SEC Bulletin Offers CECL Guidance

The SEC recently published Staff Accounting Bulletin 119 to provide guidance for CECL documentation expectations. Although the FASB delayed the CECL effective date for smaller reporting companies, private companies and not-for-profit entities to fiscal years beginning after December 15, 2022, planning ahead will be key to compliance.

Below are highlights from the Bulletin:
Q: What are some of the factors to consider when developing or performing an assessment of methodology for determining allowance for credit losses under GAAP?
A: Assessments of internal and third party methodologies should:
  • Incorporate management’s current judgments about credit losses expected from the existing loan portfolio, including reasonable and supportable forecasts about changes in credit quality on a disciplined and consistently-applied basis
  • Take into account the organization’s size, structure, access to information, business environment and strategy, management’s risk assessment, complexity of the loan portfolio, loan administration procedures and management information systems
Q: What internal accounting controls should be addressed in written policies and procedures?
A: Written policies and procedures should address:
  • Roles and responsibilities of lending, credit review, financial reporting, internal audit, senior management, audit committee, board of directors and others who determine or review this allowance to be reported in the financial statements
  • Methods and policies for developing the allowance and determining significant judgments
  • Description of the methodology, which should be consistent with accounting policies
  • How internal controls provides reasonable assurance that the allowance and financial statements are prepared in accordance with GAAP
  • Measures to provide reasonable assurance regarding reliability and integrity of information and compliance with laws, regulations, and internal policies and procedures
Q: What should be included in documentation of the methodology?
A: Refer to FRR 28. Documentation of the relationship between detailed analysis of the characteristics and portfolio credit quality and the amount of the allowance for credit losses reported in each period should include:
  • Policies and procedures over systems and controls that maintain an appropriate allowance
  • Methodology and key judgments, including data used, assessment of risk, identification of significant assumptions in the allowance estimation process, and validation of the methodology
  • Summary or consolidation of allowance balance
  • Periodic adjustments to the allowance
Q: What elements of the methodology should be described in written policies and procedures?
A: Written policies and procedures should include, at a minimum:
  • How portfolio segments are determined
  • Approach used to pool loans based on similar risk characteristics
  • Documentation of the elections made
  • Method(s) used to determine contractual term of financial assets, including consideration of prepayments and when contractual term is extended
  • If a loss-rate method is used, historical data used to develop components of the loss rate and how that rate is applied to the amortized cost basis of the financial asset as of the reporting date
  • Method for estimating expected recoveries when measuring allowance for credit losses
  • How the historical period for estimating expected credit loss statistics was determined
  • How historical information was adjusted for current conditions and reasonable and supportable forecasts
  • How the entity plans to revert to historical credit loss information for periods beyond which it is able to make or obtain reasonable and supportable forecasts of expected credit losses
  • How it was determined when purchased financial asset would qualify to be accounted for as a purchased financial asset with credit deterioration

Q: What documentation is required to support the allowance under the new lease accounting standard?
A: Regardless of the method used, documentation should show consideration of the underlying assumptions used to develop expected credit loss measurements, such as current conditions and reasonable and supportable forecasts and:
  • Show methods and assumptions are in accordance with GAAP as of financial statement date 
  • Include a process to evaluate whether adjustments to the methodology are necessary, due to changes in business strategy or market conditions, and, if so, support adjustments to the methodology
  • Support the conclusion that expected credit losses, measured on a collective (pool) basis when similar risk characteristic(s) exist, by showing that the loans in each pool have similar characteristics
  • Show relevance and reliability of external data, if used
Q: What summary documentation should be prepared to support financial statements?
A: Allowance for credit losses summaries should include:
  • Reasonable and supportable economic forecasts used
  • Estimate of expected credit losses
  • Summary of current allowance for credit losses balance and amount, if any, by which the allowance balance is to be adjusted
  • Detailed subschedules, depending on the level of detail that supports the analysis
Q: How should a bank validate its methodology to estimate allowance for credit losses?
A: Methodology is considered reasonable when it results in a valuation account that adjusts the net amount of the existing portfolio to cash flows expected to be collected. Procedures should allow management to determine whether there may be deficiencies in its overall methodology, including:
  • Review of how management’s prior assumptions, including expectations regarding loan delinquencies, troubled debt restructurings, write-offs, and recoveries, have compared to actual loan performance
  • Review of allowance process by an independent party, including source documents and underlying data and assumptions to determine that the established methodology develops reasonable loss estimates
  • Retrospective analysis of whether models used performed in a manner consistent with the intended purpose
  • Evaluation of appraisal process of the underlying collateral, when fair value of collateral is used, by periodically comparing the appraised value to the actual sales price on selected properties sold
Click here to read SEC Bulletin 119

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