cecl: if i knew then what i know now

Independent Bankers of Colorado Annual Convention – CommUNITY

September 16, 2021

CECL: If I Knew Then What I Know Now

© 2021 Crowe LLP 2

Crowe | CECL: If I Knew Then What I Know Now

Your Presenters

Sindy NicholsonPartner+1 303 831 5023 [email protected]

Kevin BrandSenior Manager+1 720 221 [email protected]

Agenda

1 Observations from the Adoption of CECL

2 FASB’s CECL Post Implementation Review

3 FRB’s SCALE

4 Mergers and Acquisitions

Observations From the Adoption of CECL

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CECL vs Incurred Allowance Trends for SEC Filers

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CECL vs Incurred Reserve Increases

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CECL Adoption: The Stats

# of CECL Banks @ 1/1/2020: 152# of CECL Banks @ 6/30/2021: 167

Average increase in ACL on Day 1: 27%

Range of Day 1 ACL Impact: -39% to +222%

*As of June 30, 2021Source: Earnings releases filed with the SEC

2%

53%

45%

AS OF JUNE 30, 2021 PERCENTAGE OF ISSUERS WHO:

Delayed

Are 2023 Adopters

Adopted CECL

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CECL Adoption Dates: Reminders

• Issuers Electing the CARES Act Deferral• Must adopt as of Jan. 1, 2022 (absent an early termination of the national

emergency)

• All Other Institutions• Must adopt at the beginning of fiscal years beginning after Dec. 15, 2022 (i.e.,

Jan. 1, 2023 for calendar year-end institutions)

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CECL Adoption Challenges Observed

Extreme economic circumstances challenged the effectiveness of many models built for CECL that were primarily driven by declines in home price index or changes in unemployment.

Effectiveness of models

In benign times, developing a forecast and understanding its interaction with the model may be the most difficult part of applying the standard.

The pandemic increased this challenge, especially in estimating the impacts of announced and potential fiscal stimulus and loan modification efforts.

Developing a reasonable and

supportable forecast

Economic forecasts changed significantly during the first quarter and into April 2020. Significant pressure was placed on banks to communicate which economic conditions were captured in their estimate and to provide expectations of how the changing economic environment may affect future results.

Rapidly changing economic conditions

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Advice From Banks Who Have Adopted CECL

Data quality (and warehousing) takes time and must be taken seriously.

Q-factors are still important. Identify what is missing/different from the base calc and avoid double counting.

More parallel runs are best.

Use stressed scenarios to determine calculation limits and develop contingency plans in advance.

Agility to support robust, on-demand analysis and sensitivity testing is invaluable.



Advice From Banks Who Have Adopted CECL

Document key decisions as youimplement – do not save the effort until the end

Don’t ignore unique pockets of theportfolio that might warrant additional segmentation or qualitative factors.

Remember off-balance-sheet credit exposures and held-to-maturity securities are also in scope

It is unlikely CECL is going away. FIs adopting in 2023 should not count on substantive changes to the standard.



Off-balance-sheet Credit Exposure

• Off-balance-sheet exposures that are not unconditionally cancellable require an estimate of expected credit losses over contractual period in which they are exposed to credit risk. • Should consider both the likelihood that funding will

occur and the amount expected to be funded over the estimated remaining life of the commitment.

• May be significant for portfolios such as construction and HELOCs, and caused a significant increase in total reserves at many adopters.

• Where to record the expense – provision expense or non-interest expense?

• No credit losses should be recognized for off-balance-sheet credit exposures that are unconditionally cancellable by issuer. Consider change in practice.

• Example: Bank A has a significant credit card portfolio, including funded balances on existing cards and unfunded commitments (i.e., available credit) on credit cards. Bank A's cardholder agreements stipulate that the available credit may be unconditionally cancelled at any time. When determining the allowance for expected credit losses, Bank A estimates the expected credit losses over the estimated remaining lives of the funded credit card loans. However, Bank A would not evaluate or record an allowance for unfunded commitments on credit cards because it has the ability to unconditionally cancel the available lines of credit.



Qualitative Factors

• Differentiating between qualitative and quantitative factors can be misleading when it comes to estimating a properly determined ACL. More constructive terms to differentiate the ACL components may be a baseline estimate and then adjustments to refine that estimate to arrive at management’s best estimate of expected credit losses.

• Those refinements may include quantitative analysis or expert judgment. The keys is to have a systematic approach to establishing qualitative factors that is supportable and repeatable and that uses available and relevant information.



Qualitative Factors – Best Practices

• Start with a baseline quantitative estimate• Consider utilizing multiple forecast scenarios to evaluate sensitivity to key assumptions over the

forecast period. If the bank has determined that the model underperforms in times of economic distress, consider incorporating a more severe forecast as part of the qualitative framework to address this model limitation.

• Reduce, or even eliminate, the use of arbitrary adjustment mechanisms that are difficult to defend or support. If used, these should likely be in place for a short time period and should generally not be material to the overall ACL estimate.

• Step through the qualitative factors listed in the standard (and SEC and FFIEC guidance) and evaluate which are sufficiently captured in the baseline model and which may be redundant. Clear documentation of how each are addressed without duplication is suggested.

• Management’s narrative supporting the ACL estimate should be clear, transparent and succinct, avoiding unnecessary documentation that distracts from the key narrative or that may give a reader a sense that there is double-counting or redundancy embedded in the framework.



Accounting and Regulatory Alignment

Assesses the ability of the CECL model to meet accounting and

regulatory needs and objectives.

CECL Transition Key Takeaways

Enabling TechnologyImplementing and fine-tuning the technology for data aggregation and running models takes a lot of time.

Data InventoryPain point for many adopters, and time consuming to identify and correct data issues

Resource CapabilitiesIt’s important to bring several groups together to accomplish this goal

Risk IdentificationRenewed importance with portfolio triage due to the economic environment and industries most heavily impacted. Don’t ignore unique pockets of portfolios that might warrant separate segmentation or other considerations

Accounting and Regulatory AlignmentSpend more time on documentation

in advance.

Governance and OversightUnderstanding the sensitivity of the models to certain inputs and assumptions is crucial, especially with new models and in a volatile environment. More parallel runs, sensitivity analysis, and stressed scenario runs are all important



Now 2 – Years Before Effective Year Before Effective

Risk Identification

Data Inventory

Resources

Enabling Tech

Gov & Oversight

Evaluate What Drives Credit Losses Scenario Modeling

Risk Factor Reassessment

Historical Data Collection

Resource Capability Continuous Assessment

Develop Plan to Fill Shortfalls

Data Aggregation and Management

Develop Roadmap

Educate Testing of ICoFR

Data Analysis

Create Teams

Identify Shortfalls

ICoFR Design

Determine Risk Profile

Create Supplemental Data

Risk Factor Reassessment

Data Collection (Years 2 and 3)

Modeling Approach

Model Development and Calibration

Develop and Finalize Policies

Model Validation

Develop FS Disclosures

Data Validation & Data Governance Revisit

What does a Roadmap look like?

2020 AICPA Conference on Credit Unions

Q&A Break



Regulator Guidance

• “Frequently Asked Questions (FAQs) on the New Accounting Standard on Financial Instruments – Credit Losses”• https://www.federalreserve.gov/supervisionreg/topics/faq-new-accounting-

standards-on-financial-instruments-credit-losses.htm• Allowances for Credit Losses: New Comptroller’s Handbook Booklet (April 15,

2021)• https://www.occ.gov/news-issuances/bulletins/2021/bulletin-2021-20.html

• BAAS – CECL Section (Topic 12)

https://www.federalreserve.gov/supervisionreg/topics/faq-new-accounting-standards-on-financial-instruments-credit-losses.htm

https://www.occ.gov/news-issuances/bulletins/2021/bulletin-2021-20.html



CAQ CECL Tool

• Preparing for the New Credit Losses Standard: A Tool for Audit Committees (May 2019)• Designed to help A/Cs exercise their oversight

responsibilities• Includes a CECL overview• Offers key questions and resources for A/Cs to consider

https://www.thecaq.org/wp-content/uploads/2019/05/caq_preparing_for_new_credit_losses_standard_2019-05.pdf

https://www.thecaq.org/wp-content/uploads/2019/05/caq_preparing_for_new_credit_losses_standard_2019-05.pdf

FASB’s CECL Post Implementation Review



FASB CECL Post-Implementation Review

Public Roundtable Meeting on Credit Losses - May 20, 2021• Topic 1: Summary of Feedback (outreach with 117

stakeholders)• Buy-side and sell-side analysts• Preparers (Financial institution who have and have not yet

adopted and non-FIs)• Academics• Federal financial institution regulators• Financial Accounting Standards Advisory Council (FASAC)



FASB CECL Post-Implementation ReviewPublic Roundtable Meeting on Credit Losses - May 20, 2021

• Topic 2: Purchased Financial Assets with Credit Deterioration (PCD) and Non-PCD:1.Discussion of PCD for all purchased loans2.Elimination of the PCD model, but perhaps add additional disclosures around acquired troubled

loans3.Pros/cons of PCD for all purchased loans

• Topic 3: Accounting for TDRs by Creditors:1.General support (outside of regulator concerns) to eliminate existing TDR measurement

guidance for entities who have adopted CECL and retention of modification related disclosures (i.e., identification)

2.Mixed feedback on how to account for modified loans (i.e., 10% test or principle-based framework for “loss mitigation” loans)

Next Steps (no tentative decisions made during the meeting)• Perform additional research and outreach on the accounting for non-PCD financial assets and

TDRs for consideration as part of future request activities.• Continue to monitor feedback related to the scope of financial assets included in ASU 2016-13.• Continue to monitor feedback on disclosures under ASU 2016-13.



PCD and non-PCD accounting• Illustrative example, loan purchased at discount:

Facts:Purchase Price $900,000 Par Amount $1,000,000Discount ($100,000) Stated Coupon 5.00% Purchase Yield 7.47% Remaining Term 5 years Initial ACL estimate $60,000



PCD and non-PCD accounting• Illustrative example, loan purchased at par:Facts:Purchase Price $1,000,000 Par Amount $1,000,000Stated Coupon 5.00% Remaining Term5 years Initial ACL estimate $60,000

*Under the gross-up approach, a premium is recorded (instead of a discount) for assets acquired at par or where the ACL estimate is greater than the discount.



Troubled Debt Restructurings (TDR) accounting• Some believe TDR accounting does not provide decision-useful information after

CECL adoption.• To address these concerns, stakeholders proposed eliminating TDR accounting.

Under the proposal: • Instead of evaluating modifications for TDRs, entities would determine if a

modification is a new loan or a continuation of the existing loan. •This may require applying the “10% test” (change in present value of cash flows) to determine if the modification is more-than-minor.

• If effect of a concession is not recognized in the ACL, entities must consider ASC 310-10 guidance that prohibits recognizing interest income if the net investment in a loan becomes greater than the payoff amount.

• Certain disclosures related to loan modifications would be retained.

Federal Reserve Bank’s SCALE



More information (including link to July 15 “Ask the Fed” webinar): https://www.supervisionoutreach.org/cecl

Scaled CECL Allowance for Losses Estimator (SCALE)

• Federal Reserve released a new community bank CECL implementation tool: Scaled CECL Allowance for Losses Estimator (SCALE) • Spreadsheet-based tool for banks with less than $1 billion in assets• Uses publicly available regulatory and industry data

https://www.supervisionoutreach.org/cecl

Mergers and Acquisitions



Overview: Acquired Loans Under CECL

• An allowance for expected credit losses (ACL) must be established for all acquired loans• Applies to loans acquired prior to CECL and loans acquired after CECL implementation• Applies to PCD and non-PCD loans• “Negative” ACL for recoverable amounts would not be allowable on Day 1 as recoverable

amounts included in the valuation account cannot exceed the aggregate of amounts previously written off by the entity

• Purchase accounting discounts cannot be used to reduce the amount of ACL established.• The SOP 03-3/PCI accounting model was eliminated by CECL. The ACL on acquired

loans will be calculated using the same methodology that is used for originated loans… although the offset to the ACL entry will depend on whether the loan is PCD or not-PCD.



Overview: Acquired Unfunded Commitments & CECL

• An allowance for acquired unfunded commitments (UFC) will need to be established on day 1 through provision expense.

• Because the UFC is not a “financial asset” it cannot be within the scope of the PCD guidance.

• UFC should be measured at fair value at the date of acquisition. Fair value of the liability will be accreted into interest income over the remaining life of the commitment.

• UFC ACL should be recorded through provision expense at the date of acquisition; there is no mechanism that would allow the liability to offset the needed ACL.

• Can feel more impactful in a transaction with an institution that has not yet adopted CECL and thus has a $0 ACL for UFC recorded (or perhaps only a minimal one recorded under an ASC 450/460 approach).



CECL Impact – Mergers and Acquisitions

• For CECL adopters acquiring non-CECL adopters, consider• Data available for consolidation• Pro-forma adjustments • Footnote requirements• PCD determination and subsequent measurement



PCD Defined

• Purchased financial assets with credit deterioration (PCD) are… • Acquired individual financial assets (or acquired groups of financial assets with similar risk

characteristics) that, as of the date of acquisition, have experienced a more-than-insignificant deterioration in credit quality since origination, as determined by an acquirer’s assessment.

• Key judgments management must make are underlined

• ASC 326-20-55-59 includes the following examples* of characteristics that may indicate a more-than insignificant deterioration in credit quality since origination:• Delinquent as of the acquisition date • Downgraded since origination • Placed on nonaccrual status • Credit spreads after origination have widened beyond the threshold specified in the institution’s loan policy

* These examples represent only a few of the possible characteristics that may indicate more-than insignificant deterioration in credit quality since origination.



More on PCD Loans

• ACL on PCD assets are recorded as a component of the business combination or asset acquisition

• There are no ongoing disclosure requirements specific to acquired loans (e.g., no requirement to separately disclose level of and ACL on PCD or non-PCD loans)

• The ACL measurement method is the same for acquired and non-acquired loans, after acquisition may pool these loans together with originated loans to calculate the ACL

• FASB has received feedback from investors that they were unable to compare how companies determined (i.e., identification) which loans are classified as PCD versus non-PCD based on disclosures that have been provided



Selected 2020 M&A Transactions

TransactionNon-PCD FV Mark

Non-PCD ACL

PCD ACL PCD% of Loans

Non-PCD + OBS ACL

A -2.18% 1.50% 4.90% 18% 1.67%

B -1.00% 1.08% 4.87% 31% 1.18%

C -0.74% 1.06% 4.30% 21% 1.06%

D 0.16% 3.06% 3.63% 41% 3.67%

E -2.15% 0.82% 3.94% 24% 0.90%

Average -1.18% 1.51% 4.33% 27% 1.57%

Q&A Session

Sindy NicholsonPartner+1 303 831 5023 [email protected]

“Crowe” is the brand name under which the member firms of Crowe Global operate and provide professional services, and those firms together form the Crowe Global network of independent audit, tax, and consulting firms. Crowe may be used to refer to individual firms, to several such firms, or to all firms within the Crowe Global network. The Crowe Horwath Global Risk Consulting entities, Crowe Healthcare Risk Consulting LLC, and our affiliate in Grand Cayman are subsidiaries of Crowe LLP. Crowe LLP is an Indiana limited liability partnership and the U.S member firm of Crowe Global. Services to clients are provided by the individual member firms of Crowe Global, but Crowe Global itself is a Swiss entity that does not provide services to clients. Each member firm is a separate legal entity responsible only for its own acts and omissions and not those of any other Crowe Global network firm or other party. Visit www.crowe.com/disclosure for more information about Crowe LLP, its subsidiaries, and Crowe Global. The information in this document is not – and is not intended to be – audit, tax, accounting, advisory, risk, performance, consulting, business, financial, investment, legal, or other professional advice. Some firm services may not be available to attest clients. The information is general in nature, based on existing authorities, and is subject to change. The information is not a substitute for professional advice or services, and you should consult a qualified professional adviser before taking any action based on the information. Crowe is not responsible for any loss incurred by any person who relies on the information discussed in this document. Visit www.crowe.com/disclosure for more information about Crowe LLP, its subsidiaries, and Crowe Global. © 2021 Crowe LLP.

Thank You

Kevin BrandSenior Manager+1 720 221 [email protected]

“Crowe” is the brand name under which the member firms of Crowe Global operate and provide professional services, and those firms together form the Crowe Global network of independent audit, tax, and consulting firms. Crowe may be used to refer to individual firms, to several such firms, or to all firms within the Crowe Global network. The Crowe Horwath Global Risk Consulting entities, Crowe Healthcare Risk Consulting LLC, and our affiliate in Grand Cayman are subsidiaries of Crowe LLP. Crowe LLP is an Indiana limited liability partnership and the U.S member firm of Crowe Global. Services to clients are provided by the individual member firms of Crowe Global, but Crowe Global itself is a Swiss entity that does not provide services to clients. Each member firm is a separate legal entity responsible only for its own acts and omissions and not those of any other Crowe Global network firm or other party. Visit www.crowe.com/disclosure for more information about Crowe LLP, its subsidiaries, and Crowe Global. The information in this document is not – and is not intended to be – audit, tax, accounting, advisory, risk, performance, consulting, business, financial, investment, legal, or other professional advice. Some firm services may not be available to attest clients. The information is general in nature, based on existing authorities and is subject to change. The information is not a substitute for professional advice or services, and you should consult a qualified professional adviser before taking any action based on the information. Crowe is not responsible for any loss incurred by any person who relies on the information discussed in this document. Visit www.crowe.com/disclosure for more information about Crowe LLP, its subsidiaries, and Crowe Global. © 2021 Crowe LLP.

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