roadmap to the future: fact vs fiction

Copyright 2019 by Financial Accounting Foundation, Norwalk CT. For non-commercial, educational/academic purposes only.

Roadmap to the Future:Fact vs Fiction(On CECL, SOFR & Other FASB Standards)

Hal Schroeder

FASB Member

September 11, 2019

Investor Briefing

Barclays Global Financial Services Conference

The views expressed in this presentation are those of the presenter. Official positions

of the FASB are reached only after extensive due process and deliberations.


2

Recent . . . Stop & Study?


3

Recent . . . Effective Dates

Still

2020

Now 2023

(?)


Price-to-Book Non-financials

Recent . . . Investors Estimate, Again?

4

Price-to-Book Financials

Price-to-Book Difference

Devaluationof US

commercial banks

begins mid-year 2006

Year

Before

Financial

Crisis

2004 to 2006

Significant Increase in Credit Risk


❑ Better Data

✓ Quality and Quantity

• Consistency for multiple uses

• Technology improvements help

❑ Better Internal Controls

✓ Consistency over time

✓ Compliance with Sarbanes Oxley

❑ Better Estimation Processes

✓ Have been improving over time

• Improvements expected to continue

• Technology improvements help

❑ Better Internal Communication /

Coordination

✓ Between modelers, financial reporting, risk

managers, treasury, senior management

5

Recent . . . Benefits Justify Costs?W

hat

we’r

e h

eari

ng

. .

.

❑ Better Risk

Management

❑ Better Pricing

❑ Better Capital

Allocation

❑ Better Credit

Decisions

Resu

ltin

g i

n .

. .

❑ Clean up data

❑ Time to develop

better internal

controls &

estimation

processesC

osts

. .

.

Taking a Business vs Compliance Approach?


“[Bank’s CFO] says CECL implementation showed him the gaps and

limitations within [its] analytics”

6

Recent . . . Benefits Justify Costs?W

hat

we’r

e h

eari

ng

. .

.

“[CFOs] believe there are ways they

can leverage their respective CECL

processes to better serve

customers and ultimately reward

shareholders. Those benefits range

from better data to stronger controls

to potentially improved profitability.”

Resu

ltin

g i

n .

. .

“Many banks have mounds of

historical loss information that could

be useful but will require scrubbing,

vetting and backfilling.”

Co

sts

. .

.

Taking a Business vs Compliance Approach?

“Executives are rightly concerned about the time and expenses . . . But CECL

implementation allows banks an unusual opportunity to make significant

improvements to their data, internal controls, analytics and modeling.”

“many community banks have adequate systems in place but . . . the

programs and their data are siloed from each other.”

“these bankers take the approach that, ‘If we’re going to do it, we’re going to fix

this issue that we’ve been dealing with for years through workarounds. We’re

going to do this right.’”

Source: How CECL Can Make Your Bank Better

By: Kiah Lau Haslett, managing editor for Bank Director, July 17, 2019

“A lifetime allowance hinges on lifetime loss information; using their own data

can help a bank save on expenses and potentially provide a more accurate

figure, compared to buying the data externally.”

“[CFO] expects that efficiency

gains will free up credit and finance

employees for other responsibilities.”

“A more controlled, automated process could also strengthen internal controls

and a bank’s governance process”

“[CFO says bank will] do a deeper

dive into our various asset

categories . . . help us shape

decisions about what type of

lending we want to do”

“When employees see the CECL taskforce—the chief credit officer, the CFO

and the chief risk officer attending all these meetings [sets] the tone at the top for

the rest [of the employees] to say, ‘Okay, this really is something that we need

to pay close attention to’ [CFO] says.”


0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Allowance as % of Gross LoansNBER Recessions in Gray

alll_incurred (actual) acl_cecl_(estimate)

Debate . . . Pro- vs Counter-cyclical?

7

Rises 29%from beginning of

recession to reach peak

Peaks in 1Q2009 5 quarters after

recession begins

Source: Analysis based on quarterly Federal Reserve Bank Y9C data.

Peaks in 1Q2010 9 quarters after

recession begins

Rises 264%from beginning of

recession to reach peak


0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Provision Expense as % of Gross LoansNBER Recessions in Gray

provisions_incurred (actual) provisions_CECL (estimate)

8

Year before Recession

Source: Analysis based on quarterly Federal Reserve Bank Y9C data.

Timing

Quar

ters

Average

Incurred

Average

CECL

Incurred vs

CECL

Higher Risk

(2004 to 2006) 12 0.14% 0.26% -0.12%

Year before Recession

(2007) 4 0.29% 0.56% -0.27%

Recession

(2008 to 1H2009)

%Change from

2004 to 2006

60.80%

+470%

0.68%

+163%

+0.12%

Post-Recession

(2H2009 to 2010)

%Change from

2004 to 2006

6

0.72%

+415%

0.41%

+59%

+0.31%

Normalized Risk

(2011 to 2013) 12 0.21% 0.22% -0.01%

Full Cycle

(2003 to 2013) 40 0.36% 0.36% 0.00%

Recession Post-Recession

Higher Risk

Normalized Risk

Debate . . . Pro- vs Counter-cyclical?


Term Loans

Amortized Cost Basis by Origination Year

As of December 31, 20X5 20X4 20X3 20X2 20X1 Prior

Revolving

Loans Total

Residential Mortgage:

Risk Rating:

1 – 2 internal grade 8,313 7,784 5,925 3,853 5,573 1,291 1,875 34,614

3 – 4 internal grade 5,542 5,190 3,950 2,568 3,716 860 1,250 23,076

5 internal grade 12,673 9,117 6,939 4,512 6,528 1,512 2,196 43,477

6 internal grade 695 500 381 248 358 83 120 2,385

7 internal grade 86 62 47 31 44 10 14 294

Total residential mortgage

loans 27,309 22,653 17,242 11,212 16,219 3,756 5,455 103,846

Residential Mortgage loans:

Current-period gross writeoffs 29 21 16 10 15 14 5 110

Current-period recoveries - - 2 5 2 1 1 11

Current-period net writeoffs 29 21 14 5 13 13 4 99

Term Loans

As of December 31, 20X5 20X4

Residential Mortgage:

Risk Rating:

1 – 2 internal grade 34,614 37,122

3 – 4 internal grade 23,076 24,748

5 internal grade 43,477 44,651

6 internal grade 2,385 2,636

7 internal grade 294 708

Total residential mortgage loans 103,846 109,865

Residential Mortgage loans:

Current-period gross writeoffs 110 220

Current-period recoveries 11 8

Current-period net writeoffs 99 212

Debates . . . Enhances Transparency?

Current GAAP Future GAAP

Will expanded data set provide better understanding of . . .

1. migration within vintages?

2. changes from historical trends?

3. changes in estimates?

9

?


-5.0%

-2.5%

0.0%

2.5%

5.0%

7.5%

10.0%

12.5%

-$50

-$25

$0

$25

$50

$75

$100

$125

2000Y 2001Y 2002Y 2003Y 2004Y 2005Y 2006Y 2007Y 2008Y 2009Y 2010Y 2011Y 2012Y 2013Y 2014Y 2015Y 2016Y 2017Y 2018Y

U.S. Commercial Banks

$ Buybacks vs % Loan Growth$ in billions

Loan Growth % yoy $ Annual Buybacks for 30 Largest Banks (L)

10

Debates . . . Less Loans or Buybacks?

Post-Recession

Less loan growth, more stock buybacks

Pre-Recession

More loan growth, less stock buybacks

Source: Analysis based on loan data for all FDIC-insured commercial banks and buyback data provided by KBW.


“Probable” Threshold

Debates . . . Comparability?

11

Contractual +

Renewals

Day

1

Co

ntr

actu

al

Life

When?

How

much?

CECL

12

months

Allowance by Period

Current


12

Reference Rate Reform . . . It’s Coming!

“The major Wall Street banks—

not to mention insurers, money

managers, law firms and

advisory business—are all

mobilizing employees around

the globe in anticipation of

Libor’s demise.”

Source: Wall Street Prepares for the End of a

Crucial Benchmark, Bloomberg, August 27, 2019


Phase 1(complete)

13

2018 2019 2020 2021

ARRC

recommended

Secured

Overnight

Financing Rate

(SOFR) to replace

USD LIBOR

Board

deliberationsAdded SOFR as a

permissible

benchmark interest

rate for hedge

accounting

Added a project on

IBOR transition issues

International Swaps and

Derivatives Association

(ISDA) to release final

amendments to the 2006

ISDA Definitions and

protocol

ARRC recommending

LIBOR fallback language

for cash instruments

LIBOR contract

modifications

expected

Continue to

monitor IBOR

transition and take

additional action

as necessary

2014

Alternative

Reference Rates

Committee (ARRC)

convened to

identify USD

LIBOR alternative

The Fed requested

the rate chosen by

ARRC to be eligible

for hedge

accounting

Potential

LIBOR

cessation

date

Evaluate

feedback on

proposal and

issue a final

accounting

standard

2017

New York Fed

began publishing

SOFR

Added a

separate

project on

SOFR

Considered the

Fed’s request as

part of the hedging

project (completed

in 2017)

F

A

S

B

M

A

R

K

E

T

Current Status:

Issue proposal for

public comment

(“Exposure Draft”)

in September

Phase 2(current phase)

Reference Rate Reform . . . Moving in Tandem with Market


OR

14

Financial Assets &

Liabilities referencing an

IBOR

Interest Rate Derivatives

referencing an IBOR

Leases & other contracts

referencing an IBOR

No contract modification

IBOR → existing fallback waterfall rate

(e.g., Prime, fixed at last available IBOR)

Modify contract to replace

(a) stated rate or (b) fallback rate

IBOR→ SOFR, Prime, other

CURRENT

EXPOSURES

CHANGES IN

FUTURE CASH FLOWS

ISDA revising its protocol

(USD LIBOR → overnight SOFR)

FINANCIAL STATEMENT

IMPACTS

New yield going forward

(no gain/loss)

Minor modification:

New yield going forward

(no gain/loss)

Derivatives continue to be

carried at fair value

Substantive modification

(financial assets/liabilities):

• Gain/loss for difference

between carrying amount &

new fair value

• New yield going forward

Interest rate

hedge relationshipAdjust hedge

parameters

OR

“VALUE TRANSFER”

UPON MODIFICATION and OVER TIME:

• Future cash flow changes due to change in reference index &

spread

• For balances carried at fair value, expectations of new yield will

likely be reflected in the valuation prior to flipping to the new rate

Reference Rate Reform . . . Quantifying & Assessing


❑July 17 Board meeting:

➢ Hedge accounting

• Change in critical terms

• Cash flow hedge effectiveness

• Fair value hedge effectiveness

➢ Disclosures

➢ Transition

➢ Relief period

❑Fall 2019: Issue Exposure Draft

15

Reference Rate Reform . . . Recent Developments & Path Forward


For Questions & Comments . . . Investor Liaison

Chandy Smith

FASB Investor Liaison

[email protected]

16

roadmap to the future: fact vs fiction

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