On September 6, 2017, the Federal Reserve Board of Governors, Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency and National Credit Union Administration agencies (the Agencies) released an updated Frequently Asked Questions on the New Accounting Standard on Financial Instruments—Credit Losses. The FAQs focus on the application of the current expected credit losses (CECL) methodology, supervisory expectations and regulatory reporting effect. The release combined the FAQs issued in December 2016 (Questions 1–23) with new questions and answers (Questions 24–37). The Agencies plan to keep issuing and updating the FAQs to assist institutions and examiners as they begin implementation.
The new FAQs in this release primarily address the public business entity (PBE) criteria and provide various examples. Other questions and answers revolve around qualitative factors, data, the effect of adoption on Call Reports and collateral-dependent loans.
As CECL effective dates depend on whether institutions are considered a U.S. Securities and Exchange Commission (SEC) filer, non-SEC PBE or a non-PBE, determining the entity type is crucial.
Highlights of the FAQs related to the PBE criterion include:
- For an entity to be considered an SEC filer, it must be required to file or furnish its financial statements with either the SEC or a regulatory agency other than the SEC as required by Section 12(i) of the Securities Exchange Act of 1934.
- For non-SEC filers to be considered a PBE, the entity must conclude it meets at least one of the following criteria:
- It’s not required by the SEC to file or furnish financial statements, but does file or furnish financial statements with the SEC (including entities with financial statements or financial information required to be, or included in, another entity’s filing).
- It’s required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that aren’t subject to contractual restrictions on transfer.
- It has issued or is a conduit bond obligor for securities that are traded, listed or quoted on an exchange or over-the-counter market.
- It has one or more securities that aren’t subject to contractual restrictions on transfer, and it’s required by law, contract or regulation to prepare U.S. generally accepted accounting principles financial statements (including notes) and make them publicly available on a periodic basis, e.g., interim or annual periods.
- Contractual restrictions on transfer of issued securities can be explicit or implicit. An implicit contractual restriction is presumed to exist when an institution is wholly owned by its parent holding company, as the holding company must approve the transfer of any of the institution’s outstanding securities.
- The PBE determination should be applied on an entity-by-entity basis, e.g., the parent holding company and the subsidiary bank may reach different conclusions as to whether it’s a PBE.
- The fact that an entity is subject to Section 36 of the Federal Deposit Insurance Act and Part 363 of the FDIC’s regulation, “Annual Independent Audits and Reporting Requirements” (Federal Deposit Insurance Corporation Improvement Act of 1991 requirements), does not in and of itself mean the entity is a PBE. The entity would need to evaluate each criterion in the definition of a PBE and should be evaluated on an entity-by-entity basis.
Below are other key takeaways from the new FAQs:
- Qualitative factors will still be relevant. While historical data will generally be an appropriate starting point for an assessment of expected credit losses, institutions should adjust historical loss information to reflect current conditions and “reasonable and supportable” forecasts not already reflected in the historical data. As such, the qualitative or environmental factors identified in the December 2006 Interagency Policy Statement on the Allowance for Loan and Lease Losses will continue to be relevant under CECL.
- Institutions should begin identifying currently available data to be maintained and start considering whether additional data may be relevant to estimating the lifetime expected credit losses that align with each method used to estimate their allowance for credit losses under CECL. An institution may apply different estimation methods to different pools; however, only one estimation method needs to be applied to each pool.
- The Agencies are encouraging institutions to discuss availability of historical loss data internally with lending, credit risk management, information technology and other internal functional areas, as well as their core loan service providers. Depending on the method or methods selected, institutions may need to capture additional data and retain data longer than they have in the past on loans and other financial assets that have been paid or charged off. See Question 22 of the FAQs for examples of other types of data that may be needed.
- Institutions should consider available information relevant to assessing the collectability of cash flows. This information could be internal, external or a combination and should be related to past events, current conditions and reasonable and supportable forecasts.
- The Agencies won’t require institutions to reconstruct data from previous periods that aren’t reasonably available without undue cost and effort; however, an institution may find it beneficial to do so to more effectively implement CECL. The institution should, however, begin to capture and maintain such data going forward.
- Under CECL, a collateral-dependent financial asset is defined as a “financial asset for which the repayment is expected to be provided substantially through the operation or sale of the collateral when the borrower is experiencing financial difficulty based on the entity’s assessment as of the reporting date.” The Agencies plan to continue requiring institutions to use the fair value of collateral to measure expected credit losses on collateral-dependent loans, but don’t plan to extend to other financial assets.
As with the original FAQs issued in December 2016, the Agencies continue to emphasize that CECL can be scalable to all institutions and community banks aren’t expected to adopt complex models to implement; however, it’s important to begin planning for the transition and implementation now. Institutions should be in the process of determining the method(s) to be used and collecting data required to implement each selected method.
For more comprehensive information on CECL and implementation, check out these articles:
Contact your trusted BKD advisor if you have questions.