote
Thank you!
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Jim McGough, CPA, CGMA
Senior Audit Manager
jmcgough@wolfandco.com
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